Statutory contingencies reserve deductible for taxable income where strict statutory limits and use restrictions remove free disposal

A statutory contingencies reserve required under the electricity law was held deductible in computing taxable income because it was not a voluntary appropriation of distributable profits. The reserve had to be created within a fixed statutory limit, invested only in approved securities, used only for specified contingencies with Government approval, and transferred to the purchaser on sale of the undertaking. Those restrictions showed the was not at the free disposal of the assessee and did not form part of taxable profits. The reference was therefore answered in favour of the assessee.

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Issues: Whether the contingencies reserve required under the Sixth Schedule to the Electricity (Supply) Act, 1948 is deductible in computing the taxable income of an electricity undertaking under section 37(1) of the Income-tax Act, 1961.

Analysis: The reserve was not a voluntary appropriation out of distributable profits. It was a statutory reserve to be created from the existing reserves or from the revenues of the undertaking, subject to a fixed percentage limit, compulsory investment in approved securities, restricted drawing only on specified contingencies and with State Government approval, and transfer to the purchaser on sale of the undertaking. These features showed that the amount was not at the free disposal of the assessee and that its character differed from a normal reserve created out of profits.

Conclusion: The contingencies reserve was deductible in computing the taxable income of the assessee and the answer was in favour of the assessee.

Final Conclusion: A statutory contingencies reserve imposed under the electricity law was treated as not forming part of the assessee's taxable profits, so the reference was answered against the Revenue.

Ratio Decidendi: Where a reserve is compulsorily created by statute out of revenue and is subject to strict statutory restrictions on investment, utilisation and transfer, it is not an amount at the free disposal of the assessee and is deductible in computing taxable income.

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