1. This common reference is under Section 256(1) of the I.T. Act, 1961. The following questions have been referred for the opinion of this court:
'1. Whether, on the facts and in the circumstances of the case, the contributions made by the assessee-society to the 'education fund' should be allowed as a deduction in computing the income for the assessment years 1965-66 to 1968-69 ?'
2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee was entitled to deduction of the loss of Rs. 22,364 incurred by it in the sale of Government securities held by it for the assessment year 1968-69 ?'
2. We shall first deal with the common question for all the assessment years before going into the question relating to the assessment year 1968-69. The assessee is a co-operative society engaged in the business of purchase and sale of foodgrains, pulses, sugar, agricultural operation requisites and marketing of commodities for the Government. The ITO determined, by his assessment orders for the relevant years, the total income as follows :
Rs.For the assessment year1965-6650,000'1966-672,14,670'1967-682,87,620'1968-693,02,560
3. In doing so, he disallowed the claim of the assessee for the amount set apart towards 'education fund' on the ground that 'the payment was not made to any educational institution or charitable trust'. The assessee appealed to the AAC and contended that the amount set aparttowards 'education fund' was in compliance with the provisions of the Madras Co-operative Societies Act, 1961, and that the amount so set apart had to be paid to the Tamil Nadu Co-operative Union and it had also been paid to the Tamil Nadu Co-operative Union within a period of two months and that, therefore, the ITO should have allowed the deduction of the said amount in the assessment made for the several years. The AAC, on appeal, negatived the claim holding that the provisions of Rule 46 of the Co-operative Societies Rules do not create a charge on the profits of the co-operative societies but only provided for allocation of profits and that the appropriation of profits after they are ascertained, which was not in the nature of diversion by an overriding title, could not justify the claim for deduction in computing the assessment. The assessee appealed to the Tribunal, and it held that it was a statutory obligation imposed on co-operative societies to set apart a portion of the profits as contribution to the 'education fund' and that the amount so set apart ceased to belong to the co-operative societies and became vested in the Tamil Nadu Co-operative Union and that, therefore, the amount was not available to the society. Such contributions were held by the Tribunal to be admissible deductions for each of these years. It is this problem which has given rise to the first question.
4. The question referred requires consideration in the light of the provisions of the Madras Co-operative Societies Act, 1961, in so far as they are relevant for the purpose of assessment to income-tax. Section 62 provides:
'Disposal of net profits.--The net profits of any registered society as declared by the Registrar for the purposes of this Act in respect of any co-operative year shall be appropriated-
firstly, for being credited to a reserve fund, the amount so credited being not less than twenty-five per cent. of the net profits;
secondly, towards contribution to such other funds and at such rates as may be specified in the rules;
thirdly, towards payment of dividends on shares to members at such rate as may be specified in the rules;
fourthly, towards payment of bonus to members and paid employees of the registered society at such rate and subject to such conditions as may be specified in the rules ;
fifthly, towards contribution to the co-operative education fund at such rate not exceeding two per cent. of the net profits as may be specified in the rules;
sixthly, towards contribution to such other funds and at such rates as may be specified in the bye-laws ;
seventhly, towards contribution to the common good fund at such rate not exceeding ten per cent. of the net profits as may be specified in the rules; and
eighthly, the balance, if any, of the net profits being credited to the reserve fund.'
5. Rule 46 is the rule regulating the contribution to such other funds as are contemplated in Section 62. Rule 46, in so far as it is relevant, runs as follows :
'Distribution of net profits.--...
(6) (i) Every society shall set apart a sum calculated at two per cent. of its net profits subject to a maximum of Rs. 2,500 for contribution to the co-operative education fund.
The sum so allocated shall be remitted to the Tamil Nadu Co-operative Union within two months of the date of allocation of the net profits by the general body.
(ii) The fund shall be maintained and administered by the Tamil Nadu Co-operative Union. It shall be utilised for the furtherance of cooperative education including propaganda as contemplated in the bye-laws of the said union.
(iii) No part of the co-operative education fund shall be spent by the Tamil Nadu Co-operative Union except in accordance with the bye-laws of the Union and the general directions that may be issued by the Registrar from time to time.
(iv) The Tamil Nadu Co-operative Union shall maintain a separate account for this fund in accordance with regulations to be framed by the Union with the approval of the Registrar.
(v) It shall be competent for the Registrar to constitute a committee of not more than five persons, of whom two shall be members of the committee of the Tamil Nadu Co-operative Union, for the administration of the fund.....'
6. The learned counsel for the Commissioner submitted that the amount set apart for the 'education fund' and made over to the Tamil Nadu Cooperative Union represented only appropriation of the profits and did not constitute either any expenditure for earning the income or any payment under any overriding title. The learned counsel for the assessee, on the other hand, submitted that the amounts were set apart and paid over to the co-operative union under statutory compulsion and would, therefore, have to be excluded as profits diverted by overriding title.
7. Section 62 of the Tamil Nadu Co-operative Societies Act itself contains the heading 'disposal of the net profits'. The provision also starts with the expression, 'The net profits of any registered society... shall be appropriated.' There is clear indication in Section 62 that the appropriation isout of or after the net profits are arrived at. Profits on coming into existence attract tax at that point, and the revenue is not concerned with the subsequent application of the profits. See Pondicherry Railway Co. Ltd, v. CIT . For instance, Section 62 itself contemplates payment of dividends on shares to members at such rate as may be specified in the Rules. It cannot be contended with any justification that such payment of dividends is diversion of profits by way of overriding title and, therefore, deductible in ascertaining the income of the co-operative society.
8. The 'education fund' under consideration comes within the scope of the clause starting with 'fifthly'. The payment is at the rate of two per cent. of the net profits. The payment is conditional on profits being earned. Though that part of the profits which may have to be paid for earning the income can be allowed as deduction, this is not such a case. The nature of the liability is such that the amount is only a distribution out of the profits, and is not related to the earning of profits.
9. Rule 46 also, on which strong reliance was placed by the assessee, does not take the matter further. It is after all a rule to give effect to Section 62. It opens with the words 'Distribution of net profits'. This gives an indication of what the rule deals with. After the net profits are declared by the Registrar of Co-operative Societies, appropriations are to be made in the manner contemplated by this rule. Clause (3) of Rule 46 speaks of the payment of dividend on shares to members by a society at a rate not exceeding six per cent. per annum. Just as, as seen already, the payment of dividends cannot be said to be any diversion of the profits by any overriding title, similarly payments made to the education fund would only be an appropriation out of the net profits and not profits diverted by the overriding title. In all the cases, where there is a diversion, the legal position is that before the profits reach the society, the profits are diverted to some one other than the society. In this case, the profits reached the society and the appropriation thereafter cannot affect the taxability of the net profits, which are the subject of appropriation. Merely because the statute contemplates the creation of a particular fund and its utilisation in a particular manner, it does not mean that there is any diversion by overriding title as such. If Section 62 read with Rule 46 is analysed, it dealt with what could or should be done after the profits are earned and have reached the assessee, and does not refer to any profits before they accrued to him. The amount set apart is not also any expenditure to earn the profits.
10. The learned counsel for the assessee was not in a position to bring to our notice any decision, which was in his favour. The result is that the amount paid to the 'educational fund' is not liable to be excluded from the taxable profits or allowed as deductions in determining the profits.
11. The first question is, therefore, answered in the negative and in favour of the revenue.
12. The second question arises on the following facts. The assessee was required by the Govt. of Madras to procure paddy during the relevant year. It needed finance for the said purpose. By a resolution dated 6th of February, 1966, the board of directors of the assessee resolved to apply to the South Arcot Co-operative Central Bank for a loan of Rs. 30 lakhs. The bank sanctioned a loan of only Rs. 11,50,000 and the assessee had, therefore, to sell the Govt. securities and debentures it held. As a result of the sale of securities, the assessee sustained a loss Rs. 22,364. The loss was claimed as a deduction in the assessment as business loss in carrying on the assessee's business. The ITO rejected the claim holding that the loss was capital in nature and the AAC concurred with him. The Tribunal had before it two statements setting out the details of the Govt. securities sold and the loss sustained by the society. The Tribunal, taking into account the fact that the assessee had to sell the Govt. securities for the purpose of raising necessary finance for purchasing the paddy as determined by the Government, came to the conclusion that the amount of loss sustained on the sale of Govt. securities was allowable as deduction. In doing so, the Tribunal relied upon two decisions, namely, (1) Sardar Indra Singh and Sons Ltd. v. CIT : 24ITR415(SC) and (2) Rajasthan Financial Corporation v. CIT . The correctness of the conclusion of the Tribunal in allowing this loss is challenged by reference of the second question which relates to the assessment for the year 1968-69 only.
13. The factual position is as follows:
The assessee had Govt. securities carrying rates of interest between 3 3/4 and 41 per cent. They were sold on various dates. The sales consisted of debentures and other Govt. securities. There is a provision under the Madras Co-operative Societies Act, 1961, which provides that a registered society may invest or deposit funds in certain types of security. Section 60 runs as follows:
'Investment of funds.--Subject to the provisions of Sub-section (3) of Section 58, a registered society may invest or deposit its funds-
(a) in the Government Savings Bank, or
(b) in any of the securities as specified in Section 20 of the Indian Trusts Act, 1882 (Central Act II of 1882), or
(c) in the shares or securities of any other registered society, provided that no such investment shall be made in the shares of any society with unlimited liability except with the general or special sanction of the Registrar and subject to such limits as may be specified by him from time to time, or
(d) with any bank or person carrying on the business of banking, approved for this purpose by the Registrar, or
(e) in any other mode permitted by the rules.'
14. The surplus funds of the society were invested in Govt. securities in the present case. The society is not a dealer in such securities, nor is it carrying on any banking or financing business. Its business, as seen already, is that of only a dealer in foodgrains, pulses, sugar, etc. The question for consideration is whether the profit or the loss arising under the sale of the securities in such a case is on capital or revenue account. As the assessee was not a dealer in such securities and is not also carrying on any business of banking or financing business, the investment in Govt. securities cannot be considered to be on trading account, as such securities do not represent stock-in-trade. The securities had been held apparently for a number of years as the statement shows. They were sold in the assessment year 1968-69 only because of necessity. Sale of an asset held on capital account and not on revenue account does not result in revenue profit or loss, even if such sale is the product of necessity. The society will be in the same position as an ordinary trader who carries on business in a particular line and who has invested his surplus money in any kind of share, security or immovable property. If such a person, because of financial needs, realises the shares, securities or other immovable properties, and he incurs a profit or loss, the profit or loss would not be on revenue account. The learned counsel for the assessee was not in a position to produce any authority in which a similar plea for allowance of loss had been admitted in the case of non-banking or non-financing co-operative society. The two cases relied on by the Tribunal are cases of financiers and do not apply to an assessee like the society here carrying on other lines of business. The loss has, therefore, to be considered to be on capital account.
15. There is one aspect which made us ponder much over the result in this case. Co-operative societies enjoyed exemption from taxation under a notification during the British days. The idea was obviously to encourage the co-operative sector by exempting from tax the income they earn. By a slow process, they have now been brought into the category of taxable entities. Just as other entities earning income pay tax, these co-operative societies also do, except to the extent specified in Section 80P. By the statute applicable to such societies, they are made to pay the 'education fund' which is strictly not a business expenditure. The consequence is they have to pay tax on such statutory obligation. They are not free to borrow as they please. They could not get the loan to the extent needed for carrying on an activity which was in a way forced on it. The sale of the securities thus became unavoidable. Any other trader would have hesitated to sell the securities at such a loss, for carrying on a business and do some benefit to the public. But the assessee had no choice and could not have refused to carry on the trade it was required to do by pointing out this loss. It is indeed harsh on an assessee like this that this loss cannot be allowed. We are, however, powerless to give relief to the assessee. We have to leave it to Parliament to move in this behalf if it so desires. After all, there are, nowadays, very strong voices heard in support of a fillip to the co-operative movement. The assessee has to look to these quarters for help.
16. The second question is answered in the negative and against the assessee. There will be no order as to costs.