Reserve under business profits tax depends on substance, with capital-expenditure receipts included and provident fund deductions limited proportionately.

For purposes of Schedule II, rule 2 of the Business Profits Tax Act, the term "reserve" depends on the true character of the amount and is not confined to sums created out of taxed profits. Amounts received for capital expenditure and carried in the balance-sheet as such were treated as reserves in substance and included in capital. In relation to a works provident fund, only the portion of investments referable to the reserve element could reduce capital, because employees' contributions were not the company's own money. The result is a pro rata deduction only for the reserve component.

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Issues: (i) Whether amounts shown as contribution from outside parties for capital expenditure constituted reserves for computing capital under Schedule II, rule 2 of the Business Profits Tax Act; (ii) Whether, in relation to the works provident fund, the investments referable to the employees' contribution could be excluded while computing the reduction of capital under Schedule II, rule 2.

Issue (i): Whether amounts shown as contribution from outside parties for capital expenditure constituted reserves for computing capital under Schedule II, rule 2 of the Business Profits Tax Act.

Analysis: The expression "reserve" in rule 2 is not confined to sums created out of taxed profits. The decisive test is the true character of the amount and whether it is specifically kept apart for use in the business. The Supreme Court's interpretation of rule 2 shows that reserves may arise from sources other than profits, and the Explanation to rule 2 confirms that the provision is not limited to profit-derived reserves. Applying that principle, the amounts received for capital expenditure and carried in the balance-sheet as such were held to be reserves in substance.

Conclusion: The amounts constituted reserves and were includible in capital for rule 2 purposes, in favour of the assessee.

Issue (ii): Whether, in relation to the works provident fund, the investments referable to the employees' contribution could be excluded while computing the reduction of capital under Schedule II, rule 2.

Analysis: The provident fund comprised both the employer's and employees' contributions, but the employees' share was held for their benefit and not as the company's own money. Since rule 2 requires diminution only by the cost of the assessee's investments, the deduction must correspond only to the portion of the investments referable to the part treated as reserve. A full deduction of the entire fund investments would be inconsistent with the scheme of the rule where only part of the fund is treated as reserve.

Conclusion: Only a pro rata deduction corresponding to the reserve element was allowable, and the investments referable to the employees' contribution were to be excluded, in favour of the assessee.

Final Conclusion: Both referred questions were answered in the assessee's favour, and the assessment had to be computed by treating the capital-expenditure contributions as reserves while allowing only proportionate deduction in respect of the provident fund investments.

Ratio Decidendi: For purposes of rule 2 of Schedule II to the Business Profits Tax Act, "reserve" is determined by the substance of the amount and is not confined to profits alone; where only part of a fund is a reserve, only the corresponding part of the related investments can reduce capital.

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