Commissioner Of Wealth-Tax, Bombay v. Bombay Suburban Electric Supply Ltd.

Kantawala, C.J:— By this reference under section 27 of the Wealth-tax Act, 1957 (hereinafter referred to as “the Act”), the following three questions are referred for our determination:—

“1. Whether, on a proper interpretation of the relevant provisions of the Electricity (Supply) Act and the Indian Electricity Act, the capital reserve of Rs. 43,08,785, the contingent reserve of Rs. 7,53,433 and the development reserve of Rs. 7,22,477 are liable to be included in determining the net wealth of the assessee?

2. Whether in determining the net wealth of the respondent the sum of Rs. 8,58,850, being the provision made for gratuities to employees, should be allowed as a deduction?

3. Whether the sum of Rs. 5,18,160 being provision made for taxation in respect of the year ended on March 31, 1959 (assessment year 1959-60), should be allowed as a deduction in determining the respondent's net wealth?”

2. So far as the last two questions are concerned, Mr. Joshi on behalf of the revenue and Mr. Dastur on behalf of the assessee have stated that these questions are now concluded by the decisions of the Supreme Court. So far as question No. 2 is concerned, it is covered by the decisions of the Supreme Court in the case of Standard Mills Co. Ltd. v. Commissioner of Wealth-tax [1967] 63 ITR 470 SC. and in the case of Bombay Dyeing and Manufacturing Co. Ltd. v. Commissioner of Wealth-tax [1974] 93 ITR 603 SC. and in accordance with the said decisions question No. 2 shall have to be answered in the negative and against the assessee. We, accordingly, answer question No. 2 in the negative and against the assessee.

3. So far as question No. 3 is concerned,- counsel are agreed that it is covered by the decision of the Supreme Court in the case of Kesoram Industries and Cotton Mills Ltd. v. Commissioner of Wealth-tax [1966] 59 ITR 767 SC. and it has to be answered in the affirmative and in favour of the assessee. We, accordingly, answer question No. 3 in the affirmative and in favour of the assessee.

4. Then remains for consideration question No. 1 and the facts relevant thereto should be set out. The assessee is an undertaking for supply of electricity. The relevant assessment year under consideration is the year 1959-60, for which the relevant valuation date is March 31, 1959. Question No. 1 relates to three kinds of reserves, namely, capital reserve, contingencies reserve and development reserve. The facts relating to the capital reserve are as under:

At the beginning of the year the capital reserve stood at a sum of Rs. 37,32,003. The additions to this reserve during the year came to Rs. 5,76,782. The total of this reserve as on the valuation date was Rs. 43,08,785. For the purpose of supply of electricity to the consumers, the assessee has got the distributing mains. Before the electricity can reach the consumers, connecting lines have to be laid between the assessee's distributing main and the consumers' premises. The company has been laying these service lines and charging the consumers concerned for the cost of such lines as follows: For the first 100 ft. of service lines, no charge is made from the consumers. In respect of the cost of service lines in excess of 100 ft., 60% is recovered from the consumers and the balance is borne by the company. The amount which is contributed by the consumer is taken to a separate account and is shown in the balance-sheet under the head “Capital reserve”. For the relevant year a sum of Rs. 43,08,785 stood as a credit under the head. The question whether the reserve should be included in the assets of the assessee for the purpose of wealth-tax is concluded by the decision of the Supreme Court in the case of Calcutta Electric Supply Corporation v. Commissioner of Wealth-tax. The Supreme Court held that the fact that the service lines were acquired by the company by utilising the contributions made by the consumers was a wholly irrelevant circumstance: the only relevant thing for the purposes of the Wealth-tax Act was that the assessee should be the owner of the assets in question on the relevant valuation date. The fact that the value of one or more of the assets of the undertaking will not be taken into consideration in computing the value of the undertaking when sold under compulsion of law because of some statutory provision did not by itself show that it was not a valuable asset. The balance-sheet showed the service connections as the assets of the appellant-company and also the market value of these assets. In that case the Supreme Court held that the sum of £8,54,948 was, therefore, not deductible in determining the net value of the assets under section 7(2)(a) of the Act. The Supreme Court further pointed out that section 7(2) nowhere says that the Wealth-tax Officer, while proceeding under that section, was bound to accept every entry in the balance-sheet. The section authorises him to accept the valuation of the assets of a business as shown in the balance-sheet of the company. He is not bound to accept any deduction shown in the balance-sheet if he comes to the conclusion that the said deduction was not permissible. The Wealth-tax Act does not concern itself with the mode in which the assets of the assessee are acquired. It is immaterial whether the assessee acquired these assets from his own money or with the assets of others. Section 7 does not take note of hypothetical possibilities in the matter of valuation of assets. It merely concerns itself as to what is the true market value of the assets in question on the valuation date. Thus, the Supreme Court has emphasised that the only thing relevant for the purposes of the Act is that the assessee should be the owner of the assets in question on the relevant valuation date. The balance-sheet shows those service connections as the assets of the assessee. The Supreme Court also considered the provisions contained in section 7A and section 8 of the Indian Electricity Act, 1910, where-under the undertaking or the property of the company can be sold and it is pointed out:

“It is true that in view of section 7A(2) of the Electricity Act, in computing the market value of the undertaking sold under sub-section (1) of section 5 of that Act, the value of service lines which had been constructed at the expense of the consumers will not be taken into consideration. The reason for this provision is obvious. It will be the duty of the new licensee to not only maintain and repair those lines but also to replace them when they become unserviceable. But section 7a of the electricity act only deals with sales under section 5(1) of the Act. But if a sale is effected under section 8, the licensee shall have the option to dispose of all land, building, works, material and plants belonging to the undertaking in such manner as he may think fit. In such sales, it is open to the licensee to value the service connections put up at the expense of the consumers and add the same in computing the sale price…………… The fact that the value of one or more of the assets of an undertaking will not be taken into consideration in computing the value of an undertaking when sold under compulsion of law because of some statutory provision does not by itself show that it is not a valuable asset. Section 7 of the Act does not take note of hypothetical possibilities in the matter of valuation of the assets. It merely concerns itself as to what is the true market value of the assets in question on the valuation date. So far as the market value of the asset with which we are concerned in this case there is no difficulty. We have the assessee's own admission in its balance-sheet.”

5. Thus the ratio of this decision directly applies to the amount standing to the credit of the capital reserve and, accordingly, the sum of Rs. 43,08,785 standing to the credit of the capital reserve is liable to be included in determining the net wealth of the assessee and we direct accordingly.

6. We will then deal with the question of the contingencies reserve of Rs. 7,53,433. Such reserve has to be maintained in view of the provisions of the Electricity (Supply) Act, 1948, read with the provisions of the Sixth Schedule thereto. The relevant clauses of the Sixth Schedule for the purposes of the contingencies reserve are paragraphs III, IV and V which are as under:

“III. There shall be created from existing reserves or from the revenues of the undertaking a reserve to be called ‘Contingencies Reserve’.

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 made which would have the effect of increasing the reserve beyond the said maximum.

(2) The sums appropriated to the Contingencies Reserve shall be invested in securities authorised under the Indian Trusts Act, 1882, and such investment shall be made within a period of six months of the close of the year of account in which such appropriation is made.

V. (1) The Contingencies Reserve shall not be drawn upon during the currency of the licence except to meet such charges as the State Govern ment 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;

(c) 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.”

7. The argument of Mr. Joshi, on behalf of the revenue, is that under the charging section 3 of the Act wealth-tax is to be charged as a tax in respect of the net wealth on the corresponding valuation date of every company at the rate or rates specified in the Schedule. He said that the computation of the net wealth is to be made in the manner indicated in section 4. Secondly, according to his submission “net wealth” means the amount by which the aggregate value computed in accordance with the provisions of the Act of all the assets, wherever located, belonging to the assessee on the valuation date, is in excess of the aggregate value of all the debts which are permitted to be deducted under the Act. He also emphasised that so far as exemption from the computation of net wealth is concerned, regard is to be had to the provisions of the Act and the principles which may govern consideration of income under the Income-tax Act ordinarily may or may not be germane. He admitted that under the relevant paragraphs of the Sixth Schedule to the Electricity (Supply) Act, 1948, there are certain fetters or restrictions upon the use of the amount of the contingencies reserve and also it further provides that in the event of a compulsory purchase the amount of the contingencies reserve has to be handed over to the purchaser and maintained by such purchaser as the contingencies reserve. Such restrictions, according to his submission, do not affect the question whether the amount of the contingencies reserve is an asset belonging to the assessee. If it is so, then simply because there are fetters or restrictions upon the use of such a reserve or because on a compulsory purchase such reserve is to be handed over to the purchaser will not result in excluding such item from the wealth of the assessee which can be subjected to tax under the Act. On the other hand, Mr. Dastur on behalf of the assessee-company contended that in determining the net wealth the principles which also govern the computation of the income under the Income-tax Act ought not to be overlooked. He submitted that an item may not be assessable as income either because it is not of an income nature or though it is of an income nature it is exempt from tax or it is diverted at source and, therefore, does not accrue or arise to the assessee nor belong to the assessee. His further submission was that where an amount is diverted at source it does not legally reach the assessee and, therefore, the amount does not belong to the assessee. He submitted that under the Income-tax Act any amount which is deducted under section 10(1) in computing the income of an assessee is not an asset belonging to the assessee. He further submitted that even if it is an asset belonging to the assessee it is met by a corresponding debt owed by the assessee and cannot be treated as part of the assessee's net wealth. His submission in short was just as under the Income-tax Act an assessee's real income is to be determined and taxed for income-tax purposes, so also under the Wealth-tax Act it is really the assessee's net wealth that is to be determined and subjected to tax for wealth-tax purposes. His further submission was that, having regard to the specific provisions of paragraphs III, IV and V of the Sixth Schedule to the Electricity (Supply) Act, 1948, an amount which is appropriated or diverted as contingencies reserve is an expenditure and when it is regarded as an expenditure it is an outgoing and cannot form part of the net wealth belonging to the assessee.

8. At the outset it may be stated that every principle which may or may not be relevant for determining the income of an assessee which can be brought to tax, is not necessarily attracted for determining the net wealth of an assessee which can be subjected to wealth-tax. Income-tax is a tax on the real income, i.e, profits arrived at on commercial principles subject to the provisions of the Income-tax Act. The real profits can be ascertained only by making the permissible deductions. For the purposes of the wealth-tax the charging section is section 3 and it is as under:

“3. Subject to the other provisions contained in this Act, there shall be charged for every assessment year commencing on and from the first day of April, 1957, a tax (hereinafter referred to as wealth-tax) in respect of the net wealth on the corresponding valuation date of every individual, Hindu undivided family and company at the rate or rates specified in the Schedule.”

9. Such net wealth is to be computed in the manner indicated in section 4 and the assets which are to be exempted from the computation of the net wealth are enumerated in section 5. “Net wealth” is defined in section 2(m). In the Act, unless the context otherwise requires, “net wealth” means the amount by which the aggregate value computed in accordance with the provisions of the Act of all the assets, wherever located, belonging to the assessee on the valuation date, including assets required to be included in his net wealth as on that date under the Act, is in excess of the aggregate value of all the debts owed by the assessee on the valuation date other than the items which are specifically enumerated. The first question that we have to consider is whether the amount of the contingencies reserve appropriated in the manner required by the Sixth Schedule to the Electricity (Supply) Act, 1948, is an asset belonging to the assessee-company. It is not the case of Mr. Dastur that even if it is an asset it is exempted under any of the specific provisions of the Act. For determining the question whether it is an asset belonging to the assessee regard must be had to the provisions contained in paragraphs III, IV and V of the Sixth Schedule to the Electricity (Supply) Act. Such contingences reserve has to be created from existing reserves or from the revenues of the undertaking. Existing reserves undoubtedly is a part of the assets of the assessee-company. So also any revenue earned by it will form part of its assets. Under clause (1) of para. IV a licensee is under an obligation to appropriate to contingencies reserve from the revenue of each year of account a sum therein prescribed. Thus, under this clause a contingencies reserve is created by appropriation of the revenue of an assessee-company. The fact that there is a limitation as regards the amount in which the appropriation to contingencies reserve can be made will not alter the position. The amount appropriated to the contingencies reserve is required to be invested in securities authorised under the Indian Trusts Act, 1882, and it is obligatory upon the licensee to make such investment within a period of six months from the close of the year of account in which such appropriation is made. A mere look at the balance-sheet of the assessee-company for the relevant year will show that on the assets side the various investments made from the contingencies reserve are specified. Thus, the assessee itself has treated these investments from the contingencies reserve as forming part of the assets of the company. 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 other than expenses requisite for normal maintenance or renewal or for compensation payable under any law for the time being in force and for which no other provision is made. Incurring of expenses and payment of compensation are the normal liabilities of an assessee-company and a sum which can be utilised for such purposes cannot be treated as belonging to anybody other than the assessee itself. So also the fact that the amount of contingencies reserve can be utilised for meeting the expenses of replacement or renewal of plant or works indicates that it is used for replacing an asset which ultimately formed part of the assessee's undertaking. It is undoubtedly true that under clause (2) of paragraph V of the Sixth Schedule, in the event of a compulsory purchase of the undertaking, the amount standing to the credit of the contingencies reserve has to be handed over to the purchaser, namely, the Electricity Board, the State Government or a local authority because they are the only authorities who can exercise the power of compulsory purchase, but that by itself will not be a sufficient reason to come to the conclusion that it cannot be treated as a part of the asset of the assessee-company. If power of compulsory purchase is not exercised, then under section 8 it continues to form part of the assets of the undertaking and can be dealt with like any other assets belonging to the assessee-company. This being the nature of the amount of contingencies reserve, can it be said that this amount which is an asset, belongs to an entity other than the assessee-company? It was urged by Mr. Dastur that the provisions contained in the Sixth Schedule are meant for the benefit of the public and, therefore, the public should be treated as beneficiaries in respect of the amount of contingencies reserve. It is undoubtedly true that the maintenance of contingencies reserve is a provision made for the benefit of the public, but that is because an electricity supply undertaking being a public utility concern for supply of electrical energy to the consumers, it is undoubtedly the duty of the State to see that such supply of electrical energy is not interrupted. It is from that point of view that specific provisions are made for the purposes of appropriation and maintenance of a contingencies reserve and restrictions are imposed on the use of the amount of the contingencies reserve. The 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.

10. Mr. Joshi has relied upon the decision of the Supreme Court in the case of Calcutta Tramways Co., Ltd. v. Commissioner Of Wealth Tax, where their Lordships had occasion to consider whether the amounts transferred to the shareholders' reserve account and the amounts transferred to special reserve account for ultimate benefit of the Government can be treated as forming part of the net wealth of the assessee-company. The facts of the case show that the assessee, a sterling company, which ran the Calcutta Tramways, was a non-resident company for the purpose of Explanation 2 to section 6 of the Act. On August 30, 1951, the West Bengal Government entered into an agreement with the assessee, which was later given statutory force. Under the agreement the Government was entitled to acquire the undertaking of the company on January 1, 1972, by giving twelve months' notice. Even if the Government did not serve such a notice, the Government had an option to acquire subsequently on giving two years' notice. Pending the acquisition, the company was bound under the agreement to apply its revenues in specific ways as provided in the agreement. It was to set aside, in each accounting year, in a fund called the shareholders' account, certain specified sums. The assessee was also required to accumulate any surplus of its profits after providing for losses, if any, in a special reserve account which was eventually to accrue to the benefit of the Government. The assessee, inter alia, claimed that the amounts set aside in the special reserve account and in the shareholders' account were to be deducted in computing its net wealth for the relevant assessment years. It was held that till the undertaking was acquired the amounts shown in the special reserve account were the assets of the company and, therefore, were not deductible in computing its net wealth; that the fact that a separate shareholders' reserve had to be maintained by it because of the agreement with the Government did not change the character of the asset. It was sought to be contended on behalf of the assessee-company that under the agreement with the Government the company was under an obligation to maintain the special reserve account and that it could not deal with the same except in accordance with the provisions of the agreement and, therefore, the same did not form or could not be considered as forming part of the assets of the company. Such a contention was regarded as wholly untenable by their Lordships. It is pointed out:

“No part of the assets of the company had been acquired by the Government. Between the Government and the company, there was only an agreement. The Government could not have acquired the company before the ‘purchase date’, viz., January 1, 1972. Even after that date, only an option is given to the Government to acquire the company. The Government could not be compelled to acquire the company. The agreement had fixed the consideration to be paid for the acquisition of the company. Till the company was acquired, the amounts shown in the special reserve were the assets of the company. Once we come to the conclusion that they were not the assets of the Government, which conclusion to our mind is obvious, then it follows that they are the assets of the company. It is not the case of the company that these assets belonged to some third party. Every item of asset must belong to someone. The question is to whom did it belong? The obvious answer is that it belonged to the company.”

11. So far as the amount standing to the credit of the shareholders' account was concerned, it was contended on behalf of the company that the amount belonged to the shareholders and, therefore, could not be regarded as an item of asset of the company. That contention was also rejected on the ground that the company is a different legal entity from its shareholders. This case, therefore, shows that the material question to be decided for the purpose of section 3 of the Wealth-tax Act is to determine to whom did a particular asset at the relevant date belong. Looked at from that point of view, notwithstanding the restrictions imposed upon the use of the amount of the contingencies reserve and the fact that it was a mandatory provision to maintain such an account will not result in treating such an amount as not forming part of the assets or net wealth of the assessee-company.

12. Mr. Dastur relied upon the decision of the Kerala High Court in the case of Cochin State Power & Light Corporation Ltd. v. Commissioner of Income-tax and our decision in the case of Amalgamated Electricity Co. Ltd. v. Commissioner of Income-tax with a view to contend that as the amount of the contingencies reserve is diverted at source it cannot be regarded as income accruing to the assessee company and, therefore, not an asset of the assessee-company. He submitted that whatever amount is permitted as a deduction can never form part of the assets of the assessee. He also submitted that in both these cases it has been held that it was deductible under section 10(1) of the Income-tax Act and, therefore, it cannot be regarded as an asset of the company. At the outset it should be pointed out that in both these cases the court was really concerned with the question of determination of the income of the assessee-company under the head of profits and gains of business. Questions which may be relevant for the purpose of determining the liability to pay income-tax may not be germane or applicable while deciding a question whether a particular asset is an asset belonging to the assessee and can be subjected to a liability for payment of wealth-tax. Under the Income-tax Act “income-tax” is a tax on the real income, i.e, profits arrived at on commercial principles subject to the provisions of the Act. The real profit can be ascertained only by permissible deductions. We are not concerned in the present case with the question of determination of real profits or real income. As shown in paragraph III of Schedule 6, contingencies reserve can be created either from the existing reserves or from the revenues of the undertaking which by itself shows that it is created from assets which form part of the net wealth of the assessee-company. It can never be said that existing reserves do not form part of the assets of a company. Even in the case of revenue it is first received by the assessee and thereafter it is appropriated in the manner permitted by paragraph IV of Schedule 6 of the Electricity (Supply) Act. In either event it will be treated as part of the assets belonging to the assessee. The character of the asset is not altered by the fact that there are restrictions upon the user of the contingencies reserve and that in the event of a compulsory purchase under law it has to be handed over to the purchaser like the Electricity Board, the State Government or local authority who are under an obligation to main tain such reserve and continue the undertaking. Having regard to these provisions it is not possible to accept the contention of Mr. Dastur that either because it is diverted at source or is deductible under section 10(1) it cannot be regarded as forming part of the assets of the assessee-company. The principles applied and the ratio of the decision in the case of Calcutta Electric Supply Corporation's case will equally apply and govern the present case and the amount of the contingencies reserve shown in the balance-sheet will be treated as a part of the assets of the company includible for computing the net wealth of the assessee-company. Thus the sum of Rs. 7,53,433 standing to the credit of the contingencies reserve is liable to be included in determining the net wealth of the assessee-company.

13. This takes us to the question whether the sum of Rs. 7,22,477 standing to the credit of development reserve is liable to be included in determining the net wealth of the assessee-company. The development reserve has to be created as provided in paragraph VA of Schedule 6 to the Electricity (Supply) Act, 1948. Its provisions are as under:

“VA. (1) There shall be created a reserve to be called the development reserve to which shall be appropriated in respect of each accounting year a sum equal to the amount of income-tax and super-tax calculated at rates applicable during the assessment year for which the accounting year of the licensee is the previous year, on the amount of development rebate to which the licensee is entitled for the accounting year under clause (vi)(b) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922:

Provided that if in any accounting year, the clear profit (excluding the special appropriation to be made under item (va) of clause (c) of subparagraph (2) of paragraph XVII together with the accumulations, if any, in the Tariffs and Dividends Control Reserve less the sum calculated 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.”

14. Thus if regard be had to the provisions of paragraph VA the language is much better than that in the paragraphs dealing with contingencies reserve. Such development reserve has to be created out of net profits. Secondly, it is available only for investment in the business of electricity supply of the undertaking. The mere fact that in the event of a compulsory purchase under law by the Electricity Board or the State Government without receiving any compensation the amount standing to the credit of the development reserve is to be transferred to the Board or the State Government is a matter of no consequence. In Commissioner of Income-tax v. P.K Badiani a Division Bench of this court had occasion to consider the distinction that exists between an amount to be set apart for depreciation and that for development rebate. What is the nature of a development rebate is clearly pointed out in this judgment. The very use of the word “development” shows that the intention and the object of providing this allowance is to provide a fund for development of industry. Development rebate is for expansion of the industry by adding something to its existing machinery or other asset or of a totally different kind. The intention behind the provision of development rebate is, therefore, obviously to encourage capital formation through the medium of savings out of current profits. Clause (3) of paragraph VA makes it amply clear that the amount standing to the credit of development reserve can only be used in the development of the business of the company. Thus, it is clearly an asset belonging to the assessee-company and is includible in the net wealth of the assessee-company. Thus, the sum of Rs. 7,22,477 standing to the credit of development reserve is liable to be included in determining the net wealth of the assessee.

15. The assessee shall pay the costs of the revenue.