Reserve versus provision under super profits tax law: income-tax provisions and unappropriated profits were excluded from capital computation.

A provision for income-tax earmarked to meet an accrued liability was treated as a provision and not a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, so it was excluded from capital computation. The remaining unappropriated profits were also held to be undistributed profits, not a reserve, because they had not been specifically appropriated or set apart for any purpose. On that reasoning, both amounts were kept out of the capital base and the reference was answered for the revenue.

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Issues: (i) whether the provision for income-tax of Rs. 3,35,914 formed a reserve within rule 1 of the Second Schedule to the Super Profits Tax Act, 1963; and (ii) whether the balance of unappropriated profits of Rs. 11,41,689 qualified as a reserve under the same provision.

Issue (i): whether the provision for income-tax of Rs. 3,35,914 formed a reserve within rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.

Analysis: The expression "reserve" in the capital computation scheme of the Super Profits Tax Act was construed in light of the commercial and accounting distinction recognised in the Companies Act, 1956 and the accepted principles of accountancy. A sum earmarked to meet a known or accrued tax liability was treated as a provision and not as money set apart for future use. The Court followed its earlier decisions and held that the statutory context did not permit a provision for taxation to be treated as part of the company's reserves.

Conclusion: The provision for income-tax did not qualify as a reserve and was not includible in the capital base.

Issue (ii): whether the balance of unappropriated profits of Rs. 11,41,689 qualified as a reserve under the same provision.

Analysis: Amounts remaining after provision for taxation, reserves and dividend, if not specifically appropriated or set apart for any purpose, retain the character of undistributed profits. Such a mere balance of profits, without earmarking or appropriation, does not become a reserve merely because it is carried forward in the accounts.

Conclusion: The amount of Rs. 11,41,689 was unappropriated profits and not a reserve.

Final Conclusion: Both disputed amounts were excluded from the capital computation under the Super Profits Tax Act, 1963, and the reference was answered in favour of the revenue.

Ratio Decidendi: For purposes of the Super Profits Tax Act, 1963, a sum retained to meet an ascertained or accrued liability is a provision and not a reserve; only amounts deliberately set apart as part of the company's capital resources can be treated as reserves.

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