Undistributed profits are not a reserve unless clearly set apart before the valuation date under business profits tax rules.

Undistributed profits do not qualify as a reserve under the Business Profits Tax Act unless they are clearly set apart as such on the relevant date. On 1 April 1946, the sum of Rs. 5,08,637 remained undistributed profits because the directors had recommended its distribution as dividend and it had not been earmarked for any reserve purpose; it was therefore not a reserve. For the same reason, profits earned from 1 January 1946 to 1 April 1946, which were also not separately appropriated, were not includible in reserves as on 1 April 1946.

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Issues: (i) Whether the amount of Rs. 5,08,637 constituted a reserve of the assessee company on 1 April 1946 within rule 2(1) of Schedule II to the Business Profits Tax Act, 1947. (ii) Whether the profits of the assessee for the period from 1 January 1946 to 1 April 1946 were to be included in the reserves as on 1 April 1946.

Issue (i): Whether the amount of Rs. 5,08,637 constituted a reserve of the assessee company on 1 April 1946 within rule 2(1) of Schedule II to the Business Profits Tax Act, 1947.

Analysis: The term "reserve" was treated according to its ordinary meaning and the true character of the amount had to be judged on the crucial date. On 1 April 1946 the amount stood only as undistributed profits. The directors had already recommended its distribution as dividend, and the shareholders later accepted that recommendation. The amount had not been set apart as a reserve for any purpose, and the company's accounts and the Companies Act provisions supported the view that a reserve required a clear act of setting apart before dividend recommendation.

Conclusion: The amount did not constitute a reserve on 1 April 1946 and the finding was against the assessee.

Issue (ii): Whether the profits of the assessee for the period from 1 January 1946 to 1 April 1946 were to be included in the reserves as on 1 April 1946.

Analysis: The profits for that period were not separately set apart as reserve. They remained part of the company's undistributed profits and were not earmarked for reserve treatment on the relevant date. The same reasoning that excluded the larger sum from reserve status applied to these profits as well.

Conclusion: The profits for 1 January 1946 to 1 April 1946 were not includible in reserves and the finding was against the assessee.

Final Conclusion: The appeal by the Revenue succeeded on the reserve question, while the assessee's challenge on the three-month profits failed, resulting in the rejection of the assessee's substantive claim under the business profits tax computation.

Ratio Decidendi: Undistributed profits do not become a reserve for business profits tax purposes unless they are clearly set apart as such by an authorised act before the relevant valuation date.

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