1. The assessees are a limited company owning house properties of considerable value. The assessment concerned is for the year 1939-40 in respect of the accounting year 1938-39. In this reference obtained at the instance of the Commissioner of Income-tax, there are two questions raised, they are:
Question 1. -- Whether in the facts and circumstances of the case the debentures have been kept alive for the purpose mentioned in Section 127, Clause (3), Companies Act.
Question 2. -- If the answer to the first question should be in the affirmative, whether interest accrued due and payable in respect of these debentures and should be treated as allowable deduction under Section 9(1) (iv), Income-tax Act.
2. It was conceded at the outset, by learned Counsel for the Commissioner of Income-tax, that the answer to the first question should be' in the affirmative. Therefore, consideration is required only with respect to the second question. Before stating the facts it is convenient to set out the relevant provisions of the Income-tax Act:
Section 8. -- The tax shall be payable by an assessee under the head 'Interest on securities' in respect of the interest receivable by him on any security....
Provided that no income-tax shall be payable under this section by the assessee... in respect of any interest payable on money borrowed for the purpose of investment in the securities, by the assessee....
Section 9(1). -- The tax shall be payable by an assessee under the head 'Income from property' in respect of the bona fide annual value of property... subject to the following allowances, namely,
(iv) Where the property is subject to a mortgage... the amount of any interest on such mortgage....
3. About the year 1920, the company issued 3 series of debentures totalling Rs. 31,50,000; this reference is concerned solely with the second series. Each debenture in this series was for Rs. 500, the total amount issued was Rs. 9,00,000, bearing interest at the rate of 7 per cent. per annum. Originally they were redeemable in 1935, the date of redemption was subsequently extended to 1942, they were covered by a trust deed dated 7th July 1920, in which they are called 'the second debentures.' At some date, which has not been stated but which has no importance, the company purchased Rs. 7,35,000 of this series leaving Rs. 1,65,000 held by the public. The company borrowed the necessary funds to effect this purchase by means of an overdraft with the Allahabad Bank. This loan carried interest at the rate of about 31/2 per cent. per annum which was at all times fully paid. Having obtained the debentures the company deposited them with the bank as security for the loan. The annual amount of interest paid to the bank was about Rs. 21,000 and the annual amount of interest in respect of the deposited debentures was Rs. 51,450. Up to and including the year 1937/38, the year before the year of account, the company paid all the interest on the three series of debentures, including interest on the debentures in the second series, for Rs. 1,65,000 which the public held. The income-tax assessments upon the company were made in the following manner: (a) Under Section 8 of the Act, on the sum of Rs. 51,400 in respect of interest upon the securities of Rs. 7,35,000 debentures, from which amount the interest, about Rs. 21,000 paid by the company to the bank was deducted. Thus making a net assessment of about Rs. 30,000. (b) Under Section 9(1) of the Act, on the amount of the bona fide annual value of the company's properties, less a deduction of the sum paid for interest in respect of all the debentures which deduction included Rs. 51,450, the amount of interest borne by the debentures for Rs. 7,35,000 which were deposited with the bank.
4. During the accounting year 1938-39, in respect of which the present assessment was made, the company paid no interest on any of its debentures but it did pay the interest to the bank on the over-draft loan. Since no interest was paid on the debentures there was no assessment, under Section 8, on the sum of Rs. 51,400 the amount of interest borne by the debentures deposited with the bank. In the assessment, under Section 9, the amount of interest in respect of the three series of debentures was allowed as a deduction against the annual value of the company's properties, including interest on the Rs. 1,65,000 of the second series held by the public but the interest on Rs. 7,35,000 of this series deposited with the bank, being the sum of Rs. 51,450, was not included in this allowance, and the Income-tax Officer disallowed the company's claim for this to be added to the deduction. The disallowance was apparently made on the ground that this amount of interest was not 'payable' during the year of account. The sum paid to the bank for interest upon the overdraft, about Rs. 21,000 was treated as a loss and taken into account in the assessment.
5. Learned counsel, on behalf of the Commissioner of Income-tax, conceded that, under the provisions of Section 127(1), Companies Act, the purchase by the company of the Rs. 7,35,000 debentures did not extinguish them but they were kept alive for the purpose of re-issue and at all times the company had the power to reissue these debentures. Under Sub-section (3) of the above section, where a company has deposited any of its debentures to secure advances on current account or otherwise, the debentures shall not be deemed to have been redeemed by reason only of the account of the company having ceased to be in debit whilst the debentures remained so deposited. If, therefore, the deposit by the company of the Rs. 7,35,000 of debentures was a re-issue of them contemplated by Section 127(1), it must follow that they were subsisting during the whole of the period they were deposited with the bank.
6. On behalf of the Commissioner of Income-tax it was contended, with respect to the year of assessment that: (1) Neither the trust deed nor the debentures nor both together was a mortgage since the trustees, as mortgagees, did not make an advance to the company. (2) Assuming the debentures, or the trust deed together with the debentures, was a mortgage, when the company purchased Rs. 7,35,000 of the second series of debentures it became both the mortgagee and the mortgagor and the mortgage was thereby extinguished, in so far as this amount of debentures is concerned. (3) The deposit by the company of the debentures, to secure the overdraft loan, was not a mortgage of the company's properties but a mortgage of a mortgage on those properties. (4) The transaction being of the nature in (3), there was not a mortgage on the company's properties, the interest upon which is an allowable deduction under Sub-clause (iv) of Sub-section (1) of Section 9 of the Act.
7. It is convenient now to give the material provisions of the trust deed made between the company of the first part, Arrathoon Stephen of the second part and two named trustees (therein called 'the second trustees') of the third part. They are:
Clause (3) -- The second debentures might be issued on such terms as the company might determine.
(4) The second debentures should be held subject to the conditions set forth in the first schedule.
(5) The company should pay to the second debenture holders interest on the second debentures at the rate of 7 per cent. per annum. The interest and principal of the debentures when due and payable constituted debts owing by the company to the debenture holders and might be sued for without the intervention of the trustee.
(6) For more effectually securing payment to the second debenture-holders of the amounts due to them the company thereby granted conveyed transferred and confirmed unto the trustees the properties described in the first part of the second schedule.
(7) The trustees should stand possessed of the mortgaged premises upon the trusts and for the purposes thereinafter declared and by way of specific charge to secure the payment of the second debentures and the interest thereon.
(8) The trustees should permit the company to hold and enjoy the mortgaged premises and to grant leases of any part of the mortgaged premises and the trustees (upon the happening of the events therein set out) should take possession of the mortgaged premises, and sell, call in, collect and convert into money in such manner as the trustees should think fit with full power to sell any of the mortgaged premises.
(14) The trustees should hold the moneys arising from any sale calling in collection and conversion upon trust that thereout they should pay, in the first place, the costs and expenses incurred and their remuneration and apply the residue in or towards payment of the liabilities therein mentioned and secondly in or towards payment to the second debenture holders pari pasu in the proportion to the amount due to them respectively and should pay the surplus, if any, to the company.
8. Schedule 1 (referred to in Clause (4)) gives the form of the debenture to be issued, and its contents include the rate of interest payable and a provision that it was issued subject to and with the benefit of the trusts, powers and provisions contained in the trust deed. The first part of Schdule 2 (referred to in Clause 6), gives a detailed list and description of the company's properties. It is unnecessary to refer to Arrathoon Stephen, the party of the second part to the deed, and to the portions of the trust deed with which he is concerned. It is convenient to deal seriatim with the contentions raised on behalf of the Commissioner, of Income-tax.
9. As to (1) -- Section 58(a), T. P. Act, defines a mortgage as
the transfer of an interest in specific immoveable property for the purpose of securing the payment of money advanced or to be advanced by way of loan....
10. A mortgage being made between a mortgagee and a mortgagor, no one save the former can enforce the mortgage but the definition does not require that the mortgagee should make the advance, it merely requires that the transfer of an interest in land must be for the purpose of securing the payment of money advanced. Neither in Section 58(a) nor in any other parts of the section, which explain the nature of the several kinds of mortgages, is it requisite for the mortgagee to make the advance in order that a mortgage be constituted. By the trust deed the company's immovable properties were granted, conveyed, transferred and confirmed unto the trustees for more effectually securing payment to the debenture holders of the amounts due to them and apart from the question by whom the advances were to be made, the deed and transaction bear all the incidents and character of a mortgage. The debentures were issued pursuant to the provisions in the deed, by which they were constituted. The form of the debenture is given in the deed which empowers the company to issue debentures. The debentures formed part of the trust deed.
11. In Sir N. N. Sircar's and Mr. S. C. Sen's text book on the Indian Companies Act, at page 16, it is stated that debentures are very often secured by a trust deed by which property is mortgaged to trustees for debenture holders, upon trust if the company makes default, to sell and pay off the debentures. In Edn. 17 of Palmers Company Law it is observed, at pages 309 and 319, that debentures and debenture stock are frequently constituted and secured by a trust or covering deed conveying property of the company to trustees in favour of the debenture holders, regulating the respective rights of the company and the debenture holders and containing a covenant for the payment of a specified capital sum and for payment of interest and gives the trustees security, by way of a mortgage or charge. Further, when debentures are issued under a trust deed, the debenture holders are the cestuis que trust of the trust created by the deed, vide In re Uruguay Central and Hygeuritus Railway Co. of Monte Video (1879) 11 Ch. D. 372, and the observation of Jessel M. R. at pp. 880 and 381. It is a practice well settled, and which has been recognised and followed for a long period both in this country and in England that debentures are issued under a trust deed by which they are constituted and that the trust deed is a mortgage over the company's properties when they are conveyed or transferred to trustees to secure payment to debenture holders of the principal sum and interest due from the company.
12. There being nothing in Section 58, T. P. Act, requiring the mortgagees to make the advance in order to constitute a mortgage, the trust deed fulfils all the requirements and the incidents of, and it created a mortgage. The trustees, and not the company, are the mortgagees, and the former could enforce the mortgage Hut they would do so as trustees for, and for the benefit of, the debenture holders. Incidentally it is of interest to notice that the same objection has not been taken with respect to the debentures for Rs. 1,65,000 which were still held by the public and which are part of the same series as the Rs. 7,35,000 debentures and the interest which they bear has been allowed to be deducted under Section 9(1) (iv), Income-tax Act.
13. As to (2) -- As pointed out above the trustees and not the company were the mortgagees. At no time, therefore, could the company be both mortgagee and mortgagor. Up to the year of account the Income-tax Officer assessed the company, under Section 8, in respect of Rs. 51,450, the amount of interest borne by the debenture purchased by the company and deposited with the bank. 'Whether this was correct is a matter which does not arise and does not call for decision. When the company purchased, or redeemed, the debentures for Rs. 7,35,000 the position created is dealt with by Section 127(1), Companies Act. It provides, so far as is material, that when a company has redeemed any debentures previously issued it shall have power to keep the debentures alive for the purpose of re-issue and to re-issue the debentures either by reissuing the same debentures or by issuing other debentures in their place and upon such re-issue the person entitled to the debentures shall have the same rights and properties as if the debentures had not been previously issued.
14. This provision created a unique situation and position, the effect being that the redemption of debentures by a company paying off debenture holders and obtaining the debentures, does not extinguish the debentures but they are available to the company to issue again and they are kept alive between the dates of purchase and re-issue. When it redeemed the Rs. 7,35,000 of the second series of debentures the company availed itself of the provision of the Act. Even assuming that the debenture holders were the mortgagees, which perhaps would have been the position had there been no trust deed covering the debentures and, being the purchaser, the company became both the mortgagee, as well as being the mortgagor; nevertheless the sub-section would have enabled the debentures to be kept alive and available for re-issue with all their incidents, character and rights and they would not have been extinguished. Section 127(1) creates a position of convenience and expendience by which a company can obtain a future loan by using debentures which it previously redeems and obviates what otherwise would be necessary, namely, to go through the cumbersome formalities which precede a debenture issue.
15. As to (3) -- These debentures were 'bearer debentures'. The purpose of the deposit of the debentures by the company and their acceptance by the bank was to secure the overdraft loan given to the company. Bearer debentures are transferable by delivery: vide Palmer's Company Law 17th Ed. at p. 34. The intention of the deposit was that, upon the failure by the company to meet its obligations to the bank, the bank should be in a position to enforce the security up to the amount due-upon the debentures at the date of enforcement subject to accounting to the company in respect of any surplus left after discharge of the bank's indebtedness. Nothing remained to be done in order to place the bank in a position to enforce the security against the company in the event of it defaulting to the bank. The machinery by which the bank could enforce the debentures is not of importance but, under Clause (5) of the deed of trust, the amount due, both principal and interest, is a debt by the company to the debenture holder and he can sue for the debt without the intervention of the trustees. A debenture holder was not a party to the deed but each debenture, as therein provided, was issued by the company to the debenture holder subject to and with the benefit of the powers and provisions contained in the deed. The remedies against the company's properties could only be enforced by the trustees but they would have to exercise their powers if an event occurred by which, under the deed, they were enabled to do so.
16. When the company redeemed Rs. 7,35,000 of the debentures, by Section 127(1), they were kept alive and they remained in an inoperative condition but with all their incidents preserved. Upon re-issue by the company the person entitled to them had the same rights and priorities as if they had not been previously issued. Redeemed debentures, which are being kept alive, have exactly the same attributes as unissued debentures. If the company had deposited debentures with the bank which had not previously been issued, as security for the loan, it is beyond doubt that they would be in full force and effect and could be enforced in the event of any default by the company with regard to the overdraft. Since re-issued debentures have the same attribute as previously un-issued debentures, it follows that the bank would have the same rights with regard to re-issued debentures as they would have had with respect to previously unissued debentures.
16. If any default occurred entitling the bank to enforce their security, they could do so at once without calling upon the company to do anything further to enable enforcement. The deposit, or delivery, of the debentures by the company was a transfer of them to the bank which thereafter held them to secure the loan. This security could be enforced upon the happening of any event enabling enforcement. In those circumstances the deposit by the company of the debentures with the bank was an exercise of the power given to it by Section 127(1), Companies Act, and amounted to the re-issue to the bank of the debentures which the company had redeemed but which had been kept alive by virtue of the above section. The trust deed is a mortgage upon the company's properties and the debentures are part of the deed. The deposit, or re-issue, of the debentures to the bank did not create a mortgage of a mortgage on the company's properties but was the completion of a transaction by which the bank became entitled, as security for the overdraft, to the benefit of the mortgage in favour of the trustees which was created by the trust deed over the properties of the company.
17. As to (4) -- The deposit with or the delivery to the bank of the debentures was a reissue of those debentures which had been kept alive after redemption by the company. The bank was the person entitled to them and under Section 127(1), Companies Act, it had the same rights and priorities as if the debentures had not previously been issued. During the year of account, the bank was entitled to the benefit of the mortgage upon the company's property, the interest upon which is a deduct-able allowance, under Section 9(1) (iv), Income-tax Act, from the amount of the bona fide annual value of the company's properties. In the matter of Behari Lal Mullick (27) 14 A. I. R. 1927 Cal. 553 it was held that 'the amount of any interest on such mortgage' in Sub-clause (iv) is interest which is 'payable' and not which is paid and the amount of such interest is a permitted allowance within the clause although not actually paid. The question which now arises is whether interest was payable in the year of account. Debenture interest was not paid by the company in that year. The bank held the debentures as security for their loan and in fact were paid the interest upon the principal of the overdraft loan. If the company had defaulted in that year, or committed any default, in any subsequent year, by which the bank became entitled to enforce the security, it could have done so in respect of all moneys due under the debentures and which had not been paid. This must include the interest which was not paid during the year of account. Since the bank could, in the event of the company's default, have enforced the security to the full extent of the moneys payable under it and, inter alia, in respect of the interest for the year of account which had not been paid, it must follow that whilst it was not recovered it was payable in respect of that year. Since, in the year of account, interest was payable upon the debentures and was interest upon a mortgage of the company's properties assessed under Section 9 of the Act, the amount of such interest is an allowable deduction under Sub-clause (iv) of Sub-section (1) of Section 9, Income-tax Act. In my opinion the answer to the second question should be in the affirmative. The assessee is entitled to his costs which are fixed at Rs. 200.
18. I agree.