Reserve versus provision: amounts set aside without accrued liability were includible in capital for surtax computation.

For surtax capital computation under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, the character of an appropriation depends on its true substance, not its accounting label. An amount set aside to meet a known liability or diminution in asset value is a provision, while an appropriation of profits retained as part of capital employed is a reserve. On the stated facts, no rent liability had accrued and the sums were not set apart to meet a present or contingent obligation, so they fell outside the exclusion for provisions or liabilities and were includible in capital.

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Issues: Whether the amount credited to the account styled as provision for rent or lease money on UNICEF plant and machinery was a reserve within rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and therefore includible in the capital computation.

Analysis: The distinction between a provision and a reserve depends on the true nature and character of the appropriation. A provision is made to meet a known liability or diminution in value of assets, whereas a reserve is an appropriation of profits retained as part of the capital employed in the business. On the facts, no rent was payable and no present, future, disputed, or contingent liability had accrued against the assessee. The amounts were set apart only to meet the cost of the assets if ultimately transferred, and the accounting description used by the assessee could not control the real character of the amount. The amount was not covered by the exclusion for provisions or liabilities.

Conclusion: The amount constituted a reserve and had to be included in the computation of the assessee's capital under the Act.

Final Conclusion: The reference was answered in favour of the assessee, and the amount in question was held to be includible in the capital computation for surtax purposes.

Ratio Decidendi: For surtax capital computation, an appropriation is a reserve if, in substance, it is not set apart to meet a known liability or depreciation but is retained as part of the capital employed in the business.

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