2004 (4) TMI 21 - HC - Income Tax

Amount of reserve fund transferred from the net profit - Assessee is a co-operative marketing society who claimed that rule 68 of the Rajasthan Sahakari Sansthan Rules of the Rajasthan Co-operative Societies Rules 1966 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 the assessee but it goes under the control of the Registrar Rajasthan Co-operative Societies therefore it does not form part of the assessee s real income and for that reason it was sought to be excluded from the computation of taxable income of the assessee. The deduction was also claimed under section 37 Held that the amount of reserve fund transferred from the net profit under section 62 of the Co-operative Societies Act 1965 read with 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.

Issues Involved:
1. Deduction Claim under Section 37 of the Income-tax Act.
2. Diversion of Income by Overriding Title.
3. Real Income Concept.
4. Nature and Utilization of Reserve Fund under the Cooperative Societies Act.

Issue-wise Detailed Analysis:

1. Deduction Claim under Section 37 of the Income-tax Act:
The assessee, a co-operative marketing society, claimed that 25% of its net profits transferred to a reserve fund under Rule 68 of the Rajasthan Co-operative Societies Rules, 1966, should be excluded from taxable income. The Assessing Officer disallowed the deduction, stating that the transfer to the reserve fund is not an expenditure but a below-the-line adjustment. The Commissioner of Income-tax (Appeals) upheld this decision. However, the Tribunal allowed the deduction, relying on the Madhya Pradesh High Court decision in Keshkal Co-operative Marketing Society Ltd. v. CIT.

2. Diversion of Income by Overriding Title:
The court examined whether the transfer to the reserve fund constituted a diversion of income by overriding title. It was argued that the reserve fund, controlled by the Registrar of Co-operative Societies, did not form part of the society's real income. The court analyzed various precedents, including Raja Bejoy Singh Budhuria v. CIT and CIT v. Sitaldas Tirathdas, to determine whether the income was diverted before it reached the assessee. The court concluded that the reserve fund remains part of the society's assets and is used for the society's purposes, not diverted to a third party.

3. Real Income Concept:
The court discussed the concept of real income, emphasizing that income-tax is levied on real income, which is the profit arrived at on commercial principles. The court distinguished between deductions made for ascertaining profits and distributions made out of profits. It referred to the Supreme Court's decision in Poona Electric Supply Co. Ltd. v. CIT, where excess profits were returned to consumers, and Associated Power Co. Ltd. v. CIT, where reserves were created for future contingencies. The court concluded that the reserve fund in question is not an expense or diverted income but part of the society's capital.

4. Nature and Utilization of Reserve Fund under the Cooperative Societies Act:
The court analyzed the provisions of the Rajasthan Co-operative Societies Act, 1965, and the Rules of 1966. It noted that the reserve fund is created from net profits and remains part of the society's assets, used for meeting future contingencies and financial needs. The fund is regulated by the Registrar but remains the property of the society. The court rejected the argument that the reserve fund is created for public utility, stating that it is intended to strengthen the society's financial base.

Conclusion:
The court held that the amount transferred to the reserve fund under Section 62 of the Co-operative Societies Act, 1965, read with Rule 68 of the Cooperative Rules, 1966, is not allowable as a deduction in computing the taxable income of the society. The judgment of the Tribunal was set aside, and the Assessing Officer's decision was restored. No order as to costs.

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