1. These two appeals filed by the same assessee are heard together and disposed of by this common order for the sake of convenience.
2. The assessee is a charitable trust. In course of the assessment proceedings for the year 1973-74 (previous year ended 31-12-1972), the ITO found that the assessee had invested funds in a firm, styled Das & Co., without any security, and that the said firm came within the list of persons enumerated in Section 13(3) of the Income-tax Act, 1961, and so the assessee was hit by Section 13(2). He also found that the assessee had invested in the shares of a company, styled Laxmi Starcy Ltd., to an extent which exceeded 5 per cent of the capital of the said company and that the said company was one to which Section 13(2)(h) read with Explanation 3 applied. Hence, he held that the assessee was also hit by Section 13(2)(h) and not saved even by Section 13(4).
Hence, he denied the exemption under Section 11 and subjected the entire income of the assessee to tax.
3. For the assessment year 1974-75 (previous year ended 31-12-1973) there was no loan to Das & Co. but the funds of the assessee continued to remain invested in the shares of Laxmi Starch Ltd. For the same reason given by him in the order for the assessment year 1973-74, the ITO taxed the income of this year also.
4. The assessee appealed to the AAC and contended that the ITO erred in his decision ; but the AAC agreed with the ITO and dismissed the appeals for both the years.
5. Shri Dilip Dwarkadas, the learned representative for the assessee, urged before us that the decision of the AAC was erroneous. He urged that adequate interest was charged from Das & Co. and that the firm was quite prosperous and the personal security of the partners should have been considered adequate. Regarding the investments in the shares of Laxmi Starch Ltd., he pointed out that the persons enumerated in Section 13(3) together held shares worth only Rs. 7,10,400 in both the years, which was less than 20 per cent of the equity capital of Rs. 40 lakhs of the said company. Hence, the company is not one in which the persons enumerated in Section 13(3) were substantially interested within the meaning of Explanation 3. Consequently, Section I3(2)(h) has no application and the exemption under Section 11 should not have been denied.
6. Shri G.S. Bhargava, the learned representative for the department, on the other hand, supported the order of the AAC. He pointed out that Section 13(2)(a) refers to "adequate security" and personal security is no security under the law. Regarding the other point, he urged that the investments of the assessee in the company exceeded 5 per cent of the equity capital of the company and so Section 13(4) did not apply. Shri Dilip Dwarkadas replied that the investments of the assessee in the company did not exceed 5 per cent of the equity capital of the company in the second year as it was only Rs. 1,98,100.
7. We have considered the contentions of both the parties as well as the facts on record. So far as the first year is concerned, we find that the assessee is squarely hit by Section 13(2)(o). Personal security is no security in the eye of law because in the event of the dissolution of the firm the debt due to the assessee can only be regarded as unsecured. This debt has admittedly not been secured against any of the assets of the firm. Hence, the assessee loses exemption on all its income under Section 13(2)(a) itself. It is, therefore, not necessary to go into the question as to whether the assessee is also hit by Section 13(2)(h) and, if so, whether any portion of its exemption can be salvaged under Section 13(4) read with Explanation 3. We, therefore, uphold the order of the AAC for the assessment year 1973-74.
8. The position in the assessment year 1974-75 is, however, different.
In this year, there was no loan given to the firm and so Section 13(2)(a) does not apply. So, it is necessary to see whether Section 13(2)(h) applies. This section will apply if the persons enumerated in Section 13(3) hold more than 20 per cent of the equity capital of the company as laid down in Explanation 3. We find that the equity capital of the company is Rs. 40 lakhs and the aggregate holdings of the persons enumerated in Section 13(3) comes to only Rs. 7,10,400 which is less than 20 percent of the former sum. Hence, they cannot be said to have a substantial interest in the company and, consequently, Section 13(2)(h) has do application. If so, it is not necessary to see whether the holding of the assessee is more than 5 per cent of the equity capital because that point is relevant only for the application of Section 13(4) which does not come into play when Section 13(2)(h) itself cannot be invoked.
9. Shri G.S. Bhargava urged before us that while determining the applicability of Section 13(2)(h), the holdings of the assessee should also be included in the holdings of the person enumerated in Section 13(3) and if such total exceeds 20 per cent, then Section 13(2)(A) should be applicable. We have considered this contention but we do not agree. "Substantial interest" has been defined in Explanation 3. A plain reading of this section shows that it clearly refers only to the holdings of the persons enumerated in Section 13(3) and not to those of the assessee itself. Section 13(3) does not include the assessee itself. Hence, we do not find any force in this contention raised for the revenue. Thus, we hold that for the assessment year 1974-75, the assessee is not hit by Section 13(2)(h) and so the exemption under Section 11 was erroneously denied to it. We, reverse the decision of the lower authorities and direct that the assessment for this year be modified accordingly.
10. In the result, the appeal for the assessment year 1973-74 is dismissed and that for the assessment year 1974-75 is allowed.