TMI Blog2004 (4) TMI 21X X X X Extracts X X X X X X X X Extracts X X X X ..... udge(s) : RAJESH BALIA., O. P. BISHNOI. JUDGMENT The judgment of the court was delivered by Rajesh Balia J.- This appeal is against the judgment of the Income-tax Appellate Tribunal, Jodhpur Bench, Jodhpur, dated February 6, 2001, and concerns the assessment of the assessee-respondent for the assessment year 1989-90. The assessee is a co-operative marketing society who claimed that rule 68 of the Rajasthan Sahakari Sansthan Rules of the Rajasthan Co-operative Societies Rules, 1966 (in short "the Rules of 1966"), framed under the Rajasthan Co-operative Societies Act, 1965 (in short "the Act of 1965") requires the society to transfer 25 per cent, of its net profits to a reserve fund. The said amount, according to the assessee, does not remain under the control of the assessee or the co-operative society but it goes under the control of the Registrar, Rajasthan Co-operative Societies, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ies only in case the net profit of the co-operative society is positive and after it has reached it and it remains a part of assets and investment of the society to be used for the purpose of the society in accordance with law. The provisions of the Act and the Rules ensure that no part of the reserve fund be used during the continuance of business of the society for any purpose other than for the purposes of the society. The attention of the court was drawn to sections 62, 63, and 82 of the Act of 1965, and rules 55 and 56 of the Rules of 1966. It is contended that neither is it a case of expenditure which could be allowed under section 37 nor is it a case of diversion of income at source by overriding title, nor can it be said that the amount so transferred to the reserve fund is not the real income of the society so as to be excluded from the computation of taxable income of the 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 assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 200 ITR 130 (Karn) buttressing with the submission that the special leave petition against the last mentioned decision has also been dismissed by the Supreme Court. Before considering the various precedents having some bearing on the controversy before us, it would be apposite to acquaint ourselves with the relevant provisions of the Co-operative Societies Act, 1965, which deals with the creation of reserve fund and its user to understand the exact nature of the reserve fund in question. The object of enacting the Rajasthan Co-operative Societies Act, 1965, was to provide for long-term loans to holders of land to enable them to discharge their debts, to carry out agricultural improvements, to acquire land for the formation of economic holding and other like purpose and thereby to promote thrift and self-help among them and for these purposes to give effect to the concept of State 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 balanc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vision as has been projected by the assessee. Sections 62 and 63 which directly concern us in appeal, read as under: "62. Disposal of net profits.-(1) A co-operative society shall, out of its net profits in any year- (a) transfer, to the reserve funds, such percentage of its profits and within such period as may be prescribed; and (b) credit such portion of the profits, as may be prescribed, to the co-operative education fund constituted under the rules. (2) The balance of the net profits may be utilised for all or any of the following purposes, namely:- (a) payment of dividend to members on their paid up share capital at a rate not exceeding the prescribed limit; (b) payment of bonus on the amount or volume of business done by them with the society, to the extent and in the manner specified in the bye-laws; (c) constitution of or contribution to such 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her assigned by the Registrar to an object of public utility or to a charitable purpose as defined under section 2 of the Charitable Endowments Act, 1890 or may be placed in fixed deposit with the financing bank until such time as a new society with similar conditions is registered and such surplus may be credited to the reserve fund of such new society. Apparently, this dealing of surplus after paying all outstanding of the society applies to residue of the entire assets of the society including the funds created under section 62 of the Act read with rule 68 of the Rules. The distribution of reserve fund is not in isolation but is a part of the general scheme of the Act dealing with assets and profits of the society in general during the continuance of its business as well as after the society ceases to exist leaving its assets firstly to discharge its 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 Endowme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the end can also not be referable to any specific asset forming part of the total mass of assets of the society. Thus, the contention that the reserve fund is created for an object of public utility is rejected. The relevant rule which deals with the creation of the reserve fund and its utilisation which gives effect to the above provision may now be noticed. Rule 68 while giving effect to section 62 provides that in a society with shares and limited liability, not less than one-fourth of the net profits shall be carried to the reserve fund. In a society with shares and unlimited liability, not less than one-third of the net profits shall be carried to the reserve fund. In the latter case, 1/3rd share of the net profits is to be transferred continuously until the reserve fund equals the paid up share capital of the society. Thereafter, such society 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reserve fund during the continuance of the society can be utilised for the purposes other than for the purpose of society albeit in consonance with general policy of the Act. User of the reserve fund which has primarily its object to have financial strength of the society and to the co-operative movement, has been regulated by the approval of the Registrar but there is no absolute prohibition against the user of the entire reserve fund for the purposes of the society without there being necessity to reimburse and refurnishing existing reserve fund. In the case of winding up of a co-operative society, rule 56 gives effect to section 82 of the Parent Act which we have adverted to above, which ordains that firstly, the debentures be paid then to repay the paid up share capital with dividend not exceeding 6 per cent, return for any period or periods 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 dissolut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nforced from the fact that the Registrar has no power to use the reserve fund credited under section 62 of the Act for any purpose other than for the purpose of the society during the existence of the society. (vii) Even after the society is dissolved or cancelled, it can be used primarily for the repayment of debts of the society and the repayment of share capital with dividend up to the maximum rate of dividends provided under the law. (viii) It is only if there remains surplus of the assets, which may include the part of the reserve fund also, it is not to be divided amongst the shareholders but is either to be utilised for some object of public utility decided by members of the society through its bye-laws or by passing a resolution to that effect in its general body or in consultation with the general body, or for any charitable 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 afo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r; to that extent what he received for her was not his income. It was not a case of the application by the appellant of part of his income in a particular way. Lord Macmillan delivering the opinion of the Board stated: "In the present case, the decree of the court by charging the appellant's whole resources with a specific payment to his stepmother has to that extent diverted his income from him and has directed it to his stepmother; to that extent what he receives for her is not his income. It is not a case of the application by the appellant of part of his income in a particular way, it is rather the allocation of a sum out of his revenue before it becomes income in his hands." It may be noticed that the title to receive the income in the aforesaid case vested with the assessee but the assessee has received it for someone 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 [196 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee itself, nor is there any obligation to provide for such reserve before it becomes part of the net income earned by the society. In the like way is the case of K. A. Ramachar v. CIT [1961] 42 ITR 25 (SC), where though under the deed of settlement which was irrevocable, each of the beneficiaries of the settlement was entitled to receive 1/4 of the shares of the settlement in the profits of the firm during a period of 8 years from the date of the settlement, the beneficiaries were entitled to directly receive and collect from the firm their shares under the settlements. The assessee's claim that those amounts were payable to the wife and children of the settlor under the obligation arising under the irrevocable deed of settlement was negatived on the ground that on the facts, the effect of deeds of settlement was 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 dispo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fter such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one's own income which has been received and is since applied. The first is a case in which the income never reaches the assessee who even if he were to collect it, does so, not as part of his income, but for and on behalf of person to whom it is payable." In CIT v. Imperial Chemical Industries (India) P. Ltd. [1969] 74 ITR 17 (SC) the court held that: "the payment of amounts by the respondent to the outgoing agents was not by an overriding title created either by act of parties or by operation of law, and it could not be said that the amount of compensation paid to the outgoing 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 diver ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he society. Even on the dissolution of the society the first obligation of the assets of the society including the reserve fund as part of the total assets and not specifically, is to the discharge of its debts outstanding and obligation towards the shareholders to pay their contribution with interest and dividend payable to them for the period such dividends are not paid. Surplus, if any, left thereafter, is to be applied according to the resolution of the general body of the members of the society only. Therefore, there is no insignia of diversion of income through an overriding title vesting in a third party outside the corpus of the society itself so as to consider it to be a case of diversion of income by overriding title to somebody other than the assessee. It is also to be noticed that the question of 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uture, such an apportionment partakes of the character of reserve fund. The court explained: "An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known-liability of which the amount cannot be determined with substantial accuracy is a provision." If in this background, we examine the different cases which have been cited before us, the distinction would be apparent. We may first notice Poona Electric Supply Co. Ltd.'s case [1965] 57 ITR 521 (SC) which was relied on by Mr. Ranka and on which the decision of the Madhya Pradesh High Court in Keshkal Co-operative Marketing 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arrived at on commercial principles subject to the provisions of the Income-tax Act. There is a clear-cut distinction between deductions made for ascertaining the profits and distributions made out of profits. The court also pointed out that there is a distinction between real profits ascertained on commercial principles and profit fixed by the statute for a specified purpose. It may be noticed that profits earned in excess of reasonable return in a given case was required to be returned to the consumers and not to be retained by the company at any rate, whether it is to return immediately by giving immediate rebate or is to be returned in future by keeping the amount in a "consumer benefit reserve account" did not make any difference as the same never became the part of the company's profit which it 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... siness profits of the assessee, it must be taken into account. Reversing the decision of the Tribunal from which a direct reference was made to the Supreme Court under section 257 of the Income-tax Act, 1961, the court adverted to Poona Electric Supply Co. Ltd.'s case [1965] 57 ITR 521 (SC) which has been relied on by the Tribunal and by various other High Courts in different set of circumstances like the one, after referring to various judgments of the High Court wherein Poona Electric Supply Co. Ltd.'s case [1965] 57 ITR 521 (SC) has been considered and applied, the court pointed out the distinction laying emphasis on the fact that the amount paid into the "consumers benefit reserve fund" has to be returned to the consumers, therefore, it is as if the electricity company did not receive the amount 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... purposes set out in paragraph V of the Sixth Schedule to the Electricity (Supply) Act, which are the expenses which the electricity company has to incur and the reservation is made so that money is always available for meeting these expenses and the supply of electricity is not interrupted." We have already examined the scheme of the co-operative societies governing the creation of the reserve fund in question which clearly indicates that under section 61 no part of the funds other than the net profits of a co-operative society shall be utilised by way of bonus or dividend or otherwise distributed amongst its members and section 62 has unequivocally provided for disposal or application of net profit. It is only after the net profit reaches the co-operative society that the question of its 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... liability and that too as per the resolution of the members of the society only. Thus, in our opinion, the principle governing dealing with the reserve fund in question, which is created under the Co-operative Societies Act, 1965, is fully governed by the ratio of the decision in Associated Power Co. Ltd.'s case [1996] 218 ITR 195 (SC); Vellore Electric Corpn. Ltd.'s case [1997] 227 ITR 557 (SC) and not by the ratio laid down in Poona Electric Supply Co. Ltd.'s case [1965] 57 ITR 521 (SC). The decision of the Madhya Pradesh High Court in Keshkal Co-operative Marketing Society Ltd. [1987] 165 ITR 437 undoubtedly supports the contention of the assessee-respondent. We have already noticed that the decision of the Madhya Pradesh High Court in Keshkal Co-operative Marketing Society Ltd. [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 req ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome to meet any contingencies occurring in future cannot be excluded from the computation of total income either on the principle of diversion of income by overriding title or on the principle of income not forming part of the real income or as part of deductible expenses under section 37; the decision in Madhya Pradesh High Court cannot be considered as an authority laying down the proposition in respect of the reserve fund created by the co-operative societies for its own purposes as the law laid down correctly and is impliedly overruled. The other decisions referred to and relied on by learned counsel for the Revenue (?) in Pandavapura Sahakara Sakkare Karkhane Ltd. [1988] 174 ITR 475 (Karn); Hiranyakeshi Sahakari Sakkare Kharkhane [1993] 200 ITR 130 (Karn) all from the Karnataka 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 Coop ..... X X X X Extracts X X X X X X X X Extracts X X X X
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