JUDGMENT
S.P. Sinha, J.
1. At the instance of the assessee as required by the High Court a statement of the case has been made under Section 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 deducibility or otherwise of contingencies reserve in computing the taxable income of the assessee, the question needs to be refrained 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.
4. 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.”
5. When such is the diversity in the opinion of the High Courts I wish there had been a provision akin to Section 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.
6. 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 disallowing 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 Section 37(1) of the Act. According to the Tribunal, the expression “reserve fund” connoted a fund created out of distributable profits.
7. These are the relevant facts concerning the question at issue.
8. 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.
9. 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”.
10. 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.
11. 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.
12. 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.
13. 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.”
14. 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.
15. 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.
16. 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. [1914] 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.”
17. 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.
18. 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.
19. 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 ?
20. 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, I think it is a misnomer to call it “Contingencies Reserve”. A more appropriate name would have been “Reserve in Contingencies otherwise amount lost”.
21. I would accordingly answer the question, as refrained, in the affirmative and against the department. There will, however, be no order as to costs.
S. Sarwar Ali, J.
22. I agree.