VAZIR SULTAN TOBACCO CO. LTD. ETC. ETC. vs. COMMISSIONER OF INCOME-TAX ANDHRA PRADESH, HYDERABAD

CIVIL APPEAL No. 860/1973Supreme Court[1982] 1 S.C.R. 78925 September 1981Bench: 3 JudgesAuthor: V.D. TULZAPURKAR, E.S. VENKATARAMIAH, AMARENDRA NATH SEN47 pages
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What were the facts?

The assessees, Vazir Sultan Tobacco Co. Ltd. and others, are challenging the levy of Super Profits Tax and Sur-tax for various assessment years. The core issue revolves around the classification of certain amounts in their balance sheets as either 'provisions' or 'reserves'. The assessees treated sums appropriated for taxation, retirement gratuity, and dividends as 'other reserves' to be included in the computation of capital for determining the standard deduction under the Super Profits Tax Act, 1963, and the Companies (Profits) Sur-tax Act, 1964. The Super Profits Tax Officer, however, classified these as 'provisions' and excluded them from capital computation, leading to a higher tax liability. The Appellate Assistant Commissioner initially agreed with the assessees, but the Appellate Tribunal and the High Court ruled against them, holding these sums were not 'reserves'. In one specific case (Tax Reference no. 5), a sum transferred to general reserves was reduced by the dividend paid from it.

What did the Supreme Court hold?

The Supreme Court, per Tulzapurkar and Venkataramiah JJ., held that while 'reserve' and 'provision' are not defined in the taxing Acts, their distinction is crucial and should be understood in the context of commercial accountancy and the Companies Act, 1956. A 'provision' is a charge against profits to meet a known liability, whereas a 'reserve' is an appropriation of profits. Sums set apart to meet tax liability, even if unquantified, are 'provisions' and not 'reserves', unless the provision is in excess of what is reasonably necessary, in which case the excess could be a 'reserve'. However, the plea of excess provision was not raised earlier. Appropriations for gratuity are generally considered provisions for a contingent liability. Crucially, amounts recommended for dividend payment, as reflected in the balance sheet under 'provisions', are not intended to constitute a reserve and are understood by the business community as provisions for dividend payment, not reserves. Therefore, such amounts cannot be included in capital computation. The Court affirmed the High Court's decision on these points.

What were the issues?

1. Whether sums appropriated for taxation, retirement gratuity, and proposed dividends, when shown under 'current liabilities and provisions' in the balance sheet, qualify as 'reserves' under Rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, and the Companies (Profits) Sur-tax Act, 1964, for the purpose of capital computation. This question turns on the distinction between 'provision' and 'reserve' as understood in commercial accountancy and company law. Assessee's Contention: The assessees argued that these appropriations, particularly those not allowed in computing profits under the Income Tax Act, should be treated as 'other reserves' and included in the capital computation. They relied on the principle that if an amount is not a 'provision', it can be a 'reserve'. Revenue's Contention: The revenue contended that these sums were correctly classified as 'provisions' and therefore should be excluded from capital computation. They relied on the distinction between 'provision' and 'reserve' as judicially evolved and as reflected in the Companies Act, 1956.

Which sections of the Income-tax Act were involved?

Section 211

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• • 789 A VAZIR SULTAN TOBACCO CO. LTD. ETC. ETC. v. COMMISSIONER OF INCOME-TAX ANDHRA PRADESH, HYDERABAD September 250 !981 (V.D. TULZAPURKAR, E.S. VENKATARAMIAH AND AMARENDRA NATH SEN, JJ.] Super Profits Tax Act, 1963 and Company's (Profits) Sur-tax Act, 1964- Ru/e I of Second Schedule-Scope of-'' Provision" and "Reserve"·-Distinction- A sum of money transferred from current profits to general reserves-Dividend paid from that fund-General reserve how calculated.

The Super (Profits Tax) Act, 1963 and the Company's (Profits) Sur-ta.

Act, 1964 (the scheme and main provisions of both of which are almost identical) impose a special tax on excess profits earned by companies. The special t~ is imposed in respect of so much of a company's "chargeable profits" of the previous year as exceeded the "standard deduction"- The term "chargeable profit" is defined to mean th~ total income of an assessee computed under the Income Tax Act, 1961 for aDy previous year and adjusted in accordance with the provisions of that Act. "Standard deduction" is determined by computing the capital of a company in accordance with the rules laid down in the schedule.

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