Reserve versus provision test: sums set aside from taxed profits were includible in capital base where no accrued liability existed.

Amounts appropriated out of taxed profits and shown in the balance-sheet as reserves were treated as reserves for capital base purposes where they were not earmarked against any existing accrued liability. The fund described as reserve for repayment of the I.F.C.I. loan existed before the loan was negotiated, was not used to meet instalments, and was later applied for bonus shares; it was therefore a general reserve, not a provision. The gratuity reserve was also a reserve because no gratuity scheme was in force and no accrued liability arose in the relevant year. The amounts had to be included in the capital base for super profits tax and surtax.

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Issues: Whether the amounts shown as reserve for repayment of loan from the Industrial Finance Corporation of India, reserve for repayment of loan from the Industrial Credit and Investment Corporation of India, and gratuity reserve were to be treated as reserves includible in the capital base for super profits tax and surtax purposes.

Analysis: The amounts were appropriations out of taxed profits and were shown in the balance-sheet as reserves. The reserve for repayment of the I.F.C.I. loan had come into existence even before the loan was negotiated, the instalments of repayment were not made out of that fund, and the fund was ultimately used for bonus shares. On those facts it was not a provision for an existing liability but a general reserve. The gratuity reserve also stood on the same footing because there was no gratuity scheme in force and no accrued liability during the relevant year. For the later years, the same factual and legal position applied to the reserves connected with the I.F.C.I. and I.C.I.C.I. loans, and the manner in which the amounts were described in the balance-sheet did not alter their real character.

Conclusion: The disputed amounts were reserves and had to be taken into account in computing the capital base.

Ratio Decidendi: A sum appropriated out of taxed profits is a reserve, and not a provision, where in substance it is kept back for future use and is not earmarked against an existing accrued liability.

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