2024 (11) TMI 645 - HC - Income Tax

Bank transfers to Statutory Reserve Fund under Sections 45IC and 45Q not deductible for income tax computation

Shriram City Union Finance Limited Versus Assistant Commissioner of Income Tax, Company Circle VI (2), Chennai

Madras HC held that amounts transferred to Statutory Reserve Fund under Sec.45IC read with Sec.45Q of RBI Act, 1934 are not allowable deductions while ... Diversion of income by overriding charge in respect of amount transferred to Statutory Reserve Fund in compliance with the mandatory provisions of Sec.45IC read with Sec.45Q of RBI Act - Whether Tribunal was right in noticing that the amount transferred to Reserve Fund in compliance with the provisions of Reserve Bank of India Act, 1934, by the appellant from its income, is not an allowable deduction in computing the assessable income under the provisions of Indian Income Tax Act, 1961? HELD THAT:- The above substantial questions have been answered in the case of this very assessee for other assessment years by this Court [2022 (6) TMI 1428 - MADRAS HIGH COURT] the reserve is the amount of profit which is retained for use in business, when difficulty arises and on the basis of our earlier findings and from the very language of section 45 IC, this court comes to a conclusion that the amount transferred by the assessee’s herein, to the statutory reserve as mandated under the provisions of the RBI Act, is not an allowable deduction in computing the assessable income under the provisions of the Act under the regular computation and computation of book profits under section 115JB, as the case may be and therefore, the orders of the authorities below, do not call for any interference. Accordingly, the consequential issue is also decided against the assessee’s - Decided in favour of revenue. Issues Involved:1. Whether the Tribunal was right in holding that there has been no diversion of income by overriding charge in respect of the amount transferred to the Statutory Reserve Fund in compliance with the mandatory provisions of Sec.45IC read with Sec.45Q of the RBI Act.2. Whether the Tribunal was right in holding that the amount transferred to the Reserve Fund in compliance with the provisions of the RBI Act is not an allowable deduction in computing the assessable income under the provisions of the Indian Income Tax Act, 1961.Detailed Analysis:Issue 1: Diversion of Income by Overriding ChargeThe core question revolves around whether the transfer of income to a Statutory Reserve Fund, as mandated by Section 45IC of the RBI Act, constitutes a diversion of income by overriding charge. The assessee, a Non-Banking Financial Company (NBFC), argued that the 20% of net profits transferred to the reserve fund does not form part of the company's real income, as the company loses control over this income from the outset. This argument was based on the premise that the transfer is not a voluntary application of income but a statutory obligation, which should be considered a diversion of income at source.However, the Revenue contended that the transfer to the statutory reserve fund is merely an appropriation of profits and remains under the control of the assessee. The funds are not diverted at source by an overriding title, and thus, the income is not diverted before it reaches the assessee. The Tribunal and the appellate authorities supported this view, concluding that the transfer is an application of income rather than a diversion, and thus, it is taxable.The court agreed with the Revenue's stance, noting that the income transferred to the reserve fund is part of the profits earned by the assessee and does not constitute a diversion by overriding charge. The court cited precedents, including the decision in Seshasayee Paper Boards Ltd, to support the view that statutory requirements do not equate to a diversion of income at source.Issue 2: Allowability of Deduction for Amount Transferred to Reserve FundThe second issue concerns whether the amount transferred to the reserve fund can be deducted from the assessable income under the Income Tax Act. The assessee argued that the transfer is a necessary business expenditure under Section 37 of the Act, as it is essential for complying with the RBI Act provisions and maintaining the business's viability.The Revenue, however, maintained that the transfer to the reserve fund is not an expenditure but an appropriation of profits. The funds remain under the control of the assessee and are not a charge against the profits. The Tribunal upheld this view, noting that the reserve fund does not meet the criteria for deduction under the Income Tax Act.The court upheld the Tribunal's decision, emphasizing that the reserve fund is an appropriation of profits and not an expenditure incurred by the assessee. The court referenced the decision in Associated Power Co. Ltd, which established that funds kept under statutory reserve requirements are not deductible and must be taxed. The court concluded that the amount transferred to the statutory reserve does not qualify for deduction under the Income Tax Act, as it is not a diversion of income at source nor an expenditure.Conclusion:The court concluded that both issues were to be decided against the assessee. The transfer of income to the statutory reserve fund does not constitute a diversion of income by overriding charge, and the amount transferred is not an allowable deduction under the Income Tax Act. Consequently, the appeal was dismissed, and the substantial questions of law were answered in favor of the Revenue.