Full Judgment
The assessee had received in full the controlled price of Ethyl Alcohol supplied by it to its constituents. It credited to effluent disposal reserve account various sums as stipulated in the note attached to the table given in clause 2 of the Order. The said adjustments were made through journal entries. Even after passing the requisite journal entries the assessee retained full control and domain over the amount in question. It is the policy of the Government of India to ensure that manufactures and industrialists set up adequate effluent disposal facilities so that the environment is not harmed. This policy of the State naturally obligated the assessee to set up such faclities and to set apart adequate fund therefor. But this obligation cannot be equated to that type of obligation which gives rise to diversion of income by overriding title. The assessee's obligation to set apart funds for creating adequate effluent disposal facilities is qualitatively different from an obligation that gives rise to diversion of income by overriding title. Therefore, the sums credited by the assessee to effluent disposal reserve are not revenue deductible.
1. A single common issue arises for consideration in these appeals by the assessee. The appeals were, therefore, heard together and are disposed of by a common order.
2. The assessee, a company in which public are not substantially interested, runs a distillery.
On 30-1-1971, the Government of India, Ministry of Petroleum & Chemicals and Mines & Metals (Department of Petroleum and Chemicals), issued an order bearing No. S.O. 577 and styled "Ethyl Alcohol (Price Control) Order, 1971". This order was amended from time to time. Clause 2 of the said order prescribed the maximum ex-distillery prices of Ethyl Alcohol. These prices were exhibited in the form of a table.
Appended to the table was a note which, at the relevant point of time, read as below: These prices include six rupees and forty paise (Rs. 6.40) per kilo litre for effluent disposal facilities. This amount shall be separately funded and shall be utilised in accordance with the orders that may be issued for the regulation of such funds.
3. Pursuant to the said direction, the assessee company, it is common ground, set apart under the head "Effluent Disposal Reserve" sums detailed below:Assessment year Amount1985-86 Rs. 76,1841986-87 Rs. 57,8261987-88 Rs. 67,080 The assessee contended before the Assessing Officer that the said sums were revenue deductible on the ground that the amount set apart could not be utilised for any other purpose, The Assessing Officer rejected the assessee's claim. In this regard he was impelled by the consideration that in the earlier years identical claim of the assessee had been negatived on the ground that this was a case of not of diversion of income by over-riding title but of application of income.
The CIT (Appeals) and the ITAT had declined to interfere in the matter.
4. In this regard it may here be noted that in the cross-objection bearing No. 134 (Mds.)/1980 in ITA No. 1813 (Mds.)/1980 (assessment year 1977-78) filed by it, the assessee-company had contended before the Tribunal that the amount set apart by it under the head 'Effluent Disposal Reserve' did in fact get diverted by over-riding title particularly in view of the provisions of the aforesaid price control order. It also relied in that regard on a Tribunal decision in the case of Madurai Sugars Ltd. in IT Appeal No. 1675 (Mad.) of 1976-77 in which it had been held that sums transferred to 'Molasses Storage Fund' pursuant to the orders issued by the Government of India in that regard did not form part of assessee's income. The Department's case before the ITAT was that the ruling of the jurisdictional High Court in the case of CIT v. South Arcot District Cooperative Supply & Marketing Society Ltd. [1981] 127 ITR 467 (Mad.), which was directly to the point, supported the Department's case; and that, therefore, the sum set apart by the assessee under the head 'Effluent Disposal Reserve' was not revenue deductible.
On an examination of the matter the Tribunal found that the matter should be concluded against the assessee by the said Madras case - see order dated 22-8-1981 in ITA No. 1812 (Mad.), 80 (assessment year 1977-78) and CO. No. 134 (Mad.)/80 relating thereto.
5. Thereupon, the assessee filed an appeal before the first appellate authority, raising a two-fold contention. First, the aforesaid Madras case was distinguishable. In that case, a statutory contribution of a portion of the co-operative society's profits to education fund was held to be only application of income. In the assessee's case, however, what was set apart was not a portion of the profits but a part of sale proceeds. The assessee's case obviously was that if a portion of the profits were to be set apart, it would be application of income. On the contrary, if a portion of the sale proceeds was set apart, it could not be said that there was application of income. In such cases, that part of the sale proceeds set apart must be deducted from the total sale proceeds and the assessee's income computed thereafter.
The second limb of the assessee's case before the CIT (Appeals) was that in the case of Sugar Mills the ITAT had consistently taken the line that amounts credited to Molasses Storage Fund would not form part of the income of the assessee. The same ruling will apply to the assessee's case also.
6. None of the aforesaid arguments found favour with the CIT (Appeals), who declined to interfere in the matter.
8. Smt. Meenakshi Krishnaswamy, the learned counsel for the assessee took us through the facts and circumstances of the case and reiterated the arguments that had earlier been advanced, unsuccessfully, before the first appellate authority. According to her, the aforesaid Madras case is distinguishable because that was a case of funding for an "education fund with no obligation attached on the part of the assessee to its being spent for a particular statutory requirement". In other words, once the society set apart the sums in question, the matter ended there.
Further, the sum was set apart out of the profits of the society. In the case before us, however, the sum to be set apart formed part of the turnover of the assessee.
The second limb of Smt. Meenakshi Krishnaswamy's argument was that, as in the case of Sugar Mills setting apart funds for Molasses Storage Fund, so in the case of the assessee, which had set apart funds for effluent disposal reserve, the sum set apart is revenue deductible.
9. On his part, Shri K. Argal, the learned Departmental Representative, strongly supported the impugned orders of the lower authorities.
Besides relying on the aforesaid Madras case, he also relied on the M.P. case of Jiwajirao Sugars Co. Ltd. v. CIT [1989] 176 ITR 182, in which the High Court has clearly held that the part of the price of the molasses set apart under Molasses Control Order to a specific fund to be utilised for adequate storage facilities did not amount to diversion of income by over-riding title. The amount set apart was mere application of income of the assessee.
10. At the time of the hearing, we specifically elicited the response of the learned counsel for the assessee to the following two propositions: (1) From the accounting point of view simpliciter, sums were transferred to effluent disposal reserve through journal entries and the reserve as such was exhibited in the balance-sheet. Such journal entries did not entail any outflow of cash. In such a situation, did not the control over cash remain with the assessee (2) In the aforesaid Madhya Pradesh case the High Court wanted to know whether there was any material to indicate that in the event of the assessee's ceasing to carry on its business, the assessee would not be entitled to the outstanding amount credited in the molasses storage fund. The learned counsel for the assessee therein was, however, unable to point out any provision to the contrary. In the case before us also, in the event of the assessee's ceasing to carry on its business, would not the assessee be entitled to the outstanding amount credited in the effluent disposal reserve account In response, Smt. Meenakshi Krishnaswamy fairly conceded not only that the assessee retained control over the cash represented by the sums set. apart, but also that in the contingency envisaged in proposition No. (2), it will be the assessee who would be entitled to the outstanding amount credited in the effluent disposal reserve fund.
11. We have looked into the facts of the case. We have considered the rival submissions.
12. As pointed out earlier, in the assessment for the assessment year 1977-78 the Tribunal has decided the issue against the assessee. There being no change in the fact-situation in the assessment for the three assessment years under consideration, we would be justified in following the aforesaid decision of the Tribunal and in rejecting on that basis the assessee's claim - see in this regard the Madras High Court case of CIT v. L.G. Ramamurthi [1977] 110 ITR 453.
13. Normally the matter should have rested there. Even so, since the learned counsel for the assessee sought to distinguish on facts the Madras case of South Arcot Distt. Co-operative Society Ltd. (supra), we proceed to consider the arguments advanced by the learned counsel in that regard. The first point made by her in this regard was that the setting apart by the assessee-society of a part of its profits for the purpose of education fund saw the end of the matter. The basis on which the said argument came to be advanced is not quite clear. The intention of the State Government is clear, namely, that the society must set apart funds for the purpose of education fund, which fund would be used in due course for education purposes. In any event, no evidence was produced to show that the education fund was spent otherwise than for purposes of education by the State Government.
14. The second point made in this regard was that whereas in the said case a part of the profit was to be set apart and credited to education fund, in the case before us a part of the turnover was to be set apart and credited to effluent disposal reserve. As we see it, the said distinction is a distinction without difference. It is well settled that whenever the right to receive money in the course of trading transactions accrues or arises, or the money is realised, the profit or the income embedded in the receipt also arises or accrues or is received. Thus, in the case of Turner Morrison & Co. Ltd. v. CIT [1953] 23 ITR 152 the Supreme Court at page 161 of the Report observed: There can, therefore, be no question that when the gross sale proceeds were received by the Agents in India they necessarily received whatever income, profits and gains were lying dormant or hidden or otherwise embedded in them. Of course, if on the taking of accounts it be found that there was no profit during the year then the question of receipt of income, profits and gains would not arise but if there was income, profits and gains, then the proportionate part thereof attributable to the sale proceeds received by the Agents in India were income, profits and gains received by them at the moment the gross sale proceeds were received by them in India and that being the position the provisions of Section 4(1)(a) were immediately attracted and the income, profits and gains so received became chargeable to tax under Section 3 of the Act.
Again, in the case of Raja Mohan Raja Bahadur v. CIT [1967] 66 ITR 378 the Supreme Court observed at p. 382 of the Report: ...If accounts are maintained according to the mercantile system, whenever the right to receive money in the course of a trading transaction accrues'or arises, even though income is not realised, income embedded in the receipt is deemed to arise or accrue. Where the accounts are maintained on cash basis receipt of money or money's worth and not the accrual of the right to receive is the determining factor. Therefore, if commercial assets are received by a trader maintaining accounts on cash basis in satisfaction of an obligation, income which is embedded in the value of the assets is deemed to be received; the receipt of income is not deferred till the asset is realised in terms of cash or money. It makes no difference whether the receipt of assets is in pursuance of an agreement or that the trader is compelled by law to accept the assets from the debtor. Once title of the trader to an asset received is complete, whether by a consensual arrangement or by operation of law, he receives the income embedded in the value of the asset. In Californian Copper Syndicate v. Harris (1904) 5 Tax Cas. 159, 167, Lord Trayner In dealing with a case of assessment to income-tax of a company, formed for the purpose, inter alia, of acquiring and re-selling mining property, which resold the whole of its assets to a second company and received payment in fully paid shares of the purchasing company, observed: 'A profit is realised when the seller gets the price he has bargained for. No doubt here the price took the form of fully paid shares in another company, but, if there can be no realised profit, except when that is paid in cash, the shares were realisable and could have been turned into cash, if the Appellant had been pleased to do so. I cannot think that income-taxis due or not according to the manner in which the person making the profit pleases to deal with it'.
In view of the foregoing, therefore, we reject the related contentions of the learned counsel for the assessee.
15. This brings us on to the question whether the case before us is one of diversion of income by overriding title, or one of application of income. The doctrine of diversion of income by over-riding title postulates - that a part of that income is diverted to another person (say B) by reason of - such person's possessing anterior, over-riding, superior title to the said part of income.
Certain conclusions readily suggest themselves. First, the doctrine of diversion of Income by over-riding title obviously envisages the existence of more than one person. Clearly, it will be strange to say that part of income of 'A' gets diverted to himself by over-riding title.
Secondly, part of the income of 'A' gets diverted to 'B', because 'B' has anterior, over-riding, superior title to part of the income that reaches the hands of 'A'. In other words, that part of income which reaches 'A' and which had been assigned to 'B' represents an actionable claim.
Thirdly, from the point of view of 'A', that part of the income which is received by 'A' and which is assigned to 'B' is not the income of 'A'; it is the income of 'B' who has control and domain over the stipulated part, of the Income see the Privy Council case of Raja Bejoy Singh Dudhuria v. CIT (1933) 1 ITR 135.
16. Application of income stands on a different footing. It connotes an alienation by one person of what is truly his own income. The alienation may be voluntary as in the case of a gift. It may even be the result of an obligation. But the basic, critical criterion is that what is applied is truly one's own income.
17. The distinction between the two concepts, if we may say so with respect, has been lucidly brought out by the Supreme Court in the case of CIT v. Sitaldas Tirathdas [1961] 41 ITR 367. At page 374 the Supreme Court observed: ...In our opinion, the true test is 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 obligations 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 reaches 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 the case before us the assessee, it is common ground, had received in full the controlled price of Ethyl Alcohol supplied by it to its constituents. It is also common ground that, as stipulated in the Ethyl Alcohol (Price Control) Order, 1971, it credited to effluent disposal reserve account various sums as stipulated in the note attached to the table given in Clause 2 of the order. It is also not in dispute that the said adjustments were made through journal entries. But the question that arises for consideration is, did the assessee actually pay out cash to a third person, namely. Government of India and thereby lose domain and control over the funds in question The answer is no.
Even after passing the requisite journal entries the assessee retained full control and domain over the amount in question.
Secondly, as rightly conceded by the learned counsel for the assessee, there is nothing to indicate that in the event of closure of the assessee's business the assessee would not be entitled to the outstanding amount credited in the effluent disposal reserve. For a fact, even if the assessee had utilised the funds standing to the credit of the said reserve for purposes of setting up effluent disposal facilities, the assessee would continue to have control and domain over that facility. This means that in the event, of, say, the assessee's choosing to sell its business as a going concern to a third party, the assessee, while deciding upon the aggregate consideration payable by the purchaser, would be entitled to and would naturally take into account the value of the effluent disposal facilities set up by it.
18. The fact of the matter in this case is that it is the policy of the Government of India to ensure that manufacturers and industrialists set up adequate effluent disposal facilities so that the environment is not harmed. This policy of the State naturally obligated the assessee to set up such facilities and to set apart adequate fund therefor. But this obligation, cannot, by any stretch of imagination, be equated to that type of obligation which gives rise to diversion of income by over-riding title. As pointed out by the Supreme Court, there are obligations and obligations. And as we see it, the assessee's obligation to set apart funds for creating adequate effluent disposal facilities is qualitatively different from an obligation that gives rise to diversion of income by over-riding title. We, therefore, hold that the sums credited by the assessee to effluent disposal reserve are not revenue deductible.
19. Before taking leave of this case, we may notice the Madhya Pradesh case of Jiwajirao Sugars Co. Ltd. (supra). There the assessee was running a sugar factory. Under the Molasses Control Order, 1961, as amended by the Molasses Control (Amendment) Order, 1975, a part of the price of molasses received by the assessee was to be credited to a specific account called 'Molasses storage fund'. The relevant provision of the order is as follows: From the price fixed under the above Schedule, 331/3% thereof shall be accounted for and funded separately by the producers and shall be utilised for erection of adequate storage facilities in accordance with the orders that may be issued by the Central Government for the regulation of such funds.
Pursuant to the said provision, the assessee did credit a sum of Rs. 62,200 to the said fund and claimed that the sum in question was revenue deductible. The assessee was unsuccessful all through. And the matter reached Madhya Pradesh High Court. After noticing, inter alia, the Supreme Court case of Sitaldas Tirathdas (supra), the High Court held that the case before it was not one of diversion of income but of application of income.
20. Two points are here noteworthy. First, the provisions of the Molasses Control Order, 1961 as amended by the Molasses Control (Amendment) Order, 1975, insofar as they related to the setting up of molasses storage fund are analogous to those of the Ethyl Alcohol (Price Control) Order, 1971. Therefore, the ruling in the said Madhya Pradesh case is directly applicable to the case before us.
Secondly, in the case of certain other sugar mills the Tribunal had taken the contrary view to the effect that the amount credited to molasses storage fund is revenue deductible. But such decision cannot avail the assessee, especially in the context of the aforesaid Madhya Pradesh ruling. There is no ruling of the jurisdictional High Court on this issue. Therefore, following the ruling in the Bombay case of CIT v. Smt. Godavaridevi Saraf [1978] 113 ITR 589 (Bom.), we apply the ruling of the aforesaid M.P. case and hold that the assessee's claim fails.