Capital base for surtax turns on whether a gratuity provision is a contingent liability and doubtful debts are a true reserve.

A gratuity provision is treated as a provision for contingent liability and not as capital, so its disallowance under section 40A(7) does not alter its character for surtax capital base computation and it is excluded. By contrast, an amount retained as a reserve for doubtful debts is an appropriation of profits kept in the business as capital employed, so it retains the character of a reserve and is includible in the capital base. The note distinguishes between a mere provision for a liability and a genuine reserve out of profits for surtax purposes.

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Issues: (i) Whether the amount representing a gratuity provision, which was disallowed in computing total income, could nevertheless be included in the capital base for surtax purposes. (ii) Whether the amount kept as reserve for doubtful debts was liable to be included in the computation of capital base.

Issue (i): Whether the amount representing a gratuity provision, which was disallowed in computing total income, could nevertheless be included in the capital base for surtax purposes.

Analysis: A provision made towards gratuity is treated as provision for a contingent liability and not as capital. The fact that the amount was not allowed as a deduction because the conditions of section 40A(7) of the Income-tax Act, 1961 were not satisfied did not change its character as gratuity provision. The amount therefore could not be treated as part of the capital base.

Conclusion: The question was answered in the negative, in favour of the Revenue and against the assessee.

Issue (ii): Whether the amount kept as reserve for doubtful debts was liable to be included in the computation of capital base.

Analysis: The amount was found to be a reserve for doubtful debts and not a bad debt. It was treated as an appropriation of profits retained in the business as capital employed, and therefore had the character of a reserve includible in the capital base.

Conclusion: The question was answered in the affirmative, in favour of the assessee and against the Revenue.

Final Conclusion: The reference was disposed of by holding that the gratuity provision was not includible in the capital base, while the reserve for doubtful debts was includible.

Ratio Decidendi: A gratuity provision remains a provision for contingent liability and is excluded from capital base computation, whereas an amount set apart as reserve out of profits and retained in the business is includible as reserve in the capital base.

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