Meaning of “General Reserves” for the purpose of deduction under section 36(1)(viii) restricted

Issue before the Income-tax Appellate Tribunal (ITAT)
 Whether the phrase “paid up capital and general reserves” should be defined as “Net worth” as considered under other laws?
Contentions of the taxpayer
 The words “paid up capital” and “general reserves” are inseparable and have to be read together and not as separate words carrying different meaning.
 Since the Act does not define these words, definition under other laws should be considered. The word “Net worth” as defined under the Companies Act, 1956 as sum of paid up capital and free reserve. “Free Reserves” means all reserves created out of profits and share premium but do not include reserves created out of revaluation of assets, write back of depreciation provisions and amalgamation.
 The word “the general reserves” is in plural and therefore covers more than one reserve which forms part of shareholders‟ funds.
 The Finance Minister in his 2007 budget speech in respect of proposing an amendment to the amount of deduction under section 36(1)(viii) has used the word “Net worth”. Finance Minister‟s speech can be relied upon to throw light on the object and purpose of a particular provision of the Finance Bill.
 Intent of the legislature should be considered while interpreting statues. Beneficial provisions should be liberally construed or interpreted.
 Word prefixed with “the” should be read with reference to the previous word used in an enactment.
 Taxpayer also relied upon definitions provided in the Compendium of Guidance Notes issued by the Institute of Chartered Accountants and in a book published by a subsidiary of the credit rating company CRISIL.
Contentions of the department
 General reserve should be a revenue reserve capable of distribution as dividend freely through the P&L account.
Facts
 Taxpayer is a housing finance company. The relevant year is assessment year 2006-07.
 The taxpayer claimed a deduction of Rs.14,79,41,734 under section 36(1)(viii) 1 of the Income-tax Act, 1961 („the Act‟) The aggregate amount carried to the Special Reserve stood at Rs.98,39,00,000 as on April 1, 2005. Therefore, the amount carried to Special Reserve as at the year-end was Rs.113,18,41,734 (i.e. Rs.98,39,00,000 plus Rs.14,79,41,734). The taxpayer claimed that amount carried to Special Reserve did not exceed twice the amount of paid up capital and general reserves.


 The taxpayer considered the amount under the proviso to section 36(1)(viii) consisting of paid up capital Rs.20,48,75,450, general reserve Rs.29,89,00,000, share premium Rs.5,25,00,000 and Profit & Loss account (P&L) balance Rs.4,85,44,330 and Special Reserve opening balance Rs.60,48,19,780.
 For the purpose of the proviso, the Assessing Officer (AO) considered amounts of paid up capital Rs.20,48,75,450 and general reserve Rs.29,89,00,000 only and restricted the taxpayer‟s claim to Rs.2,36,50,900 (twice the amount of share capital and general reserve Rs.100,75,50,900 minus Special Reserve as at the beginning of the year of Rs.98,39,00,000).
 The AO‟s stand was upheld by the Commissioner of Income-Tax Appeals [„CIT (A)‟].
1 Section 36(1)(viii) grants deduction for special reserve created by specified financial corporations. For the year under appeal, deduction allowable was an amount not exceeding 40% of profits derived from eligible business. The deduction was subject to further condition under the proviso to the section, that where the aggregate of the amounts carried to such reserve exceeds twice the amount of the paid-up capital and of the general reserves, no allowance shall be made of such excess.
 Share premium, P&L account and Special reserve are not free reserves.
 “Net worth” is defined in sections 49, 50, 50C of the Act for the purposes of those sections. Finance Minister‟s reference to “Net worth” in the budget speech should not be considered as there is no ambiguity in the proviso to section 36(1)(viii).
Observations and Ruling of the ITAT
 There is no definition of the term "General Reserve" under the Act and there is also no positive definition under the Companies Act, 1956.
 Basically a general reserve is capable of being distributed through the P&L account and therefore is not a capital reserve. Thus, every general reserve has to have the character of a revenue reserve and a free reserve.
 In terms of the Companies Act, the balance in share premium account cannot be distributed through the P&L account. Due to this incapacity, it is not a revenue reserve. Therefore, it is not a general reserve.
 The balance under P&L account in the balance sheet cannot be called a reserve since the amount is not transferred to the reserve account.
 Special reserve is a reserve created to meet a specific requirement under law for a specific purpose. As per the definition given by Institute of Chartered Accountants, a general reserve should have no specific purpose. Special reserve cannot be distributed freely through the profit and loss account as dividends or otherwise. It is therefore not a free reserve.
Conclusion
General Reserve would not include amounts in respect of share premium account, P&L account and Special Reserve for the purpose of computing the limitation of the eligible amount for claiming deduction under section 36(1)(viii) of the Act.
Source: Canfin Homes Ltd. v.DCIT (Bangalore ITAT) (ITA No. 861 / Bang /2010) order dated 24 February 2012