Revaluation reserve transferred to general reserve loses exclusion status once the underlying assets are fully depreciated.

For surtax capital computation, dividend declared out of general reserve remained excluded from capital, following the settled approach on reserve-based distributions. By contrast, a transfer from revaluation reserve to general reserve was not to be treated as continued revaluation reserve where the underlying revalued assets had been fully depreciated and the reserve had lost its original character. Rule 1 fixed capital with reference to the opening day of the previous year, and Explanation 1 to rule 2 excluded only capital or reserve created by revaluation or similar book adjustment. The change in nature of the reserve, not its label, determined the result, so the transferred amount was not excluded from capital.

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Issues: (i) Whether the amount representing dividend declared out of general reserve was liable to be excluded from the assessee-company's capital for surtax computation; (ii) Whether the amount transferred from revaluation reserve to general reserve remained liable to exclusion from capital under Explanation 1 to rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Issue (i): Whether the amount representing dividend declared out of general reserve was liable to be excluded from the assessee-company's capital for surtax computation.

Analysis: The exclusion of the dividend-related amount stood covered by the settled legal position and followed the binding ratio already applied to the same kind of reserve-based distribution.

Conclusion: This issue was decided against the assessee.

Issue (ii): Whether the amount transferred from revaluation reserve to general reserve remained liable to exclusion from capital under Explanation 1 to rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: Rule 1 required capital computation with reference to the opening day of the previous year, while Rule 2 and Explanation 1 excluded only capital or reserve brought into existence by creating or increasing a book asset by revaluation or otherwise. The reserve originally created against revalued fixed assets had lost its original character once the relevant assets had been fully depreciated. In that situation, the transfer to general reserve reflected a real change in the nature and quality of the reserve, and the mere change in nomenclature did not justify continued exclusion. The special context of the cited Supreme Court decision on amalgamation and purchase of assets did not control this case.

Conclusion: This issue was decided in favour of the assessee.

Final Conclusion: The appeal succeeded only to the extent that the transferred amount of revaluation reserve could not be excluded from capital, while the dividend-related exclusion was sustained.

Ratio Decidendi: Where a revaluation reserve has ceased to retain its original character because the revalued assets are fully depreciated, the amount transferred to general reserve is not to be treated as revaluation reserve for the purpose of exclusion under Explanation 1 to rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

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