Provisions versus reserves: amounts set aside for known liabilities or asset depreciation cannot enter capital computation as reserves.

Amounts set aside from profits to meet an existing customs duty liability, a tax liability arising at year-end, or expected diminution in the value of trade-mark rights are provisions and not reserves under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963. Where the liability already exists, even if the exact amount is not finally quantified, the appropriation cannot be treated as capital reserve. Likewise, amounts earmarked for depreciation of a wasting asset are not reserves. On this reasoning, none of the three sums could be included in capital computation as reserves, and the reference was answered against the assessee.

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Issues: (i) Whether the amount set aside for additional customs duty was a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963. (ii) Whether the amount set aside for taxation was a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963. (iii) Whether the amount set aside towards trade marks was a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.

Issue (i): Whether the amount set aside for additional customs duty was a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.

Analysis: An amount set apart out of profits to meet an existing and known liability, even if the exact quantum cannot then be ascertained with substantial accuracy, is a provision and not a reserve. The customs duty provision was made against provisional assessments already raised by the customs authorities. The liability was in existence though its precise amount was under dispute. Amounts earmarked to discharge such liability do not become part of the capital as reserves.

Conclusion: The amount was a provision and not a reserve. The finding is against the assessee.

Issue (ii): Whether the amount set aside for taxation was a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.

Analysis: A provision made for tax liability arising on the close of the accounting year is a provision for a known liability. The amount set apart for taxation represented a liability already incurred, though not yet quantified with exactitude.

Conclusion: The amount was a provision and not a reserve. The finding is against the assessee.

Issue (iii): Whether the amount set aside towards trade marks was a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.

Analysis: The trade-mark rights were a wasting asset available only for a fixed period and the balance-sheet itself treated the amount as depreciation. An amount set aside to cover diminution in the value of a capital asset is a provision, not a reserve. The materials on record supported the conclusion that the trade-mark rights had depreciated in value.

Conclusion: The amount was a provision towards depreciation and not a reserve. The finding is against the assessee.

Final Conclusion: None of the three disputed sums could be included in the capital computation as reserves under the Second Schedule, and the reference was answered wholly against the assessee.

Ratio Decidendi: Amounts appropriated out of profits to meet known liabilities or anticipated diminution in the value of assets are provisions, not reserves, and therefore do not enter capital computation as reserves under the super profits tax scheme.

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