Commissioner of Income Tax vs Bank of Madura Ltd.

Thanikkachalam, J.—At the instance of the Department under s. 256(1) of the IT Act, 1961 (hereinafter referred to as ""the Act""), the

Tribunal referred the following two questions for our opinion :

Whether the amounts of Rs. 7,27,292 for the asst. yr. 1975-76 and Rs. 19,69,989 for the asst. yr. 1976-77 collected at the rate of 7% of the

interest on loans and advances are interest within the meaning of s. 2(7) of the Interest-tax Act, 1974 ?

Whether the Tribunal was right in holding that only what is paid as per contract will be interest and what is paid voluntarily by the debtor is not

interest ?

The assessee is Bank of Madura Ltd., Madras. The statement of the case relates to the asst. yrs. 1975-76 and 1976-77. The accounting years

are the respective calender years 1974 and 1975. The assessee is a non-nationalised banking company. The assessee has made loans and

advances to various parties at specified rates of interest. The Interest-tax Act, 1974, came into force w.e.f. 1st Aug., 1974. That Act provided that

tax will be levied on banking companies at the rate of 7% on the amount of interest accruing or arising to the bank in the relevant accounting year.

So the assessee-bank found out a device by which that 7% or a substantial portion of it could be passed on to the debtors or reimbursed. So the

assessee issued a circular to its branch offices, which reads as follows :

Bank of Madura Ltd.,

Central office, Madurai

Accounts and Statistics

19th Dec., 1974

BID/CIR : GEN : MISC : 57/74

28th Aghn., 1896

CIRCULAR

Interest-tax Act, 1974 - 7% tax on interest, loans and advances

The Interest-tax Act, 1974, enacted by Parliament recently, envisages the levy of a special tax at 7% on the total amount of interest, accruing or

arising to banks every accounting year. Consequently, it has been decided to collect the special taxes from the borrowers for payment to the

Government exchequer.

Branches are hereby requested to study the following instructions carefully and adopt the enunciated procedure for the recovery of the special tax.

(1) The special tax is leviable on the interest debited to the various loans and advances accounts after 1st Aug., 1974.

(2) The special tax is not applicable on interest on loans and advances made to other scheduled banks and the discount on treasury bills.

(3) Interest means interest on loans and advances made in India and includes, -

(a) commitment charges on unutilised portion of any credit limits sanctioned for being availed of in India; and

(b) discount on promissory notes and bills of exchange drawn or made in India,

but does not include the items mentioned in (2) above.

In our bank, the 7% tax is leviable on the interest on loans and advances and interest and discount on local bills discounted, usance bills

discounted, bills purchased clean and bills purchased documentary.

(4) The tax is to be debited/recovered at the rate of 7% at the time of every quarterly interest application or closing of the relevant account

whichever is earlier.

(5) With regard to the interest debited already for the quarter ended 30th Sept., 1974, the tax on that part of the interest which relates to the

months August and September, 1974, has to be collected this month. The tax collected for the five months August to December, 1974, should be

credited in your P&L account under a separate head styled ''Special tax account''.

A similar procedure should be followed with regard to the interest discount, etc., collected in subsequent quarters.

(Sd.)

Deputy Chief Officer.

On the basis of that circular the bank began to collect extra 7% from its debtors. Many people who had already availed of the loan facilities before

the date of circular, protested against such additional levy. So, in their case, it was not levied or if levied, then waived and if collected refunded.

The total levy for the asst. yr. 1975-76 was about Rs. 13 lakhs and about Rs. 6 lakhs were so waived or refunded so that the net amount

chargeable and in controversy before us is only Rs. 7,27,292 for the asst. yr. 1975-76 and for the asst. yr. 1976-77 it is Rs. 19,69,989. The

assessee had offered this 7% so collected for the purposes of IT assessment. But the assessee contended in interest-tax proceedings that it is not

interest and, therefore, not chargeable to tax under the Interest-tax Act. The IT authorities decided against the assessee.

Aggrieved, the assessee filed appeals before the Tribunal. The Tribunal held that the amount so collected is not interest within the meaning of

interest"" in s. 2(7) of the Interest-tax Act, because, according to the Tribunal, it is not interest on loans and advances, but only interest on interest.

Before the Tribunal, the assessee made an alternative submission. According to the assessee, it was not interest at all ether in law or under any

statute for the time being in force. The Tribunal, accordingly, classified the amount into two categories, viz., amounts paid by the debtors voluntarily

and the amounts paid by the party as part of the contract. According to the Tribunal, what is paid voluntarily is not interest and what is paid as per

the terms of the contract is interest. Therefore, the Tribunal originally thought that the case must be referred back for determination of the amounts

falling under these two categories, but since the Tribunal ultimately came to the conclusion that it is not interest on loans and advances, the case

was not referred back. Accordingly, the Tribunal held that it is not interest on loans and advances under the Interest-tax Act.

Learned standing counsel for the Department submitted as under :

The amount of 7% collected is at least in substance interest on loans and advances. This 7% on interest amount is only a method of determination

of the quantum of interest that can be collected and that what is collected as extra interest of 7% is really in form and in substance interest on such

advances and loans. The assessee-bank collected 7% tax payable by it from its borrowers. The interest is payable on the principal sum by the

borrower since he is utilising the borrowed amount for his own benefit. The 7% collected by the bank is related to the borrowing by the borrower.

The bank after collecting the 7% is paying the tax payable by it under the Interest-tax Act. The 7% collected from the borrowers by the bank is in

turn paid by the assessee-bank towards the tax payable by it under the Interest-tax Act. It cannot be said that by diversion by overriding title the

assessee-bank is not receiving this 7%. Since the collection of 7% reached the hands of the assessee-bank, the question of diversion by overriding

title cannot arise. The bank has no authority to collect tax from the borrowers. The tax was levied on the interest amount collected by the bank.

Even though the collection of 7% is illegal, it is taxable as interest in the hands of the assessee under the Interest-tax Act. It was, therefore, pleaded

that the Tribunal was not correct in holding that 7% collected by the assessee-bank from its borrowers is not interest under the Interest-tax Act.

On the other hand, learned counsel appearing for the assessee submitted as under :

Under the Interest-tax Act, 1974, interest was levied at 7% on the interest collected by the assessee-bank. The assessee-bank is collecting the

said 7% tax from the borrowers and paying the same as tax under the Interest-tax Act. This collection of 7% was offered for Income Tax

purposes and the tax was levied on such collection. The assessee-bank is collecting the amounts under various heads. All these amounts would not

come under the caption ""interest"". The assessee is paying the advance tax under the Interest-tax Act, 1974, every three months. There is no

prohibition for the assessee-bank to collect this 7% tax from the borrowers. Since the assessee-bank used to collect this tax amount from the

borrowers and paying the same as tax under the Interest-tax Act, 1974, by diversion by overriding title, the assessee has no interest over this

amount. The assessee-bank is not collecting 7% on the amounts advanced. The collection of 7% is on the interest payable by the borrowers. If

once this collection does not come under the purview of interest, as contemplated under the Interest-tax Act, 1974, then no tax under the said Act

can be levied. This 7% was collected from the borrowers not along with the 12% interest charged by the assessee-bank. But this 7% is collected

separately under a different head and credited in the books of account under the head ""Special tax accounts"". For all these reasons, it was

submitted, that the Tribunal was correct in holding that the 7% of the amount collected by the assessee from its borrowers is not interest under the

Interest-tax Act. In order to support this contention, learned counsel appearing for the assessee relied upon the decision in Commissioner of

Income Tax Vs. State Bank of Indore, and Commissioner of Income Tax Vs. Canara Bank, .

We have heard the rival submissions.

The fact remains that the assessee-bank has made loans and advances to various parties at certain specified rates of interest. The assessee-bank

was charging 12% interest from its borrowers. The Interest-tax Act came into force w.e.f. 1st Aug., 1974, according to which, tax will be

collected on banking companies at the rate of 7% on the amount of interest accruing or arising to the bank in the relevant accounting year. In the

asst. yrs. 1975-76 and 1976-77, the assessee collected Rs. 7,27,292 and Rs. 19,69,989, respectively. According to the assessee-bank, these

amounts so collected are not interest within the meaning of ""interest"" under the Interest-tax Act, since it is not interest on loans and advances. But

according to the Department, the amount of 7% collected by the assessee-bank is in the nature of interest and, therefore, tax is payable on this

collection as per the provisions of the Interest-tax Act, 1974.

Sec. 2(5) of the Interest-tax Act, 1974, defines ""chargeable interest"". Chargeable interest means the total amount of interest referred to in s. 5,

computed in the manner laid down in s. 6. Sec. 2(7) defines ""interest"". Interest means interest on loans and advances made in India and includes

(a) commitment charges on the unutilised portion of any credit sanctioned for being availed of in India, and (b) discount on promissory notes and

bills of exchange drawn or made in India; but does not include : (i) any amount chargeable to Income Tax, under the IT Act, under the head

Interest on securities""; (ii) discount on treasury bills; and (iii) interest on moneys lent for the creation of a capital asset in India where the agreement

under which such moneys are lent provides for the repayment thereof during a period of not less than seven years. Sec. 4 deals with charge of tax

in the following manner :

Subject to the provisions of this Act, there shall be charged on every scheduled bank for every assessment year commencing on or after the 1st

day of April, 1975, a tax (in this Act referred to as ''interest-tax'') in respect of its chargeable interest of the previous year at the rate of 7% of such

chargeable interest.

Sec. 5 deals with the scope of chargeable interest as, ""subject to the provisions of this Act, the chargeable interest of any previous year of a

scheduled bank shall be the total amount of interest (other than interest on loans and advances made to scheduled banks) accruing or arising to the

bank in that previous year.....

According to the assessee-bank, the 7% amount collected by it was credited in its books of account under the caption ""Special tax accounts"".

The assessee offered these amounts collected by it for Income Tax purposes. According to the assessee, the 7% collected from the borrowers has

no connection with the loans and advances made to the borrowers. In fact, the tax payable by the assessee-bank was collected from the

borrowers. Therefore, it will not come under the definition of interest under the Interest-tax Act. It is the case of the assessee that by diversion by

overriding title the amount collected by the assessee-bank reached the hands of the taxing authorities. But, learned standing counsel pointed out

that, if these collections before reaching the hands of the assessee, reached the hands of the collector, then the question of diversion by overriding

title would arise. In the present case, the amounts were collected by the bank and it reached the hands of the assessee and it is only thereafter the

assessee is paying the tax to the tax authorities. Therefore, according to learned standing counsel, the principle of diversion by overriding title

would not be applicable to the facts of the case. In order to elucidate this point, learned standing counsel relied upon a decision in The

Commissioner of Income Tax, Bombay City II Vs. Shri Sitaldas Tirathdas, . In the said decision, while considering the principle of diversion by

overriding title, the Supreme Court held : ""the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his

income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between

an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of

the income of the assessee. Where, by the obligation, income is diverted before it reaches the assessee, it is deductible; but where the income is

required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the

first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one''s

own income which has been received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were

to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable. In our opinion, the present case is one in

which the wife and children of the assessee continued to be members of the family and received a portion of the income of the assessee, after the

assessee had received the income as his own. The case is one of application of a portion of the income to discharge an obligation and not a case in

which by an overriding charge the assessee became only a collector of another''s income. The matter in the present case would have been different,

if such an overriding charge had existed either upon the property or upon its income, which is not the case"". According to the facts arising in the

present case, the assessee-bank collected the amounts and then paid the tax under the Interest-tax Act. If once the collection reached the hands of

the assessee, then it is not possible to say that the principle of diversion by overriding title would apply.

Learned counsel appearing for the assessee relied upon a decision in CIT vs. State Bank of Indore (supra). According to the facts arising in this

case, the assessee, a banking-company, purchased bills of exchange drawn by its constituents, and in some cases, on account of delay in payment

beyond the days of grace, received liquidated damages by way of compensation. In the assessment proceedings under the Interest-tax Act, the

assessee claimed that the amount received as damages was not interest on loans and advances exigible to tax under the Interest-tax Act. The

assessee further contended that it had to pay to the Industrial Development Bank of India (IDBI) rediscounting charges and after adjusting that

amount against the discount charges recovered by the assessee, the balance alone should be held exigible to tax. On these facts, the Madhya

Pradesh High Court held ""under the Bills Rediscounting Scheme, when bills were rediscounted by the assessee, there was an overriding title of the

IDBI and the assessee had to part with a portion of the discounting charges. Therefore, the amounts paid to the IDBI as rediscounting charges

could not be held to be exigible to tax under the Interest-tax Act"".

Yet another decision relied upon by learned counsel appearing for the assessee was that reported in CIT vs. Canara Bank (supra). According

to the facts arising in this case, the assessee was assessed under the Interest-tax Act for the asst. yr. 1975-76. The assessee filed a return admitting

chargeable interest of Rs. 80,81,25,641. The assessee had not included in the return a sum of Rs. 80,55,976 since, according to it, the said sum

did not represent interest income at all as the correct interest income to be taken into account was the net income after setting off the rediscounting

charges paid to the Reserve Bank of India (RBI) and the IDBI under the IDBI Bills Rediscounting Scheme. On these facts, the Karnataka High

Court held that ""under the scheme, the assessee-bank was only a medium or conduit pipe for disbursement of the development fund for the

implementation of the scheme for which it could retain upto 1.75% which alone accrued to the bank and in respect of the remaining interest

received from the purchaser on the advance made to him, there was an overriding title of the IDBI. Therefore, the Tribunal was right in holding that

the sum of Rs. 80,55,976 representing the rediscounting interest paid on bills did not form part of the interest income of the assessee chargeable

under the provisions of the Interest-tax Act, 1974"".

The facts arising in the present case would go to show that the tax was levied under the Interest-tax Act, 1974, against the assessee in respect of

the tax collected from its borrowers and credited the same in the books of account under the head ""Special tax accounts"". This amount collected

by the assessee-bank was offered for tax under the IT assessment. There is no prohibition for the bank to collect the tax payable by it from its

borrowers under the various heads for various purposes. The bank was charging interest at 12% on the amount advanced by it to its borrowers.

The amount of 7% collected from the borrowers is for the purpose of paying tax under the Interest-tax Act. In fact, the collection of these amounts

has no nexus with the amount advanced by the assessee-bank to its borrowers. In reality, it is interest on interest. It is stated that there is an oral

contract between the borrowers and the bank for the payment of 7% on the borrowed amount. The amount collected at 7% by the bank was paid

as tax under the Interest-tax Act, 1974. The assessee-bank is also offering this 7% collection for Income Tax purposes and Income Tax was

levied thereon. The assessee-bank has to pay advance tax every three months. Therefore, the amount collected by the assessee-bank, though it

reached its hands, ultimately went into the coffers of the Government. The assessee-bank is not appropriating the said amount for its own benefit.

Under the law there is no prohibition for such collection. Thus, considering the facts arising in this case in the light of the judicial pronouncements

cited supra, we hold that the Tribunal was correct in holding that 7% amount collected by the assessee-bank would not fall under the definition

interest"" as stated in s. 2(7) of the Interest-tax Act. Accordingly, we answer the questions referred to us in the affirmative and against the

Department. No costs. Counsel''s fee is fixed at Rs. 1,000.