Reserve versus provision distinction governs surtax capital computation for gratuity and dividend reserves

Gratuity amounts set aside ad hoc, without an approved gratuity scheme or actuarial valuation, were treated as reserves rather than provisions because they were not created to meet an ascertained or existing liability; they were therefore includible in capital for surtax computation under Schedule II. Dividend reserves, however, were not includible in the capital computation under the same provision, as earlier decisions had already settled that question against inclusion. The governing distinction is that an amount set apart for a known liability on a discounted present value basis is a provision, while an amount retained without such valuation is a reserve.

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Issues: (i) Whether amounts standing to the credit of gratuity reserve were includible in the capital computation under rule 1 of Schedule II to the Companies (Profits) Surtax Act, 1964. (ii) Whether dividend reserves were includible in the capital computation under the same provision.

Issue (i): Whether amounts standing to the credit of gratuity reserve were includible in the capital computation under rule 1 of Schedule II to the Companies (Profits) Surtax Act, 1964.

Analysis: The capital base under rule 1 includes reserves, but excludes amounts allowed as deductions under the income-tax law. The gratuity amounts had been set apart ad hoc without any approved gratuity scheme and without actuarial valuation. On the facts, the amounts were not created to meet a known or existing liability and were not computed on the discounted present value of any ascertained gratuity obligation. Applying the distinction between reserve and provision, the amounts retained in the gratuity reserve were treated as reserves.

Conclusion: The question was answered in the affirmative and in favour of the assessee.

Issue (ii): Whether dividend reserves were includible in the capital computation under the same provision.

Analysis: This question was covered by earlier decisions of the same court on the computation of capital under Schedule II to the Companies (Profits) Surtax Act, 1964. On that basis, the dividend reserves were not includible in the capital computation.

Conclusion: The question was answered in the negative and in favour of the department.

Final Conclusion: The reference was disposed of by holding that gratuity reserve formed part of capital for surtax purposes, while dividend reserves did not.

Ratio Decidendi: An amount set apart without actuarial valuation and not to meet a known or existing liability is a reserve, whereas an ascertained liability computed on a discounted present value basis is a provision.

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