Reserve capital under business profits tax requires conscious retention, while mere earned profits do not qualify as reserves.

"Reserves" under Rule 2(1) of Schedule II of the Business Profits Tax Act bear their plain meaning, so profits retained by directors and not distributed as dividends may qualify even if not earmarked for a specific purpose; on that basis, the carried-forward balance of Rs. 5,08,637 was treated as a reserve. By contrast, profits earned during 1 January 1946 to 1 April 1946 were not reserves because reserve status requires a conscious act of retention, and mere earning or use in business does not convert profits into reserve capital.

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Issues: (i) Whether the amount of Rs. 5,08,637 carried over in the balance sheet constituted a reserve for the purposes of Rule 2(1) in Schedule II of the Business Profits Tax Act. (ii) Whether profits earned from 1 January 1946 to 1 April 1946 could be treated as reserves for the purposes of Rule 2 in Schedule II.

Issue (i): Whether the amount of Rs. 5,08,637 carried over in the balance sheet constituted a reserve for the purposes of Rule 2(1) in Schedule II of the Business Profits Tax Act.

Analysis: The expression "reserves" was held to bear its plain and natural meaning and not a technical accountancy sense. An amount need not be earmarked for a specific purpose to be a reserve. What mattered was that the profit was retained by the directors and not distributed as dividends. Since the sum was kept back out of profits and subjected to taxation, it satisfied the requirements of the rule.

Conclusion: The amount of Rs. 5,08,637 was a reserve within Rule 2(1) of Schedule II, and this question was answered in favour of the assessee.

Issue (ii): Whether profits earned from 1 January 1946 to 1 April 1946 could be treated as reserves for the purposes of Rule 2 in Schedule II.

Analysis: Profits and reserves were treated as distinct concepts. For an amount to become a reserve, there must be a conscious act of retention by the directors so that part of the profits is kept back instead of being distributed. During the period in question, no occasion arose for distribution or for any decision to retain profits as reserve, and the mere earning or use of profits in business did not make them reserves.

Conclusion: The profits earned from 1 January 1946 to 1 April 1946 could not be included as reserves under Rule 2, and this question was answered against the assessee.

Final Conclusion: The reference was decided by holding that the carried-forward balance was a reserve, but interim profits not consciously appropriated as such were not reserve capital.

Ratio Decidendi: A reserve under the relevant business profits tax provision means profits consciously retained and not distributed, and the mere earning or business use of profits does not convert them into reserves.

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