TMI Blog2015 (1) TMI 485X X X X Extracts X X X X X X X X Extracts X X X X ..... issed. - ITA. No. 1580/Hyd/2013 - - - Dated:- 31-12-2014 - Shri B. Ramakotaiah And Smt. Asha Vijayaraghavan,JJ. For the Petitioner : Mr. B. Satyanarayana Murthy For the Respondent : Mr. Ramakrishna Bandi ORDER Per B. Ramakotaiah, A.M. This appeal by assessee is directed against the order of the Ld. CIT(A)-III, Hyderabad dated 24.09.2013. The issue in this appeal is with reference to allowance of an amount of ₹ 11,66,894 being contribution to education fund made by assessee and claimed as revenue deduction. The A.O. was of the opinion that this is not an expense out of the profits but has only contributed to the National Cooperative Union of India out of the net profits and therefore, the amount is not allowable as deduction. Ld. CIT(A) confirmed the same. Hence, the present appeal. 2. We have heard the Ld. Counsel and Ld. D.R. and perused the material available on record. 3. Briefly stated, assessee is engaged in the business of banking, corporate agency for insurance and is registered under Multi-State Cooperative Societies Act. In the course of assessment, A.O. noticed that assessee has claimed an amount of ₹ 11,66,894 towards educa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... section 2 of the Charitable Endowments Act, 1890 (6 of 1890); (d) payment of ex gratia amount to employees of the multi-State Co-operative society to the extent and in the manner specified in the bye-laws. (Emphasis provided) 6.3 A plain reading of the above will show that the very opening line of subsection (1) begins by stating that the allocations are to be made out of the net profits . This clearly implies that after meeting all expenditure and after payment of taxes, the net profits are to be allocated in the manner prescribed in clauses (a), (b) and Cc) of the above subsection. A harmonious reading of the above section would clearly show that the subsection is concerned with the use of net profits after taxes i.e. it states that the society shall transfer minimum amount of 25% of the net profits to the reserve fund, credit 1% of the net profit to the education fund and transfer a minimum of 10% to the reserve fund for meeting unforeseen losses. These are very clearly in the nature of prudential norms and are applicable only if there is a net profit. During the course of appeal proceedings the Id AR was asked whether the appellant would be required to credit 1% of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to the Government share capital redemption fund belonged to the assessee. It never got diverted to anybody. The fact that there was a restriction on the use of the amount standing to the credit of the fund in the business of the wholesale stores of the assessee or that there was an obligation on the assessee to deposit the same as fixed deposit with the Central Finance Agency or invest it in the Government loan and securities in consultation with the authority as contemplated under section 70 of the Maharashtra Cooperative Societies Act does not make any difference. (Observations of the Hon'ble Bombay High Court) 6.8 A reference to the aforementioned ratios will clearly show that the term overriding title refers to a legal charge on the revenue which overrides the liability of taxation as enshrined, in the Income Tax Act. Very clearly, the multistate co-operative societies Act, 2002 uses the term net profit and not revenue. It does not in anyway state that net profit is to be calculated by denying the liability under the Income Tax Act. Indeed, if that were the case, then the amendment itself would be ultra vires of the Constitution of India because the Constitution ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submissions on this issue. 7. Ld. Counsel has placed detailed written submissions on the issue which are as under : 3............. Section 63 of the Multi State Co-operative Societies Act, 2002, which governs this contribution is reproduced below for favour of ready reference : 63. Disposal of net profits - (i) A Multi State Co-operative Society shall, out of its profits in any year, (a) Transfer an amount not less than twenty-five per cent to the Reserve Fund; (b) Credit one per cent to Co-operative Education Fund maintained by the National Co-operative Union of India Ltd., New Delhi, in the manner as a prescribed; (c) Transfer an amount not less than ten per cent to a Reserve Fund for meeting unforeseen losses. (2) Subject to such conditions as may be prescribed, the balance of the net profits may be utilised for all or any of the following purposes, namely: (a) Payment of dividend to the members in their Paid-up Share Capital at a rate not exceeding the prescribed limit; (b) Constitution of, or contribution to, such special funds including Education Funds, as may be specified in the bye-laws; (c) Donation of amounts not exceeding five per cent of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e wording of Section 57 of the Karnataka Co-operative Societies Act, 1957 and that of Section 63 of the Multi State Co-operative Societies Act, 2002, are similar. The Headnote to the case reads as under. An analysis of Section 57 of the Karnataka Co-operative Societies Act, 1957, and Rule 20 of the Societies Rules discloses that the condition for payment to the Cooperative Education Fund is that if the profits of a society exceed RS.5001-, and a declaration of payment of dividend to the members on Paid-up Share Capital at the rate of 2 per cent, is made, then the society is under an obligation to contribute towards the Co-operative Education Fund at a rate not exceeding 1 1h per cent of the net profits. The rate of contribution depends upon the rate of dividend. The language of Section 57(4)(a) of the Societies Act makes it clear that though the contribution is to be made with reference to profits, it is not out of the profits, and the rate is with reference to the rate of dividend. What is provided in the section is an obligation to contribute to the Co-operative Education Fund under certain contingencies and is a statutory liability which is an overriding charge on the income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le deduction. 8. The Madhya Pradesh High Court in the case of Keshkal Co-operative Marketing Society Ltd. vs. CIT 165 ITR 437, dealing with deductibility of transfer to the Reserve Fund u/s. 43(2) of the Madhya Pradesh Cooperative Societies Act, 1960, that it is an allowable deduction as the said amount does not comprise the income of the assessee as the same is divested u/s. 43(2) of the Societies Act and as it should be invested in such manner and on such terms and conditions as may be laid down by the Registrar in that behalf. The Court came to the conclusion that the said amount is not available for use of the Society at its option, as the assessee lose control over the said amount. The Court came to a conclusion that the amount is deductible u/s. 37 of the Income Tax Act. 9. The Karnataka High Court in the case of CIT Vs. Pandavapura Sahakara Sakkare Karkhane Ltd., 198 ITR 690 was dealing with deductibility of transfer by a sugar factory to a fund called Molasses Storage Fund . In this case, the Government has stipulated under the Molasses Control Order that 1/3rd of the price charged should be transferred to a fund called Molasses Storage Fund. This amount could be use ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ........................ Sub-rule (4) of rule 55 unfolds the areas in which reserve fund can be put to use. It reads (i) to meet unforeseen losses incurred by the society (ii) to meet such claims of the society as cannot otherwise be met; and (iii) to provide for other financial need in times of special scarcity. The aforesaid provisions convey in no uncertain terms that the reserve fund remains part of the capital and assets of the society and is to be used only for the purposes of the society in future according to the needs of the society either to be adjusted against its future losses or to payoff its dues which cannot otherwise be paid or to provide for funding needs in the case of financial crisis. ................... 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a reversed judgment of the Madras High Court and decision of the other High Court founded on the judgment of the Supreme Court which has been distinguished on the very same principle which has been applied by Poona Electric Supply Co. Ltd.'s case (1965) 57 ITR 521 (SC), the judgment must be deemed to have been rendered per incuriam and not a binding precedent. As a result of the aforesaid discussion, we allow this appeal and hold that the amount of reserve fund transferred from the net profit under section 62 of the Cooperative Societies Act, 1965 read with rule 68 of the Cooperative Rules, 1966 is not allowable as deduction in computing the taxable income of the society on any of the grounds raised by the assessee. The judgment of the Tribunal is set aside and that of the assessing officer is restored. 13. The Judgement is on the transfer to Reserve Fund whereas the issue in our case is transferred to the Co-operative Education Fund maintained by the National Co-operative Union of India. The Rajasthan High Court in the above case came to the conclusion because the amount in the Reserve Fund account does not cease to belong to the Society even after remittance and on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n appropriation of profit. (c) transfer of amount not less than 10% to reserve fund for meeting unforeseen losses, this amount also is not claimed as deduction as it is also appropriation of income. The issue is only with reference to item (b) i.e., credit 1% to Cooperative Educational Fund maintained by National Cooperative Union of India, New Delhi in the manner as prescribed. We are also not concerned with the other amounts which are subject to utilisation of funds as per section 63(2). It is the contention of assessee that amount paid u/s 63(1)(b) is an amount paid to third party out of the profits of the year. Therefore, it is a charge on the profit and so, diversion of income at source. The submissions in this regard are also summarized on the same principles that if the funds are for the benefit of the society, then, it is only an appropriation of income and if the funds are utilized for third party, then, it is an outgo from assessee s profits, therefore, an allowable deduction. 10. Before adverting to the legal principles, what is to be noted here is that assessee is not claiming deduction of the amount paid out of profits of the financial year which is under considerat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns his income, he cannot be taxed upon the income arising after the assignment of the source. In such event, it is not income of the assessee at all. On the contrary, if the source is not assigned to, or transferred but passes through the assessee to an ultimate purpose, the case of application of income in a particular manner. Even though he may enter into a legal obligation to apply it in a particular way, still it remains the income of the assessee. Sec. 61 to s. 62 provides an exception to legislative rule where notwithstanding assignment of source of income, the income is deemed to be the income of the person who has assigned such source by creating a legal fiction. 33. Another shade of such controversy is where the income is not applied but diverted by an overriding title from the assessee, which he would otherwise have received. Such diverted income cannot be considered the income of the assessee at all. Reference may be made to Raja Bejoy Singh Dudhuria vs. CIT (1933) 1 ITR 135 (PC) where the assessee has succeeded to the family ancestral estate on the demise of his father. Subsequent to such succession, his step-mother who had legal right to maintenance out of the estat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income by overriding title. The Supreme Court repelled the contention by holding that the deed of assignment was, it its true nature, only a contract by the assessee to transfer, or make over, to his wife in future all dividends that may be declared in respect of the shares; as a company can pay dividend only to the registered holder of the shares, neither s. 16(1)(c) nor its third proviso was applicable to the case; the income continued to accrue to the assessee and was assessable in the hands of the assessee as his income, even though it was ultimately payable to his wife under the terms of the deed. It was a case of application of income after it had accrued and not a case of diversion of any sum of money before it had become the income of the assessee nor was a case where the assessee has received the income for someone else. 37. Two features need be taken into consideration. Firstly, it was a case where diversion of income under overriding title was claimed to be given to a person other than the assessee after receipt of it by the assessee. Secondly, it was held to be an obligation on income of the assessee only after it had accrued and was not a case of diversion of any s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . He had also directed them to pay out of the income of his property, the costs of taking out probate of his will. The board opined that these are the income of the estate coming to the hands of the appellants as executors and in pursuance of obligation imposed by the testator. It was not a case in which a portion of the income was by an overriding title diverted from the person who would otherwise have received it as in Bejoy Singh Dudhuria s case (supra), but a case in which the executors having received the whole income apply a portion of it in a particular way. 42. In other words, rights to receive income should exist independent of the accrual and receipt of income by the assessee in some third party who could lay claim before it reaches the assessee. 43. The difference between obligation of income after it reaches the assessee and diversion of income by overriding title before it reaches the assessee was explained by the Supreme Court in CIT vs. Sitaldas Tirathdas (1961) 41 ITR 367 (SC). 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, bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se of the income being received in cash by one person or another. What the Court emphasised is the nature of the obligation by reason of which the income becomes payable to a person other than the one entitled to it. Where the obligation flows out of an antecedent and independent title in the former (such as, for example, the rights of the dependants to maintenance or of coparceners on partition, or rights under a statutory provision or an obligation by a third party and the like), it effectively slices away a part of the corpus of the right of the latter to receive the entire income and so it would be a case of diversion. 46. Significantly, the nature of diversion of income by overriding title is that income reaches to a party other than the assessee by reason of a pre-existing title to it. 11.1. Thus, on the basis of principles as down by Hon ble Supreme Court what is to be considered is, whether the amount is diversion of income by overriding title or appropriation of income. 12. Coming to the facts of the present case, apparently, the liability to pay the amount is after quantification of profits by the society under the Societies Act. It is only after the net profit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rmarked for various payments are of part of section 63 of Multi-State Cooperative Societies Act, we are of the opinion that the principles will apply equally. In the above said case, Hon ble Rajsthan High Court clearly distinguished the law on the subject considering the principles laid down by Hon ble Supreme Court, as under : 31. The said principle was reiterated with reinforced vigour in Vellore Electric Corpn. Ltd. vs. CIT (1997) 141 CTR (SC) 398 : (1997) 227 ITR 557 (SC) distinguishing the Poona Electric Co. Ltd. s case (supra) and following the Associated Power Company s case (supra), when the Court said: The contingencies reserve is to be created from existing reserves or from the Revenues of the undertaking which indicates that the monies which have to be put into the contingencies reserve reach the electricity company and it is the electricity company which has to invest the sums appropriated to the contingencies reserve. The contingencies reserves differs from the consumers benefit since the amount appropriated in the consumers' benefit has to be returned to the consumers and it is as if the electricity company had not received that amount which it is obliged ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urpose for which the reserve fund is to be applied, also forms part of the need of the society and none else. The fund is always available for the society and forms the part of its assets for paying off its dues and to pay off the share capital on its dissolution. Therefore, there is no overriding title vesting in any other person or obligation to which such profit is diverted before it reaches the society. The requirement of surplus, if any, on dissolution of the society after appropriation of assets to discharge its liabilities towards creditors and shareholders to be used for an object of public utility is also an obligation of the net surplus of the society and not merely of the remainder of reserve fund, if any, towards object of public utility or charitable purposes as may be ordained by the members of the society. That also clearly amounts to appropriation of the funds of the society as per the decision of the general body of the society. At the end of the day, it may be appropriation of remainder as per the requirement of law, but it does not, at the time of creation of a reserve fund becomes a certain obligation which it is obliged to discharge but rest in domains of uncer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eserve fund created under the statute for meeting out of contingent liability in future. Undoubtedly, in the latter case, it always remained capital of the company and notwithstanding its use could only be with the approval of the State Government, it did not make any difference so far as the nature of the contingency reserve fund is concerned. Apparently, the M.P. High Court has not noticed this distinction and has not adverted to the provisions of the M.P. Co-operative Societies Act which concerned creation of reserve fund, its object and the Government Rules about obligation to apply the reserve fund for the purposes of the society. Had the same been brought to the notice of the Court, perhaps the M.P. High Court would have reached the same conclusion to which we have reached. Be that as it may, in view of the direct decision of the Supreme Court in Associated Power Co. Ltd. s case (supra) and Vellore India Co. Ltd. s case (supra) making out a distinction between reserve fund created for the benefit of consumers and reserve fund to be used for the assessee s own income to meet any contingencies occurring in future cannot be excluded from the computation of total income either ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pply Co. Ltd. s case (supra) was also demonstrably contrary to the principle enunciated by the Supreme Court in the two cases referred to above by us. The Supreme Court drew the distinction obvious in Poona Electric Supply case that there is no parity between the contingency reserve for the benefit of the society itself and the consumer benefit reserve fund, which was intended to be returned to the consumers, the latter never becomes part of the companies business assets. Since the aforesaid decision of this Court is founded on a reversed judgment of the Madras High Court and decision of the other High Court founded on the judgment of the Supreme Court which has been distinguished on the very same principle which has been applied by the Poona Electric Supply Co. Ltd. s case (supra), the judgment must be deemed to have been rendered per incuriam and not a binding precedent. 36. As a result of aforesaid discussion, we allow this appeal and hold that the amount of reserve fund (sic net profit) transferred to the net profit (sic reserve fund) under s. 62 of the Co-operative Societies Act, 1965 r/w r. 68 of the Co-operative Rules, 1966 is not allowable as deduction in computing t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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