Reserve versus provision: profits set aside without an ascertained liability can count as capital for surtax computation.

For surtax computation under the Companies (Profits) Surtax Act, an amount credited out of profits is treated as a reserve where its substance shows no setting aside to meet an ascertained liability. The governing test is the true nature of the appropriation, assessed from the surrounding circumstances, the intention behind the fund, and its commercial purpose. On the facts described, the amount was created voluntarily, was not contractually required, was not earmarked against a specific repayment obligation, remained invested in the business, and was later moved to general reserve. It therefore qualified as a reserve and was includible in capital.

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Issues: Whether the amount credited as loan redemption reserve was a reserve or a provision for the purpose of inclusion in the capital computation under the Companies (Profits) Surtax Act, 1964.

Analysis: The governing test is the true nature and character of the amount as gathered from the surrounding circumstances, the intention with which it was set apart, and the purpose for which it was retained. A provision is a charge against profits made to meet a known liability, contingency, or diminution in value of assets, whereas a reserve is an appropriation of profits retained as part of the capital employed in the business. The material facts showed that the amount was created voluntarily out of profits, without any contractual obligation to create such a fund, without direct earmarking against repayment of any identified instalment, remained internally invested in the business, and was later transferred to general reserve. The existence of a loan liability did not by itself convert the appropriation into a provision, particularly when the fund was not shown to have been created to meet an ascertained liability in the commercial sense applicable to the surtax computation.

Conclusion: The amount was a reserve and not a provision, and it was includible in the capital of the company for surtax purposes.

Final Conclusion: The reference was answered in the affirmative in favour of the assessee, and the disputed sum was held to qualify for inclusion in capital under the statutory scheme.

Ratio Decidendi: For surtax computation, an amount appropriated out of profits is a reserve if, on a consideration of its substance, it is not set apart to meet an ascertained or known liability but is retained as part of the business capital.

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