Reserve for surtax purposes excludes surplus carried forward; undistributed profits from re-computation do not enlarge capital base.

For surtax computation under the Second Schedule to the Companies (Profits) Surtax Act, only paid-up capital and properly appropriated reserves form the capital base. Recomputed profits arising because expenditure was treated as capital and depreciation allowed did not automatically become reserve; the excess remained undistributed profits carried to surplus in the balance-sheet. The Explanation to Rule 1 excluded such surplus from reserve, and Rule 1(iii) did not convert increased distributable profits into reserve. The assessee could not enlarge its capital base by adding that amount, so recomputation of surtax failed.

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Issues: Whether the assessee was entitled to enhance its capital base for surtax purposes by adding the amount by which profits increased after the income-tax authority treated certain expenditure as capital and allowed depreciation, so as to treat that incremental amount as reserve under the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: The capital base under the Second Schedule is computed with reference to paid-up capital and qualifying reserves, and the statutory deduction is derived as a percentage of that base. Rule 1(iii) reduces reserves by amounts already allowed as deductions under the income-tax assessments, but it does not create a mechanism by which increased distributable profits are automatically transmuted into reserve. Applying the principles governing the distinction between provision and reserve, the excess amount resulting from the capital treatment of expenditure remained a mass of undistributed profits. On the facts, the balance was carried to the surplus in the balance-sheet, and the Explanation to Rule 1 excluded such surplus from the concept of reserve for capital computation purposes.

Conclusion: The incremental amount could not be added to the assessee's reserve or capital base, and the claim for recomputation of surtax failed.

Final Conclusion: The decision confirms that only amounts properly earmarked as reserve can enter the capital base under the Second Schedule, while surplus or undistributed profits carried forward do not qualify for such enlargement.

Ratio Decidendi: Undistributed profits or surplus arising on re-computation of income do not automatically become reserve for surtax purposes unless specifically appropriated as such; surplus carried forward is excluded from reserve under the statutory scheme.

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