Reserve versus provision test: amounts set apart for known liabilities were excluded from capital under super profits tax rules.

For computing capital under the Super Profits Tax Act, an appropriation is a reserve only if it is clearly earmarked as surplus for future use and not set apart to meet a known liability, whether present or contingent. The court applied the real nature of the appropriation rather than the balance-sheet label, noting that tax liability is a present liability even if quantification is deferred, gratuity was a known contractual liability, and the recommended dividend was specifically identified for payment. On those facts, the amounts set apart for taxation, gratuity, and dividends were provisions, not reserves, and were excluded from capital computation.

---

---

Issues: Whether the sums set apart for taxation, retiring gratuity, and dividends were "reserves" or "provisions" for computing capital under the Second Schedule to the Super Profits Tax Act, 1963.

Analysis: The computation of capital under the Act depends on the real nature of the appropriation and not on the label used in the balance-sheet. Amounts retained to meet a known liability, even if the amount cannot be determined with substantial accuracy, are provisions and not reserves. A reserve requires a clear earmarking of surplus for future use, whereas an amount set apart for a known liability, depreciation, contingency, or diminution in asset value is excluded. Tax liability is a present liability though quantification may be postponed, gratuity was a known contractual liability, and the dividend amount had been specifically recommended for payment. On the facts, these amounts were not earmarked as reserves.

Conclusion: The three amounts were provisions and not reserves, and therefore could not be included in the capital for super profits tax purposes.

Final Conclusion: The assessee was not entitled to have the amounts set apart for taxation, gratuity, and dividends treated as reserves in computing capital under the Act.

Ratio Decidendi: For capital computation under the Super Profits Tax Act, an appropriation is a reserve only if it is earmarked as surplus for future use and is not made to meet a known liability, contingent or otherwise, the amount of which cannot be determined with substantial accuracy.

---