Holding

The amount credited to the Contingencies Reserve is not a deductible business expense and must be included in the assessee’s taxable profit.

Summary

Associated Power Co. Ltd., an electricity generation and distribution company, appropriated Rs 46,460 to a Contingency Reserve as required by the Electricity (Supply) Act, 1948 and claimed it as a deduction for the assessment year 1973‑74. The Income Tax Officer rejected the claim; the Appellate Assistant Commissioner allowed it, but the Income‑Tax Appellate Tribunal set aside that order and referred the question to the Supreme Court. The Court examined whether the amount transferred to the Contingency Reserve is a deductible business expense or a statutory diversion of income. It held that the reserve is created from revenue, belongs to the company, and is meant to meet future contingencies, not a known liability, so the doctrine of diversion of income does not apply. Consequently, the amount must be taken into account in computing taxable profit and cannot be deducted. The Court answered the reference in favour of the Revenue, dismissing the assessee’s claim for deduction.

Issues considered

Whether the sum transferred to the Contingencies Reserve under the Electricity (Supply) Act, 1948 is allowable as a deduction in computing the taxable business income of an electricity company.

Legislation cited

Electricity (Supply) Act, 1948s. Sixth Schedule, clauses III, IV, V
Income Tax Act, 1961
Indian Trusts Act, 1882s. Section 2

Subjects

Income TaxDeductionContingency ReserveElectricity (Supply) ActDoctrine of Diversion of IncomeBusiness ProfitSixth ScheduleStatutory Reserve

Judgment

ASSOCIATED POWER CO. LTD. A
v.
COMMISSIONER OF INCOME TAX

NOVEMBER 28, 1995

[S.P. BHARUCHA, FAIZAN UDDIN AND S.B. MAJMUDAR, JJ.) B

Income Tax Act, 1961 :

Contingency Reserve Account-Amount set apart to meet contingen-
cies-Assessee owner thereof-Not a business expenditure-Hence not allow-
able as a deduction in aniving at the taxable business income.
c
Electricity (Supply) Act, 1948 :

Sixth Schedule-Clauses III, IV and V-Contingencies Reserve--
Created from the revenue of each year of account-Invested i!l securities D
authorised under the Indian Trusts Act, 1882-Within a period of six
months-Not to be drawn upon during cwTency of licence-Except to meet
specified charges with the approval of State Govemment-To be handed over
to the purchaser on purchase of the undertaking. Doctrine of diversion of
income-Applicability of.
E
These are references by the Income Tax Appellate Tribunal to this
Court under Section 257 of the Income Tax Act, 1961. The references have
been made because of a divergence of opinion between several High Courts.

The appellant - assessee is a company engaged in the business of
generation of electricity and distribution thereof to consumers. It is F
governed by the Electricity (Supply) Act, 1948.

By reason of the provisions of the Electricity (Supply) Act and of the
Sixth Schedule thereto, the appellant - assessee appropriated the sum of
Rs. 46,460 out of its revenue to a Contingency Reserve account during the G
previous year relevant to the Assessment Year 1973 • 74. This amount was
claimed by the appellant - assessee as a deduction in the computation of
its total income for the purpose of income tax. The I.T.O. rejected the
claim. The Appellate Assistant Commissioner allowed the assessee's ap-
peal. The Revenue filed an appeal before the Tribunal which set aside the
order of the Appellate Assistant Commissioner, but referred the following H
721
,._
722 SUPREME COURT REPORTS (1995] SUPP. 5 S.C.R.

A question. to, this Court
''Whether, on the facts and in the circumstances of the case, the
Income-tax Appellate Tribunal was correct in holding that the sum of Rs.
46,460 transferred to the Contingencies Reserve Account is not allowable
as a deduction in arriving at the taxable business income of the assessee-
B company?"

On behalf of the appellant-assessee it was contended that there was
no distinction between the Consumers' Benefit Reserve and the Contingen-
cies Reserve; that the amount credited to the Contingencies Reserve is ·a
C business deduction; and the doctrine of diversion of income is applicable.

Disposing of the references, this Court

HELD : 1. It is particularly noteworthy that the electricity company
can make good from out of the Contingencies Reserve even a loss of profit
D arising out of strikes, accidents and other circumstances over which it has
not control. There can be no doubt, in the circumstances, that the monies
in the Contingencies Reserve belong to the electricity company. These are
all expenses which the electricity company has to incur. The amount paid
into the Consumers' Benefit reserve has to be returned to the consumers.
It is as if the electricity company had not received the amount which it was
E obliged to return. The amount that it was obliged to return was not a part
of its income. This is altogether different from the case of monies standing
to the credit of the Contingencies Reserve which are set apart to be utilised
by the electricity company for the purposes set out in clause V of the Sixth
Schedule to the Electricity (Supply) Act, 1948. [735-C-D; 734-H; 735-A]
F
Poona Electric Supply Co. Ltd. v. C./. T., Bombay City; 57 ITR 521,
held inapplicable.

Ve/lore Electric Corporation Ltd. v. C.l.T. Madras, 109 ITR 454 and
Commissioner of Income Tax, West Bengal v. Sijua (Jharriah) Electric Supply
G Co. Ltd., 145 ITR 740, approved.

Cochin State Power & Light Corporation Ltd. v. C./. T., Kerala, 93 ITR
582 and Amalgamated Electricity Co. Ltd. v. C./. T. Bombay, 97 ITR 334,
overruled.

H 2. The amount credited to the Contingencies Reserve is set apart to

t
ASSOCIATED POWER CO. LTD. v. C.l.T. 723

meet possible exigencies. It is not a provision for known existing Jiabilities. A
[736-E]
Commissioner of Income Tax, West Bengal v. Sijua (Jharria) Electlic
Supply Co. Ltd., 145 !TR 740, approved.

3. The doctrine of diversion of income by reason of an over-riding B
title is quite inapposite. The doctrine applies when, by reason of an
over-riding title. or obligation, income is diverted and never reaches the
person in whose hands it is sought to be assessed. In the present case, the
statute requires the electricity company to create certain reserves if its
clear profit exceeds reasonable return (clause II, Sixth Schedule to the
Act). Again, the Contingencies Reserve is to be created from existing C
reserves or from "the revenues of the undertaking". This clearly indicates
that the monies which have to be put into the Contingencies Reserve reach
the electricity company and are not diverted away from it. The investment
would be in its name and it would be owner thereof. The amount credited
to the Contingencies Reserve is not diverted by reason of an overriding D
obligation or title and, in determining the business profits of the assessee,
it must be taken into account. [735-E-F; 736-C]

CIT v. Sitaldas Tirathadas, 41 ITR 367 (S.C.), relied on.

CIVIL APPELLATE JURISDICTION: Tax Ref. Case Nos. 13-16 E
of 1981.

From the Order dated 29.12.78 of the Income Tax Appellate
Tribunal, Calcutta in R.A. No. 176 (Cal)/79 (Arising out of LT.A. No.
2643/Cal of 1977-78.
F
Rajinder Sachar, Bimlesh Ghosh, AK. Ghosh for Fox Mondal & Co.,
for the Appellant.

J. Ramamurthy, S.N. Terdol, R. Satish, Manoj Arora and Ms. A.
Subashini for the Respondent.
G
The Judgment of the Court was delivered by

BHARUCHA, J. These are references by the Income Tax Appellate
Tribunal to this Court under Section 257 of the Income Tax Act, 1961. The
references have been made because of a divergence of opinion between
several High Courts. H
724 SUPREME COURT REPORTS [1995] SUPP. 5 S.C.R.

A The Assessment Year in question in Tax Reference Case No. 13 of
1981 is 1973-74; in Tax Reference Cases Nos. 14 & 15 of 1981 they are
1972-73 and 1973-74; and in Tax Reference Case No. 16 of 1981 it is
1972-73.

Each of the assessees is a company engaged in the business of
B
generation of electricity and distribution thereof to consumers. It is
governed by the Electricity (Supply) Act, 1948.

For the sake of convenience the facts in Tax Reference Case No. 13
of 1981 are set out'. By reason of the provisions of the Electricity (Supply)
C Act and of the Sixth Schedule thereto, the assessee appropriated the sum
of Rs. 46,460 out of its revenues to a Contingency Reserve account during
the previous year relevant to the Assessment Year 1973-74. This amount
was claimed by the assessee as a deduction in the computation of its total
income for the purposes of income tax. The l.T.O. rejected the claim. The
D Appellate Assistant Commissioner allowed the assessee's appeal, relying
upon the decision of the Kerala High Court in the case of Cochin State
Power & Light Corporation Ltd. v. C./. T. Kera/a, 93 l.T.R. 582, and of the
Bombay High Court in the case of Amalgamated Electricity Co. Ltd. v.
C.l. T., Bombay, 97 LT.R. 334. The Revenue filed an appeal before the
Tribunal and cited the judgment of the Madras High Court in the case of
E Ve/lore Electlic Corporation Ltd. v. C.l.T., Madras, 109 l.T.R. 454. The
Tribunal relied on the decision of the Madras High Court, which had
disagreed with the view taken by the Kerala High Court and the Bombay
High Court. It set aside the order of the Appellate Assistant Commis-
sioner, but referred the tallowing question to this Court :
F
"Whether, on the facts and in the circumstances of the case, the
Income-tax Appellate Tribunal was correct in holding that the sum
of Rs. 46,460 transferred to the Contingencies Reserve Account is
not allowable as a deduction in arriving at the taxable business
income of the assessee-company?"
G
Section 57 of the Electricity (Supply) Act reads thus :

"57. Licensee's charges to consumers-The provisions of the Sixth
Schedule shall be deemed to be incorporated in the licence of
H every licensee, not being a local authority -
ASSOCIATED POWER CO. LTD. v. C.I.T. (BHARUCHA, J.] 725
.
(a) in the case of a licence granted before the commencement of A
this Act, from the date of the commencement of the licensee's next
succeeding year of account; and

(b) in the case of a licence granted after the commencement of
this Act, from the date of commencement of supply,
B
and as from the said date, the licensee shall comply with the
provisions of the said schedule accordingly, and any provisions of
the Indian Electricity Act, 1910 (9 of 1910), and the license granted
to him thereunder and of any other law, agreement or instrument
applicable to the licensee shall, in relation to the licensee, be void c.
and of no effect in so far as they are inconsistent with the provisions
of Section 57-A and the said Schedule."

The Sixth Schedule to the Electricity (Supply) Act sets out financial
principles applicable to electricity companies and their application. Clause
I requires a licensee to so adjust his charges for the sale of electricity that D
his clear profit in any year of account shall not, as far as possible, exceed
the amount of reasonable return. The expressions "clear profit" and
"reasonable return" are defined in the Sixth Schedule. Sub-clauses (1) and
(4) of clauses II reads thus :

"II. (1) If the clear profit of a licensee in any year of account is in
E
excess of the amount of reasonable return, one- third of such
excess, not exceeding five per cent of the amount of reasonable
return, shall be at the disposal of the undertaking. Of the balance
of the excess, one-half shall be appropriated to a reserve which
shall be called to Tariffs and Dividends Control Reserve and the F ;~
remaining half shall either be distributed in the form of a propor-
tional 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. G

"(4) On the purchase of the undertaking, after the expiry, or on
the revocation, of its licence or otherwise, all amounts of rebate
lying undistributed to the consumers on the date of such purchase
shall be handed over to the purchaser who, in turn, shall enter the
same in his books .of account, under the heading Consumers' H

I
726 SUPREME COURT REPORTS [1995] SUPP. 5 S.C.R.

A Rebate Reserve and any amount lying undistributed in that
Reserve shall be carried forward for distribution to the consumer
concerned:

Provided that the share of money in the Consumers' Rebate
Reserve payable to the consumers who are not traceable or who
B have ceased to be consumers in relation that undertaking, may be
utilised in the development works of the purchaser."

Clauses III, IV & V are most relevant to our purpose and they read thus:

"III. There shall be created from existing reserves or from the
c revenues of the undertaking a reserve to be called "Contingencies
Reserve".

IV. (1) The licensee shall appropriate to Contingencies Reserve
from the revenues of each year of account a sum not less than
D one-quarter of one per centum a~d not more than one-half of one
per centum of the original cost of fixed assets, provided that if the
said reserve exceeds, or would by such appropriation be caused to
exceed five per centum of the original cost of fixed assets, no
appropriation shall be made which would have the effect of in-
creasing the reserve beyond the said maximum.
E
(2) The sums appropriated to the Contingencies Reserve shall be
invested in securities authorised under the Indian Trusts Act, 1882,
(2 of 1882), and such investment shall be made within a period of
six months of the close of year of account in which such appropria-
tion is made.
F
V. (1) The Contingencies Reserve shall not be drawn upon during
the currency of the licence except to meet such charges as the State
Government may approve as being -
-
G (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 renewal of plant or works other
than expenses requisite for normal maintenance or renewal;

H (c) compensation payable under any law for the time being in force
ASSOCIATED POWER CO. LTD.,v. C.I.T. [BHARUCHA, J.J 727

and for which no other provision is made. A
(2) On the purchase of the undertaking, the Contingencies
Reserve, after deduction of the amounts drawn under sub-para-
graph (1), shall be handed over to the purchaser and maintained
as such Contingencies Reserve:
B
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 compensa-
tion, 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 the State Government, as the case may be.
c
Before we advert to the judgments of the High Courts that took
divergent views, it is appropriate to refer to the judgment of this Court in
Poona Electric Supply Co. Ltd. v. C.I. T., Bombay City, 57 I.T.R. 521. This
was a case that related to the Consumers' rebate Reserve. The Poona D
Electric Supply Co. Ltd., the assessee in that case, claimed deduction of
the amount credited to this reserve from its taxable income. This Court
noted the provisions of the Electricity (Supply) Act and its Sixth Schedule
and observed that their object was to statutorily rationalize and regulate
the rates chargeable for energy supplied in the interest of the public and
E·
for electrical development. Under the rules embodied in the Sixth Schedule
certain appropriations and deductions had to be made to arrive at the clear
profit; otherwise, the items might be manipulated to sustain a demand for
abnormal rates. These rules had no concern with income-tax; though for
the purposes of arriving at the clear profit, the taxes paid were deductible.
The Court then said : F
"Under section 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 G
business profits and not statutory profits. They are real profits and
not notional profits. The real profit of a businessman under section
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 H
7']13 SUPREME COURT REPORTS (1995] SUPP. 5 S.C.R.

A 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."
B (Emphasis supplied)

After considering various judgments, this Court was led to observe that
inc9me tax was a tax on real income, i.e., the profit arrived at on commer-
cial principles subject to the provisions of the Income-tax Act. The real
C profit could be ascertained only by making the permissible deductions.
There was a clear-cut distinction between deductions made for ascertaining
the profits and distributions made out of profits. In a given case, whether
the outgoings fell in one or the other of the heads was a question of fact
to be found on the relevant circumstances, having regard to business
principles. Another distinction that had to be borne in mind was that
D between real profits and statutory profits, that is, between commercial
profits arid statutory profits; the latter were statutorily fixed for a specified
purpose. The assessee was a commercial undertaking. It did the business
of supply of electricity subject to the provisions of the Electricity (Supply)
Act. As a business concern its real profit had to be ascertained on the
E principles of commercial accountancy. As a licensee governed by the
statute its clear profit was ascertained in terms of the statute and its
Schedule. The two profits were for different purposes - one was for
commercial and tax purposes and the other was for statutory purposes in
order to maintain a reasonable level of rates. For the purposes of the
Electricity (Supply) Act, during the accounting year the assessee credited
F an amount to the Consumers Rebate Reserve. It was a part of the excess
amount paid to it and it was reserved to be returned to the consumers. It
did not form a part of the assessee's real profit. So, to arrive at the taxable
income of the assessee from the business, that amount had to be deducted
from its total income.
G In Cochin State Power & Light Corporation Ltd. v. C.l. T. Kera/a, 93
l.T.R. 582, the question referred to the Kerala High Court was whether the
Tribunal was right in holding that the sums transferred to the Contingen-
cies Reserve, the Development Reserve and the Special Reserve were not
to be deducted in arriving at the taxable income of the assessee, which was
H a company carrying on the business of distribution and supply of electricity
ASSOCIATED POWER CO. LTD. v. C.l.T. [BHARUCHA, J.] 729

and was governed by the provisions of the Electricity (Supply) Act, 1948. A
The High Court considered the nature of the Contingencies Reserve and
observed:

"Paragraph III of the Sixth Schedule indicates that the creation of
the contingencies reserve is from out of the revenues of the
undertaking. This is quite significant. The term "revenue" in the
B
context in which it has been used in that Paragraph refers to the
total receipts and not to what is left as profit after meeting the
expenses. Therefore, the creation of a reserve is irrespective of the
profit of the licensee. It is either out of the existing reserves or
from the revenues of the undertaking. As Paragraph IV of the Sixth C
Schedule indicates, the amount that has to be appropriated to such
reserve has no relation to the profit made in any year, but is a fixed
percentage of the original cost of fixed assets. The paragraph
furth~r provides that on no account shall such appropriation be
made to such reserve to exceed five per cent, of the original cost D
of fixed assets. Sub- clause (2) of Paragraph IV is also significant.
The sums appropriated to the contingencies reserve have to be
invested in securities within a fixed period and it is that which
could be drawn upon for specified purposes as provided under
Paragraph V(l). Sub-clause (2) of Paragraph V indicates that on
the purchase of the undertaking this reserve has to be handed over E
to the purchaser and maintained as such subject to the proviso
therein."

The High Court referred to this Court's Judgment in the case of Poona
Electric Supply Co. Ltd. and the passage therein which is extracted above. F
It said that the view expressed by this Court appeared to it to be that in
computing the commercial or real profit such diversions as the Consumers'
Benefit Reserve must be deducted. Though before the Kerala High Court,
counsel for the assessee urged that the amount of this reserve was not a
part of the assessee's income, what he really meant, the High Court said,
as elaborated in the argument, was that in determining the real profits the G
statutory diversion in regard to these amounts had to be noticed and
deducted. The Contingencies Reserve had been created from out of
revenues and not out of profits and it was to be done irrespective of
whether the assessee made a profit or not. Though the amount of the
reserve could be utilised for certain purposes, the nature of the purposes H
730 SUPREME COURT REPORTS [1995'] SUPP. 5 s.c.R,

A indicated in clause V of the Sixth Schedule was sufficient to show that the
purposes were not general. The Contingencies Reserve could 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 done within a specified time. Clause V provided that the
Contingencies Reserve should not be drawn upon during the currency of
B the licence. This was subject to the exception that it could be drawn upon
for meeting the charges therein specified as the State Government might
approve. On the purchase of the undertaking the reserve had to be handed
over to the purchaser, who had to maintain it as such. If the undertaking
was purchased by the Electricity Board or the State Government, after
c deduction of the compensation payable to the employees of the out-going
licensee, the reserve had to be handed over to the Electricity Board or the
State Government. In the provisions in the Indian Electricity Act, 1910,
relating to price fixation, when such Board or the State Government took
over, no allowance was made in the purchase price for the amount of the
D Contingencies- Reserve. All these provisions indicated that though to a very
limited extent the assessee might have a benefit from out of the Contingen-
cies Reserve, in that in certain contingencies which the State Government
approved he might get the benefit of the amount reserved, Generally, the
amount was not one which was at the disposal of the assessee in the matter
of its application. The creation of the reserve was apparently with the prime
E object of making available sufficient resources for meeting commitments
- necessary for the efficient running of the business, commitments which, if
the licensee failed to meet them, would really affect the consumers. An
uninterrupted supply of electric energy and proper maintenance of the
supply from time to time by the licensee were amenities which had to be
F assured to the public and the object of the clause concerning this reserve
appeared to be to assure them these. The High Court then said :

"Bearing in mind the fact that the amount under the contingencies
reserve is not available to the assessee for any purpose of his own
or even for any purpose other than those indicated in Paragraph
G V of the Sixth Schedule and also noticing the object of the creation
of this reserve and further noting the provision that it is a diversion
from the revenue, we think that the diversion is one which is
deductible in determining the real profit. There is the further fact
that the assessee does not get even compensation on account of
H this reserve as an and when the undertaking is purchased and even
ASSOCIATED POWER CO. LTD. v. C.l.T. [BHARUCHA,J.] 731

the purchaser has to maintain the reserve as such. Therefore, in A
spite of the distinction that we have pointed out in regard to certain
features between this reserve and the consumers' benefit reserve
with which the Supreme Court was concerned in the Poona Electric
Supply Company case, we feel that the amount covered by the
contingencies reserve is a diversion by reason of overriding obliga-
B
tion created by the statute and, therefore, for determining the
commercial profits of the assessee, the_ amount of this reserve has
to be deducted."

The question that was referred was, insofar as it related to the deduction
of the amount credited to the Contingencies Reserve, answered in favour C
of the assessee.

The Bombay High Court followed the judgment in Cochin State
Power & Light Corporation Ltd., in a Tax" Reference. It said:

"In other words it is clear that the Kerala High Court was consid- D
erably influenced, and in our view rightly, by three or four aspects
of this contingencies reserve, namely, the source from which this
reserve is created, the purpose for which this reserve could be
drawn upon as mentioned in paragraph V, that this reserve was
not available to the assessee for any purposes of its own, that the
assessee would not get any compensation on account of this reserve
E
as and when the undertaking would be purchased and that the
purchaser is required to maintain the reserve as such. We, there-
fore, feel that substantial reasons have been given by the Kerala
High Court for coming to the conclusion that the transfers or
appropriations made by the assessee to the contingencies reserve F
should be deducted while computing the real profit of the assessee.
In this view of the matter, the question, so far as it relates to
transfers or appropriations made by the assessees to the contin-
gencies reserve in the instant case before us, will have to be
answered in favour of the assessee. We accordingly answer the G
question in favour of the assessees."

It is, interesting to note that the same Bench of the Bombay High
Court ha<f thereafter occasion to consider the Contingencies Reserve in
the context of the Wealth Tax Act, that is to say, whether the amount
standing to the credit of that reserve was liable to be included in determin- H
732 SUPREME COURT REPORTS [1995] SUPP. 5 S.C.R.

A ing the net wealth of the assessee, which was also a company that generated
and supplied electrical energy and was governed by the provisions of
the Electricity (Supply) Act, 1948. This was the case of Commissioner of
Wealth Tax, Bombay v. Bombay Suburban Electric Supply Co. Ltd. The
judgments in Cochin State Power & Light C01poration Ltd. and Amal-
B gamated Electricity Co. Ltd. were cited on behalf of the assessee. It was
submitted that in both these cases it had been held that the amount
standing to the credit of the Contingencies Reserve was deductible under
the Income-tax Act and, therefore, it could not be regarded as an. asset.
The Court said :

c "At the outset it should be pointed out that in both these cases the
court was really concerned with the question of determination of
the income of the ass·essee-company under the head of profits and
gains of business. Questions which may be relevant for the purpose
of determining the liability to pay income-tax may not be germane
D or applicable while deciding a question whether a particular asset
is an asset belonging to the assessee and can be subjected to a
liability for payment of wealth-tax. Under the Income-tax Act
"income-tax'' is a tax on the real income, i.e., profits arrived at on
commercial principles subject to the provisions of the Act. The
real profit can be ascertained only by permissible deductions. We
E are not concerned in the present case with the question of deter-
mination of real profits or real income. As shown in paragraph III
of Schedule 6, contingencies reserve can be created either from
the existing reserves or from the revenues of the undertaking which
by itself shows that it is created from assets which form part of the
F net wealth of the assessee-company. It can never be said that
existing reserves do not form part of the assets of a company. Even
in the case of revenue it is first received by the assessee and
thereafter it is appropriated in the manner permitted by paragraph
IV of Schedule 6 of the Electricity (Supply) Act. In either event it
will be treated as part of the assets belonging to the assessee. The
G character of the asset is not altered by the fact that there are
restrictions upon the user of the contingencies reserve and that in
the event. of a compulsory purchase under law it has to be handed
over to the purchaser like the Electricity Board, the State Govern-
ment or local authority who are under an obligation to maintain
H such reserve and continue the undertaking."
ASSOCIATED POWER CO. LTD. v. C.I.T. [BHARUCHA, J.] 733

The Madras High Court in Ve/lore Electric Corporation Ltd. v. C.L T. A
Madras, 109 I.T.R. 454, was required on a reference by the Tribunal to
determine whether the Tribunal had been right in holding that the amount
transferred to the Contingencies Reserve was not to be deducted in arriv-
ing at the taxable profits of the assessee, which was a company engaged in
the business of generating and supplying electrical engergy and was B
governed by the provisions of the Electricity (Supply) Act, 1948. The
decision of this Court in Poona Electric Supply Co. Ltd. was cited on behalf
of the assessee. The Madras High Court said that it was of no assistance
to the assessee. The amount standing to the credit of the Contingencies
Reserve could not be said to be an amount which had gone out of the hands
or control of the assessee and become the subject matter of ownership of C
somebody else. The statute had imposed certain restrictions over the
disposal of that amount by the assessee, but that did not mean that the
amount had ceased to be money belonging to the assessee. What was meant
by diversion of profits by overriding title was that a part of the profits
earned by an assessee was not really his profit but it belonged to somebody D
else and the assessee had no title. As far as the Contingencies Reserve was
concerned, the statute had clearly indicated the purposes for which it could
be ~pent and those purposes clearly showed that they were connected with
the business of the assessee and it was the assessee which would have to
utilise it. Equally, the fact that the assessee was required to invest the
amount standing to the credit of Contingencies Reserve in securities E
authorised under the Indian Trusts Act, 1882, did not in any way affect this
position. The assessee continued to be the owner of the investment and,
however limited be the benefit that the assessee might derive from such an
investment, it could not be held that the investment was not the assessee's
investment but somebody else's investment. Simply because the statue F
required a licensee like the assessee to make an appropriation out of its
revenue for a particular purpose, and it was a compulsory appropriation
which the assessee had to make, did not mean that for the purpose of
income-tax such appropriation must necessarily be deducted for arriving
at the profits and gains of the assessee's business. The judgments in the
case of Cochin State Power and Light Corporation Ltd., was, therefore, not G
followed.

The Calcutta High Court in Commissioner of Income Tax, West
Bengal v. Sijua (Jltoniah) Electric Supply Co. Ltd., 145 1.T.R. 740, was also
concerned with a case in which the assessee was an electric supply com- H
734 SUPREME COURT REPORTS [1995] SUPP. 5 S.C.R.

A pany governed by the Electricity (Supply) Act, which had appropriated and
amount towards the Contingencies Reserve and had claimed its deducti;:ln
in the computation of its business income. The cases aforementioned were
considered. The Calcutta High Court held that there had been no diversion
of income by an overriding title. The amount appropriated to the Contin-
gencies Reserve was Collected by the assessee as its revenue from sale of
B electricity. The amount remained at the disposal of the assessee and for
the benefit of the assessee. It could be used only for a few specified
purposes, but the purposes for which the fund could be used were all
business purposes of the assessee. Payment of compensation to workers,
replacement of plant and machinery and other expenditure envisaged in
c clause V of Schedule 6 were all normal business expenditure of a company.
This was not a case of diversion of income before it reached the assessee
but only a case of setting apart of a portion of the assessee's income under
compulsion of law for the use and benefit of the assessee although the
mode and the objects of the expenditure was statutorily restricted. A
D portion of the revenue earned by the assessee had been set apart and kept
in a reserve fund for some specific purposes of the assessee. That fund
belonged to the assessee, the assessee had the use of it. Under those
circumstances, it could not be said that there had been any diversion of
income of source by an overriding title from the assessee or that the
amount that had been appropriated did not form part of the real income
E of the assessee. It was contended before the Calcutta High Court that the
appropriation to the Contingencies Reserve was, in any event, expenditure
wholly and exclusively laid out for the assessee's business and should be
allowed as a deduction. This argument was not accepted for the appropria-
tion that had been made was not towards any known liability. The money
F had been set apart for meeting unknown future liabilities. It was not a
provision but a reserve. There had been no expenditure in the real sense
of. the term.

Mr. Sachar learned counsel for the assessee before us, submitted that
there was no distinction between the Consumers, Benefit Reserve which
G had been considered by the Supreme Court in the case of Poona Elecaicity
Supply Co. Ltd. and Contingencies Reserve. The argument is fallacious. We
have quoted the appropriate passage of this Court's earlier judgment. The
emphasis is on the fact that the amount paid into the Consumers' Benefit
Reserve has to be returned to the consumers. Therefore, it is as if the
H electricity company had not received the amount which it was obliged to
.. ASSOCIATED POWER CO. LTD. v. C.I.T. [BHARUCHA,J.] 735

return. The amount that it was obliged to return was not a part of its A
income. This is altogether different from the case of monies standing to
the credit of the Contingencies Reserve which are set apart to be utilised
by the electricity company for the purposes set out in clause V of the Sixth
Schedule-. These are to meet expenses or recoup loss of profits arising out
of accidents, strikes or other circumstances which the electricity company
B
could not have prevented; to meet expenses on replacement or renewal of
plant or works; and for payment of compensation required by law for which
no other provision has been made. These are all expenses which the
electricity company has to incur. The reservation is made so that money is
always available for meeting these expenses and the supply of electricity is
not interrupted. For the same reason, payments out of the contingencies c
Reserve can be made only with the State Government's approval. It is
particularly noteworthy that the electricity company can make good from
out of the Contingencies Reserve even a loss of profit arising out of strikes,
accidents and other circumstances over which it has no control. There can
be no doubt, in the circumstances, that monies in the Contingencies D
Reserve belong to the electricity company.

The application of the doctrine of diversion of income by reason of
an over-riding title is quite inapposite. The doctrine applies when, by
reason of an over-riding title or obligation, income is diverted and never
reaches the person in whose hands it is sought to be assessed [See CIT v. E
Sitaldas Tirathdas, 41 I.T.R. 367 (S.C.).] In the present case, the statute
requires the electricity company to create certain reserves if its clear profit
exceeds a reasonable return (clause II, Sixth Schedule). Again, the Contin-
gencies Reserve is to be created from existing reserves or from "the
revenues of the undertaking". This clearly indicates that the monies which F
have to be put into the Contingencies Reserve reach the electricity com-
pany and are not diverted away from it.

It is the electricity company which has to invest the sums ap-
propriated to the Contingencies Reserve. The investment would be in its
name and it would be the owner thereof. The restriction that the investment G
can be made only in securities mentioned in the Indian Trusts Act makes
no difference to this position.

That on the purchase of the undertaking the Contingencies Reserve
has to be handed over to the purchaser and maintained as such is only to H
736 SUPREME COURT REPORTS [1995] SUPP. 5 S.C.R.

A make explicit the obvious for the reserve is for the purposes of the
undertaking that is being transferred. There is nothing in the statute to
suggest, as argued, that the amount standing to its credit cannot be taken
into consideration in arriving at the purchase price. For the purposes of
sale to a State Board or Government, a different statute lays down how the
price is to be fixed, and with it we are not here concerned.
B
We must add that we asked Mr. Sachar to whom, in his submission,
the amounts credited to the Contingencies Reverse were diverted. Mr.
Sachar replied that they were diverted to and vested in the State Govern-
ment. This, for the reasons set out above, is quite unacceptable.
c We hold that the amount credited to the Contingencies Reserve is
not diverted by reason of an overriding obligation or title and, in determin-
ing the business profits of the assessee, it must be taken into account.

Mr. Sachar contended that if the amount credited to the Contingen-
D cies Reserved was includible in the computation of the business income of
the assessee, the amount so appropriated should be allowed as a business
deduction, being expenditure necessary to carry on the assessee's business.
As the Calcutta High Court bps pointed out, there is no expenditure. The
amount appropriated to the Contingencies Reserve is set apart to meet
possible exigencies. It is not a provision for known, existing liabilities.
E
In the result, the identical question referred to us in the three
references is answered in the affirmative and in favour of the Revenue.

The assessee shall pay to the Revenue the costs of the references,
quantified in the sum of Rs. 10,000.

v.s.s.
'
References disposed of.