Reserve versus provision test for bad debts: mere apprehension of future loss does not turn an appropriation into a provision.

Amounts appropriated by a banking company for bad and doubtful debts were treated as reserves, not provisions, for surtax purposes. A provision is a charge against profits made to meet a known liability, or one legitimately and reasonably anticipated on the balance-sheet date, while a reserve is an appropriation of profits not intended to meet such liability. On the facts, no bad debt had been written off or adjusted, no deduction had been claimed or allowed, and the sums remained employed in the business and were treated as reserves. Mere business apprehension of future bad debts did not convert the appropriation into a provision, so the amounts qualified for exclusion from chargeable profits and inclusion in capital.

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Issues: Whether amounts set apart by a banking company for bad and doubtful debts in its balance-sheets constituted a reserve or a provision for the purposes of rule 1(xi)(b) of the First Schedule and rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and were therefore entitled to exclusion from chargeable profits and inclusion in capital.

Analysis: A provision is a charge against profits made to meet a known liability, or one legitimately and reasonably anticipated on the balance-sheet date, whereas a reserve is an appropriation of profits not designed to meet such a liability. The true nature of the amount set apart must be determined from its substance, the intention behind the appropriation, and the surrounding facts. On the facts found, no amount of bad debt had been written off or adjusted, no deduction had been claimed or allowed on that account, and the sums had remained employed in the business and treated as reserves. The Court held that the High Court misapplied the distinction between a known or anticipated liability and a mere business expectation of future bad debts.

Conclusion: The amounts set apart were reserves and not provisions; they qualified for relief under the Act, and the assessee succeeded.

Ratio Decidendi: An amount appropriated out of profits is a reserve, and not a provision, unless it is set aside to meet a known liability or a liability legitimately and factually anticipated on the balance-sheet date; mere business apprehension of future loss does not convert a reserve into a provision.

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