Capital base reduction under surtax law requires an actual reserve; notional depreciation differences cannot justify the adjustment.

Excess depreciation allowed in income-tax assessment could not be reduced from the company's capital base under rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964 unless there was an actual reserve credited in the books. The Madras HC held that the provision applies only where an identifiable reserve, such as a general or special reserve, contains the differential amount taken into account for surtax purposes. On the facts, there was no separate depreciation reserve, no finding of a credit to general reserve, and the assessing authority relied on a notional reserve not supported by the books or profit and loss account. Mere difference between tax depreciation and book depreciation was insufficient.

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Issues: Whether the excess depreciation allowed in income-tax assessment over the depreciation charged in the books of account was required to be reduced from the company's capital base under rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: Rule 1(iii) permits reduction from the capital base only where amounts have been credited to reserves that are taken into account for surtax purposes. The Court held that the rule could operate only if there was an identifiable reserve, such as a general reserve or a special reserve, and a corresponding credit of the differential amount to that reserve. On the facts found by the Tribunal, there was no separate depreciation reserve, no finding that the difference had been credited to the general reserve, and the assessing authority had proceeded on a notional reserve unsupported by the books of account or profit and loss account. Mere existence of a difference between depreciation in the tax assessment and in the accounts was held insufficient to justify reduction of the capital base.

Conclusion: The excess depreciation was not liable to be reduced from the capital base under rule 1(iii), and the answer was in favour of the assessee and against the Revenue.

Ratio Decidendi: Reduction from capital base under rule 1(iii) requires an actual reserve and a credit to that reserve; a notional reserve cannot be assumed merely because tax depreciation exceeds book depreciation.

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