Horace Owen Compton Beasley, C.J.
1. This reference by the Commissioner of Income-tax, Madras, under Section 66 (2) of the Income-tax Act (XI of 1922) has arisen out of an assessment to income-tax of the profits of the Madura Hindu Permanent Fund, Limited. This Fund was incorporated as a limited company in 1894 under the Indian Companies Act (VI of 1882). Its Memorandum of Association shows that the objects of the Fund are:
(a) to enable persons to save money;
(b) to invest their savings in landed property and Government promissory notes;
(c) to secure loans at favourable rates of interest and to grant loans on sound securities; to grant loans to societies registered under the Cooperative Credit Societies Act; and
(d) to do all such other things as are incidental or conducive to the attainment of the above objects.
2. The nominal capital of the Fund at its inception was stated to be Rs. 2,99,964 divided into 3,571 shares of Rs. 84 each to be paid in monthly instalments of one rupee. This was raised in 1896 and again in 1902 by the addition of further shares of the same denomination. In 1906 a new class of shares of Rs. 45 each was introduced, and in 1909, 1914, 1915, 1923, 1927 and 1929 the numbers of the shares in both classes were raised until in the last year the capital was stated to be Rs. 38,70,000 divided into 30,000 shares of Rs. 84 each ('B' class shares) and 30,000 shares of Rs. 45 each ('A' class shares).
3. The capital of the Fund is contributed by these 'A' and 'B' class subscribers at the rate of Re. 1 per mensem per share. The subscribers in 'A' class go on paying their subscriptions for 45 months and those in ' B ' class for 84 months. As soon as 'A' class subscriber has paid Rs. 45 for one share in this manner, his account, in so far as that particular share is concerned, is closed, and he is paid off with a sum of Rs. 50. A 'B' class subscriber is paid off at the end of 84 months with Rs. 102-8-0. The amounts of Rs. 5 and Rs. 18-8-0 thus paid out to 'A' and 'B' class subscribers in excess of their subscriptions to the Fund are called 'guaranteed interest'.
4. During the year of account (ending with the 20th January, 1930) there was also a third class of subscribers ('C' class). These subscribers did not pay any periodical contributions but paid a subscription of Rs. 2 on entry into the Fund. They had no share in the profits but were entitled to obtain loans from the Fund and their accounts were closed when they repaid their loans or at the expiry of three years from the date of admission if they did not take any loan. For the purpose of this reference it is not necessary to take into account the existence of these subscribers in ' C ' class.
5. The rules make provision for the receipt of fixed and current deposits from any person, whether a subscriber to the Fund or not. The rules also make provision for the grant of loans not only to subscribers but also to non-subscribers and to registered Co-operative Societies. But in fact no fixed deposits have been received, and no loans have been made either to non-subscribers or to Co-operative Societies. The reference has therefore been made, and falls to be dealt with, on the assumption that all the transactions of the Fund are with its own members. It is the members of the Fund who subscribe the capital, and it is to the members of the Fund that the subscribed capital is lent.
6. During the year of account the Fund received a total income of Rs. 1,00,907-8-10 made up as follows:
Rs. A. P.From 'A' and 'B' class subscribers .. 84,205 14 2' 'C' class subscribers .. 2,808 4 8' others .. 12,698 8 0House rent .. 1,194 14 0
7. From this the Fund claimed to be entitled to deduct Rs. 86,559-3-8 made up as follows:
Rs. A. P.Guaranteed interest to ' A' and ' B' classsubscribers .. 68,462 13 3Interest paid to 'A' and 'B' class subscribers onFixed Deposits .. 6 9 3Interest paid on security deposits and Provident Fund .. 850 14 3Interest paid to non-subscribers .. 139 12 0Establishment .. 10,308 5 1Contingencies .. 6,790 13 10
8. This left a net profit according to the Fund of Rs. 14,348-5-2, and that figure was returned to the Income-tax Officer. The Income-tax Officer made certain minor adjustments. He allowed in the main all the items of expenditure except the item of Rs. 68,462-13-3. He held that this was a profit earned during the year and therefore liable to be assessed to income-tax. His decision was based mainly upon the point that the Fund had dealings with 'C class shareholders who were not subscribers of capital and not sharers in the profits. He was influenced also by the fact that according to the bylaws loans could be made to persons who were not members of the Fund and to Co-operative Societies. As already indicated, these circumstances have to be left out of account in dealing with this reference.
9. The Fund appealed to the Assistant Commissioner of Income-tax and the appeal was dismissed. The Fund thereupon applied to the Commissioner of Income-tax to make a reference to this Court under Section 66(2) of the Income-tax Act. The Commissioner considers, agreeing with the Income-tax Officer and the Assistant Commissioner, that this amount of Rs. 68,000 distributed in the shape of 'guaranteed interest' forms part of the profit earned by the Fund, (by trading with its own members), and that this would be assessable to income-tax if it were not for the decision of this Court in the Mylapore Fund case I.L.R. (1923) 47 Mad. 1 : 1 I.T.C. 217 (S.B.). The Commissioner admits that the facts of the present case are very similar to those of the Mylapore Fund case I.L.R. (1923) 47 Mad. 1 : 1 I.T.C. 217 (S.B.), and as the decision in the Mylapore Fund case I.L.R. (1923) 47 Mad. 1 : 1 I.T.C. 217 (S.B.) was based upon the case of The New York Life Insurance Co. v. Styles (1889) 14 A.C. 381 : 2 T.C. 460 he has framed the questions which he desires to refer in the following form:
Question I.--Are the facts of this case such that the ruling in The New York Life Insurance Company v. Styles (1889) 14 A.C. 381 : 2 T.C. 460 can be applied to them?
Question II.--If the Fund is conducting a business and making a profit, is the 'guaranteed interest' to be deducted in computing that profit as being 'interest on borrowed capital' within the meaning of Section 10(2)(iii) of the Act?
10. With regard to the first question what were the facts in The New York Life Insurance Company v. Styles (1889) 14 A.C. 381 : 2 T.C. 460? They were that the life insurance Company had no shares or shareholders. The only members were the holders of participating policies, each of whom was entitled to a share of the assets and liable to all losses. A calculation was made by the Company of the probable death-rate among the members and of the probable expenses and other liabilities, and the amount claimed for premiums from members was commensurate therewith. An account was annually taken and the greater part of the surplus of such premiums over expenditure referable to these policies was returned to the policy-holders as bonuses, either by addition to the sums insured or in reduction of future premiums. The remainder of the surplus was carried forward as funds in hand to the credit of the general body of members. It was admitted that the income derived by the Company from investments and from all transactions with persons not members, was assessable to income-tax. It was held by Lords Watson, Bramwell, Herschell and Macnaghten, Lord Halsbury, L. C. and Lord FitzGerald dissenting, that no part of the premium income received under participating policies was liable to be assessed to income-tax as profits or gains under Schedule D. Lord Halsbury, L.C. and Lord FitzGerald held that the surplus returned or credited to members was liable to income-tax. In this case the majority of their Lordships distinguished the case from Last v. London Assurance Corporation (1885) 10 A.C. 438 the income in that case being derived from transactions with persons not members and not from mutual insurance between members only. That is what the headnote to Styles' easel states. Lord Watson on page 393 says:
The main and to my mind essential difference between Last's case 2 and the present, consists in the fact that in this, case the policy-holders are not outsiders, because they, and they alone, are members of the company. In Last's case2 the insured and the corporation stood to each other in no other relation than that of creditor and debtor; they were in all respects separate and independent bodies, without community of rights and interests, their sole connection being a right on the one part to pay premiums, with a counter obligation, when these had been duly settled, to pay the sum insured
and on page 394:
When a number of individuals agree to contribute funds for a common purpose, such as the payment of annuities, or of capital sums, to some or all of them, on the occurrence of events certain or uncertain, and stipulate that their contributions, so far as not required for that purpose, shall be repaid to them, I cannot conceive why they should be regarded as traders, or why contributions returned to them should be regarded as profits. That consideration appears to me to dispose of the present case. In my opinion, a member of the appellant company, when he pays a premium, makes a rateable contribution to a common fund, in which he and his co-partners are jointly interested, and which is divisible among them, at the times and under the conditions specified in their policies.
11. On page 396 Lord Bramwell states with reference to the facts in Last v. London Assurance Corporation (1885) 10 A.C. 438 as follows:
I understand the principle of that decision to be, that there was a Company making profits, meaning to make profits, not from its own members, but from those it dealt with; that although it returned two-thirds of those profits to those it dealt with, they were not the less profits, and that therefore income-tax was payable on them. I thought, and still think, that wrong. I thought that the profits were only what remained, after the return they had agreed to make, on what was divisible among the shareholders. But whichever opinion is right, and it must be taken that the opinion of the majority was, it seems clear that it does not govern this case. There were in that case two bodies, the shareholders and the assured. The object of the former was to make profits in dealing with the latter, and as much profit as they could, giving them no better terms than were necessary to attract business. Here there is one body only, the assured, who are not dealing with another body, and are not to make profits, but to insure themselves and each other on terms as low as can be consistent with safety and solvency. In that case it was the insurers who were taxed; in this it is the assured. I think the cases wholly different.
12. On page 411 Lord Macnaghten says:
Certain persons agree to insure their lives among themselves, on the principle of mutual insurance. They take care to admit none but healthy lives. They contribute according to rates fixed by approved tables, and they invite other persons to come in and join them by insuring their lives on similar terms. The rates fixed by the tables are taken as being sufficient to provide for expenses, to meet liabilities, and to leave a margin for contingencies. What is to become of the surplus if everything goes right? The practice is to take an account every year of assets and liabilities, and to give the insured the benefit of the surplus, either by way of reduction of premium or by way of addition to the sum insured. It can make no difference in principle whether the surplus is so applied, or paid back in hard cash. In either case it is nothing but the return of so much of the amount contributed as may be in excess of the amount really required. I do not understand how this excess can be regarded from any point of view or for any purpose as gain or profit earned by the contributors. I do not understand how persons contributing to a common fund in pursuance of a scheme for their mutual benefit--having no dealings or relations with any outside body--can be said to have made a profit when they find that they have overcharged themselves, and that some portion of their contributions may be safely refunded. If profit can be made in that way, there is a field for profitable enterprise, capable, I suppose, of indefinite expansion.
13. At the bottom of page 412 he continues:
I do not think that that decision (Last v. London Assurance Corporation) (1885) 10 A.C. 438 compels your Lordships to hold in a case like the present, where the business is a mutual undertaking pure and simple, that persons who contribute in the first instance more than is wanted, and then get back the difference, are earning gains or profits, and so liable to income-tax.
14. On page 410 Lord Herschell says:
Once show that profits are made by trading and they are taxable, whatever the purpose to which they may be applied. But in the present case I cannot see that the income sought to be taxed is profit arising from trading.
15. It is obvious that in one respect--and it certainly is an important one--the facts of this case differ from those in The New York Life Insurance Co. v. Styles (1889) 14 A.C. 381 : 2 T.C. 460. In the latter case the fund sought to be taxed was the surplus arising out of an overestimate. It was nothing that had been earned. A member who paid a premium of 50 got back not more than the 50 contributed by him either by means of a cash bonus or by reduction of premium. Their Lordships in that case were therefore dealing only with a surplus. Here the facts are quite different because the guaranteed interest is certainly interest which has been earned. The New York Life Insurance Co. v. Styles (1889) 14 A.C. 381 : 2 T.C. 460- therefore can have no application here; nor could the decision in The Board of Revenue v. The Mylapore Hindu Permanent Fund I.L.R. (1923) 47 Mad. 1 : 1 I.T.C. 217 (S.B.) case have been rightly based upon it. The only support that it gives to that case are the observations of Lord Bramwell, Lord Watson and Lord Macnaghten and Lord Herschell--where the fact that the business was a mutual undertaking pure and simple was so strongly emphasised. Styles' case was also the basis of this High Court's decision in English and Scottish Co-operative Society v. Commissioner of Income-tax (1929) 3 I.T.C. 385. It is not necessary, to refer to the facts of that case because the point for consideration is shortly set out in the concluding portion of Odgers, J.'s judgment as follows:
If therefore this return of interest on the share capital to the persons called shareholders, namely, the Co-operative Wholesale Society and the Scottish Co-operative Wholesale Society, is simply, as it appears to be and as is sworn by the affidavit of Sir Fairless Barber, merely a return on the amount of its subscribed capital or a handing back of a portion of the amount subscribed and in no sense a dividend on the profits earned by the Company, then I think it falls within the ambit of Styles' case (1889) 14 A.C. 381 : 2 T.C. 460; and if that is so, it is simply a return in another form of the rateable dividend in Rule 20(e). It is clearly not a division of profits in the ordinary sense but is purely notional, for we are told that no money changes hands. This notional profit is calculated on the difference between the market price of the commodifies at the time they are distributed to the members of this Society and the actual cost of their production to the Society when ascertained. This so-called profit is distributed in the six ways provided for by Rule 20 and on this so.-called profit after allowing for depreciation, interest is to be paid on the share capital, i.e., to the only two members of the Society in proportion to their contributions to the capital. I am unable to see on the facts of this case as disclosed in the rules and on the only evidence we have, namely, the affidavit of Sir Fairless Barber, any evidence of a profit being made by sales to persons outside the membership of the Society. There is no evidence as stated above that any other societies except the two named in Rule 5 have been admitted to membership. It seems to me that this is a case of a purely mutual concern. We know that the whole of the produce raised and exported by the Association is in fact divided among these two members.
16. I think that it is hardly right to say that The New York Life Insurance Co. v. Styles (1889) 14 A.C. 381 : 2 T.C. 460 governed either of the two cases referred to--and it does not govern this case--although the observations made by their Lordships in their judgment certainly support the result arrived at in both, I am not disposed to say therefore that those two cases were wrongly decided although, in my opinion, The New York Life Insurance Co. v. Styles (1889) 14 A.C. 381 : 2 T.C. 460 does not govern them. I would answer Question No. I in that way although, in my opinion, it is not necessary here to consider the effect of the ruling in The New York Life Insurance Co. v. Styles (1889) 14 A.C. 381 : 2 T.C. 460 or the two income-tax decisions of this High Court to which reference has already been made because I think that this question can be answered favourably to the assessees in Question No. II for reasons which I will now give. Of course if no profit has been earned, then no question of deductions under Section 10(2)(iii) of the Indian Income-tax Act arises. But on the assumption that the assessees have earned a profit, I will proceed to the consideration of Question No. II. Is this guaranteed interest on capital borrowed for the purposes of the business where the payment of interest thereon is not in any way dependent on the earning of profits For the Income-tax Commissioner it is contended that this guaranteed interest is interest on share capital, that interest on share capital must always be dependent upon its being earned by profits being made and that it is not capital borrowed for the purposes of the business within Section 10(2)(iii) of the Indian Income-tax Act. It is to be observed that by Clause (5) of the Memorandum of Association there is to be a nominal capital divided into shares and it is further argued that there is here a share capital, that the proprietors of the shares are shareholders and that the interest earned is profit made by the assessees. On the other hand the contention of the assessees is that this is not really share-capital at all but subscription-capital raised by recurring subscriptions paid periodically by the shareholders or subscribers, that the shareholders or subscribers are creditors of the Company and that as they must under the Articles of Association be repaid the accumulated subscriptions plus the guaranteed interest at the end of the specified period, these subscriptions cannot really be share-capital, although so described and of course a shareholder cannot demand repayment of his share-capital. The Income-tax Commissioner meets this point with the argument that the provision for the return to the shareholders of the amounts contributed by them is ultra vires because this Fund has chosen to get itself registered under the Indian Companies Act and it is therefore a Company and it must have capital and it is repugnant to the provisions of the Indian Companies Act for the capital of the registered Companies to be returned to its shareholders. Capital, of course, can be reduced but only with the sanction of the Court. In my opinion, the fact that the Fund is registered under the Indian Companies Act and is subject to its provisions is not by any means conclusive of a question which arises under the Indian Income-tax Act. The fact is that the machineries of the Indian Companies Act cannot be in its entirety adopted to a Fund such as this. This Fund and many similar are not really companies but Mutual Benefit Societies with a fluctuating capital dependent entirely upon the amount subscribed by their members and the repayment of subscriptions plus guaranteed interest to the members. The capital is bound to vary from time to time and to say that, whenever this capital is reduced by a repayment to the members, it is necessary to get the sanction of the Court would be to make such funds unworkable. In my opinion, although these subscriptions are called share-capital, they are not really so as that description is understood in its ordinary sense; nor is this capital borrowed for the purpose of the business as that capital is ordinarily understood. It is something different from both. That this is so and that the Legislature recognised the distinction is clearly shown by the Explanation to Section 10(2)(iii) of the Indian Income-tax Act where recurring subscriptions paid periodically by shareholders or subscribers in such Mutual Benefit .Societies as may be prescribed are to be 'deemed' to be capital borrowed within the meaning of Section 10 2(iii). If it is 'deemed' to be capital borrowed then it is not ' really capital borrowed but is for the purpose of the Indian Income-tax Act to be so considered. The fact that no Mutual Benefit Societies have as yet been prescribed may be due to various causes with which we are not really here concerned. What we are concerned with is the apparent intention of the Legislature to recognise an association of persons not having share-capital but borrowing and lending from and to themselves for the mutual benefit of themselves. This borrowing is to be deemed to be a borrowing of capital and that being so the interest on it can be deducted from the profits and gains of the Association under Section 10(2)(iii) of the Indian Income-tax Act if the payment of interest upon it is not in any way dependent on the earning of profit. For the Income-tax Commissioner it is argued that if the subscriptions to this Fund are to be treated as capital borrowed for the purpose of the business, the payment of interest upon that capital is dependent upon the earning of profits. If there are no profits, it is argued, there can be no interest; and a Company can only pay interest out of profits and cannot pay interest out of capital. The answer to that contention is that this Fund is really not a Company and that it is not paying interest on its share-capital but is paying a ' fixed interest to its members or subscribers who occupy the position of lenders to the Fund of sums of money upon which the Fund contracts to pay fixed interest and for which I am of the opinion the fender can sue the Fund in the same manner as any one who has lent money to a partnership or firm at a certain rate of interest could sue that partnership or firm for repayment of the principal and interest. It seems to me, therefore, that the guaranteed interest is interest on capital borrowed for the purpose of the Fund's business and that its payment is not in any way dependent on the earning of profits. I would accordingly answer Question No. II in the affirmative.
17. I entirely agree with my Lord's judgment. As I delivered the judgment in The Board of Revenue v. The Mylapore Hindu Permanent Fund, Ltd. I.L.R. (1923) 47 Mad. 1 : 11. T.C. 217 (S.B.) it is only proper to add that I also agree with my Lord in thinking that the actual decision in Styles' case (1889) 14 A.C. 381 : 2 T.C. 460 did not govern the Mylapore Fund case I.L.R. (1923) 47 Mad. 1 : 11. T.C. 217 (S.B.) 'although the observations made by their Lordships in their judgment certainly support the result arrived at' in the latter case, and that it cannot be said that the case in The Board of Revenue v. The Mylapore Hindu Permanent Fund, Ltd. I.L.R. (1923) 47 Mad. 1 : 1 I.T.C. 217 (S.B.) was wrongly decided. That case arose under Section 9 of Act VII of 1918.
18. It is unnecessary now to say how exactly that decision ought to have been put--whether the guaranteed interest payable to subscribers was not 'profits' at all within the meaning of Section 9 of Act VII of 1918, or whether the subscriptions paid by the subscribers should be considered to be analogous to borrowed capital. It seems to me that the Legislature considered the decision right and sought to put it on the latter basis by adding the explanation to Sub-clause (iii) of Section 10(2) of the present Act, the sections being otherwise similar. The fact that no Mutual Benefit Societies have been prescribed under the explanation does not, as pointed out by my Lord, prevent us from adopting the construction now adopted.
19. The assessee will have his costs--which we fix at Rs. 500.
Sundaram Chetty, J.
20. I am in entire agreement with the judgment of my Lord, the Chief Justice, and have nothing to add.
Pakenham Walsh, J.
21. I agree with my Lord and have nothing to add.
22. I agree with my Lord the Chief Justice.