1. This is a reference under sub-section (1) of section 66 of the Indian Income-tax Act at the instance of the department. the assessee is a registered firm carrying on business as share and stock broker on a large scale. We are here concerned with the assessment year 1959-60, relevant accounting year being Samavat year 2014. At the end of the said Samvat year (Samvat year 2014), the balance in the overdraft account of the assessee stood at Rs. 13,54,781 as against shares of Rs. 13,36,208 and Government securities of Rs. 24,925 held and offered as security for the overdraft.
2. On the aforesaid overdraft account, the assessee paid Rs. 67,773 as interest for the said Samvat year 2014. The assessee claimed the aforesaid amount of Rs. 67,773 as a deduction under sub-section (2) of section 12 of the Income-tax Act against its dividend income of Rs. 81,967. It may be stated that during the assessment year, the income earned by the assessee was form three sources : Income earned by it form its business under the head 'business', income earned by it under the head 'securities' and income earned by it under the head 'dividends'. The Income-tax Officer did not allow the claim of the assessee for deduction of the said amount of Rs. 67,773 gains tits dividend income. The Income-tax Officer, however, allowed the said amount as deduction against the assessee's business income. The reasons given by the Income-tax Officer for disallowing the assessee's claim for deduction in his own words are :
'The position would have been different in the case of a investor who borrows money purely for the purpose of earning dividends and interest form investments; such a case would be no doubt covered by section 12(2). Even then no investor would borrow money for the purpose of investing in securities because he would have always to pay a higher rate of interest than what he would get from the securities. The assessee being a dealer in shares and securities, section 12(2) has no application here at all because the payments of interest against the borrowings will have to be considered only under section 10 as the borrowing is for the purpose of doing business.
I have looked into the assessee's balance-sheets as on Diwali day of 1957, as well as on Diwali day of 1958, which are the last days of S. Y. 2013 and the accounting year under consideration, respectively, and I find that the bulk of the borrowed money on which interest is paid is used in buying substantial quantity of shares and securities in the year and in Vyaj Badla transactions. Both these activities of the assessee-firm are business activities and therefore interest on borrowed money is correctly allowed against the income form business. The assessee's claim is therefrom rejected. The interest paid on the borrowings will be allowed only under section 10 against business income.'
3. Against this order the assessee preferred an appeal before the Appellate Assistant Commissioner. In dismissing the appeal, the Appellate Assistant Commissioner observed :
'On the facts of the case, I have no doubt that the main object in purchasing the shares and securities out of the borrowings form the bank was not for the purpose of earning income form dividends, but for the purpose of dealing in shares and securities. As already observed, the profit of the appellant as a result of trading in shares and securities is quite substantial an the earning of income from dividends and interest on securities was only incidental to the main business do dealing in shares as securities. This being the position, I hold that the Income-tax payment of Rs. 67,773 can be allowed as a deduction only against the business income of the appellant under the provisions of section 10 and not against the dividend income of the appellant under the provisions of section 12(2) of the Act.'
4. The assessee took a further appeal to the Tribunal and the Tribunal allowed the appeal. The reasons given by the Tribunal are contain in paragraphs 2 and 3 of its order, which are in the following terms :
'2. The shares in question are admittedly the stock-in-trade of the assessee. The dividends received form these shares as also the interest paid to the banks on the loans taken with the shares as security must form part of the normal business transactions of the assessee.
3. All the same, dividend income requires to be assessed under section 12, so that it is necessary to separate it form the otherwise trade receipts. In arriving at such income, which is the net income, all expenses necessary for the purpose of earning it have necessarily to be deducted. It cannot be disputed that the dividend in question has been earned only form the very shares which had been purchased out of the borrowings on which the impugned interest has been paid; had it not been for the interest payments, the dividend could not have been earned. the income form 'other sources' to be assessed under section 12 will thus have to be only the net income form dividends after deduction of the interest paid to the bank. The assessee's contention is accordingly accepted.'
5. On an application by the Commissioner, the Tribunal has referred the following question of law to this court :
'Whether the interest of Rs. 67,773 is a proper deduction in the computation of the dividend income under section 12 ?'
6. The question thus that arises for decision relates to the construction of sub-section (2) of section 12 of the Act.
7. Mr. Joshi, learned counsel for the revenue, contends that the Tribunal was in error in allowing deduction of the said amount of Rs. 67,773 against the dividend income. According to him, the expenditure which is allowable under sub-section (2) of section 12 is only an expenditure which is incurred solely for the purposes of earning dividend income. The assessee is a trader in shares and securities. The amounts were borrowed in the course of its business of trading in shares and securities. The shares and securities were not purchased with the objective of earning dividend income. The interest paid on these borrowings therefore is not a deductible allowance under sub-section (2) of section 12. Mr. S. P. Mehta, learned counsel for the assessee, on the other hand, contends that deduction has been properly allowed by the Tribunal under sub-section (2) of section 12. A dealer in shares as well as an investor in shares and securities earns dividend income. It cannot be said that a dealer in shares has not the objective of earning dividend income. It is in the course of his business that he earns dividend income. Therefore, the interest paid on the borrowings utilised in the purchase of shares and securities, form which dividend income is earned, is properly deductible under sub-section (2) of section 12. He has also referred us to a decision in Eastern Investments Ltd. v. Commissioner of Income-tax. We find it difficult to accept the contention of Mr. Mehta. material part of section 12 is in the following terms :
'12. Other sources. - (1) The tax shall be payable by an assessee under the head 'income form other sources' in respect of income, profits and gains of every kind which may be included in his total income (if not included under any of the proceeding heads).
(1A) Income form other sources shall include dividends..........
(2) Such income, profits and gains shall be computed after making allowance for any expenditure............ incurred solely for the purpose of making or earning such income, profits or gains.........'
Section 6 of the Act enumerates the various heads of income and the heads of income mentioned in sections preceding to section 12 are : Salaries, interest on securities, income form propertied, and profits and gains of business, profession or vocation.
8. Looking to the legislative history will be of some assistance in considering the question which falls for consideration. It is not in dispute that person who carry on business as share and stock brokers deal both in shares and securities. The course of their activities is to purchase shares and securities and sell them with a view to earning profit in the process thereof. Prior to the introduction of sub-section (1A) in section 12, income received by way of interest on securities, which were the stock-in-trade of a person dealing in shares and securities, was computed under section 8, but income received by him by way of dividends form the shares, which were his stock-in-trade but held by him in the year of account, was computed under section 10. After the said amendment of section 12 in the year 1955, the dividend income is computed under section 12 of the Act, Income by way of interest on securities continued to be computed under section 8 as before. Substituting the words 'in sub-section (2), the material part of sub-section (2) would read :
'Income form dividends shall be computed after making allowance for any expenditure incurred solely for the purposes of making or earning such dividend income.'
9. It would be noticed that what is allowable as expenditure under the said sub-section is only the expenditure incurred soled for the purpose of making or earning dividend income. Emphasis thus appears to be on the object or purpose of incurring of the expenditure. The exclusive object of incurring the expenditure has to be the making or earning of the dividend income. The mere fact that income by way of dividend has accrued and that the expenditure incurred is in some manner or other related to the accrual of the dividend income is not sufficient. If this aspect is kept din view and the facts of the case are looked at, it becomes abundantly clear that the object of the assessee in incurring the expenditure was not to earn income by way of dividends. The borrowing of the assessee by way of overdraft form the bank was not for the purposes of acquiring shares with the object of earning dividends on those shares, but the object of the borrowing was to purchase shares for the purpose of the assessee's business, namely, buying and selling of shares and securities with a view to earning profits. The object of the borrowing thus was not for making or earning dividend income. The appellate Assistant Commissioner, on the facts of the case, has found that the main object of the assessee in purchasing the shares and securities out of the borrowing form the bank was not for the purposes of earning income form dividends, but for the purposes of dealing in shares and securities. This finding of fact does not appear to have been challenged before the Tribunal, nor has the Tribunal held that the main object for the purchase of shares out of the borrowing was to make or earn profit by way of dividends form these shares. On the other hand, the Tribunal also had found that the shares in question which have yielded the dividend income were the stock-in-trade of the assessee. The dividend received by the assessee form these shares and the interest paid by the assessee to the bank on the loan borrowed by it formed part of its normal business transactions, which as we have already stated is trading in shares and securities. These being the findings, it is not possible to agree with the Tribunal that the interest paid by the assessee to the bank on its borrowing was an expenditure incurred solely for the purposes of making or earning dividend income within the meaning of sub-section (2) of section 12.
10. We may look at the facts form a different angle having regard to the provisions of section 10 of the Act. Section 10 relates to the computation of income under the head 'business'. In computing the profits and gains of business, certain allowances enumerated in clauses (i) to (xv) of sub-section (2) are allowed as deduction, and clause (iii) of sub-section (2) is material for the purposes of this case :
'(2) Such profits or gains shall be computed after making the following allowances, namely :-...
(iii) in respect of capital borrowed for the purposes of the business, profession or vocation, the amount of the interest paid.'
11. We have already stated that on the findings the overdraft account related to the borrowing of the assessee for the purposes of its business. The expenditure incurred by way of payment of interest on these overdrafts falls under clause (iii) of sub-section (2) of section 10, it being the amount of interest in respect of the capital borrowed by the assessee for the purposes of its business, namely, the business of a share and stock broker. The expenditure thus squarely falls under clause (iii) of sub-section (2) of section 10. It is difficult to assume that an expenditure, which squirreled falls under clause (iii) of sub-section (2) of section 10, can be said to be an expenditure incurred solely for the purposes of making or earning dividend income, in the context of the present case. A reported decision relating to the interest income earned on securities by a dealer in shares and securities is also of assistant in deciding the question. A share and stock broker ordinarily deals both the in shares as well as securities. The income by way of interest on securities is computed under section 8, while income by way of dividends in computed under section 12. The language used in the material part is also very similar. Section 8 provides that a tax shall be payable by an assessee under the head 'interest on securities' in respect of interest received by him on any security or on debentures or other securities for monies issued either by the Central Government, a State government or a local authority or a company. The proviso thereto relates to the computation of the said income and the material part is in the following terms :
'Provided that no income-tax shall be payable under this section by the assessee.......... in respect of any interest payable on money borrowed for the purpose of investment in the securities by the assessee............'
12. The facts in Indian Steamship Co. Ltd. v. Commissioner is Income-tax were : the assessee, who was a steamship company, had fallen on bad days and its share capital was considerably reduced. It decided to launch upon a real business and obtained permission of the Controller of Capital Issues for the issue of shares and debentures. The Controller imposed a condition that any sum in excess of a certain amount received by the assessee should be invested in Government securities, pending actual expenditure on the purchase of ships. The assessee accordingly invested a certain sum in government securities and received interest in the year of account under section 8. The assessee claimed that the amount of interest paid by it on the borrowings to the debenture holders out of which the securities were bought should be allowed as a deduction against the interest income. The income-tax authorities disallowed the claim on the ground that the object of issuing the debentures was not to invest the money in securities but to employ it in the assessee's business and that the condition imposed by the Controller made no difference. The decision of the income-tax authorities was upheld by the High Court in the reference. It will be noticed that the decisive factor was the object of the borrowing. It the object of the borrowing was to invest the borrowed money in purchase of securities with a view to earning interest, then certainly the interest paid on the borrowing was interest allowable under the proviso to section 8 of the Act. In our opinion, having regard to the language used in section 12(2), the same principle should govern the admissibility or otherwise of deduction in respect of payment of interest under sub-section (2) of section 12 of the Act.
13. The decision in Eastern Investments Ltd. v. Commissioner of Income-tax on which reliance has been placed by Mr. Mehta, is distinguishable on facts and can hardly be said to be of any assistance to the assessee. The distinguishing feature is that the assessee-company there was an investment company and it is that investment company which had utilised the borrowed money for the purposes of investment in shares on which it earned dividend. In the circumstances, the interest paid by it on the loans was held to be permissible deduction under section 12(2) of the Act. Here the assessee firm is a dealer in shares. It is not a firm doing business of investing money in shares. The borrowings were not with the object of purchase of shares by way of investment with a view to earning dividend thereon. The object with which the borrowings were made was for the purposes of carrying on its business activities of purchasing and selling shares and securities. The accrual of the dividend income had only been incidental in the course of the business. As the figures of income would show, the income of the assessee-firm form business, that is, the business of purchase and sale of shares, had been very nearly Rs. 2 lakhs. The decision on which reliance is placed can,therefore, have hardly any application to the facts of the present case. It is for these reasons, with respect to the learned Members of the Tribunal, it is not possible for us to concur in the line of reasoning adopted by them.
14. In the result, our answer to the question referred to us is in the negative.
15. The assessee shall pay the costs of the Commissioner.
16. Question answered in the negative.