Provision versus reserve under super profits tax: tax liability entries are excluded, while proposed dividend appropriations may count as capital.

For capital computation under rule 1 of the Second Schedule to the Super Profits Tax Act, an amount set aside to meet an existing tax liability is treated as a provision and not a reserve, so it is excluded from capital. By contrast, an amount specifically appropriated out of profits for a future purpose, such as proposed dividend, is treated as a reserve if the substance of the entry shows it was kept apart on the balance-sheet date, and later shareholder approval does not change that character. The document applies the commercial accounting distinction between provision and reserve and emphasises the substance of the entry as on the relevant date.

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Issues: (i) Whether the amount standing in the provision for taxation account as on the relevant date was includible in the capital computation as a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963. (ii) Whether the amount standing in the proposed dividend account as on the relevant date was includible in the capital computation as a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.

Issue (i): Whether the amount standing in the provision for taxation account as on the relevant date was includible in the capital computation as a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.

Analysis: An amount set aside to meet an existing or known liability is a provision and not a reserve. The taxation amount was appropriated to meet the tax liability on profits already earned and therefore represented a charge against profits rather than an appropriation of profits to be retained for future use. On the commercial accounting approach recognised in the case law, such an item does not answer the description of reserve.

Conclusion: The amount in the provision for taxation account was not includible in the capital computation and the answer was against the assessee.

Issue (ii): Whether the amount standing in the proposed dividend account as on the relevant date was includible in the capital computation as a reserve under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.

Analysis: The relevant test is whether, on the balance-sheet date, the sum had been specifically kept apart for future use and was not merely a mass of undistributed profits. In the light of the accounting treatment, the statutory balance-sheet form, and the principle that the substance of the matter governs, the amount set apart for proposed dividend was treated as an appropriation of profits to a specific purpose. The later shareholder approval related back to the closing date and did not alter the character of the appropriation.

Conclusion: The amount in the proposed dividend account was includible in the capital computation and the answer was in favour of the assessee.

Final Conclusion: The reference was answered by excluding the taxation provision from capital while including the proposed dividend amount, so the assessee succeeded only in part on the issues decided.

Ratio Decidendi: For capital computation under the super profits tax scheme, an item set apart to meet a known liability is a provision, whereas an amount specifically appropriated out of profits for future use or a specific purpose is a reserve, and the true character of the entry is determined by its substance as on the relevant balance-sheet date.

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