TMI Blog1972 (12) TMI 23X X X X Extracts X X X X X X X X Extracts X X X X ..... is : " Whether, on the facts and in the circumstances of the case, the Income-tax Appellate 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 ?" The assessee is a public limited company carrying on business of distribution of electricity. It is governed by the provisions of the Electricity (Supply) Act, 1948 (hereinafter referred to as the Act). For the year ending March 31, 1965, relevant for the assessment year 1965-66, the assessee claimed that the sums appropriated by it towards of " contingencies reserve ", "development reserve " and " special reserve " should be allowed as deduction in the computation of its business income. This was for the reasons that these reserves were created under statutory obligations and the amounts appropriated to these reserves did not form part of the income of the assessee. The amounts so appropriated during the year of account were as follows : Rs. Contingencies r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om time to time give to him for the purpose of achieving the maximum of economy and efficiency in the operation of his undertaking or any part thereof. The provisions of the Sixth and Seventh Schedules are to be deemed as incorporated in the licence of every licensee. The Sixth Schedule deals with the financial principles and their application. We are concerned in this case with the contingencies reserve and development reserve and these are referred to in Paragraphs III, IV, V and VA of the Sixth Schedule and, therefore, we have to refer to these articles. Paragraph III enjoins the creation of a " contingencies reserve " from existing reserves or from the revenues of the undertaking. Paragraph IV(1), which is particularly relevant for our purpose, may be read here : " IV. (1) The licensee shall appropriate to contingencies reserve from the revenues of each year of account a sum not less than one-quarter of one per centum and not more than one-half of one per centum of the original cost of fixed assets ; provided that if the said reserve exceeds, or would by such appropriation, be caused to exceed, five per centum of the original cost of fixed assets, no appropriation shall be ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lculated as aforesaid falls short of the reasonable return, the sum to be appropriated to the development reserve in respect of such accounting year shall be reduced by the amount of the shortfall. (2) Any sum to be appropriated towards the development reserve in respect of any accounting year under sub-paragraph (1) may be appropriated in annual instalments spread over a period not exceeding five years from the commencement of that accounting year. (3) The development reserve shall be available only for investment in the business of electricity supply of the undertaking. (4) On the purchase of the undertaking, the development reserve shall be handed over to the purchaser and maintained as such development reserve : Provided that where the undertaking is purchased by the Board or the State Government, the amount of the reserve may be deducted from the price payable to the licensee. " The provision with regard to the contingencies reserve is not identical with the provision with regard to the development reserve and, therefore, these require to be considered independently. Now we will first consider the nature of the contingencies reserve. Paragraph III of the Sixth Sched ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing is purchased by the Board or by the State Government the amount reserved may be deducted from the price payable to the licensee. It will be appropriate in this context to refer to the circumstances relating to this inclusion of the provision for creating a development reserve as Paragraph V-A in the Sixth Schedule to the Electricity (Supply) Act, 1948. By the Finance Act, 1955, provision for allowance by way of development rebate was incorporated in the Indian Income-tax Act, 1922. Section 10(2)(vi)(b) of the Indian Income-tax Act, 1922, provided for an allowance by way of development rebate in respect of the year of acquisition of a new ship or installation of a new machinery or plant. The development rebate was allowable only if an amount equal to 75 per cent. of it was debited to the profit and loss amount of the relevant previous year and credited to a reserve account to be utilised by the during the period of 10 years next following for the purposes of the undertaking except for distribution by way of dividends of profits or by way of remittances outside India as profits or the creation of any asset outside India. This obligation which every assessee who sought develop ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from the revenue and not from the income, that, therefore, these deductions are deductions not from the income, but before the income was received and for that reason the assessee is entitled to claim exemption. Alternatively, even if it be otherwise, in view of the specific purposes to which alone these could be applied, these have to be excluded from the assessable income by reason of section 37 of the Income-tax Act, 1961. Elaborating the last of these contentions, counsel urges that inasmuch as the income is not available for the use of the assessee except in a limited manner, namely, to the extent permitted by the statutes, this has necessarily to be deducted from the assessee's income. In Poona Electric Supply Co.'s case claim for deduction of the amount credited to the consumers' benefit reserve was held to be admissible and it is contended before us that the same rule must apply in regard to the development reserve and contingencies reserve. Regarding the third reserve, namely, the " special reserve " it is not shown that it is under any statutory provision, but what is said is that the electricity board directed the assessee to keep such a reserve and since it is done in a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o categories. The position was summed up in that case in the following words : " Income-tax is a tax on the real income, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act. The real profit can be ascertained only by making the permissible deductions. There is a clear-cut distinction between deductions made for ascertaining the profits and distributions made out of profits. In a given case whether the outgoings fall in one or the other of the heads is a question of fact to be found on the relevant circumstances, having regard to business principles. Another distinction that shall be borne in mind is that between the real and the statutory profits, i.e., between the commercial profits and statutory profits. The latter are statutorily fixed for a specified purpose. If we bear in mind these two principles there will be no difficulty in ansewering the question raised. The appellant-company is a commercial undertaking. It does business of the supply of electricity subject to the provisions of the Act. As a business concern its real profit has to be ascertained on the principles of commercial accountancy. As a licensee governed by st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... may arise and the assessee may have to succeed. Paragraph II of the Sixth Schedule to the Act provides for the appropriation of one-third of the excess of the clear profit over the reasonable return by the undertaking for itself. But such amount shall not exceed five per cent. of the amount of reasonable return. That would be at the disposal of the undertaking. Of the balance of the excess, one half has to be appropriated to a reserve which shall be called the " tariffs and dividends control reserve " and the remaining half shall either be distributed in the form of a 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. Therefore, the amount credited to the consumers' benefit reserve is an amount returnable to the consumers and is not to be at the disposal of the licensee. We have to see whether the position is the same in the case of the contingencies reserve and the development reserve. We will now take up the case of development reserve provided under Paragraph V-A of the Sixth Schedule. This, as we have already pointed out, is of the same ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... makes a profit or not. It is related to the original cost of the fixed assets. Though the amount of the reserve could be utilised for certain purposes, the nature of the purposes indicated in Paragraph IV of the Sixth Schedule is sufficient to show that the purposes are not so general as in the case of the development reserve. Whereas the development reserve can be used for investment in the business of the undertaking, the contingencies reserve can be utilised only in certain specified contingencies. The amount of the reserve had to be invested in securities authorised under the Indian Trusts Act, 1882, and that had to be made within a specified time. Paragraph V provides that the contingencies reserve shall not be drawn upon during the currency of the licence. This rule is subject to exceptions. The exception clause provides that it shall be drawn upon for meeting such charges as the State Government may approve as being,--- (a) expenses or loss of profits arising out of accidents, strikes or circumstances which the management could not have prevented ; (b) expenses on replacement or removal of plant or works other than expenses requisite for normal maintenance or renewal ; ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the business of the licensee. The amount of the reserve can be used for such purposes as are specified in Paragraph V(1) of the Sixth Schedule as the State Government may approve. These purposes indicate that the object is to see that the undertaking is smoothly and properly run. One of the purposes is the meeting of charges by way of expenses or loss of profits arising out of accidents, strikes or circumstances which the management could not have prevented. Another is the meeting of expenses on replacement or removal of plant or works other than expenses requisite for normal maintenance or renewal and the third is the compensation payable under any law for the time being in force and for which no other provision is made. The default of the licensee in regard to any of these obligations would have immediate impact upon the manner in which the undertaking is run and the result would affect the consuming public. Therefore, the creation of this reserve is apparently with the prime object of making available sufficient resources for meeting commitments necessary for the efficient running of the business, commitments which, if the licensee fails to meet, would really affect the consumer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ffer costs. A copy of this judgment under the seal of the High Court and the signature of the Registrar will be sent to the Appellate Tribunal, Cochin Bench, as required by section 260(1) of the Income-tax Act, 1961. VISWANATHA IYER J.-I concur, but I wish to add a few words of my own. In the light of the financial principles laid down in the VIth Schedule to the Electricity (Supply) Act, 1948, which strikes a balance between the conflicting interest of the investor who would seek a maximum return on the investment and of the consumer who must be protected by limiting to the minimum dividends of the investor consistent with the industry's ability to attract fresh capital at reasonable rate of interest for future development and expansion, it is clear a ceiling is imposed on the profits made by the electricity undertakings. The Sixth Schedule prescribes this ceiling by laying down that the clear profit of an undertaking in any year of account shall not exceed the amount of reasonable return. To effectuate this ceiling the undertaking is required by the subsequent provisions of the Schedule, to dispose of the excess over the clear profits in the manner prescribed in Paragraph 2 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent rebate in the computation of profits and gains of a business. Section 10(1) and (2)(vib) of the Indian Income-tax Act, 1922, and sections 33 and 34 of the new Act relate to this rebate. Under these provisions a certain portion, viz, 75% of the amount allowed as development rebate, is directed to be appropriated to a reserve and to be utilised for the specific purpose of the business. The reserve should not be utilised for distribution by way of dividends and profits or remittance outside India as profit arises for acqusition of assets outside the country. The assets also should not be sold before the expiry of the period within which the development rebate must be utilised for the purpose of the business. If the conditions mentioned therein are not observed the rebate will be withdrawn and the amount made taxable. The said provision exempts companies carrying on the business of electricity supply under the Electricity (Supply) Act, 1948. This was because by Act 101 of 1956, the Electricity (Supply) Act was amended and in the VIth Schedule, Para. V-A was added which required the amount representing the tax payable on the rebate allowed for the year to be kept as a reserve and pe ..... X X X X Extracts X X X X X X X X Extracts X X X X
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