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Issues: (i) Whether Rs. 3,40,000 out of the dividend equalisation reserve was includible in the computation of capital for surtax purposes as a reserve on 1 November 1964; (ii) Whether Rs. 5,20,000 transferred to the dividend equalisation reserve during the current year was includible in the computation of capital for surtax purposes as a reserve on 1 November 1964.
Issue (i): Whether Rs. 3,40,000 out of the dividend equalisation reserve was includible in the computation of capital for surtax purposes as a reserve on 1 November 1964.
Analysis: For surtax purposes, capital is to be computed with reference to the first day of the previous year. A proposed dividend does not create a liability on that date, because under company law dividend can be declared only out of distributable profits and the directors merely recommend the amount; the liability arises only when the shareholders approve it. The balance of Rs. 3,40,000 remained part of the accumulated reserve on the crucial date and answered the description of capital under the relevant surtax schedule.
Conclusion: The issue is answered in favour of the assessee. Rs. 3,40,000 was includible in the computation of capital as a reserve on 1 November 1964.
Issue (ii): Whether Rs. 5,20,000 transferred to the dividend equalisation reserve during the current year was includible in the computation of capital for surtax purposes as a reserve on 1 November 1964.
Analysis: The amount of Rs. 5,20,000 had been appropriated out of current profits for payment of proposed dividend and therefore represented an amount set apart for that liability rather than an available reserve for capital computation on the relevant date.
Conclusion: The issue is answered in favour of the revenue. Rs. 5,20,000 was not includible in the computation of capital as a reserve on 1 November 1964.
Final Conclusion: The reference was answered by treating only the accumulated balance in the dividend equalisation reserve as capital on the crucial date, while excluding the amount appropriated from current profits for dividend payment.
Ratio Decidendi: For surtax computation, only amounts that retain the character of reserve on the crucial date are includible as capital; sums appropriated for proposed dividend do not become liabilities until shareholder approval and do not relate back to the first day of the previous year.
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