KESHKAL CO-OPERATIVE MARKETING SOCIETY LTD. vs COMMISSIONER OF Income Tax.

This is a reference u/s 256(1) of the Income Tax Act, 1961 (hereinafter referred to as "the Act") made at the instance of the assessee for our answering the following questions of law :

"(i) Under the facts and circumstances of the case, whether the activity of purchasing paddy from the members, milling it and selling the same amounted to marketing of the agricultural produce of the members as contemplated u/s 80P(2)(iii) of the Income Tax Act, 1961 ?

(ii) Under the facts and circumstances of the case, whether the amount of Rs. 1,66,763 required to be transferred to the reserve fund u/s 43(2) of the Madhya Pradesh Co-operative Societies Act, 1960, was an allowable deduction either as a business expenditure or as having been diverted by an overriding title ?"

The assessee is a co-operative marketing society registered under the M. P. Co-operative Societies Act (hereinafter referred to as "the Societies Act"). The assessee, apart from the business of rice-milling, is also carrying on various business activities including cloth, grain and other ancillary activities thereto.

The assessment year relates to 1976-77. The assessee-society claimed relief u/s 80P(2)(iii) of the Act, i.e. deduction in respect of income derived by the co-operative society by its co-operative business activities, mainly in the instant case, the marketing of the agricultural produce of its members, as referred to in section 80P(2)(a)(iii) of the Act, on the ground that the income derived from marketing of agricultural produce is liable to be exempted from the income of milling of paddy.

The assessee further claimed deduction of an amount of Rs. 1,66,763 representing the reserve credited u/s 43(2) of the Societies Act.

Right from the Income Tax Officer to the Tribunal, the submission of the assessee was repelled, upon which, at the instance of the assessee, this reference has been made before this court for our answer to the questions of law referred to above.

As far as question No. (i) is concerned, the point in issue is fully covered against the assessee by the decision of this court in Commissioner of Income Tax Vs. Kisan Co-operative Rice Mills Ltd., wherein it has been held that the income arising to the society out of the business of purchase of paddy and sale of rice by it on its own account, was not liable to be exempted u/s 80P(2)(a)(iii) of the Act. Further, the same view is again reiterated in Commissioner of Income Tax Vs. Mahasamund Kissan Co-operative Rice Mill and Marketing Society Ltd., . Therefore, the point in issue, being fully covered by the aforesaid decision of this court, needs no elaborate discussion and as such the same is answered in favour of the Revenue.

As far as the second point is concerned the finding reached by the Tribunal that the apportionment of profit for capital redemption was not allowable expenditure and the Societies Act does not even indicate the purpose for which the apportionment is made, appears to have been reached by misconstruing the provisions of sections 28, 36 and 37(1) of the Income Tax Act, 1961, and section 43(2)(a) and (b) and section 44(2) of the Societies Act and against the settled law as laid down in numerous decisions. The reserve fund created u/s 43(2) of the Societies Act is a "statutory one" and is created at the instance of the Registrar and further, having once created the reserve fund, the assessee does not have control over it, as u/s 44(2) of the Societies Act, the reserve fund of the society shall be invested or utilised only in such manner and on such terms and conditions as may be laid down by the Registrar in this behalf. Therefore, the creation of the reserve fund and the control thereon fully remain with the Registrar and in this respect the assessee, in any manner whatsoever, does not remain the beneficiary of the said reserve fund. This position, being the statutory position, is not disputed.

income tax is assessable on the net profit, i.e. real profit. u/s 2(24) of the Act, "income" is defined so as to postulate that the word "income" has to be given a very wide meaning, but certainly it does not mean mere production or receipt of a commodity which may be converted into money, which certainly cannot be construed to be an income in the normal connotation of the term "income" as envisaged u/s 2(24) of the Act. Therefore, Income Tax is levied on the real income, i.e. profit received in mercantile trade, as prescribed under the Income Tax Act, 1961. In accordance with section 28 of the Act, profits and gains of business carried on by an assessee based on purely mercantile principles, should always be amenable to business profits, but not statutory profits. In sum and substance, only the real profits of business are to be taken into account for assessing Income Tax, but not notional profits and, therefore, the statutory deposit (reserve fund) in the instant case, as contemplated u/s 43(2) of the Societies Act, which after its creation comes within the domain of the Registrar u/s 44(2) of the Societies Act, cannot be said to be profit in the real sense.

On this background, learned counsel appearing for the assessee argued that the said amount of Rs. 1,66,763 does not comprise income of the assessee, because the said amount has been diverted u/s 43(2) of the Societies Act. In support of his contention, learned counsel relied upon the principle enunciated in Poona Electric Supply Co. Ltd. Vs. Commissioner of Income Tax, Bombay, wherein it has been held that the reserve fund formed in accordance with the statutory provisions by the amount credited by the appellant during the accounting year 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 appellants real profits and to arrive at the taxable income of the appellant from the business u/s 10(1) of the Indian Income Tax Act, 1922, which is in parimateria to sections 28, 37 of the Income Tax Act, 1961, the said amount is liable to be deducted.

Relying upon the ratio laid down in Poona Electric Supply Co. Ltd. Vs. Commissioner of Income Tax, Bombay, learned counsel for the assessee argued that the reserve fund has been created under the statutory provisions of section 43(2) of the Societies Act and the said amount having been diverted under the statutory provisions, does not comprise the income of the assessee, being deductible u/s 37(1) of the Act.

It is settled law that in order to claim a deduction from income, it must fulfil two essential conditions, viz. (i) that the amount must be laid out wholly and exclusively for the purpose of the business, and (ii) that it should not be expenses of capital nature. Both these conditions must be complied with before the assessee claims deduction from the income. In the instant case, as stated aforesaid, if the said amount of Rs. 1,66,763 does not comprise the income of the assessee on account of its being diverted under the statutory provisions of section 43(2) of the Societies Act, then certainly, in our opinion, the assessee can claim deduction u/s 37(1) of the Act which reads as under :

"37. (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and section 80VV and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purpose of the business or profession shall be allowed in computing the income chargeable under the head Profits and gains of business or profession.

The view taken in Poona Electric Supply Co. Ltd. Vs. Commissioner of Income Tax, Bombay, was followed by the Bombay High Court in Amalgamated Electricity Co. Ltd. Vs. Commissioner of Income Tax, Bombay City I, and reiterated by the Supreme Court in The Commissioner of Income Tax, Kerala, Ernakulam Vs. The Travancore Sugar and Chemicals Ltd., . Further, in Commissioner of Income Tax, Bombay City III Vs. Bombay State Road Transport Corporation, it has been held that the contributions made under a legal obligation cast upon a statutory organisation under a statutory provision will have to be allowed as deduction in computing its profits.

Therefore, in the instant case also, the deduction as claimed by the assessee-society amounting to Rs. 1,66,763 is an allowable deduction as the said amount does not comprise income of the assessee because the same having been diverted under the provisions of section 43(2) of the Societies Act, can only be invested or utilised in such manner and on such terms and conditions as may be laid down by the Registrar in this behalf as required under clause (2) of section 44 of the Societies Act. As such, the said amount is not available for the use of the assessee-society at its opinion. Therefore, the real test for such sum to be deductible is that if by making statutory deposits, the assessee loses control over the said amount, being not available for its use, then such amount is certainly deductible from the income as contemplated u/s 36 and 37 of the Income Tax Act, 1961.

On behalf of the Revenue, Shri B. K. Rawat, learned counsel relying upon the decision in Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, argued that the said amount is not liable to deduction. In Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, the main question raised was whether amounts retained or appropriated or set apart by the concerned assessee-company by way of making provision(a) for taxation, (b) for retirement gratuity, and (c) for proposed dividends from out of profits and other surpluses, could be considered as "other reserves" within the meaning of rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, for inclusion in the capital computation of the company for the purpose of levying super tax. Their Lordships of the Supreme Court remanded Vazir Sultan Tobacco Co.s case as it was found that there was no sufficient material on record regarding whether the appropriation made by the Vazir Sultan Tobacco Co. towards gratuity reserve was based on any actuarial valuation or whether it was an appropriation of an ad hoc amount. Such is not the position in the instant case wherein section 43(2)(a) of the Societies Act specifically speaks of "transfer of an amount not less than 25% of such profits to the reserve fund" and according to section 44(2), the said amount is not available for the use of the assesses and thus the facts of Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, referred to by the Revenue are quite distinguishable from the facts of the instant case and hence of no avail to the Revenue.

From the discussion aforesaid, our answer to question No. (ii) is in the affirmative in favour of the assessee, that the amount required to be transferred to the reserve fund under the statutory provisions is liable to be deducted as business expenditure.

We, therefore, answer the questions of law referred to us thus :

Question No. (i) is answered in favour of the Revenue that under the facts and circumstances of the case, the activity of purchasing paddy from the members, milling and selling the same did not amount to the marketing of the agricultural produce of the members as contemplated u/s 80P(2)(a)(iii) of the Income Tax Act, 1961.

Question No. (ii) is answered in favour of the assessee, that under the facts and circumstances of the case, the amount of Rs. 1,66,763 required to be transferred to the reserve fund u/s 43(2) of the Societies Act was an allowable deduction either as business expenditure or having been diverted by an overriding title. There will be no order as to costs in this reference.