Reserve versus provision: contingency reserve held includible in capital base because it was set aside for an unknown future contingency.

The true nature of an appropriation determines whether it is a reserve or a provision: an amount set apart for a known liability of uncertain quantum is a provision, while an amount retained for an unforeseen or unknown contingency is a reserve. Applying that test, the contingency reserve was found not to have been created to meet an existing or known liability, because bonus liability had been separately provided for each year. The balance therefore retained the character of a reserve and was includible in the capital base under rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

---

---

Issues: Whether the amount standing to the credit of the contingency reserve was a reserve or a provision, and whether it could be included in computing the capital base under rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: The controlling test is the true nature and character of the appropriation, to be gathered from the purpose for which it was made. An amount set apart to meet a known liability of uncertain quantum is a provision, whereas an amount appropriated to meet an unforeseen or unknown contingency is a reserve. The Tribunal found that the assessee had separately provided each year for bonus liability and that the contingency reserve was not created to meet an existing or known liability, but to meet an uncertain future shortfall or contingency. On that finding, the amount retained the character of a reserve and was eligible for inclusion in the capital base.

Conclusion: The contingency reserve was correctly treated as a reserve and not a provision, and its balance was includible in the capital base. The answer is in the affirmative and in favour of the assessee.

---