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Issues: (i) Whether the deferred taxation reserve constituted a reserve for inclusion in the computation of capital under the Second Schedule to the Companies (Profits) Surtax Act, 1964; (ii) Whether the doubtful debts reserve constituted a reserve, and not a provision, for inclusion in the computation of capital under the Second Schedule to the Companies (Profits) Surtax Act, 1964.
Issue (i): Whether the deferred taxation reserve constituted a reserve for inclusion in the computation of capital under the Second Schedule to the Companies (Profits) Surtax Act, 1964.
Analysis: An amount is a reserve when it is set apart out of profits or surplus and is not designed to meet a liability, contingency, commitment, or diminution in asset value known to exist at the balance-sheet date. The deferred taxation reserve was found to have been created without any specific known or existing liability in mind and on an ad hoc basis.
Conclusion: The deferred taxation reserve was a reserve and was includible in the computation of capital, in favour of the assessee.
Issue (ii): Whether the doubtful debts reserve constituted a reserve, and not a provision, for inclusion in the computation of capital under the Second Schedule to the Companies (Profits) Surtax Act, 1964.
Analysis: A provision is made to meet a known or existing liability, whereas a reserve is an amount set aside without reference to such liability. The doubtful debts reserve had been carried forward from year to year, was not shown to have been made to meet any known liability or contingency, and was treated as an appropriation for future contingencies rather than as a quantified provision for an existing liability.
Conclusion: The doubtful debts reserve was a reserve and not a provision, and was includible in the computation of capital, in favour of the assessee.
Final Conclusion: Both disputed reserves were held includible in capital for surtax computation, and the reference was answered for the assessee.
Ratio Decidendi: For surtax capital computation, an appropriation out of profits is a reserve unless it is shown to have been made to meet a known or existing liability or contingency at the balance-sheet date.
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