1. The following three Questions have been referred to us for decision:

"(1) Whether, on the facts and in the circumstances of the case, the sum of Rs. 1,05,357 being the reserve created under the society's bye-law 37(1 )(iv) was includible in the income of the society ?

(2) Whether the assessee was entitled to the exemption in respect of the sum of Rs. 62,540 under Section 14(3)(i)(c) of the Indian Income-tax Act, 1922? and (3) Whether, on. the facts and in the circumstances of the case, the assessee was entitled to rebate under Section 15B(2)(v) of the Income-tax Act in the sum of Rs. 22,013 paid to the Central Co-operative Training Institute ?"

2. The assessee in this case is a co-operative society registered under the Madras Co-operative Societies Act. Its bye-laws had been registered with the Registrar of Co-operative Societies. In the previous year ending June 30, 1960, relevant for the assessment year 1961-62, the society debited its profit and loss account with a sum of Rs. 1,05,357 and credited the said amount to a reserve account in accordance with its bye-law 37(a)(3) which is as follows :--

"Notwithstanding anything contained in this bye-law the society may undertake any scheme for procurement of foodgrains entrusted to it by the revenue authorities under such conditions and terms as may be agreed upon by the board from time to time. Separate accounts shall be maintained for the transactions connected with the procurement operation --seventy five per cent. of the profits made on the scheme shall be carried to a special reserve for business losses and depreciation and shall not be available for distribution."

3. In computing its business income it claimed deduction of the said sum. The Income-tax Officer rejected that claim observing that the creation of such reserve is not under any statutory obligation of the society, that the reserve is intended to offset any business loss and depreciation and to safeguard the interest of its members in respect of procurement business undertaken under the direction of the revenue authorities, and that in his opinion the reserve is only an allocation of profits. There was an appeal to the Appellate Assistant Commissioner but without success.

4. The assessee then appealed to the Appellate Tribunal contending that bye-law 37(a)(3) had a statutory force as the bye-laws had to be registered with the Registrar of Co-operative Societies under the provisions of the Co-operative Societies Act, that the reserve created under that bye-law should be treated as a diversion by an overriding title and not as an appropriation of profits. The assessee relied on the decision in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax, . The revenue, however, contended that the transfer of the sum in question to the reserve was a transfer after the profits had accrued, that though the appropriation has been made under the bye-laws it is not a diversion by any overriding title and that the decision in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax had no application to the facts of the assessee's case. The Appellate Tribunal held that the transfer of the above sum represented only an appropriation of profits and that it was not a diversion of income in favour of any third party by an overriding title. The Tribunal distinguished the decision of the Supreme Court in Poona Electric Supply Co. Lid. v. Commissioner of Income-tax with the following observations :

In the case cited by the assessee, the company carried on the business of distribution of electricity under a licence issued by the Government by Section 37(1) of the Electricity (Supply) Act, 1948, provisions of Schedule VI and VII were part of the licence and Schedule VI imposed a duty on the licensee to so adjust his rate for the sale of electricity by periodical revision that his clear profit in any year did not as far as possible exceed the amount of 'resonable return'. A part of the excess had to be either distributed in the form of proportional rebate or to be carried in the accounts to be distributed to the consumers under the directions of the State Government. The company claimed that the amounts so credited did not form part of the assessee's real profits. This contention was upheld by the Supreme Court. It will be seen that the facts in the case before us are entirely different.

5. The assessee attacks the view of the Tribunal by way of the first question set out above.

6. The facts leading to the second question as found by the Tribunal are these : Some members of the society sold their paddy to the society. After purchase such paddy was hulled by the society and it sold the rice to the other members of the society. The value of rice bags so sold came to Rs. 89,344 and the profit made by the society in these transactions amounted to Rs. 62,540. Though this sum was included by the society in its business income in the previous year ending June 30, 1960, at the stage of the assessment proceedings it claimed exemption in regard to this sum under Section 14(3)(i)(c) of the Indian Income-tax Act, 1922. The Income-tax Officer rejected the said claim on the ground that the rice sold did not belong to the members, that it is not an agricultural produce, that, therefore, the assessee, while selling rice to its members, cannot be said to market the agricultural produce of its members and that the income is assessable under the provisions of Section 14(3)(ii). There was an appeal to the Appellate Assistant Commissioner but without success. On further appeal to the Tribunal it was contended that as paddy could not be consumed as such it had to undergo some process to meet the consumers' market and that, therefore, rice continued to be an agricultural produce of the members of the society and that the assessee was entitled to the exemption under Section 14(3)(i)(c). The assessee relied on the decision in Commissioner of Income-tax v. P.K. Veeran, (1964] 54 I.T.R. 393 (Ker) in support of its stand. The Tribunal actually found that the paddy belonging to the members had been purchased by the society and thereafter hailed and the resultant rice was sold to the other members. It, therefore, held that the assessee was not entitled to exemption under Section 14(3)(i)(c) of the Act. The reasoning of the Tribunal is thus :

It cannot be said on the facts of this case that the assessee was marketing the agricultural produce of its members. In the ultimate analysis what the assessee recovered was for the hulling of the paddy belonging to the members. When paddy was hulled and sold as rice, it was not the agricultural produce of the members that was sold. The paddy had undergone a process which is not the one usually employed for marketing the produce.

7. It is, in these circumstances, the second question came to be referred at the instance of the assessee.

8. The facts relating to the third question are these : The assessee donated a sum of Rs. 22,013 to the Madras Co-operative Training Institute in pursuance of a requisition made by the Registrar of Co-operative Societies for the purpose of upgrading the institute into a Co-operative Training College. The assessee claimed exemption of this amount under Section 15B and this claim was rejected by the Income-tax Officer on the ground that the college had not started functioning and that, in any event, it has not been affiliated to any University, that the contribution was not to a recognised institution nor was it a donation for a charitable purpose. There was an appeal to the Appellate Assistant Commissioner wherein the assessee's claim for exemption was accepted on the ground that the claim came under section 15b(2)(v). The revenue took the matter in appeal before the Tribunal. It was urged by the revenue that the college has not started functioning and that, in any event, it was not an institution financed either wholly or partly by the Government. The Appellate Tribunal held that the assessee was not entitled to claim exemption as regards the said sum under section 15b(2)(v). In that view the Tribunal allowed the department's appeal in this regard.

9. As regards the first question, Mr. Padmanabhan, learned counsel for the assessee contends that the reserve created in pursuance of bye-law 37(a)(3) cannot be treated as an appropriation of profits, that it is a statutory obligation of the society to create that reserve and that, therefore, it cannot be taken as the income of the society. According to the learned counsel, even if the obligation to create a reserve under bye-law 37(a)(3) is not statutory, still it -has to be treated as diversion at source by an overriding title and even a diversion on the basis of contractual obligations has been recognised in various decisions as not amounting to appropriation of profits. Reference has been made to the decision of the Privy Council in Bejoy Singh Dudhuria v. Commissioner of Income-tax, [1933] 1 I.T.R. 135 (P.C.). In that case by a compromise decree an owner of an impartible estate was made liable to pay an annual maintenance' of Rs. 1,100 to his step-mother out of such estate and the maintenance was charged thereon. The Privy Council held that there was a diversion of income pro tanto from the Rajah who received the income from the impartible estate of the step-mother, that it was not the application by the Rajah of a part of his income in a particular way and that there is a diversion of income to the step-mother even at the source. The test propounded in that case was to find out whether there is allocation of a sum out of the assessee's revenue before it becomes income in his hands or whether the obligation is merely to apportion the income after it has been received by the assessee. If any obligation to apply the income had arisen before the income accrues or arises to the assessee, it will result in the diversion of income, but if the obligation to apply the income is imposed after the income has accrued or arisen, it will merely amount to an appropriation of income.

10. In this case the first question to be considered is whether the obligation to create a reserve is by a statutory or overriding title. For that purpose it has to be seen whether the bye-law is statutory. We are of the view that the said bye-law, though it may have a statutory basis in that the society is authorised to make its bye-laws under the Co-operatives Societies Act with the approval of the Registrar of Co-operative Societies, it cannot be said to have any statutory force. Bye-laws can be amended from time to time with the approval of the Registrar by the general body of the society. Therefore, it cannot be said that the bye-law has been made by any statutory authority exercising control over the society. If the bye-law is held to have no statutory effect, then it has to be seen whether the diversion of income was contemplated even at the source. The bye-law provides that 75% of the profits made on the procurement scheme shall be carried to a special reserve to meet business losses and depreciation. This clearly indicates that the diversion of income is not at the source but it is only after the income has accrued to the assessee. An obligation to apply an income in a particular way before it is received by the assessee or before it is accrued or arisen to him results in the diversion of income. But the obligation to apply the income which has accrued or arisen or has been received amounts merely to the apportionment of income. As pointed out by Samoath Iyengar in his book on Law of Income-tax, 6th edition, at page 194, the true test for the application of the rule of diversion of income by an overriding title is to find out whether the amount sought to be deducted in truth never reached the assessee as his income. There is a clear distinction between a diversion of income by an overriding title and an application of the income by the assessee's own choice, he being under no obligation to provide for any such payment. In this case the society by its own bye-law has earmarked the profits earned for a particular purpose by creating a reserve and such creation of a reserve by the assessee itself for its own purposes cannot constitute a diversion in law or by a superior title.

11. The Privy Council in P.C. Mullick v. Commissioner of Income-tax, [1938] 6 I.T.R. 206 (P.C.) dealt with a case where a testator had by his will directed the executors to pay Rs. 10,000 towards the expenses of his Addya Sradh and also obtaining the probate of his will from and out of the income from his properties. The question was whether the payments made for sradh expenses and towards the probate in pursuance of an obligation imposed by the testator could be excluded in computing the chargeable income of the estate. The Judicial Committee held that it was not a case in which a portion of the income was by an overriding title diverted from the person who otherwise would have received it as in Raja Bejoy Singh Dudhuna v. Commissioner of Income-tax, but a case in which the executors having received the whole income apply a portion of it in a particular way. In that view the claim for deduction was held to be unsustainable. In Commissioner of Income-tax v. Sitaldas Tirathdas, , an assessee put forward a claim for deduction of certain amounts paid by him as maintenance to his wife and children under a decree of a court passed by consent in a suit. No charge on any property of the assessee was created. While dealing with the sustain ability of the claim for deduction, the Supreme Court expressed :

"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, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible ; but where the income is required to be applied to discharge an obligation after 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 the person to whom it is payable."

12. Applying the above test it was held in that case that the wife and children received a portion of the income of the assessee after the income had been received by him as his own and, therefore, it is one of application of a portion of the income to discharge the assessee's own obligation and not a case in which by an overriding charge the assessee became only a collector of another's income.

13. In Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax, the Supreme Court held that the amounts credited by an electric supply company to the "consumers' benefit reserve account" being part of excess amounts paid to it and reserved to be returned to the consumers did not form part of the assessee's real profits and, therefore, in arriving at the taxable income of the assessee from business under Section 10(1) the amounts thus credited had to be deducted. The court observed :

"Income-tax is a tax on real income, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act. The real profit can be ascertained only by making the permissible deductions. There is a clear-cut distinction between deductions made for ascertaining the profits and distributions made out of profits. In a given case whether the outgoings fall in one or the other of the heads is a question of fact to be found on the relevant circumstances, having regard to business principles. Another distinction that shall be borne in mind is that between the real and the statutory profits, i.e., between the commercial profits and statutory profits. The latter are statutorily fixed for a specified purpose."

14. In Commissioner of Income-tax v. Bansi Dhar, [1965] 67 I.T.R. 374, 378 (Delhi), the assessee's father was the holder of certain shares in a private company. The assessee's father died in 1949, leaving behind him two sons (including the assessee) and two daughters. On such death the shares came to be registered in the assessee's name. But a portion of the dividend in respect of those shares was paid to his sisters in accordance with Article 7(e) of the articles of association of the company which provided that succession to the shares of a deceased shareholder shall be in accordance with Hindu (Mitakshara) law subject to certain conditions, one of the conditions being that if the shares of a deceased shareholder are succeeded to by his sons, then the sons shall pay out of the dividends on the said shares a 1/4th share of what is left to each of the sons to all the daughters put together and that such payments shall be a first charge on the said dividends and made direct by the company out of the dividends due to the sons. It was held in that case that the amounts paid by the company to the assessee's sisters out of the dividends on their shares left by the father could not be assessed to tax in the hands of the assessee as they were diverted at source by an overriding title before they reached the assessee, nor could they be said to be payments made for or on behalf of the assessee. The reasoning of the learned judges in that case is this:

"The true legal position, in our view, is that the person in whose name the shares of a company stand registered is to be considered to be the owner thereof and the income by way of dividends yielded by such shares is ordinarily to be considered as assessable income, but the dividends must in law come to his hands, whether in actual fact or construclively. The constructive receipt would include cases where the law creates a fictional or notional income not in fact received by a shareholder."

15. In Hans Raj Gupta v. Commissioner of Income-tax, [1969] 73 I.T.R. 765, 770, 771 (Delhi), the court, after considering the various decisions, stated :

"The principles deducible from the above decisions are that if a person has assigned his source of income in such a manner that it ceases to be his, he cannot be taxed on that income but if, on the other hand, he merely applies the income in such a manner that it passes through him and goes over to another person he may be taxable on the income notwithstanding the legal obligation to apply it for the transferee. Profits attract tax ay soon as they come into being and the subsequent application thereof would be indifferent. But, if there is an overriding title created to divert the income from the assessee it cannot be considered as the income of the assessee at all. Such diversion by overriding title may be created either by a will or by law or by any other document. The crux of the problem always being--is it an application of income or a diversion at the source before becoming the income of the assessee."

16. On the facts of this case it cannot be said that there is a diversion of income even at source or that there has been an assignment of the source of income of the society. It is only after the assessse has earned his income a portion of the same was set apart as a reserve in pursuance of a bye-law which it has framed. Admittedly, there is no legal or statutory obligation to create the reserve in question. Therefore, it is only a matter of application of the income after it has been earned by the society. As tax is attracted as soon as the income is earned, the subsequent application thereof would not affect the liability to tax. We are, therefore, of the opinion that it is purely an application of income and not a diversion at the source. In every case the matter has to be decided on the construction of the deed, document or law creating the title. In our view, the Tribunal is right in holding that the sum of Rs. 1,05,357 set apart as a reserve under the bye-law was includible in the income of the assessee. The first question is, therefore, answered in the affirmative and against the assessee.

17. The second question involves the interpretation of Section 14(3)(i)(c) of the Income-tax Act, which runs as follows :

"The tax shall not be payable by a cooperative society in respect of its profits and gains of business carried on by it if it is a society engaged in the marketing of the agricultural produce of its members."

18. The finding of the Tribunal is that the assessee has purchased paddy from its members and, thereafter, hulled the same and sold the rice to the (1). other members of the society. According to the assessee the rice sold by the society is an agricultural produce of its members, and, therefore, it is entitled to the exclusion of the profits earned by such sales. The revenue, however, contends that rice is not an agricultural produce and that in any event it was its own produce when it sold it to the other members of the society. In the face of this contention it has to be considered whether rice sold by the society is an agricultural produce of its members.

19. The expression "agricultural produce" has not been defined in the Income-tax Act. The learned counsel for the assessee, however, refers to the definition of "agricultural produce" in Section 2(a) of the Agricultural Produce (Development and Warehousing) Corporations Act, 1956. Agricultural produce has been defined in Section 2(a) of that Act as meaning any of the following commodities :

(i) foodstuffs, including edible oil-seeds ; (ii) cattle fodder, including oil-cakes and other concentrates ; (iii) raw cotton, whether ginned or unginned, and cotton-seed, etc.

20. The assessee's learned counsel says that rice will definitely come under the word "food-stuffs". Reference is also made to the entry relating to cotton which shows that cotton whether ginned or unginned and cottonseed are agricultural produce. Relying on this definition it is said that merely because paddy has been hulled into rice to find a ready market it will not cease to be an agricultural produce. Reference is also made to Explanation (/) to Section 2(r) of the Madras General Sales Tax Act which is as follows:

"Agricultural or horticultural produce shall not include such produce as has been subjected to any physical, chemical or other process for being made fit for consumption, save mere cleaning, grading, sorting or drying."

21. In support of the contention that in the absence of any such provision in the Income-tax Act the expression "agricultural produce" has to be understood in a wide and comprehensive sense,

22. In State of Madras v. Saravana Pillai, (1956] 7 S.T.C. 541 (Mad.), the assessee grew arecanuts and gathered the same while they were still raw. They were then peeled and the kernels were, thereafter, sliced, boiled and dried. It is only after this process that the arecanuts were fit to be marketed and there is no market for them as gathered from the trees. The question was whether the cured arecanuts continued to be horticultural produce. It was held therein that where any agricultural or horticultural produce has to be subjected to a minimum processing before that produce can be marketed at all, it will still retain its character as agricultural or horticultural produce despite that minimum processing. In K. Subramania Pillai v. State of Tamil Nadu, [1970] 25 S.T.C. 448 (Mad.), Veeraswami C. J., speaking for the Bench, expressed the view that jaggery is not an agricultural produce and as such not exempt from tax under Section 2 (r) of the Madras General Sales Tax Act, as jaggery is the result of a process both physical and mechanical. In Commissioner of Income-tax v. P. K. Veeran, [1964] 54 I.T.R. 393 (Ker.), the question arose as to whether the profit made by the conversion of cocoanuts grown in the assessee's own garden into rotted husks and copra is exempt from tax under the provisions of Section 4(3)(viii) of the Act having regard to the definition of agricultural income in Section 2(1)(b)(ii) of the Income-tax Act. The court took the view that the process employed by the assessee is a process ordinarily employed by a cultivator to render the produce raised fit to be taken to the market and, therefore, the assessee is entitled to the exemption.

23. The attempt of the learned counsel for the assessee in this case is to show that paddy as such has got a restricted market and that it is only after conversion into rice it will find a good market and, therefore, rice should be treated as having the same character as paddy which is admittedly an agricultural produce. To find out whether rice is an agricultural produce one has to see whether the process for converting paddy into rice is one which is ordinarily employed by a cultivator for the purpose of rendering the produce fit to be sold in the market, and whether the produce retains its original character in spite of the process. It cannot be said that there is no market for paddy at all and that the sale can only be that of rice. Hulling cannot be said to be a process which is normally employed by a cultivator to render the produce fit for market. A cultivator normally hulls paddy only for his personal consumption and it is not usual for an agriculturist to hull all the paddy produced by him and sell the resultant rice. It is not also possible to say that rice continues to have the same original character as paddy in spite of the process. Paddy and rice are separate marketable commodities. central act 28 of 1956 is a regulatory measure and, therefore, a comprehensive definition of agricultural produce has been given. We cannot, therefore, adopt the definition of agricultural produce in central act 28 of 1956 in this case. If we give a literary meaning to the expression "agricultural produce of its members " occurring in Section 14(3)(i)(c), it cannot be said that rice sold by the assessee is an agricultural produce of its members. Apart from the finding given by the Tribunal that the society has purchased paddy and itself hulled and sold, the rice, rice is not an agricultural produce normally sold by an agriculturist. Therefore, the Tribunal was right in holding that the assessee is not entitled to the exemption under Section 14(3)(i)(c). This question is, therefore, answered in the negative and against the assessee.

24. As regards the third question, we are, however, of the view "that the Tribunal's view is erroneous. It is not in dispute that the sura of Rs. 22,013 has been paid as a donation to the Co-operative Training Institute for the purpose of upgrading that institute into a training college. The reasons given by the Tribunal for holding that it is not entitled to the deduction under section 15b(2)(v) are that the college has not started functioning and that it is not receiving any financial help from the Government. section 15b(2)(v) says that the institution to which the donation is made should be an institution financed wholly or in part by the Government or a local authority in order to become eligible for the exemption. Admittedly the donation was made to the Co-operative Training Institute which is receiving financial help from the Government. The fact that the college has not come into existence or the upgrading of the institute into a college was partly with the funds collected from the various other co-operative societies in the State will not disable the assessee from claiming the benefit of exemption under Section 15B. We are, therefore, of the view that the assessee is entitled to claim the exemption in respect of the said amount paid as donation. The question is, therefore, answered in the affirmative arid in favour of the assessee. There will, however, be no order to costs.