Recommended dividend from reserve must be excluded from capital computation under the Companies (Profits) Surtax Act.

Capital under Schedule II of the Companies (Profits) Surtax Act, 1964 is computed by reference to the character of amounts standing to the credit of reserves on the first day of the accounting year. Where a dividend has been recommended out of general reserve, the amount is intended for distribution to shareholders and is no longer available as reserve for capital computation. Applying the principle in Vazir Sultan Tobacco Co., the High Court treated the recommended dividend as inconsistent with continued reserve treatment; Rule 1A of the Second Schedule was viewed as reflecting the same principle. The sum of Rs. 2,03,250 had therefore to be deducted from general reserve, and the issue was answered against the assessee.

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Issues: Whether the sum of Rs. 2,03,250, representing dividend recommended out of the general reserve, was liable to be deducted from the general reserve while computing capital under Schedule II of the Companies (Profits) Surtax Act, 1964.

Analysis: The computation of capital under Schedule II depends on the character of the amount standing to the credit of reserves on the first day of the accounting year. A dividend, once proposed for distribution, is intended to be disbursed to shareholders and is inconsistent with retention of the amount as reserve. The decision of the Supreme Court in Vazir Sultan Tobacco Co. was applied as laying down that the intention behind the appropriation and the nature of the distribution govern the treatment of the amount, and that a recommended dividend out of reserves cannot continue to be regarded as part of the reserve for capital computation. Rule 1A of the Second Schedule, though introduced later, was treated as consistent with and reflective of the same principle rather than as creating a new rule.

Conclusion: The sum of Rs. 2,03,250 was required to be deducted from the general reserve for the purpose of arriving at the statutory deduction, and the answer was against the assessee.

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