Reserve versus provision under surtax law: amount kept for future contract losses was treated as a reserve, not a provision.

An appropriation out of profits is treated as a reserve, not a provision, where it is not earmarked to meet any liability or contingency known to exist on the balance-sheet date. Applied to an amount set apart for loss on future contracts, the court noted that no present liability or known contingency existed and that the sum was retained only for a possible future contingency. The balance-sheet presentation did not change its character. The amount was therefore a reserve includible in capital computation, and it was not a provision against anticipated losses and contingencies.

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Issues: (i) Whether the amount set apart as reserve for loss on future contracts was a reserve within the meaning of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964; (ii) whether the same amount was in the nature of a provision made against anticipated losses and contingencies.

Issue (i): Whether the amount set apart as reserve for loss on future contracts was a reserve within the meaning of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: An amount placed out of profits and surpluses is a reserve if it is not earmarked to meet any liability or contingency known to exist on the date of the balance-sheet. On the facts found, no present liability or known contingency existed, and the amount was kept apart only to meet a future contingency, if any. The manner in which part of the amount was shown in the balance-sheet did not alter its true character.

Conclusion: The amount was a reserve, not a provision, and was includible in the computation of capital.

Issue (ii): Whether the same amount was in the nature of a provision made against anticipated losses and contingencies.

Analysis: A provision is made to meet an existing or reasonably ascertained liability or contingency, whereas a reserve is an appropriation intended to strengthen the resources of the business or meet a future contingency not presently existing. The amount in question was not created against any liability known at the balance-sheet date and therefore did not fall within the category of a provision.

Conclusion: The amount was not a provision against anticipated losses and contingencies.

Final Conclusion: The reference was answered in favour of the assessee, subject to verification of the correct amount for the relevant assessment year in accordance with the balance-sheet and the governing principles for capital computation.

Ratio Decidendi: An appropriation out of profits is a reserve, and not a provision, where it is not made to meet any liability or contingency known to exist on the balance-sheet date.

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