Rajkot District Gopalak Co-op. Milk Producers'' Union Ltd. vs Commissioner of Income Tax

G.T. Nanavati, J.—In this reference u/s 256(1) of the income tax Act, 1961 (''the Act''), the Tribunal has referred the following two

questions to this Court for its opinion:

Whether, on the facts and in the circumstances of the case, the assessee was entitled to deduction of Rs. 78,273 from its total income?

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in deciding the issue whether the assessee was liable to pay

any amount to the Government when both the income tax Officer and the Appellate Assistant Commissioner granted it that the assessee was so

liable and decided the appeal on the principles of application of income or diversion by overriding title?

This reference has been made at the instance of the Rajkot District Gopalak Co-operative Milk Producers'' Union Ltd. which was initially known

as ''Rajkot Jilla Milk Co-operative Union'' and then as ''Rajkot Jilla Gopalak Sahkari Sangh''. In the year 1969, the assessee approached the

Gujarat Government to hand over the milk conservation project which was till then run by the Government. As the said project was running into

losses, the Government agreed to transfer the working of that project to the assessee temporarily on an experimental basis for a period of twelve

months. A resolution to that effect was passed by the Government on 31-7-1969, and in the said resolution, the terms and conditions on which the

said project was handed over to the assessee were set out. Broadly stated, the assessee was given a licence for a period of twelve months to run

the said project on a nominal licence fee of Re. 1 per month. All the properties and assets of the project were to continue to be the properties and

assets of the Government and though the assessee was permitted to add to the establishment the fixed and movable assets, a clear provision was

made that no legal or financial liability was to devolve upon the Government in consequence of such addition. The assessee was to arrange for the

working capital. The employees employed in the said project were to be treated as on deputation till the licence continued. All matters relating to

the working and business of the dairy project including fixation of the price for purchase and sale of milk and milk products were to be decided by

the assessee, but in case of difference between the assessee and the two nominees of the Government who were to be members of the managing

committee, the decision of the Government was to be regarded as final. The assessee was to maintain a trading account and a profit and loss

account in the manner prescribed by the agreement and profits and losses were also required to be worked out on the basis which was followed

by the Government in respect of that project. Profits, if any, made were first to be applied to the accumulated losses of the project which at the

time of passing the resolution were determined at Rs. 64,670 as on 31-3-1968, and by the time the agreement became effective, amounted to Rs.

78,273. Losses, if any, were to be borne by the assessee. Pursuant to this resolution and arrangement between the parties, the assessee took over

the project on 21-2-1970. The assessee being a co-operative society was required to draw up its accounts as on the 30th day of June every year.

For the accounting period 1-7-1970 to 30-6-1971, the assessee made a profit of Rs. 1,25,840 from the business of the dairy project, but filed a

nil return in view of various deductions claimed by it. The ITO did not accept all the claims for deduction and the assessable income was computed

at Rs. 94,000. The assessee preferred an appeal against that order. The AAC found that the assessment was not properly made as the return filed

by the assessee was defective. He was of the view that the unit of assessment should be the society itself and that the society should show the

income or loss from all its activities and not merely the activity of the milk project. The assessee, therefore, filed a revised return showing not only

the profit made by the dairy project but also other profits made by the other business of the society. Thus, the total profit was shown at Rs.

1,73,273 but again claiming certain deductions, the assessee filed a nil return. The assessee claimed deduction of Rs. 78,273 paid by it to the

Gujarat Government towards losses as per the terms and conditions of the leave and licence agreement. The ITO disallowed that claim treating

that payment as the application of its income by the assessee and rejecting the contention that as the said payment amounted to diversion of income

by overriding title, that sum cannot be regarded as the real income of the assessee. In appeal, the AAC upheld that view. The Tribunal also

confirmed that view and dismissed the assessee''s second appeal.

What is contended by the learned counsel appearing for the assessee is that the Tribunal has not properly appreciated the true nature of

payment of Rs. 78,273 to the Government and wrongly held that the said payment was by way of application of its income by the assessee. In

support of his contentions, he drew our attention to various clauses of the terms and conditions on which the dairy project was handed over by the

Government and also some decisions of High Courts. He emphasised the fact that only the management of the milk conservation project or dairy

project was transferred by the Government to the assessee. Again, it was for a temporary period and on an experimental basis. The licence could

have been terminated by giving one month''s notice. He then contended, relying upon clause 6 of the terms and conditions, that profits, if any, were

first to be applied to the accumulated losses of the project. The profits derived were, thus, to be applied to the accumulated losses of the dairy

project and that clearly indicated that there was an obligation cast upon the assessee to discharge its liability before the profits reached the till.

Therefore, this was a clear case of diversion of income by an overriding charge. He submitted, as held by this Court in Udayan Chinubhai and

Others Vs. Commissioner of Income Tax and Another, that income taxable under the Act, is the real income of the assessee. In determining real

income, the question is not of any physical receipt of income but of the concept of the receipt in law. As pointed out by the Supreme Court in The

Commissioner of Income Tax, Bombay City II Vs. Shri Sitaldas Tirathdas, , the true test in deciding whether income has been diverted by

overriding title is to see 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 reached the assessee, it is deductible; but where the income is required to be applied to discharge an

obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be

excused and not the second. The second payment is merely an obligation to pay another a portion of one''s own income, which has been received

and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to collect it, does so, not as part of his

income, but for and on behalf of the person to whom it is payable. In H.M. Kashiparekh and Co., Ltd. Vs. Commissioner of Income Tax,

Bombay North, Kutch and Saurashtra, , the Bombay High Court has also pointed out that it was the real income of the assessee that was liable to

tax. The Bombay High Court further pointed out that the principle of real income is not to be so subordinated as to amount virtually to a negation

of it when payment is made or is required to be made some time after the close of an accounting year. It is pointed out that in examining any

transaction and situation of this nature, the Court would have more regard to the reality and specialty of the situation rather than the purely

theoretical and 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 the statutory language.

Again, an amount paid by reference to profit, as pointed out by the Supreme Court in The Commissioner of Income Tax, Kerala, Ernakulam Vs.

The Travancore Sugar and Chemicals Ltd., , can either be that it is paid after the profits become divisible or distributable or that the amount is

payable prior to such distribution or division to be computed by reference to notional or what, in some decisions, is termed as apparent net profits.

In the former instance, it will be a distribution of profits and not deductible as an expenditure incurred in running the business but in the latter, it

may, on the facts and circumstances of the case, and the agreement or the nature of the obligation under the particular instrument which governs the

obligation, be an expenditure incurred as a contribution to the profit-earning apparatus or incurred at the inception and deductible as an overriding

charge on the profit-making apparatus or one laid out and expended wholly and exclusively for purposes of such business.

The Kerala High Court in Commissioner of Income Tax Vs. Travancore Sugars and Chemicals Ltd., , has observed that the statement that a

payment conditional on profits being ascertained cannot be a payment to earn profits has not been accepted as absolutely correct. A payment

conditional on profits being ascertained may also be diverted by overriding title.

The above decisions make it clear that what is taxable is the real income and it is that income which reaches the assessee that has to be regarded

as the real income. Payment to be made as a result of statutory or contractual obligation even though it may be related to the profits, may be in the

nature of an obligation as a result of which profit to that extent is diverted by an overriding title. Thus, in such a case, what is required to be

considered is the true nature of the obligation and the payment to be made to discharge the same.

As stated earlier, the assessee was given a right to run the dairy project on the leave and licence basis. The reason for doing so was that the

Government was making losses in running that project. Since it was running into losses, the Government had decided to give it to the assessee on a

nominal licence fee of Re. 1 per month. The assessee was under an obligation to maintain separate accounts for the dairy project in the same

manner in which they were maintained earlier by the Government. If we look at the pro forma, it becomes apparent that the accounts to be

maintained were that of the milk conservation project and they were required to be signed by the accounts officer and the officer on special duty of

the milk conservation project. The milk conservation project was to be regarded as an independent entity and it was possibly for that reason that

the assessee initially filed a separate return in respect of the income derived from the milk project. So far as the assessee''s own accounts were

concerned, the assessee had shown the profits in the reserve account. It, thus, becomes clear that even though the assessee was given a right to run

the project, a separate account with respect to profits made or losses suffered in running that project was to be maintained. It is in this context that

we have to construe clause 6 of the terms and conditions which reads as follows:

Profits and losses shall be worked out on the same basis as has been followed in respect of the dairy project so far, that is, in the two pro forma

for maintaining trading accounts and profit and loss accounts, respectively, which are appended herewith. Profits, if any, as might be derived by the

Sangh under this agreement shall first be applied to the accumulated losses of the project which, according to the accounts of the dairy project,

stood at Rs. 64,670 as on March 31,1968, and which, for the purpose of this agreement, would be computed at the figure as on the date of

commencement of this agreement. Losses, if any, shall be borne by the Sangh.

The profits and losses which are referred to in this clause are in respect of the milk project. In this context, the words ''profits, if any, as may be

derived by the Sangh'' would mean profits made by running the milk project and cannot mean profits earned by the assessee, in the sense that the

assessee was free to distribute or use the profits in the manner it liked. The said clause speaks of physical receipt of profits by the assessee and not

receipt of profits in the eye of law. Out of these profits, accumulated losses were required to be wiped out and only thereafter, the net profits were

to go to the assessee. Profits in the hands of the assessee would be that amount which remained with it after the payment contemplated by the

agreement was made to the Government. Thus, this appears to be a clear case of diversion of profits by an overriding title. The Tribunal was,

therefore, wrong in taking the view that this was a case of application of its own profits by the assessee.

In the case of M.K. Brothers (P) Ltd. Vs. Commissioner of Income Tax, Kanpur, , which was relied upon by the learned counsel for the

revenue, the Supreme Court was not called upon to decide the question which we are required to consider in this reference. Question No. 1

quoted by the Supreme Court indicated that such controversy did not arise up to the stage of reference to the High Court. But, before the

Supreme Court, the only contention which was raised on behalf of the assessee was as to whether the payment which was made was in the nature

of revenue expenditure and, thus, a permissible deduction. In the last but one paragraph, the Supreme Court has observed as under:

...The present is a case relating to the application of income of discharge a liability incurred not in the course of running the business but a liability

undertaken for the purpose of acquiring the sole selling agency right which was indisputably an asset of capital nature."" (p. 44)

This decision of the Supreme Court, therefore, cannot help the revenue. For the reasons stated above, we answer question No. 1 in the

affirmative, that is, in favour of the assessee and against the revenue. In view of this answer, question No. 2 is not required to be answered and,

therefore, we decline to answer the same. Reference is disposed of accordingly with no order as to costs.