Poona Electric Supply Co. Ltd. Vs.
Commissioner of Income-Tax, Bombay [1965] INSC 113 (19 April 1965)
19/04/1965 SUBBARAO, K.
SUBBARAO, K.
SHAH, J.C.
SIKRI, S.M.
CITATION: 1966 AIR 30 1965 SCR (3) 818
CITATOR INFO:
RF 1967 SC 477 (6) RF 1973 SC2486 (8) R 1973
SC2766 (9) R 1986 SC 368 (16) MV 1986 SC 757 (15)
ACT:
Income-tax Act (11 of 1922) s. 10(1)--Profit
arrived at after deducting amounts according to Electricity (Supply) Act,
1948---Taxable income--If deductions can be allowed.
HEADNOTE:
The appellant-company was a commercial
undertaking, doing the business of supply of electricity subject to the
provisions of Electricity (Supply) Act, 1948. For the purpose of
rationalization of rates and keeping them under control, the licensee was
directed by the Act to adjust the rates in such a way that the clear profit in
any year did not exceed the amount of reasonable return as defined in the Act;
but that if an excess was collected, the licensee should distribute half of
that excess by way of rebate to the consumers, or carry the amount forward in
the accounts for distribution to the consumers. For the purposes of the Act,
during the accounting years, the assessee credited certain amounts which formed
part of the excess collected to the "Consumers Benefit Reserve
Account", and claimed deduction of those amounts from the taxable income.
The Income Tax Officer and the Appellate
Assistant Commissioner disallowed the claim, but the Tribunal allowed the
deductions. The High Court, on a reference, held against the assessee.
In it appeal to this Court the appellant
contended that there was a distinction between commercial accurancy,. As a'
profit" under the Electricity (Supply) Act and that the real or commercial
profit under s. 10(1) of the Income Tax Act, 1922, could be determined only
after excluding the amounts statutorily transferred to the "Consumers
Benefit Reserve Account", for, that amount represented a rebate to the
consumers, of the excess amount: collected from them.
HELD: As a business concern the real profit
of the appellant had to be ascertained on the principles of commercial
accountancy. As a licensee governed by the statute its "clear profit"
was ascertained in terms of the statute and the schedule annexed thereto. The
two profits are for different purposes-one for commercial and tax purposes and
the other for statutory purposes in order to maintain a reasonable level of
rates. The amounts for which deduction was claimed were a part of the excess
amount paid to the assessee and reserved to be returned to the consumers. They
did not form part of the assessee's real profits, and therefore, to arrive at
the taxable income of the assessee from the business, under s. 10(1) of the
Income-tax Act the said amounts had to be deducted from its total income.
[827G-828A] The income tax is a tax on the real income, that is the real
profits arrived at on commercial principles subject to the provisions of the
Income-tax Act. The real profit can be ascertained only by making the
permissible deductions. There is a clear cut distinction between deductions
made for ascertaining the profits and distributions made out of profits. It is
a question of fact to be found on the relevant circumstances, having regard to
business principles. Another 819 distinction that should be borne in mind is
that between the real and the statutory profits, that is between the commercial
profits and statutory profits. The latter are statutorily fixed for a specified
purpose. The real profit of a businessman under s. 10(1) of the Incometax Act,
cannot ,obviously include the amounts returned by him by way of rebate to the
consumers, under statutory compulsion, from the statutory profits. [822C, 827E,
F] Case law referred to.
CIVIL APPELLATE JURISDICTION: Civil Appeals
Nos. 633 and 634 of 1964.
Appeals from the judgement and order dated
July 23 and 24, 1962 of the Bombay High Court in Income-tax Reference No. 61 of
1961.
A. V. Viswanatha Sastri, S.N. Vakil, T.A.
Ramachandran,
1. B. Dadachanji, O.C. Mathur and Ravinder
Narain, for the appellant (in both the appeals).
Niren De, Additional Solicitor-General, R.
Ganapathy lyer and R.N. Sachthey, for respondent (in both the appeals).
A.V. Vishwanatha Sastri, M.N. Shroff and 1.
N. Shroff, for the Intervener (in all the appeals).
The Judgment of the Court was delivered by
Subba Rao, J. The appellant, the Poona Electric Supply Co., Ltd., hereinafter
called the Company, carried on the business of distribution of electricity in
the city of Poona under a licence issued by the Government. Under the relevant
provisions of the Electricity (Supply) Act, 1948, (Act 54 of 1948), hereinafter
called the Act, the Company's "clear profit" in any year should not,
as far as possible, exceed the amount of "reasonable return" as
defined under the Act.
The excess, if any, after making some
deductions, the Company has to distribute to its consumers in the form of
rebate. During the assessment years 1953-54 and 1954-55 the Company claimed
deduction of two amounts of Rs. 42,148/- and Rs. 77,138/- for the said two
years from its taxable income as they were credited to "Consumers Benefit
Reserve Account". The Income-tax Officer disallowed the claim; and on
appeal the Appellate Assistant Commissioner agreed with the Income-tax Officer.
On a further appeal, the Income-tax Appellate Tribunal accepted the contention
of the appellant and allowed the deductions. At the instance of the Revenue, the
Tribunal submitted the following question of law to the High Court of
Judicature at Bombay for its opinion:
"Whether the two sums of Rs. 42,1481- in
the assessment year 1953-54 and Rs. 77,138/- in the assessment year 1954-55
were deductible in computing income, profits and gains from the assessee's
business assessable to tax." 820 A Division Bench of the said High Court
answered the question in the negative and against the appellant. The present
appeals have been filed by the Company after obtaining the requisite
certificate from the High Court.
The argument of Mr. A.V. Viswanatha Sastri,
learned counsel for the appellant, may be summarised thus: (1) There is a
distinction between commercial profit of a company and "clear profit"
under the Act---one is arrived at on commercial principles and the other is
regulated by the statute; the real profit of a company under s. 10(1) of the
Indian Income-tax Act can be determined only after excluding the amount
statutorily transferred to the "Consumers Benefit Reserve Account",
for that amount represents a rebate to the customers of the excess amount
collected from them. (2) As the reservation of a part of the said excess is a
statutory condition subject to which the Company carries on its business, it is
an expenditure wholly and exclusively incurred for the purpose of the Company's
business and, therefore, it is an allowance deductible under s. 10(2)(xv) of
the Income-tax Act for computing the profit of the Appellant's business. (3)
The Company follows the mercantile system of accounting and, therefore, the
amount of rebate so reserved is deductible for arriving at the commercial
profit of the Company in the year when the statutory liability arises and not
when the amount is actually paid; and in the present case the statutory
liability for the said two amounts arose in the accounting years of 1952 and
1953.
Learned Additional Solicitor General
contended that (1) under the relevant provisions of the Act the transference of
a part of the said excess to the consumers benefit reserve account would only
amount to apportionment or distribution of the profit after it has been earned
and, therefore, it is not a deductible item for ascertaining the profit of the
Company under s. 10(1) of the Income-tax Act; (2) the said amounts could not be
said to be an expenditure wholly and exclusively incurred for the purpose of
the business, as the expenditure was not incurred either during the course of
the business or for the purpose of earning the profits of the business, but was
only apportioned or distributed from and out of the profits already earned.
To appreciate the rival contentions and to
arrive at a satisfactory solution it will be necessary to notice the relevant
provisions of the Act and of the Income-tax Act.
The gist of the relevant provisions may be
stated thus:
No person can supply electric energy in any
area unless he has obtained a licence from the State Government under s. 3(1)
of the Indian Electricity Act, 1910 (9 of 1910). The Act, i.e., The Electricity
(Supply) Act, 1948, provides for the rationalization of the production and
supply of electricity and generally for taking 821 measures conducive to
electrical development. One of its main objects is to prevent such licensees
from charging unreasonable rates to the detriment of the consumers. Under s.
57(1) of the Act the provisions of the Sixth Schedule and the table appended to
the Seventh Schedule thereto are deemed to be incorporated in the licence of
every licensee.
Paragraph I of the Sixth Schedule imposes a
duty on every such licensee to so adjust his rates for the sale of electricity
by periodical revision that his clear profit in any year shall not, as far as
possible, exceed the amount of "reasonable return". The expressions
"clear profit" and "reasonable return" are defined. Under
Para. II thereof if the clear profit of a licence in any year of account is in
excess of the amount of reasonable return, one-third of such excess, not
exceeding 7 1/2% of the amount of reasonable return, shall be at the disposal
of the undertaking; one half of the said excess shall either be distributed in
the form of a proportional rebate on the amounts collected from the sale of
electricity and meter rentals or carried forward in the accounts of the
licensee for distribution to the consumers in future in such manner as the
State Government may direct. It is, therefore, clear from these provisions that
for the purpose of rationalization of rates and keeping them under control the
licence is directed to adjust his rates in such a way that his clear profit in
any year shall not, as far as possible, exceed the amount of reasonable profit;
but if an excess is collected, the licensee shall distribute half of that excess
in the form of a proportional rebate to the consumers or carry forward the same
in his accounts for future distribution to the consumers. Briefly stated, the
scheme of the provisions is that a part of the excess collected is returned to
the consumers by way of a rebate. The question is whether the amount so
returned or returnable by the licensee to his consumers is deductible for
ascertaining his taxable income from his business under s. 10(1) or s. 10(2)(xv)
of the Income-tax Act.
Learned Additional Solicitor General took us
though the various paragraphs of the Sixth Schedule to the Act and argued that
under them the licensee's clear profit was arrived at after all the deductions
were made, including the appropriations for all taxes on income and profits
and, therefore, the distribution of a part of the excess was only a
distribution out of the profits. There is plausibility in this argument and at
the first blush it appears to be attractive. But there is an obvious fallacy
underlying the argument and that arises from the fact that the argument equates
the expression "clear profit" with that of commercial profits. The
object of the Act and that of the Sixth Schedule thereto, as aforesaid, is to
statutorily rationalize and regulate the rates chargeable for the energy
supplied in the interest of the public and for electrical development. The
rules embodied in the Sixth Schedule to the Act are intended only to achieve
that object. Under the said rules certain appropriations and certain deductions
have to be made to. arrive at the clear profit; otherwise the items may be
manipulated 822 to sustain a demand for abnormal rates. The rules have no
concern with income-tax; though for the purpose of arriving at the clear profit
the taxes paid are also deductible. If this distinction is borne in mind, the
problem presented is easily and readily solved.
Under s. 10 (1) of the Income-tax Act, tax
shall be payable by an assessee under the head "profits and gains of
business" in respect of profits and gains of any business carried on by
him. The said profits and gains are not profits regulated by any statute, but
profits in a business computed on business principles. They are business
profits and not statutory profits. They are real profits and not notional
profits. The real profit of a businessman under s. 10(1)of the Income-tax Act
cannot obviously include the amounts returned by him by way of rebate to the
consumers under statutory compulsion. It is as if he received only from the
consumers the original amount minus the amount he returned to them. In
substance there cannot be any difference between a businessman collecting from
his constituents a sum of Rs. Y in addition to Rs. X by mistake and returning
Rs. Y to them and another businessman collecting Rs. X alone. The amount
returned is not a part of the profits at all.
In this context some of the decisions cited
at the Bar may be of some help. In Pondicherry Railway Co., Ltd. v. Commissioner
of Income-tax, Madras(1). under an agreement with the French Colonial Government
the railway company had to pay to the said Government half of its net profits
calculated as provided there under. One of the questions that arose in the
appeal was whether the appellant-company was entitled to deduct the payments
made under the agreement with the said Government as being expenditure incurred
solely for the purpose of earning such profits within s. 10(9) of the
Income-tax Act. In dealing with the question, Lord Macmillan observed:
"A payment out of profits and
conditional on profits being earned cannot accurately be described as a payment
made to earn profits.
It assumes that profits have first come into
existence. But profits on their coming into existence attract tax at that
point, and the revenue is not concerned with the subsequent application of the
profits." The learned Lord, after citing with approval the principle laid
down by Lord Chancellor Halsbury in Gresham Life Assurance .Society v. Styles(2),
proceeded to observe:
"The word 'profits' I think is to be
understood in its natural and proper sense...
in a sense which no commercial man would
misunderstand. But once an individual or (1) [1931] L.R. 58 A.C. 239, 251-252,
252.
(2) [1892] A.C. 309.
823 a company has in that proper sense
ascertained what are the profits of his business or his trade, the destination
of those profits or the charge which has been made on those profits by previous
agreement or otherwise is perfectly immaterial. The tax is payable upon the
profits realized, and the meaning to my mind is rendered plain by the words
'payable out of profits." The distinction between payment out of profits
and a payment to earn profits is unexceptionable. The difficulty is to
ascertain in each case whether a particular payment falls under one or other of
the two categories. The statement in the aforesaid observations that a payment
conditional on profits being earned cannot be a payment made to earn profits
has been modified and explained by the Privy Council in The Indian Radio and
Cable Communications Company, Ltd., v. The Commissioner of Income-tax, Bombay
Presidency & AdenC). There, their Lordships were dealing with a case of a
joint venture by two companies; and Lord Maugham pointed out thus:
"It may be admitted that, as Mr. Latter
contended, it is not universally true to say that a payment the making of which
is conditional on profits being earned cannot properly be described as an
expenditure incurred for the purpose of earning such profits. The typical
exception is that of a payment to a director or a manager of a commission on
the profits of a company." To that extent the principle laid down by Lord
Macmillan in the case of Pondicherry Railway Co.(2) has been modified. Lord
Macmillan himself in a later decision in The Union Cold Storage Co. Ltd., v.
Adamson (H. M. Inspector of Taxes)(3) explained his observations in the
Pondicherry Railway Co.'s case (2). There, the appellant-company leased lands
and premises abroad under a deed reserving a particular rent per annum. The
deed provided that if at the end of any financial year it was found that after
providing for this rent the result of the Company's operations was insufficient
to pay both interest on its charges and debentures and dividends at fixed rates
on its preference shares and also at least 10 per cent, on its ordinary shares,
the rent for the year was to be abated to the extent of the deficiency,
repayment of rent already paid being made if necessary. The question raised in
that case was whether such repayments made were allowable as deductions in
assessing the Company's income to income-tax. The House of Lords held that they
were allowable deductions. When the observations of Lord Macmillan in the
Pondicherry Railway Co.'s case(2) were pressed upon the House in support of the
contention (1) (1937) 5 I.T.R. 270, 277. (2) L.R. 58 A.C. 239.
(3) (1931) 16 A.C. 328, 331.
824 on behalf of the Revenue, Lord Macmillan
explained his earlier observations thus:
"When, therefore, in the passage
referred to by the Attorney-General in the Pondicherry case I said that "a
payment out of profits and conditional on profits being earned cannot
accurately be described as a payment made to earn profits", I was dealing
with a case in which the obligation was, first of all, to ascertain the profits
in a prescribed manner, after providing for all outlays incurred in earning
them, and then to divide them. Here the question is whether or not a deduction
for rent has to be made in ascertaining the profits, and the question is not
one of the distribution of profits at all." Though a contractual term of
payment of rent operated after the profits were ascertained and on the
insufficiency to meet certain obligations was discovered, the House of Lords
did not find any difficulty in holding that the deductions for rent were made
only for ascertaining the profits and not for distributing the same. The
decision of the Court of Appeal in British Sugar Manufacturers, Ltd. v. Harris
(Inspector of Taxes(1) is rather instructive. There, a company carrying on a
manufacturing business agreed with two other companies to pay them a stated
percentage of its "net profits" in consideration of their giving to
the company the full benefit of their technical and financial knowledge and
experience, and giving to the company and its directors advice to the best of
their ability. The question arose whether in computing the profits of the
company for the purpose of income-tax, the company was entitled to deduct the
sums so paid as being money wholly and exclusively laid out or expended for the
purposes of the trade within Rule 3(a) of Cases I and II. Greene, M.R., pithily
observed thus:
"Once you realise that as a matter of
construction the word "profits" may be used in one sense for one
purpose and in another sense for another purpose, I think you have the real
solution of the difficulties that have arisen in this case." Applying that
test, the Master of the Rolls held that:
"In the present case there are two funds
of so-called profits which come into the picture.
The first one is the fund which has to be
ascertained for the purposes of calculating the 20 per cent
...................... Now when that amount has been ascertained, that fund has
ceased to have any usefulness at all, and it then becomes necessary to
ascertain what are the divisible profits, and for that purpose, to take another
account, which not only would bring in depreciation, but would also take into
(1) [1939] 7 I.T.R. 101, 105, 106, 108-109.
829 account the sum that had been paid out to
the Skoda works, and the Corporation upon the taking of the first
account." Romer, L.J., put the test in a different way when he said:
"Is the payment that has to be made by
the trader under the contract in question a mere division of profits with
another party or is it a payment to the other party, the amount of which is
ascertained by reference to the profits?" MacKinnon, L.J. stated much to
the same effect thus:
"The whole question in this, as in other
cases, is whether this, which is an annual payment, is an annual payment to be
taken into account in order to ascertain the profits, or is it an annual
payment payable out of the profits after they have been ascertained? I think
the true facts of this case are that it is of the former character. The
difficulty in the case arises largely because of the necessary ambiguity in the
word "prof its" and the fact that in this agreement
"profits" as a word does appear; but "profits", as I think,
quite clearly of a different description from the annual profits or gains with
which one is concerned in assessing the income-tax." This decision accepts
the principle that a contract or a statute may provide for the ascertainment of
two profits for different purposes and the question to be decided in each case
is whether the amount claimed as deduction is payable out of the real profits.
The Judicial Committee again in Raja Bejoy Singh Dudhuria v. Commissioner of
Income-tax, Calcutta(1) emphasized the concept of real income in the context of
payment of income-tax. Lord Macmillan, speaking for the Board, after adverting
to the Imperial System of income-tax legislation, proceeded to observe:
"The correlative of the obligation to
return as income sums which are really charges upon the taxpayer's income is
the right to reimbursement of the tax on such charges. The Indian Income-tax
Act makes no similar provision for the deduction of tax at the source and the
consequent reimbursement of the taxpayer in the case of such a charge as that
to which the revenues of the appellant are subject
.............................. that the omission from the Indian Act of any
such provision points rather to an intention to tax, in Lord Davey's Phrase,
only "the real income" of. the taxpayer, than to an intention to
impose, without right of reimbursement, a tax on what is a charge upon his
income." (1) L.R. (1933) 60 I.A. 196, 202.
826 The concept of "real income" is
also expounded in the decision of the Bombay High Court in H.M. Kashiparekh
& Ca.
Ltd. v. Commissioner of Income-tax, Bombay
North (1).
There, under the managing agency agreement
the managing agent was under a duty to forgo up to one-third of its commission
where the profits of the managed company were not sufficient to pay a dividend
of 6 per cent. The contention of the Revenue that such a surrender of the
commission under the provisions mentioned in the agreement was not deductible
for the purpose of income-tax was negatived. The principle has been succinctly
stated in the head note thus:
"The principle of real income is not to
be subordinated as to amount virtually to a negation of it when a surrender or
concession or rebate in respect of managing agency commission is made, agreed
to or given on grounds of commercial expediency, simply because it takes place sometime
after the dose of an accounting year. In examining any transaction and situation
of this nature the court would have more regard to the reality and speciality
of the situation rather than the purely theoretical or doctrinaire aspect of
it. It will lay greater emphasis on the business aspect of the matter viewed as
a whole when that can be done without disregarding statutory language."
Now let us look at two of the cases on which strong reliance is placed on
behalf of the Revenue. In Mersey Docks and Harbour Board v. Lucas(3) the
harbour board was empowered by Act of Parliament to levy dock dues to be
applied in maintaining the concern and in paying interest on moneys borrowed;
any surplus income remaining after meeting these charges was directed to be
applied in forming a sinking fund to extinguish the debt incurred in the construction
of the docks. It went to reduce the capital liability. The question was whether
the sum carried to the sinking fund, and the surplus carried to the following
year's accounts, were "profits" within the meaning of the Income-tax
Acts. The House of Lords held that the surplus was profit assessable to the
incometax. In this case the surplus income formed the sinking fund and was
utilised to pay off the debts of the harbour board; therefore, the Court
rightly held that the said amount was utilised by the board from and out of its
profits and, therefore, the said surplus could not be an allowable deduction.
The decision of the Queen's Bench Division in Paddington Burial Board v. Commissioners
of Inland Revenue(3) was also based on the same principle. Under a public Act
of Parliament a burial ground was provided out of the poor rates, and fees were
charged to persons using it; any (1) (1960) 39 I.T.R. 706, 707.
(2) (1883) 2 T.C. 25. (3) (1884) 2 T.C. 46.
827 surplus of income over expenditure was
applied in aid of the poor rates as required by the Act. It was held that the
surplus was a profit assessable to income-tax. It will be seen that the burial
ground was managed on behalf of the Parish of Paddington and the surplus was
applied for the benefit of the parishners. In the words of Day, J., it was a
business carried on for the benefit of the rate-payers of the parish of
Paddington. This case also, therefore, dealt with payments out of profits
utilised for the benefit of those on whose behalf the business was conducted.
In Young (H. M. Inspector of Taxes) v. Racecourse Betting Control Board(1) the
question that arose was whether the Racecourse Betting Control Board was
entitled in computing the profits of the trade of totalisatot operator for the
years 1953-54 and 1954-55 to deduct certain payments. The Board would be
entitled, under the appropriate statutes, to deduct payment of moneys wholly
and exclusively laid out or expended for the purpose of trade. It was held in
that case that the said payments were all voluntary payments and were not made
for the purpose of the trade. This decision has no bearing on the question
raised before us.
The said decisions lead to the following
results: Income- tax is a tax on the real income, i.e., the profits arrived at
on commercial principles subject to the provisions of the Income-tax Act. The
real profits can be ascertained only by making the permissible deductions.
There is a clear-cut distinction between deductions made for ascertaining the
profits and distributions made out of profits. In a given case whether the
outgoings fall in one or the other of the heads is a question of fact to be
found on the relevant circumstances, having regard to business principles.
Another distinction that shall be borne in
mind is that between the real and the statutory profits, i.e., between the
commercial profits and statutory profits. The latter are statutorily fixed for
a specified purpose. If we bear in mind these two principles there will be no
difficulty in answering the question raised.
The appellant-company is a commercial
undertaking. It does business of the supply of electricity subject to the
provisions of the Act. As a business concern its real profit has to be
ascertained on the principles of commercial accountancy. As a licensee governed
by the statute its clear profit is ascertained in terms of the statute and the
schedule annexed thereto. The two profits are for different purposes--one is
for commercial and tax purposes and the other is for statutory purposes in
order to maintain a reasonable level of rates. For the purposes of the Act,
during the accounting years the assessee credited the said amounts to the
"Consumers Benefit Reserve Account". They were part of the excess
amount paid to it and reserved to be returned to the consumers. They did not
form part of the asessee's real profits. So, to arrive at the taxable income of
the assessee from the business (1) (1959) 38 T.C. 452 (H.L.).
(D)5SCI--14 828 under s. 10(1) of the Act,
the said amounts have to be deducted from its total income.
In this view it is not necessary to express
our opinion on the question whether the said amounts would be allowable
deductions under s. 10(2)(xv) of the Act.
The next question is whether the amounts so
reserved for future payment were deductible in computing the income, profits or
gains from the assessee's business for the assessment years 1953-54 and
1954-55. It is not disputed that the assessee adopts the mercantile system of
accounting. The liability to return the amounts was incurred by the assessee
during the relevant accounting years. This Court held in Calcutta Co. Ltd., v. Commissioner
Income-tax, West Bengal(1) that where an assessee maintained his accounts on
mercantile basis, the accrued liability and the estimated expenditure which it
would incur in discharging the same could be deducted from the income of the
accounting year in which the said liability accrued. Indeed, this legal
position was not contested on behalf of the Revenue.
In the result we answer the question referred
to the High Court in the affirmative and in favour of the assessee.
The order of the High Court is set aside. The
appeals are allowed with costs.
Appeals allowed.
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