PETITIONER:
POONA ELECTRIC SUPPLY CO. LTD.
Vs.
RESPONDENT:
COMMISSIONER OF INCOME-TAX, BOMBAY
DATE OF JUDGMENT:
19/04/1965
BENCH:
SUBBARAO, K.
BENCH:
SUBBARAO, K.
SHAH, J.C.
SIKRI, S.M.
CITATION:
1966 AIR 30 1965 SCR (3) 818
CITATOR INFO :
RF 1967 SC 477 (6)
RF 1973 SC2486 (8)
R 1973 SC2766 (9)
R 1986 SC 368 (16)
MV 1986 SC 757 (15)
ACT:
Income-tax Act (11 of 1922) s. 10(1)--Profit arrived at
after deducting amounts according to Electricity (Supply)
Act, 1948---Taxable income--If deductions can be allowed.
HEADNOTE:
The appellant-company was a commercial undertaking, doing
the business of supply of electricity subject to the
provisions of Electricity (Supply) Act, 1948. For the
purpose of rationalization of rates and keeping them under
control, the licensee was directed by the Act to adjust the
rates in such a way that the clear profit in any year did
not exceed the amount of reasonable return as defined in the
Act; but that if an excess was collected, the licensee
should distribute half of that excess by way of rebate to
the consumers, or carry the amount forward in the
accounts for distribution to the consumers. For the purposes
of the Act, during the accounting years, the assessee
credited certain amounts which formed part of the excess
collected to the "Consumers Benefit Reserve Account", and
claimed deduction of those amounts from the taxable income.
The Income Tax Officer and the Appellate Assistant
Commissioner disallowed the claim, but the Tribunal allowed
the deductions. The High Court, on a reference, held against
the assessee.
In it appeal to this Court the appellant contended that
there was a distinction between commercial accurancy,. As a'
profit" under the Electricity (Supply) Act and that the real
or commercial profit under s. 10(1) of the Income Tax Act,
1922, could be determined only after excluding the amounts
statutorily transferred to the "Consumers Benefit Reserve
Account", for, that amount represented a rebate to the
consumers, of the excess amount: collected from them.
HELD: As a business concern the real profit of the
appellant had to be ascertained on the principles of
commercial accountancy. As a licensee governed by the
statute its "clear profit" was ascertained in terms of the
statute and the schedule annexed thereto. The two profits
are for different purposes-one for commercial and tax
purposes and the other for statutory purposes in order to
maintain a reasonable level of rates. The amounts for which
deduction was claimed were a part of the excess amount paid
to the assessee and reserved to be returned to the
consumers. They did not form part of the assessee's real
profits, and therefore, to arrive at the taxable income of
the assessee from the business, under s. 10(1) of the
Income-tax Act the said amounts had to be deducted from its
total income. [827G-828A]
The income tax is a tax on the real income, that is the
real 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. It is a question of fact to be found on the
relevant circumstances, having regard to business
principles. Another
819
distinction that should be borne in mind is that between the
real and the statutory profits, that is between the
commercial profits and statutory profits. The latter are
statutorily fixed for a specified purpose. The real profit
of a businessman under s. 10(1) of the Incometax Act, cannot
,obviously include the amounts returned by him by way of
rebate to the consumers, under statutory compulsion, from
the statutory profits. [822C, 827E, F]
Case law referred to.
JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeals Nos. 633 and
634 of 1964.
Appeals from the judgement and order dated July 23 and
24, 1962 of the Bombay High Court in Income-tax Reference
No. 61 of 1961.
A. V. Viswanatha Sastri, S.N. Vakil, T.A. Ramachandran,
1. B. Dadachanji, O.C. Mathur and Ravinder Narain, for the
appellant (in both the appeals).
Niren De, Additional Solicitor-General, R. Ganapathy
lyer and R.N. Sachthey, for respondent (in both the
appeals).
A.V. Vishwanatha Sastri, M.N. Shroff and 1. N. Shroff,
for the Intervener (in all the appeals).
The Judgment of the Court was delivered by
Subba Rao, J. The appellant, the Poona Electric Supply
Co., Ltd., hereinafter called the Company, carried on the
business of distribution of electricity in the city of Poona
under a licence issued by the Government. Under the relevant
provisions of the Electricity (Supply) Act, 1948, (Act 54 of
1948), hereinafter called the Act, the Company’s “clear
profit” in any year should not, as far as possible, exceed
the amount of “reasonable return” as defined under the Act.
The excess, if any, after making some deductions, the
Company has to distribute to its consumers in the form of
rebate. During the assessment years 1953-54 and 1954-55 the
Company claimed deduction of two amounts of Rs. 42,148/- and
Rs. 77,138/- for the said two years from its taxable income
as they were credited to “Consumers Benefit Reserve
Account”. The Income-tax Officer disallowed the claim; and
on appeal the Appellate Assistant Commissioner agreed with
the Income-tax Officer. On a further appeal, the Income-tax
Appellate Tribunal accepted the contention of the appellant
and allowed the deductions. At the instance of the Revenue,
the Tribunal submitted the following question of law to the
High Court of Judicature at Bombay for its opinion:
“Whether the two sums of Rs. 42,1481- in
the assessment year 1953-54 and Rs. 77,138/-
in the assessment year 1954-55 were deductible
in computing income, profits and gains
from the assessee’s business assessable to
tax.”
820
A Division Bench of the said High Court answered the
question in the negative and against the appellant. The
present appeals have been filed by the Company after
obtaining the requisite certificate from the High Court.
The argument of Mr. A.V. Viswanatha Sastri, learned
counsel for the appellant, may be summarised thus: (1) There
is a distinction between commercial profit of a company and
“clear profit” under the Act—one is arrived at on
commercial principles and the other is regulated by the
statute; the real profit of a company under s. 10(1) of the
Indian Income-tax Act can be determined only after excluding
the amount statutorily transferred to the “Consumers Benefit
Reserve Account”, for that amount represents a rebate to the
customers of the excess amount collected from them. (2) As
the reservation of a part of the said excess is a statutory
condition subject to which the Company carries on its
business, it is an expenditure wholly and exclusively
incurred for the purpose of the Company’s business and,
therefore, it is an allowance deductible under s. 10(2)(xv)
of the Income-tax Act for computing the profit of the
Appellant’s business. (3) The Company follows the mercantile
system of accounting and, therefore, the amount of rebate so
reserved is deductible for arriving at the commercial profit
of the Company in the year when the statutory liability
arises and not when the amount is actually paid; and in the
present case the statutory liability for the said two
amounts arose in the accounting years of 1952 and 1953.
Learned Additional Solicitor General contended that (1)
under the relevant provisions of the Act the transference of
a part of the said excess to the consumers benefit reserve
account would only amount to apportionment or distribution
of the profit after it has been earned and, therefore, it is
not a deductible item for ascertaining the profit of the
Company under s. 10(1) of the Income-tax Act; (2) the said
amounts could not be said to be an expenditure wholly and
exclusively incurred for the purpose of the business, as the
expenditure was not incurred either during the course of the
business or for the purpose of earning the profits of the
business, but was only apportioned or distributed from and
out of the profits already earned.
To appreciate the rival contentions and to arrive at a
satisfactory solution it will be necessary to notice the
relevant provisions of the Act and of the Income-tax Act.
The gist of the relevant provisions may be stated thus:
No person can supply electric energy in any area unless he
has obtained a licence from the State Government under s.
3(1) of the Indian Electricity Act, 1910 (9 of 1910). The
Act, i.e., The Electricity (Supply) Act, 1948, provides for
the rationalization of the production and supply of
electricity and generally for taking
821
measures conducive to electrical development. One of its
main objects is to prevent such licensees from charging
unreasonable rates to the detriment of the consumers. Under
s. 57(1) of the Act the provisions of the Sixth Schedule and
the table appended to the Seventh Schedule thereto are
deemed to be incorporated in the licence of every licensee.
Paragraph I of the Sixth Schedule imposes a duty on every
such licensee to so adjust his rates for the sale of
electricity by periodical revision that his clear profit in
any year shall not, as far as possible, exceed the amount
of “reasonable return”. The expressions “clear profit”
and “reasonable return” are defined. Under Para. II thereof
if the clear profit of a licence in any year of account is
in excess of the amount of reasonable return, one-third of
such excess, not exceeding 7 1/2% of the amount of
reasonable return, shall be at the disposal of the
undertaking; one half of the said excess shall either be
distributed in the form of a proportional rebate on the
amounts collected from the sale of electricity and meter
rentals or carried forward in the accounts of the licensee
for distribution to the consumers in future in such manner
as the State Government may direct. It is, therefore, clear
from these provisions that for the purpose of
rationalization of rates and keeping them under control the
licence is directed to adjust his rates in such a way that
his clear profit in any year shall not, as far as possible,
exceed the amount of reasonable profit; but if an excess is
collected, the licensee shall distribute half of that excess
in the form of a proportional rebate to the consumers or
carry forward the same in his accounts for future
distribution to the consumers. Briefly stated, the scheme
of the provisions is that a part of the excess collected is
returned to the consumers by way of a rebate. The question
is whether the amount so returned or returnable by the
licensee to his consumers is deductible for ascertaining his
taxable income from his business under s. 10(1) or s.
10(2)(xv) of the Income-tax Act.
Learned Additional Solicitor General took us though the
various paragraphs of the Sixth Schedule to the Act and
argued that under them the licensee’s clear profit was
arrived at after all the deductions were made, including the
appropriations for all taxes on income and profits and,
therefore, the distribution of a part of the excess was only
a distribution out of the profits. There is plausibility in
this argument and at the first blush it appears to be
attractive. But there is an obvious fallacy underlying the
argument and that arises from the fact that the argument
equates the expression “clear profit” with that of
commercial profits. The object of the Act and that of the
Sixth Schedule thereto, as aforesaid, is to statutorily
rationalize and regulate the rates chargeable for the energy
supplied in the interest of the public and for electrical
development. The rules embodied in the Sixth Schedule to
the Act are intended only to achieve that object. Under the
said rules certain appropriations and certain deductions
have to be made to. arrive at the clear profit; otherwise
the items may be manipulated
822
to sustain a demand for abnormal rates. The rules have no
concern with income-tax; though for the purpose of arriving
at the clear profit the taxes paid are also deductible. If
this distinction is borne in mind, the problem presented is
easily and readily solved.
Under s. 10 (1) of the Income-tax Act, tax shall be payable
by an assessee under the head “profits and gains of
business” in respect of profits and gains of any business
carried on by him. The said profits and gains are not
profits regulated by any statute, but profits in a business
computed on business principles. They are business profits
and not statutory profits. They are real profits and not
notional profits. The real profit of a businessman under s.
10(1)of the Income-tax Act cannot obviously include the
amounts returned by him by way of rebate to the consumers
under statutory compulsion. It is as if he received only
from the consumers the original amount minus the amount he
returned to them. In substance there cannot be any
difference between a businessman collecting from his
constituents a sum of Rs. Y in addition to Rs. X by mistake
and returning Rs. Y to them and another businessman
collecting Rs. X alone. The amount returned is not a part
of the profits at all.
In this context some of the decisions cited at the Bar may
be of some help. In Pondicherry Railway Co., Ltd. v.
Commissioner of Income-tax, Madras(1). under an agreement
with the French Colonial Government the railway company had
to pay to the said Government half of its net profits
calculated as provided thereunder. One of the questions
that arose in the appeal was whether the appellant-company
was entitled to deduct the payments made under the agreement
with the said Government as being expenditure incurred
solely for the purpose of earning such profits within s.
10(9) of the Income-tax Act. In dealing with the question,
Lord Macmillan observed:
“A payment out of profits and conditional
on profits being earned cannot accurately be
described as a payment made to earn profits.
It assumes that profits have first come into
existence. But profits on their coming into
existence attract tax at that point, and the
revenue is not concerned with the subsequent
application of the profits.”
The learned Lord, after citing with approval
the principle laid down by Lord Chancellor
Halsbury in Gresham Life Assurance .Society v.
Styles(2), proceeded to observe:
“The word ‘profits’ I think is to be
understood in its natural and proper sense…
in a sense which no commercial man would
misunderstand. But once an individual or
(1) [1931] L.R. 58 A.C. 239, 251-252, 252.
(2) [1892] A.C. 309.
823
a company has in that proper sense ascertained
what are the profits of his business or his
trade, the destination of those profits or the
charge which has been made on those profits by
previous agreement or otherwise is perfectly
immaterial. The tax is payable upon the
profits realized, and the meaning to my mind
is rendered plain by the words ‘payable out of
profits.”
The distinction between payment out of profits and a payment
to earn profits is unexceptionable. The difficulty is to
ascertain in each case whether a particular payment falls
under one or other of the two categories. The statement in
the aforesaid observations that a payment conditional on
profits being earned cannot be a payment made to earn
profits has been modified and explained by the Privy Council
in The Indian Radio and Cable Communications Cornpony, Ltd.,
v. The Commissioner of Income-tax, Bombay Presidency &
AdenC). There, their Lordships were dealing with a case of a
joint venture by two companies; and Lord Maugham pointed
out thus:
“It may be admitted that, as Mr. Latter
contended, it is not universally true to say
that a payment the making of which is
conditional on profits being earned cannot
properly be described as an expenditure
incurred for the purpose of earning such
profits. The typical exception is that of a
payment to a director or a manager of a
commission on the profits of a company.”
To that extent the principle laid down by Lord Macmillan in
the case of Pondicherry Railway Co.(2) has been
modified. Lord Macmillan himself in a later decision in The
Union Cold Storage Co. Ltd., v. Adamson (H. M. Inspector of
Taxes)(3) explained his observations in the Pondicherry
Railway Co.’s case (2). There, the appellant-company leased
lands and premises abroad under a deed reserving a
particular rent per annum. The deed provided that if at the
end of any financial year it was found that after providing
for this rent the result of the Company’s operations was
insufficient to pay both interest on its charges and
debentures and dividends at fixed rates on its preference
shares and also at least 10 per cent, on its ordinary
shares, the rent for the year was to be abated to the extent
of the deficiency, repayment of rent already paid being made
if necessary. The question raised in that case was whether
such repayments made were allowable as deductions in
assessing the Company’s income to income-tax. The House of
Lords held that they were allowable deductions. When the
observations of Lord Macmillan in the Pondicherry Railway
Co.’s case(2) were pressed upon the House in support of the
contention
(1) (1937) 5 I.T.R. 270, 277. (2) L.R. 58 A.C. 239.
(3) (1931) 16 A.C. 328, 331.
824
on behalf of the Revenue, Lord Macmillan explained his
earlier observations thus:
“When, therefore, in the passage referred
to by the Attorney-General in the Pondicherry
case I said that “a payment out of profits and
conditional on profits being earned cannot
accurately be described as a payment made to
earn profits”, I was dealing with a case in
which the obligation was, first of all, to
ascertain the profits in a prescribed manner,
after providing for all outlays incurred in
earning them, and then to divide them. Here
the question is whether or not a deduction for
rent has to be made in ascertaining the
profits, and the question is not one of the
distribution of profits at all.”
Though a contractual term of payment of rent operated after
the profits were ascertained and on the insufficiency to
meet certain obligations was discovered, the House of Lords
did not find any difficulty in holding that the deductions
for rent were made only for ascertaining the profits and not
for distributing the same. The decision of the Court of
Appeal in British Sugar Manufacturers, Ltd. v. Harris
(Inspector of Taxes(1) is rather instructive. There, a
company carrying on a manufacturing business agreed with two
other companies to pay them a stated percentage of its “net
profits” in consideration of their giving to the company the
full benefit of their technical and financial knowledge and
experience, and giving to the company and its directors
advice to the best of their ability. The question arose
whether in computing the profits of the company for the
purpose of income-tax, the company was entitled to deduct
the sums so paid as being money wholly and exclusively laid
out or expended for the purposes of the trade within Rule
3(a) of Cases I and II. Greene, M.R., pithily observed thus:
“Once you realise that as a matter of
construction the word “profits” may be used in
one sense for one purpose and in another sense
for another purpose, I think you have the real
solution of the difficulties that have arisen
in this case.”
Applying that test, the Master of the Rolls
held that:
“In the present case there are two funds of
so-called profits which come into the picture.
The first one is the fund which has to be
ascertained for the purposes of calculating
the 20 per cent …………………. Now
when that amount has been ascertained, that
fund has ceased to have any usefulness at all,
and it then becomes necessary to ascertain
what are the divisible profits, and for that
purpose, to take another account, which not
only would bring in depreciation, but would
also take into
(1) [1939] 7 I.T.R. 101, 105, 106, 108-109.
829
account the sum that had been paid out
to the Skoda works, and the Corporation upon
the taking of the first account.”
Romer, L.J., put the test in a different
way when he said:
“Is the payment that has to be made by
the trader under the contract in question a
mere division of profits with another party
or is it a payment to the other party, the
amount of which is ascertained by reference to
the profits?”
MacKinnon, L.J. stated much to the same
effect thus:
“The whole question in this, as in other
cases, is whether this, which is an annual
payment, is an annual payment to be taken into
account in order to ascertain the profits, or
is it an annual payment payable out of the
profits after they have been ascertained? I
think the true facts of this case are that it
is of the former character. The difficulty in
the case arises largely because of the
necessary ambiguity in the word “prof
its” and
the fact that in this agreement “profits” as
a word does appear; but “profits”, as I think,
quite clearly of a different description from
the annual profits or gains with which one is
concerned in assessing the income-tax.”
This decision accepts the principle that a contract or a
statute may provide for the ascertainment of two profits for
different purposes and the question to be decided in each
case is whether the amount claimed as deduction is payable
out of the real profits. The Judicial Committee again in
Raja Bejoy Singh Dudhuria v. Commissioner of Income-tax,
Calcutta(1) emphasized the concept of real income in the
context of payment of income-tax. Lord Macmillan, speaking
for the Board, after adverting to the Imperial System of
income-tax legislation, proceeded to observe:
“The correlative of the obligation to return
as income sums which are really charges upon
the taxpayer’s income is the right to
reimbursement of the tax on such
charges. The Indian Income-tax Act makes no
similar provision for the deduction
of tax at the source and the
consequent reimbursement of the taxpayer in
the case of such a charge as that to
which the revenues of the appellant are
subject ………………………… that
the omission from the Indian Act of any such
provision points rather to an
intention to tax, in Lord Davey’s Phrase, only
“the real income” of. the taxpayer, than to an
intention to impose, without right of
reimbursement, a tax on what is a charge upon
his income.”
(1) L.R. (1933) 60 I.A. 196, 202.
826
The concept of “real income” is also expounded in the
decision of the Bombay High Court in H.M. Kashiparekh & Ca.
Ltd. v. Commissioner of Income-tax, Bombay North (1).
There, under the managing agency agreement the managing
agent was under a duty to forgo up to one-third of its
commission where the profits of the managed company were not
sufficient to pay a dividend of 6 per cent. The contention
of the Revenue that such a surrender of the commission under
the provisions mentioned in the agreement was not deductible
for the purpose of income-tax was negatived. The principle
has been succinctly stated in the head note thus:
“The principle of real income is not to be
subordinated as to amount virtually to a
negation of it when a surrender or concession
or rebate in respect of managing agency
commission is made, agreed to or given on
grounds of commercial expediency, simply
because it takes place some time after the
dose of an accounting year. 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 statutory language.”
Now let us look at two of the cases on which strong
reliance is placed on behalf of the Revenue. In Mersey Docks
and Harbour Board v. Lucas(3) the harbour board was
empowered by Act of Parliament to levy dock dues to be
applied in maintaining the concern and in paying interest on
moneys borrowed; any surplus income remaining after meeting
these charges was directed to be applied in forming a
sinking fund to extinguish the debt incurred in the
construction of the docks. It went to reduce the capital
liability. The question was whether the sum carried to the
sinking fund, and the surplus carried to the following
year’s accounts, were “profits” within the meaning of the
Income-tax Acts. The House of Lords held that the surplus
was profit assessable to the incometax. In this case the
surplus income formed the sinking fund and was utilised to
pay off the debts of the harbour board; therefore, the Court
rightly held that the said amount was utilised by the board
from and out of its profits and, therefore, the said surplus
could not be an allowable deduction. The decision of the
Queen’s Bench Division in Paddington Burial Board v.
Commissioners of Inland Revenue(3) was also based on the
same principle. Under a public Act of Parliament a burial
ground was provided out of the poor rates, and fees were
charged to persons using it; any
(1) (1960) 39 I.T.R. 706, 707.
(2) (1883) 2 T.C. 25. (3) (1884) 2 T.C. 46.
827
surplus of income over expenditure was applied in aid of the
poor rates as required by the Act. It was held that the
surplus was a profit assessable to income-tax. It will be
seen that the burial ground was managed on behalf of the
Parish of Paddington and the surplus was applied for the
benefit of the parishners. In the words of Day, J., it was
a business carried on for the benefit of the rate-payers of
the parish of Paddington. This case also, therefore, dealt
with payments out of profits utilised for the benefit of
those on whose behalf the business was conducted. In Young
(H. M. Inspector of Taxes) v. Racecourse Betting Control
Board(1) the question that arose was whether the Racecourse
Betting Control Board was entitled in computing the profits
of the trade of totalisatot operator for the years 1953-54
and 1954-55 to deduct certain payments. The Board would be
entitled, under the appropriate statutes, to deduct payment
of moneys wholly and exclusively laid out or expended for
the purpose of trade. It was held in that case that the
said payments were all voluntary payments and were not made
for the purpose of the trade. This decision has no bearing
on the question raised before us.
The said decisions lead to the following results: Income-
tax is a tax on the real income, i.e., the 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. 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. If we bear
in mind these two principles there will be no difficulty in
answering the question raised.
The appellant-company is a commercial undertaking. It does
business of the supply of electricity subject to the
provisions of the Act. As a business concern its real
profit has to be ascertained on the principles of commercial
accountancy. As a licensee governed by the statute its
clear profit is ascertained in terms of the statute and the
schedule annexed thereto. The two profits are for different
purposes–one is for commercial and tax purposes and the
other is for statutory purposes in order to maintain a
reasonable level of rates. For the purposes of the Act,
during the accounting years the assessee credited the said
amounts to the “Consumers Benefit Reserve Account”. They
were part of the excess amount paid to it and reserved to be
returned to the consumers. They did not form part of the
asessee’s real profits. So, to arrive at the taxable
income of the assessee from the business
(1) (1959) 38 T.C. 452 (H.L.).
(D)5SCI–14
828
under s. 10(1) of the Act, the said amounts have to be
deducted from its total income.
In this view it is not necessary to express our opinion
on the question whether the said amounts would be allowable
deductions under s. 10(2)(xv) of the Act.
The next question is whether the amounts so reserved for
future payment were deductible in computing the income,
profits or gains from the assessee’s business for the
assessment years 1953-54 and 1954-55. It is not disputed
that the assessee adopts the mercantile system of
accounting. The liability to return the amounts was
incurred by the assessee during the relevant accounting
years. This Court held in Calcutta Co. Ltd., v.
Commissioner Income-tax, West Bengal(1) that where an
assessee maintained his accounts on mercantile basis, the
accrued liability and the estimated expenditure which it
would incur in discharging the same could be deducted from
the income of the accounting year in which the said
liability accrued. Indeed, this legal position was not
contested on behalf of the Revenue.
In the result we answer the question referred to the
High Court in the affirmative and in favour of the assessee.
The order of the High Court is set aside. The appeals are
allowed with costs.
Appeals allowed.
829