Reserve appropriations can relate back to the accounting year start for surtax capital computation, the Supreme Court clarifies.

Appropriations of profits to reserve funds, though formally made after the close of the accounting year, may relate back to the first day of the next accounting period when they are referable to that year's profits and are intended to govern capital computation from that date. For rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, capital is computed as on the first day of the previous year, but the later formalisation of the directors' allocation did not alter the character of the reserve. The allocation was therefore treated as part of the company's capital on the relevant date, and the Revenue's contrary contention failed.

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Issues: Whether sums appropriated by the directors to reserve funds after the close of the accounting year, but referable to the profits of that year, could be treated as reserves forming part of the company's capital as on the first day of the previous year for computation under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: The capital under rule 1 of the Second Schedule is to be computed as on the first day of the previous year, but the Court held that the character of an appropriation made after that day may relate back to the beginning of the new accounting year when it represents the directors' determination as to how the profits of the completed year are to be dealt with. The inability to make up accounts and declare the appropriation on the very first day did not change the nature of the allocation. Once the directors resolved to set apart the profits to specified reserves, that allocation was effective from the commencement of the new year. The Court approved the view that such reserve creation could be treated as relating to the relevant balance-sheet date rather than only to the later date of formal approval.

Conclusion: The appropriations were rightly treated as reserves forming part of capital as on the relevant date, and the contention of the Revenue failed.

Ratio Decidendi: An appropriation of profits to reserves, though formally made after the close of the year, may relate back to the first day of the next accounting period when it is referable to that year's profits and is intended to operate from that date for capital computation purposes.

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