JUDGMENT
G.T. Nanavati, J.
1. In this reference under section 256(1) of the Income-tax Act, 1961, the Income-tax Appellate Tribunal has referred the following two questions to this court for its opinion :
“1. Whether, on the facts and in the Circumstances of the case, the assessee was entitled to deduction of Rs. 78,273 form its total income ?
2. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in deciding the issue whether the assessee was liable to pay any amount to the Government when the both the Income-tax Officer and the Appellate Assistant Commissioner granted it that the assessee was so liable and decided the appeal on the principles of application of income or diversion by overriding title ?”
2. This reference has been made at the instance of the Rajkot District Gopalak Co-operative Milk Producers’ union Limited which was initially known as “Rajkot Jilla Milk Co-operative Union” and then as “Rajkot Jilla Gopalak Sahkari Sangh”. In the year 1969, the assessee approached the Gujarat Government to hand over the milk conservation project which was till then run by the Government. As the said project was running into losses, the Government agreed to transfer the working of that running into losses, the Government agreed to transfer the working of that project to the assessee temporarily on an experimental basis for a period of twelve months. A resolution to that effect was passed by the Government on July 31, 1969, and in the said resolution, the terms and conditions on which the said project was handed over to the assessee were set out. Broadly stated, the assessee was given an licence for a period of twelve months to run the said project on a nominal licence fee of Re. 1 per month. All the properties and assets of the project were to continue to be the properties and assets of the Government and though the assessee was permitted to add to the establishment the fixed and movable assets, a clear provision was made that no legal or financial liability was to devolve upon the Government in consequence of such additions. The assessee was to arrangement for the working capital. The employees employed in the said project were to be treated as on deputation till the licence continued. All matters relating to the working and business of the dairy project including fixation of the price for purchase and sale of milk and milk products were to be decided by the assessee, but in case of difference between the assessee and the two nominees of the Government who were to be members of the managing committee, the decision of the Government was to be regarded as final. The assessee was to maintain a trading account and a profit and loss account in the manner prescribed by the agreement and profits and losses were also required to be worked out on the basis which was followed by the Government in respect of that project. Profits,if any, made were first to be passing the resolution were determined at Rs. 64,670 as on March 31, 1968 and by the time the agreement became effective amounted to Rs. 78,273. Losses, if any were to be borne by the assessee. Pursuant to this resolution and arrangement between the parties, the assessee took over the project of February 21, 1970. The assessee took over the project on February 21, 1970. The assessee being a co-operative society was required to draw up its accounts as on the 30th day of June every year. For the accounting period July 1, 1970, to June 30, 1971 the assessee made a profit of Rs. 1,25,840 from the business of the dairy project, but filed a nil return in view of various deductions claimed by it. The Income-tax Officer did not accept all the claims for deduction and the assessable income was computed at Rs. 94,000. The assessee preferred an appeal against the order. The Appellate Assistant Commissioner found that the assessment was not properly made as the return filed by the assessee was defective. He was of the view that the unit of assessment should be the society itself and that the society should show the income or loss from all its activities and not merely the activity of the milk project. The assessee, therefore, filled a revised return showing not only the profit made by the dairy project but also other profits made by the other business of the society. Thus, the total profit was shown at Rs. 1,73,273 but again claiming certain deductions, the assessee filed a nil return. The assessee claimed deduction of Rs. 78,273 paid by it to the Gujarat Government towards losses as per the terms and conditions of the leave licence agreement. The Income-tax Officer disallowed that claim treating that payment as the application of its income by the assessee and rejecting the contention that as the said contention that as the said payment amounted to diversion of income by overriding title, that sum cannot be regarded as the real income of the assessee. In appeal, the Appellate Assistant Commissioner upheld that view. The Tribunal also confirmed that view and dismissed the assessee’s second appeal.
3. What is contended by learned counsel appearing for the assessment that the Tribunal has not properly appreciated the true nature of payment of Rs. 78,273 to the Government and wrongly held that the said payment was by way of application of its income by the assessee. In support of his contentions, he draw our attention to various clauses of the terms and conditions on which the dairy project was handed over by the Government and also some decisions of High Courts. He emphasised the fact that only the management of the milk conservation project or dairy project was transferred by the Government to the assessee. Again, it was for a temporary period and on an experimental basis. The licence could have been terminated by giving one month’s notice. He then contended, relying upon clause 6 of the terms and conditions that profits, if any, were first to be applied to the accumulated losses of the project. The profits derived were thus to be applied to the accumulated losses of the dairy project and that clearly indicated that there was an obligation cast upon the assessee to discharge its liability before the profits reached the till. Therefore, this was a clear case of diversion of income by an overriding charge. He submitted that as held by this court in Udayan Chinubhai v. CIT [1978] 111 ITR 584, income taxable under the Income-tax, 1961, is the real income of the assessee. In determining real income, the question is not of any physical receipt of income but of the concept of the receipt in law As pointed out by the Supreme Court in CIT v. Sitaldas Tirathdas [1961] 41 ITR 367, the true test in deciding whether income has been diverted by overriding title is to be see 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 reached 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. In H. M. Kashiparekh and co. Ltd. v. CIT [1960] 39 ITR 706, the Bombay High Court has also pointed out that it was the real income of the assessee that was liable to tax. The Bombay High Court further pointed out that the principle of real income is not to be so subordinated as to amount virtually to a negation of it when payment is made or is required to be made some time after the close of an accounting year. It is pointed out that in examining any transaction and situation of this nature, the court would have more regard to the reality and speciality of the situation rather than the purely theoretical or doctrinaire aspect of it. It will lay greater emphasis on the business aspect of the matter viewed as a whole when that can be done without disregarding the statutory language.
4. Again, an amount paid by reference to profit, as pointed out by the Supreme Court in CIT v. Travancore Sugars and Chemicals Ltd. [1973] 88 ITR 1. can either be that it is paid after the profits become divisible or distributable or that the amount is payable prior to such distribution or division to be computed by reference to notional or what, in some decisions, is termed as apparent net profits. In the former instance, it will be a distribution of profits and not deductible as an expenditure incurred in running the business but in the latter, it may, on the facts and circumstances of the case, and the agreement or the nature of the obligation under the particular instrument which governs the obligation, be an expenditure incurred as a contribution to the profit-earning apparatus or incurred at the inception and deductible as an overriding charge on the profit-making apparatus or one laid out and expended wholly and exclusively for purposes of such business.
5. The Kerala High Court in CIT v. Travancore Sugars and Chemicals Ltd. [1973] 90 ITR 307, has observed that the statement that a payment conditional on profits being ascertained cannot be a payment to earn profits has not been accepted as absolutely correct. A payment conditional on profits being ascertained may also be diverted by overriding title.
6. The above decisions make it clear that what is taxable is the real income and it is that which reaches the assessee that has to be regarded as the real income. Payment to be made as a result of statutory or contractual obligation even though it may be related to the profits, may be in the nature of an obligation as a result of which profit to that extent is diverted by an overriding title. Thus, in such a case, what is required to be considered is the true nature of the obligation and the payment to be made to discharge the same.
7. As stated earlier, the assessee was given a right to run the dairy project on the leave and licence basis. The reason for doing so was that the Government was making losses in running that project. Since it was running into losses, the Government had decided to give it to the assessee on a nominal licence fee of Re. 1 per month. The assessee was under an obligation to maintain separate accounts for the dairy project in the same manner in which they were maintained earlier by the Government. If we look at the pr forma, it becomes apparent that the accounts to be maintained were that of the milk conservation project and they were required to be signed by the accounts officer and the officer on special duty of the milk conservation project. The milk conservation project was to be regarded as an independent entity and it was possibly for that reason that the assessee initially filed a separate return in respect of the income derived from the milk project. So far as the assessee’s own accounts were concerned, the assessee had shown the profits in the reserve account. It thus becomes clear that even though the assessee was given a right to run the project, a separate account with respect to profits made or losses suffered in running that project was to be maintained. It is in this context that we have to construe clause 6 of the terms and conditions which reads as follows :
8. “Profits and losses shall be worked out on the same basis as has been followed in respect of the dairy project so far, that is, is in the two pro forma for maintaining trading accounts and profit and loss accounts, respectively, which are appended herewith. Profits, if any, as might be derived by the Sangh under this agreement shall first be applied to be accumulated losses of the project which, according to the accounts of the dairy project, stood at Rs. 64,670 as on March 31, 1968, and which, for the purpose of this agreement, would be computed at the figure as on the date of commencement of this agreement. Losses, if any, shall be borne by the Sangh”.
9. The profits and losses which are referred to in this clause are in respect of the milk project. In this context, the words “profits, if any, as may be derived by the Sangh” would mean profits made by running the milk project and cannot mean profits earned by the assessee, in the sense that the assessee was free to distribute or use the profits in the manner it liked. The said clause speak of physical receipt of profits by the assessee and not receipt of profits in the ye of law. Out of these profits, accumulated losses were required to be wiped out and only thereafter, the net profits were to go to the assessee. Profits in the hands of the assessee would be that amount which remained with it after the payment contemplated by the agreement was made to the Government. Thus, this appears to be a clear case of diversion of profits by an overriding title. The Tribunal was, therefore, wrong in taking the view that this was a case of application of its own profits by the assessee.
10. In the case of M. K. Brothers P. Ltd. v. CIT [1972] 86 ITR 38 (SC), which was relied upon by learned counsel for the Revenue, the Supreme Court was not called upon to decide the question which we are required to consider in this reference. Question No.1 quoted by the Supreme Court indicated that such controversy did not arise up to the stage of reference to the High Court. But, before the Supreme Court, the only contention which was raised on behalf of the assessee was as to whether the payment which was made was in the nature of revenue expenditure and thus a permissible deduction. In the last but one paragraph, the Supreme Court has observed as under (at page 44) :
“The present is a case relating to the application of income to discharge a liability incurred not in the course of running the business but a liability undertaken for the purpose of acquiring the sole selling agency right which was indisputably an asset of capital nature.”
11. This decision of the Supreme Court, therefore, cannot help the Revenue.
12. For the reasons stated above, we answer question No. 1 in the affirmative, that is, in favour of the assessee and against the Revenue. In view of this answer, question No. 2 is not required to be answered and, therefore, we decline to answer the same. Reference is disposed of accordingly with no order as to costs.