Jaganmohan Reddy, C.J.
1. Two questions have been referred, one at the instance of the department and the other at the instance of the assessee, for our decision, viz. :
' (1) Whether, on the facts and circumstances of the case, the 11/4% loan for Rs. 4,50,00,000 is a security of the State Government within the meaning of Section 8 of the Income-tax Act ?; and
(2) Whether, on the facts and circumstances of the case, the interest on the 11/4% loan for Rs. 41/2 crores is exempt from tax in the hands of the assessees under the third proviso to Section 8
2. The statement of the case would show that these questions arose in respect of assessments for 1955-56 to 1961-62 respectively and concern the nature of 11/4% interest loan of O.S. Rs. 41/2 crores advanced by the Nizam to the then Government of Hyderabad. After the police action the Military Governor had applied to the Nizam for this loan on behalf of the State of Hyderabad, which was to be income-tax free. The Nizam agreed to grant the said loan at the rate of interest specified. Though, at some stage, he seemed to have said that it was free of all taxes, nonetheless, when the amount was in fact advanced by the Nizam and received by the State of Hyderabad, it was clearly stipulated that the interest will be income-tax free. The Income-tax Officer, however, rejected the claim of the Nizam for exemption of income-tax on two grounds--firstly, that it was not a State Government security, and secondly, that even if it is not taxable, as at the time when it was granted, the income-tax that was in the contemplation of parties was the Hyderabad Income-tax Act, since the Indian Income-tax Actsubsequently became applicable, the said loan cannot foe free from income-tax unless there was notification published by the Government. The assessee's contention that the loan was to the State Government, that it was a State Government security and that it was income-tax free was rejected not only by the Income-tax Officer, but by the Appellate Assistant Commissioner as well as the Tribunal. A similar reference had earlier been made in respect of the assessment years 1950-51 and 1951-52 and identical questions were raised in that reference. This court had held that these are State Government securities issued by the State Government, but on the second question it had held that, though they are tax-free in so far as the Nizam was concerned, once he had transferred them to the miscellaneous trust, they lost that exemption. In appeal against the judgment of this court delivered by a Bench of which one of us was a party in R.C. No. 35/59 dated July 4, 1961, their Lordships of the Supreme Court confirmed the judgment of this court in respect of its answer holding that the loan was a State Government security, but reversed its answer on the second question that the assessee was not entitled to tax free exemption. It was held that the transfer of the loan by the Nizam to the Nizam's Miscellaneous Trust Fund did not make any difference in so far as the exemption to tax is concerned.
3. Sri Anjaneyulu on behalf of the assessee contends that the judgment in Commissioner of Income-tax v. H. E. H. Mir Osman Ali Bahadur, : 59ITR666(SC) applies with equal force to the identical questions raised in this reference. Sri Anantha Babu, on the other hand, contends that the question in so far as the exemption from tax is concerned was not considered either by the Bench of this court or by their Lordships of the Supreme Court in the manner in which it is now posed, viz., that in fact what was exempt from tax was only under the Hyderabad Income-tax Act and not under the Indian Income-tax Act, and that in any case, there was no notification by the Government of India to exempt the assessee from tax under the Indian Income-tax Act. He further contends that the onus to establish that the security was a tax free security was upon the assessee, which he has not discharged. The learned advocate for the assessee, on the other hand, contends that the burden has been fully discharged as can be gleaned from the letters of the Military Governor and the Chief Minister, Mr. B. Ramakrishna Rao. The letter of the Deputy Secretary to the Government of India cannot in any way have the effect of militating against the contractual obligations between the State Government and the Nizam, who in fact endorsed one of the major terms of the loan that interest on the security should be exempt from tax. At any rate, Sri Ananta Babu says that this question was also raised in the previous case and, though specifically it may not have been dealt with, the entire basis of the judgment both of this court as well as the Supreme Court is on the footingthat the securities were free from tax under the Indian Income-tax Act; otherwise, there was no point in considering whether the Nizam was exempt from tax or the trust was exempt from tax, as admittedly, the Hyderabad Income-tax Act did not apply to any income of the Nizam whether from securities or otherwise during the period when he was the ruling sovereign of the State of Hyderabad, viz., till January 25, 1950. The reference therefore to the loan being tax free could only be in respect of a tax which is leviable under some other statutory provision of law which was not then applicable to the Nizam. It may be observed and it is not denied that, at the time when the Nizam agreed to grant a loan, the Nizam and the Governor-General had already agreed to apply the provisions of the Constitution, the draft of which was signed by the Constituent Assembly. In other words, the Nizain and the Military Governor were both aware that after the applicability of the Constitution to the State of Hyderabad, the Indian Income-tax Act would be made applicable and it is in contemplation of this contingency that the correspondence and the agreement took place. Even after the promulgation of the Constitution, the Chief Minister of the State, Mr. B. Ramakrishna Rao, had in his letters dated March 21, 1955, and March 13, 1956, clearly indicated what was the intention of the parties. In the first of these letters he had observed :
' I am addressing you because it is the State that has, with the consent of the Government of India, entered into this arrangement and anything that would militate against the spirit of the agreement will not be conducive to the credit either of the State Government or Government of India, which was a party to the agreement. The income-tax will, I think, have to be calculated on the amount of interest actually paid by the Hyderabad Government to H.E.H. the Nizam, and not any a priori figure that may be calculated as reasonable.'
4. Again, in the second of the letters, the Chief Minister had observed :
' The Hyderabad Government would have been glad if the Government of India had treated the interest as being exempt from Central income-tax, but if they do not do so, I am afraid there is nothing which the Hyderabad Government can do in the matter.'
5. These letters clearly indicate that the Government of Hyderabad had agreed to take the loan free of income-tax with the concurrence of the Government of India. But if the Government of India is not going to keep up its obligation, the Hyderabad Government would have to do so. In any case, there is no question of the loan, which was taken by the State Government, not being free from income-tax because it was one of the important and vital conditions for the grant of the loan.
6. In Commissioner of Income-tax v. H.E.H. Mir Osman Alt Bahadur as we have already observed, what their Lordships of the Supreme Courtconsidered was in respect of the same loan, same rate of interest and with respect to the same trust, viz., H.E.H. the Nizam's Miscellaneous Trust. The question for consideration that arose was (at page 679) whether the 1 per cent. loan is a State Government security within the meaning of Section 8 of the Income-tax Act. The answer to this question is at page 680 where Subba Rao J. (as he then was), delivering the judgment of the court, held in these words :
' With the aid of the said definitions it will be clear that the expression 'State Government' used in the proviso to Section 8 of the Act takes in the Government of the Hyderabad State. If so, in terms of the proviso, the income-tax payable on the interest receivable on the securities of the Hyderabad Government issued income-tax free shall be payable by the State Government. Therefore, there are no merits in the contention ana the High Court rightly rejected it. '
7. On the second question as to whether the interest in respect of securities of the Government of Hyderabad was free of income-tax, the question posed was 4(iii) at page 681 and the answer to it was that the assessee was exempt from payment of income-tax but he was not exempt from payment of super-tax. The question that was posed at page 681 is identical to the first question in the present reference and the answer to this is given at page 682 wherein it was observed :
'' The interest retains its character whether the assessment is made on the trustee or the beneficiary. We cannot, therefore, accept the construction put upon Section 41 of the Act by the High Court. '
8. In view of the aforesaid decision, we do not think that the department would be justified in raising the matter once again on the basis that the assessee had not made out that the agreement to grant the loan was not subject to the condition that it was free of income-tax under the Indian Income-tax Act. We have already stated that not only the decision of the Supreme Court deals with both the questions, one of which pertains to the grant of the identical loan free of Indian income-tax but also that, even on the perusal of the correspondence, that conclusion becomes unassailable.
9. In the result, we answer the question in the affirmative and in favour of the assessee with costs. Advocate's fee Rs. 200.