Dividend liability as provision, not reserve, excluded from capital computation under the Companies (Profits) Surtax Act.

For capital computation under the Companies (Profits) Surtax Act, 1964, capital had to be taken as on the first day of the previous year under rule 1 of the Second Schedule. Dividend recommended by directors and approved by shareholders in respect of profits of the relevant year was treated as a liability relating back to the year-end, so the character of the amount depended on substance rather than balance-sheet label. Amounts set aside to meet a known liability are provisions, while only sums retained out of profits without earmarked liability are reserves. On that basis, the dividend sum that had crystallised into liability was not includible in capital, and only the balance qualified as reserve.

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Issues: Whether the amount appropriated towards dividend out of the dividend reserve was a provision or a reserve for computation of capital under the Companies (Profits) Surtax Act, 1964.

Analysis: The capital for surtax purposes had to be computed as on the first day of the previous year under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964. Dividend recommended by the directors and approved by the shareholders in respect of profits of the relevant previous year created a liability which related back to the closing date of that accounting year. The true character of the amount had to be determined by substance and not by the label used in the balance-sheet. An amount set aside to meet a known liability is a provision, while only a sum retained out of profits not earmarked for such liability can be treated as reserve. Applying that distinction, the dividend amount that had crystallised into liability could not be included in capital.

Conclusion: The amount of Rs. 76,00,000 was a provision and not a reserve, and therefore it was not includible in capital computation; only the balance of Rs. 14,00,000 qualified as reserve.

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