JEEVAIN REDDY, J.-The question referred to us under section 256(1) of the Income-tax Act is "Whether on the facts and ire the circumstances of the case, the income tax, Appellate Tribunal was right in excluding the amount of 'depreciation fund' and 'building reserve fund' for the purpose of determin--ing the deemed dividends under section 2 (6-A) (e) of the in than Income-tax Act, 1922 for the assessm ent years 1955-56 and 1956-57."
The question arises in the following circumstances.
2. The assessm ent for the year 1955-56 made on 30-11-1955 in respect of the assessee concerned herein was sought to be re-opened under section 34(l) (a) of the Indian I.-T. Act, 1922 by a notice, dated 6-3-1952 to include income from dividends as defined under section 2.(6-A) (e) of the said Act. The assessm ent in pursuance of this notice was completed o0 27-6-1964, against which order there was an appeal. The appeal was allowed and the matter was remitted to make a re- assessm ent after obtaining complete particulars regarding the extent of accumulated profit..
Accordingly the assessm ent eras completed on 10-6-1960. Against the said order an appeal was preferred to the Appellate Assistant Commissioner which was dismissed and then s further appeal to the Tribunal. Several contentions were raised before the Tribunal ; but we are concerned herein only with one of the questions decided by the Tribunal and which it held in favour of the assess.
3. We shall state the facts relevant to the said question only. The assessee is a shareholder in a company which is not a company is which the public are substantially interested within the meaning of section 23(A3 of the 1922 Act. The accumulated profit brought forward for the assessm ent year 1955-56 was Ks. 1,11,008. To this the I. T. O. Addled the amount of depreciation fund of Rs. 86,770 and building reserves o: Rs. 10,596 making a total sun: of Rs. 2,08,374 out of this amount, income-tax, in a sum of Rs. 92,479 was deducted leaving the because of accumulated profits in a sum of Rs. 1,15,895. The contention of the assessee before the depart--mental authorities as well as before the Tribunal was that the depreciation fund and the building reserve fund should not be deemed to be part and parcel of accumulated profits. In other words the contention was that the said amount should not be taken into account while determining the accumu--lated profits. Though the departmental authority did not agree with this view, the Tribunal did follow the decision of the Bombay High Court reported in Navinitilal C Jhaveri .v.
Commissioner of income Tax, Bombay City, Bombay ((1971) 80 I T R 582). The Tribunal held that both these amounts should not be takes into consideration in determining the accumulated profits. Aggrieved by the decision of the Tribunal the department asked for and obtained the reference.
4. The expression 'dividend' is defined in clause (6-A) of section 2 of the 1922 Act. It is an inclusive definition and we are concerned only with clause (e) herein which reads as follows "Any payment by a company not being a company in which the public are substantially interested within the meaning of section 23-A of any sum whether as representing a part of the assets of the company or otherwise) by way of advance or loan to a shareholder or any payment by any such company on behalf or for the individual benefit of a shareholder to the extent to which the company in either case -possesses accumulated profits."
According to clause (e) any sum paid by way of advance or loan to a share--holder or any payment by any such company or behalf or for the individual benefit of a shareholder by a company of the type mentioned therein shall be treated as dividend, to the extent to which the company in either case possesses accumulated profits. The question is what does the expression `accumulated profits' signify. This expression has not been defined in the Act but has received judicial interpretation at the hands of several High Courts as well as the Supreme Court. The first decision cited before us is a decision of the Gujarat High Court in Commissioner of income-tax, Bombay North v. Virangam Mills Co, Ltd, ((1961) 43 I T R 270). There the question .Was whether the 'buildings and machinery depreciation fund' constitutes a reserve within the peg of the first proviso to section 23-A (1) of the Act. The proviso to section 23-A (1) said that when the reserves representing accumulations of past profits, which have not been the subject of an order under subsection (1) of section 23-A exceed the paid up capital of the company, section 23-A shall apply as if instead of the words 'sixty per cent' the words 'one hundred per cent' are substituted. In the: case an order in terms of the proviso was made by the Income-tax Officer, which was questioned by the assesses contending that the inclusion of the building and machinery depreciation fund in the reserves untenable in law. In that connection the Division Bench of the Guiarat High Court referred to the oft cited passage in In re Spanish Prospecting Company Limited ((1911) 1 Ch. 92,98 (C.A)).By Flecher Moulton L. J. Which is to the following effect - ------..`profits' Implies a comparison between the state of business at two specific dates usually separated by an interval of a year. The funda--mental meaning is tire amount of gain made by the business during the yeas. This can only be ascertained by a comparison of the assets at the two dates------, if the total assets of the business at the two dates be compared the increase which they show at the later date as compared, the earlier doe (due allowance of course being made for any capital introduced into or taken out of the business in the meanwhile) represents in strictness the profits of the business during the period in question.
S. They also referred, to the decision of Mahajan, J. In Commissioner income-tax v. Ahmed bhai Umarbhai & Company ((1950) 18 I T R 472 : A I R1950 SC 134) and certain other decisions and held ultimately that the amount allowed and allocated towards depreciation of machinery and buildings is indeed a fund of cash of other liquid assets set aside for the purpose of replacing the depreciating proper .y at the end of its service life It was further held that the expression 'profits' must be understood in a commercial sense and that it is not the same thing as the taxable income under the Income-tax Act, a particular income or amount may not be taxable or may be exempt under- the Income-tax but it may yet constitute profits in the commercial sense. It was observed that the recogni--petition of depreciation is a condition precedent to the ascertainment of profits and must be deducted out of the reserves for the purpose of the first proviso to section 23-A (1) of the Act. The Court further observed that the depreciation fund did not represent accumulations of past profits and that the profits of the company could only be ascertained after providing for the depreciation is the assets of the company.
6. The next decision cited before us is of the Bombay High Court in Commissioner I Income-tax (Central), Bombay v. P. K. Badiani ((1970) 76 I T R 369: (1971) T L R 97) the head note of that de6sion clearly brings out the principle of the decision and we may set out to the extent it is relevant for the present purpose (at p. 99). `Allowance for depreciation is to replace the value of an asset to the extent it has depreciated during the period of accounting relevant to the assessment year and as the value has, to the extent been lost the corresponding allowance for depreciation takes its place and, therefore, when arriving at the profits for that period the amount of depreciation has to be deducted, because the amount of the value lost by depreciation is a capital loss which must be replaced first as otherwise, the initial capital would, to that extent incorrectly and falsely be converted into and treated as profits. Development rebate is not intended to replace any capital loss by wear and tear or in any such other way.. It, therefore, forms part of real profits and even after it is allowed as a deduction under section 10 (2) (vi) (b), it continues to retain its original character of profits, thus, 'accumulated profits' include amounts of development rebate-"
This decision was affirmed by the Supreme Court in P. K. Badianl v. Commissioner of Income-tax Bombay ((1970) 105 I T R 642: (1977) T L R 158). In this decision, the Supreme Court referred to the aforesaid definition of profits by Fletcher- Moulton, L. J. And to the decision of Mahajan, J., and held finally that the depreciation is allowed in respect of buildings and machinery with a view to provide for a fund to replace the same as and when their life is over, and, therefore, any amount or fund representing depreciation is not profits. But they made a distinction in the case of initial depreciation and development rebate which do not stand on the same footing and are in the nature of incentives to encourage industrial production. The Supreme Court, in this decision referred to the decision of the Gujarat High Court in Commissioner of Income-tax, Bombay North v.
Yirimgam, Mills Co. Ltd. With approval. It also referred to a derision of the Madras High Court in Commissioner of Income-tax, Madras v. Srinivasan ((1963) 50 I T R 788) approvingly where it was held "For the purposes of section 2 (6-A) (1) of the Indian Income-tax Act, 1972. 'accumulated profits' include general reserves. Unless the profits capitalised in some form or other mere transfer of the profits to any reserve account will not take away from profits the character of accumulated profits."
When the decision of the Calcutta High Court in Commissioner of Income-tax, Calcutta v. Bibhud Bhusan Dit ((1963) 48 I T R 233) was brought to their notice, the Supreme Court distinguished the sane, holding that was a case where the income of the assessee was assessed under the head 'Income from property' under section 9 of 1922 Act.
7. The principle that emerges from the above decisions is that the building and machinery depreciation fund is not profits and, therefore, cannot be treated as or included in accumulated profits. It as a necessary deduction from out of the profits; since it is a fund set apart each year with a view to replace toe machinery end building as the case may be, after the life, of the present machinery or building is over. But the same cannot be said with respect to other funds for example initial depreciation or development rebate as the case may be. Again an assessee by merely allocating part of his profits to a particular Head, cannot change their character; they continue to - remain profits only. Following the above principles, it must be held in this case that so far as the depreciation fund is concerned the Tribunal is right I holding that the same could not have been included in the accumulated profits within the meaning of sub-clause (2) of clause (6-A). It being a depreciation fund clearly falls within the principle of the decision of the Gujarat High Court referred to above. But so far as the building reserve fund is concern it does not appear that it is in the nature of a depreciation fund. It merely seems to be a fund set apart for constructing new building, or at any rate a amount set apart out of the profits under that Head. Unless this fund is in the nature of the depreciation fund or of a like nature, it is not entitled to be deducted while determining the accumulated profits. In the circumstances we must hold that the Tribunal was in error in treating the building reserve fund on the same footing as the depreciation fund. The decision of the Supreme Court referred to above makes it clear that several funds created comprising of initial depreciation development rebate or in the name of General reserves do continue to be profits and are not deductible while determining the amount of accumulated profits.
8. For the above reasons we answer the question referred to us partly in favour of the department and partly in favour of the assessee. So far as the depreciation fund is concerned the answer shall be m the affirmative and in favour of the assessee. But so far as the building reserve fund is concerned, our answer shall be in the negative and in favour of the department.
9. In the circumstances of the case we direct the parties to bear their own costs in this appeal.