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Issues: (i) Whether excess provision for depreciation could be treated as a reserve for computing the capital of the company under the Second Schedule to the Companies (Profits) Surtax Act, 1964. (ii) Whether the amount standing to the credit of the initial depreciation reserve account could be treated as a reserve while computing the capital of the company under the Second Schedule to the Companies (Profits) Surtax Act, 1964.
Issue (i): Whether excess provision for depreciation could be treated as a reserve for computing the capital of the company under the Second Schedule to the Companies (Profits) Surtax Act, 1964.
Analysis: Excess depreciation over that allowed by the income-tax authorities does not become a reserve unless the material shows that the amount was actually set apart for future use. Where the entry is only an adjustment entry and is transferred to general reserve merely to align the written down value of fixed assets with the accounting basis, it does not acquire the character of a reserve for the purpose of capital computation.
Conclusion: The amount of excess provision for depreciation was not a reserve and could not be included in capital.
Issue (ii): Whether the amount standing to the credit of the initial depreciation reserve account could be treated as a reserve while computing the capital of the company under the Second Schedule to the Companies (Profits) Surtax Act, 1964.
Analysis: Under Rule 1(iii), reserves included in capital must be reduced by amounts credited to such reserves that were already allowed as deductions in computing income for income-tax purposes. Since the amount in the initial depreciation reserve account had been allowed in the computation of taxable income, it had to be reduced from the reserve account and could not again be added to swell the capital base.
Conclusion: The amount standing to the credit of the initial depreciation reserve account was not liable to be treated as a reserve for capital computation.
Final Conclusion: The reference was answered against the assessee on both questions, upholding the revenue's treatment of both amounts for surtax capital computation.
Ratio Decidendi: An amount described as depreciation provision or reserve is includible in capital only if it is truly a reserve set apart for future use and is not an amount already allowed as a deduction in computing taxable income.
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