2003 PLP (Trib (PTD)

The AR has highlighted the conclusion summarized by the Honourable Judges on the basis of the case law, definitions and books cited as under:‑‑‑ (i) The ordinary natural meaning of the word, `reserve' seems to be setting apart or retaining or preserving or keeping in store or keeping back for special or general use. (ii) That the terms "reserves, provisions and current liabilities" by now carry different meanings in accountancy parlance, namely, reserves are debited to profit and loss appropriation account and are not intended to meet any contingency, liability or loss known to exist at the time of the preparation of the balance sheet, provisions, are also debited to profit and loss account but the same are for specific items existing on the date of the balance sheet which cannot be closely estimated and whereas current liabilities are sums set aside to meet accrued charges and items which can be closely estimated on the date of the preparation of the balance sheet. (iii) That provisions are intended to cover items like depreciation, bad debts, taxation and contingencies etc. (iv) That reserves can be classified into capital reserves and revenue reserves. The former are intended to provide for issuing bonus shares and the latter are available for distribution as dividend. The principles as per ii, iii, iv have been specially emphasized by the AR, has finally urged that reserve for contractual obligation was a liability and not at all a free reserve as summarily held by the DCIT/WT.

7. DR on her turn has pleaded that DCIT/WT rightly treated the reserve, for contractual obligations as reserves to be added for calculation of BUV in terms of the provisions of Rule 8(2)(c)(ii) and clarification issued by the C.B.R. The learned DR was, however, called upon to state that in case DCIT decided to calculate BUV for valuation of shares whether was not required to confront the assessee on the basis to be adopted or for the matter to scrutinize the matter of free reserves on the basis of details and explanation by the appellant in order to satisfy the provisions of law. If yes, has DCIT/WT. Tax not proceeded unilaterally. It has been opined by the DR that DCIT/WT was perhaps convinced on merit on the basis of entry of the balance sheet and the provisions as per Rule 8(2)(c)(ii). On the issue of set aside DR has contended that as facts and law had been appreciated in letter and spirit and the assessment framed under section 16(3) CIT(A) was not justified to order de novo proceedings.

8. We have considered the facts of the impugned orders, arguments of both the parties and carefully examined the case law relied upon by the learned AR. Our conclusion are:‑‑‑ (A) There is no doubt that calculation of BUV by treating the reserve for contractual obligation as a free reserve has been made without scrutinizing the balance sheet with a view to exclude items which should really form part of the reserve as has been simply assumed that reserve for contractual obligation constituted free reserve without saying anything in terms of the detailed facts of such reserve or for that matter having proved the surplus over the liabilities which could have formed the part of the reserves in terms of provisions of rule 8(2)(c)(ii). (B) The mere fact that DCIT/WT intended to treat reserves for contractual obligation as free reserve deviating from the past or if put in the words of the learned AR that reserve for contractual obligation as declared position had been accepted on merit in the past, it was required that for proper details should have been ascertained and assessee allowed opportunity to put their point of view. Since it was not done action of the DCIT in calculating BUV was rightly declared by the CIT (A) that it is not sustainable in law.

9. We have considered the arguments of the learned AR and the ratio decided through the case law relied upon. We are of the opinion that reserve for contractual obligation is clearly distinguishable as reserves based on provisions for contractual obligation which constituted ascertainable liability. What the Assessing Officer should have done was to ascertain the excess over the contractual obligation met for which provisions was created.

10. In arriving at our conclusion we have been strengthen in this regard after having benefit from the judgment reported in 1984 PTD 18 the Honourable Madras High Court while answering the question observed as:‑‑‑ "The issue arises this way. In the industrial establishment of each of the assessees before us, there is a gratuity scheme for the workers and the staff, gratuity would be payable on certain events happening, such as the employee's retirements, resignation, retrenchment or death. In this sense, the liability is said to be a `contingent liability'. But owing to modern systems of actuarial valuation, it would be possible to ascertain the present discounted value of the employer's commitment to pay gratuity to his entire labour force as and when the time comes. This value, if ascertained on actuarial basis, would be progressively increasing every year, even if the strength of the workmen and staff remains constant. As between one year and the next, the figure of discounted value would register an increase. This actuarial increase is often called incremental: value. According to sound principles of commercial accounting, the annual, increment in the discounted value will be a proper charge which the employer can make against the year's profits. That is to say, the net profit of the year will be properly ascertained only after allowing for this charge. In the balance sheet too, the amount will figure as a "provision for grauity". The Supreme Court in Vazir Sultan's case (1981) 132 ITR 559, has laid down that if a provision of this kind is made for gratuity, than that would have the effect of separating the amount so provided for, from the employer's own capital and reserves. So far as income‑tax computation is concerned, it has now become well settled that where an employer has gratuity scheme rendering him liable to pay gratuity to workmen, and where having regard to the liability which might arise under the scheme, the employer obtains a scientific actuarial calculation under which the present discounted value of the gratuity liability is ascertained, and here the employer charges his P&L account with the incremental value of the year and also makes a provision for that amount, then the employers will be entitled to compute his net profits after deducting the figure of incremental value". Further we have benefited from the ratio decided in a reported case (1969) 73 ITR 53 with the following observations:‑‑‑ "Two questions, therefore, arise; (1) Whether it is legitimate in such a scheme of gratuity to estimate the liability on an actuarial valuation and deduct such estimated liability in the P&L account while working out its net profits; and (2) If it is, whether such appropriation amounts to a reserve or a provision. If it is a reserve, obviously the amount has to be added back while computing the gross profits. But in that event the company would be entitled to interest thereon at 6 per cent per annum under item i(iii) of the Third Schedule to the Act. In the case of an assessee maintaining his accounts on mercantile system, a liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy, it is not as if such deduction is permissible only in case of amounts actually expended or paid. Just as receipts, though not actual receipts but accrued due are brought in for income tax assessment, so also liabilities accrued would be taken into account while working on the profits and gains of the business. A company carrying on business of buying land and selling it after development sold certain plots, received a part of the price but entered the whole of the price receivable as it maintained its books of accounts on mercantile method. It also debited a certain sum, being the estimated expenditure for the developments if undertook to carry out within six months from the execution of the sale‑deeds although no part of such expenditure was actually incurred during that year. It was held that, having regard to the accepted commercial practice and trading principles and there being no prohibition against it in the Income Tax Act, deduction of such estimated liability, even though it did not come under any specific provisions of section 10(2) of the Income Tax Act, 1922, was permissible".

11. After having considered various facts and factors and merits of the arguments of both the parties our observations are as follows; (i) The Assessing Officer calculated BUV without properly ascertaining the facts of reserves or in the spirit of law scrutinized the facts of the reserves/provisions before treating the same as free reserves. In the process provisions of law and instructions of the C.B.R. on the subject have been dealt in contravention of method and manner for purposes of calculation of BUV. (ii) It was requirement of justice and fair-play that when deviating from history and creating liability of a very high proportion appellant should have been heard by confronting and their point of view considered. (iii) CIT(A) in his turn as emphasized by the learned AR although got persuaded to hold that the treatment of calculation of BUV was not sustainable yet in the interest of justice and fair-play to both the parties (particularly the Revenue) deemed it proper to order de novo proceedings. The objections of the learned AR on the setting aside by the CIT(A) though are well based yet we feel that it will be appropriate to let the DCIT scrutinize the facts of the reserves for contractual obligation which in all fairness is ascertained liability.

12. Having considered all the facts and factors and particularly ratio decided by the judgments specifically quoted above we direct that reserve for contractual obligation be scrutinized for purposes of exclusions 'from free reserves. In the light of observations above appeal of the department against the setting aside is obviously without merit. The appeal of the assessee is disposed of to the extent indicated above. Order accordingly. C.M.A./521/Tax (Trib.) Order accordingly.