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Srei Infrastructure Finance Ltd vs. ACIT (Delhi High Court)
February, 18th 2015

S. 115JB: Distinction between "reserve" & "provision" explained. Statutory reserve created u/s 45-IC of RBI Act is not a "diversion of income at source" and cannot be excluded from book profits

(i) Under clause (c) of Explanation (1) to Section 115JB of the 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 the book profit under Explanation (1) to Section 115JB of the Act. Unascertained provisions have to be added and included. It was for the assessee to explain and show that what was treated as a Debt Redemption Reserve was in fact a provision and that too for an ascertained liability. This explanation is missing and absent.

(ii) The term “provision” differs from “liability” because liability is certain and definite amount whereas a provision is an amount which is estimated (See Note 3 of Schedule III of the Companies Act, 2013, with reference to the term “current liabilities”). Reserves fall on the 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 a provision or liability. It is less certain than a provision as the possible obligation has not yet been confirmed and the assessed does not have control whether or when it will be confirmed or the amount cannot be measured with sufficient reliability. The potential obligation is so uncertain that it should not be recognized in the accounts. A provision, therefore, is somewhat between accrual and the contingent liability.

(iii) The argument in respect of Section 45-IC of the Reserve Bank of India Act, 1934 and diversion of income at source is misconceived. The decisions of different courts including the Supreme Court and the Delhi High Court in the case of Molasses Storage Fund are inapplicable. Diversion of income at source by way of overriding title as a principle is applicable when under a statutory or contractual obligation or under the provisions of Memorandum and Articles of Association, the earning is divested and the assessed has no title over a particular receipt. When such charge exists, the amount or income so charged must be excluded from income of the assessed as income never reaches his hands and in fact belongs to a third person. Thus, the income stands diverted at source. Diversion of income at source implies that income or the amount mentioned therein belongs to a third party and was not income of the assesse. Similar question arose before the Supreme Court in Associated Power Co. Ltd Vs. CIT (1996) 218 ITR 195.

(iv) The reserve, which is required to be created under Section 45-IC, is out of the profits earned by a non-banking financial institution. It is not an amount diverted at source by overriding title. The Reserve Bank of India Act, 1934 can permit appropriation in respect of the said reserve. The assessee can also ask for specific directions from the Central Government subject to proviso to sub-section (3) of the said Section.

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