Reserve versus provision in surtax capital computation: retained dividend equalisation balance counts, earmarked dividend amount does not.

For surtax capital computation, a balance retained in a dividend equalisation reserve is treated as a true reserve where it represents appropriation of profits kept available for future years, and may be included in capital. By contrast, an amount earmarked for payment of dividend is a provision or current liability and is excluded from reserves under the statutory Explanation. The analysis turns on the commercial distinction between reserve and provision, and on the character of the amount as retained surplus or proposed dividend rather than its label.

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Issues: (i) Whether the balance of Rs. 3,40,000 in the dividend equalisation reserve was includible in the computation of capital as a reserve under the surtax law; (ii) Whether the sum of Rs. 9,60,000 earmarked for payment of dividend was includible in the computation of capital as a reserve.

Issue (i): Whether the balance of Rs. 3,40,000 in the dividend equalisation reserve was includible in the computation of capital as a reserve under the surtax law.

Analysis: The amount remaining after payment of the dividend represented a true appropriation of profits kept available for future years and did not answer the description of a known liability or a provision. Applying the commercial distinction between a reserve and a provision, and reading the capital computation rules in the Second Schedule to the surtax statute, the balance retained in the dividend equalisation reserve had the character of a reserve.

Conclusion: The sum of Rs. 3,40,000 was includible in capital computation as a reserve, in favour of the assessee.

Issue (ii): Whether the sum of Rs. 9,60,000 earmarked for payment of dividend was includible in the computation of capital as a reserve.

Analysis: Amounts of the nature of proposed dividend fall within the category of items under current liabilities and provisions and are excluded from reserves by the Explanation to the capital computation rule. The character of the amount was determined by its earmarking for dividend payment, not by its description as part of a reserve. The later insertion of rule 1A did not alter that position.

Conclusion: The sum of Rs. 9,60,000 was not includible as a reserve, in favour of the Revenue.

Final Conclusion: The reference was answered by treating the retained balance in the dividend equalisation reserve as part of capital, while excluding the amount set apart for dividend payment from capital computation.

Ratio Decidendi: For surtax capital computation, only amounts truly retained as reserves and not earmarked for a known liability or proposed dividend can be included as reserves; amounts attributable to proposed dividends are excluded by the statutory Explanation.

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