1991 (4) TMI 5 - HC - Income Tax

Court rules 'contingency reserve' part of capital base under Surtax Act, distinguishes from provisions.

The court ruled in favor of the assessee, affirming that the 'contingency reserve' should be considered in computing the capital base under the Surtax ... Company, Reserves, Surtax Issues:Interpretation of the term 'contingency reserve' for computing the capital base under the Surtax Act.Analysis:The case involved a dispute regarding the treatment of a 'contingency reserve' in the computation of the capital base under the Surtax Act. The Income-tax Officer disallowed the claim made by the assessee, stating that the reserve was created towards a known liability but the quantum was unascertained, and it was used to make bonus payments. The Commissioner of Income-tax (Appeals) allowed the claim, emphasizing that the reserve was not earmarked for any specific purpose. The Appellate Tribunal found that the reserve was created to meet an unforeseen eventuality, not a known liability, and hence should be treated as a reserve, not a provision.In the judgment, the court considered the difference between a provision and a reserve as explained in previous Supreme Court decisions. It was highlighted that a provision is a charge against profits, while a reserve is an appropriation of profits to form part of the capital employed in the business. The court emphasized that the intention and purpose behind the appropriation must be considered to determine whether an amount constitutes a reserve or a provision. The court also referred to a Calcutta High Court decision, stating that an amount set aside to meet a known liability would be a provision, while an amount set aside for an unknown contingency would be a reserve.The court concluded that the 'contingency reserve' in question was created to meet an unknown liability, not a known liability like bonus payments. The reserve was set apart as a prudent measure to provide for an unforeseen eventuality, aligning with the principles laid down by the Supreme Court. As the reserve was not intended for a specific known liability, it was deemed to be a reserve and not a provision. The court ruled in favor of the assessee, affirming that the amount in the contingency reserve should be considered in computing the capital base under the Surtax Act.The judgment was a significant clarification on the distinction between provisions and reserves in the context of creating reserves for unknown contingencies. It highlighted the importance of the intention behind creating such reserves and provided guidance on how to categorize them based on their purpose and foreseeability of the liability they aim to address.