Gratuity reserve classification turns on reserve versus provision distinction for capital base treatment under tax law.

An amount set apart in a balance-sheet as gratuity reserve is includible in capital base under the Super Profits Tax Act only if it is truly a reserve and not a provision. A reserve is an appropriation of profits retained as capital, while a provision is a charge against profits made for a known or foreseeable liability. Gratuity liability is a definite business liability; an ad hoc gratuity appropriation or an amount based on actuarial valuation is generally a provision. Only any excess over the actuarially determined liability can qualify as reserve. On the stated facts, the nature of the sum was not established, and the view treating it as reserve could not be sustained.

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Issues: Whether the amount set apart in the balance-sheet as a gratuity reserve was a reserve includible in the capital base under the Second Schedule to the Super Profits Tax Act, 1963.

Analysis: The governing distinction is between a reserve, being an appropriation of profits retained as capital, and a provision, being a charge against profits made to meet a known or foreseeable liability. Gratuity liability is a definite business liability. Where an amount is set apart ad hoc for gratuity, or is based on actuarial valuation of the liability, it is a provision and not a reserve. Only the excess, if any, over the actuarially determined liability can be treated as reserve. The earlier High Court decisions treating ad hoc gratuity appropriations as reserves were inconsistent with the later Supreme Court ruling. On the facts, however, the nature of the sum of Rs. 7,75,000 was not established as being ad hoc, actuarial, or excess over actuarial liability.

Conclusion: The Tribunal's view that the amount was part of capital base as a reserve could not be sustained, and the question was answered in the negative.

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