Madras Co-Operative Central Land Mortgage Bank Ltd. v. Commissioner of Income-Tax, Madras

Shah, J.-This is an appeal with special leave .

The appellant is a Society registered under the Co-operative Societies Act, 1912. The following table sets out the data relating to the earnings, investments, working capital, outgoings and expen-diture of the Society for the year ending June 30, 1955, relevant to the assessment year 1956-57: - G (i) Interest from Government securi·

ties Rs. 4.31l,453.00 (ii) Total gross earnings Rs. 21,00.9~.oo (iii) Investments in Government

securities Rs. 130,60.653.00 (iv) Total working capital ... Rs. 473,42,603.00 B (v) Interest paid on debentures, depo-

sits and other accounts Rs. 15,09.490.00 (vi) Total overhead expenses and es-

tablishment overhead charges Rs. 3,01, I 02.00 32 SUPlllJOi COUI\T llBPOll'l'I [1968] l s.c.11.

In a proceeding for assessment of the total income of the Society to tax for the year 1956-57 it was claimed that under s. 14 13) of the Indian Income-tax Act, 1922 (as added by s. 10 of the finance Act, 1955, with effect from April l, 1955) the income of the Society from business was exempt from payment of tax, and that in accordance with the instructions issued under s. 60 of the Act, out of the gross income from securities amounting to Rs. 4,30,053/·, Rs. 4,16.475/· being income attributable to the assets utilized in the business, only the balance of Rs. 13,578/· was chargeable to tax. In support of its claim the Society relied upon the instructions published in the Income-tax Manual, 1946. In the view of the Income-tax Officer the Society could not claim the benefit of the Departmental Instructions, since in the relevant year of assessment those instructions had ceased to operate, and the Society's claim was governed by the Explanation to s. 8 of the Income-tax Act as incorporated by the Finance Act of 1956, with elfect from April I, 1956. He accordingly computed the taxable income under the head-"interest on securities" in the sum of Rs. 59,498 /-. The Appellate Assistant Commissioner modified the order of the Income-tax Officer and reduced the taxable income under the head "interest on securities" to Rs. 13,578 /. applying the Departmental Instructions. He held that the Explanation . to s. 8 of the Act applied to Banking Companies and not to Co-ope· ra.tive Societies.

In appeal by the Commissioner of Income-tax the Appellate Tribunal reversed the order of the Appellate Assistant Commis-sioner, and restored the order of the Income-tax Officer. · In the view of the Tribunal, the Explanation to s. 8 of the Act cannot be invoked as the Society was not a Banking Company. but the principle of the Explana.tion may well be called in aid and that the relief granted by the Income-tax Officer was the only relief to which the Society was entitled.

The following question of "law was submitted by the Tribunal to. the High Court of Madras:

"Whether the Tribunal is justified in law in holding that the taxable income of the assessee from interest on secu-rities is Rs. 59,498 / ·?"

The High Court reframed the question to read:

"Whether the taxable income of the assessee from inter-est on securities is Rs. 13,578 /- as contended by the assessee and as worked out on the basis of the Depart· mental imtructions contained at pages 248 and 249 in Part III of the year 1946?", and answered it in favour of the Commissioner.

Counsel for the Society in the first instance, contended rely-ing upon the judgment of this Court in Commissioner of Income-tax, Andhra Pradesh v. Cocanada Radhaswami Bank Ltd.,(') contended that no Pilrt of the income of the Society, even if it be earned from Government secmities, was liable to be taxed. It may be recalled that the. Society had claimed before the Departmental authorities and the Tribunal that according to the instructions issued by the Central Government under s. 60 of the Income-tax Act only Rs. 13,578 /- out of the income from Government securi-ties were chargeable to tax. The IncOllle-tax Officer and the Tri-bunal held that Rs. 59,498 /- were chargeable to tax. The decision in Cocanada Radlwswami Bank's case(') relates to the right of a Bank to carry forward the net loss incurred by a Bariking Company and to set it off in subsequent years against income from securities held as part of its trading assets. It is not a decision under s. 14(3) of the Act. Again it is not open to the Society in this reference to contend that the amount of Rs. 13,578 /- itself is not taxable. Such a question was never raised before the Tribunal and cannot be permitted to be raised in this Court.

The Income-tax Act, 1922, as originally enacted, did not give to a Co-operative Society exemption from payment of tax in res-pect of income from its business activities. But by Departmental Instructions issued under s. 60 of the Act, certain exemptions were given by a notification issued on August 25, 1925 and modified by notifications dated June 25, 1927, October 20, 1934 and August 18 •. 1945. Among the classes of income exempt from liability to pay tax under the notification was:

"(2) The profits of any co-opera.live society other than . . . or the dividends or other payments receiv-ed by the members of any such society out of such pro- · fits.

Explanation-For this purpose the profits of a co-operative society shall not be deemed to include any income, profits or gains from : -

(!) investments in (a) securities of the natme referred

to in section 8 of the Indian Income-tax Act, or (b) • • .

(2) dividends, or (3) the 'other sources' referred to in section 12 of the

Indian Income-tax Act".

By the notification, profits of a Co-operative Society were exempt from tax, but those· profits were not to Include any income, profits or gains from securities of the nature referred to in s. 8 of the Pl'57 r.r.11. aoo.

81IPllBllll COUllT llBPOllTS [1968] l s.c.11. Indian Income-tax Act. The Legislature by s. 10 of the Finance Act of 1955 added sub-sec. (3) to s. 14, whereby it was enacted, inter alia, that:-

"The tax shall not be payable by a co-operative society, including a co-operative society carrying on the business of banking-

(i) in respect of profits and gains of business carried

on by it;

(ii) in respect of interest and dividends derived from

its investments with any other co-operative society; .. A. co-operative society since the enactment of the Finance Act, 1955, with effect from April I, 1955, was therefore not liable, by the express provisions in the Act, to pay tax in respect of the pro-fits and gains of business carried on by it. Under s. 8 of the Income-tax Act, 1922, tax is payable by an assessee under the head "Interest on securities" in respect of the Interest receivable by him on any security of the Central Government or of -a State Govern-ment, or on debentures or other securities for money issued by or on behalf of a local authority or~co pany, subject to exemption, 1'nter alia, in res~t of any sum d · ucted from such interest by way of comm1Ssion by a er realizing such interest on behalf of the assessee, or .Jn respect of any interest pay· able on money borrowed for the purpose of investment in the securities by the assessee. The Parliament by the Finance Act, 1956 amended the first proviso, and added an Explanation to s. 8 providing for the computation of the sum reasonably spent for the purpose of realising interest and of interest paid on sums borrowed for the purpose of investment by a Banking Company. The Explanation provides: r

"Explanation-In the case of a banking company,-

(a) the amount which bears to the aggregate of its ex·

pcnses as are admissible under sub-section (2) of section I 0, other than clauses (iii), (vi), (vi.a), (vi-b), (vii). (viii), (xi), (xii), (xiii) and (xiv) thereof, the same proportion as the gross receipts from interest on securities inclu· sive of tax deducted at source) chargeable to tax under this sectiqn bears to the gross receipts from all sources wliich are included in the profit and loss account of the company, shall be deemed to be the sum reasonably expended by it for the pur· pose of realising such interest; !Ind the amount for which allowance is admissible under sub-sec-tion (2) of section 10 shall be reduced correspond· inaly; and

COOP, BANK ti. a.LT. (Shal1, J.) (b) money borrowed shall incl11de moneys received

by wa.y of deposits; and that amount which bears to the amount of interest payable on moneys borrowed. the same proportion as the gross receipts from interest on securities (inclusive of tax deduct-ed at source) chargeable to tax under this section bears to the gross receipts from all sources which are included in the profit and loss account of the company, shall be deemed to be interest payable on money borrowed for the purpose of investment in the securities by the assessee, and the amount of such interest for which allowance is due under sub-section (2) of section I 0 shall be reduced correspondingly."

Broadly stated, under cl. (a) the sum reasonably spent is computed as that proportion of the aggregate of the expenses admissible 'under the various clauses of sub-s. (2) of s. 10 mentioned therein which the gross receipts from interest on securities bear to the gross receipts from all sources included in the profit and loss account of the banking company. Similarly under cl. (6) interest payable on money borrowed for ttie purpose of investment in Government securities is that proportion of the total interest paid on borrowings which gross receipts from securities bear to gross receipts from all sources.

Income of the Society from its trading activity being exempt from tax, its income from Government securities had, it was common ground, to be apportioned between income earned from investments for trading purposes and for non-trading purposes. The Income-tax Officer applied the first proviso read with the Expla-nation to s. 8 of the Income-tax Act. The Income-tax Appellate Tribunal held· that in terms, the Explanation to s. 8 did not apply because the Society was not a banking company, but the principle r of the Explanation furnished, after the Departmental Instructions

had been withdrawn, a reasonable basis for apportionment. In the view of the Tribunal, the principle embodied in the Explanation was an "improvement on the instructions", since it co-related the·· income chargeable under the head with the expenditure and also provided for proportionate allocation of overhead charges. The High Court held that the benefit of the departmental notification was not available to ·the Society in the year of assessment, because it must be deemed to be withdrawn and the Explanation to s. 8 did not in terms apply to the Society.

It was common 'ground between the parties in this Colirt and the High Court that Explanation to s. 8 has no application to a co-operative society which does not carry on the business of a banking company. There is also no dispute that the departmental notification relied upon by the company was withdrawn before the relevant assessment year. There is, therefore, no statutory rule, and nor there are departmental instructions, governing the appor· tionment of income 'from Government securities, between business

SUPREME OOUl\T REPORTS (1968) 1 $.C.R.

and non-business sources of income. It was never urged, and it cannot be urged, that in the absence of a specific rule for appor-tionment, the entire income from Government securities should be brought to tax. Any attempt to bring the entire income from Government securities would infringe s. J 4(3) of the Act. A rule of apportionment consistent with commercial accounting must be evolved for determining the income from Government securities attributable to business activity of the Society. The rule contained in cl. (a) of the Explanation to s. 8 has specially been evolved for determining the appropriate outgoings for the purpose of realizing interest from securities held by a Banking Company in computing income chargeable to tax; it seeks to exempt, on the footing that it is deemed to be the sum reasonably expended for the purpose of realizing interest, a part thereof which is equal to the proportion which the gross receipts from interest on securities chargeable to tax, bear to the gross receipts from all sources. The rule is an artificial rule for allocating business expenditure between different sources of income of Banking Companies. It is not a rule for apportionment. for the purpose of taxation of composite income which is partly taxable and partly not. Clause (b) provides for allocation of outgoings in respect of. "money borrowed", which expression includes money deposited with the Bank. Interest pay-able on borrowings is directed to be allocated in the proportion in which income is received from investments from securities and from other sources. This clause also deals with the proportion in which the outgoings are allocable. The problem arising under s. 14(3) is of apportionment of income under heads taxable and non-J!l taxable: it is not .a problem relating to alloc:1tion of outgoings to determine taxable income.

Jn our judgment. a rule of apportionment which dismembers income in proportion to the busines.• and non-business components of the single source from which it arises would be more consistent with principles of commercial accounting. The proportion of income from securities whicl> is exempt from taxatJon under s. 14 (3) of the Act will be that proportion which the capital of the Society used for' the purpose of the business bears to the total working capital.

Jt is admitted that Rs. 13,5781· is the gross inc6me from securities which is. according to that rule. liable to tax. No question was raised in the High Court about any deduction to be made in respect of expenses for collection of that amount. and admissibility of deduction on that score does not fall to be considered.

The appeal is allowed. Answer to the question as reframcd by the High Court is that Rs. 13,5781-arc taxable as income of the Society received from Government securities under s. 8 of the Income-tax Act. The Commissioner will pay lhc wsts of the Society in this Court.

CIVIL APPELLATE JURISDICTION: Civil Appeal No. 19"'5 of 1966.

Appeal by special leave from the judgment and order dated July 11, 1962 of the Madras High Court in Tax Case No. 84 of 1960.

S. ~waminathan and R. Gopa/akrisl111an, for the appellant. Veda Vyasa, A. N. Kirpa/, R. N. Sac/11/Jey and S. P. Nayar, for the respondent.

, The Judgment of the Court was delivered by