TaxTMI 
TaxTMI 
2004 (4) TMI 21
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....es, therefore, it does not form part of the assessee's real income and for that reason, it was sought to be excluded from the computation of taxable income of the assessee. The deduction was also claimed under section 37 of the Income-tax Act. Reliance for the purpose was made on a decision of the Madhya Pradesh High Court in Keshkal Co-operative Marketing Society Ltd. v. CIT [1987] 165 ITR 437, special leave petition against which was dismissed by the Supreme Court. The Assessing Officer in his order dated January 31,1991 disallowed the aforesaid claim to deduction. The Assessing Officer after referring to the provisions of the Act of 1965 and the rules of 1966 and bye-laws which also provide for creation of certain other funds out of net profits, was of the opinion, that the bye-laws of the rules of the co-operative society only guide the functioning of the society and recommend transfer of profits to a certain extent to the reserve fund for various purposes, so that the co-operative societies remain financially sound, but the transfer of profits to reserve fund is a below the line adjustment and is not at all an expenditure for the assessee, which can be allowed as deduction ....
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....society for the relevant period. Mr. N. M. Ranka, learned senior counsel appearing for the assessee, urged that the reserve fund required to be created under section 62 read with rule 68 is not under the volition of the assessee but under the compulsion of the statute which cannot be used by the assessee at his option. Its control is absolutely outside the society and rests with the Registrar of Co-operative Societies. It was also urged that the amount of reserve fund is ultimately to be used for some object of public utility as it appears from rule 56 of the Rules. The residue has to be applied for any public purpose either as per resolution by the society or as per the direction of the State Government, on the society's failure to resolve about the public utility to which the residue reserve fund is to be applied. These requirements clearly indicate that the amount which has to be transferred to the reserve fund before utilisation of net profits for the purposes of the society, really does not become the income of the society in the sense in which income is ordinarily understood. Since the amount is carried under the compulsion of the statute to a reserve fund ultimately to be....
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....tate partnership in share capital and State participation in the management of the co-operative society. The various provisions of the Co-operative Societies Act show that while giving room for a fair amount of autonomy, the State Government has also kept its regulatory and guiding hand to ensure a balanced and strong growth of the co-operative movement as the principal organ of rural economy through co-operative societies to be set up under the Act. Chapter II requires and deals with registration of co-operative societies. While providing for management of co-operative societies, it is envisaged under section 29 of the Act that the final authority in a co-operative society shall vest in its general body of members. Under Chapter IV it is envisaged that where a State has contributed a substantial amount towards share capital directly or indirectly, the State Government can nominate a Government servant as member of the society to a limited extent under section 35; and can also appoint its Chief Executive Officer or Executive Officer, as the case may be under section 55A and section 35B, respectively. Chapter VI delineates the policy of State to see all steps to encourage t....
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....h special fund as may be specified in the bye-laws; (d) donations of amounts not exceeding ten percentum of the net profits for any charitable purpose as defined in section 2 of the Charitable Endowments Act, 1890 (Central Act 6 of 1890); and (e) payment of bonus to employees of the society, to the extent and in the manner specified in the bye-laws. 63. Investment of funds.-(1) Except as otherwise provided in subsection (2), a co-operative society shall invest its funds in one or more of the following:- (a) Central Co-operative Bank; (b) apex bank; (c) in the shares or securities or debentures issued by any other co-operative society with limited liability; (d) in any other mode permitted by the rules or by general or special order of the Government. (2) A co-operative society may deposit its funds for a temporary period in such manner as may be prescribed." Another relevant provision that need be noticed in this regard is section 82 which deals with disposal of surplus assets which is amalgam of all assets of the society including the reserve fund in the case of winding up or dissolution of society which reads as under: "82. Disposal of surplus assets....
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....ts own liability towards persons other than share capital, then to repay its members, the share capital contributed by the members with dividends to the extent permissible and the remaining surplus, if any, either to be utilised for any object of public utility or for the purposes of charitable as defined under the Charitable Endowment Act, 1890 or the corpus to be retained for a new society to come into existence in future with the like object as the cancelled society. Significantly, the application of surplus assets to an object of public purpose to be assigned by the Registrar for public utility or charitable purpose or it is to become the corpus fund of a new society of like nature remains the decision of the society through its members in general body either providing for such contingencies in the bye-laws or by resolving in general body about how to use the surplus. From these provisions, it cannot be spelled, except the generality of application of the surplus of all its assets, that creation of the reserve fund is for the purpose of feeding any object of public utility or charity. In this connection, it is significant that section 62 not only provides for creation of the....
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....iety has also to carry 25 per cent. of its net profits to the reserve fund. However, looking to the financial position of any society and its needs, the Registrar may fix a lower rate of contribution made to the reserve fund but not below 1/10th of the net profits. Sub-rule (2) provides for setting apart such part of its net profits by any agricultural credit society other than a land development bank. This is in addition to the reserve fund envisaged under sub-rule (1). This fund is to be utilised to enable the borrower to make postponement of repayment of loan on account of famine, drought or such unforeseen causes. Sub-rules (3), (4) and (5) of rule 68 provide for distribution of dividends and bonus out of remainder to its members to the extent of business run by these members with the society, details of which we are not concerned here. We have noticed above that section 63 of the Parent Act provides for avenues in which the co-operative society is to invest its fund including the reserve funds. It ensures that the funds are to be invested in such avenues where there is no risk to its repayability and for a fairly longevity of time to yield good return to the society. The in....
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....eriods for which the dividends have not been paid. It is only after all these sums are paid and all the liabilities of society to its creditors and shareholders are discharged, if there remains any surplus funds or for that matter, surplus assets, the same are to be applied to such object of public utility as is resolved in the event of dissolution or cancellation of society. In distribution of the assets of which the reserve fund is also a part, no distinction is made in the application of surplus. Surplus, if any left, is of the entire assets of the society without being any mark of any particular asset or fund, has to be applied for some object of public utility or for charitable purposes, as defined under the Charitable Endowments Act as may have been approved by its members, whether through the bye-laws or by a resolution of the general body of members. The provision clearly brings out the following features about the nature of the reserve fund: (i) The net profits of the society are first to be determined on the basis of declaration by the Registrar after making adjustment in accounts as per the requirements of the bye-laws and after the net profit is so worked, out of ....
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....table purposes as defined under the Charitable Endowments Act, 1890 or to be kept as a live corpus with a view to become the corpus of a future society with like objects. But, it does not ever become part of the State funds as such to be utilised by the State for its own purposes. The contention raised before us is to be decided on the anvil of the aforesaid nature and characteristics of the reserve fund created under the Act. The first issue which arises for consideration is whether in the circumstances stated above, carrying forward a part of net profit of the society amounts to diversion of income by overriding title. The diversion of income has multi-facets. Diversion arises where income is applied in a particular manner under statutory or contractual obligation or under the provisions of a document under which the company is constituted, viz., memorandum or articles of association or a firm has come into existence. In these circumstances, the principle that has emerged is that if a person has alienated or assigned the source of his income so that it no longer remains his income, he cannot be taxed upon the income arising after the assignment of the source. In such eve....
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....e else than himself and the income at no stage became part of the assessee's capital block which could be used by him in future for his own purpose. In fact, it was made a charge on the assessee's income which if the assessee failed to pay, could be directly recovered before it reached the assessee. This case is more akin to the Poona Electric Supply case [1965] 57 ITR 521 (SC) to which we shall shortly advert to. In Provat Kumar Mitter v. CIT [1961] 41 ITR 624 (SC), the assessee who was a registered holder of 500 ordinary shares in a limited company, assigned to his wife, by a deed of settlement, the right, title and interest to all dividends and sums of money which might be declared or which may be due and payable in respect of those shares for the term of her natural life and covenanted to deliver and endorse over to her any dividend warrant or other document of title to such dividends or sums of money and to instruct the company to pay such dividends and sums of money to her. The assessee claimed exclusion of dividends on the aforesaid 500 ordinary shares on the ground of transfer by diversion of income by overriding title. The Supreme Court repelled the contention by hol....
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....as that the profits were first to be accrued to the assessee and then to be applied for determination of the share payable to the beneficiaries and under the law of partnership, it was the partner and the partner alone who was entitled to the profits. A stranger, even if he were an assignee, did not have and could not have any direct claim to the profits. The dispositions were, in law and in fact portions of the assessee's income after it had accrued to him and tax was payable by him at the point of accrual. On these principles, the decision in Raja Bejoy Singh Budhuria's case [1933] 1 ITR 135 (PC) was distinguished by the court. In P. C. Mullick v. CIT [1938] 6 ITR 206 (PC) for the aforesaid reasons, the Privy Council too distinguished its earlier decision in Raja Bejoy Singh Budhuria's case [1933] 1 ITR 135 (PC). It was a case in which a testator had by his will appointed the appellants as his executors and had directed them to pay Rs. 10,000 out of the income of his property on the occasion of his "addya sradh" for expenses in connection therewith to the person who was entitled to perform the sradh. He had also directed them to pay out of the income of his property, the co....
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....agents did not form part of the respondent's income. Applying the principles in Raja Bejoy Singh Budhuria's case [1933] 1 ITR 135 (PC) and Sitaldas Tirathdas's case [1961] 41 ITR 367 (SC), the court opined that an obligation to apply the income in a particular way before it is received by the assessee or before it has accrued or arisen to the assessee results in the diversion of income. An obligation to apply income which has accrued or arisen or has been received amounts merely to the apportionment of income and the income so applied is not deductible. The true test for the application of rule of diversion of income by an overriding title is whether the amount sought to be deducted in truth never reached the assessee as his income." In a recent decision, the Supreme Court in Moti Lal Chhadami Lal Jain v. CIT [1991] 190 ITR 1 explained the connotation of the expressions "reaches the assessee" and "has been received" as has been used by the court earlier in Sitaldas Tirathdas's case [1961] 41 ITR 367 (SC). The court said: "The expressions 'reaches the assessee' and 'has been received' have been used ... not in the sense of the income being received in cash by one person or ano....
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.... transferring any amount to the reserve fund arises only in case the assessee-society received its net profit, after paying off all its expenses. Therefore, the question of transfer of any amount to the reserve fund arises only after the society earns a net profit after paying all its expenses and then it becomes a question of apportionment of its profit for different purposes including carrying to the reserve fund, distribution of dividends and bonus and other funds that may be required to be provided for and also for donations towards charitable purpose as defined under the Charitable Endowments Act, 1890, and the Rules named thereunder. Therefore, on a circumspect view of the scheme of the Co-operative Societies Act, notwithstanding there being an obligation to carry 25 per cent. or such lesser percentage of the net profit as may be permitted by the Registrar, profit is not diverted to any person other than the assessee and remains a part of the assessee's corpus to be utilised for its own purposes, the assessee cannot claim its exclusion from the income by claiming it to be diversion of income by overriding title, which vests in a third party. Even applying the test that the....
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.... Society Ltd.'s case [1987] 165 ITR 437 is founded, which is the sheet anchor of the contention on behalf of the assessee and to which case we shall advert later on. In Poona Electric Supply Co. Ltd. [1965] 57 ITR 521 (SC), the assessee was required by section 57(1) of the Electricity (Supply) Act, 1948 under which the provisions of Schedules VI and VII of the Act were deemed to be incorporated in the licence. Schedule VI imposed a duty on the licensee to so adjust his rates for the sale of electricity by periodical revision that his clear profits in any year did not, as far as possible, exceed the amount of "reasonable return". If the clear profit in any year of account was in excess of the amount of reasonable return, one-third of such excess, not exceeding seven-half per cent of the amount of reasonable return, was at the disposal of the licensee; one half of the excess had to be either distributed in the form of proportional rebate on the amounts collected from the sale of electricity and meter rentals or carried forward in the accounts of the licensee for distribution to the consumers in future in such manner as the State Government might direct. During the accounting years....
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.... had received over and above the amount of reasonable amount. It could only earn reasonable profits. The profits in excess of this are to be computed for the purpose of finding out the amount of rebate to be given to the consumers. In contrast, the matter of constituting a reserve fund to meet contingent liability that may arise in future under the very Electricity (Supply) Act, 1948 invited attention of the apex court in Associated Power Co. Ltd. v. CIT [1996] 218 ITR 195. It was a case in which clause II of the Sixth Schedule to the Electricity (Supply) Act, 1948 required the electricity company to create certain reserves if its clear profit exceeds a reasonable return. The court said as under: "Moneys standing to the credit of the contingencies reserve which are set apart to be utilised by the electricity company for the purposes set out in clause V of the Sixth Schedule are to meet expenses or recoup loss of profits arising out of accidents, strikes or other circumstances which the electricity company could not have prevented; to meet expenses on replacement or renewal of plant or works; and for payment of compensation required by law for which no other provision has been....
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....ount which it was obliged to return. The amount that it was obliged to return was not a part of its income. The apex court repelled the suggestion that there was diversion of income by overriding title in the case. It has categorically stated that: "The application of the doctrine of diversion of income by reason of an overriding title is quite inapposite. The doctrine applies when, by reason of an overriding title or obligation, income is diverted and never reaches the person in whose hands it is sought to be assessed. In the present case, the statute requires the electricity company to create certain reserves if its clear profit exceeds a reasonable return (clause II Sixth Schedule). Again, the contingencies reserve is to be created from existing reserves or from 'the revenues of the undertaking'. This clearly indicates that the monies which have to be put into the contingencies reserve reach the electricity company and are not diverted away from it. It is the electricity company which has to invest the sums appropriated to the contingencies reserve. The investment would be in its name and it would be the owner thereof. The restriction that the investment can be made onl....
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....s disposal in terms of the provisions arise of the Act of 1965 and not earlier thereto. The net profit is to be apportioned by transferring part of it as may be prescribed by the rules to the reserve fund. Part of the profits has to be carried to the co-operative deduction fund constituted under the rules and the balance is available for utilisation for payment of dividends to the members, bonus to the members and contribution to such other special funds as may be specified in the rules. Donations not exceeding 10 per cent, of the net profits of any charitable purposes and payment of bonus to the employees of the society to the extent required by the bye-laws. The reserve funds object has been set out in rule 55 by declaring that it shall belong to the society and is intended to meet unforeseen losses. That is to say for the society's own purpose in future and ordinarily is not to meet any existing liabilities or obligations. The unforeseen losses and other purposes to which such fund can be used have also been spelt out as noticed by us that apart from meeting unforeseen losses in the society, it can also be used to meet such other purposes, viz., to pay off its debts and to us....
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..... [1987] 165 ITR 437 is founded on the principle enunciated in Poona Electric Supply Co. Ltd.'s case [1965] 57 ITR 521 (SC). With utmost respect, we regret our inability to fall in line with the decision in Keshkal Co-operative Marketing Society Ltd.'s case [1987] 165 ITR 437 (MP) in this regard. Apparently, the distinction which existed between the reserve fund for the benefit of the consumers required to be created under the Electricity (Supplies) Act, 1948 with an object to return to the consumers the excess profit charged by the supply company and the fund created to meet the future requirement of the supply company or the cooperative society had not been noticed. We may also notice that perhaps the attention of the court was not drawn to the detailed scheme of the Madhya Pradesh Co-operative Societies Act, as we do not find any mention thereof in the decision. In the backdrop of the later Supreme Court decision to which we have adverted about the case of consumer benefit fund, which arose for consideration in Poona Electric Supply Co. Ltd.'s case [1965] 57 ITR 521 (SC) was for the benefit of the consumers exclusively, could not have been equated with the reserve fund cre....
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....ka High Court proceed on the principle laid in Poona Electric Supply's Co. case [1965] 57 ITR 521 (SC) without noticing the aforesaid distinction as noticed by the apex court in Associated Power Co. Ltd.'s case [1996] 218 ITR 195 and Vellore Electric Corporation Ltd.'s case [1997] 227 ITR 557 (SC). For the reason stated above while considering the decision of the Madhya Pradesh High Court in Keshkal Cooperative Marketing Societies' case [1987] 165 ITR 437, we express our inability to agree with the aforesaid decisions also. Lastly, reliance was placed on a Bench decision of this court in CIT v. Kotputli Rural Electric Co-operative Society Ltd. [2002] 255 ITR 563. Firstly, it was not a case relating to reserve fund to be created under the cooperative society. Hence the question of examining the reserve fund in the light of the provisions of the Co-operative Societies Act was not before the court. Secondly, it was a case of creating a contingency reserve fund at 0.5 per cent. under clause (iv) of the Sixth Schedule to the Electricity (Supplies) Act. Relying on the decision in Keshkal Co-operative Marketing Society Ltd.'s case [1987] 165 ITR 437 (MP) and the decision of the Madras ....