Commissioner Of Income Tax v. The Atul Products Ltd

O/SUTR/2/1993 JUDGMENT IN THE HIGH COURT OF GUJARAT AT AHMEDABAD SUR TAX REFERENCE NO. 2 of 1993 FOR APPROVAL AND SIGNATURE: HONOURABLE MR.JUSTICE M.R. SHAHand HONOURABLE MR.JUSTICE K.J. THAKER ====================================== 1 Whether Reporters of Local Papers may be allowed to see the judgment ?see the judgment ? 2 To be referred to the Reporter or not ? 3 Whether their Lordships wish to see the fair copy of the judgment ?judgment ? 4 Whether this case involves a substantial question of law as to the interpretation of the Constitution of India, 1950 or any order made thereunder ?law as to the interpretation of the Constitution of India, 1950 or any order made thereunder ? 5 Whether it is to be circulated to the civil judge ? ======================================COMMISSIONER OF INCOME TAX....Applicant(s) Versus THE ATUL PRODUCTS LTD.....Respondent(s) ====================================== Appearance: MR MANISH BHATT, ADVOCATE for the Applicant(s) No. 1MR JP SHAH, ADVOCATE for the Respondent(s) No. 1====================================== CORAM: HONOURABLE MR.JUSTICE M.R. SHAHandHONOURABLE MR.JUSTICE K.J. THAKER Date : 01/07/2014 ORAL JUDGMENT (PER : HONOURABLE MR.JUSTICE M.R. SHAH) 1.The present Reference, at the instance of the revenue, is made by the Income Tax Appellate Tribunal in compliance with this Court’s order under Section 256(2) of the Income Tax Act for its opinion on the following substantial question of law; “Whether, the appellate tribunal has erred in law and on facts in holding that the debenture redemption reserve of Rs.33,22,855/- which in fact is a reserve forming part of the capital employed?” 2.The facts leading to the present Reference in a nutshell are as under; 2.1.The respondent-assessee filed the return of income on 26/08/1976declaringthechargeableprofitsat Rs.1,17,34,811/-. The notice under Section 7(2) of the Companies (Profit) Sur Tax Act, 1964 (hereinafter referred to as ‘the Act’) was issued to the assessee proposing the computation of net chargeable profits at Rs.1,49,96,631/-. The assessee submitted its objections and after considering the same, the Income Tax Officer completed the provisional assessment under Section 7(2) of the Act computing the net chargeable profit at Rs.1,49,96,631/-. Later on the Income Tax Officer modified the provisional order dated 24/09/1976 under Section 13 of the Act to adopt the net chargeable profit as per return. The aforesaid was without prejudice to the rights of the Department to make interpretation of the Sur Tax Act and Rule thereon while completing the regular assessment and as such the assessee agreed not to take support of the order under Section 13 of the Act. It appears that the assessee created the Debenture Redemption Reserve of Rs.44,22,855/-and the assessee treated the same as capital. While framing the regular assessment, the Income Tax Officer negatived the claim of the assessee to treat the said Debenture Redemption Reserve as a liability or a reserve by observing that the aforesaid amount of Debate Redemption Reserve, which was set apart was to meet the known liability in future and the same was not available for future use for business of the Company. Consequently, the Income Tax Officer did not consider the aforesaid amount of Rs.44,22,855/-, which was kept as Debenture Redemption Reserve, as reserve under Clause I (iii) of the Second Schedule. That on appeal by the assessee, the Commissioner of Income Tax (Appeals) held the aforesaid amount of Rs.44,22,855/- as reserve following his order for the Assessment Years 1979-80 and 1980-81 and on appeal by the revenue, the tribunal has confirmed the order of the Commissioner of Income Tax (Appeals). Thereafter, at the instance of the revenue and pursuant to the order passed by this Court, the tribunal has referred the aforesaid question to this Court for its opinion. 3.Shri Manish Bhatt, learned Counsel appearing on behalf of the revenue has vehemently submitted that both the Commissioner of Income Tax (Appeals) as well as the tribunal have materially erred in treating the Debenture Redemption Reserve of Rs.44,22,855/- as reserve and/or part of capital. It is submitted that as such the aforesaid issue/question is now not res integra in view of the decision of the Hon’ble Supreme Court in the case of National Rayon Corporation Ltd. Vs. Commissioner of Income Tax reported in (1997) 227 ITR 765 as well as another decision of Hon’ble Supreme Court in the case of Commissioner of Income Tax Vs. Travancore Titanium Products Ltd. reported in (2001) 247 ITR 186. It is submitted that as such in view of the aforesaid two decisions of Hon’ble the Supreme Court, the decision in the case of Nutan Mills Ltd, which has been relied upon by the Commissioner of Income Tax as well as tribunal is no longer a good law. It is further submitted by Shri Bhatt, learned Counsel appearing on behalf of the revenue that in view of the aforesaid two decisions of the Hon’ble Supreme Court the view taken by the Commissioner of Income Tax (Appeals) confirmed by the tribunal treating the Debenture Redemption Reserve of Rs.44,22,855/- as reserve and/or part of capital cannot be sustained and, therefore, it is requested to answer the question in favour of the revenue. 4.Shri J.P. Shah, learned Counsel has appeared on behalf of the assessee. He has fairly conceded that as such the issue referred to this Court would be covered by the decision of the Hon’ble Supreme Court in the case of National Rayon Corporation Ltd. (Supra), however, has submitted that considering the decision of the Hon’ble Supreme Court in the case of National Rayon Corporation Ltd. (Supra) only that amount, which is kept in reserve to the extent of liability, is not to be treated as reserve and any amount beyond the liability is required to be treated as part of reserve. It is submitted that in the present case as such factually nothing is on record that the Debenture Redemption Reserve was towards future liability and/or the same was much more than the actual liability. It is submitted that as such as the tribunal considered the orders in favour of the assessee in the previous years and when the Commissioner of Income Tax (Appeals) granted full benefit to the assessee there was no occasion for the assessee to provide for the same. It is therefore requested to remand the matter to the Income Tax Officer or to the tribunal. No other submissions have been made. benefit to the assessee there was no occasion for the assessee to provide for the same. It is therefore requested to remand the matter to the Income Tax Officer or to the tribunal. No other submissions have been made. 5.We have heard Shri Bhatt, learned Counsel appearing on behalf of the revenue and Shri J.P. Shah, learned Counsel appearing on behalf of the assessee. The question, which is referred to this Court by the tribunal is, whether the tribunal has erred in law and on facts in holding the Debenture Redemption Reserve of Rs.44,22,855/- as reserve forming part of capital employed? It was the contention on behalf of the assessee that the Debenture Redemption Reserve of Rs.44,22,855/- was required to be treated as reserve and/or part of capital. However, it was specifically found by the Income Tax Officer that the aforesaid amount of Rs.44,22,855/- was set apart to meet the known liability in future and the same was not liable for future business of the Company. In view of the aforesaid finding recorded by the Income Tax Officer, the question, which is referred to this Court, is required to be considered. Thus, as such, the aforesaid amount of Rs.44,22,855/-/- was kept as Debenture Redemption Reserve for future liability, which could not have been used by the Company in the business. In the case of National Rayon Corporation Ltd. (Supra) while considering the very provisions under the Act and the very issue it is held that the Debenture Redemption Reserve cannot be treated as reserve and is not includible in capital. While holding so, the Hon’ble Supreme Court has observed and held as under; “The expressions “provision” and “reserve” have not been defined under the Companies (Profits) Surtax Act, 1964. Therefore, the two concepts “reserve” and “provision” which are fairly well known in commercial accountancy and which are used under the Companies Act dealing with preparation of balance-sheet and profit and loss accounts, have to be gathered from the meanings attached to them by the Companies Act itself. “Provision” and “reserve” have been defined in Part III of Schedule VI to the Companies Act, 1956. The definition clearly indicates that if an amount is retained by way of providing for any known liability that amount shall not be treated as reserve. Clause 7(2)(b) makes it clear that only an amount which is in excess of what is reasonably necessary for meeting a known liability shall be treated as reserve and not as provision. The directors will have to form an opinion as to what is reasonably necessary for meeting the known liability of a company. The opinion of an accountant or an auditor or a lawyer is quite immaterial for this purpose. The liability to repay arises the moment money is borrowed. The amount borrowed may be repayable immediately or in future. The date of repayment of loan may be deferred by agreement but the obligation or the liability to repay will not cease on that account. By issuing debentures a company takes a loan against the security of its assets. This loan may not be repayable in the year of account. But the obligation to pay the loan is a present obligation. Any money set apart in the accounts of the company to redeem the debentures must be treated as money set apart to meet a known liability. The debentures will have to be shown in the company’s balance sheet of the year as “liability”. Merely because debentures are not redeemable during the accounting period, the liability to redeem the debentures does not cease to exist. It is redeemable on repayable at a future date. By issuing debentures a company takes a loan against the security of its assets. This loan may not be repayable in the year of account. But the obligation to pay the loan is a present obligation. Any money set apart in the accounts of the company to redeem the debentures must be treated as money set apart to meet a known liability. The debentures will have to be shown in the company’s balance sheet of the year as “liability”. Merely because debentures are not redeemable during the accounting period, the liability to redeem the debentures does not cease to exist. It is redeemable on repayable at a future date. There is another aspect of this case. In the prescribed form of balance-sheet, under the heading “Reserves and Surpluses” seven types of reserves have to be shown: (1) Capital reserves (2) Capital redemption reserve, (3) Share premium account, (4) Other reserves, (5) Surplus i.e., balance in profit and loss account, (6) Proposed additions to reserves, (7) Sinking funds. However, for the purpose of computation of capital of a company under Rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 items 5, 6 and 7 will not be treated as reserves. A sinking fund created for redemption of debentures will not be treated as reserve even though (1) it has to be shown as “reserve” in the balance sheet and (2) the amount kept in this fund is in the nature of allocation of profits and not a charge against them. In the context of this Rule in the Second Schedule to the Surtax Act, a debenture redemption reserve cannot be treated as “reserve” on the ground that the amounts set apart for redemption of debentures are not in the nature of a charge against profits but merely appropriation of profit. What has to be computed under rule 1 of the Second Schedule to the Surtax Act is the capital of the company and not its working capital. The amount shown as sinking fund maybe invested in a fruitful way so that the principal and gains from the investments taken together will enable the company to pay off its debts. Investment of monies standing to the credit of the sinking fund is nothing but utilisation of the company’s assets for the discharge of its liabilities. There is no reason why a sinking fund for redemption of debentures should not be a reserve but a debenture redemption reserve created with the same purpose should be treated as reserve and included in the computation of capital of the company for surtax purpose. A construction which leads to absurdity should be avoided. The basis principle is that any amount retained by way of providing for a known liability will not be “reserve”. Explanation to Rule 1 of the Second Schedule to the Surtax Act takes this principles to its logical conclusion by providing that even a sinking fund, which has to be shown as a reserve in the prescribed form of balance-sheet will not be treated as “reserve” for the purpose of computation of capital. Moreover, the surplus and unallocated balance in the profit and loss account has been specifically excluded from “reserves” for computation of capital under the Surtax Act. Therefore, availability of the amount for utilisation as working capital of the company or for distribution of dividend cannot be a criterion for deciding whether a particular amount retained from the profits of the company will be treated as its reserve or not.” 5.1.Similar view has been expressed by Hon’ble the Supreme Court in the case of Travancore Titanium Products Ltd. (Supra). In the said decision it is held that Debenture Redemption Reserve amount, which is set apart to meet the liability, is not includible in capital. 5.1.Similar view has been expressed by Hon’ble the Supreme Court in the case of Travancore Titanium Products Ltd. (Supra). In the said decision it is held that Debenture Redemption Reserve amount, which is set apart to meet the liability, is not includible in capital. 5.2.In view of the aforesaid two decisions, the view taken by the tribunal and the Commissioner of Income Tax (Appeals) to treat the Debenture Redemption Reserve of Rs.44,22,855/- as reserve and part of capital cannot be sustained. The tribunal has heavily relied upon the decision in the case of Nutan Mills Ltd., however, in view of the aforesaid two decisions of the Hon’ble Supreme Court, the decision in the case of Nutan Mills Ltd. is no longer a good law. 6.Under the circumstances, as such, the question, which is referred to this Court, is required to be answered in favour of the revenue and against the assessee. Now so far as the request made by Shri J.P. Shah, learned Counsel appearing on behalf of the assessee to remand the matter to the Income Tax Officer is concerned, as nothing is on record whether the Debenture Redemption Reserve of Rs.44,22,855/- was in excess of actual Debenture Redemption Reserve liability or not is concerned, in the facts and circumstances of the case, the same cannot be accepted. As observed hereinabove, the Income Tax Officer has specifically given the finding and has observed that the aforesaid Debenture Redemption Reserve of Rs.44,22,855/- was set apart to meet the known liability in future and the same was not available for future use in business of the Company. In view of the aforesaid clear cut finding, no fruitful purpose would be served to remand the matter to the Income Tax Officer once it is found that the aforesaid Debenture Redemption Reserve of Rs.44,22,855/- was for a future liability and in view of the aforesaid two decisions of the Hon’ble Supreme Court, the same cannot be treated as reserve and/or part of capital. Under the circumstances, the request made by Shri Shah, learned advocate appearing on behalf of the assessee to remand the matter to the Income Tax Officer is hereby rejected. 7.In view of the above and for the reasons stated hereinabove, the question referred to this Court is answered in favour of the revenue and against the assessee. With this, the present Reference is disposed of. (M.R. SHAH, J.) (K.J. THAKER, J.) Siji