Reserve versus provision under surtax law: sums set aside for known liabilities were treated as provisions, not capital reserves.

For surtax capital computation, amounts set aside out of profits qualify as reserves only if they are not intended to meet a known liability, contingency, or commitment existing on the balance-sheet date and are clearly appropriated as such. Applying the substance of the entries and surrounding circumstances, sums described as reserve for pension and reserve for roofing repairs were treated as provisions because they were linked to existing liabilities and no clear intention to create free reserves was shown. Later description as reserves did not change their true character, so the amounts were excluded from capital computation.

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Issues: Whether the sums shown as reserve for pension and reserve for roofing repairs were reserves within the meaning of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, or provisions not includible in the capital computation.

Analysis: The decisive test was the substance of the entries, the surrounding circumstances, and whether the amounts had been set apart to meet known liabilities, contingencies, or commitments existing on the balance-sheet date. An amount appropriated out of profits for a liability known to exist, even if its precise quantification is uncertain, is a provision and not a reserve. The manner in which the items had earlier been shown in the balance-sheets, their linkage with pension obligations and roofing-repair liabilities, and the absence of a clear intention to earmark them as free reserves showed that they were originally set apart to meet liabilities of the company. Mere later description as reserve did not alter their true character.

Conclusion: The amounts were not reserves but provisions and were rightly excluded from the assessee's claim; the reference was answered in favour of the Revenue.

Ratio Decidendi: For surtax capital computation, an amount set apart out of profits is a reserve only if it is not meant to meet a known liability, contingency, or commitment existing on the balance-sheet date and is clearly appropriated as such by the persons in authority.

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