One thing is clear and that is that this would be a provision and not a reserve. In Metal Box Company of India Ltd vs Their Workmen, 73 ITR 53 (SC), the Supreme Court had this to say with regard to the differentiation between a provision and a reserve while dealing with the provision for gratuity which was made in the accounts of the company, at pages 67-68: "The next question is whether the amount so provided is a provision or a reserve. The distinction between aprovision and a reserve is in commercial accountancy fairly well-known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the P&L account and the balance-sheet. 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. 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 and Pegler's Book-keeping and Accounts, 15th edition, page 42).

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 knownliability of which the amount cannot be determined with substantial accuracy is a provision. (see William Pickles Accountancy, second edition, p. 192; Part III, clause 7, Schedule VI to the Companies Act, 1956, which defines provision and reserve)."

A provision made on a proper basis must be considered as a proper charge against profits even for the purposes of the Income-tax Act, 1961, as has been held in the Metal Box case, supra.

Though it is true that in respect of write off of a debt, there is a separate procedure to be followed as laid down in Section 36(1)(vii) of the act, it is submitted that if only a provision is made and the said provision is an accurate one following certain guidelines, there is nothing in the act which prohibits such a provision from being claimed as a deduction.

This is particularly so when one sees the provisions of Section 40 and 40A of the act. These are the sections which provide for amounts which are not deductible under the act while computing the business profits.But for the provisions of Section 40A(7) of the act, even a provision for gratuity, properly made, is an allowable deduction, since a provision is deductible under the residuary section dealing with business expenses, viz., Section 37 of the act. That a provision is a proper deduction under Section 37 of the act need not be laboured upon too much as this is now an accepted position in the law, thanks to the decision of the House of Lords in Southern Railway of Peru Ltd vs Owen, 32 ITR 737 (HL) and the decision of the Supreme Court in Metal Box Company of India Ltd vs Their Workmen, 73 ITR 53 (SC). In the Metal Box case, the Supreme Court had this to say about making a provision and the allowability of a provision for gratuity while computing the profits for the purposes of taxation, at pages 64-65: ".... In the instant case, the question is not whether such estimated liability arising under the gratuity schemes amounts to a debt or not. The question that concerns us is whether, while working out the netprofits, a trader can provide from his gross receipts his liability to pay a certain sum for every additional year of service which he receives from his employees. This, in our view, he can do, if such liability is properly ascertainable and it is possible to arrive at a proper discounted present value. Even if the liability is a contingent liability, provided its discounted present value is ascertainable, it can be taken into account. Contingent liabilities discounted and valued as necessary can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into account. Contingent rights, if capable of valuation, can similarly be taken into account as trading receipts where it is necessary to do so in order to ascertain the true profits. (see CN Beatti's Elements of the Law of Income and Capital Gains Taxation, 8th edition, p.54)."

At page 66 of the judgment in Metal Box Company's case, supra, theSupreme Court also referred to the opinion of Lord Radcliff who cited, with approval, the dictum of Lord Haldane in Sun Insurance Office vs Clerk (1912) AC 443 at 445 which reads as under: "It is plain that the question of what is or is not profit or gain must primarily be one of fact, and of fact to be ascertained by the tests applied in ordinary business. Questions of law can only arise when (as was not the case here) some express statutory direction applies and excludes ordinary commercial practice, or where, by reason of its being impracticable to ascertain the facts sufficiently, some presumption has to be invoked to fill the gap."

Thus, in the above background, if a provision is made on the basis of certain mandatory guidelines, such a provision would not be a reserve. There is no prohibition in the act from claiming provisions as deductions for the purpose of computing profits and gains of business or profession under the act. A provision for bad debts, properly made, would, therefore, be a properclaim of deduction under Section 37 of the act.

The author is a Mumbai-based chartered accountant