BALASUBRAHMANYAN J.


This case raises a point about the computation of capital under Sch. II of the Companies (Profits) Surtax Act, 1964 The point arises this way. The assessee is a company with calendar year as its account year. Out of the profits for the year ended December 31, 1, 970, the assessee decided to credit Rs. 13, 32, 992 to the company's general reserve. Having done so, the directors recommended that a; dividend be declared for the year ended December 31, 1970, at a rate which worked out to a total commitment of Rs. 2, 03, 250. They decided to declare and pay the dividend from out of the general reserves. The board's recommendation was on May 4, 1971. The general body met and approved of the dividend on June 16, 1971. The dividend was actually distributed subsequently, but before the close of the year ended December 31, 1971


In the assessment of the assessee to surtax for 1972-73, relevant to the year ended December 31, 1971, the assessee's capital as on January 1, 1971, had to be ascertained. As part of the computation of capital, the general reserves as on that day had to be ascertained. In that connection, the assessee claimed that since the general reserve stood at Rs. 13, 32, 992 as on January 1, 1971, this figure must be taken as such without alteration for purposes of capital computation as on January 1, 1971. The ITO did not accept this claim. He took the view that if the dividend had been provided for out of the profits of the year ended December 31, 1970, under a provision for proposed dividend, that amount could not, at the same time, have been appropriated to the general reserve. He proceeded to observe that the fact that the assessee did not straightway declare the dividend from out of the profits of the year ended December 31, 1970, or, make a provision in the accounts for proposed dividends, but decided instead to credit the profits first to the general reserve and then to declare the dividend out of the general reserve did not make any difference in principle. He said that although the dividend had been recommended by the directors and approved by the general body subsequent to the commencement of the year of account on January 1, 1971, it really related back to the year ended December 31, 1970, in which event the general reserve as on January 1, 1971, could not by any means have included the amount of Rs. 2, 03, 250. On this reasoning the officer computed the general reserves as on January 1, 1971, at Rs. 13, 32, 992 minus Rs. 2, 03, 250. On appeal, the Tribunal agreed with the ITO's viewThis decision of the Tribunal is challenged by the assessee-company in the following question of law


"Whether, on the facts and in the circumstances of the case, it has been rightly held that a sum of Rs. 2, 03, 250 was to be deducted from the general reserve for the purpose of arriving at the statutory deduction ?" *


The answer to this question is to be found in the recent decision of the Supreme Court in Vazir Sultan Tobacco Co. v. CIT. The decision was rendered in a group of cases in which the Supreme Court had to interpret the provisions of Sch. If of this Act as well as similar provisions in an earlier enactment (the Super Profits Tax Act, 1963). One of the cases dealt with by the Supreme Court related to a company called Hyco Products (P.) Ltd. That company transferred to its general reserves, a sum of Rs. 29, 77, 000 out of its current year's profits. The company thereafter paid out Rs. 3, 10, 450 as dividend from the general reserves. The company did not make any separate provision in the balance-sheet for proposed dividends, but simply declared the dividend out of the general reserves. The question before the Supreme Court was whether in the computation of the company's capital under Sch. II as on the first day of the account year, the amount of Rs. 3, 10, 450 being the dividend subsequently distributed from out of the general reserve should be deducted from the reserve or whether it should be regarded as forming part of the general reserve as on the opening day of the account year. In the course of their judgment the Supreme Court took care to point out that the recommendation of the board of directors for the payment of dividend can, at any time, be revoked by them and it can also be countermanded by the general body. The Supreme Court further observed that in that sense the dividend recommended by the directors cannot be regarded, as yet, as an appropriation from the general reserve. Nevertheless, the court proceeded to observe that the question whether any amount credited in the company's reserve account constitute "reserves" or not must be examined from the point of view of the nature and circumstances relating to the appropriation and the intention with which such appropriation had been made. Adverting to the distribution of dividends from out of the general reserves without making a separate provision therefor, the Supreme Court observed that the mere fact that the directors had recommended the distribution of a dividend from out of the reserves would show that the amount representing the proposed dividend was earmarked for distribution as dividend, and not to be retained as part of the general reservesThe Supreme Court's decision aforesaid is based on the principle that a dividend, in essence, involves the release of assets by the company to the shareholders, whereas a reserve has precisely the opposite effect, namely, retention of the assets as capital of the company. The creation of a reserve and the distribution of a dividend pull in different directions. It is in the context of this distinction that the question of intention of the board of directors assumes significance. The intention, according to the Supreme Court, is not to retain the amount in the company, but to set aside the amount for being disbursed to the shareholders as dividend. On the basis of this decision of the Supreme Court, therefore, our answer to the question in this case must be in the affirmative and against the assessee


Mr. Subramaniam, learned counsel for the assessee, invited our attention to r. 1A of the Second Schedule to the C.(P.)S.T. Act, 1964. This rule was introduced by the Finance Act in the year 1976, with a limited retrospective effect. The assessment year under consideration in this case is 1972-73, and hence r. 1A does not enter into the reckoning. Nevertheless, the argument based on r. 1A bears examination. The sum and substance of the rule is that where no provision is made in the appropriation accounts for proposed dividends, or where the provision made is inadequate, then the whole amount distributed as dividend, or that amount of distribution which is in excess of the provision made, shall be deducted from the general reserves for purposes of capital computation under Sch. II of the Act. This is the gist of r. 1A. Mr. Subramaniam's thesis is that the rule introduced, for the first time and in a statutory form, is new principle. He said that the rule answers, for the first time, the question whether a company's general reserve as on a particular day will have to be shown as having been depleted in any case and to any extent for the purpose of reflecting a subsequent distribution of dividends from out of the reserve. Learned counsel said that the judgment of the Supreme Court in Vazir Sultan's case, does not show that their attention had been drawn to this new rule. He liked to imagine that if the Supreme Court had known about this rule, they might, not have decided the case in the way they did. According to Mr. Subramaniam, the Supreme Court might have laid down the law differently from r. 1A, in the view that the rule reflected a definite change in the law desired by Parliament. Learned counsel's argument was that the enactment of r. 1A by Parliament is an indication to show that prior to the introduction of that rule, the law under Sch. If of the Act was intended to be quite differentWe are not impressed by this argument. Earlier, we have summarised the decision of the Supreme Court in Vazir Sultan's case. While rendering their judgment, the Supreme Court themselves had occasion to remark that the reasoning on the basis of which they had rendered their decision was, based on "first principles". This means that r. 1A, which Parliament introduced, only translated, into statutory terms, what was already part of the law according to the general principles of corporate accounting


The argument of Mr. Subramaniam cannot, in any case, have the effect of rendering the Supreme Court's decision any the less binding on us. The Supreme Court were deciding a case which had arisen prior to the introduction of r. 1A. Hence it cannot be a matter for, comment that they had not looked into r. 1A while rendering their decision in the case on hand. It follows that we cannot justifiably assume that the Vazir Sultan ruling in had been rendered by the Supreme Court Per incuriam. Even if it were, we are yet bound by that decision. We may, however, add, with respect, that the view expressed by the Supreme Court on the effect of a proposed distribution of dividend on the general reserves of a company is the correct view. It was only this principle that Parliament gave expression to while enacting r. 1A. There cannot be any presupposition that prior to r. 1A, or without r. 1A, the position in law was any different from what the rule laid down. In one respect, perhaps, the new rule mig

ht be regarded, as having laid down rule of thumb. The Supreme Court had held that even though the actual distribution of dividend takes place later, since by that time the board of directors would have already recommended the dividend in question, it will have to reduce the figure of reserves in the balance-sheet for purposes of capital computation. The new r. 1A says nothing about the board's recommendation to declare dividend out of reserves. The rule says nothing about the proposal being made by the directors prior to the first day of the account year. The rule brings the axe down in all cases and reduces the reserve by the amount of the dividend where no separate provision is made therefor in the balance-sheet. Rule 1A also applies to cases where there is an excess declaration of dividend over and above the provision made in the balance-sheet. The rule lays down that to the extent of the excess, the reserves must be deductedFor the reasons aforesaid, the reference is answered against the assessee. There will, however, be no order as to costs.