Pandhyan Insurance Co. Ltd vs Commissioner Of Income-Tax, Madras

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 816 of 1963

Decision Date: 29 September 1964

Coram: S.M. Sikri, K. Subbarao, J.C. Shah

In this matter, the Supreme Court examined an appeal filed by Pandhyan Insurance Co. Ltd against the Commissioner of Income‑Tax, Madras. The judgment was delivered on 29 September 1964 by a bench consisting of Justice S. M. Sikri, Justice J. C. Shah and Justice K. Subbarao, and the case was reported as 1965 AIR 1004 and 1965 SCR (1) 367. Pandhyan Insurance Co. Ltd was a public limited company engaged in the business of general insurance. Toward the end of 1952 the company constructed a substantial modern building at a cost of approximately Rs 12,00,000. For the accounting year 1953 the company wrote off a sum of about Rs 1,00,000 as depreciation on various items of its assets. The Income‑Tax Officer, however, disallowed four‑fifths of that depreciation on the ground that only one‑fifth of the building was used for the insurer’s own business while the remaining four‑fifths was let out, and the rent received from that portion was exempt under section 4(3)(xii) of the Income‑Tax Act, 1922. The assessee appealed the disallowance, but the Appellate Assistant Commissioner dismissed the appeal and further increased the assessment by withdrawing even the one‑fifth portion of depreciation that the officer had allowed, reasoning that rule 3(b) of the Schedule required an actual depreciation of the value of the assets. On further appeal, the Appellate Tribunal restored the officer’s decision regarding the one‑fifth portion but upheld the Assistant Commissioner’s view concerning the four‑fifths portion. The Madras High Court, on a reference concerning whether the four‑fifths portion of depreciation could also be claimed as a deduction under section 10(7) and the applicable rules of the Schedule, ruled against the appellant. Upon reaching the Supreme Court, the Court held that the appeal must be allowed. It explained that rules 3(b) and 6 of the Schedule should be read in the context of the Insurance Act 1938, which contains detailed provisions to ensure a true valuation of assets and an accurate determination of the insurer’s profit balance. Consequently, the Income‑Tax Officer could exclude from the profit balance only those expenditures that were not allowable under section 10 of the Income‑Tax Act. The Court observed that the term “expenditure” in rule 6 meant a disbursement and did not encompass depreciation. Regarding depreciation, the Court stated that the term covered both actual and notional depreciation, and therefore the officer had no discretion to refuse the deduction under rule 3(b); the officer could not require the assessee to prove that any actual depreciation had taken place. The Court’s reasoning was supported by the precedent set in Life Insurance Corporation of India v. Commissioner of Income‑Tax (1964) 51 I.T.R. 773, and the judgment was delivered as a civil decision.

The appeal was filed as Civil Appeal No 816 of 1963 under special leave against a judgment dated 4 July 1961 delivered by the Madras High Court in case referred No 4 of 1957. Counsel for the appellant consisted of a senior advocate and two junior advocates, while the respondent was represented by a team of three advocates. The judgment of the Supreme Court was delivered by Justice Sikri. The matter before the Supreme Court concerned a question of law arising under the Indian Income‑Tax Act, 1922, specifically whether four‑fifths of a sum of Rs 1,21,245, which the assessee had written off in its books as depreciation for the calendar year 1953, could be allowed as a deduction in the assessment completed under section 10(7) and the rules contained in the Schedule of the Act.

The assessee was a public limited company engaged in the general insurance business. It had constructed a modern, substantial building equipped with lifts and air‑conditioning at a cost of Rs 12,08,252 and had made the premises ready for occupation from 1 December 1952. In the account books for the calendar year 1953, corresponding to the assessment year 1954‑55, the company recorded a depreciation write‑off of Rs 1,21,245. The depreciation was apportioned as follows: buildings at ten per cent amounting to Rs 1,06,940; air‑conditioning plant at fifteen per cent amounting to Rs 2,973; lifts at fifteen per cent amounting to Rs 6,214; transformers at fifteen per cent amounting to Rs 1,442; and internal telephone equipment at fifteen per cent amounting to Rs 3,676, totalling Rs 1,21,245.

It was unanimously accepted before the Income‑Tax Appellate Tribunal that one‑fifth of the building was occupied for the company’s own purposes, while the remaining four‑fifths was let out to tenants for rent. The Income‑Tax Officer disallowed the depreciation claimed on the four‑fifths portion on the ground that the rentals from that portion were shown separately under the head “Property” and the income from those rentals had been claimed as exempt under section 4(3)(xii). The Officer argued that if the property income had not been exempt, there would have been a statutory allowance to compensate for depreciation, and that the total exemption of the income reinforced the view that no allowance could be granted.

Upon appeal, the Appellate Assistant Commissioner rejected the entire depreciation claim, including the portion that the Income‑Tax Officer had allowed, on a different basis. He held that the property fell within the expression “other assets” used in Rule 3(b) of the Schedule, and that Rule 3(b) contemplated only actual depreciation of the value of such assets. Since the counsel for the assessee had admitted that the property was new, the Commissioner concluded that no actual depreciation could have occurred.

The matter was then taken to the Appellate Tribunal. The Tribunal concluded that the immovable property, to the extent of four‑fifths, constituted an investment held solely for the purpose of earning rent, and that such an investment was capable of appreciation either through appreciation in value or by sale and realisation. The Tribunal’s conclusion set the stage for further consideration of the applicability of Rule 6 of the Schedule, as discussed in the subsequent portion of the judgment.

The Court observed that rule 6 of the Schedule authorizes the Income‑tax Officer to determine a figure that is fair and just, and accordingly the Officer allowed the appeal in part. When the matter was referred to the High Court, that Court held that, for the purpose of computing profits and gains, the Income‑tax Officer possessed the authority to examine the amount of depreciation that had either been written off or set aside, and to be satisfied that such amount did not exceed the depreciation allowance permitted by law. Both parties agreed that, under section 10(7) of the Income‑Tax Act, the profits and gains of any insurance business must be computed according to the rules contained in the Schedule to the Act, and that sections 8, 9, 10, 12 and 18 of the Act were inapplicable in this context. The Court then turned to the interpretation of rule 3(b) and rule 6, the understanding of which was essential to answer the question presented. The provisions read as follows: “3. In computing the surplus for the purposes of rule 2‑(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 as credit 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; 6. The profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938 [4 of 1938], to be furnished to the Controller of Insurance, after adjusting such balance so as to exclude from it 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. Profits and losses on the realisation of investments and depreciation and appreciation of the value of investments shall be dealt with as provided in rule 3 for the business of life insurance.” Finally, counsel for the petitioner, Mr Viswanatha Sastri, contended that the Insurance Act, 1938 (4 of 1938) contains detailed provisions designed to ensure the accurate valuation of assets and the correct determination of the true balance of profits of an insurance business.

In this case, the Court observed that the Insurance Act contains detailed provisions for the valuation of assets and for determining the true balance of profits of an insurance business, and that the petitioner’s contention on this point was supported by an examination of several sections of the Act. Section 11 required every insurer, at the end of each calendar year, to prepare a balance sheet, a profit‑and‑loss account and a revenue account in the manner prescribed by the schedules to the Act. Part I of the First Schedule laid down the regulations, while Part II provided the forms to be used for preparing a balance sheet. Regulation 6 specifically mandated that the balance sheet be accompanied by a statement in Form AA, which is set out in Part II of the First Schedule. Form AA was required to display both the market value and the book value of all assets, including house property. The form consisted of three columns: the first column recorded the book value as defined in sub‑paragraph (a); the second column recorded the market value as defined in sub‑paragraph (b); and the third column contained remarks as defined in sub‑paragraph (c). Sub‑paragraph (a) indicated the value for which credit was taken, sub‑paragraph (b) indicated the market value of assets ascertained from public quotations, and sub‑paragraph (c) explained how the value of assets not obtainable from public quotations had been derived. The Act further provided that it was not necessary to show market values when those values were not less than the book values; in such cases a certificate to that effect could be appended to the statement. Consequently, if the market value exceeded the book value, the market value need not be shown. As a result of these provisions, the statement of assets would normally display the book value of house property and its market value, except where the market value was higher, in which case only the book value would appear.

The Court then turned to the Second Schedule, which prescribed the regulations and forms for preparing the profit‑and‑loss account of certain insurers. Form B, required by that schedule, contained two columns that had to be completed: one for depreciation of investments that were not charged to reserves or any particular fund or account, and another for appreciation of investments that were not credited to reserves or any particular fund or account. The Third Schedule set out the regulations and forms for preparing a revenue account. Among the items to be shown in Form D was “Rents for offices belonging to and occupied by the Insurer.” Form F was identified as the form to be used for the revenue account of fire insurance business, marine insurance business and miscellaneous insurance business. One of the items required to be shown in Form F was “expenses of management,” and note (c) to that form clarified that if any sum had been deducted from this expense item and entered on the assets side of the balance sheet, the amount deducted had to be shown separately.

After the balance sheet, profit‑and‑loss account and revenue account had been prepared, the Court noted that they were required to be audited unless they fell within the scope of an audit already prescribed under the Indian Companies Act. Under section 15 of the Insurance Act, the audited accounts and statements thus prepared had to be furnished to the Controller of Insurance as returns. Section 18 further required every insurer to provide the Controller with a certified copy of every report on the affairs of the concern that was submitted to the members or policyholders of the insurer.

The Court observed that Section 21 of the Insurance Act authorised the Controller to require any insurer to furnish additional information that the Controller deemed necessary to correct or supplement a return. Such information could include the examination of books of account, registers, documents or even the examination of any officer of the insurer. The Court noted that the Controller was empowered to refuse acceptance of any return unless the identified inaccuracy had been corrected or the missing information had been supplied. In the event that the Controller declined to accept a return, the insurer would be deemed to have failed to comply with the provisions of Sections 15, 16, 28 or 28A that related to the furnishing of returns. The Court further explained that subsection (2) of Section 21 permitted an insurer to approach the court for the cancellation of any order made under clauses (a), (b) or (c) of subsection (1), or for a direction that a return previously rejected by the Controller be accepted. The Court stated that these statutory provisions must be read in the context of the background described earlier.

The Court then turned to the argument presented by the appellant concerning Rule 6, which authorised an Income‑Tax Officer to make two categories of adjustments. The appellant contended that the first category allowed the officer to exclude from the profit balance any expenditure that was not permissible under Section 10 of the Income‑Tax Act. The appellant argued that the depreciation claimed by the assessee did not constitute “expenditure” within the meaning of Rule 6 because, according to the appellant, expenditure must be a disbursement. To support this position, the appellant referred to the language of Section 10(2)(xii), (xiv) and (xv), which expressly used the term “expenditure”. Regarding the second category of adjustment under Rule 6, the appellant submitted that the term “depreciation” encompassed both actual and notional depreciation, and that the same interpretation applied to the word “depreciation” in Rule 3(b). The appellant maintained that if this view were correct, Rule 3(b) would obligate the Income‑Tax Officer to allow the depreciation written off by the assessee without requiring the assessee to prove the existence of actual depreciation. The appellant relied heavily on the decision of this Court in Life Insurance Corporation of India v. Commissioner of Income‑Tax (1964) 51 I.T.R. 773, seeking to apply that precedent to the present dispute.

To determine the relevance of the cited precedent, the Court examined the scope of the decision of Justice Sarkar. Justice Sarkar had interpreted Rule 3(b) by stating that the first part of the rule imposed an obligation on the Income‑Tax Officer to allow certain amounts that the assessee had written off or reserved as deductions, and to include in the surplus any sums for which credit had been taken on account of appreciation or gains arising from the realisation of securities or other assets. Justice Sarkar clarified that this portion of the rule merely compelled the officer to accept those specific deductions and credits that were reflected in the assessee’s accounts. It did not empower the officer to adjust the accounts on the basis of a revaluation performed by the officer himself. The Court quoted this passage, noting that the language of the rule did not authorize the officer to make discretionary adjustments beyond what was recorded in the assessee’s books. Consequently, the Court concluded that the earlier decision could not be extended to permit the Income‑Tax Officer to override the statutory definition of expenditure or to treat notional depreciation as automatically allowable under Rule 3(b).

The learned judge explained that Rule 3(b) requires certain special deductions and additions to be made to the annual average of the surplus that is calculated under Rule 2. Because the life fund is invested in securities and the market values of stocks and shares vary, Rule 3(b) includes a provision for making adjustments. The main part of Rule 3(b) commands that adjustments be based on the amounts recorded in the accounts, and those entries determine what must be added to or deducted from the surplus. Accordingly, the Income‑tax Officer must subtract from the annual average of the surplus any amount that has been entered in the accounts to cover depreciation of securities and other assets, and must add any amount for which credit has been taken on account of appreciation. In performing this duty, the Income‑tax Officer follows the accounts and gives effect to the entries exactly as they appear. The provision is therefore mandatory and the Income‑tax Officer possesses no discretion in applying it. The judge further observed that any discrepancy between the actual facts and the entries recorded in the accounts is addressed by the proviso to Rule 3(b). The Court has therefore held in unequivocal terms that Rule 3(b) does not empower the Income‑tax Officer to revalue the accounts on his own initiative or to correct mismatches between the recorded entries and the underlying facts.

Mr Ganapathy Iyer attempted to distinguish this position by contending that Rule 6 was not applicable to a life‑insurance business and had not been considered by the Court. He initially argued that the word “depreciation” in the second part of Rule 6 did not include notional depreciation. When counsel pointed out that accepting this view would render Rule 3(b) inapplicable, Mr Iyer altered his argument and maintained that “depreciation” in Rule 3(b) should be interpreted narrowly, excluding notional depreciation. The Court disagreed with this limited construction, stating that the phrase “any amount written off … in the accounts … to meet depreciation of … other assets” must be understood in its ordinary meaning. If the drafter had intended to limit depreciation to physical assets such as buildings, a different wording could have been used. Accordingly, the Court affirmed that the term “depreciation” in Rule 3(b) embraces notional depreciation, and that the Income‑tax Officer must honor the recorded amounts without revaluation.

The Court noted that, according to the citation [1964 151 I.T.R. 773, L2Sup./64-11], there was no argument advanced that the depreciation being written off was anything other than notional depreciation. It emphasized that the rate of depreciation prescribed by the statute did not possess any absolute sanctity, and consequently, even if the rate applied by the assessee and accepted by the Controller differed from the statutory rate, the assessee could still be said to have written off an amount for the purpose of meeting depreciation. The Court observed that counsel for the petitioner, Mr Ganapathy Iyer, had referred to several authorities, but these authorities had already been considered in the earlier decision of this Court, and therefore a further discussion of them was unnecessary. The Court further remarked that the learned counsel for the Revenue had incorrectly argued that the term “expenditure” in the first part of Rule 6 should be interpreted to include depreciation. Aligning with the submission of counsel for the petitioner, Mr Sastri, the Court held that the word “expenditure” in Rule 6 carries its ordinary meaning of a disbursement and does not extend to depreciation. On this basis, the Court affirmed the appeal, answered the question in the affirmative, and ordered that the respondent should bear the costs incurred in both this Court and the High Court. Accordingly, the appeal was allowed.