Reserve versus provision test governed capital computation; most profit appropriations counted as reserves, but proposed dividend did not.

For super profits tax capital computation, the decisive test was whether amounts set aside out of profits were reserves or provisions. Terminal pay, bad and doubtful debts, staff gratuity, and tax-exempt dividend amounts were treated as reserves because they were not shown to meet any known or existing liability, so they were includible in capital. The proposed dividend amount was a provision for a specific liability to distribute profits and was therefore excluded from capital. The ruling restated that a provision arises only for an identified liability, even if the exact amount cannot be determined with precision; otherwise, the amount remains a reserve.

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Issues: (i) whether the reserve for terminal pay was includible in the capital computation for super profits tax purposes; (ii) whether the reserve for bad and doubtful debts was includible in the capital computation for super profits tax purposes; (iii) whether the reserve for staff gratuity was includible in the capital computation for super profits tax purposes; (iv) whether the amount set apart for proposed dividend was includible in the capital computation for super profits tax purposes; (v) whether the tax exempt dividend reserve was includible in the capital computation for super profits tax purposes.

Issue (i): whether the reserve for terminal pay was includible in the capital computation for super profits tax purposes.

Analysis: The amount was treated as a possible provision for retrenchment compensation, but there was no existing or known liability and no material showing any quantified claim then due. Applying the settled distinction that an amount set apart to meet a known liability is a provision, whereas an amount set apart for a future contingency not involving a known liability is a reserve, the amount fell on the reserve side.

Conclusion: The reserve for terminal pay was includible in the capital computation and the issue was decided in favour of the assessee.

Issue (ii): whether the reserve for bad and doubtful debts was includible in the capital computation for super profits tax purposes.

Analysis: The appropriation was made on an ad hoc basis by reference to debts outstanding beyond one year and a percentage of the balance of current debts. No specific debt was identified as bad or doubtful, and bad debts were in practice charged to the profit and loss account. The amount was therefore not shown to answer any known liability or diminution in value of assets then existing.

Conclusion: The reserve for bad and doubtful debts was includible in the capital computation and the issue was decided in favour of the assessee.

Issue (iii): whether the reserve for staff gratuity was includible in the capital computation for super profits tax purposes.

Analysis: The amount was transferred without any actuarial valuation or estimation of the present liability. It was created on a general footing that gratuity claims might arise in future, which did not amount to a provision for a known liability.

Conclusion: The reserve for staff gratuity was includible in the capital computation and the issue was decided in favour of the assessee.

Issue (iv): whether the amount set apart for proposed dividend was includible in the capital computation for super profits tax purposes.

Analysis: The sum was specifically earmarked by the directors for distribution as dividend and was not described as a reserve. An amount earmarked for payment of dividend is a provision for a specific liability and does not qualify as reserve for capital computation.

Conclusion: The amount set apart for proposed dividend was not includible in the capital computation and the issue was decided against the assessee.

Issue (v): whether the tax exempt dividend reserve was includible in the capital computation for super profits tax purposes.

Analysis: The amount represented profits segregated to identify the portion enjoying tax rebate under the statutory scheme and to facilitate the corresponding dividend exemption. It was not set apart to meet any existing liability and was not a provision.

Conclusion: The tax exempt dividend reserve was includible in the capital computation and the issue was decided in favour of the assessee.

Final Conclusion: The statutory test for capital computation under the super profits tax scheme turned on whether the amounts were reserves or provisions, and on that basis the assessee succeeded on all disputed items except the proposed dividend amount.

Ratio Decidendi: An amount set aside out of profits is a reserve if it is not earmarked to meet a known or existing liability, and it becomes a provision only where it is intended to provide for such a liability capable of being identified, even if its exact amount cannot be determined with substantial accuracy.

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