Retirement gratuity reserve counts as capital reserve, not current liability, for surtax computation

Retirement gratuity reserve was treated as a reserve, not a provision or current liability, for capital computation under the Companies (Profits) Surtax Act, 1964. The amount had not become an accrued liability or debt due in the accounting year; it was retained out of profits for future application. The balance-sheet explanation excluded current liabilities and provisions, but that exclusion did not apply because no present gratuity liability had arisen. The item had to be characterised by its substance rather than its accounting label, so it was includible in capital under rule 1 of the Second Schedule.

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Issues: Whether the amount credited as retirement gratuity reserve was a reserve includible in the capital for computation of statutory deduction under the Companies (Profits) Surtax Act, 1964, or was excluded as a provision or current liability under the balance-sheet explanation.

Analysis: The amount was not a liability already accrued or a debt due in the accounting year; it was money kept back from profits for future use. A reserve may be specific as well as general, but it must represent sums appropriated out of profits and retained for future application. The explanation to the Second Schedule excluded items of the nature of current liabilities and provisions shown in the balance-sheet, but the disputed gratuity reserve did not answer that description because no current liability had arisen and the amount was not earmarked to meet a liability that had already accrued. The proper character of the item was therefore to be determined by its substance, not merely by the label used in the accounts.

Conclusion: The retirement gratuity reserve was a reserve and was includible in the capital computation under rule 1 of the Second Schedule. The answer to the reference was in favour of the assessee and against the revenue.

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