S. RANGANATHAN ( 1 ) THESE two references arise underthe Companies (Profits) Sur-tax Act, 1964 (hereinafter referredto as "the Act") and involve the much debated question whethercertain sums set apart by the respondent constituted reserves within the meaning of Rule 1 of the Second Schedule to the Act. ( 2 ) THE assessee is a public sector corporation carrying on thebusiness of import and export of minerals and metals. It isincorporated as a company under the Companies Act. For theassessment years 1966-67 and 1967-68 the assessee claimed thatthe following amounts which were shown in the balance sheetof the corporation for the relevant years as on 1/04/1965and 1/04/1966 respectively constituted reserves whichshould be added to the capital base of the company for determining the statutory deduction under The Act: THE Income-tax Officer was of opinion that the above threeitems were in the nature of "current liabilities are previsions"and could not, therefore, be treated as "reserves". The Appellateassistant Commissioner agreed with this view. But on furtherappeal the Tribunal held that the amounts were "reserves". At the instance of the Commissioner of income-tax the followingquestions have been referred to us for our decision :for the Assessment Year 1966-67. "whether on the facts and in the circumstances of thecase, the Tribunal was correct in law in holding thatthe accounts styled as staff Benefit Reserves , and self-Insurance Reserve were outside the. scope ofthe Explanation to Rule I of the Second Schedule tothe Companies (Profits) sur-tax Act, ]964 are theamounts standing to the credit thereof constitutereserves within the meaning of the said Schedule ?". For the Assessment Year 1967-68. "whether on the facts and in the circumstances of thecase, the Tribunal was correct in law in holding thatthe accounts styled as staff Benefit Reserves , staffbonus Reserve , and self-Insurance Reserves , wereoutside the scope of the Explanation to Rule I of thesecond Schedule to the Companies (Profits) Sur-taxact, 1964 and the amounts standing to the creditthereof constitutes reserves within the meaning of thesaid Schedule ?" ( 3 ) THE Act presently under consideration replaced the Super ,profits Tax, 1963. Broadly the pattern of the two Acts is thesame but there are some minor differences. The 1963 Actbrought to tax the super profits of a company by which wasmeant the excess of its chargeable profits of a previous year overthe standard deduction. Broadly the pattern of the two Acts is thesame but there are some minor differences. The 1963 Actbrought to tax the super profits of a company by which wasmeant the excess of its chargeable profits of a previous year overthe standard deduction. The chargeable profits were profitsmade by the company during the relevant previous year as determined for the purposes of income tax with same adjustmentsit is unnecessary to consider here. The standard deductionwas an amount equal to 6% of the capital of the company orrs. 50,000 whichever is greater. The rules for computation ofthe capital were set out in the Second Schedule. Rule 1 of thesaid schedule, in so far as it is material for our present purpose,. provided that the capital of a company shall be the sum of theamounts, as on the first day of the previous year relevant to theassessment year of " (1) its paid up share capital; (2) its reserves if any, created under the proviso (b) to clause (vi-b) of subsection (2) of Section 10 of the Indian Income-tax Act, 1922 (11 of 1922), or under sub-section (3) of Section 34 of the Income-tax Act, 1961 (43 of 1961); (3) Its other reserves as reduced bythe amounts credited to such reserves as have been allowed asa deduction in computing the income of the company for thepurpose of the Indian Income-tax Act, 1922 (11 of 1922), or the. Income-tax Act, 1961 (43 of 1961 ). . . . . . " There was nodefinition of the expression "reserves" in this Act. ( 4 ) THE 1964 Act also brought to charge the chargeableprofits of a company in excess of the amount of statutory deduction provided for by the Act. Chargeable profits were computedin each previous year by mating certain adjustments to theprofits determined for income tax purposes. Statutory deductionmeant an amount equal to 10% of the capital of the companyas computed in accordance with the provisions of the Secondschedule or an amount of Rs. two hundred thousand whicheveris greater. The rules for computation of the capital were laiddown in the Second Schedule and Rule 1 was on the same linesas the 1963 Act and defined the capital of the company as theaggregate of the amounts of its paid up share capital and itsreserves in the same language as [he 1963 Act. two hundred thousand whicheveris greater. The rules for computation of the capital were laiddown in the Second Schedule and Rule 1 was on the same linesas the 1963 Act and defined the capital of the company as theaggregate of the amounts of its paid up share capital and itsreserves in the same language as [he 1963 Act. However, anexplanation was added in the following terms: "explanation For the removal of doubts it is herebydeclared that any amount standing to the credit of anyaccount in the books of a company as on the first dayof the previous year relevant to the assessment yearwhich is of the nature of item (5) or item (6) or item (7)Under the heading "reserves AND SURPLUS"or of any item under the heading "currentliabilities AND PROVISIONS" in the columnrelating to "liabilities" in the "form of Balance-Sheet" given in Part 1 of Schedule VI to the Companies Act, 1956 (1 of 1956), shall not be regarded asa reserve for the purposes of computation of thecapital of a company under the provisions of thisschedule. " ( 5 ) NEITHER the 1963 Act nor the Act presently under consideration contained a definition of the term "reserve". But the 1964act clarified by means of a reference to the form of balancesheet prescribed for companies under the Companies Act thatany item which is displayed in the balance sheet under the heading"current liabilities and provisions" would not constitute a"reserve". Similarly it clarifies that an item displayed againstitems (5), (6) and (7) in the balance sheet under the heading"reserves and surplus" shall not also be treated as a " reserve". Items (5), (6) and (7) in the balance sheet under the heading"reserves and surplus" are as follows : " (5) Surplus, i. e. , balance in profit and loss account afterproviding for proposed allocations, namely, dividend,bonus or reserves. (6) Proposed additions to reserves. (7) Sinking funds. "under the heading "current liabilities" are to be shown theliabilities of the company towards "acceptances, sundry creditors,subsidiary companies, advance payment and unexpired discounts,unclaimed dividends", other liabilities, if any, and liability byway of interest accrued but not due on loans. Under the subhead provisions mention is made of provision for taxation,for proposed dividend, for contingencies, for provident fundscheme, for insurance, pension and similar staff benefit schemesand other provisions. Under the subhead provisions mention is made of provision for taxation,for proposed dividend, for contingencies, for provident fundscheme, for insurance, pension and similar staff benefit schemesand other provisions. It is further clarified that a foot-note tothe balance-sheet may be added to show separately claimsagainst the company not acknowledged as debt, uncalled liabilityon shares partly paid, arrears of fixed cumulative dividends,estimated amount of contracts remaining to be executed oncapital account and not provided for andother money for whichcompany is contingently liable. Rule 7 of Part III of the Sixthschedule to the Companies Act also contains a definition clause. This rule runs as follows : "7 (1) For the purpose of Parts 1 and 11 of this Schedule,unless the context otherwise requires (a) the expression "provision" shall, subject to subclause 2 of this clause, mean any amount writtenoff or retained by way of providing for depreciation, renewals or diminution in value of assets,or retained by way of. providing for any knownliability of which the amount cannot be determined with substantial accuracy; (B) the expression "reserve" shall not, sobject asaforesaid, include any amount written off orretamed by way of providing for depreciation,renewals or diminution in value of assets orretamed by way of providing for any knownliability; (C) the expression "capital reserve" shall not includeany amount recorded as free for distributionthrough profit and loss account; and the expression "revenue reserve" shall mean any reserveother than a capital reserve. " A sub-paragraph appended to sub-clause (1) clarifies thatthe expression liability used in the sub-clause shall includeall liabilities in respect of expenditure contracted for and alldisputed or contingent liabilities. Sub-clause (2) of the aboverule clarifies that were an amount of provision is made ? excessof the amount which in the opinion of the directors is reasonablynecessary for the purpose the excess shall be treated for thepurpose of the schedule as a "reserve" and not as a "provision". ( 6 ) IT is in the context of the above provisions of the 1964act that the questions in the present case have to bedecided and it will be convenient at the present stage to brieflyset out the nature of the three items of appropriations made bythe assessee. ( 7 ) THE first item is the staff benefit reserve. ( 6 ) IT is in the context of the above provisions of the 1964act that the questions in the present case have to bedecided and it will be convenient at the present stage to brieflyset out the nature of the three items of appropriations made bythe assessee. ( 7 ) THE first item is the staff benefit reserve. The managementof the corporation was setting apart a portion of the surplusevery year under different heads and staff benefit reserve wasone of the heads under which such allocation was made yearafter year. This amount was kept aside for the implementationof various benefit scheme of the company. The corporationhad formulated a set of rules blown as "staff Benefit Rules"for regulating the expenditure on different welfare schemes. Such rules were quite detailed and provided for various kinds ofexpenditure on welfare schemes such as: (1) grant of educationalallowance to the children of the corporation s employees; (2)grant of scholarships to deserving children of the employees: (3) relief to the members of the staff and their families in caseof distress not admissible under the normal rules; (4) grant inaid for sports and recreation clubs; (5) establishment of familywelfare centres for giving training in tailoring, embroideringand other arts to members of the employees families; (6) establishment of departmental/cooperative canteens and stores;and (7) other items of welfare sanctioned from time to time andconsidered to be beneficial for the general well being of theemployees subject to the approval of the Managing Director. ( 8 ) THE next item is the "staff Bonus Reserve". This wasan allocation made ill order to enable the company to dischargeits statutory liability under the Bonus Act, 1965. Bonus payments are to bemade by an employer to its employees out of the"allocable surplus" of the profits of the year, determined inaccordance with well established principles. The Bonus Actapart from defining "allocable surplus" made certain modifications in the general principles that were being applied in Industriallaw. In the first place. Section 10 of the Act laid down thatwhether the employer has an allocable surplus at all or not,each eligible employee should be paid a minimum bonus offour per cent of the salary. Secondly, it provided that thebonus payable should be increased above 4. % where the allocablesurplus was more than the amount necessary for the paymentof the minimum bonus. Section 10 of the Act laid down thatwhether the employer has an allocable surplus at all or not,each eligible employee should be paid a minimum bonus offour per cent of the salary. Secondly, it provided that thebonus payable should be increased above 4. % where the allocablesurplus was more than the amount necessary for the paymentof the minimum bonus. The bonus payment was to be proportionately stepped up, where the allocable surpus permitted it,upto amaximum of 20% of the Salary. Thirdly and this is whatis material for our present purpose the Statute at the relevanttime contained a set-off/set-on provision by which the shortfallof the allocable surplus in any year below the amount necessaryfor distribution of the minimum bonus could be set off againstthe surpluses available in a subsequent year; and likewise, thesurplus left over after the distribution of the maximum bonusfor any year could be set on and added to the surpluses availablein a subsequent year to declare a higher bonus. Such carryforward for set off or set on was envisaged for a period of fouraccounting years. The practical application of this principle (which has been modified in certain aspects by an amendmentof 1976 with effect from 25-9-1975 with which we are not concerned) has been illustrated in the Fourth Schedule (now thethird Schedule) to the Act. The company, therefore, set asideout of its. profits cortain sums representing the "set on" that wouldbe necessary to meet a possible deficiency of profits in a futureyear when it may be required to distributed the minimum bonus despite the absence of sufficient profits. THE last item in dispute is the "self-Insurance Reserve". The Corporation was operating a scheme of self insurance toeconomise on insurance charges. The corporation was importing various commodities from abroad and it had to insure thesame against loss in marine transit. A comprehensive insuranceof all the commodities for their full value with insurance companies against all risks was considered to be uneconomical. The corporation, therefore, insured the commodities only againstlimited risks but at the same time considered it wise and prudentto provide for possible losses that may arise and that may not becovered by the insurance policies taken by it. Every year, therefore, the corporation set apart some amounts at a fixed ratewith a view to meet any marine loss in transit over and abovethose covered by regular insurance. Every year, therefore, the corporation set apart some amounts at a fixed ratewith a view to meet any marine loss in transit over and abovethose covered by regular insurance. A comprehensive schemehad been framed with approval of the Board of Directors and an"insurance premium" calculated at a particular rate on eachimport consignment was debited to the profit and loss account andcredited to the "reserve" account. ( 9 ) SO far as the Staff Benefit Reserve is concerned theappellate Assistant Commissioner took the view that as the disbursement of funds on the several welfare schemes was governedby elaborate rules, it was open to the employees of the corporationto insist upon expenditure being incurred on their welfare, eventhough there was no statutory liability for the corporation to do so. He felt that this was covered fully by item 12 of theitems listed under the sub-head "current liabilities and provisions" in the form of balance sheet. In regard to the Staffbonus Reserve he was of the view that the provision had beenmade in pursuance of a statutory liability under the Bonus Actwhich could at best be called a contingent liability. The factthat these amounts were debited to the profit and loss accountalso showed that they were in the nature of provisins for contingentliabilities and not appropriations to reserves from the appropriation account. In regard to the insurance reserve hefound that the accumulations in this account were earmarkedfor a particular liability which could arise at any time dependingupon loss in a particular asignment. The amounts creditedto this reserve were provisions against liabilities dependent onthe happening of a contingency in future and it would not becorrect to call them. reserves. ( 10 ) ON the other hand the Appellate Tribunal was of opinionthat the amounts set apart under the head of Staff Benefitsreserve could not be said to be amounts set apart for any knownliability of which the amount could not be determined withsubstantial accuracy. So far as the Staff Bonus reserve wasconcerned the Tribunal pointed out that there was no definiteliability on the part of the company in this respect in the yearunder consideration and that unless and until some deficiencyof profits arose in a subsequent year there would be no liabilityon the part of the corporation to distribute a bonus and so thisamount was also a reserve and could not be treated as aprovision. So far as the third item was concerned, theTribunal was ofopinion tha,t despite the fact that there was a scheme formulatedthe accumulations in the account did not partake of the natureof liabilities as there was no known liability against the corporation. for the amounts in question and, therefore, they could notbe treated as liabilities but could only be treated as reserves. ( 11 ) WE think that there can be no doubt at all thatthe conclusion of the Tribunal was clearly right in so far asamounts set apart for the Staff Benefit Reserve and Self Insurancereserve were concerned. Though the form of balance sheetprescribed, under the Companies Act refers to provisions forinsurance and staff benefit schemes for inclusion under item 12"under the sub-head "current liabilities and provisions" thequestion whether any particular item has to be listed under the"current liabilities and provisions" or not has to be decidedin terms of the definition contained in Rule 7 of Part III of Vlthschedule to the Companies Act to which reference has beenmade earlier. A provision in respect of self insurance, bonusand similarly staff benefit schemes can come under the aboveheading only if it is capable of being described either as acurrent liability or as a provision, i. e. , as a liability which existson the date of the balance sheet or as an item of amount retainedby the company by way of providing for any known liability ofwhich the amount cannot be determined with substantial accuracy. In either case there should exists a liability though it couldbe a disputed or contingent liability as contemplated in the aboverule. However, so far as these two items are concerned, weare unable to see any liability on the part of the company forwhich it is at all necessary to make any provision whether "current"or otherwise. So far as the staff benefit schemes are concernedthe relevant rules have not been placed before us. But itappears clear from the details appearing in the record that thereis no liability on the part of the corporation to incur any expenditure in this respect. So far as the staff benefit schemes are concernedthe relevant rules have not been placed before us. But itappears clear from the details appearing in the record that thereis no liability on the part of the corporation to incur any expenditure in this respect. The company has no doubt several schemesfor the benefit of the employees and no doubt the companyalso utilising the money set apart under this head for the benefisof the employee s. But the finding of the Tribunal is that thereis no obligation on the part of the company towards ,itsemployees to spend the monies for the benefit of any particularemployee. There is no commitment on the part of the companythat any or all the amounts set apart in this account would orshould be spent only towards the benefit schemes. There is nomaterial placed before us to show that the "rules" in accordancewith which the funds in reserve are distributed are binding onthe corporation vis-a-vis its employees. On the other hand theitems of welfare schemes some of which have been referred toearlier would show that the application of money is purely discretionary on the part of the company. Thus, e. g. , while thecompany could grant scholarships to deserving children of theemployees none of the employees would be in a position to insistthat his child should receive a scholarship from the company. Similarly while the fund will be utilised to relieve distress in thecase of any members of the staff or his family the relief isprovided for only in cases where it is not admissible under thenormal rules. There is no claim on the part of the staff by whichit could insist that the monies should be given in any particularcase. So also the grant in aid for sports and recreation clubsis a matter of disbursement at the will and pleasure of thecorporation. In other words though the company has builtup a fund for the benefit of various employees of the companyand though the company has also formulated for its own guidancevarious schemes and rules according to which amounts wouldbe given out of this fund there is no corresponding right on thepart of any employee to claim as of right any funds out of thisappropriation. Per contra there is no liability whether presentor future on the part of the company to spend the money inany particular way for the benefit of any particular employee. Per contra there is no liability whether presentor future on the part of the company to spend the money inany particular way for the benefit of any particular employee. The fund set apart in this account cannot therefore be describedas a fund to meet any known liability present or even the futureliability. They are clearly funds accumulated by the companyfrom time to time out of its profits with a view to be spent forsuch advantage of the employees as the company might choosein accordance with certain well defined policy. They cannotbe described as provisions. ( 12 ) THE self-insurance reserve is also in an analogous position. The corporation while importing its consignments is not obligedto insure them against all risks conceivable during a marinetransit. The corporation found it uneconomical to insure thegoods against all possible contingencies. It therefore limitedthe insurance to certain type of risks but against possible futurelosses or difficulties, the corporation also made a prudentallocation out of its profits. It calculated a certain amountin respect of each import consignment and debited the corresponding amount to the profit and less account and credited it tothe reserve account. This was only a fund built up by thecompany to enable to it off-set future losses that may arisedue to pilferage etc. in the case of marine transit of the goodswhich may not be adequately covered by the insurance. There isno obligation on the part of the company either to incur theexpenditure by way of insurance nor is the company liable to anythird party in respect of any pilferage that may occur duringtransit which is not covered by the insurance. These are merelyfunds built up by the company to safeguard itself against lossesthat may arise on account of the insurance cover not beingadequate. This again is not a provision against a liability ofthe company whether present or future. We are, therefore, inagreement with the Tribunal that this would also constitute onlya setting apart of certain funds otherwise than by way of providing for any known liability and the Tribunal was right inholding that the amounts standing to the credit of this accountrepresented reserves as on the relevant dates. ( 13 ) THIS leaves the question of the bonus reserve. In orderto understand this one has to refer to section 11 of the Bonusact. ( 13 ) THIS leaves the question of the bonus reserve. In orderto understand this one has to refer to section 11 of the Bonusact. From the provisions of the Bonus Act referred to earlier,it will be seen that the company was providing against the contingency of its being required to pay the minimum bonus in ayear in which there are not sufficient profits and also buildingup a fund that would enable the company to utilise the surplusesthus carried forward to distribute a larger or the maximum bonusin respect of any year. In so far as the reserve is being setapart to enable the assesses to meet the contingency of its beingcompelled to distribute a bonus despite the loss of profits in thatyear, the amounts credited to this account can be described asamounts set apart to meet a future contingent liability the exactamount of which cannot be ascertained with substantial accuracyat the date of the balance sheet. It can therefore be urged thatthe amounts set apart under this head would not fall within themeaning of the expression "reserve" contained in the Companiesact particularly having regard to the extended meaning ofthe word "liabilities" as set out in sub-clause (2) of Rule (7)of Part III of Schedule VI to the Companies Act. ( 14 ) SRI Desai, learned counsel for the corporation, soughtto get out of this situation by raising two contentions. Hisfirst contention was that the explanation to Rule 1 of the Secondschedule to the Act covers only a case where certain amountsstand to the credit of an account described as "current liabilitiesand provisions" in the balance sheet of the company and notto a case where the amount or amounts are shown under theheading "reserve" in the company s balance sheet. The secondpoint urged by him is that even assuming that it is not the description or the manner of depletion by the assessee in the balancesheet that is material but the real nature and substance of theallocation determined in accordance with the definition containedin Part III the amounts in question still do not constitute "provision" because they are not set apart to meet any known liability. The contention of Shri Desai is that while the word "liability"is defined to include both disputed and contingent liabilitiesfull significance should be attached to the word "known" that isused in the definition. The contention of Shri Desai is that while the word "liability"is defined to include both disputed and contingent liabilitiesfull significance should be attached to the word "known" that isused in the definition. This according to him means existingas at the date of the balance sheet. He submits that as on thedate of the balance sheet there should exist a liability whetherit is an accrued liability or a disputed liability or contingentliability. But such a liability should not on the date of thebalance sheet be purely in the realm of the unknown. To givean example, he points out, if there is a guarantee deed executedby the company in respect of loans taken by the directors therewould in a sense be a contingent liability against the companyt ne moment sucha deed is executed for the possibility of thedebtors defaulting or the creditors proceeding against the company cannot be ruled out. However, he points out a provisionin that regard needs to be made in the balance sheet only whensome director has committed default or conducted himself insuch a manner that the liability under the guarantee may, tothe company s knowledge, be sought to be enforced against thecompany. In such a situation, the liability though not determined by any appropriate authority and though disputed orcontingent has to be provided for. But where all that has happened is that the company has executed a deed of guarantee andthere is a possibility, some day in future, of a liability being fastened on the company eventually, according to the counsel,even if any amount is provided for in the balance sheet towardssuch possibility, it would still be only a "reserve". In otherwords, the attempt of the learned counsel is to restrict the expanded meaning given to the word liability by placing emphasison the use of the word known in the manifest of the definition. ( 15 ) IN support of his first contention Mr. Desai relied oncertain observations in the decision of the Bombay High Courtin Commissioner of Income Tax vs. Otis Elevator Co. (India) Ltd. (1977-107 ITR 241) (1 ). ( 15 ) IN support of his first contention Mr. Desai relied oncertain observations in the decision of the Bombay High Courtin Commissioner of Income Tax vs. Otis Elevator Co. (India) Ltd. (1977-107 ITR 241) (1 ). At page 248 the learned judges observed that the explanationto rule I of the second schedule to the 1964 Act was only forthe removal of doubts and not in order that the explanationshould apply it should be shown that, in the balance sheet ofthe company for the relevant period, certain items falling underthe heading "current liabilities and provisions" have been shownin the column relevant to "liabilities" in the form of the balancesheet or that the items are be of the nature of items (5), or (6)or (7) falling under the heading "reserves and surplus". Thecourt pointed out that the item of Rs. 53,330. 55 (which wasin issue before the Court) did not at all appear in the columnof liabilities in the balance sheet for the relevant year but appearedunder the heading "reserves and surplus" and as such the question of applying the explanation to the facts of the case did notarise. Here it seems to us and we say so with respect the Courtwas under a slight misapprehension regarding the interpretationof the explanation in the context of the form of balance sheetprescribed under the Company Law, for any item shown inthe balance sheet under the head "reserves and surplus" is anitem that will automatically fall in the column relating to liabilities in the form of balance sheet, as a glance at the balancesheet would show. The liabilities column referred to in theexplanation should not be mixed up with the heading of "currentliabilities and provisions" appearing in that column which iscertainly distinct from the heading of reserves and surplus whichis also shown under the same column. We therefore do notthink it would be correct to say that an item which appearsunder the heading "reserves and surplus" does not occur inthe column of liabilities at all in the balance sheet. However,the Bombay High Court also held that the item in questionbefore it was not of the nature of items Nos. 5, 6 or 7 under theheading "reserves and surplus" or of any of the items appearingunder the heading "current liabilities and provisions" and hencethis decision does not help Sri Desai. However,the Bombay High Court also held that the item in questionbefore it was not of the nature of items Nos. 5, 6 or 7 under theheading "reserves and surplus" or of any of the items appearingunder the heading "current liabilities and provisions" and hencethis decision does not help Sri Desai. ( 16 ) SRI Desai also invited our attention to the decisionof the Calcutta High Court in Commissioner of Income Tax v. Indian Standard Wagonco. Ltd. (1979-116 ITR 539) (2 ). At page 543 it was pointed out. that the item in question with which the court was concerned didnot fall under any of the heads mentioned in the subheading"a" under "current liabilities". It was pointed out that in theform of the balance sheet " current liabilities" and "provisions"were separately treated, the former being classified under thesub-heading "a" and "provisions" being classified separatelyunder the sub-heading "b". The Court then proceeded toobserve that what is excluded by the explanation from beingtreated as reserve is not anything which is included in the subheading "provision" but only those items which are includedunder the heading "current liabilities". It was therefore heldthat an amount falling under Item 13 or 10 under the heading"provisions" did not really fall for exclusion in the computationof reserve under the explanation. Here also, if we may say sowith respect, there appears to have been the same misapprehension regarding the scope of the explanation arising out ofa mix-up between the expression "liabilities" which refers toone of the two columns of the balance sheet and the expression"current liabilities" which is a subheading under a headingfalling under that column. As we read it, the explanation takesin for exclusion from the concept of reserve all items shownunder either of the two sub-headings a and b of the heading,,"current Liabilities and Provisions". The reference to thecolumn relating to "liabilities" made a little later in the explanation is not a reference to the heading "current liabilities"shown under the sub-heading "a" but to the general columnof liabilities as opposed to the column relating to assets in theform of balance sheet. Once, therefore, an item is recognisedto fall under the headings "current liabilities" or "provisions"or is one of the stipulated items referrable to the heading "reservesand surplus" it would certainly be liable to be excluded frombeing treated as a reserve. We are therefore unable to agreewith these aspects of the two judgments relied upon by Sri Desai. Once, therefore, an item is recognisedto fall under the headings "current liabilities" or "provisions"or is one of the stipulated items referrable to the heading "reservesand surplus" it would certainly be liable to be excluded frombeing treated as a reserve. We are therefore unable to agreewith these aspects of the two judgments relied upon by Sri Desai. ( 17 ) WE are also unable with respect to agree with whathas been referred to in the Bombay decision as the "technical"approach which seems to suggest that the question whether anitem is to be treated as a "current liabilities or "provisions" ora "reserve and surplus" should be decided on the basis of themanner in which it is exhibited in the balance sheet. The explanation does not confine itself only to amounts shown in the booksof the company under items 5, 6 or 7 of the heading "reservesand surplus" or lender the heading "current liabilities and provisions. " It empowers the Income-tax Officer to enquire whetherthere is any amount shown in the balance sheet which is of thenature of items 5, 6 or 7 under the heading "reserves and surplus" or of any item under the heading "current liabilities andprovisions". The addition of these words "of the nature of"inclines us to the view that what is to be considered is not whetherthe assessee has exhibited it under one head or another butwhether in its nature any item standing to the credit of anyaccount in the books of the company on the relevant date canbe described as falling within the above categories. Thereforethe argument that as the assessee has shown these items underthe head "reserves and surplus" and they are not of the natureof items 5,6 or 7 under that head. they cannot be treated, as provisions does not appeal to us. If an item is really of the nature ofan item under the heading "current liabilities and provisions" itcannot be regarded as a reserve and in order to decide whether itis of the nature of a provision or not the Income-tax Officerwill be entitled to consider the definition contained in sixthschedule to the Companies Act and come to a conclusion as tothe head under which the item should be properly exhibited. If he comes to the conclusion that it is properly capable ofbeing shown as a reserve other than items 5, 6 and 7 he can treatit as a reserve. If he comes to the conclusion that it is properly capable ofbeing shown as a reserve other than items 5, 6 and 7 he can treatit as a reserve. But if he comes to the conclusion either that,though it is a reserve it is of the nature of items Nos. 5,6 or 7thereunder or that it is in the nature of a current liability or aprovision, he cannot regard it as a reserve in view of the explanation. The first contention of the learned counsel is, therefore, rejeced. ( 18 ) THE second contention raised by the learned counselreally calls for an interpretation of the expression "knownliability"used in rule 7 of the sixth schedule to the Companiesact. If the allocation has been made for providing for a knownliability the amount of which cannot be determined with substantial accuracy it will only be a provision. However, in viewof the sub-paragraph of Rule 7 (1) the expression"liability" should be understood to mean all liabilities includingdisputed or contingent liabilities. Introducing this expandeddefinition of the word "liability" in clause (1), an item willbe in the nature of a provision if it is an amount retained byway of providing for any known present, future, disputed orcontingent liability the amount of which cannot be determinedwith substantial accuracy. The argument of the learned counselis that though all liabilities present or future, certain orcontingent, admitted, or disputed, can all be treated as liabilitiesfor the purpose of this definition, the real emphasis in the definitionhas to be attached to the word "known" used in clauses (a) and (b) of rule 7 (1 ). Learned counsel contends that the introductionof this word qualifies the otherwise very wide scope of the definition and restricts it only to cases of provision for a liability theexistence of which is known as on the date of the balance sheet. In support of this contention, again, learned counsel refers tothe Bombay decision earlier cited. At page 250 the learnedjudges observed that although the expression "liability" is definedas inclusive of contingent liabilities even so such contingentliabilities must be known contingent liabilities that such wouldbe the correct position in commercial accountancy, they pointout, is clear from that has been stated in standard treaties onauditing and Accountancy. At page 250 the learnedjudges observed that although the expression "liability" is definedas inclusive of contingent liabilities even so such contingentliabilities must be known contingent liabilities that such wouldbe the correct position in commercial accountancy, they pointout, is clear from that has been stated in standard treaties onauditing and Accountancy. Quoting a passage from page 149of Spicer and Pegler s Practical Auditing (4th Indian Edition) itis pointed out that contingent liabilities spoken of in Rule 7 (1)will be of the type referred to in the said passage, which may beconveniently quoted here : " (12) Contingent liabilities the auditor should ascertainwhether there are any transactions outstanding at thedate of the balance-sheet which might involve thepayment of money at some subsequent date. Suchoutstandings are termed contingent liabilities andmay be of two classes : the one involving a loss shouldthe liability accrue, and other involving theacquisition of an asset of corresponding value. IT is sufficient for the amount of the contingent liability tobe stated on the face of the balance-sheet by way of anote, unless there is a definite probability that a losswill materialize, when specific provision should bemade therefor. The most similar instance is the contingent liability on bills receivable which have beendiscounted. If at the date of the balance-sheet any ofthe bills that have been discounted are outstanding,there will be a contingent liability in respect thereof,since, if the acceptors do not meet the bills on maturity,the holders will have a right of recourse against thedrawer or any prior indorser. . . . . . . . . . OTHER instances of contingent liabilities which might involvea loss, should they accrue, would be damages andcosts in the case of an action pending, forward contracts, guarantees for third parties, and speculativetransactions on the stock exchange still undecided. " (underlining ours) ( 19 ) LEARNED counsel submits that the expression known"imports the idea that as at the relevant date a transaction shouldhave been completed or an event must have happened whichrenders the accrual of the liability definitely probable. Thisimportance of the existence of some transaction or of some eventhaving taken place has also been sought to be reinforced by areference to the observations of the Kerala High Court in Commissioner of Income Tax v. Parakaramalai Tea and Produce Co. Ltd. (1973 92 ITR 65 (3 ). Thisimportance of the existence of some transaction or of some eventhaving taken place has also been sought to be reinforced by areference to the observations of the Kerala High Court in Commissioner of Income Tax v. Parakaramalai Tea and Produce Co. Ltd. (1973 92 ITR 65 (3 ). In that case the Kerala High Court was concerned with the question 0as to how for reserves for gratuity created by the companycould be treated as reserves within the meaning of the 1964act. After referring to the dictionary meaning of the expression"reserve" and the decisions of the Supreme Court and certainother High Courts the Court held that in the case of gratuity nocurrent liability had arisen in the accounting year and observed : "in regard to a liability which has not arisen (in the senseno debt has become due from the assessee by reason ofretirement) any amount reserved does not have thecharacter of amount reserved by way of provision tomeet a liability. The argument of counsel for revenueis that even such a reserve is in the nature of liabilitymentioned in the heading "current liabilities and provisions". It is easy to see that it is neither a currentliability nor one in the nature of such liability. If"provision" has to be understood in relation to abalance-sheet for the current year as one for meetingthe liabilities of the year as we feel it should be, it isevident that the disputed reserve is not in the nature ofa provision. Counsel for the revenue argues that theterm "contingencies" referred to in the form of balance-sheet has not to be related to the year in question butto any liability that may arise at any point of time. In a balance-sheet where the financial position for theyear is reflected and the liabilities as at the end of theyear are shown, we see no reason to read the entries inthe manner in which the counsel for the revenue wants. us to read it. Apart from the fact that by its verynature a reserve such as one for retirement gratuityis not a reserve for meeting any liability that has alreadyarisen, we see no reason to hold that the expression"other money for which the company is contingentlyliable" in item 5 of the foot-note or "for contingencies"as item 10 under the heading "provisions" means anyliability that has not accrued and will not be, by itsvery nature, liability in the current year. " ( 20 ) WE are of opinion that there is force in the contentionof Shri Desai. Though the definition in Rule 7 is very Wide,somemeaning has to be given and significance to be attachedto the use of the word "known" in the above definition. Wethink learned counsel is right in saying that this does not merelymean that the assessee should have a knowledge that someliability present, future, disputed or contingent may or may notarise at some date in the future. For, if that be so and if allsuch amounts were to be treated as provisions, than there wouldbe no meaning to the foot-note that is to be attached to the balancesheet to show separately : " (1) Claims against the company not acknowledged asdebts. (2) Uncalled liability on shares partly paid. (3) Arrears of fixed cumulative dividends. (4) Estimated amount of contracts remaining to beexecuted on capital account and not provided for. (5) Other money for which the company is contingentlyliable. "and the further direction that "the amount of any guarantees given by the companyon behalf of Directors or other officers of the companyshall l)e stated and where practicable, the generalnature and amount of each such contingent liability,if material, shall also be specified. " SUCH an interpretation would also leave no amount whatevercapable of being treated as a reserve, for a company will setapart sums for future use only against the contingency of aliability that may arise in future. That apart, as the Keralahigh Court has pointed out and a Bench of this Court had alsooccasion to mention in the Orissa Cement case (1980 124itr 251) (4) there is good reason to restrict the scope of thisexpression by reference to the known financial position of thecompany, i. e. , as it stands on a particular date and as a resultof the financial working of the company during the earlieraccounting year. In the Orissa Cement case decided underthe Super Profits Tax Act, we pointed out that the expression"known" should be understood as referring to an existingliability and not to a future liability. But that was because thedefinition in the Companies Act and the terms of the explanationin the Act of 1964 were not available there. In the Orissa Cement case decided underthe Super Profits Tax Act, we pointed out that the expression"known" should be understood as referring to an existingliability and not to a future liability. But that was because thedefinition in the Companies Act and the terms of the explanationin the Act of 1964 were not available there. But even in thecontext of the 1964 Act it appears to us that the whole objectof the provision would be defeated if one were to considereven the setting apart of the sums towards future liabilities whichmay or may not arise at all as amounting to provisions. Aspointed out by the Bombay and the Kerala High Courts it isnecessary in the context to restrict the operation of this definitiononly to cases where there is a known liability, i. e. , a liabilityreferable to an outstanding transaction or an event that hastaken place as a result of which it is definitely probable that aliability will be fastened on the company. For instance, thecompany may have drawn a large number of bills during theaccounting year. But only a few of them might have beendiscounted by them with the bank or otherwise. "the passagefrom Spicer and Pegler s accountancy which we have extractedabove would indicate that the provision that the company isexpected to make would only be in respect of bills discountedthough even. there the entire amount of the bills discountedwill not be set apart by the company. But where a bill has beendiscounted, there is outstanding, a definitely probable liabilityon the part of the company in the event of some of the bills notbeing accepted when presented in due course. It is, therefore,necessary that a provision should be made to meet this knownliability, which cannot be accurately determined. ( 21 ) IN the present case so far as the allocation for bonus isconcerned the allocation is not against any liability that hascrystallised or accrued or known to exist during the accountingyear or as at the relevant date. The liability of the company topay maximum bonus or minimum bonus to its employees wouldarise only in the event of the company incurring a loss or thecompany not having sufficient allocable surplus whether of thatyear alone or whether of that year and the earlier years out ofwhich such bonus could be distributed. As at the relevantdates in the. present case viz. As at the relevantdates in the. present case viz. 1/04/1965 and 1/04/1966 there is nothing to indicate that there was a definite probability of the company having to meet these liabilities which hadnot accrued during the accounting year but were likely to accruein the immediate future. Unless there is on the relevant datesome liability present or future in the contemplation of thedirectors of the company, in respect of which the companywould be called upon to shoulder the responsibility, the allocation cannot be said to be in the nature of a provision. We are,therefore, in agreement with the conclusion of the Tribunalthat there was no known liability as at the relevant date inrespect of which the amounts could be said to have been setapart as provision. ( 22 ) FOR the above reasons, we answer the questions referredto us in the affirmative and in favour of the assessee. As theassessee has succeeded, it will be entitled to its costs of thisreference: counsel s fee Rs. 500. 00.