IN HIGH COURT OF DELHI AT NEW DELHI INCOME TAX APPEAL NO. 371/2012 Reserved on : 11th December, 2014 Date of decision : 13th February, 2015 SREI INFRASTRUCTURE FINANCE LTD. ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. U.A. Rana, Ms. Mrinal Elker Mazumdar, Mr. Himanshu Mehta and Mr. Abirat Kumar, Advocates. versus ADDITIONAL COMMISSIONER OF INCOME TAX..Respondent Through Mr. Rohit Madan, Sr. Standing Counsel with Mr. Akash Vajpai and Mr. Ruchir Bhatia Advocates. INCOME TAX APPEAL NO. 372/2012 SREI INFRASTRUCTURE FINANCE LTD. ..... Appellant Through Mr. S. Ganesh, Sr. Advocate with Mr. U.A. Rana, Ms. Mrinal Elker Mazumdar, Mr. Himanshu Mehta and Mr. Abirat Kumar, Advocates. versus ADDITIONAL COMMISSIONER OF INCOME TAX..Respondent Through Mr. Rohit Madan, Sr. Standing Counsel with Mr. Akash Vajpai and Mr. Ruchir Bhatia Advocates. CORAM: HON'BLE MR. JUSTICE SANJIV KHANNA HON'BLE MR. JUSTICE V. KAMESWAR RAO ITA Nos. 371/2012 & 372/2012 Page 1 of 24 SANJIV KHANNA, J.: These two appeals under Section 260A of Income Tax Act, 1961 (Act, for short) by assessee SREI Infrastructure Finance Ltd. pertaining to assessment years 2006-07 and 2007-08, are directed against common order dated 23rd February, 2012 passed by Income Tax Appellate Tribunal (Tribunal, for short). aforesaid appeals require adjudication on two separate aspects. first aspect, which is common to both assessment years, relates to rate of depreciation in respect of motor vehicles given on lease. substantial question of law framed on said aspect vide order dated 10th April, 2013, reads as under:- Whether Income Tax Appellate Tribunal has erred in law in reminding issue of claim of depreciation at higher rate of 30% to Assessing Officer in respect of motor vehicles given on lease? 2. Tribunal in impugned order has referred to decision of Delhi High Court in CIT Vs. MGF (India) Ltd. (2006) 285 ITR 142 (Delhi) and CIT Vs. Bansal Credits Ltd. (2003) 259 ITR 69 (Del). Tribunal in impugned order reproduced paragraph 23 of judgment in case of Bansal Credit Ltd. (supra), which reads as follows:- Before we close, we may point out that in some of cases before us (ITAs No.64/99, 65/99, 73/99 & 74/99), Tribunal has remanded matters back to AOs to examine whether leased out vehicles had been actually used by lessee in business of hire. In light of view taken by us, we do not find any infirmity in such direction. As matter of fact, wherever there is doubt it must be examined whether leased out vehicles are actually being used in business of hiring. Only in such situation depreciation at higher rate of 40 per cent or 50 per cent as case may be, is to be allowed under relevant entry in Appendix I to Rules. ITA Nos. 371/2012 & 372/2012 Page 2 of 24 3. In terms of aforesaid observations, Tribunal restored matter to file of Assessing Officer to decide issue in accordance with law, i.e. end user on part of persons, who had put vehicles to use. It was observed that assessee had canvassed said factum; however, necessary verification at end of Assessing Officer should have been undertaken. contention of assessee is that order of remand should not have been and is not required to be passed. 4. Supreme Court in case of ICDS Vs. Commissioner of Income Tax, Mysore and Anr (2013) 350 ITR 527 (SC), had examined and considered issue of depreciation on vehicles given on hire, in depth and detail. It is noticeable that under Section 32 of Act, assessee is entitled to depreciation on buildings, machinery, plant, furniture, etc. being tangible assets owned wholly or partly by assessee and used for purpose of business or profession. Supreme Court observed that depreciation is monetary equivalent of wear and tear suffered by capital asset that is set aside to facilitate its replacement when asset becomes dysfunctional. Referring to expression for purpose of business , it was observed that it does not mandate use of asset by assessee itself, but requires that asset should be utilised for purpose of business of assessee. Thus, income derived from leasing of trucks by financing company would be business income as asset was used in course of business. Reference was made to decision of Supreme Court in Commissioner of Income Tax Vs. Shaan Finance (P) Ltd. Bangalore (1998) 231 ITR 308 (SC), which interpreted analogous provisions of Sections 32A(2)(a), (b) and Section 33 of Act dealing with investment allowance and development rebate, respectively. ITA Nos. 371/2012 & 372/2012 Page 3 of 24 second contention of Revenue that assessee was not owner of asset, i.e. trucks, was also rejected after relying upon observations of Tribunal that vehicles were given under lease agreement on payment of lease rent as prescribed under schedule. lease agreement it was elucidated was different from hire-purchase agreement and was contract of bailment with no element of sale therein. Supreme Court observed that Tribunal had rightly held that lease agreements in fact were transactions of hire . Supreme Court also observed that lease rentals received were treated as business income in hands of assessee and as deductible revenue expenditure in hands of payer/lessee. It was accordingly held as under:- Finally, learned senior counsel appearing on behalf of assessee also pointed out large number of cases, accepted and unchallenged by Revenue, wherein lessor has been held as owner of asset in lease agreement (CIT v. A. M. Constructions [1999] 238 ITR 775 (AP) ; CIT v. Bansal Credits Ltd. [2003] 259 ITR 69 (Delhi) ; CIT v. M. G. F. (India) Ltd. [2006] 285 ITR 142 (Delhi) ; CIT v. Annamalai Finance Ltd. [2005] 275 ITR 451 (Mad)). In each of these cases, leasing company was held to be owner of asset, and accordingly held entitled to claim depreciation and also at higher rate applicable on asset hired out. We are in complete agreement with these decisions on said point. 5. On question of rate of depreciation, it was exemplified:- With regard to claim of assessee for higher rate of depreciation, import of same term "purposes of business", used in second proviso to section 32(1) of Act gains significance. We are of view that interpretation of these words would not be any different from that which we ascribed to them earlier, under section 32(1) of Act. There- fore, assessee fulfils even requirements for claim of higher rate of depreciation, and, hence, is entitled to same. In this regard, we endorse following observations of Tribunal, which clinch issue in favour of assessee. ITA Nos. 371/2012 & 372/2012 Page 4 of 24 "15. Central Board of Direct Taxes, vide Circular No. 652, dated June 14, 1993, has clarified that higher rate of 40 per cent. in case of lorries, etc., plying on hire shall not apply if vehicle is used in non-hiring business of assessee. This circular cannot be read out of its context to deny higher appreciation in case of leased vehicles when actual use is in hiring business. (emphasis supplied) Perhaps, author meant that when actual use of vehicle is in hire business, it is entitled for depreciation at higher rate. 6. Following said reasoning, we do not think that order of remand was required to be passed as it is accepted and admitted position that motor vehicles in question were given on lease and, therefore, motor vehicles have to be treated as given on hire . Accordingly, appellant- assessee was entitled to higher rate of depreciation. substantial question of law is accordingly answered in favour of appellant-assessee and against respondent-Revenue. 7. second aspect/question raised before us relates to computation of book profits under Section 115JB of Act. substantial question of law framed in two appeals on said aspect read as under:- (Assessment year 2006-07) (1) Whether on facts and in circumstances of case Tribunal in computing book profit under Section 115JB was justified in confirming addition of Rs. 9,80,00,000/- transferred to special reserve pursuant to provisions of Section 45-IC of Reserve Bank of India Act, 1934 under Clause (b) of Explanation to Section 115JB? ITA Nos. 371/2012 & 372/2012 Page 5 of 24 (Assessment year 2007-08) (1) Whether on facts and in circumstances of case Tribunal in computing book profit under Section 115JB was justified in confirming additions of :- (a) Rs. 16,00,00,000/- transferred to special reserve pursuant to provisions of Section 45-IC of Reserve Bank of India Act, 1934; and (b) Rs. 18,66,00,000/- transferred to debt redemption reserve, both under Clause (b) of Explanation to Section 115JB? 8. Facts in brief may be noted. 9. appellant is non-banking financial company engaged, inter alia, in business of leasing of commercial vehicles, infrastructure construction machinery/equipment and financing of infrastructure projects equipment/machinery. For assessment year 2006-07, appellant had filed return on 27th November, 2006, declaring total income of Rs.2,03,13,738/- under normal provisions and had declared book profit of Rs.38,95,04,834/- under Section 115JB of Act. This return was revised on three occasions and in last revised return dated 31st March, 2008, returned income under normal provisions was revised to Rs.1,25,92,360/-. book profits remained unchanged at Rs.38,95,04,834/-. By assessment order dated 31st December, 2008, total income of appellant-assessee was assessed under normal provisions at Rs.16,17,08,631/- and book profits under Section 115JB of Act were computed at Rs.67,92,04,834/-. appellant approached Commissioner of Income Tax (Appeals) and then filed appeal before Tribunal. By ITA Nos. 371/2012 & 372/2012 Page 6 of 24 impugned order, addition of Rs.9,80,00,000/- to special reserve as per mandate of Section 45-IC of Reserve Bank of India Act, 1934 stands confirmed relying upon Explanation 1 clause (b) to Section 115JB(2) of Act. 10. In assessment year 2007-08, assessee had filed return declaring loss of Rs.37,94,15,570/- under normal provisions and book profit of Rs.47,54,42,043/-. Assessee had created special reserve of Rs.16 crores under Section 45-IC of Reserve Bank of India Act, 1934. Assessing Officer by his assessment order applied clause (b) to Explanation 1 to Section 115JB (2) of Act and added back said amount to Book profit. For same reason, Assessing Officer also made adjustment of Rs.18,66,00,000/-, which were treated by assessee as Debt Redemption Reserve. Commissioner of Income Tax (Appeals) and Tribunal have affirmed said findings of Assessing Officer. 11. contention of appellant-assessee is two-fold. Firstly, reserve created as per mandate of Section 45-IC of Reserve Bank of India Act, 1934, is in fact liability and not reserve. Reliance is placed upon decision of Supreme Court in National Rayon Corporation Vs. Commissioner of Income Tax (1997) 227 ITR 764 (SC), and Vazir Sultan Tobacco Company Ltd. Vs. CIT (1981) 132 ITR 559 (SC). Secondly, it is submitted that in terms of Section 45-IC of Reserve Bank of India Act, 1934, appellant-assessee does not have any title over reserve and, therefore, it is case of diversion of income at source. Reliance is placed upon several decisions relating to Molasses Storage Fund, namely, DCM Ltd. Vs. Commissioner of Income Tax [2004] 192 CTR 0408, Commissioner of Income-tax Vs. Salem Co-operative Sugar Mills Ltd ITA Nos. 371/2012 & 372/2012 Page 7 of 24 (1998) 229 ITR 285, Commissioner of Income-tax Vs. Pandavapura Sahakara Sakkare Kharkane Ltd. (1992) 198 ITR 690, Somaiya Orgeno- Chemicals Ltd. Vs. Commissioner of Income-tax (1995) 216 ITR 291. On issue of Debt Redemption Reserve, again reliance is placed upon decision in National Rayon Corporation (supra) to effect that amount was neither reserve nor provision for unascertained liability so as to attract clause (b) or (c) of Explanation 1 to Section 115JB(2) of Act. Revenue has contested and argued to contrary. Decision of Supreme Court in Southern Technologies Ltd. Vs. Joint Commissioner of Income Tax, [2010] 320 ITR 577 (SC), was referred. 12. In order to appreciate controversy, we would like to reproduce provisions of Section 115JB of Act as applicable to assessment year 2007-08 reads:- [Special provision for payment of tax by certain companies. 115JB. (1) Notwithstanding anything contained in any other provision of this Act, where in case of assessee, being company, income-tax, payable on total income as computed under this Act in respect of any previous year relevant to assessment year commencing on or after 1st day of April, [2007 ]], is less than [ten per cent] ] of its book profit, [such book profit shall be deemed to be total income of assessee and tax payable by assessee on such total income shall be amount of income-tax at rate of [ten per cent]]]. (2) Every assessee, being company, shall, for purposes of this section, prepare its profit and loss account for relevant previous year in accordance with provisions of Parts II and III of Schedule VI to Companies Act, 1956 (1 of 1956) : Provided that while preparing annual accounts including profit and loss account, (i ) accounting policies; (ii ) accounting standards adopted for preparing such accounts including profit and loss account; (iii ) method and rates adopted for calculating depreciation, ITA Nos. 371/2012 & 372/2012 Page 8 of 24 shall be same as have been adopted for purpose of preparing such accounts including profit and loss account and laid before company at its annual general meeting in accordance with provisions of section 210 of Companies Act, 1956 (1 of 1956) : Provided further that where company has adopted or adopts financial year under Companies Act, 1956 (1 of 1956), which is different from previous year under this Act, (i ) accounting policies; (ii ) accounting standards adopted for preparing such accounts including profit and loss account; (iii ) method and rates adopted for calculating depreciation, shall correspond to accounting policies, accounting standards and method and rates for calculating depreciation which have been adopted for preparing such accounts including profit and loss account for such financial year or part of such financial year falling within relevant previous year. Explanation[ 1]. For purposes of this section, "book profit" means net profit as shown in profit and loss account for relevant previous year prepared under sub-section (2), as increased by (a ) amount of income-tax paid or payable, and provision therefor; or (b ) amounts carried to any reserves, by whatever name called 24 [, other than reserve specified under section 33AC]; or (c ) amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities; or (d ) amount by way of provision for losses of subsidiary companies; or (e ) amount or amounts of dividends paid or proposed ; or (f ) amount or amounts of expenditure relatable to any income to which 25[ section 10 (other than provisions contained in clause (38) thereof) or 26[***] section 11 or section 12 apply; or [( g) amount of depreciation,] [( h) amount of deferred tax and provision therefor, [(i) amount or amounts set aside as provision for diminution in value of any asset, if any amount referred to in clauses (a ) to (i) is debited to profit and loss account, and as reduced by, ]] [( i) amount withdrawn from any reserve or provision (excluding reserve created before 1st day of April, 1997 otherwise than by way of debit to profit and loss account), if any such amount is credited to profit and loss account: ITA Nos. 371/2012 & 372/2012 Page 9 of 24 Provided that where this section is applicable to assessee in any previous year, amount withdrawn from reserves created or provisions made in previous year relevant to assessment year commencing on or after 1st day of April, 1997 shall not be reduced from book profit unless book profit of such year has been increased by those reserves or provisions (out of which said amount was withdrawn) under this Explanation or Explanation below second proviso to section 115JA, as case may be; or] (ii ) amount of income to which any of provisions of [ section 10 (other than provisions contained in clause (38) thereof)] or 31[***] section 11 or section 12 apply, if any such amount is credited to profit and loss account; or [( iia) amount of depreciation debited to profit and loss account (excluding depreciation on account of revaluation of assets); or (iib) amount withdrawn from revaluation reserve and credited to profit and loss account, to extent it does not exceed amount of depreciation on account of revaluation of assets referred to in clause (iia); or] [( iii) amount of loss brought forward or unabsorbed depreciation, whichever is less as per books of account. Explanation. For purposes of this clause, (a) loss shall not include depreciation; (b) provisions of this clause shall not apply if amount of loss brought forward or unabsorbed depreciation is nil; or] (iv ) amount of profits eligible for deduction under section 80HHC , computed under clause (a) or clause (b) or clause (c ) of sub-section (3) or sub-section (3A), as case may be, of that section, and subject to conditions specified in that section; or (v ) amount of profits eligible for deduction under section 80HHE computed under sub-section (3) or sub-section (3A), as case may be, of that section, and subject to conditions specified in that section; or (vi ) amount of profits eligible for deduction under section 80HHF computed under sub-section (3) of that section, and subject to conditions specified in that section; or (vii) amount of profits of sick industrial company for assessment year commencing on and from assessment year relevant to previous year in which said company has become sick industrial company under sub-section (1) of section 17 of Sick Industrial Companies (Special Provisions) Act, 1985 (1 of 1986) and ITA Nos. 371/2012 & 372/2012 Page 10 of 24 ending with assessment year during which entire net worth of such company becomes equal to or exceeds accumulated losses. Explanation. For purposes of this clause, "net worth" shall have meaning assigned to it in clause (ga) of sub-section (1) of section 3 35 of Sick Industrial Companies (Special Provisions) Act, 1985 (1 of 1986); or ( viii) amount of deferred tax, if any such amount is credited to profit and loss account.] Explanation 2. For purposes of clause (a) of Explanation 1, amount of income-tax shall include (i ) any tax on distributed profits under section 115-O or on distributed income under section 115R; (ii ) any interest charged under this Act; (iii ) surcharge, if any, as levied by Central Acts from time to time; (iv ) Education Cess on income-tax, if any, as levied by Central Acts from time to time; and (v ) Secondary and Higher Education Cess on income-tax, if any, as levied by Central Acts from time to time.] (3) Nothing contained in sub-section (1) shall affect determination of amounts in relation to relevant previous year to be carried forward to subsequent year or years under provisions of sub- section (2) of section 32 or sub-section (3) of section 32A or clause (ii) of sub-section (1) of section 72 or section 73 or section 74 or sub- section (3) of section 74A. (4) Every company to which this section applies, shall furnish report in prescribed form 37 from accountant as defined in Explanation below sub-section (2) of section 288, certifying that book profit has been computed in accordance with provisions of this section along with return of income filed under sub-section (1) of section 139 or along with return of income furnished in response to notice under clause (i ) of sub-section (1) of section 142. (5) Save as otherwise provided in this section, all other provisions of this Act shall apply to every assessee, being company, mentioned in this section.] (6) provisions of this section shall not apply to income accrued or arising on or after 1st day of April, 2005 from any business carried on, or services rendered, by entrepreneur or Developer, in Unit or Special Economic Zone, as case may be. ITA Nos. 371/2012 & 372/2012 Page 11 of 24 13. As noticed by this Court in Commissioner of Income Tax (Central- II) Vs. Goetze (India) Limited [2014] 361 ITR 505 (Del), Sub-section (1) to Section 115JB of Act begins with non obstante expression, which gives overriding effect to said section. Sub-section (2) states that every assessee being company shall prepare Profit and Loss account for previous year in accordance with provisions of Part II and III of Schedule VI of Companies Act, 1956. Explanation to said section in first part refers to increase in book profit by amounts specified in sub paragraphs (a) to (g). Explanation in second part states that book profit shall be reduced under clause (i) to (iii). Thus, book profits of previous years preferred in accordance with provisions of Part II and III of Schedule VI of Companies Act, have to be decreased or increased as per express mandate of Explanation 1 to Section 115JB (2) of Act. 14. In present case, we are concerned with clause (b) to Explanation 1 which states that book profit prepared in accordance with Part II and III of Schedule VI of Companies Act, 1956 will be increased by amount carried to any reserve by whatever name called, other than reserve specified under Section 33AC of Act. legislature in express, lucid and categorical terms has stipulated that book profit shall be increased by amounts carried to any reserve. word any , it is obvious, refers to all kinds of reserves and encompasses all types and categories without exception. legislature did not stop and has thereafter used expression reserve by whatever name called . There could not have been more clarity and articulateness in language of clause (b) to Explanation (1). intention is unambiguous, i.e. book ITA Nos. 371/2012 & 372/2012 Page 12 of 24 profit would include all amounts carried to any reserve by whatever name called, except reserve specified under Section 33AC of Act. nature and type of reserve or its character would not affect operation of clause (b) to Explanation (1). Only reserves specified in Section 33AC of Act have to be excluded. Guidance Note on revised Schedule VI to Companies Act, 1956 by Institute of Chartered Accountants of India would indicate that reserves and surplus are generally classified as; (a) capital reserve; (b) capital redemption reserve; (c) securities premium reserve; (d) debenture redemption reserve; and, (e) revaluation reserve or other reserves. In addition, there can be share options outstanding account and surplus, i.e. balance in statement of profit and loss disclosing allocations and appropriations such as dividend, bonus shares and transferred to/from reserves, etc. 15. In view of aforesaid legal position and language of clause (b) to Explanation (1) to Section 115JB of Act, appellant-assessee had adopted different line of argument relying upon decision of Supreme Court in case of National Rayon Corporation (supra) and Vazir Sultan Tobacco Company Ltd. (supra) and argued that amounts appropriated under Section 45-IC of Reserve Bank of India Act, 1934 are not reserve. We record and express our inability to agree with said contention for reasons set out below. 16. In Vazir Sultan Tobacco Company Ltd. (supra), Supreme Court was concerned with Companies (Profits) Surtax Act, 1964 and it was observed that terms provision and reserve were not defined in said Act, but are well-known terms in commercial accountancy and are used in Companies Act with reference to preparation of balance sheets ITA Nos. 371/2012 & 372/2012 Page 13 of 24 and Profit and Loss account. It was held that if sum of money had not been set apart for certain purpose, it would not be provision but it did not follow that it would be reserve . Referring to Part I and II of Schedule VI, it was observed that expression provision has been defined positively and meant any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability of which, amount cannot be determined with substantial accuracy. However, expression reserve has been defined in negative manner, and would exclude, i.e., not include, any amount written off retained by way of providing for depreciation, renewal or diminution in value of assets, or retained by way of providing for any known liability. Therefore, amount retained in excess of amount retained for any known liability was not necessarily reserve. provision, it was held, is charge against profits and therefore to be taken into account against gross receipts in Profit and Loss account. reserve , on other hand, is appropriation of profits, assets by which it is represented being retained to form part of capital employed in business. Whether amount was reserve or provision , it was observed, must be determined with reference to nature and character of sum retained and substance of matter. balance-sheet contains separate heads for reserve and surplus and current liabilities and provisions . 17. aforesaid position still holds good when we refer to Guidance Note issued by Institute of Chartered Accountants of India on revised Schedule VI to Companies Act, 1956 (December, 2011 Edition) in which it has been observed:- 8.1.2.1. Reserve: ITA Nos. 371/2012 & 372/2012 Page 14 of 24 Guidance Note on Terms Used in Financial Statements defines term Reserve as portion of earnings, receipts or other surplus of enterprise (whether capital or revenue) appropriated by management for general or specific purpose other than provision for depreciation or diminution in value of assets or for known liability. Reserves should be distinguished from provisions . For this purpose, reference may be made to definition of expression `provision in AS-29 Provisions, Contingent Liabilities and Contingent Assets. As per AS-29, `provision is liability which can be measured only by using substantial degree of estimation . liability is present obligation of enterprise arising from past events, settlement of which is expected to result in outflow from enterprise of resources embodying economic benefits. 'Present obligation obligation is present obligation if, based on evidence available, its existence at Balance Sheet date is considered probable, i.e., more likely than not. 18. Thereafter, Guidance Note under different headings describes capital reserve, capital redemption reserve, securities premium reserve, debenture redemption reserve, revaluation reserve, share options outstanding account and other reserves. 19. Similarly, in Guidance Note on Terms Used in Financial Statements GN(A) 5 issued in 1983, terms reserve and provision were explained as under:- 14.04 Reserve portion of earnings, receipts or other surplus of any enterprise (whether capital or revenue) appropriated by management for general or specific purpose other than provision for depreciation or diminution in value of assets or for known liability. reserves are primarily of two types: capital reserves and revenue reserves. 13.14 Provision amount written off or retained by way of providing for depreciation or diminution in value of assets or retained by way of providing for any known liability amount of which cannot be determined with substantial accuracy. ITA Nos. 371/2012 & 372/2012 Page 15 of 24 20. In case of National Rayon Corporation (supra), assessee company had issued secured redeemable mortgage debentures against security of land, building and machinery and floating charge on undertaking. High Court held that this was merely provision to enable it to redeem debentures when they became due for redemption. aggregate amount of debentures was higher than amount of Debenture Redemption Reserve. High Court on aforesaid reasoning held that amount set aside to meet future liability, which was certain to come into existence was provision and not reserve . Supreme Court, therefore, disagreed with said reasoning observing that High Court itself had come to conclusion that Debenture Redemption Reserve was less than company s liability on this account. Further, liability had arisen moment money was borrowed, which would be repayable. obligation or liability to repay would not cease just because fact that date of repayment was deferred by agreement, as obligation was ascertained liability. Therefore, money set apart for redemption of debentures must be treated as money set apart to meet known liability and amount should be shown as liability. In these circumstances, it was held that amount set apart was not reserve . Reference was made to Batliboi's Advanced Accountancy with reference to nature of sinking funds and it was held that redemption of debenture would not be reserve , though it was shown as reserve in balance-sheet. amount shown as reserve is in nature of allocation of profits and not charge against them. Debenture Redemption Reserve, it was held, was in nature of charge against profits and not appropriation of profits. ITA Nos. 371/2012 & 372/2012 Page 16 of 24 21. We do not see how this decision can help and assist appellant- assessee. 22. In respect of Debt Redemption Reserve of Rs.18,66,00,000/-, no specific explanation was given; on what account and why said reserve was created. Nothing has been shown or pointed out to us to show why said reserve was created. reply dated 9th March, 2009 quoted in assessment order refers to definition of term provision or reserve and various decisions and in end it is stated that amounts set apart for provision of Debt Redemption Reserve to meet any known liability cannot be termed as reserve as same was essentially provision for meeting ascertained liability and, therefore, cannot be added to book profit either under clause (b) or clause (c) to Explanation 1. Why and for what reasons amount of Rs.18,66,00,000/- represented ascertained and known liability, is not indicated or stated. nature and character of debt is not mentioned and adverted to. Assessing Officer also noticed that in earlier years, Debt Redemption Reserve was offered or added by assessee himself for computation of book profit. assessment order records that assessee had created reserve for meeting any kind of debt without specifying its details or particulars. 23. It is noticeable that under clause (c) of Explanation (1) to Section 115JB of Act, amount set aside to provisions made for meeting liabilities, other than ascertained liabilities, have to be added back while computing book profit. Thus, provisions for ascertained liabilities would be excluded and are not to be added to book profit under Explanation (1) to Section 115JB of Act. Unascertained provisions have to be added and included. It was for appellant-assessee to explain and show ITA Nos. 371/2012 & 372/2012 Page 17 of 24 that what was treated as Debt Redemption Reserve was in fact provision and that too for ascertained liability. This explanation is missing and absent. 24. term provision differs from liability because liability is certain and definite amount whereas provision is amount which is estimated (See Note 3 of Schedule III of Companies Act, 2013, with reference to term current liabilities ). Reserves fall on other end/side for they are associated with equity. Transfer of such reserves is appropriation of retained earnings rather than expenses. Contingent liability, however, is not provision or liability. It is less certain than provision as possible obligation has not yet been confirmed and assessed does not have control whether or when it will be confirmed or amount cannot be measured with sufficient reliability. potential obligation is so uncertain that it should not be recognized in accounts. provision, therefore, is somewhat between accrual and contingent liability. 25. argument in respect of Section 45-IC of Reserve Bank of India Act, 1934 and diversion of income at source is misconceived. decisions of different courts including Supreme Court and Delhi High Court in case of Molasses Storage Fund are inapplicable. Diversion of income at source by way of overriding title as principle is applicable when under statutory or contractual obligation or under provisions of Memorandum and Articles of Association, earning is divested and assessed has no title over particular receipt. When such charge exists, amount or income so charged must be excluded from income of assessed as income never reaches his hands and in fact ITA Nos. 371/2012 & 372/2012 Page 18 of 24 belongs to third person. Thus, income stands diverted at source. Diversion of income at source implies that income or amount mentioned therein belongs to third party and was not income of assessed. Similar question arose before Supreme Court in Associated Power Co. Ltd Vs. CIT (1996) 218 ITR 195. In that case, assessed was company engaged in business of generation of electricity and distribution thereof to consumers. companies were governed by Electricity (Supply) Act, 1948. By reason of provisions of said Act and VI Schedule thereto, assessed appropriated certain sums out of its revenue to contingency reserve account and claimed deduction of same in computation of its total income for purposes of Act. Income-tax Officer rejected claim of assessee. However, on appeal, Appellate Assistant Commissioner allowed assessee s claim. On appeal by Revenue, Tribunal set aside order of Appellate Assistant Commissioner and referred question regarding deductibility of amount transferred to contingency reserve fund account in arriving at taxable business income of assessee-company directly to Supreme Court under Section 257 of Act. Supreme Court on consideration of facts and circumstances of case and scheme of Electricity (Supply) Act, 1948, observed that monies in contingencies reserve belonged to electricity company. Supreme Court, therefore, repelled claim of assessed that there was diversion of income by overriding title. While doing so, Supreme Court observed:- application of doctrine of diversion of income by reason of overriding title is quite inapposite. doctrine applies when, by ITA Nos. 371/2012 & 372/2012 Page 19 of 24 reason of overriding title or obligation, income is diverted and never reaches person in whose hands it is sought to be assessed. Applying above principle to facts of case before it, Supreme Court observed (page 207) : In present case, statute requires electricity company to create certain reserve if its clear profit exceeds reasonable return (clause II, Sixth Schedule). Again, contingencies reserve is to be created from existing reserves or from revenues of undertaking . This clearly indicates that monies which have to be put into contingencies reserve, reach electricity company and are not diverted away from it. Supreme Court further observed : It is electricity company which has to invest sums appropriated to contingencies reserve. investment would be in its name and it would be owner thereof. restriction that investment can be made only in securities mentioned in Indian Trusts Act makes no difference to this position. Supreme Court, therefore, concluded that amount credited to contingencies reserve was not diverted by reason of overriding obligation or title and, it being taxable receipt/earning, it must be taken into account. 26. Section 45-IC of Reserve Bank of India Act, 1934 reads as under:- 45-IC. Reserve fund.--(1) Every non-banking financial company shall create reserve fund and transfer therein sum not less than twenty per cent of its net profit every year as disclosed in profit and loss account and before any dividend is declared. (2) No appropriation of any sum from reserve fund shall be made by non-banking financial company except for purpose as may be specified by Bank from time to time and every such appropriation shall be reported to Bank within twenty-one days from date of such withdrawal: Provided that Bank may, in any particular case and for sufficient cause being shown, extend period of twenty-one days by such further period as it thinks fit or condone any delay in making such report. ITA Nos. 371/2012 & 372/2012 Page 20 of 24 (3) Notwithstanding anything contained in sub-section (1), Central Government may, on recommendation of Bank and having regard to adequacy of paid-up capital and reserves of non- banking financial company in relation to its deposit liabilities, declare by order in writing that provisions of sub-section (1) shall not be applicable to non-banking financial company for such period as may be specified in order: Provided that no such order shall be made unless amount in reserve fund under sub-section (1) together with amount in share premium account is not less than paid-up capital of non- banking financial company. 27. reserve, which is required to be created under Section 45-IC, is out of profits earned by non-banking financial institution. It is not amount diverted at source by overriding title. Reserve Bank of India Act, 1934 can permit appropriation in respect of said reserve. assessee can also ask for specific directions from Central Government subject to proviso to sub-section (3) of said Section. 28. special reserve under Section 40IC of Reserve Bank of India Act, 1934 of Rs.9,80,00,000/- and Rs.16,00,000/- relating to Assessment Years 2006-07 and 2007-09, respectively was not on account of specific or known liability to repay. It is not case of charge on profits. It was only appropriation of profits after they had been earned. It is not expense. 29. During course of argument it was ascertained and accepted on behalf of appellant assessee that reserve under Section 45-IC of Reserve Bank of India Act, 1934 and debt redemption reserve were below line allocations, after computing financial profit and were not treated and regarded as expenditure/liability for for purpose of profit and loss account in accounts. amount treated as reserve created under Section 45-IC of Reserve Bank of India Act, 1934 was not regarded as diversion of income at source by statutory auditors. ITA Nos. 371/2012 & 372/2012 Page 21 of 24 Indeed, reserve created under Section 45-IC of Reserve Bank of India Act, 1934 can neither be diversion of income at source nor constitute expenditure or liability. Reserve under Section 45-IC of Reserve Bank of India Act, 1934 of not less than 20% of net profit every year can only be computed after net profit is calculated and computed. Reserve, so created is not liability known or ascertained, even estimated. Section 45- IC ensures that Non- Banking Finance Company does not appropriate entire net profit as disclosed in Profit and Loss account but this percentage is either ploughed back into business or is represented by portion of asset. No separate bank account is required to be maintained. It is added measure of protection created by statute, to prevent defaults by Non Banking Financial Companies. Section 45-IC of Reserve Bank of India Act, 1934 also permits appropriation but in restricted or controlled manner by Non Banking Financial Company. 30. Accounts in case of company are prepared as going concern assuming that business will continue in foreseeable future. To ascertain net profit of each year, not only current liabilities and contingencies but future contingencies should also be considered. Thus, Chapter VI of Companies Act in Part II and III provides for Provision and Reserves which relate to future payments, future needs and contingencies for which part of current earning is set aside. 31. underlying purposes of financial accounts may not necessarily be same as those of taxing accounts which are maintained and computed in accordance with provisions of taxing statute, i.e. Income Tax Act, 1961. Notwithstanding clear commonalities such as matching of income with expenses, in case of financial accounts there is ITA Nos. 371/2012 & 372/2012 Page 22 of 24 greater emphasis on ensuring that profits are not overstated, in contrast in tax accounts emphasis is on ensuring that profits are not understated. 32. As noticed above, provision and reserves are different accounting terms. provision created to meet known liability is charge against profit. Hence, it is debited to Profit and Loss account and reduces profit. Provisions should be created, even if there is insufficient profit. Provision is not, therefore, invested. On other hand, reserve is only appropriation of profit and, therefore, it is not debited to Profit and Loss account. purpose of reserve is to strengthen financial position and to meet unforeseen liabilities which may arise in future. reserves are created out of adequate profits. However, once reserve is created, it reduces divisible profit. This is amount of profit which is retained for use in business when difficulty arises. Reserves can be invested. said investments can be even outside business and in such cases reserve is called reserve fund. Reserves are shown on liability side of balance sheet and are generally treated as belonging to proprietor just as capital. It is sum owned by business to proprietor. Reserves themselves are not assets but represent portion of assets which proprietor is free to utilize for business as one likes, i.e. assets equalling reserves that are not required to pay liabilities. Generally reserves are created at discretion of management as matter of prudence, but in certain cases statute can direct creation of special reserves. For purpose of Section 115JB of Act, statutory reserves are treated alike and in similar manner as other reserves. ITA Nos. 371/2012 & 372/2012 Page 23 of 24 33. Reserves are normally treated as part of equity which is defined as residual, i.e. assets less liabilities, but as recorded above sometimes reserves are required to be created by statute in order to give entity and its creditors added measure of protection from effect of losses. 34. To reiterate, reserve is below line of allocation of profits. amount mentioned in reserve does not get reflected in Profit and Loss account. Further, amount mentioned in reserve is not to be kept in designated bank account, but would get reflected in form of assets under heading assets , etc. 35. In view of aforesaid reasoning, two substantial questions of law mentioned in paragraph 7 above have to be answered against appellant-assessee and in favour of respondent-Revenue. To this extent, appeal is dismissed. As substantial question of law relating to rate of depreciation has been answered in favour of appellant- assessee, we are not inclined to impose costs. -sd- (SANJIV KHANNA) JUDGE -sd- (V. KAMESWAR RAO) JUDGE FEBRUARY 13, 2015 NA/VKR ITA Nos. 371/2012 & 372/2012 Page 24 of 24 Srei Infrastructure Finance Ltd. v. Additional Commissioner of Income-tax