Commissioner of Income Tax Vs. Jodhpur Co-operative Marketing Society - Court Judgment

Rajesh Balia, J.

1. This appeal is against the judgment of Tribunal, Jodhpur Bench, Jodhpur dt. 6th Feb., 2001 and concerns the assessment of the assessee-respondent for asst. yr. 1989-90.

2. The assessee is a co-operative marketing society who claimed that Rule 68 of the Rajasthan Sahakari Sansthan Rules of the Rajasthan Co-operative Society Rules, 1966 (in short the Rules of 1966) framed under the Rajasthan Cooperative Societies Act, 1965 (in short the Act of 1965} requires the society to transfer 25 per cent of its net profits to a reserve fund. The said amount, according to the assessee, does not remain under the control of assessee or the co-operative society but it goes under the control of the Registrar, Rajasthan co-operative societies, therefore, it does not form part of assessee's real income and for that reason, it was sought to be excluded from computation of taxable income of the assessee. The deduction was also claimed under Section 37 of the IT Act. Reliance for the purpose was made on a decision of the Madhya Pradesh High Court in Keshkal Co-operative Marketing Society Ltd v. CIT : [1987]165ITR437(MP) special leave petition against which was dismissed by the Supreme Court.

The AO in his order dt. 31st Jan., 1991 disallowed the aforesaid claim to deduction. The AO after referring to the provisions of the Act of 1965 and the Rules of 1966 and bye-laws which also provide for creation of certain other funds out of net profits, was of the opinion, that the bye-laws of the Rules of co-operative society only guide the functioning of the society and recommend transfer of profits to a certain extent to the reserve fund for various purposes, so that the co-operative societies remain financially sound, but the transfer of profits to reserve fund is below the line adjustment and is not at all an expenditure for the assessee, which can be allowed as deduction against the profits. Before the AO, reference was made to Ramanlal Kamdar v. CIT : [1976]103ITR489(Mad) and CIT v. Kisan Co-operative Rice Mills Ltd. : [1976]103ITR264(MP) .

On appeal, CIT(A) vide its order dt. 24th March, 1993 agreed with the AO and dismissed the appeal in respect of this claim.

On further appeal before the Tribunal, the society succeeded. The Tribunal following the decision of Madhya Pradesh High Court in Keshkal Co-operative Marketing Society referred to above held the amount transferred to reserve fund as allowable deduction as business expenses.

3. This appeal concerns only the aforesaid controversy which has been reflected in the following substantial question of law framed at the time of admission of the appeal :

'Whether the amount of net profit transferred to reserve fund of the society-assessee under Section 68 of the Rajasthan Co-operative Societies Rules, 1966 can be termed as expenses incurred wholly and exclusively for the purpose of business and is allowable deduction under Section 37 of the IT Act, 1961?

4. Learned counsel for the Revenue contends that the provisions of the Cooperative Societies Act relating to creation of reserve fund and its subsequent dealing goes to show that reserve fund required to be created under Section 62 of the Rajasthan Co-operative Societies Act, 1965 r/w Rule 68 of the Rules of 1966 applies only in the case of net profits of the co-operative society is positive and after it has reached it and it remains a part of assets and investment of the society to be used for the purpose of the society in accordance with law. The provisions of Act and Rules ensure that no part of reserve fund be used during the continuance of business of the society for any purpose other than for the purposes of the society. The attention of the Court was drawn to Sections 62, 63, and 82 of the Act of 1965 and Rules 55 and 56 of the Rules of 1966. It is contended that neither it is a case of expenditure which could be allowed under Section 37 nor it is a case of diversion of income at source by overriding title, nor can be said that the amount so transferred to the reserve fund is not the real income of the society so as to be excluded from computation of taxable income of the society for the relevant period.

5. Mr. N.M. Ranka, learned senior counsel appearing for the assessee, urged that the reserve fund required to be created under Section 62 r/w Rule 68 is not under the volition of the assessee but under the compulsion of statute which cannot be used by the assessee at his option. Its control is absolutely outside the society and rest with the Registrar of Co-operative Societies. It was also urged that the amount of reserve fund is ultimately to be used for some object of public utility as it appears from Rule 56 of the Rules. The residue has to be applied for any public purpose either as per resolution by the society or as per the direction of the State Government, on the society's failure to resolve about the public utility to which the residue reserve fund is to be applied. These requirements clearly indicate that the amount which has to be transferred to the reserve fund before utilisation of net profits for the purposes of the society, really does not become the income of the society in the sense in which income is ordinarily understood. Since the amount is carried under the compulsion of the statute to a reserve fund ultimately to be used for some object of public utility, it amounts to the diversion of the net profits to the reserve fund is under overriding legal obligations to be used for object of public utility, which is the specified beneficiary of the fund, and therefore, it also amounts to diversion of income by overriding title which never becomes a part of assessee's profits which can be used by him. Alternatively, it was also urged that if it is not termed as diversion of income by overriding title, and forming part of real income of the assessee, the assessee is still entitled to claim the amount transferred to the reserve fund as a business expenditure under Section 37. Mr. Ranka contends that the amount transferred to reserve fund in terms of Section 62 r/w Rule 68 is amount laid out wholly and exclusively for the purposes of carrying on the business of the assessee to further the requirements of law for running the business. He strongly relied on the decision of the MP High Court in Keshkal Co-operative Marketing Society's case (supra), Poona Electric Supply Co. Ltd. v. CIT : [1965]57ITR521(SC) , Ramanlal Kamdar (supra), Kisan Cooperative Rice Mills Ltd. (supra). He also relied on the decision of the Karnataka High Court in CIT v. Pandavapura Sahakara Sakkare Karkhane Ltd. : [1988]174ITR475(KAR) ; CIT v. Pandavapura Sahakara Sakkare Kharkane Ltd. : [1992]198ITR690(KAR) and CIT v. Hiranyakeshi Sahakari Sakkare Kharkhane : [1993]200ITR130(KAR) buttressing with submission that special leave petition against the last mentioned decision has also been dismissed by the Supreme Court.

6. Before considering the various precedents having some bearing on the controversy before us, it would be apposite to acquaint with the relevant provisions of the Co-operative Societies Act, 1965 which deals with the creation of reserve fund and its user to understand the exact nature of reserve fund in question.

The object for enacting the Rajasthan Co-operative Societies Act, 1965 was to provide for long-term loans to holders of land to enable them to discharge their debts, to carry out agricultural improvements, to acquire land for the formation of economic holding and other like purpose and thereby to promote thrift and self-help among them and for these purposes to give effect to the concept of State partnership in share capital and State participation in the management of the co-operative society.

The various provisions of the Co-operative Societies Act show that while giving room for a fair amount of autonomy, the State Government has also kept its regulatory and guiding hand to ensure a balanced and strong growth of cooperative movement as principal organ of rural economy through co-operative societies to be set up under the Act. Chapter n requires and deals with registration of co-operative societies. While providing for management of cooperative societies, it is envisaged under Section 29 of the Act that final authority in a co-operative society shall vest in its general body of members.

Under Chapter IV it is envisaged that where a State has contributed a substantial amount towards share capital directly or indirectly, the State Government can nominate Government servant as member of the society to a limited extent under Section 35; and can also appoint its Chief Elective Officer or Executive Officer, as the case may, be under Section 55A and Section 35B, respectively.

Chapter VI delineates the policy of State to see all steps to encourage the cooperative movement in the State. Sec. 46 casts a duty on the State Government to encourage and promote co-operative movement in the State and also to take such steps in this direction as may be necessary and in this direction providing a guiding provision.

Significantly, Chapter VII deals with properties and funds of the co-operative societies and their management. Having a glance at provisions of Chapter VII reveals that State Government not only has its regulatory role in creation of a reserve fund which is subject-matter of this appeal but also in all spheres of managing its assets.

Section 61 prohibits payment by way of bonus or dividend out of the funds of the society and restricting such distribution to be out of the net profits of the society. Section 62 deals with the disposal of net profits and Section 63 deals with investment of funds. Section 64 to Section 66 provide restriction on borrowing, advancing loans, limit of interest and restriction on transaction with non-members, All these provisions indicate the zealousness with which the financial interest of the co-operative society is regulated to ensure avoidance of high risk and building up of sound financial base for rural economy, such regulatory provisions are not confined to reserve fund to be created under Section 62 r/w Rule 68 but extends to properties of the society in its entirety of which reserve fund in question only forms a part. It cannot be treated in such an isolated vision as has been projected by the assessee.

Section 62 and 63 which directly concern us in appeal, reads as under :

'62. Disposal of net profits:--(1) A co-operative society shall, out of its net profits in any year-

(a) transfer, to the reserve funds, such percentage of its profits and within such period as may be prescribed; and

(b) credit such portion of the profits, as may be prescribed, to the co-operative education fund constituted under the rules.

(2) The balance of the net profits may be utilised for all or any of the following purposes, namely:--

(a) payment of dividend to members on their paid up share capital at a rate not exceeding the prescribed limit;

(b) payment of bonus on the amount or volume of business done by them with the society, to the extent and in the manner specified in the bye-laws;

(c) constitution of or contribution to such special fund as may be specified in the bye-laws;

(d) donations of amounts not exceeding ten percentum of the net profits for any charitable purpose as defined in Section 2 of the Charitable Endowments Act, 1890 (Central Act 6 of 1890); and

(e) payment of bonus to employees of the society, to the extent and in the manner specified in the bye-laws.

63. Investment of funds:--(1) Except as otherwise provided in Sub-section (2), a cooperative society shall invest its funds in one or more of the following:--

(a) Central Co-operative Bank;

(b) Apex Bank;

(c) in the shares or securities or debentures issued by any other co-operative society with limited liability;

(d) in any other mode permitted by the rules or by general or special order of the Government.

(2) A co-operative society may deposit its funds for a temporary period in such manner as may be prescribed.

7. Another relevant provision that need be noticed in this regard is Section 82 which deals with disposal of surplus assets which is amalgam of all assets of the society including the reserve fund in the case of winding up or dissolution of society which reads as under:

'82. Disposal of surplus assets:--After all the liabilities including the paid up share capital of the cancelled society have been met, the surplus assets shall not be divided amongst its members but they shall be devoted to any object or objects described in the bye-laws of the society and when no object is so described, to any object of public utility determined by the general meeting of the society and approved by the Registrar or they may, in consultation with the members, either be assigned by the Registrar, in whole or in part to any or all of the following--

(a) an object of public utility

(b) a charitable purpose as defined in Section 2 of the Charitable Endowments Act, 1890.

or may be placed in deposit with the financing bank until such time as a new society with similar conditions is registered when, with the consent of the Registrar, such surplus may be credited to the reserve fund of such new society.

It ordains that after the liabilities of the society including liability towards shareholders is paid, surplus is not to be used for distribution amongst the member of the society but shall be applied for any objects or object described in the bye-laws of the society and if no such purpose or object is provided in the bye-laws, the surplus is to be applied to any object of public utility determined by the general body of the society and approved by the Registrar. In case the general body also does not approve any such object to which the surplus can be utilised, it is to be in consultation with the members either be assigned by the Registrar to an object of public utility or to a charitable purpose as defined under Section 2 of the Charitable Endowments Act, 1890 or may be placed in fixed deposit with the financing bank until such time as a new society with similar conditions is registered and such surplus may be credited to the reserve fund of such new society.

Apparently, this dealing of surplus after paying all outstanding of the society applies to residue of entire assets of the society including the funds created under Section 62 of the Act r/w Rule 68 of the Rules. The distribution of reserve fund is not in isolation but is a part of general scheme of the Act dealing with assets and profits of the society in general during the continuance of its business as well as after the society ceases to exist leaving its assets firstly to discharge its own liability towards persons other than share capital, then to repay of its member, the share capital contributed by the members with dividends to the extent permissible and the remaining surplus, if any, either to be utilised for any object of public Utility or for the purposes of charitable purpose as defined under the Charitable Endowment Act, 1890 or corpus to be retained for a new society to come into existence in future with the like object as were with the cancelled society. Significantly, the application of surplus assets to an object of public purpose to be assigned by Registrar for public utility or charitable purpose or it is to become corpus fund of new society of like nature remains the decision of the society through its members in general body either providing for such contingencies in bye-laws or by resolving in general body about how to use the surplus. From these provisions, it cannot be spelled, except generality of application of surplus of all its assets, that creation of reserve fund is for the purpose of feeding any object of public utility or charity.

8. In this connection, it is significant that Section 62, not only provides for creation of reserve fund to be used for society in contingencies to which we shall presently advert to, but also to education fund to be constituted under Rules and to constitute such other special funds which may be envisaged under bye-laws and it also envisages donations to charitable purpose as defined under Section 2 of Charitable Endowment Act, 1890 such part of net profit not exceeding 10 per cent of net profit.

Thus, creation of number of funds for different purposes is envisaged under the statute, Rules and bye-laws of a co-operative society under the Act of 1965. Significant for the present controversy, statute also requires a regular donation to charity out of its annual net profits not exceeding 10 per cent of it. Commensurate with the general scheme of application of net profit by way of contribution to reserve fund, distribution of bonus and dividends and towards charitable purpose, on cessation of business as a result of winding up or cancellation of the society also surplus of assets, if any, left after clearing the claim of creditors and shareholder members, is to be applied to charity or corpus be kept alive to be used by a future co-operative society. These provisions neither make running of business by co-operative society for a public utility object or charitable purpose, nor it in any way creates a nexus between reserve fund created under Section 62 and the object of any public utility as its unconditional beneficiary. User of surplus at the end can also not be referable to any specific asset forming part of the total mass of assets of the society. Thus, the contention that reserve fund is created for an object of public utility is rejected.

9. The relevant rule which deals with the creation of the reserve fund and its utilisation which give effect to the above provision may now be noticed.

Rule 68 while giving effect to Section 62 provides that in a society with shares and limited liability, not less than one-fourth of the net profits shall be carried to the reserve fund. In a society with shares and unlimited liability, not less than one-third of the net profits shall be carried to the reserve fund. In the latter case, 1/3 share of the net profits to be transferred continuously until the reserve fund equals to the paid up share capital of the society. Thereafter, such society has also to carry 25 per cent of its net profits to the reserve fund, However, looking to the financial position of any society and its needs, the Registrar may fix a lower rate of contribution made to reserve fund but not below 1/10th of the net profits. Sub-rule (2) provides for setting apart such part of its net profits by any agricultural credit society other than a land development bank. This is in addition to reserve fund envisaged under Sub-rule (1). This fund is to be utilised to enable the borrower to make postponement of repayment of loan on account of famine, drought or such unforeseen causes. Sub-rule (3), (4) and (5) of Rule 68 provide for distribution of dividends and bonus out of remainder to its members to the extent of business run by these members with the society, details of which we are not concerned here.

10. We have noticed above that Section 63 of the Parent Act provides for avenues in which the co-operative society is to invest its fund including reserve funds. It ensures that the funds are to be invested in such avenues where there is no risk to its repayability and for a fairly longevity of time to yield good return to society. The investment of the co-operative society funds for a temporary period is left to the discretion of the society.

11. Rule 55 which gives effect to Section 63 clearly declares that reserve fund maintained by co-operative society will belong to the society. It also envisaged the purpose for which the fund can be used. Primarily, it is devised to meet unforeseen future losses. But, it makes flexibility about its user. In a given case, society may be permitted to invest the fund wholly or a portion thereof in its own business. In the case of housing society, the reserve fund may be utilised for the expenditure on maintenance, repairs and renewal of buildings of the society and in the case of a processing society, the funds can be used for acquisition or purchase or construction of land, building and machinery.

Sub-rule (4) of Rule 55 unfolds the areas to which reserve fund can be put to use. It reads :

(i) to meet unforeseen losses incurred by the society;

(ii) to meet such claims of the society as cannot otherwise be met; and

(iii) to provide for other financial need in times of special scarcity.

The aforesaid provisions convey in no uncertain terms that the reserve fund remains part of the capital and assets of the society and is to be used only for the purposes of the society in future according to the needs of the society either to be adjusted against its future losses or to pay off its dues which cannot otherwise be paid or to provide for funding needs in case of financial crisis. No part of reserve fund during the continuance of the society can be utilised for the purposes other than for the purpose of society albeit in consonance with general policy of the Act. User of the reserve fund which has primarily its object to have financial strength of the society and to the cooperative movement, has been regulated by the approval of the Registrar but there is no absolute prohibition against user of the entire reserve fund for the purposes of the society without there being necessity to reimburse and refurnishing existing reserve fund.

12. In the case of winding up of a co-operative society, Rule 56 gives effect to Section 82 of the Parent Act which we have adverted to above, which ordains that firstly, the debentures be paid then to repay the paid up share capital with dividend not exceeding 6 per cent return for any period or periods for which the dividends have not been paid. It is only after all these sums are paid and all the liabilities of society to its creditors and shareholders are discharged, if there remains any surplus funds or for that matter, surplus assets, the same are to be applied to such object of public utility as is resolved in the event of dissolution or cancellation of society. In distribution of the assets of which the reserve fund is also a part, no distinction is made in the application of surplus. Surplus, if any left, is of the entire assets of the society without being any mark of any particular asset or fund, has to be applied for some object of public utility or for charitable purposes, as defined under Charitable Endowments Act as may have been approved by its members, whether through bye-laws or by resolution of general body of members.

The provision clearly brings out the following features about the nature of the reserve fund :

(i) The net profits of the society are first to be determined on the basis of declaration by the Registrar after making adjustment in accounts as per the requirements of the bye-laws and after the net profit is so worked, out of it, has to be divided in two parts; 25 per cent of net profit is ordinarily to be transferred to reserve fund, the remainder is to be used by the society towards education fund constituted under Rules and other specific purposes, if any, constituted under the bye-laws and towards payment of dividend and bonus to the shareholders as may be provided by bye-laws subject to the maximum limits in that regard prescribed and towards donation to charitable purpose.

(ii) The reserve fund along with other funds of the society as may be required to be constituted by the bye-laws are to be invested in the avenues provided under the Act subject to relaxation that may be granted by the Registrar for utilising the funds for its running business.

(iii) Reserve fund so required to be created compulsorily remains the property and part of the capital block of the society.

(iv) Till the continuance of society, reserve fund created out of net profit can be used for no purpose other than for the society itself.

(v) The reserve fund so created is for the purpose of meeting the future exigencies like enduing loss or the repayment of debts which cannot otherwise be repaid or significantly to use the reserve fund as finance of the society for its own purpose in case of scarcity of finance from other sources.

(vi) The fact that the utilisation of reserve fund is subject to regulatory control of the Registrar does not make it any less the property of the society is clearly envisaged in Rule 68 and is reinforced from the fact that Registrar has no power to use the reserve fund credited under Section 62 of the Act for any purpose other than for the purpose of the society during the existence of the society.

(vii) Even after the society is dissolved or cancelled, it can be used primarily for the repayment of debts of the society and the repayment of share capital with dividend upto the maximum rate of dividends provided under the law.

(viii) It is only if there remains surplus of the assets, which may include the part of reserve fund also, is not to be divided amongst shareholders but is either to be utilised for some object of public utility decided by members of the society through its bye-laws or by passing a resolution to that effect in its general body or in consultation with general body, or for any charitable purposes as defined under Charitable Endowments Act, 1890 or to be kept a live corpus with a view to become the corpus of future society with the like objects. But, it does not ever become part of the State funds as such to be utilised by the State for its own purposes.

13. The contention raised before us is to be decided on the anvil of aforesaid nature and characteristic of reserve fund created under the Act.

14. The first issue which arises for consideration is whether in the circumstances stated above, carrying forward a part of net profit of the society amounts to diversion or income by overriding title.

15. The diversion of income has multi-facets. Diversion arises where income is applied in a particular manner under statutory or contractual obligation or under the provisions of a document under which the company is constituted viz., memorandum of article of association or a firm has come into existence. In these circumstances, the principle that has emerged is that if a person has alienated or assigned the source of his income so that it is no longer remains his income, he cannot be taxed upon the income arising after the assignment of the source. In such event, it is not income of the assessee at all. On the contrary, if the source is not assigned to, or transferred but passes through the assessee to an ultimate purpose, the case of application of income in a particular manner. Even though he may enter into a legal obligation to apply it in a particular way, still it remains the income of the assessee. Section 61 to Section 62 provides an exception to legislative rule where notwithstanding assignment of source of income, the income is deemed to be the income of the person who has assigned such source by creating a legal fiction,

16. Another shade of such controversy is where the income is not applied but diverted by an overriding title from the assessee, which he would otherwise have received. Such diverted income cannot be considered the income of the assessee at all. Reference may be made to Raja Bejoy Singh Dudhuria v. CIT (1933) 1 ITR 135 where the assessee has succeeded to the family ancestral estate on the demise of his father. Subsequent to such succession, his stepmother who had legal right to maintenance out of the estate of her husband brought a suit of maintenance against him and the assessee suffered a decree of the Court to pay a fixed monthly sum to the step-mother and it was declared that the maintenance was a charge on the ancestral estate in the hands of the assessee. The question that arose before the Privy Council was that the assessee was liable to be assessed as an individual in respect of the amount of maintenance which was payable to step-mother; to that extent what he received for her was not his income. It was not a case of the application by the appellant of part of his income in a particular way. Lord Macmillan delivering the opinion of the board stated:

'In the present case, the decree of the Court by charging the appellant's whole resources with a specific payment to his step-mother has to that extent diverted his income from him and has directed it to his step-mother; to that extent what he receives for her is not his income. It is not a case of the application by the appellant of part of his income in a particular way, it is rather the allocation of a sum out of his revenue before it becomes income in his hands.'

It may be noticed that the title to receive the income in the aforesaid case vested with assessee but the assessee has received it for someone else than himself and the income at no stage become part of the assesse's capital block which could be used by him in future for his own purpose. In fact, it was made a charge on assessee's income which if the assessee failed to pay, could be directly recovered before it reached the assessee. This case is more akin to Poona Electric Supply case (supra) to which we shall shortly advert to.

17. In Provat Kumar Mitter v. CIT : [1961]41ITR624(SC) , the assessee who was a registered dealer of 500 ordinary shares in a limited company, assigned to his wife, by a deed of settlement, the right, title and interest to all dividends and sums of money which might be declared or which may be due and payable in respect of those shares for the term of her natural life and covenanted to deliver and endorse over to her any dividend warrant or other document of title to such dividends or sums of money and to instruct the company to pay such dividends and sums of money to her.

The assessee claimed exclusion of dividends on the aforesaid 500 ordinary shares on the ground of transfer of diversion of income by overriding title. The Supreme Court repelled the contention by holding that the deed of assignment was, it its true nature, only a contract by the assessee to transfer, or make over, to his wife in future all dividends that may be declared in respect of the shares; as a company can pay dividend only to the registered holder of the shares, neither Section 16(1)(c) nor its third proviso was applicable to the case; the income continued to accrue to the assessee and was assessable in the hands of the assessee as his income, even though it was ultimately payable to his wife under the terms of the deed. It was a case of application of income after it had accrued and not a case of diversion of any sum of money before it had become the income of the assessee nor was a case where the assessee has received the income for someone else.

18. Two features need be taken into consideration. Firstly, it was a case where diversion of income under overriding title was claimed to be given to a person other than the assessee after receipt of it by the assessee. Secondly, it was held to be an obligation on income of the assessee only after it had accrued and was not a case of diversion of any sum of money before it became the income of the assessee. This brings out another essential feature of application of principle of diversion of income by overriding title, viz., that income not only payable should reach other than the assessee but income should be reachable to the third party before it becomes the income of the assessee.

19. In the present case, it may be noticed that neither the reserve fund goes to any party other than the assessee itself, nor there is any obligation to provide for such reserve before it becomes the part of net income earned by the society.

20. In the like way is the case of K.A. Ramachar and Anr. v. CIT : [1961]42ITR25(SC) , where though under the deed of settlement which was irrevocable, each of the beneficiaries of the settlement was entitled to receive 1/4 of the share of the settlement in the profits of the firm during a period of 8 years from the date of settlement, the beneficiaries were entitled to directly receive and collect from the firm their shares under the settlements. The assessee's claim that those amounts were payable to the wife and children of settlor under the obligation arising under the irrevocable deed of settlement was negatived on the ground that on the facts, the effect of deeds of settlement was that profits were first to be accrued to the assessee and then to be applied for determination of share payable to the beneficiaries and under the law of partnership, it was the partner and the partner alone who was entitled to the profits. A stranger, even if he were an assignee, did not have and could not have any direct claim to the profits. The dispositions were, in law and in fact of portions of the assessee's income after it had accrued to him and tax was payable by him at the point of accrual.

On these principles, the decision in Raja Bejoy Singh Dudhuria's case (supra) was distinguished by the Court.

21. In P.C. Mullick and Anr. (Executors) v. CIT (1938) 6 ITR 206 for the aforesaid reasons, the Privy Council too distinguished its earlier decision in Raja Bejoy Singh Dudhuria's case (supra). It was a case in which a testator had by his will appointed the appellants his executors and had directed them to pay Rs. 10,000 out of the income of his property on the occasion of his 'addya sradh' for expenses in connection therewith to the person who was entitled to perform the sradh. He had also directed them to pay out of the income of his property, the costs of taking out probate of his will. The board opined that these are the income of the estate coming to the hands of the appellants as executors and in pursuance of obligation imposed by the testator, It was not a case in which a portion of the income was by an overriding title diverted from the person who would otherwise have received it as in Bejoy Singh Dudhuria's case (supra), but a case in which the executors having received the whole income apply a portion of it in a particular way.

In other words, rights to receive income should exist independent of the accrual and receipt of income by the assessee in some third party who could lay claim before it reaches the assessee.

22. The difference between 'obligation of income after it reaches the assessee' and 'diversion of income by overriding title before it reaches the assessee' was explained by the Supreme Court in CIT v. Sitaldas Tirathdas : [1961]41ITR367(SC) .

'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 obligation 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 person to whom it is payable.'

23. In CIT v. Imperial Chemical Industries (India) (P) Ltd. : [1969]74ITR17(SC) the Court held that :

'the payment of amounts by the respondent to the outgoing agents was not by an overriding title created either by act of parties or by operation of law, and it could not be said that the amount of compensation paid to the outgoing agents did not form part of the respondent's income. Applying the principles in Raja Bejoy Singh Dudhuria's case (supra) and Sitaldas Tirathdas's case (supra), the Court opined that an obligation to apply the income in a particular way before it is received by the assessee or before it has accrued or arisen to the assessee results in the diversion of income. An obligation to apply income which has accrued or arisen or has been received amounts merely to the apportionment of income and the income so applied is not deductible. The true test for the application of rule of diversion of income by an overriding title is whether the amount sought to be deducted in truth never reached the assessee as his income.'

24. In a recent decision, the Supreme Court in Motilal Chhadami Lal Jain v. CIT : [1991]190ITR1(SC) explained the connotation of the expressions 'reaches the assessee' and 'has been received' as has been used by the Court earlier in Sitaldas Tirathdas's case (supra). The Court said :

'The expressions 'reaches the assessee' and 'has been received' have been used not in the sense of the income being received in cash by one person or another. What the Court emphasised is the nature of the obligation by reason of which the income becomes payable to a person other than the one entitled to it. Where the obligation flows out of an antecedent and independent title in the former (such as, for example, the rights of the dependants to maintenance or of coparceners on partition, or rights under a statutory provision or an obligation by a third party and the like), it effectively slices away a part of the corpus of the right of the latter to receive the entire income and so it would be a case of diversion.'

Significantly, the nature of diversion of income by overriding title is that income reaches to a party other than the assessee by reason of a pre-existing title to it.

25. Coming to the facts of the present case, apparently the obligation to carry a part of net profit to a reserve fund does not envisage diversion of any part of profits in person other than society itself. There is no overriding title vesting in a third party other than the assessee to lay claim to the reserve fund independent of co-operative society. While unravelling the essential character of the reserve fund, we have noticed that reserve fund remains part of the assessee-society's corpus and is to be applied for assessee's business only, albeit its application is being regulated by the Registrar under the provisions of the Act but the statue does not give any power even to the Registrar to utilise the reserve fund so created out of the profits of the society for any purpose other than for the purpose of the society. Even on dissolution of the society the first obligation of the assets of the society including the reserve fund as part of the total assets and not specifically, is to the discharge of its debts outstanding and obligation towards the shareholders to pay their contribution with interest and dividend payable to them for the period such dividends are not paid. Surplus, if any, left thereafter, is to be applied according to the resolution of the general body of the members of the society only. Therefore, there is no insignia of diversion of income through an overriding title vesting in a third party outside the corpus of the society itself so as to consider it to be a case of diversion of income by overriding title to somebody other than the assessee.

26. It is also to be noticed that the question of transferring any amount to the reserve fund arises only in case the assessee-society received its net profit, after paying off all its expenses. Therefore, the question of transfer of any amount to the reserve fund arises only after society earns a net profit after paying all its expenses and then it becomes a question of apportionment of its profit for different purposes including carrying to the reserve fund, distribution of dividends and bonus and other funds that may be required to be provided for and also for donations towards charitable purpose as defined under the Charitable Endowments Act, 1890 and Rules framed thereunder. Therefore, on the circumspect view of the scheme of the Co-operative Societies' Act, notwithstanding there being an obligation to carry 25 per cent or such lesser percentage of net profit as may be permitted by the Registrar, profit is not diverted to any p'erson other than the assessee and remains a part of the assessee's corpus to be utilised for its own purposes, the assessee cannot claim its exclusion from the income by claiming it to be diversion of income by overriding title, which vests in third party.

Even applying the test that the overriding title to source need not vest in any person but even if the overriding title is in the form of obligation to utilise the funds for a specified purposes, the assessee's case does not fall in exclusion as we shall presently notice.

27. The expression 'reserve' has not been defined in the Act. The term has received consideration by the Supreme Court in the context of its liability as deduction while computing the income of a company or the assessee. In Vazir Sultan Tobacco Co. Ltd. v. CIT (1987) 132 ITR 559 the Court said :

'The broad distinction between the two is that whereas a 'provision' is a charge against the profits to be taken into account against gross-receipts in the P&L; a/c, a 'reserve' is an appropriation of profits, the asset or assets by which it is represented being retained to form part of the capital employed in the business.'

In other words, as explained in the case of Metal Box Co. of India v. Their Workmen : (1969)ILLJ785SC , the test for this distinction was considered in the context that the provisions are usually made in respect of existing and known liabilities, though in some cases the amount could not be ascertained with accuracy. In case the amount of gross profit is apportioned, to meet out an estimated loss or estimated expenditure, which is existing, it amounts to a 'provision' which is to be adjusted against profits before arriving at net profits. On the other hand, if a provision or apportionment is made for an unanticipated loss or unanticipated expenditure which may accrue in future, such an apportionment partakes the character of reserve fund. The Court explained :

'The amount set aside out of profits and other surplus, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance sheet is a reserve but an amount set aside out of profits and other surplus to provide for any non-liability of which the amount cannot be determined with substantial accuracy is a provision.'

28. If in this background, we examine the different cases which have been cited before us, the distinction would be apparent.

29. We may first notice Poona Electric Supply Co. Ltd.'s case (supra) which was relied on by Mr. Ranka and on which the decision of the M.P. High Court in Keshkal Co-operative Marketing Society Ltd.'s case (supra) is founded, which is the sheet-anchor of the contention on behalf of the assessee and to which case we shall advert to later on.

In Poona Electric Co. Ltd. (supra), the assessee was required by Section 57(1) of the Electricity (Supply) Act, 1948 under which the provisions of Schedules VI and VII of the Act were deemed to be incorporated in the licence. Schedule VI imposed a duty on the licencee to so adjust his rates for the sale of electricity by periodical revision that his clear profits in any year did not, as far as possible, exceed the amount of 'reasonable return'. If the clear profit in any year of account was in excess of the amount of reasonable return, one-third of such excess, not exceeding seven-half per cent of the amount of reasonable return, was at the disposal of the licencee; one half of the excess had to be either distributed in the form of proportional rebate on the amounts collected from the sale of electricity and meter rentals or carried forward in the accounts of the licencee for distribution to the consumers in future in such manner as the State Government might direct. During the accounting years relevant to the asst. yrs. 1953-54 and 1954-55, the appellant set apart the sums of Rs. 42,148 and Rs. 77,138 respectively which were under the provisions of the Act distributable to the consumers, and credited these sums to the 'consumers benefit reserve account'; and claimed deduction of these sums in computing its profits liable to income-tax, on the ground that the amounts credited by the appellant during the accounting years to the 'consumers benefit reserve account', being a part of the excess amount paid to it and reserved to be returned to the consumers, did not form part of the appellant's real profits; and to arrive at the taxable income of the appellant from the business under Section 10(1) of the Indian IT Act, 1922, the amounts had to be deducted.

It is to be noticed before embarking on further enquiry that the amount appropriated was under an obligation created under the statute for constituting a consumer benefit fund out of its profit, which was to be returned to the consumers by way of rebate, and was to be used for no other purpose. The company was under a legal obligation that its profit does not exceed reasonable return. Thus, there was a statutory limit embraced on the profits to be earned by the company with an object to repay the excess profit to its consumers. So neither it became part of the assessee's corpus nor could it be used by the assessee at any time for its own purposes. Applying the test of the real income, the Court said that income-tax is a tax on the real income, i.e., in the case of a business, the profits arrived at on commercial principles subject to the provisions of the IT Act. There is a clear-cut distinction between deductions made for ascertaining the profits and distributions made out of profits. The Court also pointed out that there is a distinction between real profits ascertained on commercial principles and profits fixed by statute for a specified purpose. It may be noticed that profits earned in excess of reasonable return in a given case was required to be returned to the consumers and not to be retained by the company at any rate, whether it is to return immediately by giving immediate rebate or is to be returned in future by keeping the amount in a 'consumer benefit reserve account' did not make any difference as the same never became the part of company's profit which it had received over and above the amount of reasonable amount. It could only earn reasonable profits. The profits in excess of this is to be computed for the purpose of finding out the amount of rebate to be given to the consumers.

30. In contrast, the matter of constituting a reserve fund to meet contingent liability that may arise in future under the very Electricity (Supply) Act, 1948 invited attention of the apex Court in Associated Power Co. Ltd. v. CIT : [1996]218ITR195(SC) . It was a case in which Clause II of Schedule VI to the Electricity (Supply) Act, 1948 required the electricity company to create certain reserves if its clear profit exceeds a reasonable return. The Court said as under:

'Moneys 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 Schedule VI are to meet expenses or recoup loss of profits arising out of accidents, strikes of other circumstances which the electricity company 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 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 the moneys in the contingencies reserve belong to the electricity company and are not diverted away from it. It is the electricity company which has to invest the sums appropriated to the contingencies reserve. The investment would be in its name and it would be the owner thereof. The restriction that the investment can be made only in securities mentioned in the Indian Trust Act makes no difference to this position. The fact 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 make explicit the obvious, for the reserve is for the purposes of the undertaking that is being transferred.'

The Court also noticed that the amount appropriated to the contingencies reserve is set apart to meet possible exigencies. It is not a provision for known, existing liabilities. It is not deductible as business expenditure nor diverted by reason of an overriding obligation or title and, in determining the business profits of the assessee, it must be taken into account.

Reversing the decision of the Tribunal from which a direct reference was made to the Supreme Court under Section 256 of the IT Act, 1962, the Court adverted to Poona Electric Supply Co. Ltd.'s case (supra) which has been relied on by the Tribunal and by various other High Courts in different set of circumstances like the one, after referring to various judgments of the High Court wherein Poona Electric Supply Co. Ltd.'s case (supra) has been considered and applied, the Court pointed out distinction laying emphasis on the fact that the amount paid into 'consumers benefit reserve fund' has to be returned to consumers, therefore, it is as if the electricity company did not receive the amount which it was obliged to return. The amount that it was obliged to return was not a part of its income.

The apex Court repelled the suggestion that there was diversion of income by overriding title in the case. It has categorically stated that :

'the application of the doctrine of diversion of income by reason of an overriding title is quite inapposite. The doctrine applies when, by reason of an overriding title or obligation, income is diverted and never reaches the person in whose hands it is sought to be assessed [see CIT v. Sitaldas Tirathdas : [1961]41ITR367(SC) ]. In the present case, the statute requires the electricity company to create certain reserves if its clear profit exceeds a reasonable return (Clause II Schedule VI). Again the contingencies reserve is to be created from existing reserves or from 'the revenues of the undertaking'. This clearly indicates that the monies which have to be put in the contingencies reserve reach the electricity company and are not diverted from it. It is the electricity company which has to invest the sums appropriated to the contingencies reserve. The investment would be in its name and it would be the owner thereof. The restriction that the investment can be made only in securities mentioned in the Indian Trusts Act makes no difference to this position.'

The Court also noticed that in fixing the amount of purchase of the undertaking, the contingencies reserve has to be handed over to the purchaser and maintained as such is only to make explicit the obvious, for, the reserve is for the purposes of the undertaking that is being transferred. The Court also found that it cannot be considered to be an expense which occur in present and for which the liability to pay has arisen.

31. The said principle was reiterated with reinforced vigour in Vellore Electric Corporation Ltd. v. CIT (1997) 227 WR 557 distinguishing the Poona Electric Co. Ltd.'s case (supra) and following the Associated Power Company's case (supra), when the Court said:

'The contingencies reserve is to be created from existing reserves or from the Revenues of the undertaking which indicates that the monies which have to be put into the contingencies reserve reach the electricity company and it is the electricity company which has to invest the sums appropriated to the contingencies reserve. The contingencies reserves differs from the consumers benefit since the amount appropriated in the consumers' benefit has to be returned to the consumers and it is as if the electricity company had not received that amount which it is obliged to return. The position is altogether different in 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 purpose set out in Para V of the Schedule VI to the Electricity (Supply) Act, which are the expenses which the electricity company has to incur and the reservation is made so that money is always available for meeting these expenses and the supply of electricity is not interrupted.'

32. We have already examined the scheme of the co-operative societies governing the creation of reserve fund in question which clearly indicates that under Section 61 no part of funds other than the net profits of a co-operative society shall be utilised by way of bonus or dividend or otherwise distributed amongst its members and Section 62 has unequivocally provided for disposal or application of net profit. It is only after the net profit reaches the co-operative society that the question of its disposal in terms of the provisions arise of the Act of 1965 and not earlier thereto net profit is to be apportioned by transferring part of it as may be prescribed by Rules to the reserve fund. Part of the profits has to be carried to the co-operative deduction fund constituted under the Rules and the balance is available for utilisation for payment of dividends to the members, bonus to the members and contribution to such other special funds as may be specified in the Rules. Donations not exceeding 10 per cent of net profits of any charitable purposes and payment of bonus to the employees of the society to the extent required by the bye-laws.

The reserve funds' object has been set out in Rule 55 by declaring that it shall belong to the society and is intended to meet unforeseen losses. That is to say for societies own purpose in future and ordinarily is not to meet any existing liabilities or obligations. The unforeseen losses and other purposes to which such fund can be used have also been spelt out as noticed by us that, apart from meeting unforeseen losses in the society, it can also be used to meet such other purposes, viz., to pay off its debts and to use the same during the financial stringencies in the society by declaring that it shall belong to the society and has intended to meet unforeseen losses. That is to say, not to meet any existing liabilities or obligations. Unforeseen losses and other purpose for which the reserve fund is to be applied, also forms part of the need of the society and none else. The fund is always available for the society and forms the part of its assets for paying off its dues and to pay off the share capital on its dissolution. Therefore, there is no overriding title vesting in any other person or obligation to which such profit is diverted before it reaches the society. The requirement of surplus, if any, on dissolution of the society after application of assets to discharge its liabilities towards creditors and shareholders to be used for an object of public utility is also an obligation of the net surplus of the society and not merely of the remainder of reserve fund, if any, towards object of public utility or charitable purposes as may be ordained by the members of the society. That also clearly amounts to application of the funds of the society as per the decision of the general body of the society. At the end of the day, it may be application of remainder as per the requirement of law, but it does not, at the time of creation of a reserve fund becomes a certain obligation which it is obliged to discharge but rest in domains of uncertain contingency. It remains a contingent obligation of the assets of the society in future dependent upon the surplus remaining after discharge of its liability and that too as per the resolution of the members of the society only.

Thus, in our opinion, the principle governing dealing with the reserve fund in question, which is created under the Co-operative Societies Act, 1965, is fully governed by the ratio of the decision in Associated Power Co.'s case (supra), Vellore India Co. Ltd.'s case (supra) and not by the ratio laid down in Poona Electric Supply Ltd. Co.'s case (supra).

33. The decision of the M.P. High Court in Keshkal Co-operative Marketing Society Ltd. (supra) undoubtedly supports the contention of the assessee-respondent.

We have already noticed that the decision of M.P. High Court in Keshkal Cooperative Marketing Society Ltd. (supra) is founded on the principle enunciated in Poona Electric Supply Co. Ltd.'s case (supra).

With utmost respect, we regret our inability to fall in line with the decision in Keshkal Co-operative Marketing Society Ltd.'s case (supra) in this regard. Apparently, the distinction which existed between the reserve fund for the benefit of consumers required to be created under the Electricity Supplies Act, 1948 with object to return to the consumers the excess profit charged by the supply company and the fund created to meet the future requirement of the supply company or the co-operative society had not been noticed. We may also notice that perhaps the attention of the Court was not drawn to detailed scheme of the M.P. Co-operative Society Act, as we do not find any mention thereof in the decision.

In the backdrop of later Supreme Court decision in which we have adverted to the case of consumer benefit fund, which arose for consideration in Poona Electric Supply Co. case was for the benefit of consumers exclusively, could not have been equated with the reserve fund created under the Co-operative Societies Act and Rules framed thereunder, which never went out of the societies' capital asset block. It always remains the assets of the society to be used for its own purpose, albeit under the regulatory power of the Registrar. As noticed by the apex Court, there existed a clear distinction between a reserve fund created for the benefit of the consumers which was to be returned to the consumes by way of rebate and the reserve fund created under the statute for meeting out of contingent liability in future. Undoubtedly, in the latter case, it always remained capital of the company and notwithstanding its use could only be with the approval of the State Government, it did not make any difference so far as the nature of the contingency reserve fund is concerned. Apparently, the M.P. High Court has not noticed this distinction and has not adverted to the provisions of the M.P. Co-operative Societies Act which concerned creation of reserve fund, its object and the Government Rules about obligation to apply the reserve fund for the purposes of the society. Had the same been brought to the notice of the Court, perhaps the M.P. High Court would have reached the same conclusion to which we have reached.

Be that as it may, in view of the direct decision of the Supreme Court in Associated Power Co. Ltd.'s case (supra) and Vellore India Co. Ltd.'s case (supra) making out a distinction between reserve fund created for the benefit of consumers and reserve fund to be used for the assessee's own income to meet any contingencies occurring in future cannot be excluded from the computation of total income either on principle of diversion of income by overriding title or on the principle of income not forming part of the real income or as the part of deductible expenses under Section 37; the decision in M.P. High Court cannot be considered as an authority laying down the proposition in respect of reserve fund created by co-operative societies for its own purposes as the law laid down correctly and is impliedly overruled.

34. The other decisions referred to and relied on by the learned counsel for the Revenue in Pandavapura Sahakara Sakkare Karkhane Ltd. (supra), Hiranyakeshi Sahakara Sakkare Karkhane (supra) all from Karnataka High Court proceed on the principle laid in the Poona Electric Supply's case, without noticing the aforesaid distinction as noticed by the apex Court in Associated Power Supply's case and Vellore India Co. Ltd.'s case (supra). For the reason stated above while considering decision of M.P. High Court in Keshkal Co-operative Societies' case, we express our inability to agree with the aforesaid decision also.

35. Lastly, reliance was placed on a Bench decision of this Court in CIT v. Kotputli Rural Electric Co-operative Society Ltd. . Firstly, it was not a case relating to reserve fund to be created under co-operative society. Hence, the question of examining the reserve fund in the light of provisions of the co-operative society was not before the Court. Secondly, it was a case of creating a contingency reserve fund at 1.5 per cent under Clause VI of Schedule VI to the Electric Supply Act. Relying on the decision in Keshkal Co-operative Marketing Society Ltd.'s case (supra) and decision of Madras High Court in Vellore India Co. Ltd. (supra) reserve fund was held as deductible while computing the income of the assessee-co-operative society.

With utmost respect, we notice that the learned counsel appearing for the parties did not bring to the notice of the Court that decision of the Madras High Court in Vellore India Co. Ltd.'s case had since been reversed by the Supreme Court in Vellore India Co. Ltd. referred to above and directly governed the controversy before the Court. The decision rests on an overruled decision and contrary to the Supreme Court decision on the same issue. Keshkal Cooperative Marketing Society Ltd.'s case (supra), the other case referred which had followed the Poona Electric Supply Co. Ltd.'s case (supra) was also demonstrably contrary to the principle enunciated by the Supreme Court in the two cases referred to above by us. The Supreme Court drew the distinction obvious in Poona Electric Supply case that there is no parity between the contingency reserve for the benefit of the society itself and the consumer benefit reserve fund, which was intended to be returned to the consumers, the latter never becomes part of the companies business assets.

Since the aforesaid decision of this Court is founded on a reversed judgment of the Madras High Court and decision of the other High Court founded on the judgment of the Supreme Court which has been distinguished on the very same principle which has been applied by the Poona Electric Supply Co. Ltd.'s case (supra), the judgment must be deemed to have been rendered per incuriam and not a binding precedent.

36. As a result of aforesaid discussion, we allow this appeal and hold that the amount of reserve fund (sic-net profit) transferred to the net profit (sic-reserve fund) under Section 62 of the Co-operative Societies Act, 1965 r/w Rule 68 of the Cooperative Rules, 1966 is not allowable as deduction in computing the taxable income of the society on any of the grounds raised by the assessee. The judgment of the Tribunal is set aside and that of the AO is restored.

No order as to costs.