Gratuity liabilities and dollar revaluation reserves were treated differently for surtax capital base purposes.

Gratuity amounts set aside against an existing liability do not qualify as reserves to that extent under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964; the reserve must be split to identify the liability component, and relief follows only for the true reserve element. The dollar revaluation reserve was includible in capital base because the paid-up share capital remained unchanged in dollar terms and the rupee increase reflected only devaluation, not revaluation of a book asset under Explanation 1 to rule 2. The reserve was therefore treated as an accretion to paid-up share capital for surtax purposes.

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Issues: (i) Whether the gratuity reserves appearing in the assessee's balance-sheet constituted reserves for the purposes of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964. (ii) Whether the dollar revaluation reserve was includible in the capital base under the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Issue (i): Whether the gratuity reserves appearing in the assessee's balance-sheet constituted reserves for the purposes of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: The issue was treated as covered by the Supreme Court decision in Vazir Sultan Tobacco Co. Ltd. v. CIT. The governing principle was that a sum earmarked towards an existing liability is not a reserve to that extent and must be separated from any true reserve component.

Conclusion: The gratuity reserve question was answered by applying the Supreme Court ruling, and the matter was remitted for identification of the portion representing an existing liability with relief to that extent.

Issue (ii): Whether the dollar revaluation reserve was includible in the capital base under the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: The paid-up share capital had originally been subscribed in U.S. dollars and remained the same in dollar terms. On devaluation of the rupee, only the rupee equivalent increased, and the enhanced amount was reflected in the books as a dollar revaluation reserve. This was not a revaluation of a book asset within Explanation 1 to rule 2; rather, it represented an increase in the rupee value of paid-up share capital and therefore formed part of the capital base.

Conclusion: The dollar revaluation reserve was includible in the capital base and the question was answered in the affirmative, in favour of the assessee.

Final Conclusion: The reference was disposed of by applying the settled rule on gratuity reserves and by holding that the dollar revaluation surplus formed part of the company's capital for surtax purposes.

Ratio Decidendi: A rupee increase arising only from devaluation of foreign currency share subscription is an accretion to paid-up share capital, not a revaluation of a book asset; amounts set aside against an existing liability do not qualify as reserves.

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