1972 (12) TMI 23 - HC - Income Tax

Transfers to reserve accounts for business contingencies and development treated as deductible items when computing taxable income under section 37

Whether transfers to contingency, development and special reserve accounts are deductible for computing taxable income is examined; the text reasons that ... ' Whether Tribunal was right in holding that the sum of Rs. 10,225 transferred to the contingencies reserve account, the sum of Rs. 30,475 transferred to the development reserve account and the sum of Rs. 23,417 transferred to the special reserve account are not to be deducted in arriving at the taxable income of the assessee-company ?' - this amount is really laid out for the purpose of the business because it is to meet certain contingencies which a public utility concern has normally to anticipate to happen in the business and provide for. But I do not rest my final conclusion on this point applying section 37. I agree with the reasoning of my learned brother that this amount of contingency reserve must be deducted in arriving at the total income for assessment Issues: (i) Whether the amount of Rs. 10,225 transferred to the contingencies reserve account is deductible in computing the taxable income of the assessee-company; (ii) Whether the amount of Rs. 30,475 transferred to the development reserve account is deductible in computing the taxable income of the assessee-company; (iii) Whether the amount of Rs. 23,417 transferred to the special reserve account is deductible in computing the taxable income of the assessee-company.Issue (i): Whether the sum of Rs. 10,225 transferred to the contingencies reserve account is deductible in arriving at taxable income.Analysis: The Sixth Schedule to the Electricity (Supply) Act, 1948 requires appropriation to the contingencies reserve from revenues (not profits) at specified rates related to original cost of fixed assets, mandates investment in authorised securities, restricts utilisation to specified contingencies approved by the State Government, and requires handing over the reserve on purchase of the undertaking. The reserve is not at the free disposal of the licensee for general application; it is an appropriation by statutory compulsion and is intended to secure efficient operation of the public supply undertaking. These features amount to an overriding statutory diversion from revenue which affects computation of the commercial (real) profit for income-tax purposes.Conclusion: The amount of Rs. 10,225 appropriated to the contingencies reserve is deductible in computing the taxable income of the assessee-company (in favour of the assessee).Issue (ii): Whether the sum of Rs. 30,475 transferred to the development reserve account is deductible in arriving at taxable income.Analysis: Paragraph V-A of the Sixth Schedule implements a development-reserve obligation closely related to the development rebate provisions of the Income-tax Act, 1922. The development reserve is available for investment in the business and the licensee derives direct benefit from amounts so reserved; the statutory scheme complements the income-tax rebate regime rather than creating an overriding diversion that removes the amount from the assessee's commercial profit. The reserve operates as a permissible retention for development and does not resemble a consumers' benefit-style diversion that is payable back to third parties.Conclusion: The amount of Rs. 30,475 appropriated to the development reserve is not deductible in computing the taxable income of the assessee-company (in favour of the revenue).Issue (iii): Whether the sum of Rs. 23,417 transferred to the special reserve account is deductible in arriving at taxable income.Analysis: No statutory provision was shown to require creation of the special reserve; the board's direction did not establish that the reserved amount was subject to the statutory limitations or purpose-specific restrictions like the contingencies reserve. The assessee failed to prove that the special reserve was not at the disposal of the assessee for appropriation generally or that it constituted an overriding statutory diversion from revenue.Conclusion: The amount of Rs. 23,417 appropriated to the special reserve is not deductible in computing the taxable income of the assessee-company (in favour of the revenue).Final Conclusion: The reference is answered partly for the assessee and partly for the revenue: the contingencies reserve appropriation is deductible from taxable income, while the development reserve and the special reserve appropriations are not deductible.Ratio Decidendi: A statutory appropriation that effects an overriding diversion from revenue (not at the disposal of the licensee and limited to purpose-specific application under the statute) must be deducted in computing the commercial (real) profit for income-tax purposes; reserves that remain available for investment by the licensee and form part of the licensee's commercial resources are not deductible.