Expert Advisory Committee
ICAI-Expert Advisory Committee
Options:

1.36     Query

 

Presentation of ‘Development Rebate Reserve’ in

the Balance Sheet.

 

The query relates to the exhibition of the ‘Development Rebate Reserve’ in the Balance Sheet of a Company which has sustained losses.  The facts and figures of the case are given below: -

 Our Corporation is a Govt. Company under Section 617 of the Companies Act, 1956, and is, therefore, subject to audit by the comptroller and Auditor General of India under Section 619 (4) of the Companies Act.  While giving their report under Section 619 (4) ibid, the Comptroller and Auditor General of India has given the following comments/supplement to the Statutory Auditor’s Report :

 

“Development Rebate Reserve : Rs. 19,15,643/-

 

The reserve was created during the years 1971-72 to 1974-75 when the Company had no taxable income.  The reserve so created represented uncommitted reserve and should have been shown as a deduction from the debit balance of the Profit & Loss Account in the Balance Sheet, in terms of Part I of Schedule VI of the Companies Act, 1956.”

           

Thus, the point arising out of the above is that whether the “Development Rebate Reserve” should be treated as an “Uncommitted Reserve” and in case of Companies having accumulated losses, whether the said reserve should be exhibited as a deduction from debit balance of the Profit and Loss Account in the Balance Sheet in terms of instructions contained against the item “Miscellaneous expenditure (6) other items (specifying nature)—Profit and Loss Account”, in the Schedule VI of the Companies Act, 1956.  The instructions referred to above read as under: -

 

   “Show here the debit balance of Profit and Loss Account carried forward after deduction of the uncommitted reserves, if any”.

 

  We, however, disagree with the above view taken by the Comptroller and Auditor General of India.  Our stand in this respect is as follows:

The “uncommitted reserves” are only those reserves which are not meant for any specific purpose and can be utilised directly for payment of dividend or for writing off the losses without complying with any specific formalities required under any law.  The Development Rebate Reserve is a reserve of specific nature.  In this connection, para 7 (1) (b) of Part III of Schedule VI to the Companies Act, 1956, may be referred where the expression “reserve” has been defined as under: -

“The expression ‘reserve’ shall not, subject as aforesaid, include any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability.”

The Development Rebate Reserve is specifically provided to get certain advantages as mentioned in the Income-tax Act, 1961.  This provision of reserve in the books is also subject to approval of the Income-tax Officer when he conducts the assessment.  It may further be stated that this specific reserve, provided in a financial year, cannot be utilised for any purpose and has to be retained in a specific account for a minimum period of 8 Years.  Thereafter, the same reserve can be treated as a non-specific reserve.  Only at that time, i.e. after the expiry of 8 years, the said reserve can be transferred to the “General Reserve Account”, provided the Board of Directors of the Company approve of such a transfer.  The amount thus credited to “General Reserve Account” at that time, can be deducted from the accumulated losses.

It is further stated that the Development Rebate Reserve is a charge against the profits and it is debited to the Profit and Loss Account in spite of the fact that the Company might have sustained losses.  This is, however, not the case with “Uncommitted Reserve” ordinarily known as “General Reserve” which is created out of the appropriations of the profits.

 Thus, it is felt that this reserve cannot be termed as “Uncommitted Reserve” and as such, the question of its deduction from the debit balance of Profit and Loss Account does not arise. Thus, in our opinion, the contention of the Comptroller and Auditor General of India as to the exhibition of Development Rebate Reserve as a deduction from the debit balance of the Profit and Loss Account in the Balance Sheet is not correct.

  The Committee is requested to please advise us as to whether the comments of Comptroller and Auditor General of India are valid or otherwise, in the instant case.

 

                                                                     Opinion                                       December 1, 1976

 

 1  The question raised is as to the correct mode of display of “Development Rebate Reserve” in the Balance Sheet, where the Reserve is created in a year when there is no taxable income and there is a debit balance in the Profit and Loss Account in subsequent years.  The point for consideration is whether in the year in which there is a loss, the “Development Rebate” created earlier and appearing as a “Reserve” on the “Liabilities” side of the Balance Sheet is required to be shown as a deduction under the head “Miscellaneous Expenditure”.  Instructions against Note (6) under the head “Miscellaneous Expenditure” in Schedule VI to the Companies Act, 1956, make it obligatory to show the debit balance of “Profit and Loss Account” after deduction of uncommitted Reserves, if any.

2.         The question that, therefore, arises for consideration is as to the correct nature of “Development Rebate Reserve” i.e. whether such Reserve is a “committed” or “uncommitted” Reserve.  To understand the correct nature of the Reserve, it is necessary to refer to the Scheme as contained in the Income-tax Act, 1961.  Section 34(3) (a) states that deduction by way of “Development Rebate” permissible under Section 33 will not be allowed, unless an amount equal 75% 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 8 years next following the previous year, for the purpose of the business other than :

 

            (i)         for distribution by way of dividends or profits, or

 

(ii)        for remittance outside India as profits or for creation of any assets outside India.

 

3 Section 155(5) (ii) of the Income-tax Act provides that if at any time before the expiry of 8 years referred to in Section 34(3), the assessee utilises the amount credited to the Reserve account under Clause (a) of that sub-section, for distribution by way of dividends or profits or for remittance outside India as profits or for the creation of any assets outside India, or for any other purpose which is not a purpose of the business, the “Development Rebate” originally allowed shall be deemed to have been wrongly allowed and will be subjected to rectification proceedings.  In other words, “Development Rebate Reserve” created in pursuance or Section 34(3) (a) if utilised for purposes other than the permitted purposes, the Rebate will stand forfeited.

 

   4.   Thus, the statutory requirement of the Income-tax Act is that the “identity” of the Reserve and its “utilisation” should be carried out in the manner permitted under the Act, viz. use of the Reserve for the purpose of the business.

  5 . In this connection, reference could be usefully made to the decision of the Supreme Court in the case of Indian Overseas Bank Vs. Commissioner of the Income-tax Madras, 1970(77) I.T.R. 512, under the analogous provisions contained in Section 10(2) (vi b) of the Income-tax Act, 1922.  The following observations as appearing on page 514, are relevant:-

 

“The Reserve contemplated by Proviso (b) Section 10(2) (vi b) 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 Reserve account to be utilised by the assessee during a period of 10 years for the purposes of the business of the undertaking 

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.”

 

6.Thus, the view expressed by the Supreme Court is that “Development Rebate Reserve” is a Reserve for a “specific purpose”.  In view of this authoritative pronouncement of the Supreme Court on the scope and requirement of “Development Rebate Reserve”, the correct treatment would be to show “Development Rebate Reserve” as a “Specific Reserve” on the Liability side of the Balance Sheet, and not to deduct it, based on instructions on item (6), from the loss under the head “Miscellaneous Expenditure” in Schedule VI of the Companies Act, 1956.  The treatment should be identical even if the Reserve is created out of profits and where in the subsequent year or years there are losses exceeding the “Development Rebate Reserve”.

 

  7. A mention may, however, be made that the Controller of Capital Issues for the purpose of application of the guidelines in regard to Bonus issue considers “Development Rebate Reserve” as a reserve available for capitalisation.  It does not follow that it is treated as an “Uncommitted Reserve”.  It may be pointed out that this treatment is for a limited and specific purpose, viz. for determination of the residue of the Reserve as a percentage to the expanded capital by virtue of the issue of the Bonus shares.  Such treatment, it is felt, should not alter the true character of the Reserve impressed under the Income-tax Act.

 

  8.It may also be mentioned that the statutory “Development Rebate Reserve” is treated as a “Free Reserve” for the purposes of the Deposit Rules under Section 58A of the Companies Act.  However, it may pointed out that it has specifically been brought within the definition of “Free Reserve”, indicating that, but for the specific inclusion, it would not have been treated as such, i.e. as a “Free Reserve”.

 

9.Again, under the Rules framed pursuant to Section 205A(3) of the Companies Act, 1956, it is only transfers out of the “Development Rebate Reserve” on the expiry of the specified period that are to be included in the Reserves for the purposes of that Section.  This is also indicative of the recognition of the statutory provisions of the Income-tax Act for the purposes of the Companies Act.  The provisions of the Income-tax Act must thus be taken into consideration for deciding the concept of “committed” or “uncommitted” Reserves for the purposes of the Companies Act.

____________________________