True Interpretation of Section 34(3)(a) of the Income Tax Act 1961 regarding making entries in respect of development rebate and development rebate reserve even after the closure of the accounts
Commissioner Of Income-Tax vs Narula Cold Storage & Ice Factory on 1 December, 1975
Equivalent citations: 1976 104 ITR 148 Orissa
Author: R Misra
Bench: R Misra, N Dass
JUDGMENT R.N. Misra, J.
- At the instance of the revenue the Income-tax Appellate Tribunal has stated this case and referred the following question for opinion of the court:
“Whether, on the facts and in the circumstances of the case, and on a true interpretation of Clause (a) of Sub-section (3) of Section 34 of the Income-tax Act, 1961, the Appellate Tribunal was correct in holding that the assessee-firm by making entries in respect of development rebate and development rebate reserve even after the closure of the accounts on March 31, 1964, was entitled to development rebate for the assessment year 1964-65?”
- Assesses is a registered firm and the relevant year of assessment is 1964-65 corresponding to the accounting period ending March 31, 1964. Assessee maintained accounts according to the mercantile system. Profits from a cold storage and ice factory constitute the main source of income. Assessee filed its return for the year on February 12, 1968, showing a loss of Rs. 40,067. On 6th of March, 1969, a revised return was filed disclosing loss of Rs. 67,000 and the assessee claimed development rebate allowance of Rs. 20,402 in the revised return. The original return was not accompanied by the profit and loss statement.
- The Income-tax Officer did not accept the claim for development rebate on the ground :
“….. The assessee has claimed development rebate allowance at Rs. 20,402 in the revised return. The assessee has debited Rs. 20,402 in the profit and loss account. It will be seen that the assessee has filed return for the first time on February 12, 1968. The return was not accompanied by profit and loss account. In the duplicate profit and loss account there was no debit for development rebate and in the balance-sheet also there was no provision for development rebate. When the assessee filed its revised return on March 6, 1969, then only in the profit and loss account and in the balance-sheet provision was made for this development rebate. As such the advantages given to the assessee under the statute were not fully availed of and all the conditions were not satisfied in this respect. I disallow the claim for development rebate.”
- The Appellate Assistant Commissioner held that, the assessee had reopened its closed books of account and created the development rebate subsequently. According to him under the Indian law, the books of account once closed could not be reopened for any purpose and, therefore, the claim of development rebate reserve was not acceptable.
- In further appeal by the assessee before the Tribunal, the claim was re-examined on the basis of the provision in the statute and judicial precedents. The Tribunal came to hold :
“We are of the view that the income-tax law, to our knowledge, does not prohibit reopening of the accounts for carrying out accidental errors nor such law has been shown to us by the departmental representative. The case relied upon by the departmental representative has no relevance inasmuch as the facts of the case are different as no specific reserve for development rebate was made in that case and surplus in the general reserve account was shown to cover the requisite reserve for development rebate. Their Lordships held that the requirements of the law were to make separate and specific reserve for development rebate and no amount in any other reserve account would entitle the assessee to have the development rebate. In the instant case, the assessee has created a specific reserve for the purpose but on a later date and thus satisfies all the requirements of the law. In this view of the matter, we direct the Income-tax Officer to allow development rebate as claimed by the assessee.”
- There is no dispute before us that when the books of account were originally closed or the return on the first occasion was filed, provision for development rebate had not been made. Learned standing counsel relies upon a decision of the Supreme Court in Indian Overseas Bank Ltd. v. Commissioner of Income-tax,  77 ITR 512 (SC).
and a decision of the Gujarat High Court in Surat Textile Mills Ltd. v. Commissioner of Income-tax,  80 ITR 1 (Guj) , in support of his stand that the appropriate development reserve having not been provided for in the books of account when they were closed or in the profit and loss account and the balance-sheet when the return was filed, the claim was not admissible.
- The facts of the Indian Overseas Bank’s case, in the language of Hegde J., were the following:
“The admitted facts of the case are that during the accounting year relating to the assessment year, the appellant-company had transferred a sum of Rs. 6 lakhs from the profit and loss account to the reserve fund. This sum is sufficient to meet the requirements of Section 17 of the Banking Companies Act, 1949, as well as of proviso (b) to Section 10(2)(vib) of the Act (Indian Income-tax Act of 1922, corresponding to Section 34 of the 1961 Act), but no separate reserve fund as required by proviso (b) to Section 10(2)(vib) had been created. The contention of the appellant is that as the transfer to the reserve is sufficient to meet the requirements of Section 17 of the Banking Companies Act, 1949, as well as of proviso (b) to Section 10(2)(vib) of the Act, in substance, if not in form, it has complied with the requirements of law and, therefore, it is entitled to the allowance of the rebate claimed…..”
- The court extracted the provisions contained in proviso (b) to Explanation 2 of Section 10(2)(vib) of the Indian Income-tax Act of 1922 and observed :
“The creation of the reserve contemplated by this provision is a condition precedent for obtaining the allowance of development rebate. Admittedly, the appellant has not created any such separate reserve…..
The reserve contemplated by that provision (section 17 of the Banking Companies Act) is a separate reserve. The amount transferred to thatreserve cannot be utilised for business purposes. The reserve contemplatedby proviso (b) to Section 10(2)(vib) of the Act is an independent reserve.
The amount to be transferred to that reserve is debited before the profit and loss account is made up. That amount is required to be credited to a a reserve account to be utilised by the assessee during a period of ten years for the purposes of the business of the undertaking. The nature of the two reserves are different. They are intended to serve two different purposes. As observed by the Madras High Court in Commissioner of Income-tax v. Veeraswami Nainar,  55 ITR 35 (Mad), the object of the legislature in allowing a development of the assessee’s business from out of the reserve fund is apparent from the terms of the proviso. The entries in the account books required by the proviso are not an idle formality. The assessee being obliged to credit the reserve fund for a specific purpose, he cannot draw upon the same for purposes other than those of the business and that amount cannot be distributed by way of dividend. It is also clear from the terms of the proviso that the transfer to the reserve fund should be made at the time of making up the profit and loss account.”
- In Surat Textile Mills’,  80 ITR 1, 6 (Guj), case the Gujarat High Court dealt with a similar claim laid by the company. The facts of the case show:
“…..In the calendar year 1959, the company had installed what is called a cheese dyeing plant, the total cost of which came to Rs. 1,44,575. This plant was installed in the year 1959, though it had been purchased earlier, and in had started working with effect from November 1, 1959. When the return for the assessment year 1960-61 was filed by the assessee, it had not claimed any development rebate in respect of the sum of Rs. 36,144 which worked out at 25% of the original cost of instalment. In its return the assessee had claimed initial depreciation in accordance with the law prevailing at the time when the cheese dyeing plant was purchased by the assessee. The assessee appears to have been informed that for the material assessment year, the assessee would be entitled to development rebate if the conditions required for the grant of the allowance were fulfilled. The assessee was also informed that the scheme of giving initial depreciation had been deleted as per the Income-tax Act and the company realised that the condition of creation of development reserve as required fay law had not been satisfied by it in so far as the profit and loss account of the year 1959 was concerned. Under these circumstances, by its letter, dated April 14, 1961, a representation was made by the assessee to the Central Board of Revenue, Ministry of Finance, Government of India, New Delhi, requesting the Board to direct the Income-tax Officer concerned to relax the condition for the purpose of assessment for the assessment year 1960-61 and to allow the assessee to create an additional reserve ‘in the current year’s account books’ and to allow rebate to them…..”
- The company’s claim having not been allowed, the matter came before the court at the instance of the assessee. In support of the assessee’s claim, a decision of the Andhra Pradesh High Court in the case of Veerabadra Iron Foundry v. Commissioner of Income-tax, 69 ITR 425 (AP), and another decision of the Rajasthan High Court in the case of Commissioner of Income-tax v. Mazdoor Kisan Sahkari Samiti,  75 ITR 253 (Raj), were relied upon. The court, however, took the view that the question had been settled against the assessee in the Indian Overseas Bank case by the Supreme Court and, therefore, negatived relief to the assessee. After quoting a passage from the judgment of Hegde J. from the case in Indian Overseas Bank,  77 ITR 512 (SC), the learned judges of the Gujarat High Court observed,  80 ITR 1, 13 (Guj). :
“It is thus clear that according to this interpretation placed upon Clause (b) of the proviso to Section 10(2)(vib) of the 1922 Act, the amount to be transferred to the reserve contemplated by that clause must be debited before the profit and loss account is made up and, secondly, the transfer to the reserve fund should be made at the time og making up of the profit and loss account. In view of this clear interpretation by the Supreme Court, it is obvious that the observations of the Andhra Pradesh High Court and the Rajasthan High Court regarding the scope of this proviso no longer hold the field. It is clear that what may be called the strict view adopted by the Madras High Court as compared to the more liberal view adopted by the Andhra Pradesh and Rajasthan High Courts has appealed to the Supreme Court. The result, therefore, is that we have to ask ourselves in the instant case as to whether the necessary amount was debited to the reserve before the profit and loss account was made up and at the time of making up the profit and loss account.
It is clear from the narration of facts set out at the commencement of this judgment that when the profit and loss account for the relevant previous year was made up, no such reserve fund was credited ; nor was the amount for the reserve fund debited before the profit and loss account for the relevant year was made up. One further fact which goes against the assessee in the instant case is that far from debiting the profit and loss account for the relevant previous year 1960, the assessee in the instant case has debited the profit and loss account for the year 1961. In view of this decision of the Supreme Court, it is clear that the benefit of the development rebate cannot be granted to the assessee in the instant case because of non-compliance with the requisite condition laid down in Clause (b) of the proviso to Section 10(2)(vib).”
- Mr. Mohanty, for the assessee, seeks to place reliance on the two decisions of the Andhra Pradesh and the Rajasthan High Courts already referred to and three later decisions of the Allahabad, Bombay and Punjab and Haryana High Courts. These are the cases of Commissioner of Income-tax v. Modi Spinning and Weaving Mills Co. Ltd.,  89 ITR 304 (All), Tata Iron and Steel Co. Ltd. v. N. C. Upadhyaya,  96 ITR 1 (Bom) and Commissioner of Income-tax v. Sardar Singh Sachdeva, 86 ITR 387 (Punj). It is unnecessary to refer to all these decisions at length because in our opinion a good review of the judicial opinion on the point is available from the decision of the Bombay High Court in Tata Iron and Steel Co. Ltd. v. N. C. Upadhyaya. Dealing with the Supremo Court decision, it has been stated at page 9 of the report:
“The judgment of the Supreme Court in Indian Overseas Bank Ltd. v. Commissioner of Income-tax,  77 ITR 512 (SC), was rendered in an appeal against the judgment of a Division Bench of the Madras High Court consisting of Veeraswami J. (as he then was) and Natesan J. in the case of Indian Overseas Bank Ltd. v Commissioner of Income-tax,  63 ITR 733 (Mad). In that case the assessee-company had claimed development rebate and contended that it had set apart a sum of Rs, 6,00,000 during the assessment year out of its net profits which not only satisfied the requirements of Section 17 of the Banking Companies Act, but also the requisites of the Indian Income-tax Act, 1922, with regard to the creation of development rebate reserves. The Madras High Court held that, as the assessee while setting apart the sum of Rs. 6,00,000 had not expressed the purpose for doing so, the conditions with regard to the creation of a development rebate reserve were not complied with and development rebate could not be allowed. The High Court further held that even if it were assumed that the reserve was created under the Banking Companies Act, it could not be said to be available for any other purpose. The High Court observed that the provision for creation of a development rebate reserve was not a mere formality, but was intended to enable the revenue to trace the fund debited as part of the development rebate in the profit and loss account and credited to a reserve account. Unless this condition was complied with, development rebate could not be claimed. In our opinion, all that the Madras High Court decided was that the reserve created under the Banking Companies Act was not available as a development rebate reserve and that, as no development rebate reserve had been created in that case, the rebate could not be claimed. In the appeal from the above judgment the Supreme Court held in Indian Overseas Bank Ltd. v. Commissioner of Income-tax that creation of a reserve in compliance with Section 17 of the Banking Companies Ace was not sufficient compliance with the requirements of creation of development rebate reserve in the Income-tax Act.
There are two observations in the Supreme Court judgment which have led to differences of opinion between various Indian High Courts to which we shall refer presently. One observation is ‘the amount to be transferred to that reserve is debited before the profit and loss account is made up’ and the other is that ‘it is also clear from the terms of the proviso that the transfer to the reserve fund should be made at the time of making up the profit and loss account.’ We must bear in mind that the Supreme Court was dealing with a case where it came to the conclusion that no development rebate reserve had been created. It was not dealing with the question of time when such development rebate reserve could be created. The observations in quotation marks reproduced hereinabove appear to us to be no more than a mere discussion of the matter and not dicta, whether obiter or otherwise.”
- Having made the above observation regarding the Supreme Court decision, the Bombay High Court proceeded to deal with the Gujarat decision in Surat Textile Mills Ltd. v. Commissioner of Income-tax,  80 ITR (Guj) and observed,  96 ITR 1, 10 (Bom):
“…..We must point out that that was a case in which no development rebate was created during the assessment year 1960-61, although there was a profit far exceeding the amount of the development rebate of Rs. 36,144. An entry allowed to have been made after the end of the assessment year was held not to have complied with the condition of creation of a development rebate reserve in the relevant year. The learned judges of the Gujarat High Court took the view that in the case of Indian Overseas Bank Ltd.,  77 ITR 512, the Supreme Court had decided that-
‘unless the reserve was created in the very same accounting year, development rebate should not bo granted ‘, agreeing with the view of tho Madras High Court and overruling the decision of the Andhra Pradcsh and the Rajasthan High Courts. The Gujarat High Court held that in view of the aforesaid decision of the Supreme Court the benefit of the development rebate could not be granted to the assessce in the case before it because of the non-compliance with the requisite conditions as to creation of a development rebate reserve. The learned judges of the Gujarat High Court also took the view that Section 154 of the Income-tax Act was attracted as there was a mistake apparent on the record of the case. With regard to the judgment of the Gujarat High Court we must say with respect that, in our opinion, the Supreme Court nowhere lays down in Indian Overseas Bank Ltd. v. Commissioner of Income-tax,  77 ITR 512 (SC) the time at which the development rebate reserve must be created. We are unable to read in the judgment of the Supreme Court any observations to the effect that development rebate reserve must be created in the year of installation or fixation of the machinery irrespective of profits in that year or that the income-tax authorities could not permit the assessee to make up any deficiency in development rebate reserve which has occurred bona fide in subsequent years. In the case before the Supreme Court no development rebate reserve had been created at all at any time and, therefore, the claim for rebate was disallowed.”
- Having distinguished these two decisions on the grounds indicated above, the Bombay High Court proceeded to adopt the view taken by the majority of High Courts, namely, Allahabad in Commissioner of Income-tax v. Modi Spinning & Weaving Mills Co. Ltd.  69 ITR 304 (All). Andhra Pradesh in Veerabhadra Iron Foundry v. Commissioner of Income-tax,  69 ITR 425 (AP). Punjab and Haryana in Commissioner of Income-tax v. Sardar Singh Sachdeva,  86 ITR 387 (Punj) and Rajasthan in Commissioner of Income-tax v. Mazdoor Kisan Sahkari Samiti, 75 jITR 253(Raj) . The following conclusion has been indicated by the Bombay High Court,  96 ITR 1, 13 (Bom):
“Reviewing the above decisions we find that the Supreme Court has not decided in Indian Overseas Bank Ltd. v. Commissioner of Income-tax,  77 ITR 512 (SC), that the profit and loss account originally prepared and passed by a company cannot be subsequently amended by it and that the Income-tax Officer has no power to allow development rebate if the entries are made after the filing of the original return of income or even at a subsequent date in cases of bona fide mistake…..”
- We have already indicated the facts of the case before us. The assessee has made provision for the development rebate in the relevant year. The only mistake pointed out by the Income-tax Officer is that it had not been done while closing the accounts and drawing up of the profit and loss statement. We agree with the view of the Bombay High Court that there is no upper limit of time fixed under the Act for claiming benefit of development rebate and by the time the revised return was filed due provision having been made, there was no defect which disentitled the assessee to claim and be granted the relief. As we find, the revised return has been accepted and dealt with. It was open to the Income-tax Officer to reject the revised return saying that it did not come within the purview of Section 139(5) of the Act; on the other hand he chose to act upon the revised return.
- Section 34(3)(a) of the Act provides :
“The deduction referred to in Section 33 shall not be allowed unless an amount equal to seventy-five per cent. of the development rebate to be actually allowed is debited to the profit and loss account of the relevant previous year and credited to a reserve account to be utilised by the assessee during a period of eight years next following for the purposes of the business of the undertaking, other than –
(i) for distribution by way of dividends or profits; or (ii) for remittance outside India as profits or for the creation of any asset outside India :…..”
- It is not the stand of the revenue that the conditions indicated in the aforesaid provision have not been satisfied.
- Our answer to the question referred to us, therefore, is:
On the facts and in the circumstances of the case and on a true inter pretation of Clause (a) of Sub-section (3) of Section 34 of the Income-tax Act of 1961, the Appellate Tribunal was correct in holding that the assessee-
firm was entitled to the development rebate for the assessment year 1964-65.
- Assessee shall have its costs of this reference which we assess at rupees one hundred.