1980 PLP 73 (PTD)

3. Section 10 (7) of Income‑tax Act provides a special basis of compu tation of the profits and gains of insurance business and the tax payable thereon in accordance with the rules contained in the First Schedule to the Income‑tax Act. Section 10 (7) reads as follows:‑ "10.‑(7) Notwithstanding anything to the contrary contained in sections 8, 9, 10, 12 and 18, the profits and gains of any business of insurance and the tax payable thereon shall be computed in accor dance with the rules contained in the First Schedule to this Act." The relevant rule in the First Schedule relating to non‑life business is rule 6 (1) which reads as follows:‑ "6.‑(1) The profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the In surance Act, 1938 to be furnished to the Controller of Insurance after adjusting such balance so as to exclude from it any expenditure, other than expenditure which may under the provisions of section 10 of this Act be allowed for in computing the profits and gains of a business . . . . The annual accounts referred to in rule 6 (1) q mounts and statements referred to in section 11 of the Insurance Act, 1938, which are required to be furnished under section 15 (1) of the said Act to the Controller of Insurance at the expiration of each calendar year. They comprise:‑(a) a balance‑sheet in accordance with the regulations contained in Part I of the First Schedule in the form set forth in Part 11 of that Schedule; (b) the profits and less account in accordance with the regulations contained in Part I of the Second Schedule in the forms (B & C) set forth in Part it of that Schedule; and (c) a revenue account in respect of each required class or sub‑class of insurance business in accordance with the regulations and in the forms set forth in the Third Schedule applicable to that class or sub‑class of insurance business. In respect of these accounts and returns submitted to the Controller of Insurance, he has been given wide powers rider sections 21 and 22 of the Insurance Act in case of inaccuracy or defect in any respect thereof to order correction of the return or call upon the insurer to submit for his examination any book of account, register or other document or to supply any statements which he may specify in a notice, or examine any Officer of the insurer on oath in relation to the return or to decline to accept any such return unless the inaccuracy has been corrected or the deficiency has been supplied. By section 22, the Controller has the power to order investigation or revaluation to be made by an actuary appointed by the insurer for that purpose.

4. The submission of Mr. Ali Athar learned counsel for the applicant is that having regard to the wide powers conferred on the Controller of Insurance with regard to the scrutiny of the accounts of insurance com panies, the Income‑tax Officer is required by rule 6 (1) to take the balance of the profits disclosed by the annual accounts submitted to the Controller of Insurance as the profits and gains of the insurance business, subject to any adjustment which he may make so as to exclude from it any expenditure other than expenditure, which may under the provisions of section 10 of the Income‑tax Act, be allowed for in computing the profits and gains of the business. He submitted that a reserve for unexpired risks is not an expen diture within the meaning of section 10(2) of the Income‑tax Act, Although the word "expenditure" has not been defined in the Income‑tax Act, its meaning is well known to income‑tax Law. Its primary meaning is money "expended" or "paid out" or "disbursed" and is something which is gone irretrievably, as explained in Indian Molasses Co. (Private) Ltd. v. Commissioner of Income‑tax, West Bengal 37 I T R

66. As explained by the Pakistan Supreme Court in the Commissioner of Income‑tax, North Zone West Pakistan v. Lyallpur Cotton Mills Ltd., Lyallpur P L D 1960 S C 48 the word "reserve" in its plain and dictionary meaning means something set apart for some special or general purpose. A reserve for unexpired risks is an amount set aside by an insurance Company to meet any risks of loss under the policies which may mature in future. The amount set aside for such reserve, represents a percentage (usually 40 to 50% or 55 %) of the total premium income earned in the calendar year and is an item which appears in the revenue account in Form F of the Third Schedule of the Insurance Act, on the debit side for the first year and is carried forward to the credit side in the following year, less amount of loss paid. It is not disputed that until the loss is paid or accrues under the policy, the liability to pay it is a contingent liability and is clearly not an expenditure. Therefore, the contention of Mr. Ali Athar is that the Income‑tax Officer has no jurisdiction to disallow the amount claimed by the applicant as a reserve for unexpired risks at 50 % of the premium income of the year and that he was bound to take the balance of profits disclosed in the annual accounts submitted to the Controller of Insurance wherein the said reserve was claimed and accepted by him. In support of this submission, he referred to Pandyan Insurance Company Ltd. v. Commissioner of Income‑tax (Madras) 55 I T R 716==1965 P T D

475. In that case, an Insurance Company carrying on general insurance business had written off an amount as depreciation in respect of a new building which it claimed as a deduction. It was held that as rule 3 (b) of the First Schedule to the Income‑tax Act directs the I. T. O. to allow the depreciation written off in computing the surplus for purposes of rule 2, and the I. T. O. had no option but to allow it and he could not ask the assessee to prove depre ciation in fact. Pandyan's case was approved of in Commissioner of Income tax, West Bengal v. Calcutta Hospital & Nursing Home Benefits Association Ltd. (1965) 57 I T R 313=1967 P T D

176. The Indian Supreme Court observed with regard to rule 6, that the intention of the rule was that the balance of profits as disclosed by the accounts submitted to the Controller of Insurance and accepted by him, would be binding on the Income‑tax Officer, except that the Income‑tax Officer would be entitled to exclude expenditure other than expenditure permissible under the provisions of section 10 of the Act.

5. Counsel for the applicant further submitted that is a fallacy to think that the words "annual accounts" appearing in. rule 6 (1) mean only the profit and loss account, submitted in the prescribed Form B to the Controller of Insurance. Section 15 of the Insurance Act requires the insurance company to submit not only the profit and loss account in Form B but also the revenue account in the prescribed Form F, as also the balance sheet, all of which constitute the "annual accounts" referred to in rule 6 (1). In Union Cooperative Insurance Society v. Commissioner of Income‑tax, Bombay (1967) 66 I T R 360 the Indian Supreme Court observed that there was no warrant for the view that the balance of profits disclosed by the annual accounts must be equated with the balance of profits disclosed in Form B. In fact, the item "Reserve for Unexpired Risks" appears in the Revenue Account in Form h on the debit and credit side and the balance amount at the foot of Form F is "profit transferred from the revenue account" to the profit and loss account‑Form B.

6. The submission of Mr. Mansoor Ahmad Khan, learned counsel for the Commissioner, is that there is no statutory provision in the income‑tax Act for allowing reserve for unexpired risks as a deduction in computing the profits and gains of insurance business and only these allowances are to be deducted which are mentioned in section 10 (2) of the Income‑tax Act. He submitted that a reserve for unexpired risks is a hypothetical contingent liability and is not an expenditure and as such is not allowable at all under section 10 (2) of the Income‑tax Act and, therefore, the balance of profits for purposes of rule 6 has to be worked out without taking into consideration the reserve for unexpired risks. But, a normal reserve for un-expired risks of 40 % is allowed by the I. T. O. in view of the directions of the Central Board of Revenue contained in circular (published in Income tax Manual, Part 11, 1958 Edn., page 264) to allow it as a fair and proper reserve for unexpired risks, which may be increased to 50 % on account of greater risks involved in a particular case, with proper safeguard to prevent manipulation of accounts.

7. We have considered the above submissions of learned counsel for the parties and are inclined to agree with the submission of Mr. Ali Athar. In our opinion, the Board of Revenue circular, although it is binding on the I. T. O., has no legal force. In the absence of a statutory provision govern ing the allowance of an amount as a reserve for unexpired risks, the amount claimed by the applicant and accepted by the Controller of insurance cannot be questioned by the Income‑tax Officer. He is bound to accept the balance of profits as shown in the annual accounts subject, however, to disallowing expenditure which cannot be allowed under sec tion 10 (2) of the Income‑tax Act. Any other conclusion would have the effect of permitting the I. T. O. to tamper with the accounts of an insurance business which may seriously affect the working of insurance companies. In Life Insurance Corporation of India v Commissioner of Income‑tax, Delhi and Rajasthan (1964) 51 I T R 773 the Indian Supreme Court observed that there was no general right to correct the errors in the accounts of insurance company when asses sing the income‑tax, since the assessment of the profits of an insurance business is completely governed by the rules in the Schedule and there is no power to be anything not contained in it for the reason that the accounts of an insurance business are fully controlled by the Controller of Insurance under the provisions of the Insurance Act.

8. Incidentally, we would refer to an observation of the Authors of "the Law of Practice of Income‑tax" by Kanga Palkhivala 4th Edition (1958), page 883:‑ It is eminently desirable that provisions for allowance in respect of unexpired risks should be made in the statute itself rather than that the matter should be regulated merely by administrative practice and executive instructions. It appears that the Indian Legislature has accepted this wholesome advice and has since made statutory provision in the new rule 5 (c) in the First Schedule of the Indian Income‑tax Act, 1961, to the effect that "such amount carried over to a reserve for unexpired risks as may be prescribed in this behalf shall be allowed as a deduction."

9. For the foregoing reasons, we would hold that the Appellate Tri bunal was not justified in confirming the order of the I.‑T. O. reducing the reserve for unexpired risks to 40 % from 50 % of the premium income of the applicant as provided in the accounts submitted to the Controller of Insurance. We would accordingly answer the question referred to us in the negative. There will be no order as to costs. Reference answered in negative.