1997 (7) TMI 13 - SC - Income Tax

Interest on statutory contingency reserve investments counts as business profits under section 80-I; decision favors taxpayer over Revenue

SC held that sums appropriated to a statutory contingencies reserve and invested in permitted securities pursuant to licence conditions under the ... Deduction u/s 80-I - Priority Industry - Deductibility of sums transferred to the contingencies reserve, development reserve, and tariffs and dividend control reserve - HELD THAT:- In the present case, the assessee is carrying on the business of generating electricity as a licensee under the Electricity (Supply) Act. Under section 57 of the Electricity (Supply) Act, the provisions of the Sixth Schedule shall be deemed to be incorporated in the licence of every licensee. Under paragraph III of the Sixth Schedule, the licensee is obliged to create from the existing reserves or from the revenues of the undertaking a reserve called 'contingencies reserve' and under sub-para (2) of paragraph IV the licensee is obliged to invest the sums appropriated to the contingencies reserve in securities authorised under the Indian Trusts Act, 1882. The requirement to create the contingencies reserve is a part of the obligation of the assessee as a licensee to carry on its business of generating electricity and it is also part of the obligation of the assessee as a licensee that the sums appropriated to the contingencies reserve are invested in securities authorised under the Indian Trusts Act, 1882. The creation of the contingencies reserve and the investment of the sums appropriated to the said reserve in securities authorised under the Indian Trusts Act, 1882, being a condition statutorily incorporated in the licence granted to the assessee under the Electricity (Supply) Act, is incidental to the carrying on of the business of generation and distribution of electricity by the assessee. There is thus a direct and proximate connection between the carrying on of the business of generation and distribution of electricity by the assessee as a licensee under the Electricity (Supply) Act and the income derived by way of interest from the investments in securities of the sums appropriated to the contingencies reserve as required under the provisions of the Sixth Schedule to the Electricity (Supply) Act, which is one of the conditions of the licence on the basis of which the assessee can carry on its business of generating and distributing electricity. We are, therefore, of the view that the income earned by way of interest on the sums appropriated to the contingencies reserve which have been invested in securities can be said to be profits and gains attributable to the business of the assessee for the purpose of section 80-I of the Act. Question No. 3 in Civil Appeals Nos. 2613-14 of 1984 is, therefore, answered in the affirmative, i.e., in favour of the assessee and against the Revenue. Issues Involved:1. Deductibility of sums transferred to the contingencies reserve, development reserve, and tariffs and dividend control reserve.2. Eligibility for deduction under section 80-I on interest received from investments in securities from the contingencies reserve.Issue-Wise Detailed Analysis:1. Deductibility of Sums Transferred to ReservesContingencies Reserve:The court examined the deductibility of sums appropriated to the contingencies reserve. Historically, there was a conflict among various High Courts regarding this issue. The High Courts of Madras and Calcutta held that such deductions could not be claimed, while the High Courts of Kerala, Bombay, and Patna held the contrary view. This conflict was resolved by the Supreme Court in Associated Power Co. Ltd. v. CIT [1996] 218 ITR 195, which approved the decisions of the Madras and Calcutta High Courts, holding that the contingencies reserve belongs to the electricity company and must be included in its taxable income. Consequently, the High Court's decision to disallow the deduction for contingencies reserve was upheld.Development Reserve:The court analyzed the provisions under Paragraph VA of the Sixth Schedule to the Electricity (Supply) Act, which mandates the creation of a development reserve. The Kerala High Court in Cochin State Power and Light Corporation Ltd. [1974] 93 ITR 582 differentiated between development reserve and contingencies reserve, holding that development reserve appropriations could not be deducted. The Madras High Court in Vellore Electric Corporation Ltd. [1977] 109 ITR 454 agreed with this view. The Supreme Court concurred, stating that both reserves belong to the electricity company and are available for its use, thus, the amounts appropriated to the development reserve could not be deducted.Tariffs and Dividend Control Reserve:The provisions for this reserve are similar to those for the development reserve. The court held that the reasons for disallowing deductions for the development reserve equally apply to the tariffs and dividend control reserve. Therefore, the amounts appropriated to the tariffs and dividend control reserve could not be deducted.2. Eligibility for Deduction under Section 80-I on Interest from InvestmentsInterest on Investments from Contingencies Reserve:The court considered whether the interest earned from investments in securities from the contingencies reserve qualifies for deduction under section 80-I of the Income-tax Act. The relevant provision at the time allowed deductions for profits and gains attributable to priority industries. The Supreme Court in Cambay Electric Supply Industrial Co. Ltd. v. CIT [1978] 113 ITR 84 interpreted the term 'attributable to' as having a wider import than 'derived from,' covering receipts from sources other than the actual conduct of the business.The court noted that the creation of the contingencies reserve and its investment in securities are statutory obligations under the Electricity (Supply) Act, directly connected to the business of generating electricity. Thus, the interest earned from such investments has a direct and proximate connection to the business of the assessee. Consequently, the court held that the interest income qualifies for deduction under section 80-I, reversing the High Court's decision on this point.Conclusion:- The sums appropriated to the contingencies reserve, development reserve, and tariffs and dividend control reserve are not deductible.- The interest earned on investments from the contingencies reserve is eligible for deduction under section 80-I.Final Judgment:- Civil Appeals Nos. 3333-3334 of 1981 are dismissed.- Civil Appeals Nos. 2613-14 of 1984 are partly allowed, with question No. 3 answered in favor of the assessee and against the Revenue. The High Court's judgment is reversed to this extent. No order as to costs.