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Issues: (i) Whether subsidy received from the Government for industrial housing and shown in the balance-sheet as a reserve constituted a reserve within rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964. (ii) Whether amounts credited as reserve for bad and doubtful debts constituted reserves within rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964.
Issue (i): Whether subsidy received from the Government for industrial housing and shown in the balance-sheet as a reserve constituted a reserve within rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964.
Analysis: The subsidy was received for construction of workers' housing and was liable to be refunded only on insolvency, liquidation, or breach of the scheme conditions. On the relevant balance-sheet dates, the amount was not earmarked to meet any known liability or existing contingency. The distinction between a reserve and a provision depends on whether the amount is set apart for a known liability or for an unknown contingency, and a reserve need not be created only out of profits. The amount was treated in the balance-sheet as a reserve and fell within other reserves for capital computation.
Conclusion: The subsidy amount constituted a reserve and was includible in the capital base. The issue was decided in favour of the assessee and against the department.
Issue (ii): Whether amounts credited as reserve for bad and doubtful debts constituted reserves within rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964.
Analysis: The amounts set apart under the head reserve for bad and doubtful debts were not shown to have been made against any known liability or contingency on the balance-sheet dates. Such amounts were therefore not provisions in substance. Since they were not created to meet an existing liability, they answered the commercial understanding of a reserve and could be included in the capital computation under the Second Schedule.
Conclusion: The amounts constituted reserves and were includible in the capital base. The issue was decided in favour of the assessee and against the department.
Final Conclusion: Both references were answered in favour of the assessee, and the amounts in question were held to form part of the company's capital base for surtax computation.
Ratio Decidendi: For surtax computation, an amount shown in the balance-sheet is a reserve if it is not set aside to meet a known liability on the balance-sheet date and may be included in capital base even if it is not created out of profits, provided it is commercially a reserve rather than a provision.
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