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Recovery of Tax
November, 13th 2007

First Schedule

Insurance business

Expenditure - Rule 5(a)

Provision for taxation is neither an `expenditure' nor an `allowance' - Oriental Fire & General Insurance Co. Ltd. v. CIT [2004] 140 Taxman 446 (Delhi).

Second Schedule

Collection & recovery of tax - Procedure for recovery of tax

Possessed - Rule 11(3)

The use of the word `possessed' does not mean mere possession and would not in any case include possession for or on behalf of the defaulter. This rule is a part of the scheme given under rule 11 of the Second Schedule and hence, the word `possession' has to be appreciated in the context not only of the claim or objection preferred or made under sub-rule (3), but also of the aforesaid right of the Tax Recovery Officer to investigate under sub-rule (4). Sub-rule (4) requires the Tax Recovery Officer to be satisfied that the property was not in the possession of the defaulter or of some person in trust for him or in the occupancy of a tenant or other person paying rent to him or that, being in the possession of the defaulter at the said date, it was so in his possession not on his own account or as his own property, but on account of or in trust for some other person, or partly on his own account and partly on
account of some other person. This would, therefore, clarify that the word `possession' used in sub-rule (3) has to be `possession of the claimant or objector in his own right and not in trust for or on behalf of the defaulter' - George Thomas v. TRO [1995] 214 ITR 168 (Mad.).

Otherwise deal with any property - Rule 16(1)

The words, `otherwise deal with any property' convey a wider meaning. The word `otherwise' itself indicates a situation which is dissimilar to the situation reflected in the words preceding it.
Similarly, the words `dealing with' any property convey a variety of transactions touching on the property in question - D.V. Satyanarayana v. TRO [1992] 197 ITR 407 (Kar.).

Fourth Schedule

Recognised provident funds

Salary - Rule 2(h), Part A

The expression `salary' has been defined in section 17 as well as in rule 2(h) of Part A of the Fourth Schedule but each of the said definitions serves a different purpose - Gestetner Duplicators (P.) Ltd. v. CIT [1979] 117 ITR 1 (SC).

Service has been terminated - Rule 8(ii) of Part A

The words `service has been terminated' in clause (ii) of rule 8 of Part A of the Fourth schedule also cover the case of termination of service by resignation by an employee - G.S. Ratra v. CIT [1986]
161 ITR 251 (Raj.).

Building - Rule 68 of the Income-tax Rules, 1962

The word `building' or `flat' has not been defined in the Income-tax Rules. The meaning which is given in the common parlance has to be ascertained. With the growth of civilization and more
particularly in recent years in the cities instead of constructing an independent building to be used as a house the concept of multistoreyed flats has developed. The structure intended for human habitation having its place and intended for the occupation of a family has been defined as a `house'. This purpose is achieved by an independent house as well as a flat. The vertical growth leads to multistoreyed construction of buildings where independent flats are constructed for human habitation. It may be one flat or one storey or number of flats in a storey. Flat could be covered by the word `house' - Karnataka Bank Employees' Association v. CIT [1998] 233 ITR 628 (Kar.).

Eleventh Schedule

List of articles or things

Domestic - Item 12

In order to qualify to be a domestic electrical appliance, an appliance should satisfy the condition that it should be used exclusively as a domestic appliance. The meaning of `domestic' as given in the Chambers Dictionary (New Edition) reads as follows: "belonging or relating to the home or family, remaining much at house, enjoying or accustomed to being at home..." The
meaning of the expression `domestic' makes it clear that it should be confined to home only. Therefore, the intention of the Legislature in using the expression `domestic electrical appliance' appears to confine the Explanation only to those electrical appliances which are exclusively used for domestic purposes and used for similar purposes in the places enumerated in the said Explanation - CIT v. Andhra Pradesh Lightings Ltd. [2000] 109 Taxman
337/244 ITR 650 (AP).

Reserve vs. Provision

A reserve is a stand-by created out of profits of a business to meet contingencies which are unknown and which cannot be foretold on the basis of knowledge of current facts. It is created by way of appropriation of profits. It is not a charge against profits. Since it is an appropriation, it does not go out of the business but is retained in the business as a part of the capital. But a provision is a charge against profits. It is created to meet liabilities, which are known and foreseeable but whose exact timing, and hence whose quantification alone, is uncertain at the moment. Though the expression `reserve' is not defined in the Act, it cannot be forgotten that it occurs in a taxing statute which is applicable to companies only and to no other assessable entities and as such the expression will have to be understood in its ordinary popular sense, that is to say, the sense or meaning that is attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the meanings attached to these two words in the provisions of the Companies Act, 1956, dealing with preparation of balance sheet and profit and loss account would govern their construction for the purposes of the two taxing enactments. Though the term `provision' is defined positively by specifying what it means, the definition of `reserve' is negative in form and not exhaustive in the sense that it only specifies certain amounts which are not to be included in the term `reserve'. In other words, the effect of reading the two definitions together is that if
any retention or appropriation of a sum falls within the definition of `provision' it can never be a reserve but it does not follow that if the retention or appropriation is not a provision it is
automatically a reserve and the question will have to be decided having regard to the true nature and character of the sum so retained or appropriated depending on several factors including the intention with which and the purpose for which such retention or appropriation has been made because the substance of the matter is to be regarded and in this context the primary dictionary meaning of the term `reserve' may have to be availed of. But it is clear beyond doubt that if any retention or appropriation of a sum is not a provision, that is to say, if it is not designated to meet depreciation, renewals or diminution in value of assets or any known liability, the same is not necessarily a reserve. The question whether the concerned amounts in fact constituted `reserve' or not will have to be decided by having regard to the true nature and character of the sums so appropriated depending on the surrounding circumstances particularly the intention with which and the purpose for which such appropriation had been made - CIT v. Malayala Manorama Co. Ltd. [2000] 111 Taxman 99/242 ITR 144 (Ker.).

The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the profit and
loss account and the balance sheet. On the other hand, reserves are appropriations of profits the assets by which they are represented, being retained to form part of the capital employed in the business. Provisions are usually shown in the balance sheet by way of deductions from the assets in respect of which they are made whereas general reserves and reserve funds are shown as part of the proprietor's interest. An amount set aside out of profits and other
surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision - Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53 (SC).

The expression `reserve' has not been defined in the Act and, therefore, one would be inclined to resort to its ordinary natural meaning as given in the dictionary but the dictionary meaning,
though useful in itself, may not be sufficient, for the dictionaries do not make any distinction between the two concepts `reserve' and `provision' while giving their primary meanings whereas in the context of the Companies (Profits) Surtax Act, 1964, clear distinction between the two is implied.

According to the dictionaries (both Oxford and Webster) the applicable primary meaning of the word `reserve' is : `to keep for future use or enjoyment; to set apart for some purpose or end in view; to keep in store for future or special use; to keep in reserve', while `provision' according to Webster means: `something provided for future'. In other words, according to the dictionary meanings, both the words are more or less synonymous and connote the same idea. Since the rules for computation of capital contained in the Second Schedule to the Act proceed on the basis of the formula of capital plus reserve, a formula well known in commercial
accountancy, it becomes essential to know the exact connotation of the two concepts `reserve' and `provision' and the distinction between the two as known in commercial accountancy.

Besides though the expression `reserve' is not defined in the Act, it cannot be forgotten that it occurs in a taxing statute which is applicable to companies only and to no other assessable entities and as such the expression will have to be understood in its ordinary popular sense, that is to say, the sense or meaning that is attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the
meanings attached to these two words in the provisions of the Companies Act, 1956, dealing with preparation of balance sheet and profit and loss account, would govern their construction for the purposes of two taxing enactments.

The broad distinction between the two is that whereas a provision is a charge against the profits to be taken into account against gross receipts in the profits and loss account, a reserve is an appropriation of profits, the asset or assets by which it is represented being retained to form part of the capital employed in the business - Vazir Sultan Tobacco Co. Ltd./Ballarpur Industries Ltd./Bengal Paper Mills Co. Ltd./Echjay Industries (P.) Ltd./Hyco
Products (P.) Ltd. v. CIT [1981] 132 ITR 559 (SC).

Under clause 7 of Part III of Schedule VI to the Companies Act, 1956, though the term `provision' is defined positively by specifying what it means, the definition of `reserve' is negative in form and not exhaustive in the sense that it only specifies certain amounts which are not to be included in the term `reserve'. In other words, the effect of reading the two definitions together is that in any retention or appropriation if a sum falls within the definition
of `provision' it can never be a reserve but it does not follow that if the retention or appropriation is not a provision it is automatically a reserve. The question will have to be decided having regard to the true nature and character of the sum so retained or
appropriated depending on several factors including the intention with which and the purpose for which such retention of appropriation has been made because the substance of the matter is to be regarded and in this context the primary dictionary meaning of the term `reserve' may have to be availed of. But it is clear beyond doubt that if any retention or appropriation of a sum is not a provision, that is to say, if it is not designated to meet depreciation, renewals or diminution in value of assets or any known liability, the same is not necessarily a reserve.

The proper approach would be first to ascertain whether the particular retention or appropriation of a sum falls within the expression `provision' and if it does, then clearly the concerned sum will have to be excluded from the computation of capital, but in case the retention or appropriation of the sum is not a provision as defined, the question will have to be decided by reference to the true nature and character of the sum so retained or appropriated
having regard to several factors and if the concerned sum is in fact a reserve, then it will be taken into account for the computation of capital - Vazir Sultan Tobacco Co. Ltd./Ballarpur Industries Ltd./Bengal Paper Mills Co. Ltd./Echjay Industries (P.) Ltd./Hyco Products (P.) Ltd. v. CIT [1981] 132 ITR 559 (SC).

It is true that under section 217 of the Companies Act, 1956, the directors can merely recommend that a certain sum be paid as dividend but such recommendation does not result in any obligation or liability; the obligation or liability to pay the dividend arises only when the shareholders at the annual general meeting of the company decide to accept the recommendation and pass resolution for the declaration of the dividend. It is, therefore, open to the directors to withdraw or modify their recommendation at any time before the shareholders accept the same and it is equally open to the shareholders not to accept the recommendation at all or to declare a dividend of an amount lesser than that recommended by the directors. It would, therefore, follow that the appropriation of amounts by the board of directors by way of providing for proposed dividend would not constitute `provisions', for, the appropriations cannot be said to be by way of providing for any known or existing liability, none having arisen on the date when the directors made the recommendation, much less on the relevant date being the first day of the previous year relevant to the assessment year in
question. But, this by itself would not automatically convert the appropriations into `reserves', regard being had to the negative and non-exhaustive character of definition of `reserve' given in clause 7(1)(b) of Part III of the Sixth Schedule to the Companies Act, 1956. The question whether the concerned amounts in fact constituted `reserves', or not will have to be decided by having regard to the true nature and character of the sums so appropriated depending on the surrounding circumstances, particularly the intention with which and the purpose for which such appropriations had been made. The true nature and character of the appropriation
must be determined with reference to the substance of the matter; obviously this means that one must have regard to the intention with which and the purpose for which appropriation has been made, such intention and purpose being gathered from the surrounding circumstances.

The following aspects provide some guidelines in this regard :

(a) a mass of undistributed profits cannot automatically become a reserve and that somebody possessing the requisite authority must clearly indicate that a portion thereof has been earmarked or separated from the general mass of profits with a view to constituting it into either a general reserve or a specific reserve, (b) the surrounding circumstances should make it apparent that the amount so earmarked or set apart is in fact a reserve to be utilised
in future for a specific purpose and on a specific occasion, and (c) a clear conduct on the part of the directors in setting apart a sum from out of the mass of undistributed profits avowedly for the purpose of distribution as dividend in the same year would run counter to any intention of making that amount a reserve.

Further, section 217(1) of the Companies Act, 1956, read with regulation 87 of Table A in the First Schedule, clearly showed that creating reserves out of the profits is a stage distinct in point of fact and anterior in point of time to the stage of making recommendation for payment of dividend and the scheme of the provisions suggests that appropriation made by the Board of
Directors by way of recommending a payment of dividend cannot, in the nature of things, be a reserve.

In the circumstances any appropriation made by the directors for proposed dividend would not constitute `reserves' and the amounts so set apart would have to be ignored or excluded from capital computation - Vazir Sultan Tobacco Co. Ltd./Ballarpur Industries Ltd./Bengal Paper Mills Co. Ltd./Echjay Industries (P.) Ltd./Hyco Products (P.) Ltd. v. CIT [1981] 132 ITR 559 (SC).

n Ordinarily an appropriation to gratuity reserve will have to be regarded as a provision made for a contingent liability, for, under a scheme framed by a company the liability to pay gratuity to its employees on determination of employment arises only when the employment of the employee is determined by death, incapacity, retirement or resignation - an event (cessation of employment) certain to happen in the service career of every employee; moreover, the amount of gratuity payable is usually dependent on the employee's wages at the time of determination of his employment and the number of years of service put in by him and the liability accrues and enhances with the completion of every year of service; but the company can work out on an actuarial valuation its estimated liability, i.e., discounted present value of the liability under the scheme on a scientific basis and make a provision for such liability not all at once but spread over a number of years. It is clear that if by adopting such scientific method any appropriation is made, such appropriation will constitute a provision representing fairly
accurately a known and existing liability for the year in question; if, however, an ad hoc sum is appropriated without resorting to any scientific basis, such appropriation would also be a provision intended to meet a known liability, though a contingent one, for, the expression `liability' occurring in clause 7(1)(a) of Part III of the Sixth Schedule to the Companies Act, 1956, includes any expenditure contracted for and arising under a contingent liability;
but if the sum so appropriated is shown to be in excess of the sum required to meet the estimated liability (discounted present value on a scientific basis), it is only the excess that will have to be regarded as a reserve under clause 7(2) of Part III to the Sixth Schedule - Vazir Sultan Tobacco Co. Ltd./Ballarpur Industries Ltd./Bengal Paper Mills Co. Ltd./Echjay Industries (P.) Ltd./Hyco Products (P.) Ltd. v. CIT [1981] 132 ITR 559 (SC).

The term `reserve' is not defined in the Act and resort must be had to the ordinary natural meaning as understood in common parlance. The dictionary meaning of the word `reserve' is :

"To keep for future use or enjoyment; to store up for sometime or occasion; to refrain from using or enjoying at once.

To keep back or hold over to a later time or place or for further treatment.

To set apart for some purpose or with some end in view, to keep for some use.

To retain or preserve for `certain purposes' (Oxford Dictionary, Vol. VIII, p. 513)";

In Webster's New International Dictionary, Second Edition, p. 2118, `Reserve' is defined as follows :

"To keep in store for future or special use to keep in reserve; to retain, to keep, as for oneself.

To keep back; to retain or hold over to a future time or place.

To preserve" - CIT v. Century Spg. & Mfg. Co. Ltd. [1953] 24 ITR 499 (SC).

In its ordinary meaning, the expression `reserve' means something specifically kept apart for future use or for a specific occasion - CIT v. Standard Vacuum Oil Co. [1966] 59 ITR 685 (SC).

The reserve may be a general reserve or a specific reserve, but there must be a clear indication to show whether it was a reserve either of the one or the other kind. The fact that it constituted a mass of undistributed profits cannot automatically make it a reserve - CIT v. Century Spg. & Mfg. Co. Ltd. [1953] 24 ITR 499 (SC).

In determining whether an item is a `provision' or a `reserve' the true nature and character of the sum so retained or appropriated must be determined and its mere description by the assessee in its balance sheet is not conclusive of its true nature. It is now settled that a `provision' is a charge against the profits being made against anticipated losses and contingencies. A `reserve', on the contrary, is an appropriation of profits, the assets by which it is represented, being retained to form part of the capital employed in the business. Unlike a `provision' which is a present charge against the profits, the assessee continues to enjoy a proprietor's interest in the `reserve' - CIT v. Laxmi Sugar & Oil Mills Ltd. [1986] 161 ITR 168 (SC).

Where the liability has actually arisen or is anticipated legitimately by the assessee though the quantum of the liability has not been determined, provision to meet such present liability cannot be treated as `reserve'. A fund, however, created for payment of a liability which had not already arisen or fallen due but only a provision with regard to the sum that might become liable to be paid, is reserve within the meaning of rule 1 of the Second Schedule and should be taken into account in computing the capital of the company for the purpose of companies (Profits) Surtax Act - CIT v. Saran Engg. Co. Ltd. [1986] 27 Taxman 550A/161 ITR 741 (SC).

The distinction between `provision' and `reserve' is that while `provision' is a charge on profits which are taken into account in the gross receipts of the profit and loss account, `reserve' is an appropriation of profit to provide for asset which it represented. The distinction must be found out bearing in mind the main features of the reserve. These are : (1) it must be an appropriation of profits, current or accumulated, and not a charge against the profits for the year, (2) the conduct of the parties must bear out that intention, and (3) it must not be to set apart to meet any known liability, a liability known to exist on the date of the balance sheet - CIT v. Elgin Mills Ltd. [1986] 161 ITR 733 (SC).

If transfer of an amount is made ad hoc, when there is no known or anticipated liability, such fund will only be treated as `reserves' -State Bank of Patiala v. CIT [1996] 85 Taxman 416 (SC).

The term `reserve' means a sum specifically kept apart for future use or for a specific occasion. The reservation must be effected by someone having authority to do so, and it must be of a specified sum for a specified use. Where it arises out of the surplus profits of
the company, it should be set apart before the distribution of dividends to the shareholders. It is a sum laid by or stored for use or application in a future contingency which is anticipated, a fund which is created and maintained for the purpose of being drawn upon in future. Where the provision for bonus, provision for taxation and the provision for proposed dividend by a company had been actually debited in the assessee's profit and loss account and had not been allowed as deduction in the income-tax assessment, they are to be treated as `reserves' - CIT v. Security Printers of India (P.) Ltd. [1972] 86 ITR 210 (All.).

Provisions made against anticipated losses and contingencies are charges against profits and are, therefore, taken into account against gross receipts in the profit and loss account and the balance sheet. Reserves, on the other hand, are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. To constitute a provision, it must be in respect of a known liability of which the amount cannot be determined with substantial accuracy on the relevant date. If the liability is not known on that date and an amount is appropriated or set apart for a future use, a reserve is said to be created. A reserve is created and maintained for the purpose of being drawn upon in future. If certain payments are to be made in discharge of a present liability in the course of the year
to which the balance sheet and the profit and loss account relate, such payments cannot be treated as a reserve but are of the nature of expenditure. A reserve is created out of the whole or part of the surpluses and is found in the hands of the company at the end of the
year and it is reserved for application in a contingency which still lies in the future. An amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision, while an amount set aside from profits and other surpluses and not designed to meet a liability, contingency, commitment or diminution in the value of assets known to exist at the date of the balance
sheet is a reserve.

It is also necessary, in order to constitute a reserve, that the amount should not remain a mere undistributed mass of profits but should be earmarked as a reserve. If it is not earmarked as a
reserve and is carried forward to the next accounting year it remains as undistributed mass of profits and cannot be described as a reserve. Someone with authority must on the relevant date have applied his mind to the question of creating a reserve out of the profits or other surpluses and set apart an amount as a reserve. There must be clear indication that it has been made or declared as a reserve. It is not necessary that a reserve admissible in the
computation of capital should be one built out of profits, it may be created out of other surpluses also. These constitute generally the tests on the basis of which it falls to be decided whether an amount can be treated as a reserve or not - Hotz Hotel (P.) Ltd. v. CIT [1975] 101 ITR 596 (HP).

n The expression `reserve' means any amount which is set apart for a contingency, i.e., for an unknown future liability, the nature of which is not known at the time of preparation of the balance sheet whereas the expression `provision' means any amount which is kept
apart for a known liability - Oswal Cotton Spg. & Wvg. Mills v. CIT [1981] 129 ITR 761 (Punj. & Har.).

n Apart from the dictionary meaning of the word `reserve' it can hardly be disputed that nothing can be reserved unless it has been reserved or laid by or stored for use or application in a future contingency which is anticipated as certain or likely. In the actual administration of companies also a part of the surplus profits is removed from the immediate business of the company by way of a provision against future contingencies and a reserve is thus created, although after being carried to the reserve, the amount in question may be invested or re-employed in the business, if the articles so permit - Indian Steel & Wire Products Ltd. v. CIT [1958] 33 ITR 579 (Cal.).

The characteristics of a reserve are :

(1) reserve or appropriation of profits which are retained to form part of the capital employed in the business ;

(2) a reserve is not designed to meet any liability, contingency, commitment or diminution in the value of assets known to exist at the date of the balance sheet ; and

(3) a reserve is something set apart for future use or enjoyment. And the characteristics of a provision are :

(a) It is made against anticipated losses and contingencies ;

(b) It is a charge against profits;

(c) It is taken in the profit and loss account against gross receipts ;

(d) It is an amount set aside out of profits designed to meet a liability or contingency or commitment or diminution in the value of the assets known to exist at the date of the balance sheet; and

(e) It is an amount set aside to provide for any known liability of which the amount cannot be determined with substantial accuracy.

It is not the nomenclature of a reserve which will give any clue as to whether it is a provision and thus not a reserve and if not a provision, it is a reserve which shall qualify for computation in the capital for the purposes of the Act, it is the nature of the reserve which is relevant. It is necessary in all cases to see that the reserve is not created to meet any known or existing liability, the liability will be said to be known only if it is so noticed and a provision accordingly is made for it and if besides the provisions made for such a liability, a reserve is created and the provision made is not found inadequate, the reserve so created may qualify for the computation. There can hardly be any difficulty in identifying the existing liabilities and if there is some amount set apart from the profit and is not earmarked for being utilised for any
particular purpose and if marked for being utilised for a particular purpose, the purpose is not to meet any known or existing liability and is thus not kept for being appropriated to meet such a
liability, it shall be reserve and shall qualify for being computed in the capital for the purposes of the Act.

Thus, where there was no information about the nature of the funds under the head `debenture redemption reserve' the question whether such reserve was includible in capital computation could not be answered - CIT v. Ashok Leyland Ltd. [1995] 216 ITR 26 (Mad.).

If transfer of an amount is made ad hoc, when there is no known or anticipated liability, such fund will only be treated as `reverse' - State Bank of Patiala v. CIT [1996] 85 Taxman 416/219 ITR 706 (SC).

 
 
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