TaxTMI 
TaxTMI 
1983 (6) TMI 29
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....e utilised for the purposes set out in paragraph V of the said Sixth Schedule. In compliance with the provisions of the said Act, the assessee-company appropriated an amount of Rs. 66,964 towards " Reserve for contingencies " and deducted that amount in the computation of its taxable income of the previous year relevant to the assessment year 1973-74. For the reasons mentioned by him in the assessment order, the Income-tax Officer disallowed deduction of this amount in the computation of the assessee's business income and added back the same. The aforesaid disallowance, among others, was disputed by the assessee in the appeal preferred before the Appellate Assistant Commissioner against the assessment for the assessment year 1973-74. For the reasons mentioned by him in his order, the Appellate Assistant Commissioner confirmed the disallowance of the deduction in respect of this Contingency Reserve of Rs. 66,964. " The assessee preferred a further appeal to the Tribunal. The Tribunal held that the amount covered by contingency reserve was a diversion by reason of overriding obligation created by the statute and, therefore, for determining the commercial profits of the assessee....
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....going licensee under any law for the time being in force, be handed over to the Board or the State Government, as the case may be." Paragraph VI deals with allowance in respect of depreciation of fixed assets employed in the business of electricity supply. It is provided that all sums credited to depreciation account shall be invested only in the business of electricity supply of the undertaking or where it is not practicable to so invest them in investment approved by the State Govt. It is further provided that any sums invested in investments approved by the State Govt. shall, as soon as practicable, be utilised in the business of electricity supply of the undertaking. Paragraph VII is important for our purpose and is as under " VII. (1) Where any fixed asset ceases to be available for use through obsolescence, inadequacy, superfluity or for any other reason, it shall be described in the books of the licensee is no longer in use and no further depreciation in respect thereof shall be allowed as a charge against revenue. (2) The written down cost of such fixed asset including expenses incurred on the dismantling thereof shall be charged against the Contingencies Reserv....
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....ropriated to the contingencies reserve in securities authorised under the Indian Trusts Act, 1882. The assessee also cannot spend any amount out of this fund except with the approval of the State Government; but it is the assessee alone who can spend this amount so long as the assessee's business of generation and supply of electricity continues. It is true that the assessee is not at liberty to use this fund in whichever way it likes but the purposes for which the amount can be spent as prescribed in para. V are all usual business purposes of the company. The amount can be spent for meeting expenses or loss of profit arising out of accidents, strikes or other unavoidable circumstances. The amount can be utilised for payment of any statutory compensation for which no other provision has been made. The amount can also be spent for replacement or renewal of plant or works other than normal maintenance or renewal. It is also important to note in this connection that the written down cost of fixed assets of the company which cannot be used any more in the business of the assessee including the dismantling charges of such fixed assets will have to be charged against the contingencies re....
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....e Court in the case of U.P. Electric Supply Co. Ltd. v. R. K. Shukla [1969] 36 FJR 310; AIR 1970 SC 237, had occasion to go into the nature and purpose of the contingencies reserve. In that case, the licence of the U.P. Electric Supply Co. Ltd. expired in 1964 and the undertaking of the company was taken over by the State Electricity Board from the midnight of September 16, 1964. The workmen of the undertaking claimed that they were entitled to retrenchment compensation, salary in lieu of notice and other benefits from the company. The Supreme Court held that the liability to pay retrenchment compensation was a debt and if it arose on the transfer of an undertaking, it would attach to the purchase money payable to the company. It was observed by the Supreme Court at p. 323 of 36 FJR and at p. 245 of AIR 1970 SC : " Clause V only provides for the appropriation of the Contingencies Reserve : It requires an undertaking to hand over the Contingencies Reserve to the purchaser. If any amount of compensation is payable to the employees of the outgoing licensee under any law for the time being in force, it is chargeable to the Contingencies Reserve. If the retrenchment compensation beco....
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....essee does not get even compensation on account of this reserve as and when the undertaking is purchased and even the purchaser has to maintain the reserve as such. Therefore, in spite of the distinction that we have pointed out in regard to certain features between this reserve and the consumers benefit reserve with which the Supreme Court was concerned in the Poona Electric Supply Co.'s case [1965] 57 ITR 521, we feel that the amount covered by the contingencies reserve is a diversion by reason of overriding obligation created by the statute and, therefore, for determining the commercial profits of the assessee, the amount of this reserve has to be deducted. " This point also came up for consideration before a Division Bench of the Bombay High Court in the case of Amalgamated Electricity Co. Ltd. v. CIT [1974] 97 ITR 334. In that case, Tulzapurkar J., after referring to the passage from the judgment of the Kerala High Court, which we have extracted above, observed (p. 345) "In other words, it is clear that the Kerala High Court was considerably influenced, and in our view rightly, by three, or four aspects of this contingencies reserve, namely, the source from which this re....
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....ding credited as contingencies reserve was a part of the assets belonging to the assessee-company and had to be included in its net wealth within the meaning of s. 2(m) of the W.T. Act. The nature of the contingencies reserve was examined by Kantawala C.J. in that judgment and it was emphasized at pages 392, 393 : "Paragraph V undoubtedly imposes limitations or restrictions upon the power of the assessee to utilise the amounts standing to the credit of the contingencies reserve. In the first place, such amount cannot be utilised except with the prior approval of the State Government, but the fact that prior approval is required will not detract from making it an asset of the company if in law it belongs to the assessee. Even the purposes for which it may be utilised will indicate that it is done either for discharging the liability of the assessee-company or for replacement or renewal of plant or works of the assessee-company. The amount of contingencies reserve can be drawn either for the expenses or loss of profits arising out of accidents, strikes or circumstances which the management could not have prevented ; or for the expenses on replacement or renewal of plant or works o....
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....he object underlying these provisions is only to see that the supply of electricity to the consumer is maintained uninterrupted. That by itself does not mean that the members of the public or consumers have a beneficial interest in the amount standing to the credit of the contingencies reserve. The amount undoubtedly as shown in the balance-sheet is a part of the assets because investments made out of the contingencies reserve are always shown on the assets side of the company. Thus, the amount standing to the credit of the contingencies reserve is undoubtedly a part of the assets belonging to the assessee-company and will be includible in the net wealth within the meaning of section 2(m) and will be chargeable to wealth-tax under section 3." A Division Bench of the Madras High Court in the case of Vellore Electric Corporation Ltd. v. CIT [1977] 109 ITR 454, a case under the I.T. Act, held that the amount appropriated to the contingencies reserve was not lost to the assessee by an overriding obligation and the reserve was still available to the assessee. It was held by Ismail J. (as he then was) at pages 458-459 of the report: " The amounts standing to the credit of neither t....
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....s themselves it will be clear that the amount credited to the contingencies reserve cannot be said to be an expenditure, cannot be said to be lost to the assessee and is still available to the assessee and it cannot also be said to be a diversion by overriding title because it does not go out and it cannot be said that it is no longer that of the assessee who diverts it. Simply because the statute has imposed certain restrictions on the manner of utilisation of the amount credited to the reserve it cannot be held that the appropriation of the amount to such a reserve constitutes an expenditure or diversion of profit by overriding title or that the amount was lost to the assessee. Therefore, in our opinion, just as the amount appropriated to the development reserve, the amount appropriated to the contingencies reserve also cannot be deducted for arriving at the assessable profits. " In the case of CIT v. Calcutta Electric, Supply Corporation Ltd. [1982] 138 ITR 111 (Cal), a case decided under the SPT Act, a Division Bench of this court agreed with the view expressed by the Madras High Court in the case of Vellore Electric Corporation Ltd. v. CIT [1977] 109 ITR 454. In that case t....
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.... all. In the case of the contingencies reserve, the statute had clearly indicated the purposes for which the amount can be spent and the aforesaid purposes clearly show that these are connected with the business of the assessee and it was the assessee who can utilise the amount. If the said amount can be said to have been taken away by diversion of overriding title then the assessee would have no control over the same even to the limited extent provided for in cl. V of Sch. VI. The fact that the assessee was required to invest the amount standing to the contingencies reserve in securities authorised by the Indian Trusts Act did not in any way affect the position of the assessee, namely, that the assessee continued to be the owner of the investments and it is the assessee who alone is entitled to utilise the said amount for the specified purposes of the business, however limited it might be, it cannot be said that the reserve invested in securities was not the assessee's investment but somebody else's ...... It was not correct to state that such reserve was created to meet any known liability. There is no diversion of the money because the money still belonged to the assessee or tha....
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....prehend how an amount which "continues to form part of the assets of the undertaking and can be dealt with like any other assets belonging to the assessee-company " can be said to have been diverted at source from the assessee-company by an overriding title. The amount which has been appropriated to the contingencies reserve is a part of the revenue collected by the assessee in its business of generation and sale of electricity. The amount was not collected by the assessee-company for and on behalf of any other person to whom it was payable. The concept of real income or diversion of income by an overriding title was explained by Hidayatullah J. in the case of CIT v. Sitaldas Tirathdas [1961] 41 ITR 367 (SC), at pages 374-375 : " In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by....
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....e Act. The excess, if any, after making some deductions, had to be distributed to the consumers in the form of rebate. During the assessment years 1953-54 and 1954-55 the company claimed deduction of two amounts of Rs. 42,148 and Rs. 77,138 for the said two years from its taxable income as they were credited to Consumers' Benefit Reserve Account. The ITO disallowed the claim, but ultimately the Tribunal allowed the claim of the assessee. The controversy that was raised in that case was formulated by the Supreme Court thus (p. 525): " Briefly stated, the scheme of the provisions is that a part of the excess collected is returned to the consumers by way of a rebate. The question is whether the amount so returned or returnable by the licensee to his consumers is deductible for ascertaining his, taxable income from his business under section 10(1) or section 10(2)(xv) of the Income-tax Act." The Supreme Court held at pages 525-526 of the report: "Under section 10(1) of the Income-tax Act, tax shall be payable by an assessee under the head 'profits and gains of business ' in respect of profits and gains of any business carried on by him. The said profits and gains are not profi....
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.... utilised by the board from and out of its profits and, therefore, the said surplus could not be an allowable deduction." In our view, therefore, the answer to the question that has been raised in the instant case will depend on the nature and purpose of the contingencies reserve fund. The fact that this fund was created under compulsion of law is not really of any consequence. If an assessee sets apart a sum of money every year for meeting its unknown liabilities in business, it cannot be said that the sum so set apart has been diverted at source by an overriding title. Similarly, if a sum is set apart under compulsion of law for meeting unknown business needs of the company diversion of income at source by an overriding title does not take place. There is no question of intervention of any other title in this case. Neither the consumers nor the public at large have any beneficial interest in this fund. What will happen to the contingencies reserve fund, if and when the undertaking of the company is Purchased by the Board, is not really germane to the issue before us. A portion of the revenue earned by the company has been set apart and kept in a reserve fund for some specific ....