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Petitioner: COMMISSIONER OF INCOME-TAX, WEST BANGAL, CALCUTTA VS Respondent: MESSRS SIJUA (JHARRIAH) ELECTRIC SUPPLY CO. LTD.
1986 P T D 465
1986 P T D 465
[Calcutta (India)]
Before Sabyasachi Mukharji and Suhas Chandra Sen, JJ
COMMISSIONER OF INCOME‑TAX, WEST BANGAL, CALCUTTA
Versus
Messrs SIJUA (JHARRIAH) ELECTRIC SUPPLY CO. Ltd.
Income‑tax Reference No. 44 of 1979, decided oh 7th February, 1983.
Income‑tax‑‑
‑Business expenditure‑‑Assessee, Electric supply undertaking‑ Appropriation of amount towards statutorily created. "Contingencies Reserve"‑‑Includible in assessee's total income‑‑Not deductible as business expenditure.
The assessee is an Electric Supply undertaking engaged in the business of generation and distribution of electricity and is governed by statute. As per that Act, it had to create a reserve called "Contingencies Reserve", to be utilised for the purposes set out in Paragraph V of the Sixth Schedule. In compliance with the provisions of the Act she assessee‑company appropriated certain amount towards "Reserve for Contingencies" and deducted that amount in the computation of its taxable income.
Held, that there has been no diversion of income by an overriding title at .all. The amount appropriated to the contingencies reserve was collected by the assessee as its revenue from sale of electricity. The amount remained at the disposal of the assessee and for the‑benefit of the assessee. It can be used only for a few specified purposes but the purposes for which the fund can be used are all the business purposes ‑3fthe assessee‑company. Payment of compensation to workers, replacement of plant and machinery or other expenditures envisaged in the Act are all normal business expenditures of a company. This is not a case of diversion of income before it reaches the assessee, but only a case of setting apart of the assessee income under compulsion of law for the use and benefit of the assessee although the mode and the objects of the expenditure is statutorily restricted. The amounts set apart by the assessee‑company as contingencies reserve will not have to be returned to the consumers or handed over to any other person so long as‑ the company continues to do business of generation and supply of electricity. The‑ amount has been set apart under compulsion of law for the purpose o. meeting certain business obligations of the assessee. Such an amount cannot be said to have been diverted from the assessee in any manner at all. The amount set apart by the assessee- company to create "Contingencies Reserve" was, therefore, included in its total‑ income. It could not also be said that the appropriation to the contingencies reserve fund made by the assessee would be an expenditure wholly and exclusively laid out for the assessee's business and should be allowed as a deduction under section 37 of the Income‑tax Act.
138 I T R III (Cal.) (1979) 117 I T R 516 (Pat.); 109 I T R 454 (Mad.); (1976) 103 I T R 384(Bom.); (1974) 97 I T R 334_(Bom); 93 1 T R 582 '(Kar.); A I R 1970 S C 237; 57 1 T R 521; 41 1 T R 367 and (1883) 2 Tax Cas. 25 ref.
Ajit Sengupta with Sunil Mukharjee for Revenue.
Dr. D. Pal with Miss Manisha Seal and Joydev Saha for Assessee.
JUDGMENT
SUHAS CHANDRA SEN, J.‑‑The following question of law has been referred at the instance of the Commissioner of Income‑tax under section 256 (1) of the Income‑tax Act, 1961:‑
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of Rs.66,964 appropriated towards 'Reserve for Contingencies' is an allowable deduction in computing the assessee's business income from Electric Supply undertaking?"
2. The facts relevant for the question stated by the Tribunal are as under:‑
The assessee is an Electric Supply undertaking, engaged in the business of generation and distribution of electricity anti is governed by the Electricity (Supply) Act, 1948. As per paragraphs III to V of the Sixth Schedule to the aforementioned Act, it had to create a reserve called Contingencies Reserve', to be utilised for the purposes set out in paragraph V of the said Sixth Schedule. In compliance with the provisions of the said Act the asses see‑company appropriated an amount of Rs.66,964 towards 'Reserve for Contingencies and deducted that amount in the computation of its taxable income of the previous; year relevant to the assessment year 1973‑74. For the reasons mentioned by him in the assessment order, the Income‑tax Officer disallowed deduction of this amount in the computation of the business income and added back the same.
3. The aforesaid disallowance, among others; was disputed by the assessee in the appeal preferred before the Appellate Assistant-Commissioner against the assessment for the assessment year. 1973‑74, For the reasons mentioned by him in his order the Appellate Assistant Commissioner confirmed the disallowance of the deduction in respect of this contingency Reserve of Rs.66, 964.
4. The assessee preferred a further appeal to the Tribunal. The Tribunal held that the amount covered by contingency reserve was a diversion by, reason of overriding obligation created by the statute arid, therefore, for determining the commercial profits of the assessee, the amount of this reserve had to be deducted. The Tribunal further held that the amount of Rs.66,964 was deductible while computing the assessee's total income under section 28(1) of the I.T. Act, 1961.
5. The argument in‑this case on behalf of the revenue and also on behalf of the assessee has centred round the provisions contained in the Electricity (Supply) Act, 1948 and in particular the Sixth Schedule. The relevant provisions of the Sixth Schedule are set out as under:
"III. There shall, be created from existing reserves or from the revenues of the undertaking a reserve to be called 'Contingencies Reserve."
IV.(1) The licensee shall appropriate to Contingencies Reserve from the .revenues of each year of account a sum not less than one-quarter of one per centum and not more than one‑half of one per centum of the original costs of fixed assets, provided that ;f the said reserve exceeds, or would by such .appropriation, be caused to exceed, five per centum of the original cost of fixed assets, no appropriation shall be made which would have the effect of increasing the reserve beyond the said maximum.
(2) The sums appropriated to the Contingencies Reserve shall be invested in securities authorised under the Indian Trusts Act, 1882, and such investment shall be made within a period of, six months of the close of the year of account in which such appropriation is made.
V.(1) The Contingencies Reserve shall not be drawn upon during the currency of the licence except to meet such charges as the State Government may approve as being:‑
(a) expenses or loss of profits arising out of accidents, strikes or circumstances which the management could not have prevented;
(b) expenses on replacement or removal of plant or works other than expenses requisite for , normal maintenance or renewal;
(c) compensation payable under any law for the time being in force and for which no‑other provision is made:
(2). On the purchase of the undertaking the Contingencies Reserve after the deduction of .the amounts drawn under sub‑paragraph (1) shall be handed over to the purchaser and maintained as such Contingencies Reserve:.
Provided that where the undertaking is purchased by the Board or State. Government, the amount of the Reserve computed as above shall, after further deduction of the amount of compensation, if any, payable to the employees of the outgoing licensee under any law for the time being in force, be handed over to the Board or the State Government, as the case may be."
Paragraph VI deals with allowance in respect of depreciation of fixed assets employed in the business of electricity supply. it is provided that all sums credited to depreciation account shall be invested only in the business of electricity supply of .the undertaking or where it is not practicable to so invest them, in investment's approved by the State Government. It is further provided that any sums invested icy investments approved by the State Government shall, as soon as practicable, be utilised in the business of electricity supply of the undertaking.
6. Paragraph V1I is important for our purpose and is as under
"VII. (1) Where any fixed asset ceases to be available for fuse through obsolescence, inadequacy, superfluity or for any other reason, it shall be described in the books of the licensee as no longer in use and no further depreciation in respect thereof shall be allowed as a charge against revenue.
(2) The written‑ down cost of such fixed asset including expense incurred on the dismantling thereof shall be charged against the Contingencies Reserve:
Provided that where the accumulations in the Contingencies Reserve are not sufficient to permit the charging of the entire written down cost of the asset and the‑ dismantling expenses, the excess amount may be included in the capital base for the purpose of cl. (a) of sub para. (1) of Para. XVII.
(3) The amount for which any such fixed asset is sold or the amount of 'its scrap value when actually realised shall be credited to the Contingencies Reserve.
VIII. When any asset has been written down in the books of the undertaking to 10 percent or less of its original cost no further depreciation shall be allowed in respect of that amount,
IX. When any fixed asset is sold for art amount exceeding its written down cost the excess' after deducting all taxes payable thereon shall be credited to the Contingencies Reserve."
7. The provisions of, paragraph VII have been drastically altered in 1978, but in this reference we are concerned with the assessment year 1973‑74 and those changes have no bearing on the question raised in the instant case.
8. It has been contended before us on behalf of 'the assessee that the appropriation to the contingencies reserve is compulsory under the law and the assessee has really no option in this matter. This reserve has to be shown in the balance‑sheet of the assessee‑company, but the amount credited to this reserve cannot be utilised by the assessee except for the purposes laid down in the statute: Money has to be kept invested in securities authorised under the Indian Trusts Act, 1882. It is necessary to obtain prior approval of the Government before making any expenditure out of that fund. Ultimately, where the undertaking of the company is purchased, the contingencies reserve will have to be handed over to the purchaser. It has been argued that the amount; appropriated to contingencies reserve has been diverted at source .by an overriding title and cannot form part of the real income of the assessee. In the alternative, it has been argued that the money has been irrevocably set apart for a business purpose and will have to be allowed as a deduction under section 37 of the I.T, Act.
9. In this case the amount that has been appropriated to the contingencies reserve is part of the revenue collected by the assessee: in its usual business of generation and sale of electricity. The assessee is required to invest the sums appropriated to the contingencies reserve in securities authorised under the Indian Trusts Act, 1882. The assessee' also cannot spend any amount out of this fund except with the approval of the State Government; but it is the assessee alone who can spend this amount so long as the assessees business of generation and supply of electricity continues. It is true that the assessee is not at liberty to, use this fund in whichever way it likes but the purposes for which the amount can be spent as prescribed in paragraph V are all usual business purposes of the company. The amount can be spent for meeting expenses or loss of profit arising out of accidents, strikes or other unavoidable circumstances. The amount can also be utilised for payment of any statutory compensation for which no other provision has been inside. The amount can also be spent for replacement or renewal of plant or works other than normal maintenance or renewal. It is also important to note in this connection that the written down cost of fixed assets, of the company which cannot be used any more in the business of the assessee including the dismantling charges of such fixed assets will have to be charged against the contingencies reserve. The ' (excess) amount realised on sale of such fixed assets will have to be credited to the contingencies reserve. It will appear from the provisions that, have been made in respect of the contingencies reserve that the amount will be available to the assessee for utilisation in its business. The approval of the Government is necessary only to ensure that the money is not frittered away or disputed for purposes other than what has been set out in paragraph V. The company is also under an obligation to file, alongwith its Balance Sheet, a statement of contingencies reserve showing the' additions and withdrawals made every year. Therefore, the intention of the legislature was, not to prevent the assessee from using this fund or to divert this fund from the assessee to some other person, The fund will remain in the custody and control of the assessee and will be utilised for the specified business purposes of the assessee. But there are certain statutory safeguards to ensure that the, fund is used only for those limited purposes.
10. We are also not impressed by the argument that in the long run this fund may have to be handed over to the, purchaser of the electricity undertaking. The remote contingency of the undertaking of the company being taken over cannot affect the position in law in this case. This requirement of paragraph V (2) will not prevent the assessee‑company from drawing upon the contingencies reserve during the currency of the license. It is only the amount that will remain outstanding after deduction of all the payments that have been made, which will have to be handed over to the purchaser. The entire fund may 'be ‑utilised for replacement of plant and machinery or for making up loss arising out of accidents or strikes or for discharging the other liabilities. It is only the amount if any, that remains outstanding after all these payments, that will have to he handed over to the purchaser, Even then, the amount so handed over will remain charged for payment .of compensation; if any, payable to the employees of the Company. Retrenchment compensation and other dues of the employees will have to be paid out of this fund. In other words, even when the undertaking is purchased by the Board or the State Government the amount standing to the credit of this fund will be available to the Company for discharging the statuiory obligations to its employees.
11. The Supreme Court in the case of U. P. Electric Supply Co., Ltd. v‑. R. K Shukla A T R 1970 S C 237 had occasion to go into the nature sand purpose of the contingencies reserve in that case the licence of the U.P. Electric Supply Co. Ltd: expired in 1964 and the undertaking of the Company .Was taken over by the State Electricity Board from the mid‑night of 16th September, 1964; The workmen of the undertaking claimed that they were entitled to retrenchment compensation, ‑salary in lieu of notice and other benefits from 'the company. The Supreme Court field that the liability to pay retrenchment compensation was a debt and if it arose on the transfer of an undertaking, it would 'attach to the purchase money payable to the company. It was observed by the Supreme Court at page 245 of the report: ‑
"Clause V only provides for the appropriation of the contingencies Reserve: It required an undertaking to hand over the Contingencies Reserve to the purchaser. If any amount of compensation is payable to the employees of the outgoing Licensee under any law for the time being in force, it is chargeable to the Contingencies Reserve. If the retrenchment compensation becomes properly due to the employees of the Company, it would by virtue of‑ clause V sub‑clause (2) proviso, be charged upon the Contingencies Reserve and the balance sum would be handed over to the purchaser.
It was urged that the contingencies reserve has been paid over to the purchaser. There is, however, no finding by the Labour Court in that behalf. If it be found in appropriate proceedings that retrenchment compensation is payable to the workmen and the contingencies reserve out of which it .is payable has been handed over to the Board, the charge for payment of that amount may attach to that amount. On that matter we need express no opinion' at this stage."
12. The nature of the contingencies reserve has been examined in a number of cases decided under the Income‑tax Act; the Wealth‑tax Act and also the Super Profits Tax Act. Under the I.‑T. Act, it has been held by the Kerala, Bombay and Patna High Courts that any appropriation to the contingencies reserve will amount to diversion of income at source by an overriding title. The Madras High Court has taken a contrary view. The Bombay High Court, however, has held in a wealth‑tax case that the contingencies reserve fund cannot be excluded from the net wealth of an assessee as the fund was an asset belonging to the assessee. A Division Bench of this Court has 'also taken the view that contingencies reserve fund is a reserve and has to be taken into account for the purpose of computation of capital under the Super Profits Tax Act. It will be necessary to refer to those decisions in order to resolve the controversy that has been raised in this case. .
13. The Kerala High Court in the case of Cochin State Power Light Corporation v. Commr. of Income‑tax Kerala, (1974) 93 I T R 582: (1973) Tax LR 1402 held that for determining the commercial profits of the assessee, the amount appropriated towards the contingencies reserve must be deducted. In that case Subramonian Poti J. observed (at p.1408 of Tax L.R.):‑
"Bearing in mind the fact that the amount under the contingencies reserve is not available to the assessee for any purpose of his own or even for any purpose other than those indicated in paragraph V of the Sixth Schedule and also‑noticing the object of the creation of this reserve end further noting the provision that it is a diversion from the revenue, we think that the diversion is one which is deductible in determining the real profit. There is the further fact that the assessee does not get even compensation on account of this reserve as and when the undertaking is purchased and even the purchaser has to maintain the reserve as such therefore, in spite of the distinction that we have pointed out in regard to certain features between this reserve and the consumers' benefit reserve with which the Supreme Court was concerned in the Poona Electric Supply Company case, we feel that the amount covered by the contingencies reserve is a diversion by reason of overriding obligation created by the statute and, therefore, for determining the commercial profits of the assessee, the amount of this reserve has to be deducted."
14. This point also came up for consideration before a Division Bench of the Bombay High Court in the case of Amalgamated Electricity Co. Ltd, v. Commr. of Income‑tax, Bombay City‑I, (1974) 97 ITR 334. In that case Tulzapurkar, J. after referring to the passage from the judgment of the Kerala High Court that we have ‑extracted above observed:‑
"In other words, it is clear that the Kerala High. Court was considerably influenced,, and in our view rightly, by three or four aspects of this contingencies reserve, namely, the source from which this reserve is created; the purpose for which this reserve could be drawn upon as mentioned in paragraph V that this reserve was not available to the assessee for any purposes of its own, that the assessee would not get any compensation of account of this reserve as and when the undertaking would be purchased and that 'the purchaser, is required to' maintain the reserve as such. We, therefore, feel that substantial reasons have been given by the Kerala High Court for coming to the conclusion that .the transfers or appropriations made by the assessee to the contingencies reserve should be deducted while computing the real profit of the assessee. In this view of the matter, the question, so far as it relates, to transfers or appropriations made by the assessee to the contingencies reserve in the instant case before us, will have to be answered in favour of the assessee."
15. A, Division. Bench of the Patna High Court in the case of Darbhanga Laheriasri Electric Supply Corporation Ltd. v. Commr. of Income‑tax Bihar (1979) 1'17 1 T R 516, agreed with the views expressed by the Kerala High Court‑ and the Bombay High Court in the two cases referred above and held that the amount kept in the contingencies reserve under the Electricity Act was not at the disposal of the assessee and was, therefore, to be excluded in determining the profits of the assessee.
16. Elaborate argument has been advanced in this case on the point whether the amount standing in the contingencies reserve was available to the assessee‑company for its own use. In 'this connection reference was made to the Sixth Schedule to the Electricity Act which we have set out earlier. The Bombay High Court in the case, of Amalgamated electricity Company Ltd, agreed with the view expressed by the Kerala High Court in the Cochin State. Power & Light Corporation Ltd and held that this reserve was not available to the assessee for any purposes of its own". But a contrary view way taken about the nature and purpose of contingencies reserve by the same Bench of Bombay High Court in the case of Commr of Wealth‑tax v. Bombay Suburban Electric Supply Ltd. (1976) 103 I T R 331. In that case, a case under the Wealth-tax Act the nature and purpose of the contingencies reserve was examined once again by the Division Bench consisting of Kantawala: C.J and Tulzapurkar, J. it was held that the amount of Rs.7,53,433 standing credited as contingencies reserve was a part of .the assets belonging to the assessee‑company and had to be included in its net wealth within the meaning of section 2 (m) of the Wealth‑‑tax Act. The nature of the contingencies reserve was examined by Kantawala, C.J. in that judgment and it was emphasized at pages 392‑393
"Paragraph V undoubtedly imposes limitations or restrictions upon the power of the assessee to utilise the amounts standing to the credit of the contingencies reserve. In the first, place, such amount cannot be utilised except with the prior approval of the State Government, but the fact that prior approval is required will not detract from making it an asset of the company if in law it belongs to the assessee. Even the purposes for which it may be utilised will indicate that it is done either for discharging the liability of the assessee‑company or for replacement or renewal of the plant or works of the assessee‑company. The amount of contingencies reserve can lie drawn either for the expenses or loss of profits arising out of accidents strikes or circumstances which the management could not have prevented; or for the expenses on replacement or renewal of plant or works other than expenses' requisite for normal maintenance or renewal or for compensation payable under any law for the time being in
force and for which no other provision is made. Incurring of expenses and pay‑rent of compensation are the normal liabilities of an assessee‑company and a sum, which can be utilised for such purposes cannot be treated as belonging to anybody other than the assessee itself. So also the fact that the amount of contingencies reserve can be utilised for meeting the expenses of replacement or renewal of plant or works indicates that it is used for replacing an asset, which ultimately formed part of the assessee's undertaking. It is undoubtedly true that under cl. (2) of paragraph ‑V of the Sixth Schedule, in the event of a compulsory purchase of the undertaking, the amount standing to 'the credit of the contingencies reserve has to be handed over to the purchaser namely, the Electricity Board; the State Government or a local authority because' they are' the only authorities who can exercise the power of compulsory purchase, but that by itself will not be a sufficient reason to come to the conclusion that it cannot be treated as a part of the asset of the assessee‑company. If power of compulsory purchase is not exercised, then under section 8 it continues to form part of the assets of the undertaking and can be dealt with like any other assets belonging to the assessee‑company. This being the nature of the amount of contingencies reserve, can it be said that this mount, which is an asset belongs to an entity other than the assessee-company? It was urged by Mr. Dastur that the provisions contained in the Sixth Schedule are meant for the benefit of the public and therefore the public should be treated as beneficiaries in respect…
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