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Tax Case No. 141 of 1960, decided on 12th September 1962.
Banking company‑Money invested in tax‑free securities -Proportionate part of interest paid to depositors‑ Whether allowable‑Indian Income‑tax Act, 1922, Ss. 4 (3) (xvii), 8 & 10(2)‑Explanation to S. 8 as amended it; 1956, scope and effect of.
What is contemplated by the amendment to the Explanation to section 8 made in 1956 and effectuated thereby, is only to bring an allowance, such as payment of interest on money borrowed or sum expended for the purpose of realising interest on securities, in so far as such payment or expenditure might be incurred by the bank in the course of its businesses is concerned and to the extent to which such expenditure related to the income from securities under section 8 as an allowance allowable in the computation of the interest on securities, and not to deny to the banking company the totality of the expenses which would be allowable to it under section 10 (2) of the Act. The Explanation as amended, does not mean that any interest payment or expenditure over and above the figure as computed by the Explanation should be disallowed.
Where a bank receives deposits in the course of its normal banking activities, whether it purchased tax‑free securities or not, the interest charges paid by it to its depositors are not apportion able and solely for the reason that the income from certain securities was not subject to tax, an expenditure proportionate thereto could not be disallowed.
The view that where an item of income comes within the scope of section 4 (3) (xvii), the exemption is operative only to the extent of the income less any allowances which would other wise be available under section 10 or under section 8, as the case may be, is not correct.
The assessee, a banking company, realised in the relevant year, a gross income of Rs. 1,27,688. This included a sum of Rs. 2,550 being interest on securities and a further sum of Rs. 2,500 being interest on Ten Year Treasury Savings Certificates. The assessee paid Rs. 44,308'88 as interest on deposits to its customers, and claimed as expenses allowable under section 10(2) of the Income‑tax Act an amount of Rs. 41,701'44. The proportionate part of the interest paid to depositors on the sum of Rs. 50,000 invested in the purchase of these Savings Certificates worked out to Rs. 904 and the proportion of allowable expenses in this regard was Rs. 815. The income‑tax authorities dis allowed these two sums on the ground that, since the interest of these Savings Certificates was exempt from tax, these two sums cannot be allowed, and the Tribunal upheld the disallowance;
Held, that there was nothing in section 8 to justify the disallowance of these two sums, and the disallowance of these sums was not right in law.
Indian Bank Ltd. v. Commissioner of Income‑tax (1961) 41 ITR552ref.
By this application, the assessee requires the Appellate Tribunal to refer to the High Court a certain question of law, which is said to arise out of the Tribunal's order, dated 27th October 1959, in I. T. A. No. 2087 of 1959‑60. Inasmuch as, in our opinion, a question of law does arise out of the aforesaid order, we hereby draw up a statement of the case, agreed to by the parties, and refer to it to the High Court of Judicature at Madras under section 66(1) of the Indian Income‑tax Act.
2. The assessee is a banking company carrying on business in Tiruchirappalli. Its paid up capital is Rs. 1,00,000 and it had reserve funds at Rs. 1,14,860.44 as on December 31, 1957. The bank had invested a sum of Rs. 1,80,612'50 on that date in securities of Central and State Government. Out of this a sum of Rs. 50,000 was invested in 3J per cent. Ten Years Treasury Savings Deposit Certificates.
3. For the calendar year ended on December 31, 1957, the "previous year" for the assessment year 1958‑59, the assessee received a sum of Rs. 2,550 as interest from these securities. In the assessment for the year 1958‑59, the Income‑tax Officer dis allowed a sum of Rs. 1,719 as "proportionate expenses on interest on securities of Rs. 2,550 tax free".
4. The assessee appealed against this disallowance to the Appellate Assistant Commissioner and urged that it held only tax‑exempt certificates and not tax‑free certificates and that since income‑tax‑exempt certificates did not come under section 8 there was no justification for the disallowance. A copy of the grounds of appeal before the Appellate Assistant Commissioner is Annexure "A" and forms part of the case.
5. The Appellate Assistant Commissioner, however, confirmed the order of the Income‑tax Officer after referring to the decisions in United Commercial Bank Ltd. v. Commissioner of Income‑tax (1957) 32 I T R 688 ; Commissioner of Income‑tax v. Madras Provincial Co‑operative Bank Limited (1942) 10 I T R 490 and Broach Co‑operative Bank Ltd. v. Commissioner of Income‑tax (1949) 17 I T R 489 and holding that no deduction is possible in respect of any income not chargeable. The order of the Appellate Assistant Commissioner is annexed hereunto as Annexure "B" and forms part of the case.
6. The assessee appealed to the Appellate Tribunal against the aforesaid order and contended
"1. The Income‑tax Officer has no power under the Income tax Act to apportion the expenses of a banking business between the income chargeable under section 10 and the income exempt under section 4 (3) (xvii).
2. It is not lawful for the Income‑tax Officer to disallow a proportion of the expenses allowable under section 10 (2) as relating to income exempt under section 4 (3) (xvii) on the false analogy of expenses relating to other exempted income, e.g., agricultural income, in which case also the Income‑tax Officer could not resort to apportionment, but can disallow only specific expenses relating to such tax‑exempt income."
7. The Tribunal negatived the assessee's contentions and held that "in arriving at the total income, as a preliminary step, computation will have to be made in accordance with sections 7 to 12 and that accordingly computation in accordance with the provisions of section 8 was a necessary step in the present case. It is only the amount that has been arrived at after such computation that will be exempt under section 4 (3)." Copy of the order of the Tribunal is annexed hereunto as Annexure "C" and forms part of the case.
8. From out of the above facts, the question of law that arises is;
"Whether, on the facts and in the circumstances of the case, the assessment disallowing a sum of Rs. 1,719 being a proportion of the expenses allocated by the Income‑tax Officer by estimate to the interest on the Treasury Savings Certificates exempt under section 4 (3) (xvii) of the Income‑tax Act is right in law."
K. R. Ramamani for Subbaraya Aiyar, Sethuramah and Padmauabhan for the Assessee.
S. Ranganathan for the Commissioner.
The assessee is the Tiruchi Varthaga Sangam Bank Ltd. During the year of account relevant to the assessment year 1958‑59, the assessee realised a gross income from all sources of Rs. 1,27,688. This included a sum of Rs. 2,550 being interest on securities and a further sum of Rs. 2,500 being the interest on 10 years Treasury Savings Certificates. The bank in the due course of its business paid a sum of Rs. 44,308,88 towards interest on deposits of its customers. It also claimed as expenses allowable under section 10 (2) of the Act an amount of Rs. 41,701.44. The quantum of these two amounts is not in dispute. But what the Income‑tax Officer did was to disallow the proportionate part of the interest on deposits and the expenses attributable to the interest income on the 10 years Treasury Savings Certificates. Such part of the interest payment to the depositors on the sum of Rs. 50,000 invested in the purchase of these savings certificates worked out to Rs. 904 and a like proportion of allowable expenses in this regard was computed at Rs. 815. The Depart ment took the view that, in so far as the income received from these certificates is concerned, since it is exempt from tax, no portion of either the interest on the deposits or the expenses relevant thereto would be admissible. Accordingly, the total of the above two sums of Rs. 1,719 was disallowed.
When the matter was taken up in appeal to the Appellate Assistant Commissioner challenging the propriety of the disallow ance, the appellate authority took the view that section 10 had no direct application so far as the income from the source which is not chargeable to income‑tax is concerned. He thought the allowance would amount to double exemption, based on the ground that the income in question was claimed to fall under section 4 (3) of the Act and also under section 10 (2). He relied upon certain decisions which had special reference to co operative banks in reaching the conclusion that, to the extent of the exempted interest, no allowance either for expenditure or for interest paid upon borrowed capital could be allowed.
Before the Tribunal, it was urged that section 8 of the Act did not confer any power upon the taxing‑ authorities to allocate the interest and the expenses, and that it was not open to the department to apply to the process of computation under sections 7 to 12 in regard to income which was wholly exempt under section 4 (3) of the Act. This contention was negatived, the Tribunal apparently being of the view that what was exempted under section 4 (3) of the Act was only the net income after the process of computation ; that is to say, out of the sum of Rs. 2,500 realised on exempted securities, the proportionate expense and interest payment attributable to the sum invested in the purchase of securities should be deducted and only the balance could be exempted from payment of tax. The result was that the disallowance was upheld.
On the application of the assessee, the following question stands referred to us;
"Whether, on the facts and in the circumstances of the case, the assessment disallowing a sum of Rs. 1,719 being a proportion of the expenses allocated the Income‑tax Officer by estimate to the interest on the Treasury Savings Certificates exempt under section 4(3)(xvii) of the Income‑tax Act is right‑in‑law "
During the relevant year, section 8, as amended by the Finance Act of 1956 with effect from 1st April 1956, was in force. An explanation was inserted by that Act besides effecting some changes in the first proviso to the section. Section 8 deals with the mode of computation of income under the head "interest on securities". The first proviso reads
"Provided that no income‑tax shall be payable under this section by the assessee in respect of any reasonable sum expended by him for the purpose of realising such interest or in respect of any interest payable on money borrowed for the purpose of investment in the securities by the assessee . . . . . ."
The explanation deals with the case of a banking company. It is in two parts. The first part deals with the expenses. Broadly stated, what it lays down is that the expenses of the banking company, as are admissible under certain clauses of sub section (2) of section 10, should first be ascertained ; and this quantum of expenses should be divided between the gross receipt from interest on securities chargeable to tax and the gross receipt from other sources. The part of the expenses bearing the same proportion as the gross receipt from interest on securities chargeable to tax bears to the gross receipts from all sources shall within the meaning of the section be deemed to be the sum reasonably expended by it for the purpose of realising such interest. The last sentence of this part of the explanation reads;
" . . . and the amount for which allowance is admissible under subsection (2) of section 10 shall be reduced correspondingly."
The effect of this explanation clearly appears to be that where a banking company doing banking business incurs expenditure which would be admissible under section 10(2) a proportion of those expenses should be brought within the ambit of section 8. Expenses dealt with under section 10(2) would be expenses incurred by the assessee in the conduct of his business, and would represent expenses attributable to the carrying on of the business. But, where the income receipt is an item which falls under the head "interest on securities", one of the classes mentioned in section 6 of the Act for which a special mode of computation is prescribed under section 8, this section, read with the Explanation has the effect of taking out of the ambit of section 10(2) a part of the business expenditure attributable to interest on securities and bringing it within the scope of section 8. That part would no longer be expenditure which would fall within the scope of section 10(2) but has to be had regard to in the computation of the taxable income under section 8.
The second part of the Explanation deals with money borrowed for the purpose of investment in the securities by the assessee. The first proviso to section 8 permits the deduction of interest paid on money borrowed for the purpose of invest ment in the securities. This part of the Explanation defines what "money borrowed" shall mean. It states that, in the case of a banking company, money borrowed (for the purpose of investment in the securities by the assessee) shall include the moneys received by way of deposits. In so far as the allowance of interest payment on such money borrowed is concerned, this part of the Explanation also provides that that proportion of the interest payment as is equivalent to the proportion of the gross receipts from interest on securities chargeable to tax to the gross receipts from all sources shall be deemed to be interest payable on money borrowed for the purpose of investment in the securities by the assessee. Here again, the last sentence of this part of the section states;
" . . the amount of such interest for which allowance is due under subsection (2) of section 10 shall be deduced correspondingly."
The effect of this sentence is merely to transfer from the category of an allowance under section 10(2) a part thereof to an allowance under section 8.
The real effect of the decision of the Tribunal and the views taken by the departmental officers appear to be that this Explanation has the effect of limiting the allowance to which the banking company would be entitled under section 10(2) of the Act to what is specified in the Explanation to section 8. We are un able to agree. The last sentence in each of the parts of the Explanation which we have extracted does not have the effect of denying the allowance which is admissible under section 10(2) of the Act, except to the extent to which a part of it is directed to be brought under section 8, Mr. Ramamani, learned counsel for the assessee, is in our opinion right in his contention that what is contemplated by the amendment and effectuated thereby is only to bring an allowance, such as payment of interest on money borrowed or sum expended for the purpose of realising interest on the securities, in so far as such pay ment or expenditure might be incurred by the bank in the course of its business is concerned, and to the extent to which such expenditure related to the income from securities under section 8 as an allowance allowable in the computa tion of the interest on securities, and not to deny to the assessee, the banking company, the totality of the expenses which would be allowable to it under section 10(2) of the Act. What is lawfully allowable under section 10(2) of the Act under the relevant heads is by means of this section split up into two parts, one to be dealt with under section 8 and the other under section 10. The principle underlying such re‑classification of the interest payment or of expenditure appears to be that otherwise the entire expenditure on these heads would form part of the computation under section 10 leading to the result that it would carry with it the bene fit of carry‑forward in the event of there being a business loss. To the extent to which a portion of the interest pay ment and expenses are made allowable under section 8, that right of carrying forward as a business loss may not be available to the assessee. It seems to us that only this change was effected by this Explanation and the far‑reaching result claimed by the Department that any interest payment or expenditure over and above the figure as computed by the Explanation to section 8 was intended to be disallowed is not borne out by the clear terminology employed in the Explanation.
In Indian Bank Ltd. v. Commissioner of Income‑tax ((1961) 41 I T R 552), to which one of us was a party, the question arose whether interest paid to depositors to the extent that the amount was invested by the bank in tax‑free securities is concerned, was allowable under section 8, as it stood before the amend ment in 1956. It was held therein that, as between the depositor and the bank, the relationship of creditor and debtor was established and when the deposit was received by the bank in the normal course of its business, it would be capital borrowed within the section 10(2)(iii) of the Act. In such a case, the further view was that the transaction involving the purchase of securities from out of deposits received by the bank in the normal course of its banking business could not be viewed as a transaction of borrowing money for the purpose of investment in securities within the meaning of the proviso to section 8. On the specific ques tion whether interest charges could be allowed under section 10(2)(iii) of the Act, notwithstanding that a portion of the income, resulting from the business activities of the assessee was tax‑free by reason of purchase of tax‑free securities it was held that there could be no apportionment of the interest charges on any such basis. It seems to us that the Expla nation newly enacted has not in any way affected the principle underlying the above decision. To put it shortly, it is that where the bank received deposits in the course of its normal banking activities, whether it purchased tax‑free securities or not, the interest charges paid by it to its depositors were not apportionable, and solely for the reason that the income from certain securities was not subject to tax, an expenditure proportionate thereto could not be denied deduc tion. The Explanation to our minds has not altered the position in any way and so long as the bank purchased these securities as part of its normal trading activity, both the interest payment to its depositors and the expenditure which it had to incur in the normal course of its business would under the law be allowable, the only variation effected by the Explanation being that the allowance was brought partly under section 10 and partly under section 8. As pointed out, the phraseology used in the Explanation does not sup port the view that that part other than that described in the Explanation was intended to be disallowed.
The view taken by the Tribunal and the Department that where an item of income comes within the scope of section 4(3)(xvii) the exemption is operative only to the extent of the income less any allowances which would otherwise be available under section 10 or under section 8, as the case may be, wholly fails to impress us. Section 4(3) states that any income, profits or gains falling within the following classes shall not be included in the total income of the person receiving them. One of the classes is that specified in clause (17) as "interest on the 10 years Treasury Savings Deposit Certificates". What Mr. Ranganathan, learned counsel for the Department, contends is that the total income of a person as defined in section 2 clause (15), would mean the total amount of income, profits and gains referred to in subsection (1) of section 4 computed in the manner laid down in the Act. He accordingly claims that even in respect of interest on the certificates referred to in clause (17) of section 4(3) a computation is called for. Section 4(3) of the Act was amended in 1939. It previ ously stated that the Act shall not apply to the classes of income set out thereunder. Section 2(15) also defines the total world income to include all income, profits and gains wherever accruing or arising, except income to which under the provisions of subsection (3) of section 4, this Act does not apply. Despite the amendment of section 4(3) the defini tion of "total world income" in section 2(15) remained unchanged. The result would appear to be that in so far as the classes of income set out in section 4(3) are concerned the Act would not apply thereto. The definition of total income does not also refer to income set out in section 4(3) and the computation of total income is called for only in so far as the amount of income, profits and gains referred to in subsection (1) of section 4 is concerned. We are, therefore, unable to agree with the argument advanced by the learned counsel for the Department that even in respect of income dealt with under section 4(3) of the Act a computa tion is called for and that only the net income after the deduction of allowances contemplated by the relevant provi sions of the Act must be regarded as exempt from tax.
We are, accordingly, of the view that section 8 of the Act does not either inferentially or in terms justify the disallowance, which is the subject‑matter of the question. The question is answered in the negative and in favour of the assessee. The assessee will be entitled to its costs. Counsel's fee Rs. 250.
Question answered in the negative.
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