Reserve versus provision distinction governs surtax capital computation, with unpaid dividend amounts excluded as existing liabilities.

For surtax capital computation under the Companies Profits (Surtax) Act, the commercial distinction between a reserve and a provision controlled classification. Investment reserve and rehabilitation reserve were treated as appropriations of profits not set apart for existing liabilities on the balance-sheet date, so they qualified as reserves and were includible in capital. By contrast, forfeited dividend reserve represented unpaid dividends payable on shareholder claims and was treated as an existing liability, so it was not a reserve and was excluded. The governing principle is that only amounts retained as capital employed in the business count as reserves; sums earmarked to meet known obligations are provisions.

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Issues: (i) Whether investment reserve and rehabilitation reserve constituted reserves for computation of capital under the Companies Profits (Surtax) Act, 1964. (ii) Whether forfeited dividend reserve constituted a reserve for computation of capital under the Companies Profits (Surtax) Act, 1964.

Issue (i): Whether investment reserve and rehabilitation reserve constituted reserves for computation of capital under the Companies Profits (Surtax) Act, 1964.

Analysis: The governing test is the commercial distinction between a reserve and a provision. A reserve is an appropriation of profits retained as part of the capital employed in the business, whereas a provision is made to meet a known liability or anticipated loss. Applying that test to the facts found, the amounts standing in the investment reserve and rehabilitation reserve accounts were not set apart to meet existing liabilities on the balance-sheet date and were treated as appropriations from profits.

Conclusion: The investment reserve and rehabilitation reserve were reserves and were includible in the capital computation; the finding was in favour of the assessee.

Issue (ii): Whether forfeited dividend reserve constituted a reserve for computation of capital under the Companies Profits (Surtax) Act, 1964.

Analysis: Amounts representing unpaid dividends, which were payable as and when shareholders made claims, were not appropriations of profits for future use in the sense of a reserve. On the facts, the account represented an existing liability rather than a true reserve, and the earlier view excluding such an account from reserves was applied.

Conclusion: The forfeited dividend reserve was not a reserve and was not includible in the capital computation; the finding was in favour of the Revenue.

Final Conclusion: The appeals succeeded only to the limited extent that forfeited dividend reserve was excluded, while the remaining reserve items were upheld as reserves for surtax capital computation.

Ratio Decidendi: For surtax computation, an amount is a reserve only if it is an appropriation of profits not earmarked to meet a known liability or existing diminution in assets on the balance-sheet date; amounts kept to satisfy existing obligations are provisions, not reserves.

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