Capital computation under Business Profits Tax: share premium and earned surplus may both qualify as includible reserves.

Premium realised on the issue of shares may be included in capital computation where shares are issued against assets and the excess over par value is not a mere revaluation entry but retained share premium. On that reasoning, an amount described as "Capital paid in Surplus" was treated as premium, or alternatively as a reserve, and the statutory exclusion for book assets created by revaluation did not apply. Accumulated profits carried in an "earned surplus" account can also qualify as reserves when they are specifically appropriated, retained year after year, and used as a separate business fund, even if they do not arise from taxed profits. The capital base was therefore computed by including both sums.

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Issues: (i) Whether the amount shown as "Capital paid in Surplus" represented premium realised from the issue of shares, or alternatively a reserve, for inclusion in the capital computation under Schedule II of the Business Profits Tax Act, 1947; (ii) Whether the amount shown as "earned surplus" constituted reserves within the meaning of Schedule II, rule 2(1), of the Business Profits Tax Act, 1947.

Issue (i): Whether the amount shown as "Capital paid in Surplus" represented premium realised from the issue of shares, or alternatively a reserve, for inclusion in the capital computation under Schedule II of the Business Profits Tax Act, 1947.

Analysis: Where shares are issued in consideration of transfer of assets, the excess of the value of the assets transferred over the par value of the shares issued may properly be treated as premium. The account described as "Capital paid in Surplus" was not a mere revaluation entry but represented the retained excess arising from the issue of shares against valuable assets. In any event, the amount was not a book asset brought into existence by revaluation within the meaning of the Explanation to rule 2, and the statutory exclusion did not apply.

Conclusion: The amount was rightly treated as premium realised from the issue of shares, and in the alternative as a reserve; the conclusion was against the assessee.

Issue (ii): Whether the amount shown as "earned surplus" constituted reserves within the meaning of Schedule II, rule 2(1), of the Business Profits Tax Act, 1947.

Analysis: The expression "reserve" is not confined to amounts created only out of taxed profits. On the facts, the accumulated profits were not left as mere unallocated balances; under the accounting system followed, they were specifically carried to the "earned surplus" account, retained year after year, and used for the business. The account retained its identity and reflected a specific appropriation of profits for future use, satisfying the requirement of a reserve.

Conclusion: The "earned surplus" constituted reserves within rule 2(1); the conclusion was against the assessee.

Final Conclusion: The capital base was correctly computed by including both the amount standing in "Capital paid in Surplus" and the "earned surplus", so the assessee's challenge failed.

Ratio Decidendi: Amounts retained in business may form part of capital under Schedule II of the Business Profits Tax Act, 1947, where the excess on issue of shares represents premium realised from the issue of shares, and accumulated profits specifically appropriated and retained as a separate business fund constitute reserves even if they do not arise from taxed profits.

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