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Judgment
T.L. Viswanatha Iyer, J.—One Sulaiman Rowther, the predecessor of the petitioner in this petition u/s 78 of the Kerala Agricultural Income Tax Act, 1991, was an assessee to tax under the Agricultural Income Tax Act, 1950 ("the Act", for brevity). We shall refer to him as the assessee for purposes of convenience. He owned agricultural lands. He had been granted credit facility by way of overdraft in the current account by the State Bank of India on the security of these lands, for the purpose of his agricultural operations. The interest due was not paid, with the result the bank debited the amount of interest accruing for each quarter in the current account, capitalised it and treated it as part of the principal for the ensuing quarter, as per the terms of the agreement between the parties.
An amount of Rs. 61,979.31 had thus been debited in the account as the interest payable during the year ending March 31, 1981, and capitalised, treating it as part of the principal for the ensuing period. The assessee claimed deduction of this amount as allowable expenditure under Clauses (e) and (f) of Section 5 of the Act. But the Agricultural Income Tax Officer refused to allow the claim. The Commissioner of Agricultural Income Tax, on a revision filed by the assessee, directed reconsideration of the matter, in the light of the provisions contained in Clauses (e) and (f) of Section 5, as also in accordance with the method of accounting followed by the assessee. The Agricultural Income Tax Officer did not however find his way to allow the deduction in the view that the assessee had not actually paid any amount by way of interest on the loan, the amount having been only debited in the loan account. The assessee took up the matter again in revision before the Commissioner reiterating his plea that once the amount of interest is debited in the current account, it tantamounts to actual payment thereof, creating an enforceable right in the bank to recover it along with the principal. It was further pointed out that the bank had, in fact, filed a suit for recovery of the principal and interest due. The Commissioner did not accept the contention, holding that the claim cannot be allowed in the absence of payment of the interest. Evidently, his view was also that actual cash payment (and not mere debiting in the account) was necessary, to enable the assessee to claim the deduction. The tax revision case is filed challenging the disallowance of the amount of interest by the authorities below.
The statutory provision is that contained in Clauses (e) and (f) of Section 5 of the Act, which we shall extract :
" 5. Computation of agricultural income.--The agricultural income of a person shall be computed after making the following deductions, namely :--....
(e) any interest paid in the previous year on any amount borrowed and actually spent on any capital expenditure incurred for the benefit of the land from which the agricultural income is derived ;
(f) where the land from which the agricultural income is derived is subject to a mortgage or other capital charge, any interest paid in the previous year in respect of such mortgage or charge ; "
What these Clauses postulate is interest paid on the amount borrowed and actually spent on any capital expenditure under Clause (e) and on the mortgage, under Clause (f). The question for consideration is whether debiting of the interest in the overdraft account of the assessee in the bank will tantamount to payment of interest.
Different contingencies may be visualised in relation to such loan transactions and the debiting of interest therein. The assessee may have an overdraft/cash credit account up to a certain limit from which he may make periodical withdrawals for the purpose of his operations. If the interest due is not paid, it will be debited in the account and treated as part of the principal for the ensuing period. The interest so debited may or may not be within the limit granted, according to the circumstances of a given case. The other case is that of a simple loan of a lump sum, the whole of which is withdrawn, but in respect of which the defaulted instalments of interest are debited, and become part of the principal.
The question is whether the assessee could be stated to have paid the interest when his account is in fact debited with the amount and accumulated as part of the principal amount due from him. The position as regards yearly, half-yearly or quarterly rests taken by the custom of bankers is that unpaid interest becomes part of the principal sum owing by the borrower. The unpaid interest becomes a principal sum owing in addition to the principal sum originally lent, and, as such, carrying its own interest charges. (Vide the Privy Council in Imperial Life Assurance Company of Canada v. Efficient Distributors Ltd. [1992] 2 WLR 503). Does this capitalisation of the interest amount to payment of the interest ? According to the assessee, it is, because the amount becomes a loan realisable from him on capitalisation. But we do not find it a fortiori case, as the assessee claims it to be. There cannot be any controversy at all on this point in the latter category of cases postulated by us earlier, of the advance of a definite amount in lump, and the debiting of the defaulted amount of interest against the borrower. The matter is squarely covered against the assessee by the decision of the House of Lords in Paton v. IRC [1938] 21 TC 626 ; [1938] AC 341 where one Fenton borrowed �2,50,000 from a bank on the security of his property. He paid nothing in the account in reduction of the principal or interest and the bank debited his account each half year with the interest and carried forward the accumulated amount. The question was whether the interest so debited was interest paid to the bank, entitling Fenton to repayment of the tax on the amount of the interest u/s 36(1) of the Income Tax Act, 1918. Lord Atkin dealt with the matter in great detail and observed as follows (at page 657 of 21 TC) :
" The question is whether, when the charges are added to the existing indebtedness at the end of one half-year, and the whole sum brought down is a debit item at the beginning of the next half-year so that interest is charged on the last half-year''s interest, the charges have been paid. The ordinary man would, I think, say that so far from being paid, they are added to the ordinary indebtedness, because they are not paid ; and I can see no reason why the law should say anything different."
In In re Jauncey : Bird v. Arnold [1926] 1 Ch 471, a mortgage deed contained a provision that whenever interest was in arrears for twenty-one days, it should be treated as an accretion to the capital and should thenceforth bear interest. It was contended in these circumstances that interest must be deemed to have been paid for purposes of the Real Property Limitation Act. Russell J. succinctly said that such a construction (at page 476) :
"... would really amount to a travesty of the actual facts ; because in the case of such a provision as is contained in the present deed, which enables the interest to be capitalised, the interest is not capitalised because it is in fact paid, but because it has in fact not been paid."
The position is, therefore, unexceptionable that there is no payment of interest at all where interest is capitalised in the case of a lump sum advance.
The same ratio must apply to those cases where the capitalisation of the interest renders the debt in excess of the limit of the facility afforded by way of overdraft/cash credit. In that event, there is no amount which the bank holds for his benefit and the capitalisation of the interest only enhances the liabilities, consequent on non-payment of the interest in time. The ratio in Paton''s case [1938] AC 341 (HL) and In re Jauncey [1926] 1 Ch 471, applies squarely to this type of cases so that when the interest is capitalised, there is no payment thereof as known to law.
The position is, however, different in those cases where the overdraft/cash credit facility is not fully drawn, and the capitalised amount of interest falls within the limit of the facility afforded. In such cases, the overdraft/cash credit facility constitutes a reservoir from which the customer can draw up to the limit allowed. The undrawn amount remains at his disposal to be utilised by him as and when required, with an obligation on the bank to honour cheques within the agreed limit of the facility, so long as the facility is not withdrawn (vide footnote No. 4 of Paget''s Law of Banking, Ninth edition). Therefore, if amounts remain to be drawn within the limit, and the capitalised interest falls within the said limit, a notional withdrawal of the amount of the interest from out of the facility and a notional payment of the same to the bank by way of interest could be contemplated. The amount is due and available to the customer under the facility in question from out of which he could draw, within the limit allowed. What the borrower does in effect is to make payment of the interest from out of the funds available to him, though the amount available in the overdraft/cash credit facility gets reduced to that extent in the process (vide Reddie v. Williamson [1863] 1 Macph 228). We are/therefore, of the opinion that in this class of cases, the amount of interest should be held to be paid, though by way of debit in the account of the facility afforded. We shall examine the assessee''s case in the light of these principles. The assessee had produced before the Commissioner, and has also produced before us, photostat copies of his current accounts with the bank. We find therefrom that the assessee had fully drawn the amounts which had been allowed to him by way of credit facility and the debit of the interest was over and above the limit of the facility. He was not in the habit of making any payment by way of principal or interest (except once), with the result interest went on accumulating. The facility was afforded to him in 1973, and it is the capitalisation of the interest in 1980-81, that is sought to be treated as payment of interest liable to be deducted. The amount due had increased over the years, and was far above the limit allowed, at the relevant time. The assessee''s case does not, therefore, fall within the category envisaged in the preceding paragraph which alone can qualify for the deduction. He has been overambitious with claims which, in the circumstances, can never fall within the purview of Clauses (e) and (f) of Section 5. The contention is totally without merit and we have no hesitation in rejecting it.
The tax revision case is, therefore, dismissed.