It was held by the Delhi High Court in the case of Srei Infrastructure Finance Ltd. vs. ACIT that according to Explanation (1) (c) to Section 115JB of the Act, any amount set in connection with the provisions made towards liabilities except ascertained liabilities, should be added at the time of computing book profits.
In other words, the provisions for ascertained liabilities should be excluded from the book profits under Explanation (1) to Section 115JB of the Act. However unascertained provisions should be included in the book profit.
The assessee should state that the Debt Redemption Reserve was actually a provision and that was for an ascertained liability. This explanation was not found in the aforesaid case.
The judgment was passed on 11st February, 2015 by the bench consisting of Justice Sanjiv Khanna and Justice V. Kameswar Rao.
Differences between “provision” and “liability”:
It was also pointed out by the double bench that the term “provision” differs from “liability” as liability is a fixed amount whereas a provision is an amount which is estimated. Reserves are associated with equity and the transfer of reserves is appropriation of earnings and it does not refer to expenses. However, contingent liability is not a provision. It is less certain compared to a provision as the obligation is yet to be confirmed and in such cases the assessee has no control over it or the amount cannot be properly ascertained. The obligation is so uncertain that it should not be reflected in the accounts. As such, a provision is a midway between accrual and contingent liability.
The argument regarding section 45IC of the Reserve Bank of India Act, 1934, and diversion of income at source was held to be unjustified.
The decisions of the Apex Court and that of the Delhi High Court in Molasses Storage Fund were held to be inapplicable. Diversion of income at source by means of overriding title as a principle was held to be applicable when under any obligation or the terms of the Memorandum and Articles of Association, the income is divested and the assessed does not have any title in connection with a specified receipt.
When such situation exists, the income must be excluded from income of the assessed as it does not ever reach the hands and belongs to a third person. For the said reason, the income is said to be diverted at source.
Diversion of income at source denotes that income or the amount belongs to a third party and was not income of the assessee. Similar issue appeared before the Supreme Court in the case of Associated Power Co. Ltd vs. CIT (1996) 218 ITR 195.
The reserve, which should be created according to Section 45IC of the Act, is from the income of a non-banking financial institution but the same is not an amount diverted at source by overriding title. The Reserve Bank of India Act, 1934 allows appropriation for the said reserve. The assessee can also seek directions from the Central Government regarding the same.