TMI Blog1981 (3) TMI 32X X X X Extracts X X X X X X X X Extracts X X X X ..... O rejected the assessee's claim on the ground that the funds were not allowable for the capital computation to arrive at the standard deduction for a determination of the tax liability under the S.P.T. Act, 1963. Being aggrieved by this order, the assessee went up in appeal to the AAC. After referring to the several relevant decisions and authorities on accountancy, the AAC held that these three funds were reserves. Consequently, the AAC held that all the three funds constituted reserves and should be included in the computation of the capital base of the assessee-company for the purpose of the S.P.T. assessment. Being dissatisfied with the aforesaid finding of the AAC, the Revenue went up in appeal before the: Appellate Tribunal. Attention of the Tribunal was drawn to the balance-sheet as per Sch. VI of the Companies Act, 1956, and the interpretation clauses contained in Pt. III thereof. The Revenue urged the Tribunal to interpret the expression " reserves " on the same lines as in Sch. If to the C. (P ) S.T. Act, 1964, as according to it, the S.P.T. Act, 1963, was not to continue but its place was taken by the C. (P.) S.T. Act from the immediately succeeding year, that is to s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s evident that the assessee-company had been gradually redeeming the debenture stock and simultaneously increasing the sinking fund with the idea that at the appropriate time, the redeeming of the debentures would not upset the working of the business. The Tribunal, therefore, was of the view that the debentures did not constitute the capital base for the purpose of the S.P.T. Act. Sinking funds did appear in the form of the balance-sheet. The funds set aside out of the company's profits were being used for business purposes because the company wanted to replace the capital by way of debenture by the sinking funds. The Tribunal was of the view that the liability was no doubt known but it was not a revenue liability. In the premises, the Tribunal held that this fund did form part of the company's capital. Dealing with special appropriation for plant expansion, replacement and contingencies, according to the Tribunal, the nomenclature was not of much importance, but what was of importance was the purpose for which the appropriation had been made. The Tribunal was of the view that this had not been resorted to by way of debiting the profit and loss account as in the case of depreci ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ture, of the fund could not be deployed by the directors otherwise than for the specified heads. In the circumstances, the Tribunal held that this fund had been correctly treated as reserve for computation of the capital of the assessee. In the circumstances, the question as indicated above has been referred to this court. It is necessary, in this connection, to bear in mind the provisions of ss. 57 and 57A of the Electricity (Supply) Act, 1948. The relevant provisions of the said sections read as follows: " 57. The provisions of the Sixth Schedule and the Seventh Schedule shall be deemed to be incorporated in the licence of every licensee, not being a local authority (a) in the case of a licence granted before the commencement of this Act, from the date of the commencement of the licensee's next succeeding year of account; and (b) in the case of a licence granted after the commencement of this Act, from the date of the commencement of supply, and, as from the said date, the licensee shall comply with the provisions of the said Schedules accordingly, and any provision of the Indian Electricity Act, 1910, and the licence granted to him thereunder and of any other law, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... onstituted not later than three months after the expiry of the notice referred to in the first proviso to that clause ; (ii) where such committee is to be constituted at the request of the licensee, be constituted within three months of the date of such request; (c) a rating committee shall, after giving the licensee a reasonable opportunity of being beard and after taking into consideration the efficiency of operation and management and the potentialities of his undertaking, report to the State Government within three months from the date of its constitution, making recommendations with reasons therefor, regarding the charges for electricity which the licensee may make to any class or classes of consumers so, however, that the recommendations are not likely to prevent the licensee from earning clear profit sufficient when taken with the sums available in the Tariffs and Dividends Control Reserve to afford him a reasonable return as defined in the Sixth Schedule during his next succeeding three years of account Provided that the State Government may, if it so deems necessary, extend the said period of three months by a further period not exceeding three months within which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... compensation payable under any law for the time being in force and for which no other provision is made. (2) On the purchase of the undertaking, the Contingencies Reserve, after deduction of the amounts drawn under sub-paragraph (1), shall be handed over to the purchaser and maintained as such Contingencies Reserve: Provided that where the undertaking is purchased by the Board or the State Government the amount of the Reserve computed as above shall, after further deduction of the amount of compensation, if any, payable to the employees of the outgoing 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. " About the nature of the sinking fund for repayment of loans our attention was drawn to the book, Spicer Pegler's Book-Keeping and Accounts, 17th edn., where, under section 10 (p. 66) the learned editors have observed as follows: " S. 10. The operation of Sinking Funds for the Repayment of Loans. A sinking fund for the repayment of a loan is created in a manner similar to the depreciation fund for the replacement of an asset, described in s. 8(d)(p. 57) except that the annual provision is an app ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dvanced Accountancy, 27th edn., p. 678, where the learned editors have noted as follows : " Sinking Fund.-A Sinking Fund is a fund created with the object of providing means for the redemption of liabilities like debentures or any other loan. It is formed by setting aside, half yearly or yearly, a fixed sum of money for a definite period, such sum to be invested at compound interest, so that at the end of the period, the annual amounts, with accumulations of interest, will be sufficient to discharge a prescribed loan. In such a case, the amount set aside should not be debited to Revenue Account but to a Net Revenue Account or Profit and Loss Appropriation Account, as being rather in the nature of an allocation of profits than charge against them. The term Sinking Fund is often applied to what is really a provision for the replacement of a wasting asset, invested in liquid assets apart from the business, so that cash may be available at a time when the original asset has to be replaced without severely dislocating the concern. The amount thus set aside each year is a charge against revenue and not an allocation of profits. It would be clearer if the term Sinking Fund were used ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l reversed the decision of the lower authorities as regards the dividend reserve of Rs. II lakhs odd and held that this amount had to be treated as a " reserve " and included in the computation of the capital. The High Court had held that it would be clear from the provision in r. 1 of the Sch.II to the Act that before any amount or sum qualified for inclusion in the capital computation of a company, the amount or sum must be a " reserve ". On a consideration of the definitions of the expressions " provision " and " reserve " in cl. 7(1)(a) of Part III of Sch. VI to the Companies Act and the decision of the Supreme Court in the case of Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53; 39 Comp Cas 410, it was clear that where an amount was set aside out of profits and other surpluses to provide for any known liability of which the amount could not be determined with substantial accuracy, the same was a provision; but if the amount so set apart was not designed to meet a liability, a contingency, commitment or diminution in the value of assets known to exist at the date of the balance-sheet, it would be reserve. If this test was applied to the item of Rs. 22 lakhs od ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny for the purpose of super profits tax in Sch. II to the Act, the amount so set apart should be available to the assesses for being used in its business in future. The manner in which the directors in their report had indicated the appropriation of the balance of the gross profits, after making provision for commission agency, depreciation and tax, namely, that Rs. 11 lakhs odd should be appropriated towards payment of the proposed final dividend at the rates indicated in the report and having regard to the manner in which this particular item had been shown in the balance-sheet as on 3lst of December, 1961, and in the profit and loss account for the year ending 31st December, 1961, the amount of Rs. II lakhs odd would have to be regarded as not a reserve and, therefore, the same was not liable to be included in the capital computation under r. 1 of Sch. II to the S.P.T. Act, 1963. Our attention was drawn to the observations of Mr, justice Tulzapurkar at p. 32 of the report. Reliance was also placed on the decision of this court in the case of CIT v. Indian Standard Wagon Co. Ltd. 1979] 118 ITR 623, and also on the decision of this court in the case of CIT v. Eyre Smelting Pvt. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... T v. Century Spg. Mfg Co. Ltd. [1977] 108 ITR 431. There the Division Bench of the Bombay High Court was concerned with the question of setting apart of a sum of Rs. 40 lakhs in the balance-sheet. It was held by the Bombay High Court that the setting apart of Rs. 40 lakhs in the balance-sheet as on 31st December, 1961, which according to the assessee-company's own statement before the Tribunal was for the purpose of meeting the liability which might arise as a result of an award that would be made in an industrial adjudication, which was pending under a statute, would have to be regarded as a provision made for a known contingent liability, the quantification whereof was to depend upon either the actual award that Would be made by the adjudicating machinery or as a result of settlement that might be arrived at by the parties. Therefore, the setting apart of the sum of Rs. 40 lakhs being in the nature of a provision would not be includible in the capital computation of the assessee-company for the purpose of the S.P.T. Act, 1963. Reliance was placed on the observations of the court at p. 436 of the report. In the decision of the Calcutta High Court in the case of A.P.V. Engineer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e with the four tests laid down by the learned judge, we observed that a reserve need not exclusively be set apart from profits but might be available from other surplus and for this purpose we referred to the decision of the Supreme Court in the case of CIT v. Standard Vacuum Oil Co. [1966] 59 ITR 685 at p. 694. We further observed that we were inclined to take the view that the expression " reserve " in r. 1 of Sch. II might be a reserve in the ordinary sense and need not be considered in contradistinction to " provision ". Our attention was also drawn to the decision in the case of Addl. CIT v. A.L.N. Rao Charitable Trust [1976] 103 ITR 44 (Kar), and reliance was placed on the observations of the court at p. 55. On the question of contingency reserve, reliance was placed on the decision of the Kerala High Court in the case of Cochin State Power Light Corporation Ltd. v. CIT [1974] 93 ITR 582. There the court was concerned with the special reserve appropriated under a statutory provision and whether such reserves were permissible deduction. There the assessee, the Cochin State Power Light Corporation Ltd., had claimed in respect of the year ending 3rd of March, 1965, releva ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... diversion of the revenue which was to be deducted for the purpose of determining the real profits of the assessee nor was an expenditure liable to be deducted under the I.T. Act. The assessee could not, over and above the allowance by way of development rebate, claim the amount appropriated to the development reserve under the Electricity (Supply) Act to be deducted in computing the income for the purpose of assessment. As for the " special reserve ", the court held that it was not shown that it was under any statutory obligation but what was said was that the Electricity Board directed the assessee to keep such a reserve. It had not been shown that the amount so reserved was not available to the assessee for diversion for any purpose of its own. Merely because some instruction was said to have been given by the Electricity Board for the creation of the reserve which, in the normal course, would be available for appropriation by the assessee without restriction, it could not be said that it should be deductible from the income. The amount appropriated to this reserve ought not, therefore, to be deducted in arriving at the taxable income of the assessee-company. The court noted at p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... matter of ownership of somebody else. It might be that the statute had imposed certain restrictions over the disposal of the amounts by the assessee but that did not mean that the amounts ceased to be money belonging to the assessee. Simply because the statute required a licensee like the assessee to make an appropriation out of its revenue for a particular purpose and that was a compulsory appropriation which the assessee had to make, it did not follow that for income-tax purposes such appropriation must necessarily be deducted in arriving at the profits and gains of the business. Every appropriation to be made under a statutory provision did not constitute a diversion of profit by overriding title. Here, of course the question of provision and reserve in the context of our present statute was not an issue before the Madras High Court. Reliance was also placed on a Division Bench decision of the Patna High Court in the case of Darbhanga Laheriasari Electric Supply Corporation Lid, v. CIT [1979] 117 ITR 516, where at pp. 520 and 521 of a report, after discussing the Madras and Kerala decisions, the Patna High Court was unable to agree on this aspect with the views of the Madras Hig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er the said Act; (b) for the purpose of finding out whether an amount is a reserve within the meaning of r. I of Sch. II to the S.P.T. Act, 1963, one has to find out whether the amount in question represented any profit earned by the assessee company and other amounts available to the assessee-company and not distributed as a dividend, but kept away or apart for any purpose to which the same might be put in "future; (c) There must be a decision by the authorities competent to take such decision to keep the amount in question back for any purpose to which the same might be put in future; (d) The reserve might be built up not only from the profits but may be from other sources available to the assessee-company; (e) The expression " reserve " appearing in r. I of Sch. 11 meant reserve in the ordinary sense and need not be considered in contradistinction to a provision. These principles can be deduced from the decision of the Supreme Court in the case of CIT v. Standard Vacuum Oil Co. [1966] 59 ITR 685, and reference may be made to the observations of the court at pp. 693 and 694 of the report. We had also, after referring to the several decisions on this aspect in the case o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... efor which could properly be treated as part of the capital of the assessee-company. In that background and in the light of the other facts found by the Tribunal as well as by the AAC and on the ratio of the principles we have indicated before, we are of the opinion that the Tribunal was also right in treating replacement and contingencies as reserve for the purpose of computing the capital of the assessee-company under the relevant provisions The last: fund with which we are concerned in this reference is the Contingencies Reserve Fund. Our attention was drawn and we have set out certain relevant provisions of some of the provisions of the Electricity (Supply) Act, 1948, Sch . VI whereof deals with the financial principles and their application. Paragraphs III, IV, V and IX of Sch. VI deal with Contingencies Reserve It was contended on behalf of the Revenue that the nature of the reserve, the sources from which the same was created, the purposes of the fund and the manner in which the same could be drawn up or utilised should be borne in mind and in this connection reliance was placed on the decision mainly of the Kerala High Court in the case of Cochin State Power and Light Cor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee would not get any compensation on account of this reserve. In the provisions of the Electricity Act, 1910, relating to the price fixation when the Board or the State Govt. took over the undertaking of the licensee, no, allowance was to be made on the purchase price for the amount of the contingencies reserve. It was further urged on behalf of the Revenue that the contingencies reserve was, therefore, created to meet a known liability and could not, therefore, constitute a reserve. Reliance was placed on some of the decisions including in the case of CIT v. Indian Standard Wagon Co. Ltd. [1979] 118 ITR 623 (Cal), the decision in the Case of CIT v. Eyre Smelting Pvt. Ltd. [1979] 118 ITR 857 (Cal) and the decision in the case of A. P. V. Engineering Co. v. CIT [1979] 119 ITR 937 (Cal). According to the learned advocate for the Revenue, the Tribunal had found that the contingency reserve fund was meant for capital liability and, therefore, this showed that the amount in question was not a reserve under the.S.P.T. Act, 1963. In this connection, reliance was placed on the decision of the Bombay High Court in the case of CIT v. Century spg. Mfg. Co. Ltd. [1977] 108 ITR 431. It w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mount could not be considered, according to the learned advocate for the Revenue as a reserve under Sch. II to the S.P.T. Act, 1963. We have noted that the contingencies reserve had to be maintained by an electric supply company in accordance with Sch. VI to the Electricity (Supply) Act, 1948. Clause III of Sch. VI provided that there should be created from the existing reserve or from the revenues of the electricity undertaking a reserve to be called " Contingencies Reserve Clause IV(1) provided that the licensee should appropriate to the 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 the fixed assets provided that if the said reserve exceeded 5% of the original cost of the fixed asset no appropriation should be made which would have the effect of increasing the reserve beyond the said maximum. Clause V of Sch. VI provided for the purposes for which the contingencies reserve might be drawn upon as appearing from the provisions of the Act as follows : (a) to meet the expenses or loss of profit arising out of accidents, strikes or circumstan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t cannot be said that the reserve invested in securities was not the assessee's investment but somebody else's. The Division Bench of the Madras High Court in the case of Vellore Electric Corporation Ltd. v. CIT [1977] 109 ITR 454, discussed the relevant provision at pp. 458 and 459 of the report. We are in respectful agreement with the said analysis of the Division Bench of the Madras High Court. The Division Bench of the Madras High Court also considered the decision of the Kerala High Court in the case of Cochin State Power Light Corporation Ltd. v. CIT [1974] 93 ITR 582, on which reliance was placed heavily by the Revenue but the Madras High Court was unable to accept the said decision. On this aspect of the matter we are in respectful agreement with the view expressed by the Division Bench of the Madras High Court in the case of Vellore Electric Corporation Ltd. v. CIT [1977] 109 ITR 454. It is not correct, in our opinion, to hold that the amount represented by the contingencies was not at the disposal of the assessee and it was not available to the assessee for the purposes of his business. The contingencies reserve were to be utilised for the purposes specified in cl. V of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erve ", which was required to, be created under cl. II, of Sch. VI. The Supreme Court, oil an analysis of the characteristics of the said reserve, pointed out that for the purpose of rationalisation of rates and keeping them under control the licensee was directed to adjust its rates in such a way that its clear profit in any year should not, as far as possible, exceed the amount of reasonable profit, but if an excess was collected the licensee should distribute one-half of that excess in the, form of a proportional rebate to the consumer to carry forward the same in his accounts for future distribution to the consumers. Thus, according to the Supreme Court, this scheme of the provision was, that part of the excess collected was returned to the consumers by way of, rebate. It was on this analysis of the nature of the consumers' benefit reserve that the Supreme Court pointed out that these were part of the excess amount paid to it and reserved to be returned to the consumers did not form part of the assessee's real profit and hence to arrive at the taxable income of the assessee the said amount had to be reduced from the total income. As was already pointed out the consumers benefit ..... X X X X Extracts X X X X X X X X Extracts X X X X
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