Capital base for surtax includes exempt income, and true-value book entry for free land does not trigger the reserve adjustment rule.

Income exempt under section 80-I was includible in the capital base for surtax computation, and no basis was found to exclude it; the issue was answered in favour of the assessee. A capital reserve created by entering in the books the value of land received free of cost did not attract Explanation I to rule 2 of the Second Schedule, because the entry merely reflected the true value of an existing asset and corrected the accounts rather than creating or inflating a book asset by revaluation. Both questions were decided against the Revenue.

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Issues: (i) Whether income exempt under section 80-I of the Income-tax Act, 1961 could be excluded while computing the capital base for surtax purposes; and (ii) whether Explanation I to rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 applied to the capital reserve created by entering in the books the value of land received free of cost.

Issue (i): Whether income exempt under section 80-I of the Income-tax Act, 1961 could be excluded while computing the capital base for surtax purposes.

Analysis: The question was governed by the binding view already applied by the lower authorities. The exempt income formed part of the capital base computation for surtax purposes, and no contrary basis was found to disturb that approach.

Conclusion: The issue was answered in the affirmative and against the Revenue.

Issue (ii): Whether Explanation I to rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 applied to the capital reserve created by entering in the books the value of land received free of cost.

Analysis: The expression "book asset" was understood in its ordinary accounting sense as an asset appearing, or properly required to appear, in the books of account. Explanation I applies where paid-up share capital or reserve is brought into existence by creating or increasing a book asset by revaluation or otherwise. Here, the land already existed, had been received free of cost, and the books were corrected to reflect its true value and the true state of affairs rather than to create or inflate capital by artificial revaluation. On that footing, the Explanation was held inapplicable.

Conclusion: The issue was answered in the affirmative and against the Revenue.

Final Conclusion: Both referred questions were decided in favour of the assessee, and the Revenue's challenge failed.

Ratio Decidendi: A reserve created by bringing into the books the true value of an existing asset, so as to correct the accounts and reflect reality, is not a reserve brought into existence by creating or revaluing a book asset within the mischief of Explanation I to rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

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