Reserve vs provision: taxed profits set aside for future use were treated as reserves and counted in capital computation.

Amounts appropriated from taxed profits and credited to a reserve account for possible repayment of an Industrial Finance Corporation loan were treated as reserves, not as provisions, for capital computation under rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964. The governing distinction is that a reserve is money set aside for future use, whether for a general or specific purpose, while a provision is made against an accrued liability. On the facts, the reserve arose out of taxed profits, existed before the loan was actually taken, was not used for loan repayment, and was ultimately deployed for bonus shares. Accordingly, the amount was includible in the company's capital.

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Issues: Whether amounts appropriated out of taxed profits and credited to a reserve for repayment of an Industrial Finance Corporation loan were to be treated as reserves, and included in the capital computation under rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: The relevant provisions charge surtax on chargeable profits in excess of the statutory deduction, and the capital of a company includes its other reserves under rule 1(iii) of the Second Schedule. The decisive question was whether the amounts standing to the credit of the reserve account were in substance a reserve or merely a provision. On the facts found, the reserve was created out of taxed profits, it came into existence even before the loan was actually taken, the loan repayments were not made from that fund, and the amounts were ultimately used for bonus shares. The Tribunal applied the governing principle that a reserve is money kept back for future use, whether the purpose is general or specific, and held that the amount was not a provision for an accrued liability.

Conclusion: The amounts were rightly treated as reserves and taken into account in computing the capital of the company; the reference was answered in favour of the assessee-company.

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