Surtax capital base cannot be reduced by depreciation differentials or investment allowance absent a credited reserve.

Rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act applies only where amounts are consciously credited to reserves and those credited sums are allowed as deductions under the Income-tax Act; excess depreciation allowed in income-tax assessment does not, by itself, satisfy those conditions, so it cannot reduce the surtax capital base. The same reasoning rejects any reduction of the capital base by the aggregate of earlier depreciation differentials. Investment allowance under the Income-tax Act is likewise not an item that can be adjusted against capital base under rule 4, because it is a deduction in computing total income and not a reserve or excluded income item. The surtax assessments were required to be recomputed accordingly.

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Issues: (i) Whether the excess of depreciation allowed in income-tax assessment over book depreciation reduces the capital base for surtax under rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964. (ii) Whether, if any reduction is permissible, the capital base is to be reduced by the depreciation differential as on the relevant first day or by the aggregate of earlier differentials. (iii) Whether investment allowance granted under the Income-tax Act can be adjusted against the capital base under rule 4 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Issue (i): Whether the excess of depreciation allowed in income-tax assessment over book depreciation reduces the capital base for surtax under rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: Rule 1(iii) applies where there are other reserves, amounts are credited to such reserves, and those credited amounts have been allowed as a deduction in computing income under the Income-tax Act. The differential in depreciation does not, by itself, satisfy these cumulative conditions, because there is no conscious act by the board creating a reserve or crediting an amount to reserve on that account. The scheme of the surtax computation requires only the specific statutory adjustments authorised by the Act and the Schedules, and does not permit rewriting the balance sheet beyond those adjustments. The reasoning adopted by the contrary view was not accepted.

Conclusion: The depreciation differential does not reduce the capital base; the answer is in favour of the assessee.

Issue (ii): Whether, if any reduction is permissible, the capital base is to be reduced by the depreciation differential as on the relevant first day or by the aggregate of earlier differentials.

Analysis: Since no reduction is permissible on account of the depreciation differential itself, there is no basis to reduce the capital base by the aggregate differential either. The broader contention that earlier differentials could be traced to reserves was also rejected, as the statutory condition of a reserve credited with amounts allowed as deduction was not established.

Conclusion: The aggregate differential does not reduce the capital base; the answer is in favour of the assessee.

Issue (iii): Whether investment allowance granted under the Income-tax Act can be adjusted against the capital base under rule 4 of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: Investment allowance is a deduction in computing total income and is not an item of income, profit, or gain not includible in total income for the purpose of rule 4. The adjustment made by the Assessing Officer was therefore unsustainable. The statutory framework does not authorise treating such allowance as a reserve for surtax adjustment.

Conclusion: Investment allowance cannot be reduced from the capital base under rule 4; the issue is decided in favour of the assessee.

Final Conclusion: The appeals succeeded, and the surtax assessments were required to be recomputed without reducing the capital base by the depreciation differential, the aggregate differential, or the investment allowance adjustment.

Ratio Decidendi: Rule 1(iii) of the Second Schedule applies only when a reserve is consciously created, amounts are credited to that reserve, and those credited amounts are allowed as a deduction in computing income under the Income-tax Act; absent these cumulative conditions, depreciation differences cannot be brought into the capital-base reduction machinery.

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