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Commissioner of Income-tax Vs. Radha Swami Bank - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtAllahabad High Court
Decided On
Case NumberIncome-tax Reference No. 223 of 1966
Judge
Reported in[1972]85ITR136(All)
ActsIncome Tax Act, 1922 - Sections 8 and 10; Income Tax Act, 1961 - Sections 10(15) and 19
AppellantCommissioner of Income-tax
RespondentRadha Swami Bank
Appellant AdvocateGopal Behri, Adv.
Respondent AdvocateShitla Prasad, Adv.
Excerpt:
- - secondly, the reason may well be that parliament assumes that most types of expenditure which are laid out wholly and exclusively for the purpose of business would directly or indirectly produce taxable income, and it is not worth the administrative effort involved to go further and trace the expenditure to some taxable income. the learned judges pointed out that under the first proviso to section 8 the whole of the interest on such part of the borrowed capital as was expended on the purchase of tax-free as well as taxable securities should be deducted......being deductible under section 10(2).7. the question then arose whether an assessee carrying on bankingbusiness was entitled to a deduction of the entire interest paid onborrowed funds where part of those funds were utilised for the purchase oftax-free securities held as assets of the business or was entitled to thededuction of only that part of the interest which could not be attributed tothe use of the borrowed funds for the purchase of the tax-free securities.in indian bank ltd. v. commissioner of income-tax, the madras high court,considering a case where the assessee-bank had acquired mysore government securities which were totally exempt from income-tax and super-tax,observed :'we have already pointed out that the bank received its deposits inthe usual course of its banking.....
Judgment:

R.S. Pathak, J.

1. The assessee, the Radha Swami Bank Ltd., is a banking company. In the course of its banking business, it invested Rs. 75,000 out of its borrowed funds partly in treasury deposit certificates and partly in post office national savings certificates. During the previous year ended December 31, 1962, relevant for the assessment year 1963-64, the assessee received Rs. 2,750 as interest on those securities. Admittedly, interest on treasury deposit certificates is exempt from income-tax.

2. In the assessment proceedings for the assessment year 1963-64 the Income-tax Officer accepted the claim of the assessee that the interest income of Rs. 2,750 was exempt under Section 10(15)(ii) of the Income-tax Act, 1961. But, he negatived the further claim of the assessee that the expenditure incurred in earning the said income, including the interest paid on funds borrowed for purchasing those securities, was a permissible deduction. Adopting a pro rata basis he apportioned Rs. 2,533 as the expenditure capable of being related to the earning of the interest income of Rs. 2,750 and disallowed the same. An appeal by the assessee to the Appellate Assistant Commissioner was dismissed. The assessee proceeded in second appeal to the Income-tax Appellate Tribunal. The Appellate Tribunal allowed the appeal, holding that Section 19 applied to income from securities which was exempt from tax under the Act and that, therefore, the expenditure claimed was deductible. Alternatively, the Appellate Tribunal said, in case Section 19 was not applicable, the claim to deduction would be permissible under Sections 30 to 37. At the instance of the Commissioner of Income-tax, the Appellate Tribunal has referred the following question under Section 256(1) :

'Whether, on the facts and in the circumstances of the case, the expenditure of Rs. 2,533 estimated to have been incurred for earning the interest income of Rs. 2,750 which is exempt from tax is a permissible deduction under Section 19 or in the alternative under Sections 30 to 37 of the Income-tax Act, 1961 ?'

3. The question referred falls into two parts. Is the expenditure of Rs. 2,533 a permissible deduction under Section 19 Alternatively, is it a permissible deduction under Sections 30 to 37

4. It is abundantly clear from the facts before us that the assessee borrowed funds in the course of its banking business, and that a part of those funds was invested in treasury deposit certificates and post office national savings certificates. No money was specifically borrowed for the purchase of those securities. The securities were acquired evidently as part of the banking business. Their acquisition did not constitute a separate activity. The assessee paid interest on the funds borrowed for the purpose of its business. When no part of the borrowed funds can be said to have been taken specifically for the purchase of those securities, then equally no part of the interest paid on the borrowed funds can be specifically attributed to the acquisition of those securities. The Income-tax Officer, during the assessment proceedings, apportioned a sum of Rs. 2,533 as the expenditure, including the interest paid on borrowed funds, which he thought could be related to those securities. If such apportionment was permissible at all it could be only if some provision in the statute envisaged it, and not because the apportionment was desirable for determining on some equitable consideration how much of the expenditure incurred in the course of the banking business could be allowed.

5. A banking company borrows funds for the purpose of its banking business, and in the course of its business acquires securities as trading assets. There was a controversy on the question whether the interest from such securities was liable to be considered under Section 8 or under Section 10 of the Indian Income-tax Act, 1922. Section 8 describes how income falling under the head 'interest on securities' should be computed, while Section 10 sets out how income under the head 'profits and gains of business, profession or vocation' has to be computed. The Supreme Court pointed out in United Commercial Bank Ltd. v. Commissioner of Income-tax, that under the Indian Income-tax Act, 1922, the income of an assessee was one and Sections 7 to 12 of the Act directed the mode in which the income-tax was to be levied and that those sections were mutually exclusive. Where an item of income fell under one specific head it was to be charged under that head and no other, and, therefore, interest on securities would fall under Section 8 and not under Section 10 even though the securities were held as a trading asset in the course of business by a banker. Notwithstanding that it falls to be considered under Section 8, it continued in fact to be part of the income from the banking business. The purchase and sale of securities was as much part of that business as receiving deposits from clients and withdrawals by them. In such a case, the court said, the entire business fell to be treated as the same business. The principle laid down in that case was followed by the Supreme Court in Commissioner of Income-tax v. Cocanada Radhaswami Bank Ltd.

6. Then, with effect from April 1, 1956, the Finance Act, 1956, inserted an Explanation in Section 8 which indicated how the proviso to Section 8 was to be construed where it provided for the deduction of a sum expended by the assessee for the purpose of realising interest on securities or for deducting interest payable on money borrowed for the purpose of investment in such securities. Whereas, formerly the proviso to Section 8 had not been considered applicable to the case of securities purchased by a banking company in the course of its business and the expenditure incurred, including interest payable on moneys borrowed, was considered as falling under Section 10(2), the Explanation now propounded the basis on which the part of such expenditure and interest which could be related to securities fell to be deducted while computing the interest on securities under Section 8, the rest of the expenditure and interest being deductible under Section 10(2).

7. The question then arose whether an assessee carrying on bankingbusiness was entitled to a deduction of the entire interest paid onborrowed funds where part of those funds were utilised for the purchase oftax-free securities held as assets of the business or was entitled to thededuction of only that part of the interest which could not be attributed tothe use of the borrowed funds for the purchase of the tax-free securities.In Indian Bank Ltd. v. Commissioner of Income-tax, the Madras High Court,considering a case where the assessee-bank had acquired Mysore Government securities which were totally exempt from income-tax and super-tax,observed :

'We have already pointed out that the bank received its deposits inthe usual course of its banking business, and that it did not borrow any amount for the express purpose of investment in securities in general or in the Mysore securities with which we are concerned now. The monies deposited with the bank by its constituents merged with its general funds and practically all the monies in the hands of the bank constituted its stock-in-trade or circulating capital. So did the securities which it purchased and held from time to time, including the Mysore securities. The securities were purchased for the purpose of the banking business the bank carried on and in the normal course of its banking business. . . .We are concerned only with an assessee who carried on a banking business, and who borrowed money in the course of and as incidental to the carrying on of his normal banking business, and who, independent of the transaction of borrowing, purchased securities, again in the course of his normal banking business. If the borrowing and the investment in securities were independent transactions, each undertaken in the course of the normal business of the bank, it should be obvious that it would not be a case of borrowing for the purpose of investment in securities. It would really be a case of borrowing for the purpose of the business, the banking business.'

6. The learned judges held that the entire amount of expenditure incurred by the assessee-bank was admissible as a deduction under Section 10(2)(iii). They rejected the contention that a part of the interest calculated on a proportionate basis as being payable in respect of the part of the fund utilised for the purchase of tax-free securities was not deductible. They observed :

'..... .even if the bank had acquired the Mysore securities from outof the funds on which interest charges were paid in the year of account, the fact that the income from the Mysore securities was not taxable did not make the interest charges any the less trading expenses of the bank, expenses for the deduction of which, in computing its business income, Section 10(2)(iii)' provides. No apportionment is permissible where the deduction is under Section 10(2)(iii).'

7. In coming to this conclusion they relied on the principle laid down in Hughes (Inspector of Taxes) v. Bank of New Zealand, [1938] 6 I.T.R, 541 (C.A.) on appeal. [1938] 6 I.T.R. 636 (H.L.). The case was taken in appeal to the Supreme Court, and in Commissioner of Income-tax v. Indian Bank Ltd., [1965] 56 I.T.R. 77, 80 ; [1965] 1 S.C.R. 833(S.C.). the Supreme Court affirmed the decision of the High Court. It will be noticed that the decision did not involve the consideration of Section 8. It was common ground between the parties that Section 8 did not apply and, in applying the provisions of Section 10, the scope of the enquiry and its results were succinctly analysed thus:

'Let us then look at the language employed. Sub-section (1) directs that an assessee be taxed in respect of the profits and gains of business carried on by him. What is the business of the assessee must first be looked at. Does he carry on one business or two businesses or along with the business carried on by him some activity which is not a business If he is carrying on an activity which is not business, we must leave out of account the receipts of that activity. That is the first step. Secondly, we must look at Section 10(2) and deduct all the allowances permissible to him. In allowing a deduction which is permissible the question arises : Do we look behind the expenditure and see whether it has the quality of directly or indirectly producing taxable income The answer must be in the negative for two reasons : First, Parliament has not directed us to undertake this enquiry. There are no words in Section 10(2) to that effect. On the other hand, indications are to the contrary. In Section 10(2)(xv), what Parliament requires to be ascertained is whether the expenditure has been laid out or expended wholly and exclusively for the purpose of the business. The legislature stops short at directing that it be ascertained what was the purpose of the expenditure. If the answer is that it is for the purpose of the business, Parliament is not concerned to find out whether the expenditure has produced or will produce taxable income. Secondly, the reason may well be that Parliament assumes that most types of expenditure which are laid out wholly and exclusively for the purpose of business would directly or indirectly produce taxable income, and it is not worth the administrative effort involved to go further and trace the expenditure to some taxable income.'

8. The Supreme Court also adverted to the decision in Hughes v. Bank of New Zealand and pointed out that all the judges in that case took the view that interest paid by the bank on capital borrowed in the course of its business and utilised in buying tax-free securities had to be deducted in arriving at the taxable profits of the business notwithstanding that interest earned by the bank on the tax-free securities could not be taxed. The decision in Chellappa Chettiar v. Commissioner of Income-tax, [1937] 5 I.T.R. 97 (Mad.)[F.B.] was expressly approved. In that case a Full Bench of the Madras High Court had held that where a person borrowed money for his money-lending business and lent it out to constituents and was obliged in the course of the business to receive agricultural lands in repayment of debts from such constituents he was entitled to a deduction of the interest paid by him on so much of the capital borrowed by him for business purposes as was represented by the agricultural lands. He was so entitled notwithstanding that agricultural income was also not taxable under the Income-tax Act.

9. We shall now refer to two cases concerned with Section 8 itself. In Central Provinces and Berar Provincial Cooperative Bank Ltd. v. Commissioner of Income-tax, [1946] 14 I.T.R. 479 (Nag.). the Nagpur High Court held that in computing the income under Section 8 the revenue was not justified in splitting up the interest on borrowed capital and apportioning it between taxable and tax-free securities in proportion to the amount spent on the purchase of each kind of security and allowing deduction only in respect of the interest so apportioned to taxable securities. The learned judges pointed out that under the first proviso to Section 8 the whole of the interest on such part of the borrowed capital as was expended on the purchase of tax-free as well as taxable securities should be deducted. The same view was taken in Tiruchi Varthaga Sangam Ltd. v. Commissioner of Income-tax, [1963] 48 I.T.R. 763, 770(Madi). by the Madras High Court where, after referring to its earlier decision in Indian Bank Ltd. (that case had not yet been decided by the Supreme Court in appeal), the Madras High Court explained the principle underlying that decision as follows :

'To put it shortly, it is that where the bank received deposits in the course of its normal banking activities, whether it purchased tax-free securities or not, the interest charges paid by it to its depositors were not apportionable, and solely for the reason that the income from certain securities was not subject to tax, an expenditure proportionate thereto could not be denied deduction.'

10. From what has been laid down in these cases, it is clear that in cases under the Indian Income-tax Act, 1922, no part of the expenditure, including interest paid on moneys borrowed, incurred by an assessee for the purpose of its banking business can be disallowed only on the ground that it can, by apportionment, be said to relate to tax-free securities. It is necessary to emphasise that this principle is available only where the taxable securities and the tax-free securities are assets of a single indivisible trading or investment activity. The principle does not operate where the money is borrowed and the expenditure is incurred specifically in relationto tax-free securities.

11. What is the position under the Income-tax Act, 1961 Sections 18 to 21 of that Act set out the mode in which income falling under the head 'Interest on securities' should be levied. Sections 18 to 21 provide :

'18. Interest on securities.--(1) The following amounts due to an assessee in the previous year shall be chargeable to income-tax under the head 'Interest on securities',--

(i) interest on any security of the Central or State Government;

(ii) interest on debentures or other securities for money issued by or on behalf of a local authority or a company or a corporation established by a Central, State or Provincial Act.

(2) Nothing contained in Sub-section (1) shall be construed as precluding an assessee from being charged to income-tax in respect of any interest on securities received by him in a previous year if such interest had not been charged to income-tax for any earlier previous year.'

'19. Deductions from interest on securities.--Subject to the provisions of Section 21, the income chargeable under the head 'Interest on securities' shall be computed after making the following deductions-

(i) any reasonable sum expended by the assessee for the purpose of realising such interest ;

(ii) any interest payable on moneys borrowed for the purpose of investment in the securities by the assessee.'

'20. Deductions front interest on securities in the case of a banking company.--(1) In the case of a banking company-

(i) the sum to be regarded as a sum reasonably expended for the purpose referred to in Clause (i) of Section 19 shall be an amount bearing to the aggregate of its expenses as are admissible under the provisions of Sections 30, 31, 36 and 37 [other than Clauses (iii), (vi) and (vii) of Sub-section (1) of Section 36] the same proportion as the gross receipts from interest on securities (inclusive of tax deducted at source) chargeable to income-tax under Section 18 bear to the gross receipts of the company from all sources which are included in the profit and loss account of the company;

(ii) the amount to be regarded as interest payable on moneys borrowed for the purpose referred to in Clause (ii) of Section 19 shall be an amount which bears to the amount of interest payable on all moneys borrowed by the company the same proportion as the gross receipts from interest on securities (inclusive of tax deducted at source) chargeable to income-tax under Section 18 bear to the gross receipts from all sources which are included in the profit and loss account of the company.

(2) The expenses deducted under Clauses (i) and (ii) of Sub-section (1) shall not again form part of the deductions admissible under Sections 30 to 37 for the purposes of computing the income of the company under the head 'Profits and gains of business or profession.'

Explanation.--For the purposes of this section, 'moneys borrowed' includes moneys received by way of deposits.'

'21. Amounts not deductible from interest on securities.--Notwithstanding anything contained in Sections 19 and 20, any interest chargeable under this Act which is payable outside India (not being interest on a loan issued for public subscription before the 1st day of April, 1938), on whichtax has not been paid or deducted under Chapter XVII-B and in respect of which there is no person in India who may be treated as an agent under Section 163 shall not be deducted in computing the income chargeable under the head 'Interest on securities'.'

12. We have carefully examined the provisions of these sections. For the purpose of the question before us, it does not appear that they should persuade us to a different conclusion from that reached by the courts in respect of the provisions under the Act of 1922. There is nothing in the sections which marks a departure so far as the question before us is concerned. Learned counsel for the revenue urges that Section 18(1) is a charging provision and only those securities fall to be considered under it as yield income which is taxable. Tax-free securities, he says, are not contemplated within Sections 18 to 21. That is so, he points out, because of the words in Section 18(1) : 'The following amounts due to an assessee in the previous year shall be chargeable to income-tax under the head 'Interest on securities'.'

13. Now, Section 18 is not a charging section. The charge of income-tax is levied by one section alone, and that is Section 4 of the Act. Section 14 sets out the different heads of income under which all income falls to be classified for the purposes of the charge of income-tax and the computation of total income. The sections which follow, for example, Sections 15, 18 and so on, do not create a charge. They merely specify the income which is chargeable to income-tax under different heads and how that income should be computed. That being so, when considering the income from different sources which falls to be considered under the head 'Interest on securities', Sections 18 to 21 must be construed in their fullest natural comprehension. Upon computing the interest on securities under Section 18 the stage arises for excluding the income which represents the interest from tax-free securities. That exclusion is effected by virtue of another provision, not Section 18. Section 18 contemplates interest from all securities. But in effecting the computation under it, effect must be given to the other provisions of the Act which exempt from tax interest derived from what are described as 'tax-free' securities. Then, by virtue of Sections 19 and 20, a deduction must be allowed in respect of reasonable sums expended for the purpose of realising the interest from securities and also interest payable on money borrowed for the purpose of investment in the securities. Here both taxable and tax-free securities are contemplated. In other words, Sections 19 and 20 must be applied in relation to the entire indivisible activity of which both taxable and tax-free securities form part. There is no room for declining to deduct that part of the expenditure which can, by apportionment, be said to relate to tax-free securities.

14. In our opinion, the assessee is entitled to a deduction of the expenditure of Rs. 2,533 under Section 19.

15. In the circumstances, the alternative question whether the deduction can be allowed under Sections 30 to 37 need not be considered.

16. We answer the question referred accordingly. The assessee is entitled to its costs, which we assess at Rs. 200. Counsel's fee is assessed in the same figure.


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