Known liability amounts are provisions, not reserves, for capital computation under surtax and super profits tax rules.

Amounts retained or appropriated to meet known liabilities are treated as provisions, not reserves, for statutory capital computation. A debenture redemption reserve set apart for repayment of debentures was held to be a provision because the borrowing creates a known liability, so it is excluded from capital under the relevant surtax computation rules. By the same principle, a gratuity reserve set aside for future but already known gratuity liability is also characterised as a provision rather than a reserve. The governing test is the nature of the amount retained, not its label or whether the liability falls due later.

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Issues: (i) Whether a debenture redemption reserve set apart to meet repayment of debentures is a provision or a reserve for computing capital under the Companies (Profits) Surtax Act, 1964. (ii) Whether gratuity reserve is a provision or a reserve for computation of capital under the Super Profits Tax Act, 1963.

Issue (i): Whether a debenture redemption reserve set apart to meet repayment of debentures is a provision or a reserve for computing capital under the Companies (Profits) Surtax Act, 1964.

Analysis: Amounts retained to meet a known liability are excluded from the concept of reserve under Clause 7 of Part III, Schedule VI of the Companies Act, 1956. The liability to repay borrowed money arises when the borrowing is made, even if repayment falls due later. Debentures are secured loans and amounts set apart for their redemption are earmarked for a known liability. For surtax capital computation, the relevant test is the nature of the amount retained, not whether it forms part of working capital or whether the debentures are immediately redeemable. The Second Schedule also excludes amounts of the nature of liabilities and sinking funds from reserves.

Conclusion: The debenture redemption reserve is not a reserve but a provision. The exclusion from capital computation was upheld, and the assessee failed on this issue.

Issue (ii): Whether gratuity reserve is a provision or a reserve for computation of capital under the Super Profits Tax Act, 1963.

Analysis: A sum appropriated for gratuity liability is set apart for a future but known liability and therefore falls within the concept of provision rather than reserve. The settled interpretation of reserve and provision applies equally to such appropriations, and the amount cannot be treated as part of the capital base merely because it is labelled as a reserve.

Conclusion: The gratuity reserve was held to be a provision, and the assessee succeeded on this issue.

Final Conclusion: The decision affirms that amounts earmarked to meet known liabilities are outside the category of reserve for capital computation, but the particular gratuity-related amount in the connected appeal was excluded from reserve treatment in favour of the assessee.

Ratio Decidendi: An amount retained or appropriated to meet a known liability is a provision and not a reserve for purposes of statutory capital computation, even if the liability becomes payable only in future.

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