Cloth Traders (P.) Ltd. vs Commissioner of Income Tax

B.K. Mehta, J.—At the instance of the assessee, the Tribunal, Ahmedabad, has referred to us the following two questions u/s 256(1) of the income tax Act, 1961 (''the Act''):

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee was not entitled to deduction of whole of interest deficit of Rs. 2,28,484 in computing business income, but the same was required to be allocated to various heads of income?

Whether, on the facts and in the circumstances of the case, the assessee is entitled to relief u/s 80M of the income tax Act, 1961, in respect of the entire amount of the dividend income without deduction of interest paid in borrowing for acquiring the shares?

Though we are handicapped partially in answering one out of the two questions referred to us since the facts in the statement of case are not elaborate, we have to set out those facts for purposes of appreciating the ultimate result in this reference. The assessee is a private limited company deriving income from interest, dividends, property and shares from a firm, Tube Distributors. Its gross dividend income for the year under consideration, viz., assessment year 1971-72 was Rs. 8,64,155. The assessee had borrowed some of the funds for investment in shares and claimed interest deficit pertaining to these investments at Rs. 1,77,150. While determining the income from the other sources with regard to the source of dividend income, the ITO deducted this sum of Rs. 1,77,150 from the gross dividend of Rs. 8,64,155 and worked out dividend income at Rs. 6,87,805. The assessee claimed that relief u/s 80M of the Act should be allowed at 60 per cent in respect of the dividend income of Rs. 8,64,155, after adjusting the deduction of Rs. 5,100 under sections 80K and 80L of the Act.

The ITO, however, held that relief u/s 80M had to be worked out on the basis of the dividend income taken after deduction of interest deficit, i.e., Rs. 6,87,005 and from this figure the ITO deducted Rs. 5,100 and on the balance of Rs. 6,81,905, he gave section 80M relief at 60 per cent. i.e., about Rs. 4,09,143.

The assessee being aggrieved by this order of the ITO went in appeal before the AAC who dismissed the assessee''s appeal an both the points.

The assessee, therefore, carried the matter in appeal before the Tribunal on the above as well as other points. So far as the claim of the assessee for setting off of the interest deficit of Rs. 2,28,484 against the business income is concerned, the Tribunal followed its earlier decision in IT Appeal Nos. 1746, 1747 and 1748 of 1973-74 and upheld the view of the ITO as affirmed by the AAC. As regards the'' claim of the assessee that relief u/s 80M should be allowed at 60 per cent of the dividend income of Rs. 8,64,155, the Tribunal, following its earlier decision in the aforesaid appeals, affirmed the view of the ITO and the AAC. At the instance of the assessee, therefore, the questions set out above have been referred to us.

So far as the second question is concerned, it may be recalled that the Tribunal followed the decision of the Gujarat High Court in Additional Commissioner of Income Tax, Gujarat Vs. Cloth Traders (P.) Ltd., which in effect ruled that for purposes of the relief u/s 80M, the net dividend income should be considered. Now this decision of the Gujarat High Court was reversed by the Supreme Court in Cloth Traders (P) Ltd. Vs. Additional Commissioner of Income Tax , Gujarat-I, holding that the assessee were entitled to relief u/s 80M for the assessment years 1968-69 and 1969-70 and u/s 85A of the Act for the assessment years 1965-66 to 1967-68 in respect of the entire amount of the dividend income without deduction of interest paid on borrowings for acquiring the shares. By Finance (No. 2) Act, 1980, section 80AA was put on the statute book so as to be effective retrospectively, that is, from 1-4-1968 prescribing that for purposes of deduction required to be allowed u/s 80M in respect of any income by way of dividend from the domestic company which is included in the gross total income of the assessee, the deduction under that section shall be computed with reference to the income by way of such dividend as computed in accordance with the provisions of the Act before making any deduction under Chapter VI-A and not with reference to the gross amount of such dividends. The effect of the amended provision as contained in section 80MM was in effect and substance to restore the view of the Gujarat High Court in Cloth Traders (P.) Ltd. ''s case (supra). We are told by the counsels appearing for both the sides that the vires of this amended provision in section 80AA of the Act has been challenged by Distributors (Baroda)(P.) Ltd. by Writ Petition No. 2043 of 1981 and the Supreme Court has issued rule nisi and issued interim stay on the said petition [ see [1981] 130 ITR (St.) page 7]. So far as the question of law is concerned, the position as enunciated by the Gujarat High Court has been restored by insertion of section 80AA in the statute book, retrospectively. Mr. J.P. Shah, having realised this position states that if the revenue is prepared to the adjustment of the case by the Tribunal in light of the decision of the Supreme Court, he does not press this question for the time being. The learned counsel on behalf of the revenue has stated that the revenue would have no objection to the adjustment of the case by the Tribunal in light of the decision of the Supreme Court, he does not press this question for the time being. The learned counsel on behalf of the revenue has stated that the revenue would have no objection to the adjustment of the case by the Tribunal in light of the decision of the Supreme Court in the Writ Petition No. 2043 of 1981. In view of this consensus ,therefore, the second question is not pressed and is, therefore, not required to be answered and the Tribunal shall adjust the case in light of the decision of the Supreme Court in the aforesaid Writ Petition.

Now coming to the first question, it would be profitable to refer to a few decisions which have a bearing on the said question which has been set out in the statement of case for our advice. It should be recalled that the assessee was claiming before the ITO that the entire interest deficit of Rs. 2,28,489 be allowed to be set off against the business income. A part of the deficit, viz., Rs. 1,72,150 appears to have been related to the borrowings used for purposes of the purchase of shares. The ITO was not inclined to accept this claim of the assessee since he was of the opinion that only a part of the interest deficit relatable to the borrowings used for purchase of shares should be allowed to be set off against the dividend income which is computed as income from other sources and similarly the proportionate deficit interest amount, viz., Rs. 499 relatable to the borrowings used for the purposes of business and that of Rs. 50,835 as amount used for purposes of the investment in buildings should, accordingly, be allowed to be set off against the income from the business as well as property, respectively. This view was consistently upheld by the AAC as well as the Tribunal. The Tribunal in affirming this view relied on its earlier ''decision dated 31-3-1975 in Cloth Traders (P.) Ltd. v. ITO and other companion appeals, being Appeal Nos. 1746, 1747 and 1748 of 1973-74 which related to the assessment years 1968-69 to 1970-71. We must state here that when we looked to that order of the Tribunal in those appeals, we were required to look to still earlier decision of the Tribunal in IT Appeal No. 815 of 1972-73 in the matter of the same parties, namely, Cloth Traders (P.) Ltd., which related to the assessment year 1967-68. The Tribunal again sought support from its earlier decision in the matter of H.K. Investment (P.) Ltd. which is described as associate company of the assessee-group, viz., Cloth Traders (P.) Ltd. But here again we must state that we reached the dead end since the decision of the Tribunal in H.K. Investment (P.) Ltd. v. ITO, is not before us and we are told by the learned counsel for the assessee before us that he was not able to lay his hands on that decision with the result that we were required to search for this decision and fortunately for all of us we have got that decision ultimately from the old records of this Court since the assessee had sought references from the decision of the Tribunal in the appeals of H.K. Investment (P.) Ltd., which references we arc again told were withdrawn and not pressed by the assessee. We have, however, been able to lay our hands on the paper books lying deep down in our registry and that is how we were able to correlate and find out what precisely the reasoning of the Tribunal was which prompted it to reject the claim of the assessee. We were taken through this decision of the Tribunal in income tax Appeal No. 941 and other companion matters between H.K. Investment (P.) Ltd. where a similar claim was rejected by the Tribunal. The Tribunal referred to three decisions of the Supreme Court, viz. Commissioner of Income Tax Bombay Vs. Chugandas and Co., Bombay, , East India Housing and Land Development Trust Ltd. Vs. Commissioner of Income Tax, West Bengal, and United Commercial Bank Ltd. Vs. Commissioner of Income Tax, West Bengal, . On reading these decisions, the Tribunal was of the opinion that the question posed before the Supreme Court in Chugandas & Co.''s case (supra) was altogether in the different context and it was whether interest on securities formed part of the assessee''s business income for purposes of exemption from tax u/s 25(3) of the Indian income tax Act, 1922. The Tribunal, therefore, concluded that the decision of the Supreme Court in Chugandas & Co.''s case (supra) could not, therefore, be of any assistance to the cause of the assessee who was claiming such a deduction of setting off of the interest amount on the borrowings raised for purposes of purchasing shares, and for other purposes of the business. The Tribunal having read those three decisions disallowed the claim of the assessee before it on the following grounds:

Now it is also well settled that it is not the gross amount of income, which is subject to charge, but what is chargeable is the gross amount less deductions specified under the relevant provisions of the income tax Act. In other words, while computing the income under the head, the deductions which are permissible under each of the heads specified in section 14 have to be allowed from the gross income under that particular head. The net amount so determined after making allowance for deductions in respect of the expenditure or deductions permissible under each head has to be computed under each head and thereafter has to be aggregated so as to determine the total income for the purpose of levy of tax. Section 2 (45) defines ''total income'' as total amount of income referred to in section 5, computed in the manner laid down in the Act. Therefore, the income under each head has to be computed in the manner laid down under the Act. The mere fact that the assessee had debited an amount of interest to its profit and loss account for the purpose of its own accounting would not per se mean that that interest is an allowance computing the income from business only and that splitting up on that amount was not permissible. As stated in the case of East India Housing & Land Development Trust Ltd. (supra), income derived from different sources falling under specific heads has to be computed for purpose of taxation in the manner provided by the appropriate section. Consequently, the amount of interest which is attributable to income chargeable under the head ''other sources'' in respect of the dividend income has to be deducted from the gross dividend income in order to determine the correct amount of dividend chargeable to tax. The only rational basis for computing the income, which falls for assessment under the two different heads, is the bifurcation of the amount spent by the assessee on a rational basis.

It is on the basis of this view that the Tribunal disallowed the claim in this matter of the assessee under reference. At this stage, it should be recalled that the assessee, H.K. Investment (P,) Ltd., had sought reference on the question about the admissibility of the claim of setting off of the interest income against the business income to this Court by Reference Application No. 58 of 1974-75 and other companion matters pertaining to the assessment years 1966-67 to 1969-70 and also whether the Tribunal was right in holding that only the gross amount of interest paid would enter into the computation for purposes of allocation between business income and dividend income, and not the net balance of the interest amount which is debited to the profit and loss account. This reference was disposed of as withdrawn and not pressed vide the order of this stage that when this reference was returned as not pressed, this Court was by its decision of 19/20-12-1975, in the matter of Addl. Commissioner of Income Tax Vs. Laxmi Agents P. Ltd. required to consider, inter alia, similar question as to whether the payment of interest by an assessee of amounts borrowed for purposes of investment must be allowed as business expenditure. The assessee before this Court in Laxmi Agents (P.) Ltd.''s case (supra) was a private limited company carrying on managing agency business and was acting as managing agents of Digvijay Cement Co. Ltd., Sikka, at the relevant time of the assessment years 1966-67 and 1967-68. The income of the said assessee-company comprised of managing agency business income from trading in shares and income from other sources, that is, dividends. For the assessment year 1966-67, the assessee-company had paid interest of Rs. 2,44,505 on the borrowings made by it and it, therefore, claimed this payment of interest as deduction from its business income. The ITO negatived the claim which was allowed by the AAC which view was affirmed by the Tribunal. In that context the Division Bench was required to consider whether the Tribunal was justified in affirming the view of the AAC who allowed the claim of the assessee. The Division Bench has answered that question in the affirmative, that is, in favour of the assessee and against the revenue. Since this decision of the Division Bench was not reported till 1980, the reference sought by H.K. Investment (P.) Ltd. where a similar question was referred to this Court which could have been answered in favour of the assessee in light of the decision of the Division Bench in Laxmi Agents (P.) Ltd.''s case (supra), remained unanswered since the assessee did not press for the reference which was made to this Court. In that state of affairs, therefore, when the appeal of the present applicant-assessee was disposed of by the Tribunal, its earlier decision in H.K. Investment (P.) Ltd.''s case (supra) was followed and the claim of the assessee was negatived. It is in this backdrop that the present reference has arisen and we have been called upon to give our opinion on the first question as to whether the assessee is entitled to set off of the entire amount of income deficit against its business income without bifurcation as has been done by the ITO and affirmed by the Tribunal.

In Laxmi Agents (P.) Ltd.''s case (supra) the Division Bench, speaking through T.U. Mehta, J. considered the relevant decisions on the point, namely, East India Housing Land Development Trust Ltd.''s case (supra), Commissioner of Income Tax,Madras Vs. Express Newspapers Ltd., Madras, , Bengal and Assam Investors Ltd. Vs. Commissioner of Income Tax, West Bengal, , Chugandas & Co.''s case (supra) and on construction of section 36(1)(iii) of the Act, concluded the legal position in the following terms:

It is true that, in ordinary course, according to general principles applicable to this question, expenditure incurred for earning income falling under a particular head should be deducted only under that head. But this general principle has to be read subject to the special provisions contained in clause (iii) of section 36(1) as regards deduction of interest...

This being a special provision regarding deduction of the interest amount, if a case falls within its terms, the general principles on which reliance is placed by the revenue would be of no avail to it...

The main requirement of the above quoted clause (iii) of section 36(1) is that the interest amount which is sought to be deducted in computing business income u/s 28 should be in respect of capital which is borrowed ''for the purpose of" business''. Therefore, if it is found in this case that the borrowings in question were made ''for the purpose of business'', clause (iii) of section 36(1) would have full application and deduction of interest amount must be made from profits and gains of business.

The facts of the case show and that is also the finding of the Tribunal that borrowings were made only for the purpose of the assessee''s business of managing agency. The assessee invested in shares of the managed company with a view to protect its managing agency business and hence the main, object of this investment was not to earn dividend, and if the borrowings were required to enable the assessee to purchase these shares, it must follow that the interest was paid on the capital borrowed for the purpose of business. If once it is established that capital was borrowed for the purpose of business, it is immaterial how that borrowed capital was applied because all that clause (iii) of section 36(1) requires is that borrowings, on which interest is paid, should be for the purpose of business..."

(Emphasis supplied)

Two important decisions were referred to in this connection by the Division Bench - one of the Supreme Court in India Cements Ltd. Vs. Commissioner of Income Tax, Madras, and another of the Bombay High Court in Calico Dyeing and Printing Works Vs. Commissioner of Income Tax, Bombay City-II, . The Division Bench also referred to its earlier decision in Commissioner of Income Tax, Gujarat II Vs. Alembic Glass Industries Ltd., where the Court was considering the case in the context of section 10(2)(iii) of the income tax Act, 1922, corresponding to section 36(1)(iii) of the Act. The pertinent observation of the Division Bench in Alembic Glass Industries Ltd.''s case (supra) reads as under:

... The High Court of Bombay has unequivocally stated in Calico Dyeing and Printing Works Vs. Commissioner of Income Tax, Bombay City-II, that in order to attract the provisions of section 10(2)(iii) it does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset, because all that the section requires is that the assessee must borrow the capital for the purpose of his business. This dichotomy between the borrowing of a loan and actual application thereof in the purchase of a capital asset, seems to be on the ground that a mere transaction of borrowing does not, by itself, bring any new asset of enduring nature into existence, and that it is the transaction of the investment of the borrowed capital in the purchase of the new asset which brings that asset into existence. Since the transaction of borrowing is not the same as the transaction of investment, the Supreme Court has observed in India Cements Ltd. Vs. Commissioner of Income Tax, Madras, that, for considering whether payment of interest on a borrowing is revenue expenditure or not, the purpose for which the borrowing is made is irrelevant...." (P. 727)

The Division Bench in Laxmi Agents (P.) Ltd.''s case (supra) thereafter observed as under:

The principle that income falling under a specific head should be made chargeable under that head even if it is earned for business purposes, is to be worked out only for the limited purpose of computing total income of an assessee...." (p. 236)

In support of the above view, the Division Bench drew support from the decisions of the Supreme Court in Chugandas & Co.''s case (supra), Commissioner of Income Tax, Andhra Pradesh Vs. Cocanada Radhaswami Bank Ltd., and Western States Trading Co. Ltd. Vs. Commissioner of Income Tax, Central Calcutta, . The Division Bench ultimately, therefore, in light of the above settled legal position ruled as under:

It is thus clear that even though an item of income falls under a specific head, in spite of -the fact that that item is earned for the purpose of the business, for purposes other than the computation of income, the commercial character of that income can be taken into account. In the case before us, the commercial character of that income becomes helpful to us in determining whether the borrowing on which the interest is paid was for the purpose of business. We, therefore, conclude on the second question that the Tribunal was right in holding that though the income from dividend has to be assessed under a separate head payment of interest by the assessee on amounts borrowed for purposes of investments must be allowed as business expenditure, and not as expenditure incurred for earning dividend..." (p. 238)

This decision has been followed in Commissioner of Income Tax, Gujarat-IV Vs. Cotton Fabrics Ltd., to which one of us (B.K. Mehta, J.) was a party. The Division Bench, speaking through Divan, CJ. (as he then was), in Cotton Fabrics Ltd.''s case (supra) was concerned with a similar claim by the assessee which was a private limited company carrying on business as a dealer in shares. The ITO separately computed the income from dividends chargeable under the head ''other sources'' and set off against the same interest amounting to Rs. 37,961 as the amount of interest attributable to and liable to be set off against the dividend income out of the total interest paid by the assessee on loans obtained or moneys borrowed for the purpose of the assessee''s business. The amount of loss determined by the assessee under the head ''Profits and gains from business'' was, accordingly, reduced by the sum of Rs. 37,961, which was apportioned against the dividend income. On appeal, the assessee''s claim was accepted which view was affirmed by the Tribunal and on reference to this Court at the instance of the revenue, the Division Bench following the earlier decision in Laxmi Agents (P.) Ltd.''s case (supra) ruled as under:

...It is thus clear that in the case of the present assessee, though the total income of the assessee is in the course of its business, it gets part of its income from dividends and computation of that income from dividends is to be done in accordance with the provisions of sections 56 and 57 of the income tax Act. But the computation having been so done, ultimately, it still forms part of the income of the business of the assessee and it is assessable as such as profits and gains of business carried on by the assessee. u/s 36 of the income tax Act, interest paid by an assessee for the purpose of carrying on its business is deducted in its entirety while computing profits and gains of the business and, therefore, it is not possible to allocate a portion of that interest as against income from dividends by stating that that interest had to be paid for the purpose of investing in shares held by the assessee." (p. 104)

The Division Bench, therefore, answered the question in affirmative and against the revenue. In view of this settled legal position, therefore, the aspect which we will be required to consider is whether the assessee was carrying on business in shares of its managed company as well as other companies. What is the nature of the borrowing is also required to be considered. It appears from the order of the ITO that the borrowings which the assessee raised are invested in the buildings in the partnership firms and in the investment in shares and the aggregate interest-deficit which the assessee was seeking to set off against the business income was allocated to three investments in the annexures to the order of the ITO. The allocation appears to have been made by rule of average. The Tribunal has not examined this aspect as to what is the nature of the business and the nature of borrowings and how they have been applied and without these facts being ascertained, we do not think that it would be possible for us to answer the question which has been referred to this Court. In the circumstances, therefore, two courses are open to us either to call for a supplementary statement of case from the Tribunal or to decline to answer the question raised by the Tribunal and to leave the Tribunal to take appropriate steps to adjust its decision in light of the answer by this Court. If we direct the Tribunal to submit a supplementary statement of case, the Tribunal will be restricted to the evidence on record and may not be entitled to have the benefit of the entire evidence relevant and material for the purpose in that behalf which would result into injustice. In the circumstances, we are, therefore, of opinion that we must adopt the alternative course as was done by the Supreme Court in COMMISSIONER OF Income Tax, WEST BENGAL I Vs. INDIAN MOLASSES CO. P. LTD., . In the circumstances, we, therefore, think it fit to decline to answer the first question on the ground that the Tribunal has failed to consider and decide the question as to whether the borrowing was for the purposes of the business of the company and has not considered the relevant principles enunciated by the Supreme Court as well as by this Court in that behalf. It will, thus, be open to the Tribunal to dispose of the appeal u/s 260(1) of the Act, in accordance with the correct principles of law indicated in this judgment after determining the different aspects of the question which ought to have been decided. Having regard to the facts that we have declined to answer Question No. 1, there should be no order as to costs in this reference.