Capital computation under surtax law: tax equalisation reserve treated as reserve, while capital reduction for income-tax deductions was rejected.

Capital under the Second Schedule to the Companies (Profits) Surtax Act could not be reduced merely because deductions had been allowed under sections 80M, 80J and 80-O while computing income-tax, and the assessee succeeded on that point. An excess provision under the head "tax equalisation reserve" was treated as a reserve because amounts set apart beyond what was reasonably necessary to meet a known or existing liability are includible in capital, so that amount was also included in the assessee's favour. For "reserve for doubtful debts and advances", the factual basis was incomplete, so the issue was remitted for fresh consideration under the governing Supreme Court principles.

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Issues: (i) Whether, in computing capital under the Second Schedule to the Companies (Profits) Surtax Act, 1964, a diminution of capital proportionate to deductions allowed under sections 80M, 80J and 80-O of the Income-tax Act, 1961 was permissible. (ii) Whether the amount set apart as 'Tax equalisation reserve' and 'Reserve for doubtful debts and advances' was includible as reserve in the capital computation under rule 1 of the Second Schedule.

Issue (i): Whether, in computing capital under the Second Schedule to the Companies (Profits) Surtax Act, 1964, a diminution of capital proportionate to deductions allowed under sections 80M, 80J and 80-O of the Income-tax Act, 1961 was permissible.

Analysis: The question was answered by following the earlier decision relied upon by the Court on the same point. The statutory scheme of the Second Schedule did not permit the proposed diminution in capital merely because deductions were allowed while computing total income under the Income-tax Act, 1961.

Conclusion: The answer was in the affirmative in favour of the assessee.

Issue (ii): Whether the amount set apart as 'Tax equalisation reserve' was includible as reserve in the capital computation under rule 1 of the Second Schedule.

Analysis: Applying the principle that an amount set apart in excess of what is reasonably necessary to meet a known or existing liability constitutes a reserve, the Court held that the excess under the head 'Tax equalisation reserve' had to be treated as reserve and included in capital. As to 'Reserve for doubtful debts and advances', there was no finding whether the amount set apart exceeded the reasonably necessary liability, so that part could not be finally answered and was sent back for fresh consideration in light of the governing Supreme Court principles.

Conclusion: The tax equalisation reserve was includible in capital in favour of the assessee, while the question regarding reserve for doubtful debts and advances was remanded for determination.

Final Conclusion: The reference was answered partly in favour of the assessee on the merits, and the unresolved portion concerning reserve for doubtful debts and advances was remanded to the Tribunal for reconsideration.

Ratio Decidendi: An amount set apart in excess of what is reasonably necessary to meet a known or existing liability is to be treated as a reserve and included in capital computation; where the necessary factual finding is absent, the issue must be remitted for fresh determination.

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