M. C. DESAI C.J. - The Income-tax Appellate Tribunal Delhi, has, at the instance of the assessee, referred a statement of the case to this court for its opinion on the three questions given below :
'(1) Whether on a true interpretation of the provisions of section 18 and 14(7) of the U. P. Government Encumbered Estates Act, 1934, the liability for the debts and interest thereon due from Wahiduddin had passed on the U. P. Government with the passing of the decree on February 18, 1940, by the special judge appointed under the U. P. Encumbered Estates Ac ?
(2) If the answer to question No. 1 is in the affirmative whether on the facts and in the circumstances of the case the surplus of Rs. 79,347 being the difference between the market price of the U. P. Government Encumbered Estate Bonds and the balance of the debt due from Wahiduddin was revenue income liable to ta ?
(3) Whether the receipt by the assessee of the sum of Rs. 58,266 in April, 1935, during the execution proceedings of the decree was rightly treated by the Tribunal as receipt towards the principal of the deb ?'
From the statement I find that the assessee advanced a loan of Rs. 1,50,000 to two brothers, Wahiduddin and Bashiruddin on a mortgage of the property at a certain rate of interest. In 1930 the assessee field a decree for Rs. 2,27,699 made up as follows :
past & pendente lite interest
Total Rs. 2,27,699
A final decree seems to have been passed and was put into execution. In the course of the execution the assessee on April 25, 1935, realised Rs. 58,266. He is a money-lender by profession and maintains the accounts on cash basis. He did not appropriate the receipt of Rs. 58,266 and odd (which will be referred to as the disputed sum, receipt or payment) either to the principal that was due from the two brothers or to the interest that was due from them. In this accounts he simply entered the receipt on the credit side with the principal of Rs. 1,50,000 entered on the debit side and said nothing in the ledger whether the receipt was on account of interest, principal or costs. He does not maintain any separate interest account and there was therefore, no question of his debiting the interest as it accrued and of crediting any payment of interest. He has adopted the financial year as the accounting year. In his accounts for the financial year 1936-37 he brought over the sum of Rs. 91,734 (Rs. 1,50,00 minus Rs. 58,266). In the return submitted by him for the relevant assessment year 1936-37 he did not show the disputed amount as having been received either as principal or as interest; he did not show it in the return at all. The result was that he was not assessed on the disputed sum. It is conceded that if the disputed he was received by him as principal, it was not liable to assessment and that if it was received by him as principal, it was not liable to assessment and that if it was received as interest, it was, because interest received by a money-lender is revenue income. About this time the U. P. Encumbered Estates Act came into force and the two brothers applied for its benefit. In the proceedings under the Act two simple money decrees were passed under section 14(7) on February 18, 1940, against the two brothers for Rs. 93,625 each, with future interest at 3 1/4 %. The liquidation proceedings were then started under the Act. In November, 1944, the assessee got bonds of the face value of Rs. 1,19,200 payable after 20 years and bearing interest, in satisfaction of the money decree obtained against Bashiruddin. In the corresponding assessment year 1945-46 the assessee was assessed on an income of Rs. 71,809; the income-tax authorities worked out the assessable income as follows :
Principal due from the brothers.
Received on account of principal on 25-4-1935.
Principal due from the brothers.
Principal pertaining to the half share of Bash iruddin.
Received from Bashiruddin, through bonds on account of principal, interest & costs.
Due from him as principal.
One half of the costs due from Bashiruddin.
Received as interest from Bashiruddin.
Thus in the assessment for 1945-46 the disputed receipt was treated as receipt towards principal, i.e., as capital receipt.
On June 5, 1947, relevant to the assessment year 1948-49, the assessee got bonds of the face value of Rs. 1,32,000 in satisfaction of the money decree obtained against the other brother, Wahiduddin. The Income-tax Officer assessed him on an income of Rs. 79,347, treating Rs. 79,347 out of the value of the bonds as receipt on account of interest. He calculated this amount of interest as follows, after accepting the assessees contention that the bonds were of the market value of Rs. 1,26,743 and that he must be deemed to have received only that sum and not Rs. 1,31,000 on account of the principal, the interest and the costs due from Wahiduddin :
Received on account of the principal, interest and costs.
Wahiduddins half share in the principal.
Wahiduddins half share in the costs.
Which must be on account of interest.
The assessment order was upheld by the Appellate Assistant Commissioner and the Tribunal. The assessees contention in these assessment proceedings was that he had appropriated the disputed receipt as receipt on April 25, 1935, on account of interest, that consequently no part of the principal was paid up before the bonds were received by him in discharge of the debts due from the two brothers and the principal due from each of them continued to be Rs. 75,000 and that the amount received through the bonds on account of the interest due from the two brothers should have been calculated after deducting from the amounts of the bonds Rs. 75,000 on account of each brothers share in the principal and Rs. 1,529 on account of each brothers share in the costs. In this way the assessable amount would be reduced by about Rs. 30,000. Question No. 3 is in respect of this contention. A similar contention had been advanced by him in the earlier proceedings for the assessment year 1945-46 and though it had been rejected by the income-tax authorities and the Tribunal, it was accepted by this court in I. T. Misc. Reference No. 117 of 1953 (Ramji Lal v. Commissioner of Income-tax decided on November 29, 1960. The assessee now seeks a similar judgment from this court in respect of the assessment year 1948-49. He also contended that the result of the simple money decrees passed in his favour under section 14(7) of the U. P. Encumbered Estates Act was to substitute the State of U. P. as a debtor in place of the two brothers. This contention give rises to questions Nos. 1 and 2.
I shall take up the question, No. 1 first. My answer to it is an emphatic 'no'. Before I give reasons I should mention that his contention was not advanced on behalf of the assessee in the earlier assessment proceedings terminating with this courts order in I. T. R. No. 117 of 1953, referred to above. I do not treat this fact as a bar, but the fact that it did not occur to the assessee or his counsel to advance this plea in the earlier proceedings shows that there is not much force in it. Section 14(7) of the Encumbered Estates Act simply provides for the passing of a simple money decree by the special judge after ascertaining the amount due from the debtor-applicant to the creditor. It is deemed to be a decree of a court of a court of competent jurisdiction but not capable of being executed within Uttar Pradesh except as provided in the Act : vide sub-section (8). Section 18 states the effect of the special judges findings. It is 'to extinguish the previously existing rights, if any, of the claimant (e.g. the creditor), together with all rights, if any, mortgage or lien by which the same are secured and... to substitute for those rights a right to recover the amount of the decree in the manner and to the extent hereinafter prescribed'. What is extinguished by the decree is not the right of the creditor to recover the money found due to him from the debtor but simply his right as a mortgagee or lienholder. The debt due to him is not extinguished; it is only the right to the security that is extinguished. The debtor does not cease to be his debtor and of course there is no question of the State being substituted as a debtor. The State is not even referred to in either section 14 or section 18 and I fail to comprehend how the effect of these two provisions can be said to be to substitute in place of the debtor the State of U. P., which is not mentioned in them even impliedly or indirectly. The effect of the decree is simply to alter the previously existing right of the creditor as against the debtor. His right over the money due from the debtor to him remains intact and so also does the debtors obligation to pay the money; only the mode of realising the debt is altered. Chapter V of the Act contains provisions about the execution of a simple money decree passed by the special judge. Section 22 requires the Collector to allow the debtor two months within which to pay into court the whole or any part of the decretal amount; this provision is important in two respects. One is that after the passing of the decree under section 14 the person against whom it is passed is still designated as 'the debtor'. The word 'debtor' is not defined, and given an artificial meaning in the Act; it means the person from whom a debt is owning. Even after the passing of the decree under section 14, the original debtor in his place as a consequence of the passing of the decree and that the State certainly has not become the debtor. The result is that the liability to satisfy the decree continues to rest on the original debtor and is not transferred to the State. If the debtor pays into court the full decretal amount section 23 requires the Collector to 'discharge all his debts'; this confirms that he retains the liability to discharge the debt. Section 24 authorises the Collector to realise the value of the debtors property other than proprietary rights in land and to expend it in discharging the decretal debts. It is only when a creditors decree is not satisfied in this manner that he is given bonds by the State to the extent to which his decree remained unsatisfied and the debtor is required to pay certain instalments to the State. Even when this is done it cannot be said that the State has become a debtor of the creditors in place of the original debtor against whom the decree had been passed. Moreover, this is not the question referred to us; the contention advanced on behalf of the assessee was not that the State has become a debtor in place of Wahiduddin when it issued bonds to the assessee but whether it became in Wahiduddins place when the special judge passed a decree against him and in the assessees favour.
Since question No. 1 is answered in the negative, the second question does not arise. We were required to answer it only if it had been answered in the affirmative.
My answer to the third question is 'yes'. The assessee has come to this court with absolutely unclean hands. He realised the disputed sum in 1935 but did not appropriate it towards interest. Since the money was received in execution of a decree against the brothers, there was no question of their appropriating it towards the principal it towards the principal due from them or towards the interest due from them and when they could not, and did not, appropriate it the right vested in the assessee to appropriate it. He was free to appropriate it towards the interest or towards the principal. Undoubtedly there was not time limit fixed for his appropriation; he could appropriate it at any time so long as his right of appropriation was not lost by his own act. When neither party makes any appropriation and the question arises in court, the court is required to apply the payment in discharge of the debts in order of time. This is the law contained in sections 59, 60 and 61 of the Contract Act. The law laid down in these provisions has been applied to judgment debts as well and the principle contained in them has been applied to principal and interest treated as distinct debts. These provisions reproduce in a statutory form the common law of appropriation. As between a creditor and his debtor, the law is that the creditor has the right of appropriation up to the very last moment (vide the City Discount Company Ltd. v. McLean and Excyclopaedia of the Laws of England, Vol. I, page 447). The right terminates when the creditor has made an appropriation and communicated it to the debtor. But this law is not necessarily applicable when the question arises between a creditor and another person such as an Income-tax Officer. A creditor may not be allowed to contend that he is not bound by the appropriation made by him because he has not communicated it to his debtor. What happened in this case was that when the assessee received the disputed sum he did not appropriate it as against his debtors but he did appropriate it as against the income-tax authorities by not showing it in his return as a receipt of interest or revenue income. In his own accounts he reduced the principal by the amount of the disputed receipt and brought over in the next years account only the balance as the principal outstanding. He allowed the income-tax authorities to treat the disputed receipt as a receipt towards the principal. Whatever might be the law applicable to this conduct of his as against his debtors, he was certainly bound by his act as against the income-tax authorities and could not be permitted to turn round and contend, as he does now, that the disputed receipt should be appropriated towards the interest and not towards the principal. However much time might have been at his disposal to make the appropriation as against his debtors, he had to make up his mind and appropriate the disputed receipt towards the principal or the interest when the submitted his return for the assessment year 1936-37. He was obliged to treat the disputed receipt either as receipt of interest or as receipt of principal. If he had treated it as receipt of interest he would have been liable to pay income-tax on it. It suited him in 1936-37 to refrain from paying income-tax for it. He was not sure whether he would get his whole debt back from the brothers and he must have thought it better to treat the disputed receipt as receipt of principal and to escape liability for income-tax. His assessment for 1936-37 cannot now be reopened and that is why he turns round and claims that the disputed receipt was on account of interest and not principal. He must be deemed to have made an appropriation as against the income-tax authorities when he treated the disputed receipt as receipt towards the principal and not towards and not towards the interest and cannot be permitted to make a different appropriation now. There is no substance in his claim that he had a right to appropriate only when he received the bonds from the State of U. P. and that at that time he appropriated the disputed receipt towards the interest. He could not cite any authority in support of his contention that he had a right to make the appropriation when he received the bonds. I do not know what connection there is between the supposed right and the receipt of the bonds. The assessee referred us to Order XXXIV, rule 13, Civil Procedure Code, which reads as follows :
'(1) Such proceeds shall be brought into court and applied as follows :
first, in payment of all expenses.......;
secondly, in payment of whatever is due to the prior mortgage on account of the prior mortgage ........;
thirdly, in payment of all interest due on account of the mortgage in consequence where of the sale was directed, and of the costs of the suit in which the decree directing the sale was made;
fourthly, in payment of the principal money due on account of that mortgage .....;'
This provision deals with the application of particular proceeds and not proceeds in all execution cases. Rule 12 of Order XXIV is as follows :
'Where any property the sale of which is directed under this Order in subject to a prior mortgage, the court may, with the consent of the prior mortgagee, direct that the property be sold free from the same, giving to such prior mortgagee the same interest in the proceeds of the sale as he had in the property sold.'
This rule deals with 'the proceeds of the sale' of property which was subject to a prior mortgage and which was sold with the prior mortgagees consent and the words 'such proceeds' in rule 13, which immediately follows, must necessarily refer to them. In other words rule 13 has application only when a property subject to a prior mortgage is sold with the prior mortgagees consent as permitted by rule 12 and has no general application. This is confirmed by the provision that the proceeds, after payment of all payment of all expenses incident to the sale, must be applied in payment of whatever is due to the prior mortgagee. It is significant that in this clause of rule 13 the words 'if any' are not used after the words 'the prior mortgagee'. This is confirmed by the provision that the proceeds after payment of all expenses incident to the sale, must be applied in payment of whatever is due to the prior mortgagee. It is significant that in this clause of rule 13 the words 'if any' are not used after the words 'the prior mortgagee'. This shows that the prior mortgagee is paid his interest and principal. The prior mortgagee will have to be paid off in every case only if rule 13 applies only when there is a prior mortgage. Since under rule 12 the property is sold free from the prior mortgage and the prior mortgagee is given the same right in the sale proceeds as he had in the property this provision was made in rule 13 that he must be paid off before the subsequent mortgagee is paid his interest and principal. There is, therefore, no doubt whatsoever that rule 13 is connected with rule 12 and has no applicability in a case not governed by rule 12. In the present case there is no question of any prior mortgage and rule 13 cannot be applied and the assessee cannot claim that under the law itself the disputed sum was to be applied in payment of the interest first. Reference to rule 13 was entirely misconceived and misleading.
The assessee relies upon the judgment of this court in Income-tax Misc. Case No. 117 of 1953 (Ramji Lal Rais v. Commissioner of Income-tax) referred to above. Gurtu and Upadhya JJ. said :
'The provisions of Order 34, rule 13, of the Code of Civil Procedure, directing that moneys realised in execution sale of mortgaged property should be applied in payment of interest and costs and then only in payment of the principal money due on account of the suit-mortgage, in meant to regulate matters between the mortgagor and the mortgagee... The nature of the payment being determined by statute under Order 34, rule 13, we are unable to see how the alleged improper conduct of the assessee could alter its nature and make it an amount appropriated towards the principal debt. If the assessee evaded payment of appropriate tax he might have exposed himself to certain penal liabilities. Similarly, if the Income-tax Officer overlooked the provisions of Order 34, rule 13, and erroneously treated it as recovery of the principal amount the real nature of the receipt could not be changed. In the circumstances of the case we are therefore of opinion that the Tribunal was not right in treating the receipt of Rs. 58,266 in April, 1935, as having been made towards the principal amount of the mortgage. This payment must be appropriated towards the costs of the suit and interest.'
With great respect to the learned judges I am unable to agree. They have nor considered in what circumstances Order XXXIV, rule 13, applies. They were not referred to rule 12 at all and have not laid down that it applied generally and not only in the circumstances mentioned in rule 12. Since the learned judges did not consider at all the matter that I have considered, I do not think I am bound by their decision. They applied rule 13 without considering whether it was applicable at all or not and the reasons that I have given for the view that it is not applicable do not go against anything said by them.
We were next referred to Mst. Munno Bibi v. Commissioner of Income-tax. There Malik C.J. observed at page 103 :
'The general principal of law as is now well-settled is that when any payment is made in part it should first go towards the payment of costs due then interest and the balance, if any, towards the payment of principal.'
and relied upon Meka Venkatadri Appa Rao v. Raja Parthasarathy Appa Rao, which applied the rule laid down in Parrs Banking Co. Ltd. v. Yates to the effect that 'where both principal and interest' because otherwise the creditor would be deprived 'of the benefit to which he is entitled under his contract'. The facts in that case were that an assessee received a certain amount of money in execution of a decree for a sum which included principal and interest and when the money and when the money was realised neither the judgment debtor made an appropriation nor the creditor. The assessee claimed a right under section 59 of the Contract Act to appropriate part of it towards interest and part towards principal. He was denied this claim and this court held that part of it was to be appropriated towards the costs and the remainder towards the interest. Though he had appropriated the payment partly towards interest and partly towards principal in his return the Appellate Tribunal took it to be a case in which there was no appropriation by the debtor and no appropriation by the creditor simply because he had not kept any accounts. Though this court observed that an Income-tax Officer is not a court and, therefore, has no right of appropriation conferred by section 61 of the Contract Act, it itself proceeded to appropriation. If the Income-tax Officer could not appropriate and, therefore, the Appellate Tribunal also could not appropriate, this court answering a question of law referred to it under section 66(1) also could not appropriate. It could not give a decision which could not have been given by the Appellate Tribunal itself under section 33 of the Income-tax Act. Further, this court was bound by the statement of the fact in the case referred to it that no appropriation had been done by the assessee. There is no such statement binding us in the present case. Thirdly, the rule laid down in Parrs Banking Company case is a rule laid down for the benefit of the creditor and is admittedly not of universal application. This court did not lay down that regardless of all circumstances a payment must be appropriated first towards interest and then towards principle. It did not lay down that even where the creditor has in his income-tax return treated the payment as made towards principal it should be treated by the income-tax authorities as made towards interest. If an Income-tax Officer is not a court and therefore, has not the power to appropriate under section 61 of the Contract Act, he has not the power to apply the common law of appropriation also. The common law of appropriation is also for courts and not for other authorities. I would, therefore, hold that the instant case is not covered by the decision in the case of Mst. Munno Bibi. On the other hand it must be governed by the Privy Council decision in Commissioner of Income-tax v. Kameshwar Singh. Lord Macmillan said at page 101 :
'... in dubio what the assessee himself chooses to treat as income may well be taken to be income and to arise when he so chooses to treat it....... the assessee cannot complain if the officer agrees with the assessee in treating them as income of the year in which the assessee himself first thought fit so to regard them.'
The assessee in the present case treated the disputed sum as receipt towards principal and, therefore, did not show it in this return for the assessment year 1936-37; he cannot now complain if the income-tax authorities in a subsequent assessment calculate the outstanding principal be deducting the disputed sum from the original principal.
My answers to the three questions are :
Question No. 1 - 'No.' Question No. 2 - Does not arise. Question No. 3 - 'Yes.'
BY THE COURT. - Our answers to the three questions are :
Question No. 1 - 'No.' Question No. 2 - Does not arise. Question No. 3 - 'Yes.'
We direct that a copy of our judgment be sent to the Income-tax Appellate Tribunal under the seal of the court and the signature of the Registrar as required by section 66(5) of the Income-tax Act.
We further direct that the assessee shall pay to the respondent his costs of the reference which we assess at Rs. 200