Commissioner of Income Tax vs Indian Overseas Bank Ltd.

The Court

In compliance with the direction of this Court contained in the Tribunal has referred the following question for the opinion of this Court :

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of Rs. 19,78,065 representing ''rebate

interest'' should be added to the ''cost of acquisition'' of the assessee-undertaking as on 18th July, 1969, and should, therefore, be deducted from

the compensation received by the assessee for the purpose of computing the ''capital gains'' assessable for the asst. yr. 1970-71 ?

Consequent upon the nationalisation of banks and acting under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970,

the banking business of the assessee-company was taken over by the nationalised institution, the Indian Overseas Bank, on 18th July, 1969. For

the asst. yr. 1970-71, the assessee worked out a capital loss of Rs. 19,19,539 originally and subsequently at a revised figure of Rs. 29,06,396.

This was based on the value of the undertaking as on 31st Dec., 1968. The ITO, in working out the capital gains, reduced the cost of acquisition

of the assets by a sum of Rs. 19,78,065 which represented what was called ""rebated interest"". On account of a peculiar system of noting

outstandings adopted by the assessee from year to year where an account was not active for a period such as six months or more, the interest

accruing to this account was not debited (credited) to the P&L a/c but to a separate account called ""rebated interest account"". According to the

assessee, this represented actual interest accrued but was not in the method of account followed merely debited to the P&L a/c direct. The ITO

held that this interest had not been credited and could not be taken account of since there was uncertainty of realisation of the disputed loans and

advances. On appeal, the AAC held that the sum of Rs. 19,78,065 should not be deducted from the value of the advances. Accordingly, the AAC

deleted the sum of Rs. 19,78,065.

On appeal, the Tribunal found that the sum of Rs. 19,78,065 really represented amounts which should have been debited to the party''s account

and transferred to the P&L a/c. The mere fact that in respect of parties where the accounts were not active for a period entries for interest were

not passed regularly, it did not mean that this interest had not accrued to the assessee or could not be claimed by the assessee. Therefore,

according to the Tribunal, this amount does not represent any bad debt as misunderstood by the ITO. Accordingly, the Tribunal confirmed the

order passed by the AAC and held that the assessment be reduced by Rs. 19,78,065.

Learned standing counsel for the Department submitted that the debt itself was doubtful and it was shown by the assessee as can be seen from

the fact that a separate account of rebated interest was made out. Therefore, the sum of Rs. 19,78,065 could not be excluded. It was also pointed

out that the bank never treated this interest as its income. Learned standing counsel further submitted that the Tribunal, instead of following the

provisions contained in s. 45 r/w s. 48 of the Act, misdirected itself in following the accounting principles for granting the relief to the assessee in so

far as the sum of Rs. 19,78,065 is concerned. According to learned standing counsel, the loan in the present case is a sticky loan and the interest

due thereon is the income of the assessee as per the decision of the Supreme Court in State Bank of Travancore Vs. Commissioner of Income

Tax, Kerala, Learned standing counsel contended that the Tribunal has not ascertained what is the cost of acquisition and what is the value of

improvement in order to ascertain the value of the undertaking for the purpose of levying capital gain tax under s. 45 of the Act. For these reasons,

it was submitted that the Tribunal was not correct in holding that the assessee is entitled to a deduction of a sum of Rs. 19,78,065 from the

assessment.

On the other hand, learned counsel appearing for the assessee submitted that the rebated interest represents as much interest accrued as other

interest. On account of a peculiar system of nothing outstanding adopted by the assessee from year to year, where if an account is not active for a

period such as six months or more, the interest accruing to his account is not debited (credited) to the P&L a/c but to a separate account called

rebated interest account. As and when the accounts get worked on again, the interests accruing or received are transferred to the P&L a/c and

accounted for as income. The credit is given to a suspense account. This is not a bad debt or even an amount not recoverable. Learned counsel

further pointed out that since the assessee is adopting the mercantile system of accounting, the above said income credited and the assessee has

also paid tax on such income. For these reasons, it was stated that the Tribunal was correct in holding that the assessee is entitled to deduction of

Rs. 19,78,065 from the assessment of that year.

We have heard both learned standing counsel appearing for the Department as well as learned counsel appearing for the assessee. The fact

remains that consequent on the nationalisation of banks and acting under the Banking Companies (Acquisition and Transfer of Undertakings) Act,

1970, the baking business of the assessee was taken over by the Indian Overseas Bank. The assessee worked out a capital loss of Rs. 19,19,539

on the transfer. This figure was subsequently modified to Rs. 29,06,396. The undertaking was taken over on 18th July, 1969. The assessee had

drawn up a balance sheet as on 18th July, 1969. On the basis of this, the capital loss was worked out by the assessee again on Rs. 59,33,891.

This was done by revaluing the assets and adding an amount of Rs. 19,78,065 as rebated interest. According to the assessee, it follows the

mercantile system of accounting and Rs. 19,78,065 was credited in this assessment year. This is not a bad debt or even an amount not

recoverable. The assessee has paid Income Tax on this amount. According to the assessee, the system of accounting followed by it is such that

when the loan amount is not recoverable for a period of six months or more, it will be mentioned under the head ""rebated interest account"". As and

when the interests accrued or received, they were transferred to the P&L a/c and accounted for as income. Ultimately, the assessee claimed the

abovesaid sum of Rs. 19,78,065 as part of the value of the undertaking taken over under the Banking Companies (Acquisition and Transfer of

Undertakings) Act, 1970.

While considering the sticky loan and the interest accrued thereon, the Supreme Court in State Bank of Travancore vs. CIT (supra) has held as

under :

... the interest on ''sticky'' advances had accrued according to the mercantile system of accounting and the appellant had debited the respective

parties with the interest. After the close of the accounting year, the appellant, without giving up the interest, which it could have, as a bad debt, did

not offer it for taxation but carried it to the ''Interest Suspense Account''. Carrying a certain amount which had accrued as interest without treating it

as a bad debt or irrecoverable interest but keeping it in suspense account was repugnant to s. 36(1)(vii) r/w s. 36(2) of the IT Act, 1961. The

concept of real income could not be so read as to defeat the object and the provision of the statutory enactment. Even if in a given circumstance,

the amount might be taken to the Interest Suspense Account for accounting purposes, that would not affect its taxability as such. The interest on

''sticky'' advances was rightly treated as income which had accrued to the appellant.

In Commissioner of Income Tax, Bangalore Vs. B.C. Srinivasa Setty, the Supreme Court, while considering the provisions of s. 2(14), 45,

48(ii), 49, 50, 55(2), (3) of the IT Act, held as under :

Sec. 45 is a charging section. For the purpose of imposing the charge, Parliament has enacted detailed provisions in order to compute the profits

or gains under that head. No existing principle or provision at variance with them can be applied for determining the chargeable profits and gains.

All transactions encompassed by s. 45 must fall under the governance of its computation provisions. A transaction to which those provisions

cannot be applied must be regarded as never intended by s. 45 to be the subject of the charge. This inference flows from the general arrangement

of the provisions in the IT Act, where under each head of income the charging provision is accompanied by a set of provisions for computing the

income subject to that charge. The character of the computation provisions in each case bears a relationship to the nature of the charge. Thus, the

charging section and the computation provisions together constitute an integrated code. When there is a case to which the computation provisions

cannot apply at all, it is evident that such a case was not intended to fall within the charging section. Otherwise, one would be driven to conclude

that while a certain income seems to fall within the charging section there is no scheme of computation for quantifying it. The legislative pattern

discernible in the Act is against such a conclusion. It must be borne in mind that the legislative intent is presumed to run uniformly through the entire

conspectus of provisions pertaining to each head of income. No doubt there is a qualitative difference between the charging provision and a

computation provision. And ordinarily the operation of the charging provision cannot be affected by the construction of a particular computation

provision. But the question here is whether it is possible to apply the computation provision at all if a certain interpretation is pressed on the

charging provision. That pertains to the fundamental integrality of the statutory scheme provided for each head.

The point to consider then is whether if the expression ''asset'' in s. 45 is construed as including the goodwill of a new business, it is possible to

apply the computation sections for quantifying the profits and gains on its transfer.

The mode of computation and deductions set forth in s. 48 provided the principal basis for quantifying the income chargeable under the head

''Capital gains''. The section provides that the income chargeable under that head shall be computed by deducting from the full value of the

consideration received or accruing as a result of the transfer of the capital asset :

''(ii) the cost of acquisition of the capital asset...''

What is contemplated is an asset in the acquisition of which it is possible to envisage a cost. The intent goes to the nature and character of the

asset, that it is an asset which possesses the inherent quality of being available on the expenditure of money to a person seeking to acquire it. It is

immaterial that although the asset belongs to such a class, it may, on the facts of a certain case, be acquired without the payment of money. That

kind of case is covered by s. 49 and its cost, for the purpose of s. 48, is determined in accordance with those provisions. There are other

provisions which indicate that s. 48 is concerned with an asset capable of acquisition at a cost. Sec. 50 is one such provision. So also is sub-s. (2)

of s. 55. None of the provisions pertaining to the head ''Capital gains'' suggests that they include an asset in the acquisition of which no cost at all

can be conceived. Yet there are assets which are acquired by way of production in which no cost element can be identified or envisaged. From

what has gone before, it is apparent that the goodwill generated in a new business has been so regarded. The elements which create it have already

been detailed. In such a case, when the asset is sold and the consideration is brought to tax, what is charged is the capital value of the asset and not

any profit or gain.

Therefore, for levying capital gain tax under s. 45 r/w s. 48, capital gain has got to be ascertained after deducting from the total value of the

undertaking the cost of acquisition and the cost of improvement. If there is no cost of acquisition, then there could be no question of levying capital

gain tax under s. 45 of the Act. A similar question came up for consideration before the Karnataka High Court in Syndicate Bank Ltd. Vs.

Additional Commissioner of Income Tax, wherein the High Court, considering the provisions of s. 2(14), 45 and 48 of the IT Act, read with the

Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 held as under :

The term capital asset as defined in s. 2(14) of the IT Act, 1961, has a wide meaning and includes every kind of property as generally understood

except those that are expressly excluded in the definition. A business undertaking as a whole would constitute a capital asset within the meaning of

s. 2(14). However, in deciding whether Income Tax can be levied on capital gains, the following points have to be taken into account - (i) There

are assets of different nature, those involving cost in their acquisition and those which could be acquired by way of production in which the cost

element cannot be identified. But none of the provisions pertaining to ''capital gains'' suggest that they include an asset in the acquisition of which no

cost at all can be conceived; (ii) the cost of acquisition mentioned in s. 48 implies a date of acquisition; and (ii) if the cost of acquisition and/or the

date of acquisition of the asset cannot be determined, then, it cannot be described as an ''asset'' within the meaning of s. 45 and, therefore, its

transfer is not subject to Income Tax under the head ''Capital gains''.

In the present case, according to the assessee, the ITO erred in reducing from the cost of the acquisition a sum of Rs. 19,78,065 on the ground

that this cannot be treated as interest due to uncertainty of realisation of the disputed loan and advances without properly appreciating the nature of

rebated interest account"". The amount of Rs. 19,78,065 represents accumulated interest receivable as advances which had been outstanding for a

period beyond such specified periods without operation and, therefore, not credited to the P&L a/c. As and when the advances become operative

the corresponding amounts would be transferred from the rebated interest account to the P&L a/c. Therefore, the amount accumulated in the

rebated interest account could not be treated as liabilities even though for the purpose of preparation of the balance-sheet they are included in the

liabilities side. The assessee paid Income Tax on this account. According to the decisions cited supra, this kind of sticky loans are income of the

assessee. Therefore, there is no question of excluding this amount while ascertaining the cost of acquisition. In the instant case, the question is

whether this kind of sticky loan can be included in the cost of acquisition. The answer is yes. Accordingly, the order passed by the Tribunal in

holding that sticky loan should not be excluded while ascertaining the cost of acquisition is in order. Thus, we answer the question referred to us in

the affirmative and against the Department. No costs. Counsel''s fee Rs. 1,000.