UPADHYA J. - The questions of law referred for the opinion of this court under section 66(1) of the Income-tax Act are :
'1. Whether the U. P. Encumbered Estates Bonds received by the assessee in 1944 should be adjusted against the dues of both the debtors, Wahi-ud-din and Bashir-ud-din, notwithstanding the passing of two separate money decrees in 1940 against each of the debtors for half the debt by the special judge under the U. P. Encumbered Estates Act, 1934 ?
2. Whether the receipt by the assessee of the sum of Rs. 58,266 in April, 1935, was rightly treated by the Tribunal as a receipt towards the principal of the debt and
3. Whether the receipt of the U. P. Encumbered Estates Bonds by the assessee in November, 1944, was a receipt, in part, of income, profits and gains for the purpose of the assessment for 1945-46 ?'
The assessee is a Hindu undivided family which lent a sum of Rs. 1,50,000 to two brothers, Wahi-ud-din and Bashir-ud-din, on a mortgage of their properties on the 15th December, 1926. The money was monthly rests. No payment was made and the assessee brought a suit in December, 1930, and obtained a decree in January, 1931, for Rs. 2,27,699-5-0 which amount included costs amounting to Rs. 58,266 was realised on the 25th April, 1935, by sale of a portion of the mortgaged property. Before further proceedings in execution could be taken the U. P. Encumbered Estates Act, 1934, came into force and the debtors who were landlords within the meaning of that Act applied under section 4 of that Act with the result that the special judge passed simple money decrees in 1940 under section 14(7) of the Act against each of the two debtors for Rs. 98,625 with future interest at 3.25 per cent. Bashir-ud-dins half of the original debt satisfied by the local Government issuing to the creditor in accordance with section 30 of the Act twenty year bonds carrying interest at 3.25 per cent. per annum for Rs. 1,19,200. This was done in November, 1944. In respect of Wahi-ud-dins debt similarly Government bonds were issued one or two years later.
During the course of assessment for 1945-46 the assessee submitted an application to the Income-tax Officer along with the return of his income saying that a sum of Rs. 1,19,200 was received in respect of a outstanding against K. B. Wahi-ud-din and Bashir-ud-din in the form of Encumbered Estates Bonds during the relevant previous year but this amount had not been shown as a realisation of the part of the debt of money because the assessee considered that there had not been any actual realisation of the debt. It was also claimed that a sum of Rs. 3,182 had been spent in court expenses and out of this amount a sum of Rs. 3,057 had been spent in obtaining the decree for Rs. 2,27,699 on the 14th January, 1931. It was contended that this expenditure was not considered in working out the income from interest in the assessment year 1931-32. The Income-tax Officer after referring to the record was satisfied that this contention relating to expenditure was sound and he allowed a deduction of the amount out of the sum received in respect of the debt mentioned above. The debt had been split into two portions and a sum of Rs. 1,529 was apportioned as expenses pertaining to Khan Bahadur Wahi-ud-din. The Income-tax Officer calculated the income in respect of the debt due from Sri Bashir-ud-din as the bonds in respect of the decree against him had been received during the year. The amount of these bonds was Rs. 1,19,200. Out of this sum the Income-tax Officer deducted Rs. 45,862 being the principal amount outstanding against Khan Bahadur Wahi-ud-din and Rs. 1,529, court expenses, incurred prior to 1931-32. Deducting these sums aggregating to Rs. 47,391 he determined the assessees net income to be Rs. 71,809 in this transaction.
This assessee preferred an appeal to the Appellate Assistant Commissioner and appears to have contended that the mere receipt of U. P. Government bonds did not amount to any realisation of either the principal amount or the interest thereon particularly when the money of the bond was payable after twenty years and the market value of the bonds was said to be 70 per cent. of their face value. The assessee relied on a Privy Council decision where the execution of a promissory note was not considered to be payment of the original debt and interest for which the promissory note had been executed. This case was distinguished by the Appellate Assistant Commissioner on the ground that the bonds were not bonds executed by the debtors but they were bonds issued by the Government established by law and these bonds were transferable in the market and carried interest at 3.25 per cent. payable on the 20th day of August and 20th day of February, every year. Relating to the market value the Appellate Assistant Commissioner said that this contention was not supported by cogent evidence and the question could only arise when the bonds were actually sold in the market. There was some dispute relating to the expenditure allowed but the assessees contention did not find favour with the Appellate Assistant Commissioner who upheld the assessment order.
An appeal was then preferred to the Income-tax Appellate Tribunal. The assessee contended that the entire principal amount advanced under the mortgage should be realised before any receipt by way of interest or profits could be considered for tax. The mere fact that two decrees had been passed, though the mortgage was one, could not alter the nature of the transaction and the income-tax authorities were not correct in calculating the income on each half separately. It was further contended that the receipt of the bonds did not amount to realisation of the loan advanced and the assessee should not have been considered to have received any income liable to tax. The Appellate Tribunal observed that according to section 18 of the U. P. Encumbered Estates Act the decree passed by the special judge had extinguished all existing rights of the creditor together with all rights, if any, under the mortgage and the decree could be satisfied only in the manner prescribed by the Act. The bonds in question had been issued by the U. P. Government according to liquidation of the decretal amount. The receipt of the bonds therefore was considered by the Tribunal to be a realisation of the loan. The Tribunal however accepted the assessees contention that the assessee should be held to have received only the real value of the bonds which had been issued to him. The Tribunal observed that the value of the bonds in 1944-45 should be taken as equivalent of cash. Relating to the realisation of Rs. 58,266-10-3 by sale of a portion of the mortgaged property from Bashir-ud-din and his brothers, the Tribunal held that the assessee had made no express appropriation of that amount in the account. He merely entered this sum on the credit side in the account which showed that Rs. 1,50,000 had been deposited on the debit side of the ledger. The ledger account did not have any entry relating to interest and counsel for the assessee told the Tribunal that the calculations were usually made in the assessees account only when the account of a debtor was finally settled and closed. The Tribunal found that the assessee had not communicated to the mortgagor-judgment-debtor how this amount, realised in execution of the decree, had been appropriated; but, in the circumstances of the case, absence of such communication could not be construed against the assessee. The amount had been realised through court. The Tribunal observed that according to well established practice where interest is outstanding on a principal sum due from a debtor and the creditor receive an open payment from the debtor without any specification the presumption is that the payment is attributable in the first instance towards outstanding interest. This presumption is operative in dealings between the debtor and creditor, but the Income-tax Officer also in a proper case may take cognizance of it. The provisions of Order XXXIV, 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, is meant to regulate matters between the mortgagor and the mortgagee. The Tribunal observed that the revenue authorities could in appropriated cases adopt a different mode of appropriation of payment made by a debtor. In the instant case the Tribunal observed that the assessee did not show the receipt of Rs. 58,266 as receipt of interest in his return and he acquiesced in the Income-tax Officer appropriating it towards the principal. The Tribunal, therefore, considered that it was not open to the assessee to turn round and claim that the amount then received was receipt of interest and that the payment did not go to reduce the principal amount. Another contention raised before the Tribunal was that the value of the Government bonds received in 1944 should be adjusted against the dues of both the debtors, Khan Bahadur Wahi-ud-din and Sri Bashir-ud-din, and the debt was originally one and had been jointly taken by both the persons. The Tribunal overruled this contention in view the fact that the special judge had split the liability of the debtors. The appeal was, therefore, allowed in part and so far as the controversy relating to this particular transaction was modified, by the Income-tax Officer determining the market value of the U. P. Government Encumbered Estates Bonds as in 1944-45 and deducting therefrom half the balance of the principal and Rs. 1,529, half of the costs in that suit, to arrive at the interest income received by the assessee in November, 1944, on account of Bashir-ud-dins share of the debt. On the assessees application the three questions mentioned above have been referred for the opinion of this court.
It appears from the statement of facts that the decree which was passed in January, 1931, on the basis of the mortgage dated the 15th December, 1926, was for enforcement of the mortgage and was for a sum of Rs. 2,27,699-5-0. The decree was executed and Rs. 58,266 were realised on the 26th April, 1935. But when the U. P. Encumbered Estates Act came into force and the two debtors applied under section 4 of the U. P. Encumbered Estates Act, the special judge, after following the usual procedure, passed two simple money decrees under section 14(7) of the Act, one against each of the two debtors for Rs. 98,625. It would thus appear that, while on the one hand the encumbrance on the property was removed and in place of the mortgage deed a simple money decree was passed, the special judge divided the liabilities of the two debtors and determined the liability of each debtor separately. It is possible that, having regard to the provisions of section 9, the liability could have been jointly determined in respect of the joint debt when both the debtors had applied under section 4 of the Act. But in the instant case separate decrees were passed against the two debtors. Section 18 of the U. P. Encumbered Estates Act lays down that 'the effect of a decree of the special judge under sub-section (7) of section 14 shall be to extinguish the previously existing rights, if any, of the claimant, together with all rights, if any, of mortgage or lien by which the same are secured and, where any decree is given by the special judge to substitute for those rights, a right to recover the amount of the decree in the manner and to the extent hereinafter prescribed.' This provision clearly indicates that the right which the creditor had to recover jointly from both the brothers was extinguished by reason of separate decrees having been passed by the special judge as mentioned above.
As a result the realisations made in execution of the separate decrees could not be adjusted against the amounts due from both the debtors. In fact there remained no such amount as could be said to be recoverable from both the debtors. Each of the two brothers became separately liable for the amount in respect of which the decree against him was against the aggregate of their liabilities under the two decrees which were passed against them separately. The first question therefore must be answered in the negative.
The second question relates to the sum of Rs. 58,266 realised by execution of the mortgage decree in 1935. The question is as to whether this amount should be treated as payment of the interest that was due at the time of realisation or as the realisation of a part of the principal sum advanced, viz., Rs. 1,50,000. The Income-tax Appellate Tribunal has very rightly mentioned in its appellate order that, according to well established practice, where interest is outstanding against a debtor and a creditor receives an open payment without any appropriation or specification, the presumption is that the payment is attributable in the first instance towards the outstanding interest. The Tribunal has also referred to the provisions of Order XXXIV, rule 13, where this common rule finds recognition and amounts realised in execution of mortgage decrees are according to this rule applied first towards payment of interest and costs and thereafter towards the payment of the principal amount. The Tribunal however took the view that this rule of appropriation or payment towards interest obtains as between a debtor and a creditor but different questions and considered arise when the question arises between the revenue authorities and the taxpayer. In the instant case the Tribunal took the view that at the time when Rs. 58,266 were received in 1935 the assessee did not offer this amount for 1935-36, the Income-tax Officer had mentioned the loan and had said : 'In the current year the assessee had been able to realise about Rs. 59,000 from them so far.' In the assessment order for the subsequent year 1936-37 the Income-tax Officer referred to this amount of about Rs. 59,000 as realised from Wahi-ud-din and observed :
'But this has been appropriated towards the principal amount of Rs. 1,50,000.'
The Tribunal goes on to say that the assessee not only did not show this sum as receipt of interest and taxable income in his return but acquiesced in the Income-tax Officer appropriating it towards the principal. In doing so the assessee exercised an option of treating this amount towards capital and thus avoided paying tax thereon. He should not now be allowed to turn round and say now that the sum had been realised towards interest.
After giving the matter our careful consideration we are of opinion that the nature of the payment must be looked at to find the answer to the question raised. It is clear on facts that at the time when the sum of Rs. 58,266 was realised neither the creditor nor the debtor expressly specified as to whether the amount recovered was to be adjusted towards the principal or interest. The amount realised had to be appropriated according to the provisions of Order XXXIV, rule 13, Civil Procedure Code, towards the interest and costs. There is nothing on the record to warrant an inference that the amount had either been paid or received towards principal or that it was appropriated by the assessee towards the principal amount. All that remains to be seen is as to whether the conduct of the assessee in not showing this amount as interest income in his return in 1936-37 assessment could materially affect the question and also to whether the fact that the Income-tax Officer treated it as recovery of a part of the principal amount would be of any effect. The nature of the payment being determined by statute under Order XXXIV, 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 XXXIV, 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.
The answer to the third question referred to us may again be found in the provisions of the U. P. Encumbered Estates Act. The Act lays down how the Collector should proceed to liquidate the debts of the landlord after receiving the decrees passed by the special judge. The procedure in all cases is not the same and the variation depends on the amount of the debts and the value and nature of the properties of the landlord-applicant. Section 30 of the Act says that 'if the Collector has proceeded under section 27 he shall, in accordance with rules framed by the Provincial Government, give to each creditor a bond or bonds for the amount due to him. Such bond or bonds shall bear interest at one per cent. less than the fixed under section 27 and shall be payable by the Provincial Government within a period which shall not exceed 20 years.' A proviso adds that the Government may pay the whole amount remaining due ever earlier. Section 31 then says :
'31. (1) If the Collector has proceeded under sub-section (1) of section 28 he shall, in accordance with rules framed by the Provincial Government, liquidate the amount due to each creditor by transferring to him a share of the debtors entire proprietary rights in unprotected land or by giving to him a bond or bonds of the description mentioned in section 30, or partly by one of these methods and partly by the other provided that the transfer value of any share in the debtors proprietary rights in unprotected land transferred to the creditor, together with the amount of the bona or bonds given to him, shall be equal to the amount due to him.
(2) If the Collector has proceeded under sub-section (2) of section 28 he shall, as far as possible, proceed as in sub-section (1) and the whole of the landlords debt shall be deemed to be satisfied in full by the transfer to the creditors of his proprietary rights in unprotected land and by giving to them of bonds the total amount of which is equal to the instalment value of his proprietary rights in protected land.'
From these sections of the Act it is evident that the bonds are issued by the Government and not by the debtor and the bonds are in substitution of the decree passed by the special judge. It is also expressly laid down that 'the bonds are issued to liquidate the amount due to each creditor' and that by giving the bonds to the creditors as by the transfer of proprietary rights 'the landlords debt shall be deemed to be satisfied in full'. Where the statute is so plain and expressly determines the rights and liabilities of the parties there can be no scope for doubt or speculation. Besides, the Appellate Tribunal has rightly taken the view that this could not be said to be a case of mere renewal of security because so far as the debtors were concerned their liabilities came to an end when the bonds were issued and the Government took over the liability to pay the decretal amounts. In Commissioner of Income-tax v. Maharajadhiraja Kameshwar Singh the Privy Council had occasion to consider whether certain receipts by the creditor could be said to be receipts in satisfaction of the loan advanced. These receipts were the value of a colliery transferred to the creditor, the value of certain shares in different companies transferred to him, the value of bills receivable by the debtor, a decree and the transfer of a loan advanced to a company and certain pronotes and hand notes executed by third parties and certain hand notes executed by the debtor himself. Relating to the first six items the Privy Council observed that they may perhaps reasonably enough be regarded as equivalent of cash, but relating to the debtors own promissory notes it observed that it was not the quivalent of cash. Lord Macmillan observed 'a debtor who gives his creditor a promissory note for the sum he owes can in no sense be said to pay his creditor; he merely gives him a document or voucher of debt possessing certain legal attributes.'
The Tribunal has relied on this decision of the Privy Council in support of its view that bonds issued by the Government was payment in kind of the debt which the debtors of the assessee owed to him under the decree passed by the special judge. We do not think the Tribunal was wrong in doing so. The Tribunal has held that the amount received by the assessee was not the face value of the bonds issued to him but the market value of those bonds at the time of their receipt. We are of opinion that the view taken by the Tribunal is correct. This question is accordingly answered in the affirmative.
As the assessee has succeeded only in part we consider it proper that the parties should bear their own costs. Fee of learned counsel for the department is fixed at Rs. 300.
Question answered in the affirmative.
MERCANTILE EXPRESS CO. (PRIVATE) LTD. v. COMMISSIONER OF INCOME-TAX, CALCUTTA, AND OTHERS.
Matter No. I. T. 45 of 1960, decided on December 23, 1960.