Bhagwati, C.J.
1. This reference raises a very interesting question of law relating to the interpretation of section 271(1)(a) of the Income-tax Act, 1961 (hereinafter referred to as 'the new Act'). The facts giving rise to the reference are few and may be briefly stated as follows. The assessee is a registered firm and for the assessment year 1961-62, the assessee was required to furnish its return of income on or before June 30, 1961, by virtue of the public notice issued by the Income-tax Officer under Section 22, sub-section (1) of the Indian Income-tax Act, 1922 (hereinafter referred to as 'the old Act'). The date for delivery of the return, namely, June 30, 1961, was not extended by the Income-tax Officer under the proviso to section 22, sub-section (1), and the assessee should have, therefore, filed its return of the income on or before that date. But the assessee failed to do so and filed its return of income as late as January 31, 1966. By that time the old Act was repealed and the new Act had taken its place and section 297(2)(b) of the new Act required that since the return of income was filed by the assessee after the commencement of the new Act, the assessment of the assessee for the assessment year 1961-62 should be made in accordance with the procedure specified in the new Act. The return of income being filed before the expiration of four years from the end of the assessment year 1961-62, it was regarded as a voluntary return under section 139, sub-section (4), and the Income-tax Officer processed it and assessed the assessee to tax under section 143. The Income-tax officer in the course of the assessment proceedings was prima facie satisfied that the assessee had without reasonable cause failed to furnish its return of income within the time allowed by the notice under section 22, sub-section (1) of the old Act and he, therefore, issued a notice under section 274 calling upon the assessee to show cause why penalty should not be levied upon it under section 271(1)(a). The assessee submitted its explanation giving various reasons for late filing of the return, but the Income-tax Officer was not satisfied with the explanation offered by the assessee and he levied a penalty of Rs. 16,415 on the assessee under section 271(1)(a). The assessee appealed against the order of penalty to the Appellate Assistant Commissioner but the appeal was unsuccessful. The matter was thereupon carried in further appeal to the Tribunal, namely, that the return having been filed before the assessment was made and within four years from the end of the assessment year 1961-62 as provided under suggestion in the case of the assessee who was a company and was a licensee under the Electricity (Supply) Act. Apparently that was because, simultaneously, provision was made by amendment of the Schedule to the Electricity (Supply) Act, 1948, for the creation of a development reserve. Paragraph V - A of the Sixth Schedule was introduced in the Electricity (Supply) Act, 1948 in 1956 and it is that Paragraph which created the obligation in a licensee under the Act to a keep a development reserve. That reserve was directly related to the development rebate being equal to the income-tax Act, 1922, to plough back a portion of the development rebate allowed to him during the course of the succeeding years. Of course, in the case of the latter, the assessee stood the risk of losing the benefit of the development rebate in case he did not so plough back while that was not the case with the obligation to create a development reserve. The distinction is immaterial for our present purpose. When an assessee under the Indian Income-tax Act, 1922, brought back into the business a portion of the development rebate in the succeeding years, admittedly, he was not entitled to claim this as expense. If the creation of a development reserve was similar, then, of course, by merely being asked to reserve a certain amount by way of development reserve, a person who had obtained the benefit of the development rebate cannot claim to seek deduction by way of expenditure on account of the creation of such reserve.
2. The assessee contends before us in regard to the contingencies reserve and the development reserve that they were created not on the assessee's own volition but because of statutory compulsion, that these are really diversions from the revenue and not from the income, that, therefore, these deductions are deductions not from the income, but before the income was received, and for that reason the assessee is entitled to claim exemption.
3. Alternatively, even if it be otherwise, in view of the specific purposes to which alone these could be applied, these have to be excluded from the assessable income by reason of section 37 of he Income-tax Act, 1961. Elaborating the last of these contentions, counsel urges the inasmuch as the income is not available for the use of the assessee except in a limited manner, namely, to the extent permitted by the statutes, this has necessarily to be deducted from the assessee's income. In Poona Electric Supply Co.'s case claim for deduction of the amount credited to the consumers' benefit reserve was held to be admissible and it is contended before us that the same rule must apply in regard to the development reserve and contingencies reserve. Regarding the third reserve, namely, the 'special reserve' it is not shown that it is under any statutory provision, but what is said is that the electricity board directed the assessee to keep such a reserve and since it is done in accordance with such direction which the assessee was bound to comply with by reason of section 55 of the Act, that too must be considered as admissible.
4. We can dispose of the case of the assessee with regard to the last of these items, namely, the deduction of the amount under the 'special reserve'. It has not been shown that the amount so reserved was not available to the assessee for diversion for any purpose of his own. It has not been attempted to be proved that the terms of the instruction to the assessee in any way affects the right of the assessee to deal with such a reserve as in the case of any ordinary reserve which the assessee is not bound to apply to any particular purpose only. Therefore, merely because some instruction is said to have been given by the electricity board and a reserve is created which reserve, in the normal course, would be available for appropriation by the assessee without any restriction, it cannot be said that it should be deductible from the income. In fact, the assessee did not attempt to make out a case on this. The real controversy concerns the other two items.
5. In regard to the claim for deduction of the amounts credited to the contingencies reserve and development reserve we have already noticed the relevant provisions of the statutes. Before we examine the question it will be profitable to refer to the statutes. Before we examine the question it will be profitable to refer to the decision of the Supreme Court in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax which is sought to be relied on by the assessee. The Poona Electric Supply Company Ltd., a licensee, engaged in the business of distribution of electricity in the city of Poona, claimed deduction of the amount credited to the consumers' benefit reserve account from its taxable income. The contention was accepted by the Tribunal and the matter came to the High Court which decided against the assessee. It was against this that the matter was taken to the Supreme Court by the assessee. After examining the relevant provisions of law, the court considered the question as to what exactly was the profit derived by the assessee and noticed the distinction between payment out of profits and payment to earn profits. It was further noticed that while the fact that there was a distinction between these was unexceptionable, the difficulty was in ascertaining in each case whether a particular payment falls under one or other of the two categories. The position was summed up in that case in the following word :
'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 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. In a given case whether the outgoings fall in one or the other of the heads in 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 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 a part of the excess amount paid to it and reserved to be returned to the consumers. They did not form part of the assessee's real profits. So, to arrive at the taxable income of the assessee from the business under section 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 section 10(2)(xv) of the Act.'
6. It is evident that the question whether the amount credited to the 'consumers' benefit reserve' account was an admissible item of expenditure for arriving at the net income was left open by the Supreme Court. What was decided was that the amount did not from part of the assessee's real profit. By the term 'real profit' what was apparently meant was commercial profit. Statutory profit is that fixed by the statute while commercial profit is what normally any person understands as profit in ordinary commerce. The view expressed by the Supreme Court appears to us to be that in computing the commercial or real profit such diversions as the consumers' benefit reserve account must be deducted. Though, before us, counsel for the assessee urged that the two items of reserves with which we are now concerned are not part of the income, what he really means as elaborated at the argument before us, is that in determining the real profits the statutory diversion in regard to these two amounts must be noticed and these must be deducted. In other words, the contention is that though the reserves with which we are now concerned are different from the consumers' benefit reserve account it is said that the character of these is identical with that of the consumers' benefit reserve count and if that be the case, the decision of the Supreme Court must apply to the facts of this case. That is the question with which we are primarily concerned here as, if we agree with this contention, no other question may arise and the assessee may have to succeed.
7. Paragraph II of the Sixth Schedule to the Act provides for the appropriation of one-third of the excess of the clear profit over the reasonable return by the undertaking for itself. But such amount shall not exceed five per cent. of the amount of reasonable return. That would be at the disposal of the undertaking. Of the balance of the excess, one half has to be appropriated to a reserve which shall be called the 'tariffs and dividends control reserve' and the remaining half 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. Therefore, the amount credited to the consumers' benefit reserve is an amount returnable to the consumers and is not to be at the disposal of the licensee. We have to see whether the position is the same in the case of the contingencies reserve and the development reserve.
8. We will now take up the case of development reserve provided under Paragraph V - A of the Sixth Schedule. This, as we have already pointed out, is of the same character as the 75 per cent. of the development rebate which the assessee was bound to plough back into the business of the undertaking under the proviso to section 10(2)(vi)(b) of the Income-tax Act, 1922. It cannot be said that the amount is expended by the assessee nor could it be said that the amount is expended by the assessee nor could it be said that it is lost to the assessee by an overriding obligation. The development reserve is still available to the assessee with the only limitation that it is so available only for investment in the business of the electricity supply undertaking. There is no restriction as to the scope of investment of the amount no reserved in any particular manner. Even the sum to be so appropriated towards the development reserve in respect of any accounting year could be appropriated in annual instalments spread over for a period not exceeding five years. The benefit of the amount so set apart as reserve is available to the assessee directly. It could be applied by him as he pleases as investment in the business of the electricity supply undertaking. We do not think that this is in the nature of the consumers' benefit reserve with which the Supreme Court was dealing in the Poona Electric Supply case.
9. As indicated earlier, the consumers' benefit reserve was intended for the benefit of the consumer alone and there is no direct or indirect return of the benefit to the licensee under and circumstances. That is not the case here and we do not think there is a diversion of the revenue which has to be deducted for the purpose of determining the real profits of the assessee or that there is an 'expenditure' liable to be deducted under the Income-tax Act. In fact, it is not diversion in the real sense of the term since a diversion should be one which goes out and is no longer that of the person who so diverts it. We, therefore, hold that the assessee's claim for deduction of the amount under the development reserve ought not to be allowed. The question has to be answered in favour of the revenue and against the assessee.
10. But we find that the position is different in the case of the contingencies reserve. It is evident that this reserve is treated in the statute itself in a manner different from the development reserve. In fact, as I have indicated, this reserve is to be created from out of the 'revenue' and not out of the profit 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 Paragraph IV of the Sixth Schedule is sufficient to show that the purposes are not so general as in the case of the development reserve. Whereas the development reserve can be used for investment in the business of the undertaking, the 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. This rule is subject exceptions. The exception clause provides that it shall be drawn upon for meeting such charges as the State Government may approve as 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.
11. On the purchase of the undertaking, the reserve has to be handed over to the purchaser who has to maintain it as such. If the undertaking is purchased by the board or the State Government after deduction of the compensation payable to the employees of the out-going licensees the reserve has to be handed over to the 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 takes over, no allowance is made in the purchase price for the amount of the contingencies reserve. All these provisions indicate that though to a very limited extent the assessee may have a benefit from out of the contingencies reserve, in the in certain contingencies which the State Government may approve he may get the benefit of the amount reserved; generally, the amount is not one which is at the disposal of the assessee in the matter of its application. Referring to the object of the Sixth Schedule, the Supreme Court in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax said thu :
'The object of the Act ant 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.'
12. The Electricity (Supply) Act, 1948, is an Act intended to provide for the rationalisation of the production and supply of electricity, and generally for taking measures conducive to electrical development. Of course, even when the business of supply of electricity is carried on by a private individual as licensee, it is a business in which it is the public who are ultimately interested. The public are the beneficiaries. It is necessary that the licensee should conduct himself efficiently in the discharge of his duties as a licensee. The provisions of the Sixth Schedule, and in particular, those relating to the application of the contingencies reserve is intended to ensure efficiency in the running of the undertaking by the licensee. In the matter of application of the contingencies reserve it is easy to find that the object is to improve the efficiency of the running of the business of the licensee. The amount of the reserve can be used for such purposes as are specified in Paragraph V(1) of the Sixth Schedule as the State Government may approve. These purposes indicate that the object is to see that the undertaking is smoothly and property run. One of the purposes is the meeting of charges by way of expenses or loss of profits arising out of accidents, strikes of circumstances which the management could not have prevented. Another is the meeting of expenses on replacement or removal of plant of works other than expenses requisite for normal maintenance or renewal and the third is the compensation payable under any law for the time being in force and for which no other provision is made. The default of the licensee in regard to any of these obligations would have immediate impact upon the manner in which the undertaking is run and the result would affect the consuming public. Therefore, the creation of this reserve is apparently with the prime object of making available sufficient resources for meeting commitments necessary for the efficient running of the business, commitments which, if the licensee fails to meet, would really affect the consumers. An uninterrupted supply of electric energy and proper maintenance of the supply from time to time by the licensee are amenities which must be assured to the public and the object of the paragraph concerning this reserve appears to us to be to assure them these.
13. 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 than those indicated in Paragraph V of the Sixth Schedule and also noticing the object of the certain of this reserve and further nothing 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 this reserve as and when the undertaking is purchased and even the purchaser has to maintain the reserve as such. Therefore, in 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 obligation created by the statute and, therefore, for determining the commercial profits of the assessee, the amount of this reserve has to be deducted.
14. In view of what we have said here, the question whether the amount diverted to this reserve is an item of expenditure deductible under section 37 of the Income-tax act, 1961, need not be dealt with.
15. In the result, we answer the question referred to us in the following manne : The Income-tax Appellate Tribunal was not right in holding that a sum of Rs. 10,225 transferred to the contingencies reserve account was not to be deducted in arriving at the taxable income of the assessee-company. This amount ought to have been deducted. The Tribunal was right in holding that the sum of Rs. 30,475 transferred to the development reserve account was not to be deducted. The sum of Rs. 23,417 transferred to the special reserve account ought not to be deducted in arriving at the taxable income of the assessee-company and to that extent also the Appellate Tribunal was right. The question is thus answered partly in favour of the revenue and party in favour of he assessee. Parties are directed to suffer costs. A copy of this judgment under the seal of the High Court and the signature of the Registrar will be sent to the Appellate Tribunal, Cochin Bench, as required by section 260(1) of the Income-tax, 1961.
Viswanatha Iyer, J.
16. I concur, but I wish to add a few words of my own.
17. In the light of the financial principles laid down in the VIth Schedule to the Electricity (Supply) Act, 1948, which strikes a balance between the conflicting interest of the investor who would seek a maximum return on the investment and of the consumer who must be protected by limiting to the minimum dividends of the investor consistent with the industry's ability to attract fresh capital at reasonable rate of interest for future development and expansion, it is clear a ceiling is imposed on the profits made by the electricity undertakings. The Sixth Schedule prescribes this ceiling by laying down that the clear profit of an undertaking in any year of account shall not exceed the amount of reasonable return. To effectuate this ceiling the undertaking is required by the subsequent provisions of the Schedule, to dispose of the excess over the clear profits in the manner prescribed in Paragraph 2 and to create three reserves, viz., tariff and dividend control reserve, contingencies reserve and development reserve. We are concerned in this case with only the latter two reserves, viz., contingencies reserve and development reserve. Contingencies reserve has been created to meet exigencies like loss resulting from strike or accidents, expenditure incurred on replacement of plant other than normal maintenance, and compensation payable under any law in respect of which no provision exists. A small percentage of the revenue is directed to be credited towards this reserve annually. If the undertaking in sold, this reserve also must be passed on to the purchaser who is also bound to maintain it as a contingency reserve. The amount appropriated to this reserve should be invested in trust securities and it can be utilised only for purposes mentioned in the Paragraphs IV and V and for no other. The development reserve is created, as the name itself shows, for the development rebate to which the licensee is entitled under clause (vib) of sub-section (2) to section 10 of the Indian Income-tax act, 1922, is to be credited to the development reserve. This amount need not be appropriated to development reserve in the same accounting year, but may be spread over a period not exceeding five years. If the undertaking is sold, this reserve must also be transferred to the purchaser. The reserve can be used only for the development of the industry. Section 57 of the Electricity (Supply) Act has provided that the provisions of the VIth Schedule shall be deemed to be incorporated in every licence issued whether before or after the commencement of the Act and the provisions of the Schedule shall have overriding effect over the provisions of the Indian Electricity Act, 1910. That shows that compliance with the provisions of the VIth Schedule is a statutory obligation subject to which alone a licensee is entitled to do the business of generation and supply of electricity. The question is whether the appropriation to these two reserves as per these provisions can be allowed to be deducted in the computation of income for the purpose of the income-tax assessment.
18. In the case of ordinary assessee a certain amount is allowed as development rebate in the computation of profits and gains of a business. Section 10(1) and (2)(vib) of the Indian Income-tax Act, 1922, and section 33 and 34 of the new Act relate to this rebate. Under these provisions a certain portion, viz., 75% of the amount allowed as development rebate, is directed to be appropriated to a reserve and to be utilised for the specific purpose of the business. The reserve should not be utilised for distribution by way of dividends and profits or remittance outside India as profit arises for acquisition of assets outside the country. The assets also should not be sold before the expiry of the period within which the development rebate must be utilised for the purpose of the business. If the conditions mentioned therein are not observed the rebate will be withdrawn and the amount made taxable. The said provision exempts companies carrying on the business of electricity supply under the Electricity (Supply) Act, 1948. This was because by Act 101 of 1956, the Electricity (Supply) Act was amended and in the VIth Schedule, Para. V - A was added which required the amount representing the tax payable on the rebate allowed for the year to be kept as a reserve and permitted to be utilised only for the development of the industry. Of course the provision for withdrawal of the rebate, if the reserve is not utilised for the business within a time, is not there, otherwise this Para. V - A of the VIth Schedule is really complementary to the development rebate provisions of the Indian Income-tax Act. That was why in Para. V - A, it is said that appropriation to development reserve need be had only if he assessee is entitled to development rebate under the Income-tax Act. This will show that it is really a portion of the development rebate, that is allowed under the Income-tax Act, that is directed to be kept as a reserve for utilisation of the development of the industry. That this is the intention of the legislature is further clear from the 'Objects and reasons' stated in the Bill to amend the Electricity (Supply) Act, 1948, on the basis of which Para. V - A was added to the VIth Schedule of the Act. Para. 7 of the 'Objects and reasons' in the said Bill reads as follow :
'It is also proposed to provide for the electricity supply industry to avail the benefits of the development rebate permitted under the provisions of section 8 of the Finance Act, 1955, by allowing the creation of the development reserve. The accumulations in this reserve will be utilised for the development of the undertakings. The licensees, however, are not to be permitted to earn reasonable return on the assets financed from this reserve.'
19. It is by section 8 of the Finance Act of 1955 that development rebate provision was added in the Indian Income-tax Act, 1922. This being thus related to the development rebate under the Income-tax Act, the assessee cannot, over and above the allowance by way of development rebate, claim the amount appropriated to the development reserve under the Electricity (Supply) Act to be deducted in computing the income for the purpose of assessment.
20. But this cannot be said of the contingency reserve. The statute requires certain percentage from out of the 'Revenues' to be credited every year towards the contingency reserve. The maximum is also provided for. This appropriation being compulsory and by the scheme of Paragraph V being prohibited from utilising these for any purpose other than that mentioned in the Paragraph, the licensee cannot be said to be getting a benefit from it. As a matter of fact the destination of the reserve is not very often a test to decide whether the deduction claimed should be allowed or not. Even assuming that the licensee may be said to get a benefit if and when the contingency happens that is no reason to say that this is not an expenditure wholly and exclusively laid out or expended for the purpose of such business or profession. The word 'expenditure' in section 37 is not used in the ordinary sense of that word (see the categories of allowances included within brackets - Development rebate, the benefit of which goes to the assessee, is also taken as expenditure). In the context it has a wider meaning. That being so it can be stated that this amount is really laid out for the purpose of the business because it is to meet certain contingencies which a public utility concern has normally to anticipate to happen in the business and provide for. But I do not rest my final conclusion on this point applying section 37. I agree with the reasoning of my learned brother that this amount of contingency reserve must be deducted in arriving at the total income.