1. The Vazir Sultan Tobacco Company Ltd. is an asses-see under the Super Profits Tax Act, 1963 (No. 14 of 1963) hereinafter referred to as 'the Act'), for the assessment year 1963-64. For computing the chargeable profits of the previous year for the purpose of levy of super profits tax, the assessee-company claimed that the provision of (i) Rs. 33,68,360 for taxation, (ii) Rs. 9,08,106 for retiring gratuity, and (iii) Rs. 18,41,820 for dividends, should be considered as 'other reserves' within the meaning of Schedule II to the Act and taken into consideration for the determination of its capital. The Super Profits Tax Officer rejected the assessee's contention as, in his opinion, all those items were current liabilities and provisions, and not 'reserves'. He, accordingly, held that those items could not be taken into account for computation of the capital of the assessee-company. The Super Profits Tax Officer, on that basis, determined the capital, the standard deduction and levied super profits tax on that portion of the chargeable profits of the previous year which exceeded the standard deduction.
2. Although the Appellate Assistant Commissioner, in first appeal by the assessee against the assessment, accepted the assessee's contention and held that those items were 'other reserves', the Income-tax Appellate Tribunal, in the appeal filed by the Super Profits Tax Officer against the order of the Appellate Assistant Commissioner, accepted the department's contention and held that they were not 'reserves' within the meaning of the Second Schedule to the Act and those items could not enter into the computation of the capital of the assessee-company.
3. At the instance of the assessee-company, the Income-tax Appellate Tribunal, under Section 256(1) of the Income-tax Act, read with Section 19 of the Super Profits Tax Act referred the following question of law to this court:
' Whether, on the facts and in the circumstances of the case, the provision, (a) for taxation Rs. 33,68,360 ; (b) retirement gratuity, Rs. 9,08,106; and (c) dividends Rs. 18,41,820, could be treated as reserves for computing the capital for the purpose of super profits tax under the Second Schedule to the Super Profits Tax Act, 1963, for the assessment year 1963-64 '
4. The super profits tax is levied on companies and on no other assessable entities. Section 4 is the charging section under the Act. According to that section, every company for every assessment year commencing on and from the first day of April, 1963, shall be charged with super profits tax in respect of so much of its chargeable profits of the previous year or years, as the case may be, as exceeds the standard deduction, at the rate or rates specified in the Third Schedule to the Act.
5. The expression 'chargeable profits' and 'standard deduction' occurring in the charging section are defined in Sections 2(5) and 2(9) of the Act, respectively. Section 2(5) reads as follows :
' ' Chargeable profits ' means the total income of an assessee computed under the Income-tax Act, 1961, for any previous year or years, as the case may be, and adjusted in accordance with the provisions of the First Schedule.'
6. Section 2(9) of the Act reads :
' ' Standard deduction ' means an amount equal to six per cent, of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of fifty thousand rupees, whichever isgreater:
Provided that where the previous year is longer or shorter than aperiod of twelve months, the aforesaid amount of six per cent, or, as the case may be, of fifty thousand rupees shall be increased or decreased pro-portionetely :
Provided further that where a company has different previous years in respect of its income, profits and gains, the aforesaid increase or decrease, as the case may be, shall be calculated with reference to the length of the previous year of the longest duration. '
7. A reading of the above provisions indicates that the total income of the relevant previous year, determined under the provisions of the Income-tax Act, 1961, and adjusted in accordance with the provisions of the First Schedule to the Act is 'chargeable profit', and 6% of the capital oi the company on the first day of the relevant previous year, computed in accordance with the provisions of the Second Schedule, or Rs. 50,000, whichever is greater, is the 'standard deduction' and the amount by which the former exceeds the latter, is chargeable to super profits tax at the rates specified in the Third Schedule.
8. In the case before us, neither the quantum of chargeable profits determined by the Super Profits Tax Officer, nor the mode in which they have been computed, is in dispute. The only dispute that is raised in this reference is the one which relates to the computation of the capital for the purposes of determing the ' standard deduction '.
9. According to the accounting principle, the two bases of computation of capital are either the formula of capital plus reserves of the assets minus liabilities. The balance-sheet of a company is constructed on the principle that the capital, including reserves and undisclosed profits, is equal to the assets minus liabilities. In this equation, the capital is used in the sense of net wealth of the company representing the sum total or the capital, reserves and undistributed profits. In order to compute capital on the basis of the formula of capital plus reserves, it is essential to know the clear distinction that the law makes between a reserve, provision and a liability. The distinction between 'provision' and 'reserve' is also vital in determining whether a particular outgoing represents an expenditure or an asset. The point of time at which the liability accrues or arisesis material for distinguishing a 'reserve' from a 'provision' or a 'liability'.
10. The rules for computation of capital contained in the Second Schedule to the Act proceed on the basis of the formula of capital plus reserve, and not on the basis of the formula of assets minus liabilities.
11. The computation of capital, under the ordinary principles of accounting, does not exactly correspond to the principle of computation of capital under the Second Schedule to the Act. Whatever that may be, the meanings that are to be attributed to the expressions 'reserve', 'provision' and 'liability', both under the ordinary principles of accounting and under the principles enacted in the Second Schedule to the Act, are the same.
12. Although 'reserve' is one of the essential components of capital, still the word 'reserve' has neither been defined under the Super Profits Tax Act, nor under similar taxation statutes, namely, Business Profits Tax Act, or the Companies (Profits) Surtax Act, although the expression 'reserve' has been used in those Acts in the same manner and in the same context of the computation of capital as in the Super Profits Tax Act.
13. Since we are dealing with a company and the word 'reserve' has not been specially defined in the Super Profits Tax Act or in any other taxing statute, its meaning has to be understood in its ordinary, plain and natural sense and its definition as found in the Companies Act.
14. Section 211 of the Companies Act of 1956 relates to the forms and contents of a balance-sheet and the profit and loss account. General instructions for preparing and constructing the balance-sheets in respect of the profit and loss account of a company are found in Schedule VI to the Companies Act of 1956. Schedule VI contains three parts. The first and second parts give those instructions, and for the purposes of Parts 1 and 2, Part 3 deals with the interpretation of the words ' reserve, provision and liabilities '.
15. Clause (7) of Part 3 of Schedule VI to the Companies Act of 1956 provides as under:
'(1) For the purposes of Parts I and II of this Schedule, unless the context otherwise requires,--
(a) the expression ' provision ' shall, subject to Sub-clause (2) of this clause, mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy ;
(b) the expression ' reserve' shall not, subject as aforesaid, include any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability;
(c) the expression 'capital reserve' shall not include any amount regarded as free for distribution through the profit and loss account; and the expression ' revenue reserve' shall mean any reserve other than a capital reserve;
and in this sub-clause, the expression 'liability' shall include all liabilities in respect of expenditure, contracted for and all disputed or Contingent liabilities,
(a) any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, not being an amount written off' in relation to fixed assets before the commencement of this Act; or
(b) any amount retained by way of providing for any known liability;
is in excess of the amount which, in the opinion of the directors, is reasonably necessary for the purpose, the excess shall be treated for the purposes of this Schedule as a ' reserve ' and not a ' provision '. '
16. The interpretation of the term 'reserve' in Clause (7) is not exhaustive, but it only specifies certain amounts which are not to be included in the term ' reserve '.
17. In determining the question whether a sum set apart by a company constitutes a 'reserve', it may become necessary to examine the meaning of the words ' provision,' and ' liabilities '. The distinction between the words 'reserve', ' provision ' and ' liability ' is fairly well known in the commercial and accountancy fields. That distinction had been pointed out by the Supreme Court in Metal Box Company of India Ltd. v. Their Workmen, : (1969)ILLJ785SC . Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the profit and loss account and the balance-sheet.
18. On the other hand, 'reserves' are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business.
19. Provisions are usually shown in the balance-sheet by way of deductions from the assets in respect of which they are made, whereas general reserves and reserve funds are shown as part of the proprietor's interest (See Spicer & Pegler's Book-keeping and accounts, 15th edition, page 42).
20. An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet, is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantialaccuracy, is a provision. (See William Pickles' Accountancy, 2nd edition, page 193; Part III, Clause (7), Schedule VI to the Companies Act, 1956, which defines ' provision ' and ' reserve ').
21. In the above cese, the general principles of accounting have been adopted by the Supreme Court for determining the bonus (based on a certain percentage of gross profit) payable by a company to its workmen under the Payment of Bonus Act. Those principles are applicable to the case before us, because the word ' reserve ' under the Super Profits Tax Act has been used and understood in the sense in which it has been used with reference to companies, under the Companies Act, 1956.
22. In Workmen of William Jacks and Company Ltd. v. Management of William Jacks & Co. Ltd., : (1971)ILLJ503SC the Supreme Court in paragraph (8) of its judgment, reported at page 1825, held that:
'The provision for gratuity, furlough salary, passage, service and commission in the present case was all made in respect of existing and known liabilities, though, in some cases, the amount could not be ascertained with accuracy. It was not a case where it was an anticipated loss or anticipated expenditure which would arise in future. Such provision is therefore, not a reserve at all and cannot be added back under item 2(c) of the Second Schedule.'
23. Thus, in short, the amount set apart out of profits or other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet, is a 'reserve'. The amount set aside out of profits and other surpluses, to provide for any known liability, of which the amount cannot be determined with substantial accuracy, is a ' provision '.
24. Having thus known the distinction between 'reserve' and a ' provision ', it is necessary to know when and at what point of time a liability is known ?
25. In Kesoram Industries and Cotton Mills Ltd. v. Commissioner of Wealth-tax, : 59ITR767(SC) the question that fell for decision of the Supreme Court was whether the provision for taxation and proposed dividends were 'debts owed' within the meaning of Section 2(m) of the Wealth-tax Act, and as such deductible in computing the net wealth of the assessee. Under the Wealth-tax Act, net wealth on a valuation date has been defined to be the amount by which the value of assets is in excess of the debts owed on the valuation date. After an exhaustive discussion of the decided cases, Subba, Rao J. (as he then was) summarized the legal position thus, at page 784 :
'A debt is a present obligation to pay an ascertainable sum of money, whether the amount is payable in praesenti or in futuro : debitum in praesenti solvendum in futuro. But a sum payable upon a contingency doesnot become a debt until the said contingency has happened. A liability to pay income-tax is a present liability though it becomes payable after it is quantified in accordance with ascertainable data. There is a perfected debt at any rate on the last day of the accounting year and not a contingent liability. The rate is always easily ascertainable. If the Finance Act is passed, it is the rate fixed by that Act; if the Finance Act has not yet been passed, it is the rate proposed in the Finance Bill pending before Parliament or the rate in force in the preceding year, whichever is more favourable to the assessee. All the ingredients of a 'debt' are present. It is a present liability of an ascertainable amount.'
26. The word 'reserve', as earlier stated, occurs in the Business Profits Tax Act, and the Companies (Profits) Surtax Act in the same context of computing the capital of a company The connotation of the word 'reserve' occurring in those Acts, was considered by various High Courts. In Commissioner of Income-lax v. Century Spinning and ., : 24ITR499(SC) the facts were : For the accounting year ending December, 1945, the profits of the assessee-company amounted to Rs. 90,44,677. After providing for depreciation and taxation, there remained an unallocated balance of Rs. 5,08,637 which was not allowed in computing the profits of the assessee for the purposes of income-tax. In February, 1946, the directors recommended that, out of that amount, Rs 4,92,426 be distributed as dividends, and the balance be carried forward to the next year's account. The recommendation was accepted by the shareholders and dividends, shortly thereafter, were distributed. In computing the capital of the assessee-company on April 1, 1946, under the Business Profits Tax Act, the assessee claimed that the amount of Rs. 5,08,637 carried forward into the account of 1946 should be treated as 'reserve' for the purposes of Rule 2, Sub-rule (1), of the Second Schedule to the Business Profits Tax Act.
27. Ghulam Hasan J., speaking for the court, observed that:
' ....the true nature and character of the disputed sum must be determined with reference to the substance of the matter .... nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination. On the other hand, on the 28th February, 1946, the directors clearly earmarked it for distribution as dividends and did not choose to make it a reserve. Nor did the company in its meeting on the 3rd April, 1946, decide that it was a reserve. It remained on the 1st of April as a mass of undistributed profits which were available for distribution and not earmarked as ' reserve '. On the 1st of January, 1946, the amount was simply brought from the profit and loss account to the next year and nobody with any authority on that date made or declared a reserve. The reserve may be a general reserve or a specific reserve, but there must be a clear indication to show whether it was a reserve either of the one or the other kind. The fact that it constituted a mass of undistributed profits on the 1st January, 1946, cannot automatically make it a reserve.' With those observations, the Supreme Court held that profits lying unutilized and not specially set apart for any purpose on the crucial date did not constitute 'reserve' within the meaning of Schedule II, Rule 2(1).
28. In Indian Steel and Wire Products Ltd. v. Commissioner of Income-tax,  33 I.T.R. 579, 584, 588 (Cal.) the question that fell for decision before a Division Bench of the Calcutta High Court was whether the advance payments of tax by a company, under Section 18A of the Income-tax Act, can be treated as part of its reserve for the purposes of computing the capital under Schedule II to the Business Profits Tax Act, 1947, until credit in respect of them was actually given in the regular assessment. The learned Chief Justice, speaking for the court, observed that:
'.... I think that it can hardly be disputed that nothing can be reserved unless it has been reserved or laid by or stored for use or application in a future contingency which is anticipated as certain or likely.... A reserve, as I have endeavoured to explain, is by its very nature a fund which is created and maintained for the purpose of being drawn upon in future If certain payments are to be made in discharge of a present liability in the course of the year to which the balance-sheet and the profit and loss account relate, I am unable to see how such payments can be said to be made by way of creating a reserve. They are clearly of the nature of expenditure, although it may not be expenditure in the income-tax sense allowable in an assessment, but none the less they are expenses incurred and met by the company in the course of its business existence during the year when liabilities requiring an instant discharge arise. A reserve is created only out of the whole or a part of the surplus profits as they are found to be in the hands of the company at the end of the year and it is a reserve against a contingency which still lies in the future. Payments under Section 18A do not, in my view, satisfy that test. Their true nature is that they are payments on account, made under the compulsion of a statute, towards the discharge of an instant liability for liquidating a charge, the precise measure of which is to be determined at a later date,'
29. With those observations, the Calcutta High Court held that advance payments of tax under Section 1 8A were not ' reserves ' within the meaning of Rule 2 of Schedule II to the Business Profits Tax Act.
30. To the same effect is the decision of the Gujarat High Court in Commissioner of Income-tax v. Rohit Mills Ltd.,  58 I.T.R. 854 (Guj.).
31. Following the principle laid down in Commmissioner of Income-fax v. Century Spinning and ., : 24ITR499(SC) the question whether a particular fund is or is not a 'reserve fund' must be determined with reference to the substance of the matter and not the terminology given to it. The Supreme Court in First National City Bank v. Commissioner of Income-tax, : 42ITR17(SC) held that funds resereved in that case were 'reserves' within the meaning of Schedule II to the Business Profits Tax Act.
32. By following the principles laid down by the Supreme Court in Commissioner of Income-tax v. Century Spinning and . and First National City Bank v. Commissioner of Income-tax a, the Kerala High Court in Aluminium Industries Ltd. v. Commissioner of Income-tax,  68 I.T.R. 125 (Ker) held that the reserve may be a general reserve or a specific reserve, but in order to constitute a 'reserve' there must be a clear indication to show that it was a 'reserve' either of the one kind or the other. A mass of undistributed profits is not a 'reserve', even though it is shown in the balance-sheet as a ' reserve '.
33. In Commissioner of Income-tax v. Standard Vacuum Oil Company, : 59ITR685(SC) the Supreme Court, pointing out the connotation of the expression 'reserve' as something specifically kept apart for future use, or for a specific future action, held that it was not necessary that a reserve admissible in the computation of capital should be one built out of profits and that reserves built up from sources other than profits were also admissible for inclusion in capital under Rule 2(1) of the Schedule to the Business Profits Tax Act.
34. Whether the appropriations made to the reserve account on August 8, 1963, could be treated as components of capital as on the first day of the previous year, i.e., 1st April, 1963, came to be considered by the Mysore High Court in Commissioner of Income-tax v. Mysore Electrical Industries Ltd., : 80ITR566(SC) under the Companies (Profits) Surtax Act, 1964. Rejecting the contention of the department the Mysore High Court held that those appropriations made on August 8, 1963, related back to April 1, 1963, viz., the beginning of the accounts for the new year, and had to be treated as effective from that day.
35. In Commissioner of Income-tax v. Indian Metal and Metallurgical Corporation,  51 I.T.R. 240 (Mad.) the assessee claimed deduction of the amount credited to the gratuity reserve account under Section 10(2)(xv) of the Indian Income-tax Act, 1922, for the purposes of computing its income under the Income-tax Act. The High Court of Madras rejected the claim of the assessee, observing that:
'The credit of Rs. 5,600, being merely a provision by way of reserve by the assessee to meet the liability, if any, to which the assessee may become subject in the event of its sending away a few workmen because of retrenchment of surplus staff, was not a liability in praesenti in the year of account, but a liability which may arise de futuro on the happening of a particular contingency, and could not be allowed as a deduction either under Section 10(2)(xv) or on commercial principles as to computation of profits.'
36. In J. Dalmia v. Commissioner of Income-tax, : 53ITR83(SC) the board of directors of the company declared a dividend on August 30, 1950. The assessee (shareholder), received the dividend warrant on December 28, 1950. The date of declaration of the dividend fell within the assessment year 1951-52 of the shareholder, but the date of receipt of the dividend warrant fell within the assessment year 1952-53. The question arose whether the dividend income of the shareholder should be taxed in his hands in the assessment year 1951-52 or 1952-53 The Supreme Court observed that:
'A mere resolution of the directors resolving to pay a certain amount as interim dividend did not create a debt enforceable against the company, for it was always open to the directors themselves to rescind the resolution before payment of the dividend.'
37. The word 'paid' means that the company discharged its liability and made the amount of dividend unconditionally available to the shareholder. The dividend was, accordingly, held to be assessable in the assessment year 1952-53.
38. From the aforesaid discussion, it emerges that in order to decide whether a particular appropriation is or is not a 'reserve' within the meaning of Schedule II to the Super Profits Tax Act, we must examine the question with reference to the substance of the matter and not to the terminology given to it. Any amount retained by way of providing for any known liability, of which the amount cannot be determined with substantial accuracy, is a 'provision'. The retention of an amount for providing a liability which is not known on the first day of the relevant previous year, and the quantum of which cannot be determined with substantial accuracy, is a 'reserve'. Only those reserves should be taken into account which have not been allowed in computing the profits for the purposes of income-tax, subject to the exception of development reserves created under the Income-tax Act. Some one possessed of the requisite authority must have indicated on the date the manner of its disposal or destination. If it remained a mere undistributed mass of profits not earmarked as reserve, and brought over to the next year in the accounts, it is not a 'reserve'. Payments made for discharging a present liability, though disallowed in computing the profits for income-tax, still remained items of expenditure and are not 'reserves'. It is not necessary that a reserve admissible in the computation of the capital should be one built out of profits. The 'reserves' may be built not only from profits, but from other surpluses also. Appropriations made in the balance-sheet within a reasonable time, after the first day of the relevant previous year, would relate back to the first day of the previous year.
39. The question whether a particular amount is, or is not a 'reserve' has to be decided with reference to the following facts, viz.: (i) has it or has it not been earmarked for a particular purpose by a person, possessing requisite authority (ii) it must not be a payment in the nature of an expenditure, whether allowed or not in computing the profits and gains for income-tax purposes ; (iii) it must not have been retained to provide for a known liability, the amount of which cannot, with substantial accuracy, be determined ; (iv) it must not be retained to provide for depreciation, commitment, contingency or diminution in the value of the assets ; and (v) it must not have been allowed in the computation of the income for the purpose of income-tax.
40. In the balance-sheet on the liabilities side, reserves for the current year have been shown at Rs. 1,44,49,159 as per Schedule I, and the current liabilities and provisions at Rs. 91,97,164 as per Schedule II.
41. Although the terminology given by the assessee-company to those items is not the decisive factor for deciding the question, whether those items constitute 'reserves' or 'provisions', still it is absolutely clear that the directors of the assessee-company have not chosen to earmark those amounts as 'reserves'. In view of the ratio of the decision of the Supreme Court in Century Spinning and ., : 24ITR499(SC) the amounts not earmarked as 'reserves' but which have been specifically earmarked as 'dividends' have been held not to be taken into account for the computation of the capital.
42. Apart from that, the liability to pay income-tax is a present liability, though it becomes payable at a future point of time when it is quantified in accordance with the ascertainable data. That liability, on the first day of the accounting year, is known, but the amount of that liability cannot be determined on that date with substantial accuracy. (See Kesoram Industries & Cotton Mills Ltd. v. Commissioner of Wealth-tax,  591.T.R. 767 (S.C.)). Therefore, the amount set apart for tax liability is a 'provision' and not a 'reserve', because it is set apart to meet a known liability, the quantum of which, on that date, cannot be determined with substantial accuracy.
43. The amount set apart for gratuity is, certainly, a liability known onthe date of the balance-sheet. It is a contractual liability of the company.
44. If the workers retire they will have to be paid gratuity, according to the number of years of service they have put in. The liability for gratuity is known, but the exact quantum of that liability is not determinable on the first day of the accounting year, because the gratuity is payable not only on the retirement of the employees, but also on the death of the employees. Though the number of employees that may retire in a particular year, and the amount of gratuity payable to them is known and can be, worked out with substantial accuracy, still the gratuity that may be payable to the employees on their death cannot be ascertained on the first day of the accounting year because nobody would know how many deaths of the employees would occur in that accounting year. Thus, although the liability to pay the gratuity is known on the first day of the accounting year, the quantum of that liability cannot be determined on the first day of the accounting year with substantial accuracy. The amount retained for gratuity has, therefore, been set apart in respect of a liability known on the date of the balance-sheet. It is, therefore, a mere 'provision' and not a 'reserve '.
45. Then we come to the amount set apart for dividends. The directors of the assessee-company had recommended the payment of that amount as dividends. It has not been shown that the directors have rescinded their recommendation to pay it as dividends. Subsequent events may prove that the recommendation of the directors may be ratified by the shareholders. In such an event, the shareholders would be entitled to enforce the payment of the dividends against the company. Since, however, the liability to pay the dividends was existing on the date of the balance-sheet, and the amount has been set apart specifically for the payment of dividends, it is, in our opinion, a ' provision ' and not a ' reserve '.
46. In the result, we are unable to agree with the learned counsel for the assessee-company that the above amounts shown as set apart by the assessee-company in its balance-sheet are 'reserves' which have to be included in the computation of its capital for the purposes or computing the super-profit tax payable on the chargeable profits for the relevant accounting year.
47. In the result, we answer the question in the negative and against the assessee. The assessee shall pay the costs of this reference to the department. Advocate's fee Rs. 250.