Life Insurance Corporation Ltd vs Commissioner Of Income-Tax, Delhi

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeals No. 678-680 of 1962

Decision Date: 09 December 1963

Coram: A.K. Sarkar, M. Hidayatullah, J.C. Shah

In the case titled Life Insurance Corporation Ltd versus Commissioner of Income‑Tax, Delhi, the Supreme Court delivered its judgment on 9 December 1963. The bench consisted of Justice A. K. Sarkar, Justice M. Hidayatullah and Justice J. C. Shah. The petitioner was Life Insurance Corporation Ltd and the respondents were the Commissioner of Income‑Tax, Delhi and the Commissioner of Income‑Tax, Rajasthan. The reference is recorded as Civil Appeals No. 678‑680 of 1962, arising from a decision of the Punjab High Court (Circuit Bench) at Delhi dated 2 March 1960 in Income‑tax Reference No. 6‑D of 1957. The citation of the judgment appears in the 1964 volume of the All India Reporter at page 1403 and in the 1964 Supreme Court Reports (5) at page 880, with a citator reference R 1965 SC 1004 (13, 16). The statutory provision under consideration is Section 10(7) of the Income Tax Act (XI of 1922) together with Rules 2(b) and 3(b) of the Schedule to that Act, which deal with the power of the income‑tax officer to direct readjustments of accounts.

The headnote of the judgment explains that the appellant, Life Insurance Corporation Ltd, had transferred a certain sum from its Consolidated Revenue Account to the Investment Reserve Fund, a transfer it was legally entitled to make, and that this transfer reduced the surplus on which tax was to be assessed. The income‑tax officer subsequently directed the appellant to reduce that transfer by a specified amount, a direction that the appellant contested. The Court, speaking through Justice Sarkar and Justice Shah, held that the assessment of profits of an insurance business is governed exclusively by the rules contained in the Schedule to the Act, as mandated by Section 10(7), and that the income‑tax officer possesses no general power to correct any error beyond what those rules allow. Specifically, Rule 2(b) of the Schedule does not empower the officer to alter the assessee’s account figures, while Rule 3(b) merely obliges the officer to allow certain deductions and include certain amounts in the assessment; neither rule authorises the officer to adjust the accounts, and the proviso to Rule 3(b) does not provide a basis for such adjustment. Justice Hidayatullah, delivering a separate opinion, emphasised that the Income‑Tax Act envisages a special assessment scheme for insurance companies that is distinct from the ordinary business assessment principles in Section 10. He explained that if the officer doubts the accounts, his powers are limited by the proviso to Rule 3(h), which requires consultation with the Controller of Insurance and thereby negates any separate general power. Because the officer in this case failed to follow the proviso, the Court concluded that the impugned adjustment was improperly made. Counsel for the appellant, consisting of senior lawyers, and counsel for the respondents presented their arguments before the Court, after which Justice Sarkar delivered the main judgment and Justice Hidayatullah delivered a separate opinion. The Court ultimately decided to allow the appeals, holding that the income‑tax officer had acted beyond the authority conferred by the statutory provisions.

In this matter the Court decided that the appeals should be allowed. The appeals concerned the income‑tax assessment of the life‑insurance business originally carried on by the Bharat Insurance Company Limited, which has since been merged into the Life Insurance Corporation Limited. The assessment years that were examined were 1952‑53, 1953‑54 and 1954‑55. Under the Income‑Tax Act of 1922 a special provision governs the assessment of income derived from insurance business. The Income‑Tax Officer, when issuing the assessment orders, made certain adjustments to the accounts. The appellant maintains that the Officer lacked authority to make those adjustments under the statutory scheme. Consequently, the essential issue before the Court was whether the Officer possessed the statutory power to effect the adjustments he made.

Section 10 of the Act, in subsection (7), contains the specific provision that governs the assessment of insurance business income. That provision reads: “Notwithstanding anything to the contrary contained in Section 8, 9, 10, 12 or 18, the profits and gains of any business of insurance and the tax payable thereon shall be computed in accordance with the rules contained in the Schedule to this Act.” Rule 2 of the Schedule prescribes two alternative methods for calculating the profits and gains of a life‑insurance business, listed in clauses (a) and (b). The rule requires that the method which yields the larger profit figure must be applied. The text of Rule 2 states: “The profits and gains of life insurance business shall be taken to be either—(a) the gross external incomings of the preceding year from that business less the management expenses of that year, or (b) the annual average of the surplus arrived at by adjusting the surplus or deficit disclosed by the actuarial valuation made in accordance with the Insurance Act, 1938 (IV of 1938) in respect of the last inter‑valuation period ending before the year for which the assessment is to be made… so as to exclude from it any surplus or deficit included therein which was made in any earlier inter‑valuation period and any expenditure other than expenditure which may under the provisions of section 10 of this Act be allowed for in computing the profits and gains of a business, whichever is the greater.” A proviso accompanying this rule sets a limit on the management expenses that may be permitted, though that proviso is not material to the present judgment. It was not contested that, in the present cases, the calculation under clause (b) would generate the higher income figure and therefore had to be followed. The Court then turned to Rule 3 of the Schedule, which governs the computation of surplus for the purpose of applying Rule 2. Rule 3 provides that, in computing the surplus, (a) … and (b) any amount either written off or reserved in the accounts or through the actuarial valuation balance sheet to meet depreciation of or loss on the realisation of securities or other assets shall be allowed as a deduction, and any sums taken credit for in the accounts or actuarial valuation balance sheet on account of appreciation of or gains on the realisation of the securities or other assets shall be included in the surplus, subject to a further proviso concerning adjustments after consultation with the Controller of Insurance. No other rule in the Schedule was cited by either side during the arguments.

In this dispute the Court referred to Rule 3 of the Schedule to the Indian Income‑tax Act, which provides that “any amount either written off or reserved in the accounts or through the actuarial valuation balance sheet to meet depreciation of or loss on the realisation of securities or other assets shall be allowed as a deduction, and any sums taken credit for in the accounts or actuarial valuation balance sheet on account of appreciation of or gains on the realisation of the securities or other assets shall be included in the surplus: Provided that if upon investigation it appears to the Income‑tax Officer after consultation with the Controller of Insurance that having due regard to the necessity for making reasonable provision for bonuses to participating policy‑holders and for contingencies, the rate of interest or other factor employed in determining the liability in respect of outstanding policies is materially inconsistent with the valuation of the securities and other assets so as artificially to reduce the surplus, such adjustment shall be made to the allowance for depreciation of, or to the amount to be included in the surplus in respect of appreciation of, such securities and other assets, as shall increase the surplus for the purposes of these rules to a figure which is fair and just;”. No other rule in the Schedule was cited by the parties. The factual matrix that gave rise to the controversy was that the assessee had debited a sum of Rs 18,75,000 to its Consolidated Revenue Account and simultaneously credited the same amount to an Investment Reserve Fund. It was not contested that the assessee was required to maintain an Investment Reserve Fund, and the transfer was made because the assessee believed that the securities backing the Fund had depreciated, rendering the Fund inadequate. By effecting this transfer the assessee reduced the surplus on which tax under Rule 2 was to be assessed. The Income‑tax Officer, after examining the books, concluded that the transfer caused the balance in the Investment Reserve Fund to exceed the deficit shown by the book values of the securities by Rs 30,420. He further investigated the market values of the securities and determined that the assessee had undervalued those securities in its accounts. Consequently, the Officer held that the Investment Reserve Fund was in excess by Rs 1,89,185 of the amount that should have been available as a credit. On this basis, he directed that the transfer from the Revenue Account to the Investment Reserve Fund be reduced by Rs 1,75,000.

The assessee challenged this direction before the Appellate Assistant Commissioner, who modified the order and directed that the transfer be reduced by Rs 1,45,000 instead of the Rs 1,75,000 originally ordered. Unsatisfied, the assessee further appealed to the Income‑tax Appellate Tribunal. The Tribunal held that any adjustment under the proviso to Rule 3(b) required a prior consultation with the Controller of Insurance, a step that had not been taken. As a result, the Tribunal declared the adjustment illegal and ordered that the entire transfer of Rs 18,75,000 made by the assessee be accepted without reduction. Following this decision, the Commissioner applied to the Tribunal under section 66(1) of the Act seeking to state a case, but the application was rejected. Thereupon the Commissioner approached the High Court of Punjab for an order directing the Tribunal to state a case.

After the Tribunal had been directed to state a case under section sixty‑six of the Act, the High Court issued an order directing the Tribunal to do so. Accordingly, the Tribunal presented a statement of facts that had been previously described and then referred a specific question to the High Court for determination. The question framed by the Tribunal was whether, based on the facts found by the Tribunal, the Income‑tax Officer possessed jurisdiction to make an adjustment pursuant to rule three‑beta of the Schedule to the Indian Income‑tax Act.

The High Court examined the question and concluded that the matter did not fall within rule three‑beta of the Schedule. Consequently, the Court held that there was no requirement for the Income‑tax Officer to consult the Controller of Insurance. In the Court’s view, the Income‑tax Officer had not been stripped of the power to correct the types of errors that had been identified in the present circumstances, and the proviso to the rule was not intended to apply to cases where, as alleged here, the assessee had undervalued his securities in order to evade tax. Based on this reasoning, the High Court answered the Tribunal’s question affirmatively, indicating that the Income‑tax Officer did have the requisite jurisdiction.

The present appeals were lodged against that judgment of the High Court. The Court reviewing the appeals considered the High Court’s decision to be manifestly incorrect. The Court observed that rule two of the Schedule requires the Income‑tax Officer to compute the profits and gains of a life‑insurance company using the greater of the two methods of assessment specified in clauses (a) and (b). While there is no limitation on the Officer’s jurisdiction when applying clause (a), clause (b) confines the computation to a restricted field. Under clause (b), the Officer must accept the annual average of the surplus disclosed by the actuarial valuation performed in accordance with the Life Insurance Act for the most recent inter‑valuation period, and must exclude any surplus or deficit that pertains to an earlier inter‑valuation period as well as any expenditure that is not allowable under section ten of the Act.

The Court further explained that rule three makes it mandatory for the Income‑tax Officer to calculate the surplus for the purpose of rule two in accordance with the scheme set out in clauses (a), (b) and (c) of rule three. Because rule two‑beta of the Schedule confines the Officer’s authority, the Officer does not have the power to alter the figures appearing in the assessee’s accounts. Instead, the Officer must take the surplus as disclosed by the actuarial valuation prepared by the assessee under the Insurance Act and then determine the average required by the rule. The Officer may exclude any surplus or deficit that belongs to an earlier inter‑valuation period and may also exclude any expenditure that is not permissible under section ten of the Act.

The Court noted that the action taken by the Income‑tax Officer in the present case did not fall within the scope of rule two‑beta, a point that was not contested. Moreover, the Court observed that, apart from the provisions contained in rule three—specifically clause (b), which is the only clause relevant for the present purpose—there is no other provision in the Schedule that authorises the Income‑tax Officer to make adjustments to the actuarial valuation prepared by the assessee.

In this case, the Court observed that, for the purpose of its analysis, the Schedule contained no provision other than rule 3(b) that authorised an Income‑Tax Officer to alter the actuarial valuation prepared by the assessee. The Court examined the wording of rule 3(b). The first clause of that rule required the Income‑Tax Officer to treat as deductions certain amounts that the assessee had written off or set aside as reserves, and to add to the surplus any sums for which the assessee had already claimed credit because of appreciation or gains on the realisation of securities or other assets. The Court explained that this clause merely compelled the officer to permit those specified deductions and to include those specified credits in the surplus; it did not empower the officer to readjust the accounts on the basis of a revaluation conducted by the officer himself. The Court then turned to the proviso attached to rule 3(b). The proviso provided that, if, after considering certain matters (which the Court did not need to enumerate), the Income‑Tax Officer found that the rate of interest or another factor used to compute liability on outstanding policies was materially inconsistent with the valuation of securities and other assets and that such inconsistency artificially reduced the surplus, the officer could, after consulting the Controller of Insurance, make certain adjustments. The Court held that the adjustment made by the Income‑Tax Officer in the present proceedings did not fall within the category described in the proviso. The officer had not indicated that he was adjusting the accounts because a rate of interest or similar factor was inconsistent with the valuation of securities or assets; rather, the officer had adjusted the figures because he believed that the securities had been undervalued. The Court found that the proviso did not confer power to make an adjustment on the ground of alleged undervaluation, and this point was not contested. Consequently, the Court concluded that none of the rules authorised the adjustment effected by the Income‑Tax Officer in these cases. Having set out the relevant provisions, the Court observed that the provisions did not envisage any adjustment to the insurers’ accounts other than those expressly mentioned, and the present adjustment did not fit within those express categories. The Court then addressed the remaining issue of whether a general right existed to correct errors in an insurer’s accounts when assessing income tax. The High Court had held that such a general right existed, but the Court disagreed. The Court stated that the assessment of profits of an insurance business was wholly governed by the Schedule, and there was no authority to act beyond what the Schedule permitted. The Court noted that this limitation likely stemmed from the fact that the accounts of an insurance business were fully controlled by the Controller of Insurance under the provisions of the Insurance Act.

The accounts of an insurer fell under the provisions of the Insurance Act, and those accounts were examined by the Controller of Insurance. The Controller possessed authority to ensure that an insurer complied with the various provisions of the Insurance Act, thereby protecting policyholders from any adverse consequences of mismanagement. The Court observed that any interference by an Income‑Tax Officer in the insurer’s accounts could seriously disrupt the normal functioning of insurance companies. Nonetheless, setting that consideration aside, the Court was certain that the wording of section 10(7) and the Schedule to the Income‑Tax Act unequivocally barred the Income‑Tax Officer from making the adjustment that he had effected in the present matters. It was noted that the reference question was limited to the authority of the Income‑Tax Officer under rule 3(b) of the Schedule, and counsel for the assessee did not raise any argument to the contrary. The High Court, as previously indicated, had held that the proviso to rule 3(b) was not intended to apply to cases of the present kind, and consequently appeared to conclude that the Income‑Tax Officer possessed no power under that rule to make the adjustment. However, the High Court nevertheless answered the reference question in the affirmative, apparently meaning that the Income‑Tax Officer retained a separate power, independent of the rule, to make any adjustments necessary to prevent tax evasion. The High Court expressly affirmed that the rule did not strip the Income‑Tax Officer of that power, and it was clear that the High Court had gone beyond the scope of the reference question. No objection was raised at the bar to that procedure, and the Court therefore considered the matter from that perspective as well. Accordingly, the Court concluded that the framed question required a negative answer and, for that reason, allowed the appeals and awarded costs.

Justice Hidayatullah expressed agreement with the reasoning and added further observations. The matters before the Court consisted of three appeals filed by certificate, which had been granted by the High Court of Punjab under section 66(A) of the Income‑Tax Act, challenging its judgment dated 2 March 1960. The appellant was the Life Insurance Corporation, with the unit Bharat Insurance Company Ltd. as the original appellant. The appeals concerned the assessment years 1952‑53, 1953‑54 and 1954‑55, which corresponded respectively to the accounting years 1951, 1952 and 1953. The assessment against the original appellant, Bharat Insurance Co., Ltd., had been made by the Income‑Tax Officer of the Companies Circle, New Delhi, pursuant to the rules formulated for assessing insurance companies under section 10 sub‑section (7) of the Income‑Tax Act. The assessment relied on the annual average of the insurer’s surplus as determined by an actuarial valuation for the preceding four‑year inter‑valuation period that ended on 31 December 1951, and that valuation had been accepted by the Controller of Insurance under the Insurance Act, 1938. During that four‑year period, Bharat Insurance Co., Ltd. had debited an amount of Rs 18,75,000 in its consolidated revenue account between 1 January 1948 and 31 December 1951, and had transferred that amount to

The company transferred the amount to the investment reserve fund in order to meet an alleged depreciation in the value of its securities. The Income‑tax Officer examined both the book value and the market value of the stocks and shares held by the insurance company. He concluded that the insurer had under‑valued certain shares and securities by a total of Rs 1,58,756. In addition, the officer observed that the company had increased the investment reserve fund by Rs 30,420, an increase that he regarded as unnecessary. Consequently, the officer disallowed Rs 1,75,000 out of the total amount of Rs 1,89,186 and added that disallowed sum to the surplus for the purpose of calculating tax. While making this determination, the officer expressed the opinion that the balance remaining after his adjustments “provided adequate cover as contemplated by rule 3(b) of the rules under s. 10(7) of the Insurance Act.” On appeal, the Appellate Assistant Commissioner reduced the original figure of Rs 1,89,186 to Rs 1,61,770 and also reduced the disallowed amount from Rs 1,75,000 to Rs 1,45,000. Apart from these reductions, the commissioner dismissed the appeal. Thereafter, separate appeals were filed against the order of the Appellate Assistant Commissioner by both the Income‑tax Officer, Companies Circle, New Delhi, and by Bharat Insurance Co., Ltd., resulting in a total of six appeals covering the three assessment years. The Tribunal, by an order dated 23 October 1956, recorded that the Income‑tax Officer objected to the relief granted by the Appellate Assistant Commissioner, whereas the assessee contested the adjustments made by the Income‑tax Officer in their entirety. The Tribunal noted that the proviso to Rule 3(b) of the Schedule appended to Section 10(7) expressly requires the Income‑tax Officer to consult the Controller of Insurance before he is competent to make any adjustments to the actuarial surplus disclosed by the valuation. Since no such consultation appeared to have been made in this case, the Tribunal set aside the adjustments effected by the Income‑tax Officer and ordered that the assessments be modified accordingly. The Commissioners of Income‑tax for Delhi and Rajasthan then moved the Tribunal to refer a question to the High Court, asking whether the proviso to Rule 3(b) of the Schedule to the Indian Income‑tax Act, 1922, was applicable and whether the Income‑tax Officer was bound to consult the Controller of Insurance even though no issue arose regarding the rate of interest or any other factor used in determining the liability on outstanding policies.

The Tribunal prepared a consolidated statement of facts for the three assessment years and referred the following question to the High Court for decision: “Whether, on the basis of the facts found by the Tribunal, the Income‑tax Officer had jurisdiction in this case to make adjustments in terms of Rule 3(b) of the Schedule to the Indian Income‑Tax Act?” In the High Court, the Commissioner made an application under section 66(2) of the Income‑tax Act for an order directing the Tribunal to refer the earlier question concerning the applicability of the proviso. That application was disposed of together with the reference, and the High Court, by its order on appeal, answered the latter question concerning the officer’s jurisdiction to make the adjustments.

The High Court dismissed the application filed under section 66(2) of the Income‑Tax Act and also dismissed the assessment against the assessee. Chief Justice Khosla, together with Justice Grover, who disposed of the reference, observed that the question they were answering inherently included the other question presented. In its determination, the High Court held that the Income‑Tax Officer possessed the jurisdiction “to deal with the matter in the manner employed by him” and was “not obliged to consult the Controller of Insurance before he corrected the valuation of the securities”. It is pertinent to note that while the reference was pending before the High Court, a Government Administrator assumed control of the insurance company. Subsequently, the Life Insurance Corporation, by virtue of a notification issued by the Government of India under section 45 of the Life Insurance Corporation Act, 1956, took over, effective 6 July 1960, the assets and liabilities of the insurance company relating to the controlled business as defined in section 2(3) of that Act. In accordance with section 9 of the Life Insurance Corporation Act, the Corporation was substituted as the appellant in place of the original insurance company. In the present appeal, the appellant contended that the High Court erred in its conclusion and that the answer to the question should have been rendered in favour of the Life Insurance Corporation and against the Department. Before addressing the issues in this case, a brief reference to the scheme of the Insurance Act and to the rules framed under section 10(7) of the Income‑Tax Act for the assessment of insurance companies is necessary. Section 2 of the Insurance Act requires every insurer in India, as well as every foreign insurer conducting insurance business in India, to prepare at the end of each calendar year a balance sheet, a profit and loss account, and a revenue account for that year. Special forms for these statements are prescribed, and the schedules to the Act, through regulations, specify the particulars that must be shown in each account. The balance sheet, profit and loss account, and revenue account, together with any other accounts mandated by other provisions, must subsequently be audited by an auditor. Section 13 of the Insurance Act further obliges every insurer carrying on life insurance business to commission, at intervals of not less than three years, an actuarial investigation into the financial condition of its life insurance business, including a valuation of its liabilities. An abstract of the actuary’s report must then be prepared in accordance with prescribed regulations. These accounts, together with the abstract and other required statements, must be submitted to the Controller of Insurance. The Controller may request additional information, may take evidence, and may, if desired, order a re‑valuation and a concurrent investigation. Moreover, the Insurance Act mandates that every insurer must at all times keep invested assets that are equivalent to its liabilities.

In this case, the Court explained that the insurer was required to make investments for the payment of matured claims or for policies in the life business that were maturing. Sections 27 and 27A specified the categories of investments in which the insurer had to place or retain the assets and the controlled fund. The balance sheet of the life‑insurance business had to be prepared as a separate document. The regulations required that a statement in Form AA, which displayed both the market value and the book value of the assets located in India, be attached to the balance sheet. The accounts had to be signed and certified; moreover, a certificate had to be appended that explained the manner in which the values shown in the balance sheet for the investment in stocks and shares were computed and how their market values were determined for comparison with the recorded values. A further certificate was required to confirm that the items relating to reversions and life interests had been valued, as of the date of the balance sheet, by an actuary and that the assets listed under the heading “investments” had not been valued at amounts exceeding their realizable or market values. The Court noted that this precaution was essential because without it the insurer might lack sufficient cover for its liabilities. Accordingly, Form AA, which had to be annexed to the balance sheet, was required to present a classified summary of the assets on the balance‑sheet date and to disclose, in particular: (a) the amount for which credit was taken in the balance sheet for each class of assets mentioned above; (b) the market value of each of those classes of assets as determined from published quotations after deducting any accrued interest that was included in market prices where such accrued interest was shown elsewhere in the balance sheet; and (c) the method by which the value of any of those classes of assets, which could not be obtained from published quotations, had been arrived at. The revenue account had to be prepared in four separate forms. Form D presented the revenue account applicable to life‑insurance business for the year, while Form DD, Form DDD and Form DDDD respectively contained the statements of life‑insurance policies for the same year, the additions to and deductions from policies, and the particulars of policies that were forfeited or had lapsed during the year. The regulations governing the preparation of the abstract of the actuary’s report were contained in the fourth schedule to the Insurance Act. That schedule consisted of two parts. The second part stipulated, among other matters, that every abstract must show the average rates of interest earned by the assets, whether invested or uninvested, that formed the life‑insurance fund for each year covered by the valuation period. Regulation 3 of Part 1 prescribed the manner in which the average rate of interest earned in any year by the assets of the life‑insurance fund had to be calculated. The Court observed that this calculation was complex.

It was noted that a detailed description of the computational method was unnecessary at this stage, but the abstracts were required to set out clearly the precise manner in which the average rate of interest had been calculated. The consolidated revenue account was required to be presented in Form G, and a final valuation balance sheet had to be prepared in Form 1. Form 1 compared, on the one side, the net liability of the business as shown in the summary and valuation of the policies, with, on the other side, the balance of the life‑insurance fund as shown in the balance sheet. This comparison disclosed, as a matter of fact, whether there was a surplus or a deficiency for the year under review. Because investments inevitably depreciate, the regulations required the maintenance of an investment reserve fund to which amounts were transferred in order to compensate for any shortfall. Consequently, the insurance company was obliged to maintain an insurance fund that was sufficient to meet its liabilities, and any depreciation in the value of its investments had to be specially provided for by acquiring other investments that were kept within the investment reserve fund.

The Court then turned to the provisions of the Income‑Tax Act that made reference to these documents. It was emphasised that insurance companies were assessed in a manner that differed from the assessment of ordinary business organisations. Ordinarily, sections 8, 9, 10 and 12 of the Income‑Tax Act applied to the assessment of business entities, but the rules for assessment contained in those sections were expressly excluded in the case of an insurance company. Section 10 of the Act dealt with the head “profits and gains of business & c.” However, subsection 7 provided that, notwithstanding anything to the contrary contained in sections 8, 9, 10, 12 or 18, the profits and gains of any insurance business and the tax payable thereon were to be computed in accordance with the rules set out in a schedule to the Act. Those rules prescribed the method for computing the profits and gains of a life‑insurance business. Under rule 2, the profits and gains of life‑insurance business were to be taken as either (a) the gross external income of the preceding year from that business less the management expenses of that year, or (b) the annual average of the surplus arrived at by adjusting the surplus or deficit disclosed by the actuarial valuation made under the Insurance Act, 1938 (IV of 1938), for the last inter‑valuation period ending before the assessment year, excluding any surplus or deficit that related to earlier inter‑valuation periods and excluding any expenditure not allowable under section 10 of the Act for computing profits and gains, whichever of the two alternatives was greater. In the present case, the second alternative was the method applicable. Rule 3, insofar as it was relevant, then provided further guidance, the details of which were addressed later in the decision.

The rule states that any amount which is either written off or set aside in the accounting records, or reflected in the actuarial valuation balance sheet, for the purpose of covering depreciation or loss arising from the realisation of securities or other assets, must be permitted as a deduction. Conversely, any amounts that have been credited in the accounts or in the actuarial valuation balance sheet because of appreciation or gains arising from the realisation of those securities or other assets must be included in the surplus. The provision further adds that, should an investigation reveal to the Income‑tax Officer—after consulting the Controller of Insurance—that, taking into account the need to make reasonable provisions for bonuses to participating policy‑holders and for contingencies, the rate of interest or any other factor used to determine the liability on outstanding policies is materially inconsistent with the valuation of the securities and other assets and thereby artificially reduces the surplus, then an adjustment must be made either to the allowance for depreciation or to the amount to be included in the surplus for appreciation of those securities and assets. Such an adjustment shall increase the surplus to a figure that is fair and just. x x x x x Rule 2 sets out what is to be regarded as the profits and gains of the insurance company. Rule 3 describes the modifications that may be applied to the annual average of the surplus. In the context of the present case, the essence of Rule 3 can be expressed in plain language. It provides, in its principal clause, that amounts reserved in the accounts or through the actuarial valuation balance sheet to meet depreciation of securities are to be allowed as a deduction, and, conversely, any sums credited in the accounts or actuarial valuation balance sheets on account of appreciation of securities are to be included in the surplus. In summary, the reduction in value of securities is permitted as a deduction from the surplus, while any increase in value of securities is to be added to the surplus. Because the present dispute concerns only depreciation of securities recorded in the reserves, the portion of the rule dealing with appreciation is irrelevant and may be set aside. The case therefore focuses solely on the depreciation of securities as shown in the accounting records and in the actuarial valuation balance sheets. If such depreciation actually occurs, the insurance company is entitled to claim that the amount be allowed as a deduction from the surplus, and such a claim must be permitted. However, by deliberately undervaluing stocks and shares, it is possible to artificially lower the surplus by moving part of the surplus into a reserve to substitute for the amount by which the stocks and shares are claimed to have depreciated, even though no real depreciation has taken place. The proviso attached to the main rule acknowledges this possibility and provides that, if the Income‑tax Officer, after investigation and in consultation with the Controller of Insurance, finds…

The Court explained that the proviso attached to the main rule permitted the Income‑tax Officer, after conducting an investigation and consulting the Controller of Insurance, to adjust the allowance for depreciation so that the surplus would be increased to a figure that was fair and just. This power could be exercised only when the rate of interest or any other factor used to determine the liability on outstanding policies was materially inconsistent with the valuation of the securities and other assets, thereby causing an artificial reduction of the surplus. In exercising this power, the Officer was required to give due consideration to the need for making reasonable provisions for bonuses to participating policy‑holders and for contingencies. In simple terms, the provision allowed the Officer to raise the surplus to a just amount, but only if the valuation of securities and other assets had been deliberately undervalued to lower the surplus by using an inconsistent interest rate or other factor in the liability calculation, and only after taking into account the necessity of reasonable bonus and contingency reserves. The Court noted that the authority given to the Income‑tax Officer under the proviso was limited and subject to these conditions. In the facts before it, the Officer admitted that he had not consulted the Controller of Insurance. He also failed to consider the requirement to make reasonable provisions for bonuses to participating policy‑holders or for contingencies, and he did not establish that the interest rate or any other factor employed in determining the liability on outstanding policies was materially inconsistent with the valuation of the securities or other assets. Instead, the Officer determined the market value of the stocks and shares, compared that market value with the valuation reported by the insurer, and, upon finding the reported values to be undervalued, added a certain amount to the surplus for tax purposes. The Appellate Assistant Commissioner disputed the market‑value assessment, reduced the amount that had been added, but made no further adjustments. The Tribunal, which set aside the earlier orders, based its decision primarily on the Income‑tax Officer’s failure to consult the Controller of Insurance. The two questions that arose—one raised by the Commissioner and the other actually referred—highlighted respectively the actions of the Income‑tax Officer and the Tribunal’s order. The Court’s answer addressed the Officer’s decision, while the other question pertained only to the Tribunal’s judgment. The Department did not attempt to rely on the proviso before either the High Court or the Supreme Court, perhaps because it had not complied with the conditions stipulated in the proviso, whether those conditions were mandatory or merely directory. Consequently, the Department argued that the main rule alone governed the matter, a contention that the High Court appeared to accept.

The Court observed that the consolidated revenue account of the Bharat Insurance Company showed that, during the four‑year period beginning on 1 January 1948 and ending on 31 December 1951, the company had transferred a sum of rupees 18,75,000 to its investment reserve fund and that this transfer had been recorded in Form G. As a result of that transfer, the balance of the life fund was recorded as rupees 5,45,88,286‑1‑10, while the net liability of the fund stood at rupees 5,19,42,924, creating a surplus. The valuation balance‑sheet presented in Form 1 for the date 31 December 1951 therefore displayed a net liability of rupees 5,19,42,924, a balance of the life‑under‑business‑assurance fund of rupees 5,45,88,286 and a surplus of rupees 26,45,362, the figures being shown in the accompanying summary and balance‑sheet.

According to the valuation abstract prepared under the fourth schedule, the actuary had assumed an interest rate of three per cent per annum and had computed that the average rate of interest earned on the mean life fund for each year of the period was as follows: for the year ending 31 December 1948, three point five per cent; for the year ending 31 December 1949, three point two seven per cent; for the year ending 31 December 1950, three point two seven per cent; and for the year ending 31 December 1951, three point two six per cent. The Income‑Tax Officer, however, did not focus on the rate of interest used in determining the liability for outstanding policies. Instead, he examined the valuation of the stocks and shares held in the life fund in order to decide whether the rupees 18,75,000 transferred to the investment reserve fund to offset an alleged depreciation in the value of those stocks and shares was justified. In doing so, he reviewed the details of the alleged depreciation, which the assessee company had calculated as rupees 22,64,733. He observed that after the transfer of rupees 18,75,000 to the reserve fund, the balance credited to the fund amounted to rupees 22,95,154, a figure that should not have exceeded rupees 22,64,733, thereby indicating an excess of rupees 30,420. The officer disallowed this excess. Subsequently, he ascertained the prevailing market rates for the stocks and shares in the fund and concluded that some of those securities had been undervalued by a total of rupees 1,58,756. He therefore held that an excess of rupees 1,89,186 had been transferred to the investment reserve fund from the surplus. On the basis of his view that the surplus of rupees 26,45,362 shown in Form 1 required adjustment, he added a lump‑sum amount of rupees 1,75,000 to that surplus, effectively rejecting the total depreciation claimed under Rule 3(b) as an allowance. The Appellate Assistant Commissioner reduced the rupees 1,75,000 to rupees 1,45,000, and the Income‑Tax Appellate Tribunal subsequently cancelled the adjustment altogether. The learned judges of the High Court, in their consideration of the matter, noted that the excess of rupees 30,420 did not represent an actual depreciation and therefore no provision needed to be made in the reserve fund for that sum. They also held that the Income‑Tax Officer was correct in finding that certain stocks and shares had been deliberately undervalued. They accepted the proposition that the

The Court considered whether an adjustment to the surplus could be made when the Income‑tax Officer found that the rate of interest or another factor used to determine the liability on outstanding policies and other assets was materially inconsistent with the valuation of the securities and other assets, and whether providing adequate bonuses to participating policy‑holders and contingencies required a specialist. The statutory proviso required the Officer, if he chose to make such an adjustment, to obtain advice from the Controller of Insurance before acting on his own knowledge. The Court held, however, that determining a proper valuation of the securities did not require a specialist; any person could obtain market quotations and thereby ascertain the securities’ value. According to the Court, although the proviso imposed a duty on the Income‑tax Officer to consult the Controller of Insurance and to make adjustments in a particular manner, the main rule authorized the Officer to fix permissible deductions based on a correct valuation of the securities, and this jurisdiction was not limited by the proviso. Consequently, the Court observed that fixing the correct value of the assets was not the sort of adjustment contemplated by the proviso; therefore, prior consultation was unnecessary and the conditions precedent laid down in the proviso did not apply. The Court referred to the Bombay High Court decision in Western India Life Insurance Co. Ltd. In re (1) and noted that such action had been held permissible under rule 30 of the superseded rules, which was in pari materia with the present main rule 3(b). The Court also cited Commissioner of Income‑Tax, Bombay, Sind and Rajasthan v. Indian Life Assurance Co. Ltd (2), where the High Court’s dictum had been applied by the Sind Chief Court. The Court concluded that the proviso did not apply to a case where the Income‑tax Officer merely needed to determine whether the securities had been correctly valued. The Officer must be satisfied, without reference to the Controller of Insurance, that the securities transferred to the reserve fund are no more than necessary to meet actual depreciation or loss, and to reach that conclusion he must possess a correct valuation of the securities. Accordingly, the Court held that the Income‑tax Officer had full jurisdiction to deal with the matter in the manner he had employed. Counsel for the Life Insurance Corporation, Mr. Setulvad, then pointed out that the actuarial valuation balance‑sheet in Form 1 had determined the surplus by deducting from the life‑insurance fund, as on the valuation date, the net liability under the life‑insurance business. He further explained that the actuary, in working out this liability, had assumed an interest rate of three per cent per annum and

In support of its case, the Life Insurance Corporation explained that, in arriving at the figure used for the actuarial balance‑sheet, the actuary had taken into account the average interest yield observed over the four‑year period covered by the valuation. That average yield was calculated by strictly following the procedure set out in Regulation 3 of Part 1 of the fourth schedule to the Insurance Act. The corporation argued that if the interest yield were to be lowered because of a reduction in the amount of depreciation, the liability calculated for the policies in the accounts would be altered, leading to an increase in that liability. It further pointed out that Rule 30 of the earlier rules had been amended by the insertion of a proviso in the new Rule 3(b), which made it mandatory that any adjustment concerning depreciation of securities in the actuarial balance‑sheet could be made only after complying with the conditions specified in that proviso. The corporation maintained that action could be taken solely under the proviso and strictly in accordance with its terms. It submitted that the Income‑Tax Officer could not simply increase the surplus by reducing the amounts transferred to the investment reserve fund, because such a reduction would diminish the coverage and seriously disturb the provision for policy liabilities, the bonuses due to participating policy‑holders, and the contingencies, rendering the officer’s action beyond his jurisdiction. On the other side, counsel for the Department argued that the Income‑Tax Officer possessed a general power under the main provision of Rule 3(b) that was independent of the proviso and enabled him to make the adjustment. The Department’s representative did not rely on the proviso and contended that the officer could determine the market value of stocks and shares from market quotations, and, if a disparity was found, could adjust the deduction claimed under Rule 3(b) by refusing to allow it. He asserted that it was unnecessary to refer to the proviso, and that consultation with the Controller of Insurance was not absolutely required; the officer was exercising his jurisdiction in accordance with the general power derived from the main rule. The Department further argued that any discrepancy between the figures entered in the accounts and the actual facts could not be made the subject of a rule, because rules can only prescribe the procedure the officer must follow when he discovers an inaccuracy. The entire question of a disparity between the facts and the recorded entries, the Department said, was covered by the proviso. Accordingly, if the officer accepted the accounts, he must merely adjust the surplus by the amounts shown for depreciation or appreciation. His authority under the main rule would end there. However, if he discovered a material discrepancy, he must act under the proviso, which requires him to consult the Controller of Insurance and to consider that a reasonable provision must be made for bonuses to participating policy‑holders and for contingencies.

In this case the Court explained that a provision must be made for bonuses payable to participating policy‑holders and for contingencies, and that the officer may act only when the rate of interest or any other factor employed in determining liability under the policies is materially inconsistent with the valuation of securities, a situation which, in the Court’s view, produces an artificial reduction of the surplus. The Court further held that the proviso expressly negates the existence of any separate general power; consequently, any action must be taken strictly in the manner prescribed by the proviso, and no action may be taken otherwise. The Court observed that, in the present proceedings, the Income‑tax Officer failed to follow the proviso altogether. Moreover, the Department neither relied upon the proviso before the High Court nor, prior to the present appeal, attempted to justify the officer’s action by reference to the proviso. The Court noted that, although there was an attempt before it to confine the generality of the question debated in the High Court to the specific point decided by the Tribunal and outlined in the assessee’s suggested question, the essence of the matter remained unchanged regardless of the analytical approach adopted.

The Court clarified that any adjustment of the surplus concerning appreciation and depreciation of securities, when based not on the accounts but on the Income‑tax Officer’s discretion, can be performed only in the manner laid down by the proviso, because such power does not exist under the main rule, which merely permits book entries to be incorporated into the surplus. The Court found it impossible to endorse the High Court’s view that the Income‑tax Officer possessed a general power to make adjustments independently of the proviso; if a discrepancy is detected, the officer must proceed under the proviso, and to hold otherwise would render the proviso redundant, an outcome the Court deemed contrary to legislative intent. The Court further stated that cases decided under the former rule 30 cannot serve as precedents, since rule 3(b) has been materially altered by the addition of the proviso. Previously, the rule attempted to achieve both objectives by using the word “may,” which granted the officer discretion and risked arbitrary actions; the revised rule now comprises two parts: a main rule that leaves no discretion and a proviso that confers conditional power. Consequently, the Court disagreed with the High Court’s answer to the question, concluding that the correct answer was negative, and therefore allowed the appeals with costs awarded against the respondent both here and in the High Court.