Reserve versus provision principles governed surtax capital computation, with assessment timing upheld as reasonable on the facts.

Surtax capital computation under the Companies (Profits) Surtax Act, 1964 turned on whether items were reserves or provisions and whether the assessment was made within a reasonable time. The court treated the surtax assessment as timely because no express limitation applied and it followed the income-tax assessment shortly after. Amounts in a foreign taxation reserve, excess provision for taxation, general reserve, reserve for doubtful debts, and contingency reserve were held includible as reserves where no existing and known liability was shown; a later dividend did not require reduction of the general reserve. Surplus in the profit and loss appropriation account and related taxation provision could also be adjusted under rule 2(ii) to the extent not treated as reserve.

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Issues: (i) Whether the surtax assessment made under section 6 of the Companies (Profits) Surtax Act, 1964 was barred by limitation or was made within a reasonable time; (ii) whether the balance in the foreign taxation reserve was includible in computing capital; (iii) whether the excess provision over actual tax liability in the provision for taxation account was includible in computing capital; (iv) whether the general reserve had to be reduced by dividend declared later and whether the balances in reserve for doubtful debts and contingency reserve were includible in computing capital; (v) whether the surplus in the profit and loss appropriation account and the provision for taxation account, to the extent not treated as reserve, could be reduced from the cost of assets under rule 2(ii) while computing capital.

Issue (i): Whether the surtax assessment made under section 6 of the Companies (Profits) Surtax Act, 1964 was barred by limitation or was made within a reasonable time.

Analysis: No express period of limitation governed completion of the surtax assessment. The governing test was whether the assessment was completed within a reasonable time, determined by the facts of the case. Since the surtax assessment followed the income-tax assessment by only a few days, the delay was well within a reasonable period.

Conclusion: The issue was answered in favour of the Revenue.

Issue (ii): Whether the balance in the foreign taxation reserve was includible in computing capital.

Analysis: The finding was that no excess profits tax liability in Pakistan had ever arisen and the account had been maintained only as a safeguard. Where no liability exists in discharge of which an amount is set apart, the amount is treated as a reserve and not a provision.

Conclusion: The issue was answered in favour of the assessee and the amount was held includible as a reserve.

Issue (iii): Whether the excess provision over actual tax liability in the provision for taxation account was includible in computing capital.

Analysis: The matter was governed by the distinction between a true provision made for an ascertained liability and a reserve. On the facts, the excess amount did not retain the character of a provision for a known liability and fell within the reserve category for capital computation purposes.

Conclusion: The issue was answered in favour of the assessee.

Issue (iv): Whether the general reserve had to be reduced by dividend declared later and whether the balances in reserve for doubtful debts and contingency reserve were includible in computing capital.

Analysis: The dividend declared after the relevant accounting date did not require reduction of the general reserve. The balances in reserve for doubtful debts and contingency reserve were found not to represent provision for existing liabilities or known losses; they were maintained as reserves and were therefore includible in capital.

Conclusion: The issue was answered against the Revenue and in favour of the assessee.

Issue (v): Whether the surplus in the profit and loss appropriation account and the provision for taxation account, to the extent not treated as reserve, could be reduced from the cost of assets under rule 2(ii) while computing capital.

Analysis: Under rule 2 of the Second Schedule, the cost of relevant assets is diminished by the specified amounts not already taken into account under rule 1. Amounts standing in the profit and loss appropriation account and the provision for taxation account, to the extent not treated as reserve, fall within the sums to be considered for that diminution.

Conclusion: The issue was answered in favour of the assessee.

Final Conclusion: The reference was disposed of by holding the surtax assessment timely, accepting the Revenue's challenge only on the general reserve issue, and otherwise deciding the capital-computation questions predominantly in favour of the assessee.

Ratio Decidendi: In computing capital under the Companies (Profits) Surtax Act, amounts set apart without an existing and known liability are reserves and not provisions, and completion of a surtax assessment is valid if made within a reasonable time on the facts of the case.

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