Surtax capital computation turns on reserve treatment, bonus shares, and relief income under the Second Schedule

Under the Second Schedule to the Companies (Profits) Surtax Act, 1964, capital was computed with reference to the position on the first day of the previous year, so the unutilised balance in dividend equalisation reserve standing on that date remained includible. A proposed preference dividend was not a present liability deductible from capital, while excess provision for taxation and provision for gratuity were treated as reserves where they were not shown to be ascertained liabilities. Issue of bonus shares out of general reserve did not by itself increase computed capital for rule 3 purposes. Rule 4 applied only to income excluded from total income, not income that remained part of total income but enjoyed tax relief.

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Issues: (i) Whether the unutilised balance in the dividend equalisation reserve was to be included in the capital computation under the Second Schedule to the Companies (Profits) Surtax Act, 1964; (ii) whether proposed dividend on preference shares was a liability to be excluded from the capital base; (iii) whether excess provision for taxation and provision for gratuity were reserves includible in capital computation; (iv) whether capital was to be increased under rule 3 of the Second Schedule on issue of bonus shares out of general reserve; and (v) whether rule 4 of the Second Schedule applied where the relevant income was relieved under section 84 of the Income-tax Act, 1961.

Issue (i): Whether the unutilised balance in the dividend equalisation reserve was to be included in the capital computation under the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: The capital under rule 1 had to be computed as on the first day of the previous year, and the reserve standing to that date remained part of the capital base. The later distribution of dividend did not alter the amount already standing to the credit of the reserve on that date. On the facts, only the pre-existing balance in the reserve was relevant for inclusion.

Conclusion: The balance of Rs. 46,89,816 was includible in the capital computation; the issue was answered in favour of the assessee.

Issue (ii): Whether proposed dividend on preference shares was a liability to be excluded from the capital base.

Analysis: A proposed dividend, pending declaration and payment, did not amount to a present liability reducing capital for surtax purposes. The question stood covered by the earlier binding decision applied by the Court.

Conclusion: The proposed dividend was not deductible from capital; the issue was answered in favour of the revenue.

Issue (iii): Whether excess provision for taxation and provision for gratuity were reserves includible in capital computation.

Analysis: Excess provision for taxation over the finally determined liability retained the character of reserve for surtax purposes. The gratuity amount was also treated as reserve because there was no approved scheme or actuarial basis showing that it had been set apart as an ascertained liability rather than a reserve.

Conclusion: Both items were includible in capital computation as reserves; the issue was answered in favour of the assessee.

Issue (iv): Whether capital was to be increased under rule 3 of the Second Schedule on issue of bonus shares out of general reserve.

Analysis: Rule 3 operates only where the capital computed under rules 1 and 2 is increased by an additional amount during the previous year. Capitalisation of a part of general reserve by issuing fully paid bonus shares merely transfers one component already included in capital computation into another component and does not increase the computed capital. The different wording of the provision considered in the cited super profits tax decision made that authority inapplicable.

Conclusion: No proportional increase under rule 3 was admissible; the issue was answered in favour of the revenue.

Issue (v): Whether rule 4 of the Second Schedule applied where the relevant income was relieved under section 84 of the Income-tax Act, 1961.

Analysis: Rule 4 is attracted only where a part of the income, profits and gains is not includible in total income. Income covered by section 84 formed part of total income even though no tax was payable on it, and therefore did not fall within the class of income excluded by rule 4. The distinction between income not forming part of total income and income forming part of total income but enjoying tax relief was decisive.

Conclusion: Rule 4 did not exclude such income from the capital adjustment; the issue was answered in favour of the assessee.

Final Conclusion: The reference was answered partly for the assessee and partly for the revenue, with the capital computation under the surtax regime upheld or rejected issue-wise according to the specific statutory rule involved.

Ratio Decidendi: Under the Second Schedule to the Companies (Profits) Surtax Act, 1964, only an actual increase in computed capital, and not a mere internal reclassification of reserve into paid-up share capital by bonus issue, attracts rule 3; and rule 4 applies only to income excluded from total income, not to income that remains part of total income but is granted tax relief.

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