Reserve versus liability rules for surtax capital computation turn on the first day of the accounting year and the item's true character.

For capital computation under the Second Schedule to the Companies (Profits) Surtax Act, 1964, the character of an item as reserve or liability is determined as on the first day of the accounting year. A provision for taxation is treated as an accrued liability, estimated outstanding claims in insurance are liabilities, unearned premium is only a balancing entry, and premium deposits remain earmarked for a specific purpose rather than part of reserves. A proposed dividend does not create an accrued liability merely because directors have recommended it, but the amount set apart is still treated as a provision or reserve for a specific purpose and was not excluded under rule 2(ii).

---

---

Issues: Whether amounts shown as provision for taxation, estimated liability for outstanding claims, unearned premium, premium deposits and proposed dividend were deductible in computing capital under rule 2(ii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and whether they fell outside rule 2(i) or rule 2(ii) as claimed.

Analysis: The relevant date for testing whether an item is a reserve or liability is the first day of the accounting year. A provision for taxation is not a reserve because the tax liability has already accrued. Estimated liabilities for outstanding claims arising in the insurance business are liabilities and not reserves. Unearned premium is only a balancing entry representing premium attributable to the unexpired portion of the policy period and is not a reserve. Premium deposits are amounts impressed with an obligation for a specific purpose and do not form part of the company's reserves or funds for this computation. As to proposed dividend, a mere directors' recommendation does not create an accrued liability on the valuation date; however, the amount set apart for dividend remains a provision or reserve for a specific purpose and, on the reasoning adopted, cannot be excluded under rule 2(ii) in the assessee's favour. The court applied the distinction between reserve and provision and treated the statutory computation as controlled by the balance-sheet position on the relevant date.

Conclusion: The questions were answered in the affirmative and against the assessee; the disputed amounts were not entitled to the claimed exclusion in computing capital.

Final Conclusion: The reference was answered in favour of the Revenue, with costs awarded to the Revenue.

Ratio Decidendi: For capital computation under the Second Schedule to the Companies (Profits) Surtax Act, 1964, the character of an item as reserve or liability must be determined with reference to the first day of the accounting year, and amounts set apart for taxation, outstanding claims, unearned premium, premium deposits, or proposed dividend do not automatically qualify for exclusion under rule 2(ii).

---