Case: Vellore Electric Corporation Ltd. and Ors Vs. Commissioner of Income Tax

industry. 18. In English Electric Co. of India Ltd. vs. CIT (supra), the assessee had received interest from supplies of raw materials, the State Electricity Board, banks as well as on security deposits with other agencies. The Madras High Court, while following its earlier decision in Universal Radiators (P) Ltd. (supra) and the decision of this Court in Cambay Electric Supply Industrial Co. Ltd. (supra), has held that in so far as the interest received from bank deposits was concerned, the same could not be attributable to the priority industry itself but as regards interest earned on other deposits, the High Court held that they were in the nature of security deposits for the purpose of contracts by the assessee-company and in case of interest received from supply of raw materials, the same was received because the raw materials were not supplied at all and the advance receipts were returned with interest which had a direct nexus with the business of the priority industry and that when the company had to keep security deposits such deposits were necessary for the purpose of its business and any such interest obtained from such deposits would be clearly attributable to priority industry. This decision indicates that in a case where the security deposit is necessary for the purpose of business of the assessee, then the interest obtained therefrom can be said to be attributable to the priority industry. 19. To the same effect is the decision of the Calcutta High Court in CIT vs. Dunlop India Ltd. [1992] 197 ITR 34 (Cal) : [1992] 197 ITR 34 (Cal) In this case deposits were made by the assessee with the Excise Department for obtaining manufacturing facilities under the central excise laws and with the electricity boards in West Bengal and Tamil Nadu for the purpose of obtaining industrial power connections. It was held that these deposits made were incidental to and for the purpose of carrying on the business of priority industry and the interest receipts earned from these securities had to be treated as part of the profits and gains attributable to a priority industry under s. 80-I of the Act. 20. The position that emerges from these decisions is that profits and gains can be said to be attributable to the priority industry under s. 80-I if there is a direct and proximate connection between the profits and gains and the business of the priority industry. In this context, reference may be made to the recent decision in Indian Leather Corpn. (P) Ltd. vs. CIT (CA No. 292 of 1982 decided on 30th April, 1997). This Court, while construing the words Income attributable to any of the aforesaid activities in s. 104(4) of the Act, has said : In order that income can be said to be attributable to manufacture or processing of goods for the purpose of Expln. to s. 104(4) of the Act the earning of the income must be directly connected with manufacture or processing of goods. 21. In the present case, the assessee is carrying on business of generating electricity as a licensee under the Electricity Supply Act. Under s. 57 of the Electricity Supply Act the provisions of the Sixth Sch. shall be deemed to be incorporated in the license of every licensee. Under paragraph III of the Sixth Sch., the licensee is obliged to create from existing reserves or from the revenues of the undertaking a reserve called Contingencies Reserve and under sub-para (2) of paragraph IV the licensee is obliged to invest the sums appropriated to the Contingencies Reserve in securities authorised under the Indian Trusts Act, 1882. The requirement to create the Contingencies Reserve is a part of the obligation of the assessee as a licensee to carry on its business of generating electricity and it is also part of the obligation of assessee as a licensee that the sums appropriated to the Contingencies Reserve are invested in securities authorised under the Indian Trusts Act, 1882. In Cambay Electric Supply Industrial Co. Ltd. (supra) this Court has said : In our view, since the expression of wider import, namely, attributable to, has been used, the legislature intended to cover receipts from sources other than the actual conduct of the business of generation and distribution of electricity. This would mean that it is not necessary that the income should have been earned from the actual conduct of the business of generation and distribution of electricity. What is required is that the activity from which the income is earned must have a direct and proximate connection with the priority industry of generation and distribution of electricity. The creation of the Contingencies Reserve and the investment of the sums appropriated to the said Reserve in security authorised under the Indian Trust Act, 1882, being a condition statutorily incorporated in the license granted to the assessee under the Electricity Supply Act, is incidental to the carrying on of the business of generation and distribution of electricity by the assessee. There is thus a direct and proximate connection between the carrying on the business of generation and distribution of electricity by the assessee as a licensee under the Electricity Supply Act and the income derived by way of interest from the investments in securities of the sums appropriated to the Contingencies Reserve as required under the provisions of the Sixth Sch. to the Electricity Supply Act which is one of the conditions of license on the basis of which the assessee can carry on its business of generating and distributing electricity. We are, therefore, of the view that the income earned by way of interest on the sums appropriated to the Contingencies Reserve which have been invested in securities can be said to be profits and gains attributable to the business of the assessee for the purpose of s. 80-I of the Act. Question No. 3 in Civil Appeals Nos. 2613-14 of 1984 is, therefore, answered in the affirmative, i.e., in favour of the assessee and against the Revenue.

Decision (1 = appeal accepted, 0 = rejected): 0

Explanation:
0[ds]4. As indicated earlier, the assessee is a licensee under the Electricity Supply Act for the purpose of distribution of power. Under s. 57 of the Electricity Supply Act the provisions of the Sixth Sch. are deemed to be incorporated in the licence of a licensee, not being a local authority and the licensee is required to comply with the provisions of the said Schedule. The Sixth Sch. contains the financial principles and their application5. In Poona Electric Supply Co. Ltd. vs. CIT [1965] 57 ITR 521 (SC) this Court has laid that the amounts credited to the Consumers Rebate Reserve account did not form part of the real profits of the appellant-company and in order to arrive at the taxable income of the appellant-company from business under s. 10(1) of the Indian IT Act, 1922, the said amounts had to be deducted.6. As regards Contingencies Reserve, there was difference of opinion among the various High Courts. The High Courts of Madras [Vellore Electric Corpn. Ltd. (supra)] and Calcutta CIT vs. Sijua (Jharriah) Electric Supply Co. Ltd. [1984] 145 ITR 740 (Cal) had taken the view that deduction could not be claimed in respect of the amounts appropriated to the Contingencies Reserve. The High Courts of Kerala [Cochin State Power & Light Corpn. Ltd. vs. CIT [1974] 93 ITR 582 (Ker) ] Bombay [Amalgamated Electricity Co. Ltd. vs. CIT [1974] 97 ITR 334 (Bom) and Patna [Darbhanga Laheriasari Electric Supply Corpn. Ltd. vs. CIT [1979] 117 ITR 516 (Patna) ] had taken a contrary view and had held that deduction could be claimed in respect of the amounts appropriated to the Contingencies Reserve. For the purpose of wealth-tax, the Bombay High Court in CWT vs. Bombay Suburban Electric Supply Ltd. [1976] 103 ITR 384 (Bom) , had held the amount standing to the credit of the Contingencies Reserve is a part of the assets belonging to the assessee and is includible in the net wealth of the assessee and is chargeable to wealth-tax. This conflict in the views of the High Courts with regard to taxability of the amounts appropriated to Contingencies Reserve was resolved by this Court in Associated Power Co. Ltd. vs. CIT [1996] 218 ITR 195 (SC) wherein the decisions of the High Courts of Madras and Calcutta referred to above have been approved and the decisions of the High Courts of Kerala and Bombay mentioned above have been overruled. It has been held that 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. It has been pointed out that contingencies Reserve differs from Consumers Benefit Reserve since the amount appropriated in the Consumers Benefit Reserve 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 and that 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 purposes set out in paragraph V of the Sixth Sch. to the Electricity Supply Act which are the expenses which the electricity company has to incur and that the reservation is made so that money is always available for meeting these expenses and the supply of electricity is not interrupted. It was held that the monies in the Contingencies Reserve belong to the electricity company. In view of the decision of this Court in Associated Power Co. Ltd. (supra), it must be held that question No. 1 in Civil Appeals Nos. 2613-14 of 1984 relating to Contingencies Reserve has been rightly answered against the assessee and in favour of the Revenue by the High Court.A perusal of the said provisions would indicate that the main part of the sub-para (2) of Paragraph V and sub-para (4) of paragraph VA are practically the same. There is difference in the proviso to the said provisions. Under the proviso to sub-para (2) of paragraph V where the undertaking is purchased by the State Electricity Board or the State Government the amount of the Contingencies Reserve after further deduction of the amount of compensation, if any, payable to the employees the outgoing licensee under any law for the time being in force, has to be handed over to the Electricity Board or the State Government as the case may be. Under the proviso to sub-para (4) of paragraph VA where the undertaking is purchased by the State Electricity Board or the State Government the amount of Development Reserve has to be deducted from the price payable to the licensee. This difference in the two provisions does not, in our opinion, mean that the amounts appropriated to Development Reserve were not part of the real profit of the electricity company. Like Contingencies Reserve, Development Reserve also belonged to the electricity company and it had the use of it. The Contingencies Reserve is meant to be utilised by the electricity company to meet the expenses or recoup loss of profits arising out of accidents, strikes or other circumstances which the electricity company could not have promoted or to meet the expenses on replacement or renewal of plant or works or for payment of compensation required by law for which no other provision has been made. Development Reserve is meant for investment in the business of electricity supply of the undertaking. On the purchase of the undertaking Contingencies Reserve, as well as Development Reserve have to be handed over to the purchaser and have to be maintained as Contingencies Reserve and Development Reserve as the case may be, in view of the main part of sub-para (2) of paragraph V and sub-para (4) of paragraph VA. Under the proviso to sub-para (2) of paragraph V where the undertaking is purchased by the Electricity Board or the State Government the amount of Contingencies Reserve, after the deduction of the amount of compensation, if any, payable to the employees of the outgoing licensee, is to be handed over to the Electricity Board or the State Government, as the case may be. Under sub-para (4) of paragraph VA the amount of Development Reserve, instead of being handed over to the Electricity Board or the State Government, can be deducted from the price payable to the licensee. Both the provisions achieve the same result, viz., the Reserve being available to the State Electricity Board or the State Government. The difference in the language in the provisos in sub-para (2) of paragraph V and sub-para (4) of paragraph VA may be due to the fact that the liability for the payment of compensation payable to the employees of the outgoing licensee would be of the licensee and the said liability has to be met out of the Contingencies Reserve in view of paragraph V(1)(c) of the Sixth Sch. and the amount of Contingencies Reserve is to be handed over after deducting the amount of compensation so payable by the licensee.There is, therefore, no difference between Development Reserve and Contingencies Reserve and the High Court, in the impugned judgment, has rightly held that the amount appropriated towards Development Reserve could not be deducted.10. Provisions regarding Tariffs and Dividend Control Reserve are contained in sub-paras (1), (2) and (3) of paragraph II of the Sixth Sch. The said provisions are practically in the same terms as those contained in paragraph VA relating to Development Reserve. Sub-para (2) of paragraph II requires that the Tariffs and Dividend Control Reserve shall be available for disposal by the licensee only to the extent by which the clear profit is less than the reasonable return in any year of account. Under sub-para (3) of paragraph II on the purchase of the undertaking under the terms of license any balance remaining in the Tariffs and Dividend Control Reserve has to be handed over to the purchaser and has to be maintained as such Tariffs and Dividend Control Reserve and where the undertaking is purchased by the State Electricity Board or the State Government the amount of the Tariffs and Dividend Control Reserve may be deducted from the price payable to the licensee. The reasons given for holding that the amounts appropriated to Development Reserve could not be deducted are equally applicable to Tariffs and Dividend Control Reserve and it must, therefore, held that the amounts appropriated to the Tariffs and Dividend Control Reserve could not be deducted.It must, therefore, he held that the question referred in Civil Appeals Nos. 3333-3334 of 1981 and question No. 2 referred in Civil Appeals Nos. 2613-14 of 1984 have been rightly answered against the assessee and in favour of the Revenue by the High Court in the impugned judgments.14. In Indian Aluminium Co. Ltd. vs. CIT (supra) the assessee was carrying on business as manufacturer of aluminium. Income by way of interest had accrued from the surplus funds of the assessee that had been invested for short periods. It was held by the Calcutta High Court that no part of the interest accruing from company investments of surplus funds can be said to be attributable to the priority industry of the assessee and that such interest had arisen by reason of the surplus fund being not employed in the priority industry and that such temporary investment had not been shown to have any connection whatsoever direct or indirect with the priority industry of the assessee.15. In CIT vs. Universal Radiators (P) Ltd. (supra) the assessee had surplus funds which it had invested in the bank in fixed deposit and thereafter when the assessee wanted money from the bank on the security of the said fixed deposit, amounts were lent by the bank. After observing that the Court was concerned with the deposit having nexus with the priority industry at the stage at which the amount were deposited in the bank and started earning interest, the Madras High Court held that, considering the question of the interest income at the stage at which the deposit was made, the use of the receipt as security does not make the income that of the priority industry. The High Court has referred to the impugned judgment Addl. CIT vs. Vellore Electric Corpn. Ltd. [which had since been reported in [1979] 119 ITR 523 (Mad) : [1979] 119 ITR 523 (Mad) and after taking note of the decision of this Court in Cambay Electric Supply Industrial Co. Ltd. (supra), the High Court has said :In the context of the pronouncement of the Supreme Court, the view taken by this Court that the profits and gains must arise from the specific activities or business of generation of electricity may have to be reconsidered. As attributable to is wider than derived from, the relief is not confined only to the profits of the priority industry strictly so called. It would have a wider ambit. However, the conclusion arrived at in that case is unexceptionable because the character of the interest is different from the character of the income attributable to the priority industry.20. The position that emerges from these decisions is that profits and gains can be said to be attributable to the priority industry under s. 80-I if there is a direct and proximate connection between the profits and gains and the business of the priority industry. In this context, reference may be made to the recent decision in Indian Leather Corpn. (P) Ltd. vs. CIT (CA No. 292 of 1982 decided on 30th April, 1997). This Court, while construing the words Income attributable to any of the aforesaid activities in s. 104(4) of the Act, has said :In order that income can be said to be attributable to manufacture or processing of goods for the purpose of Expln. to s. 104(4) of the Act the earning of the income must be directly connected with manufacture or processing of goods.21. In the present case, the assessee is carrying on business of generating electricity as a licensee under the Electricity Supply Act. Under s. 57 of the Electricity Supply Act the provisions of the Sixth Sch. shall be deemed to be incorporated in the license of every licensee. Under paragraph III of the Sixth Sch., the licensee is obliged to create from existing reserves or from the revenues of the undertaking a reserve called Contingencies Reserve and under sub-para (2) of paragraph IV the licensee is obliged to invest the sums appropriated to the Contingencies Reserve in securities authorised under the Indian Trusts Act, 1882. The requirement to create the Contingencies Reserve is a part of the obligation of the assessee as a licensee to carry on its business of generating electricity and it is also part of the obligation of assessee as a licensee that the sums appropriated to the Contingencies Reserve are invested in securities authorised under the Indian Trusts Act, 1882. In Cambay Electric Supply Industrial Co. Ltd. (supra) this Court has said :In our view, since the expression of wider import, namely, attributable to, has been used, the legislature intended to cover receipts from sources other than the actual conduct of the business of generation and distribution of electricity.This would mean that it is not necessary that the income should have been earned from the actual conduct of the business of generation and distribution of electricity. What is required is that the activity from which the income is earned must have a direct and proximate connection with the priority industry of generation and distribution of electricity. The creation of the Contingencies Reserve and the investment of the sums appropriated to the said Reserve in security authorised under the Indian Trust Act, 1882, being a condition statutorily incorporated in the license granted to the assessee under the Electricity Supply Act, is incidental to the carrying on of the business of generation and distribution of electricity by the assessee. There is thus a direct and proximate connection between the carrying on the business of generation and distribution of electricity by the assessee as a licensee under the Electricity Supply Act and the income derived by way of interest from the investments in securities of the sums appropriated to the Contingencies Reserve as required under the provisions of the Sixth Sch. to the Electricity Supply Act which is one of the conditions of license on the basis of which the assessee can carry on its business of generating and distributing electricity. We are, therefore, of the view that the income earned by way of interest on the sums appropriated to the Contingencies Reserve which have been invested in securities can be said to be profits and gains attributable to the business of the assessee for the purpose of s. 80-I of the Act. Question No. 3 in Civil Appeals Nos. 2613-14 of 1984 is, therefore, answered in the affirmative, i.e., in favour of the assessee and against the Revenue.