1. This appeal by the assessee relates to the assessment year 1980-81, for which the previous year ended on 31-3-1980.
2. The assessee is engaged in the business of distribution and sale of ration food-grains. The dispute in the present case relates to the capital gains arising out of the transfer by the assessee to his wife of 47.5 cents of land with a building in Thiruvalla village. The land and the building previously belonged to Shri K.I. Varkey, the father of the assessee, who was also engaged in the same line of business as the assessee. The streedhan amount received at the time of the marriage of the assessee was invested in the business of his father. In the books of account maintained by the father, Shri Varkey, there was a credit balance with regard to the dowry amount in favour of Smt. Sosa Idiculla, the wife of the assessee. The credit balance, which included the interest on the amount, came to Rs. 73,570 as on 31-12-1978. On 23-8-1979, the father, Shri Varkey, executed a registered will by which he bequeathed 45 cents of land along with the building to the assessee.
At the same time, he created a charge over the property for the amounts due to the wife of the assessee. Shri Varkey died on 30-9-1979 and thereupon the property devolved on the assessee. The assessee assigned the property to his wife under two documents dated 15-10-1979 and 22-10-1979. The total consideration under the two sale deeds came to Rs. 83,700. Out of this, Rs. 78,156 was adjusted towards the amount due to the wife as per the credit balance till date in the accounts of the father. Only the balance amount of Rs. 5,544 was actually received by the assessee under the sale deeds. The assessee claimed that this is the sale consideration as far as he is concerned and that the capital gains, if any, arising out of the transaction, should be worked out with reference to this amount. The contention was negatived by the ITO, who held that the sale consideration as far as the assessee was concerned was Rs. 83,700. The assessee had also claimed that a sum of Rs. 49,047 had been spent on improvement of the property and that this amount should also be reduced from the sale consideration. As against this, the ITO allowed Rs. 20,000 as cost of improvement.
3. The AAC confirmed the finding of the ITO that the consideration received by the assessee under the sale deeds was Rs. 83,700. He also declined to enhance the cost of improvement as determined by the ITO.Aggrieved by the same, the assessee has come up in appeal.
4. The grounds taken in the appeal are lengthy and argumentative. They can be summarised as follows: The value of the consideration received or accruing as a result of the transfer for the purpose of Section 48 of the Income-tax Act, 1961 ('the Act'), was only Rs. 5,544 as far as the assessee was concerned. The balance amount of Rs. 78,156 was set off against the amounts due to the wife of the assessee, which was a first charge on the property. The property was inherited by the assessee with the charge. No sale of the property could have been effected without clearing the charge. This amount, therefore, never accrued to the assessee and was not received by him. The observations of the Supreme Court in the case of K.P. Varghese v. ITO  131 ITR 597 support the stand taken by the assessee. If the consideration received by the assessee is treated as the full amount of Rs. 83,700, it would render it impossible for the assessee to obtain the benefit of exemption under Section 54E of the Act as the assessee will have to deposit Rs. 83,700, while he had received only Rs. 5,544. The decision of the Kerala High Court in the case of Ambat Echukutty Menon v. CIT  111 ITR 880, which was relied upon by the ITO, is not attracted in the present case as it is not the case of the assessee that the amount of Rs. 78,156, which was due to the vendee, constituted cost of improvement. In any case, the assessee's claim for Rs. 49,000 as cost of improvement should have been allowed.
5. The assessee had also taken a ground, viz., that the AAC had omitted to consider a ground taken by the assessee to the effect that the ITO had wrongly added a sum of Rs. 9,004 as interest received from bank. At the time of the hearing of the appeal, the learned counsel for the assessee stated that this ground is not being pressed. It is, therefore, decided against the assessee.
6. We may first take up the contention of the assessee that the full value of the consideration received or accruing to the assessee as a result of the transfer was only Rs. 5,544 and not Rs. 83,700. The fact that a charge was created over the property inherited by the assessee for the amounts due to the wife of the assessee was not disputed by the department. It is specifically stated by the assessee in grounds 20 and 21 that it is not the case of the assessee that the payment of the amounts due to the wife of the assessee will constitute cost of improvement. Such a claim will not stand in the light of the decision of the Kerala High Court in Ambat Echukutty Menon's case (supra). In that case, the property inherited by the assessee was subjected to a mortgage and out of the land acquistion compensation received by the assessee, the mortgage amount was paid of. The High Court held that the payment will not constitute cost of improvement of the capital asset.
But a reading of the decision of the Kerala High Court would show that the claim was negatived not only on the ground that the amount will not constitute cost of improvement but also on the ground that it will not constitute cost of acquisition of the capital asset. One of the contentions advanced by the assessee in that case was that by clearing of the mortgage amount, the assessee had perfected the title to the property and that the amount was, therefore, part of the cost of acquisition of the property. It was held by the High Court that under Section 49(1)(iii) of the Act, the cost of acquisition has to be deemed to be the cost for which the previous owner of the property acquired it and that an amount paid by the assessee who inherited the property cannot be treated as cost of acquisition.
7. The assessee had relied upon a decision of the Ahmedabad Bench of the Tribunal dated 27-7-1981 in IT Appeal No. 796 (Ahd.) of 1975-76 reported at p. 137 of Tax and Planning, dated 15-8-1982. In this decision, the Ahmedabad Bench of the Tribunal had held that an amount paid by the assessee to clear of a subsisting mortgage over the property will constitute cost of acquisition. This decision cannot prevail over the decision of the Kerala High Court in the case of Ambat Echukutty Menon (supra) which is binding on this Bench of the Tribunal.
Thus, the assessee cannot claim that the sum of Rs. 78,156 constituted either the cost of acquisition or the cost of improvement.
8. At the time of the hearing of the appeal, it was contended by the learned Counsel for the assessee that the doctrine of diversion by overriding title will apply in the case of capital gains also, that in the present case Rs. 78,156 has been diverted on account of overriding title and that only the balance amount constituted the income of the assessee. Such a contention had not been advanced before and considered by the Kerala High Court in the case of Ambat Echukutty Menon (supra).
In support of the contention, the learned Counsel relied upon the commentary of Chaturvedi and Pithisaria's Income-tax Law, Vol. 1, Third edn. The relevant portion reads thus: There is a distinction between an obligation to spend money in a particular manner attaching to an income and a similar obligation attaching to the source of an income. Suppose a property is charged with an encumbrance, the income from it must be spent first in discharging the encumbrance. This is an instance of the source of an income being subject to an obligation. On the other hand, if the obligation is on the receiver of the income and not on the source of it, the legal effect of it is quite different. In the former case, the income that is subject to the obligation is diverted at the source and, therefore, not deemed to have accrued or arisen. In the latter case, the income has accrued or arisen but has to be applied in a particular manner. In the former case, the income is not to be included at all in the taxable income; in the latter case, it is M.K. Bros. (P.) Ltd. v. CIT(1967) 63 ITR 28,36-37 (All.). affirmed in  86 ITR 38 (SC). In order that a payment should be treated as a diversion at source, it is necessary that it should have been made under some legal obligation. Such obligation must attach to the source of income. In other words, for such a payment there should be an overriding charge, a charge which is created under any law for the time being in force or by virtue of any court's decree or by an agreement or by a voluntary settlement or the obligation must be such, though not made a specific charge on the property, as can be enforced in a court of law--Addl. CIT v. Rani Pritam Kunwar  125 ITR 102, 116 (All.).
The commentary has referred to two decisions. In M.K. Bros. (P.) Ltd. v. CIT  63 ITR 28 (All.) and M.K. Bros. (P.) Ltd. v. CIT  86 ITR 38 (SC), while relinquishing a sole selling agency in favour of the assessee by an agreement, the assessee authorised the monufacturer to retain a portion of the assessee's commission to be adjusted towards the selling agent's debts. The question for consideration was, whether the amount so retained by the manufacturer constituted the income of the assessee. The case of Addl. CIT v. Rani Pritam Kunwar  125 ITR 102 (All.) related to the liability of an estate holder to pay maintenance under the Hindu law to the husband's mother, sister, daughter and co-widow. In both the cases, it was held that the amounts involved were diverted by the overriding title and that they did not constitute the income of the assessee. The facts of the present case are different. The Tribunal had occasion to consider a somewhat similar case in Smt. Saraladevi K. Quilon v. ITO [IT Appeal No. 920 (Coch.) of 1983]. In that case, the property inherited by the assessee had been attached by the Income-tax authorities for arrears of tax due from the predecessor-in-interest of the assessee. The assessee sold away the property with the permission of the Income-tax Department and, as per the direction of the assessee, the vendee paid, from out of the sale consideration, the amounts due to the Income-tax Department for and on behalf of the vendor. It was contended by the assessee in that case also that there was a diversion of the amount by overriding title in respect of the payment made to the Income-tax Department and that only the balance amount can be treated as having been received by the assessee. The contention was rejected by the Tribunal in its order dated 31-8-1984. It was held that the payment of the Income-tax liabilities of the previous owner of the property from out of the sale consideration can only be treated as an application of the income. It appears to us that this will apply to the present case also and that the payment of the subsisting mortgage amount by way of adjustment can be treated as only an application of the sale consideration.
9. Under Section 48, the capital gains has to be computed on the basis of 'the full value of the consideration received or accruing as a result of the transfer'. In the present case, the full value of the consideration accruing is Rs. 83,700 and not the amount left with the assessee after discharging the encumbrances. It cannot be said as an absolute rule that the consideration received should first and immediately be applied to discharge the encumbrances, when an encumbered property is sold. It is perfectly possible that a vendor may make other arrangements of his own to discharge the encumbrances or that he may postpone the payment of the encumbrances. In such a case, he may be able to persuade the purchaser to pay the full consideration after giving sufficient indemnity to the purchaser against the failure of the vendor to discharge the encumbrances subsequently. There may also be cases where the encumbrances are to be actually discharged on a subsequent date. It cannot, therefore, be said that there is always compulsory diversion of the sale consideration for discharging the prior encumbrances. It is only a case of the vendor applying the consideration to discharge the encumbrances on the property. It may happen that a mortgage was created over the property by the vendor himself and not by his predecessor. In that case, discharge of the encumbrance from out of the sale consideration will clearly be application of the amount to discharge a debt of the vendor. If this is treated as a case of diversion of income at source, the charge of tax on capital gains can be defeated by creating a charge over the property for the debts of the vendor and then directing the vendee to discharge the encumbrances from out of the sale consideration. This will necessitate the drawing of a distinction between a discharge of encumbrances created by the vendor himself and the discharge of encumbrances created by the predecessor-in-interest. This will show that the crux of the matter lies not in the mode of discharge of the encumbrances but in the fact that the assessee had inherited the property with a liability. If the predecessor-in-interest had sold the property himself and had arranged for the discharge of the mortgage liability created by him, he could not have claimed that the consideration for the transfer was only the balance amount left, if any, after discharging the encumbrances. How can the position be different when the transfer is by the legal heir who inherited the property It, therefore, seems to be clear that there will be no variation in the nature of the full value of the consideration when the transfer is effected by the original owner and when the transfer is effected by the legal heir.
10. At the same time, there is a real hardship in the case of transfer by persons who inherit the property with encumbrances. Under Section 4 of the Act, the levy of the tax is on the person, viz., the legal heir and not on the property. The levy should, therefore, be on the capital gains made by the person who effects the transfer. It may happen that a legal heir may inherit a property which is mortgaged to the hilt and that he may get only a nominal amount after discharging the encumbrances when he sells the property. Still as the law now stands, his capital gains will be worked out on the basis of the total sale consideration without making any allowance for the encumbrances which the assessee inherited along with the property and which he discharged.
Similarly, while an assessee inheriting an unencumbered property and, subsequently, transferring the same may be able to claim the benefit of Section 54E by investing the sale proceeds in the manner indicated in the section, this benefit will be denied to an assessee who inherits an encumbered property because the sale consideration will not be available with him for being invested as required by Section 54E. This appears to be due to lack of adequate provisions in Section 48 to cover such contingencies. The remedy in the matter lies with the Legislature.
11. In view of what is stated above, we reject the contention of the assessee that the full value of the consideration should not be taken as Rs. 83,700 and should be taken as only Rs. 5,544.
12 to 14. [These paras are not reproduced here as they involve minor issues.]