Statutory reserve deductions depend on overriding diversion of income, not mere earmarking for business reserves.

A statutory reserve is deductible only where the governing law creates an overriding diversion of revenue so that the amount never forms part of the assessee's real profits. On that principle, the contingencies reserve under the Electricity (Supply) Act was treated as deductible because it was restricted by statute, had to be invested in authorised securities, and was not freely available to the assessee. By contrast, transfers to the development reserve and special reserve were not deductible because the amounts remained available for business use and no overriding legal diversion of income was shown.

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Issues: (i) Whether the amount transferred to the contingencies reserve account was deductible in computing the assessee's taxable income; (ii) Whether the amount transferred to the development reserve account was deductible in computing the assessee's taxable income; (iii) Whether the amount transferred to the special reserve account was deductible in computing the assessee's taxable income.

Issue (i): Whether the amount transferred to the contingencies reserve account was deductible in computing the assessee's taxable income.

Analysis: The contingencies reserve was created under the Sixth Schedule to the Electricity (Supply) Act, 1948, out of revenue and not as a mere allocation of profits. Its use was restricted to specified contingencies approved by the State Government, the amount had to be invested in authorised securities, and on sale of the undertaking it did not remain at the free disposal of the licensee. The reserve was therefore treated as a statutory diversion from revenue by an overriding obligation, aimed at ensuring the efficient and uninterrupted running of the undertaking.

Conclusion: The amount transferred to the contingencies reserve account was deductible, and the finding of the Tribunal on this issue was against the assessee.

Issue (ii): Whether the amount transferred to the development reserve account was deductible in computing the assessee's taxable income.

Analysis: The development reserve was linked to the development rebate mechanism and was required to be maintained for investment in the electricity business of the undertaking. The amount set apart remained available to the assessee for application in its business and was not diverted away from the assessee by an overriding title in the same manner as a consumer-benefit reserve. It was therefore not regarded as a real diversion of income or as deductible expenditure for computing commercial profits.

Conclusion: The amount transferred to the development reserve account was not deductible, and the Tribunal was right on this issue.

Issue (iii): Whether the amount transferred to the special reserve account was deductible in computing the assessee's taxable income.

Analysis: No statutory obligation or binding restriction was shown to establish that the special reserve was taken away from the assessee's disposal in a manner that would affect the computation of real income. The reserve was not proved to be anything more than an ordinary reserve created under instructions, without a demonstrated legal diversion of income.

Conclusion: The amount transferred to the special reserve account was not deductible, and the Tribunal was right on this issue.

Final Conclusion: The reference succeeded only in relation to the contingencies reserve, while the claims relating to the development reserve and special reserve failed.

Ratio Decidendi: A statutory reserve is deductible only where the governing law creates an overriding diversion of revenue so that the amount never forms part of the assessee's real profits; where the amount remains available to the assessee for its own business use, it is not deductible merely because it is required to be earmarked as a reserve.

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