Wealth Tax Act (XV of 1963)‑‑‑

‑‑‑‑S. 16(3)‑‑‑Wealth Tax Rules, 1963, R.8(2)(c)(ii)‑‑‑Calculation of break‑up value‑‑‑Reserve for contractual obligation‑‑‑Free reserve‑‑ Value of shares was declared at face value‑‑‑Break‑up value however was declared on the basis of final balance sheet without adding "reserve for contractual obligation" appearing on the liability side of the balance sheet‑‑‑Assessing Officer worked out the break‑up value by adding such reserve for contractual obligation ‑‑‑Assessee contended that "reserve for contractual obligation" appearing on the balance sheet was a trade liability emanating from future obligation which had to be provided for in terms of contract and was not free reserves as envisaged under R.8(2)(c)(ii) of the Wealth Tax Rules, 1963 which was wrongly assumed to be so by the Assessing Officer‑‑First Appellate Authority observed that Assessing Officer was required in terms of the provisions of the said rules to carefully scrutinize the balance sheet in order to exclude therefrom items which really did not form part of the reserves, as well as distinction between provisions and reserves etc.‑‑‑Validity‑‑‑Undoubtedly calculation of break‑up value was made by treating the reserve for contractual obligation as a free reserve without scrutinizing the balance sheet with a view to exclude items which should really form part of the reserve as had 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 without having proved the surplus over the liabilities which could have formed the part of the reserves in terms of R. 8(2)(c)(ii) of the Wealth Tax Rules, 1963‑‑‑Assessing Officer intended to treat reserves for contractual obligation as free reserve deviating from the past or if put in the words of the assessee that reserve for contractual obligation as declared position had been accepted on merit in the past, it was required that proper details should have been ascertained and assessee allowed opportunity to put their point of view‑‑‑Since it was not done action of the Assessing Officer in calculating break‑up value was rightly declared by the First Appellate Authority as not sustainable in law‑‑‑Appellate Tribunal held that reserve for contractual obligation was clearly distinguishable as reserves based on provision for contractual obligation which constituted ascertainable liability‑‑‑What the Assessing Officer should have done was to ascertain the excess over the contractual obligation for meeting the provisions created‑‑‑Assessing Officer calculated break‑up value without properly ascertaining the facts of reserves as acquired by law and without scrutinizing the facts of the reserves/provisions before treating the same as free reserves‑‑‑Provisions of law and instructions of the Central Board of Revenue on the subject had been dealt in contravention of method and manner for purposes of calculation of break‑up value‑‑‑Requirement of justice and fair-play was that when deviating from history and creating liability of a very high proportion assessee should have been heard by confronting him with the objection and their point of view considered‑‑‑First Appellate Authority emphasized by the assessee although got persuaded to find that the treatment of calculation of break‑up value was not sustainable yet in the interest of justice and fair-play to both the parties (particularly the Revenue) it was deemed proper to order de novo proceedings‑‑ Objections of the assessee on the setting aside by the First Appellate Authority though were well based yet Appellate Tribunal observed that it would be appropriate to let the Assessing Officer scrutinize the facts of the reserves for contractual obligation which in all fairness was an ascertained liability‑‑‑Appellate Tribunal directed that reserve for contractual obligation be scrutinized for purposes of exclusions from free reserves‑‑‑Appeal of the Department against the setting aside was declared without merit.

1979 PTD 12; PLD 1979 Lah. 63; 1985 PTD 413; S.R.O. 116(R)/68; 1964 PTD 194; (1962) 44 ITR 551; (1963)48 ITR 562; AIR 1959 SC 1049; 1982 PTD 277 and 1983 PTD 435 ref.

1984 PTD 18 and (1969) 73 ITR 53 rel.

Ch. Yousuf Ali, I.T.P. for Appellante/Assessee.

Mrs. Talat Altaf, D.R. for Respondent/Department.

Date of hearing: 15th May, 2002.

ORDER

IMTIAZ ANJUM (ACCOUNTANT MEMBER).‑‑‑In the titled case cross‑appeals have been filed contesting setting aside of the impugned order under section 16(3), dated 13‑12‑2000 vide appellate order, dated 10‑4‑2001 passed by the learned CIT/WT(A), setting aside has been objected to be unjustified by the appellant on the basis of observation "in view of the above quoted judgments numerous other decisions by the Superior Courts and maxim "A .. A . P . " it is observed that the assessment is not maintainable in the eyes of law". Setting aside has further been objected on the ground that de novo decision was not warranted as Assessing Officer had erred by adding the value of liabilities/obligations provided under the "reserve for contractual obligation" by treating them free reserves.

2. On the Ether hand Revenue has contested setting aside with the direction to provide opportunity to the assessee was unjustified a s assessment was finalized under section 16(3) and not 16(5) of the Wealth 'Tax Act, 1963. It has been further agitated on behalf of the department that CIT(A) was not justified in disapproving the procedure adopted for the valuation of shares to work out the break up value.

3. We have heard Ch. Yousuf Ali, ITP alongwith Mr. Iqbal Hashmi, Advocate, learned authorized representatives for the appellant/assessee and Mrs. Talat Altaf, learned representative for the department.

4. Facts of the case briefly stated are that value of 5333 shares of Messrs Hasnain Construction (Pvt.) Ltd. were declared at face value of Rs.1,000. However, on the basis of final balance sheet its break up value was declared at Rs.1025 per share; as per calculation reproduced by the Assessing Officer in the body of the order which was found wrong in as much as that in terms of provisions of Rule 8(2)(c)(ii) of Wealth Tax Rules "reserve for contractual obligation" appearing on the liability side of the balance sheet had not been added towards calculation of BUV. BUV was worked out at Rs.10,503,40 by adding the reserve for contractual obligation.

5. CIT(A) after considering the facts of the BUV declared by the assessee and calculated by the DCIT/WT, provisions of Rule 8(2)(c)(ii) and contentions of the assessee that "reserve for contractual obligation" appearing on the balance sheet was a trade liability emanating from future obligation which had to be provided for in terms of contract was not free reserves as envisaged under the rules which was wrongly assumed to be so by the DCIT/WT. CIT(A) at the same time appreciating the argument that DCIT was required in terms of the provisions of the rules to carefully scrutinize the balance sheet in order to exclude there from items which really did not form part of the reserves, as well as distinction between provisions and reserves etc. on the basis of case law formed the opinion that BUV had been calculated by the DCIT without confronting and allowing proper opportunity of hearing to the assessee. Relying upon reported cases 1979 PTD 12; PLD 1979 Lah. 63 Lahore High Court decided the appeal in the following manner:‑‑‑

"In view of the above quoted judgments and numerous other decisions by the superior Courts and maxim `A . A .. P ' it is observed that the assessment is not maintainable in the eyes of law. It is thus in the interest of justice that the assessment is set aside for de novo decision after providing an opportunity of being heard to the appellant and proper appraisal of facts of the case."

6. Ch. Yousuf Ali, learned authorized representative of the appellant has argued that CIT(A) after having found the basis of calculation of BUV by the CIT not maintainable in the eyes of law was not at all justified to set aside the matter for de‑novo decision. A.R. has contended that once it was established that Assessing Officer had neither carefully considered the facts nor proceeded to comply with the provisions of law calculation of BUV being arbitrary and against the facts and law was liable to be struck down. In elaborating this contention the learned AR has pointed out that DCIT failed to properly scrutinize the liabilities claimed on account of "reserves for contractual obligation" as required by law in order to determine whether it was a free reserve or a liability as such. The A. R. has further supported above contention by relying upon case reported in 1985 PTD 413. On the strength of above quoted judgment and ratio decided by the Honourable Sindh and Balochistan High Court, Karachi has emphasized that while taking up the issues of provisions of gratuity fund for payment to its employees on retirement and free reserves in terms of C.B.R. clarification No. S.R.O. 116(R)/68, dated 1‑7‑1968 declared that such provision was ascertained liability and a proper charge on the P&L account. The issue of free reserves vis‑a‑vis liability has been dealt in an exhaustive manner. The AR has emphasized that the ratio decided through the above judgment was after a detailed consultation of the case law placed before their lordships laid down in unequivocal parameters of free reserves as per the existing law at the time of operation of Finance Act, 1968 through which expression "free reserves" and definition of income were amended. In arriving at this conclusion contents S.R.O. 116(R)/68, dated 1‑7‑1968 have been discussed in detail while benefiting from reported decisions of Indian jurisdiction 1964 PTD 194; (1962) 44 ITR 551; (1963) 48 ITR 562; AIR 1959, S.C. 1049; 1982 PTD 277; 1983. PTD 435. Although the extracts from all the case law quoted above have been reproduced by the Honourable Judges of the High Court the learned AR has specifically emphasized the following: ‑‑‑

(i) M ..C ..L .. by L.C.B. Gower Second Edition on the question of statutory provisions under the Companies Act to the preparation of the Balance sheet at page 423, which reads as follows:‑‑‑

"The object of the statutory provisions is to ensure, so far as possible that the balance sheet reveals accurately and in some detail sufficient information to enable these deductions to be made. Once again the primary rule is that it must give a `true and fair view'. This time of `the state of affairs of the company as at the end of its financial year.' And, once again this is supplemented by the detailed requirements of Eighth Schedule. Among other rules, it is laid down that fixed assets shall be distinguished from current assets (as we have seen, this is necessary in order to enable the company's liquidity to be determined), and the method used to arrive at the amount of the fixed assets must be stated. The aggregate amount of capital reserves, revenue reserves and provisions are to be stated under separate headings. These are defined, and the essential distinction between them is that a provision is an amount set aside to meet a known liability the exact amount of which cannot be determined with accuracy, whereas reserve is an amount retained to meet unknown eventualities. If the reserve is not considered as free for distribution by way of dividend it is to be called a capital reserve, any other being a revenue reserve."

(ii) Kanga and Palkhivala's Income Tax Seventh Edition, Volume 1, page 450 which reads as follows:‑‑‑

"In Calcutta Co. Ltd. v. CIT the Supreme Court held that if a liability has been definitely incurred in the accounting year, e.g. and unconditional contractual liability, it cannot be regarded as contingent merely because it is to be discharged at a future date and the cost of discharging it is not definite but has to be estimated. In that case the Supreme Court allowed the estimated cost of discharging a contractual liability to undertake a development scheme within reasonable time in the future, as a proper deduction in computing the commercial profits, apart from the express statutory provisions for deductions. See further under section 28 "profits and gains", P.340, and under section 29, "List of allowances is not exhaustive", P.352."

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.