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Darbhanga Laheriasari Electric Supply. Corporation Ltd. v. Commissioner Of Income-Tax, Bihar
Judicial Opinion Summary
Factual and Procedural Background
The opinion arises from a statement of case presented under section 256(2) of the Income-tax Act, 1961 at the instance of the assessee. The central question posed was whether the creation of a "contingencies reserve" is deductible under section 37(1) of the Income-tax Act, 1961 — reframed by the court as whether the contingencies reserve is deductible in computing the taxable income of the assessee.
The assessee is a public limited company engaged in generation and distribution of electrical energy in Darbhanga and Laheriasarai under a licence granted under the Indian Electricity Act, 1910, and governed by the Electricity (Supply) Act, 1948 (as amended). The Sixth Schedule to the Supply Act required the company to create a contingencies reserve out of existing reserves or revenues. For assessment year 1962–63, the amount in issue was Rs. 6,187. The assessee claimed deduction for this amount, which was disallowed by the Income-tax Officer (ITO), the Appellate Assistant Commissioner (AAC) and the Tribunal. The Tribunal relied on the Supreme Court decision in Indian Molasses Co. (P.) Ltd. v. CIT, [1959] 37 ITR 66, and held that the assessee's dominion over the fund had not ceased and that the setting apart of the sum did not qualify as a deductible expenditure under section 37(1).
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the contingencies reserve is deductible in computing the taxable income of the assessee (i.e., whether creation of contingencies reserve is deductible under section 37(1) of the Income-tax Act, 1961).
Arguments of the Parties
The opinion does not contain a detailed account of the parties' legal arguments.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Cochin State Power & Light Corporation Ltd. v. CIT, [1974] 93 ITR 582 (Kerala High Court) | Held that the contingencies reserve is to be created from revenue (not profits) and, because of statutory restrictions on its use and requirements (investment, governmental approval), the amount was not at the disposal of the assessee and therefore could be excluded in determining taxable profits. | The court accepted the Kerala High Court's view as correctly stating the nature of the contingencies reserve and relied on that analysis in reaching its conclusion that the reserve is deductible. |
| Amalgamated Electricity Co. Ltd. v. CIT, [1974] 97 ITR 334 (Bombay High Court) | Accepted the view expressed by the Kerala High Court that the contingencies reserve was not at the disposal of the assessee and thus deductible. | The court noted that the Bombay High Court accepted the Kerala High Court view, and treated this concurrence as supportive of the position that the contingencies reserve is not at the assessee's disposal. |
| Vellore Electric Corporation Ltd. v. CIT, [1977] 109 ITR 454 (Madras High Court) | Held that the contingencies reserve, despite statutory restrictions, continued to belong to the assessee and therefore was within its control and not an expenditure or diversion of profit by overriding title. | The court recorded this directly opposite view and expressly disagreed with the reasoning of the Madras High Court, explaining why the limitations and governmental control meant the reserve was not at the assessee's disposal. |
| Indian Molasses Co. (P.) Ltd. v. CIT, [1959] 37 ITR 66 (Supreme Court) | Held that setting apart a sum as a reserve did not constitute expenditure under section 37(1) where the assessee's dominion over the fund had not ceased; the set-aside was an appropriation to a purpose on the happening of future events and not deductible as expenditure. | The Tribunal relied on this Supreme Court decision in disallowing the deduction. The present court recorded that reliance but ultimately accepted the contrary approach of the Kerala/Bombay High Courts in the particular statutory and factual context of contingencies reserves under the Sixth Schedule to the Supply Act. |
Court's Reasoning and Analysis
The court's analysis proceeded in a stepwise manner grounded in the character and statutory framework governing the contingencies reserve:
- The court first emphasized that the tax treatment of a fund described as a "reserve" depends on the nature and character of that reserve rather than the mere fact that money has been set apart.
- The court identified conflicting High Court authorities (Kerala and Bombay on one side accepting deductibility; Madras on the other rejecting it) and stated that it considered the Kerala and Bombay approach to be correct in the circumstances of the case.
-
The court examined the statutory scheme under the Electricity (Supply) Act, 1948 (Sixth Schedule) and the licence provisions:
- Paragraph III: requires an electric company to create a contingencies reserve from existing reserves or revenues.
- Paragraph IV: prescribes the annual appropriation limits (not less than 0.25% and not more than 0.5% of original cost of fixed assets per year) and a maximum aggregate limit (5% of original cost); requires investment of the appropriated sum in securities authorised under the Indian Trusts Act, 1882 within six months.
- Paragraph V: debars drawing upon the reserve except on three specified contingencies (expenses or loss of profits from unavoidable accidents/strikes; replacement or removal beyond normal maintenance; compensation payable under law for which no other provision exists) and makes withdrawal during licence currency conditional on State Government approval that such a contingency had arisen.
- Sub-paragraph (2) of Paragraph V: provides that on purchase of the undertaking the contingencies reserve (after permitted deductions) shall be handed over to the purchaser and shall not figure as an asset of the selling company in the sense of being freely available when the company is sold; special rules apply where purchased by the Board or State Government.
- Paragraph IX: requires that excess proceeds on sale of a fixed asset (over written down cost) be credited to the contingencies reserve, limiting the seller's entitlement to more than written down cost.
- Section 67 of the Indian Electricity Act, 1910: makes observance of licence terms (including the Sixth Schedule provisions) imperative, with penalties for failure.
- On the basis of these statutory constraints — mandated creation irrespective of profit, strict limits on appropriation and investment, restricted modes of utilisation, requirement of State Government approval for withdrawals, and transfer/hand-over rules on sale or purchase of the undertaking — the court concluded that the contingencies reserve was not at the free disposal of the assessee.
- The court criticized the Madras High Court's contrary conclusion that the reserve remained under the assessee's control, illustrating (by analogy) that a mandated, externally controlled set-aside which cannot be used except in narrowly defined circumstances and only with governmental approval cannot sensibly be regarded as remaining within the assessee's dominion for tax purposes.
- The court therefore followed the reasoning of the Kerala and Bombay High Courts and answered the framed question in the affirmative (i.e., in favour of deductibility) based on the statutory character and limitations attached to the contingencies reserve.
Holding and Implications
Holding: The contingencies reserve is deductible in computing the taxable income of the assessee (the court answered the question as reframed in the affirmative and against the department).
Implications:
- Direct effect: The court allowed the assessee's claim as to the deductibility of the contingencies reserve in the context of the statutory scheme governing electric company licences; the opinion therefore goes in favour of the assessee on the issue before the court. The court directed that there would be no order as to costs.
- Relation to precedent: The court expressly aligned with the Kerala and Bombay High Courts' approach and rejected the contrary view of the Madras High Court for the statutory context examined. The opinion records that the Tribunal had relied on Indian Molasses Co. (P.) Ltd. v. CIT, [1959] 37 ITR 66, but the court's conclusion in this statutory context was contrary to the Tribunal's decision based on that authority. The opinion does not state or declare that it is laying down a general new principle beyond the present statutory facts; it resolves the present question in the assessee's favour under the Sixth Schedule and licence framework described.
- Costs and concurrence: The court ordered no costs, and the opinion records that S. Sarwar Ali, J. agreed with the reasoning and conclusion.
S.P Sinha, J.:— At the instance of the assessee as required by the High Court a statement of the case has been made under s. 256(2) of the I.T Act, 1961 (hereinafter to be referred to as “the Act”). The question on which the statement has been made is:
“Whether, on the facts and in the circumstances of the case, the creation of contingencies reserve is deductible under section. 37(1) of the Income-tax Act, 1961?”
2. Since the real controversy between the parties relates to the deductibility or otherwise of contingencies reserve in computing the taxable income of the assessee, the question needs to be reframed in the following manner:
“Whether, on the facts and in the circumstances of the case, the contingencies reserve is deductible in computing the taxable income of the assessee?”
3. This question has been the subject-matter of answer by three of the High Courts, namely, the Kerala High Court, the Bombay High Court and the Madras High Court. The view expressed by the Kerala High Court in the case of Cochin State Power & Light Corporation Ltd. v. CIT, [1974] 93 ITR 582, has been accepted by the Bombay High Court in Amalgamated Electricity Co. Ltd. v. CIT, [1974] 97 ITR 334. These two High Courts have taken the view that the amount kept in the said reserve is not one which is at the disposal of the assessee in the matter of its application and, therefore, it was deductible in computing the assessee's taxable income. The Madras High Court in the case of Vellore Electric Corporation Ltd. v. CIT, [1977] 109 ITR 454, has, however, taken a directly opposite view holding that like any other reserve created by the assessee, this reserve was within the control of the assessee and available to it for its purpose. It has been observed (page 462):
“Simply because the statute has imposed certain restrictions on the manner of utilisation of the amount credited to the reserve it cannot be held that the appropriation of the amount to such reserve constitutes an expenditure or diversion of profit by overriding title or that the amount was lost to the assessee.”
4. When such is the diversity in the opinion of the High Courts I wish there had been a provision akin to s. 257 of the Act, authorising the High Court in such circumstances as the present one, to directly refer the matter to the Supreme Court for its opinion. Such opinion would not only settle the controversy, but also save time and expenditure of the, litigating parties. Be that as it may, since the question has now been posed before this court for opinion, I proceed to consider it.
5. The relevant facts are that the assessee is a public limited company carrying on business of generating and distributing electrical energy in the towns of Darbhanga and Laheriasarai within the municipal limits of the towns. The company was established under a licence granted by the Government of Bihar under the provisions of the Indian Electricity Act, 1910. The working of the company is governed by the Electricity (Supply) Act, 1948 (hereinafter referred to as the Supply Act), as amended by the Electricity (Supply) Amendment Act, 1966, and the rules framed-thereunder. According to the provision contained in Paragraph III of the Sixth Schedule of the Supply Act the assessee-company was under an obligation to create a reserve to be called “contingencies reserve”, the reserve to be created out of the existing reserves or from the revenues of the undertaking in such accounting year. For the assessment year in question, which is assessment year 1962–63, the amount of such contingencies reserve was Rs. 6,187. The assessee claimed to deduct it but the same was disallowed throughout by the ITO, by the AAC and also by the Tribunal. The Tribunal, while dis allowing the assessee's claim relied upon a decision of the Supreme Court in the case of Indian Molasses Co. (P.) Ltd. v. CIT, [1959] 37 ITR 66 and observed that the assessee's dominion over the fund had not ceased to exist. It was a sum of money set apart to be appropriated to a purpose on the happening of future events. Such setting apart did not qualify for deduction as expenditure in terms of s. 37(1) of the Act. According to the Tribunal, the expression “reserve fund” connoted a fund created out of distributable profits.
6. These are the relevant facts concerning the question at issue.
7. There can be no doubt that when one speaks of “reserve fund” it always connotes setting apart of some money for future use, the source being either the profits of the year or, as in the case of contingencies reserve, the existing reserve or the revenues of the undertaking. But merely because a certain amount has been set apart and a reserve fund, has been created, it does not necessarily spell out a taxable profit kept in reserve. It is the nature and character of the reserve which will determine its taxability or otherwise.
8. Now, as I have observed earlier, decisions concerning the character and the nature of the reserve have been at variance between the Madras High Court on the one side and the Kerala High Court and the Bombay High Court on the other. Having gone through the said decision, I am of the opinion that the view expressed by the Kerala High Court and the Bombay High Court expound the correct nature of the “Contingencies Reserve”.
9. As stated earlier, the working of the company is governed by the Electricity (Supply) Act, 1948. It will, therefore, be necessary to advert to some of the provisions relevant in respect of the creation of the reserve called “contingency reserve”. The Sixth Schedule of the said Act lays down the necessary provisions in that regard. Paragraph III of the Sixth Schedule requires an electric company to create a reserve called “contingencies reserve” from the existing reserve or from the revenues of the undertaking. Paragraph IV of the said Schedule specifies the limit of the amount which can be credited in each account year to the said reserve fund. It provides that 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 shall be appropriated to the contingencies reserve account. The said paragraph further provides the maximum limit of the appropriation of the revenues to the said reserve fund. Such maximum limit has been put at five per centum of the original cost of the fixed assets. No appropriation beyond the said percentage can be made to the said reserve fund. Sub-para. (2) of para. IV of the said Schedule enjoins upon the company to invest the sum appropriated to the contingencies reserve in securities authorised under the Indian Trusts Act, 1882. Such investment has to be made within six months of the close of the accounting year in which the appropriation is made.
10. Paragraph V of the Schedule debars the company from drawing upon the said reserve fund except on the happening of three contingencies. Those 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.
11. Besides this hurdle, there is yet another hurdle, namely, that it would only be for the State Government to decide whether at all a contingency, as may require drawing upon the contingencies reserve, had arisen. The paragraph states that the “contingencies reserve” shall not be drawn upon during the currency of the licence excepting to meet such charges as the State Government may approve (as being a contingency of the nature as stated). Therefore, the assessee's right to draw upon the contingencies reserve not only depends upon the happening of any of the contingencies mentioned in the said paragraph but further depends on the approval of the State Government which will say whether any such contingencies had actually arisen.
12. Further, according to sub-para. (2) of para. V, such reserve could not figure as an asset of the assessee when the company was being sold out. The said sub-paragraph of Para. V of the said Schedule lays down:
“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 to the State Government, as the case may be.”
13. Paragraph IX of the said Schedule lays down that when any fixed asset is sold for an amount exceeding its written down cost, the excess, after deducting all taxes payable thereon, shall be credited to the contingencies reserve. In effect, therefore, this provision means that even if the application of the contingencies reserve might have meant an improvement in the value of the fixed asset, the assessee will not be entitled to receive anything more than the written down cost when such asset is sold.
14. These terms of the Sixth Schedule are to be entered in the licence of the electrical company. Section 67 of the Indian Electricity Act, 1910, makes the observance of the terms and conditions of the licence imperative. Failure to do so may entail penalty.
15. Such being the terms and conditions of the contingencies reserve the Kerala High Court observed in the case of Cochin State Power & Light Corporation Ltd., [1974] 93 ITR 582, 592:
“In fact, as I have indicated, this reserve is to be created from out of the revenue and not out of the profits and it is irrespective of the question whether the assessee makes a profit or not. It is related to the original cost of the fixed assets. Though the amount of the reserve could be utilised for certain purposes, the nature of the purposes indicated in para. IV of the Sixth Schedule is sufficient to show that the purposes are not so general as in the case of development reserve…contingencies reserve can be utilised only in certain specified contingencies. The amount of the reserve had to be invested in securities authorised under the Indian Trusts Act, 1882, and that had to be made within a specified time. Paragraph V provides that the contingencies reserve shall not be drawn upon during the currency of the licence except for meeting such charges as the State Government may approve.”
16. Having enumerated the various provisions contained in the Sixth Schedule relating to Contingencies Reserve, the final conclusion was that the amount is not one which was at the disposal of the assessee and that, therefore, be excluded in determining the real profits of the assessee.
17. The Madras High Court in Vellore Electric Corporation Ltd. v. CIT, [1977] 109 ITR 454, on the same facts, has come to the conclusion which I have already mentioned above, namely, that notwithstanding all those restrictions, the reserve amount continued to belong to the assessee and, therefore, could neither constitute an expenditure nor diversion of profit by overriding title nor any amount lost to the assessee.
18. Having regard to the nature of the said reserve it is difficult to appreciate the Madras High Court's view that the assessee had not lost its control over the said reserve. For example, if a person in authority were to command his constituent to set apart a sum of Rs. 10 every day out of the total receipts of the day and put the same through the slit in a box whose key was not held by the constituent and then further laying down the condition that the constituent will not use the money so set apart for any purpose other than his illness or marriage in the family adding a rider that it will be for the authority to decide as to whether the contingencies relating to illness or marriage in the family had actually arisen over and above those if the further condition put upon the constituent be that after his retirement the money, if unspent, will remain as it was to be passed on to his successor who will be doing likewise in the matter, what sort of control the said constituent will be deemed to be having over the money which was being set apart by him every day? There is yet another aspect of the matter. The creation of the reserve has no link with the profit or loss of the business and it has to be created from the existing reserve or from the revenues of the undertaking. Bearing these aspects relating to the nature of the Contingencies Reserve in mind,-1 think it is a misnomer to call it “Contingencies Reserve”. A more appropriate name would have been “Reserve in Contingencies otherwise amount lost”.
19. I would accordingly answer the question, as reframed, in the affirmative and against the department. There will, however, be no order as to costs.
S. Sarwar Ali, J.:— I agree.
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