Capital-account foreign exchange gain credited to reserve was included in surtax capital base, not excluded as a deductible reserve.

Under rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, only reserves that were allowed as a deduction in computing income under the Income-tax Act can be reduced from capital base. The exchange gain credited to general reserve on foreign-currency devaluation had not been allowed as a deduction in the assessee's income-tax assessment. It arose from reduced rupee liability on repayment of a dollar loan used to acquire plant and machinery, so it was treated as a capital-account gain rather than a trading receipt or a capital gain from transfer of a capital asset. The accounting treatment did not change its character, and it could not be excluded from capital for surtax computation.

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Issues: Whether the exchange gain credited to the general reserve on account of foreign-currency devaluation was a reserve within the meaning of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and whether it could be excluded while computing the capital base.

Analysis: Under rule 1(iii) of the Second Schedule, only those reserves are to be reduced which have been allowed as a deduction in computing the company's income under the Income-tax Act. The finding was that the amount in question had not been allowed as a deduction in the assessee's income-tax assessment. The gain arose because devaluation reduced the rupee liability on repayment of a dollar loan taken for acquiring plant and machinery. It was a capital-account gain, not a trading receipt or a capital gain from transfer of any capital asset, and the mere manner in which it was credited in the accounts did not alter its character.

Conclusion: The amount could not be excluded from the company's capital for surtax computation, and the question was answered in the affirmative, in favour of the assessee.

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