Commissioner of Income Tax vs Khivaraj Motors Ltd.

Thanikkachalam, J.—At the instance of the Department, the Tribunal referred the following common question for the asst. yrs. 1977-78 to

1979-80 for the opinion of this Court under s. 256(1) of the IT Act, 1961 (hereinafter referred to as ""the Act"") :

Whether, on the facts and in the circumstances of the case and having regard to the provision of s. 40A(8) r/w Expln. (b) to the said section, the

Tribunal was right in holding that the ITO was not justified in disallowing the interest paid to the directors on their current running accounts with the

assessee-company under s. 40A(8) of the Act ?

The assessee-company was a private limited company, but because its turnover had exceeded rupees one crore, it is deemed to be a public

limited company. During the asst. yr. 1977-78, interest accrued and became due to the four directors, Khivaraji Chordia, Devarajji Chordia,

Prafulchand Chordia and Sainikraj Chordia, to the extent of Rs. 4,41,450. For the asst. yr. 1978-79 interest accrued and became due to the four

directors to the extent of Rs. 13,02,944.67. Similarly, for the asst. yr. 1979-80, interest accrued and became due to the four directors on moneys

left with the company to the extent of Rs. 11,23,785.50. For the asst. yr. 1977-78, by order dt. 24th January, 1978, the ITO without giving any

reason, disallowed under s. 40A(8) of the Act, interest of 15 per cent on Rs. 7,09,938. But a rectification order was passed on 5th April, 1978,

restricting the disallowance at 15 per cent on interest of Rs. 4,41,450. For the asst. yr. 1978-79, by order dt. 17th April, 1979, the ITO

disallowed interest under s. 40A(8) of the Act of Rs. 1,95,541. Similarly, for the asst. yr. 1979-80, the 15 per cent disallowance of interest under

s. 40A(8) came to Rs. 1,68,567. The assessee filed appeals to the CIT(A). The CIT(A) held that the moneys of the directors with the company

amount to a deposit or borrowing by the company and hence he held that s. 40A(8) of the Act applied and confirmed the disallowance of 15 per

cent interest accrued due to the directors in the company. As against such order, the assessee filed appeals before the Tribunal. The Tribunal had

gone through the rationale behind the introduction of s. 40A(8) of the Act by the Finance Act, 1975, w.e.f. 1st April, 1976, and had also

considered the Finance Ministers Speech at page 113 (St.) of 98 ITR. The Tribunal was of the view that the amounts left by the directors with the

assessee could not be considered as a deposit. The Tribunal, for the reasons given by it, held that the provisions of s. 40A(8) of the Act did not

apply and the disallowance of 15 per cent of the accrued interest due to the directors for the three years was not warranted. Regarding the

alternative plea about the non-applicability of s. 40A(8) of the Act on the ground that a substantial portion of the interest amounts were only

interest on interest, the Tribunal observed that no elaboration was necessary on this point in view of its finding in the assessee''s favour on the main

question. Thus, the Tribunal allowed the assessee''s appeal.

Learned standing counsel appearing for the Department submitted that the definition of the term deposit as per Expln. (b) to s. 40A(8) is very

comprehensive, in that it means any deposit of money and includes any money borrowed by a company. Such definition does not include any

amount received by the company in respect of nine items mentioned therein. According to learned standing counsel, the interest has been allowed

to the assessee as a deduction only as interest on the capital borrowed by the company and was allowable under s. 36(1)(iii) of the Act.

Therefore, according to learned standing counsel, the moneys of the directors with the company amount to a deposit or borrowing by the company

and hence s. 40A(8) of the Act applies and disallowance of 15 per cent of interest accrued due to the directors in the company is warranted.

According to learned standing counsel even the current account of the directors with the company would fall under s. 40A(8) of the Act. In order

to support his contention, learned standing counsel for the Department relied upon the following decisions :

(1) Commissioner of Income Tax Vs. Gandhi Metals Mills (P) Ltd., .

(2) Agew Steel Manufacturers Pvt. Ltd. Vs. Commissioner of Income Tax, .

(3) Commissioner of Income Tax Vs. Jhaveri Bros. and Co. Pvt. Ltd., .

(4) Daga and Co. (P) Ltd. vs. CIT [IT Ref. No. 148 of 1985, decided on 14th February, 1990 by the Calcutta High Court].

Learned standing counsel also drew our attention to a passage occurring in Sampath Iyengars Law of Income Tax. 9th Edn., at pp. 2826 and

2827.

On the other hand, learned counsel appearing for the assessee submitted that the amounts left by the directors in the company are not capital

borrowed by the company and the interest deduction in the case of the assessee is allowable under s. 37 of the Act as expenditure laid out or

expended wholly and exclusively for the purpose of the business. A perusal of the account entries would go to show that the directors had left their

moneys in the company and the company had maintained a running account and on different dates moneys were withdrawn by the directors or

paid by the directors to the company. This would show that the nature of the transaction was only a running current account. It was further

submitted that a substantial portion of interest for the three years in respect of the directors related to interest on interest and hence such interest on

interest amounts cannot be treated as deposits or borrowing to attract s. 40A(8) of the Act. Therefore, according to learned counsel appearing for

the assessee, the disallowance of 15 per cent of the interest payment under s. 40A(8) was incorrect and the Tribunal was correct in deleting the

disallowance. In order to support his contention, learned counsel appearing for the assessee relied upon the decision in K.M.S. Lakshmanier and

Sons Vs. Commissioner of Income Tax and Excess Profits Tax, Madras, and Commissioner of Income Tax, Lucknow Vs. Bazpur Co-operative

Sugar Factory Limited, .

We have already set out the facts in detail. Four of the company directors made deposits with the company. The point for consideration is,

whether such deposits made by the company''s directors are hit by s. 40A(8) of the IT Act, 1961. The expression deposit has been defined in

Expln. (b) to s. 40A(8) of the Act. It means any deposit of money, which includes any money borrowed by a company, but does not include any

amount received by the company mentioned in sub-cls. (i) to (ix). The deposits made by the directors do not form part of any of the exempted

categories.

The passage occurring in Sampath Iyengars Law of Income Tax, 9th Edn., p. 2826, is stated as under :

In legal parlance, a general deposit is where the money deposited itself is not returned but equivalent to the money (i.e., a like sum) is to be

returned. A perusal of s. 40A(8) of the Act shows that the word deposit mentioned therein has not clearly been defined. In the Expln. to s.

40A(8), an inclusive definition of deposit has been given which states that the word deposit means any deposit of money with, and includes any

money borrowed by, a company. This Expln. in cl. (b) has defined the word deposit in a wider sense and besides any deposit of money with the

company, the money borrowed by the company is also taken within the ambit of the word deposit. A distinction has been drawn in this definition

with regard to the deposit of money and money borrowed. In the said Explanation, certain exceptions have been provided which would not include

the amount received by the company as deposit.

Admittedly, the amount deposited by a director in the company in its current account has not been excluded therefrom. The deposits which are

understood in the business of a bank may be in the current account, savings bank account and fixed deposit account. The payment in the current

account cannot be excluded from the nature of deposits which are made in the bank. The only distinction between a fixed deposit and this deposit

is that the term for which the payment has been made in the case of a fixed deposit is a fixed one whereas, in the case of a current account, no time

is fixed therein and this distinction will not take the amount outside the purview of the deposit used in the clause. Any assistance from the

Companies (Acceptance of Deposits) Rules, 1975, cannot be taken because the said Rules came into force on 3rd February, 1975, and cl. (ix)

was specifically added in the definition of deposit in the said Rules w.e.f. 18th September, 1975, which excluded deposits by the directors from the

term deposit. This specific exclusion by the amendment in the Rules makes it more clear that deposits by the directors were included in the term

deposit and it is by way of a specific provision that the same has been excluded. The words ''deposit by the director'' which were excluded by the

insertion of cl. (ix) refers to all deposits whether they are for a fixed period or in their current accounts. In the Expln. to s. 40A(8) referred to

above, by defining the word deposit, no such exclusion has been made and, therefore, deposits by the directors in their current accounts cannot be

excluded. On a correct interpretation of the provisions of s. 40A(8), the payments which are made by a director to the company in the current

account of the said director on which the company is paying interest will be considered as a deposit. Accordingly, interest paid by a company on

current account of the directors was disallowable under s. 40A(8). However, a contrary view has also been taken.

This passage is based upon the following decisions :

(1) CIT vs. Gandhi Metals Mills (P) Ltd. (supra).

(2) Agew Steel Mfrs. (P) Ltd. vs. CIT (supra).

(3) Daga & Co. P. Ltd. vs. CIT (supra)

(4) CIT vs. Jhaveri Bros. & Co. (P) Ltd. (supra).

A contrary view was taken by the Madhya Pradesh High Court in Commissioner of Income Tax Vs. Kalani Asbestos (P.) Ltd., . According to

the Madhya Pradesh High Court, interest paid to directors and shareholders on current accounts with the company on which 15 per cent. of the

interest cannot be disallowed under s. 40A(8) of the Act.

Learned counsel appearing for the assessee relied upon the decision in K.M.S. Lakshmanier and Sons Vs. Commissioner of Income Tax and

Excess Profits Tax, Madras, . According to the facts arising in the abovesaid decision, the assessees were the sole selling agents for yarn

manufactured by a textile mill and they distributed yarn to customers under forward contracts in respect of which they obtained from their

customers advances of moneys which were adjusted towards the final payment of purchase price at the time of delivery of goods. They treated the

amounts as advance payments in relation to each contract number and kept them under the heading contracts advance fixed deposit account.

Under this arrangement a customer had to pay the price of the bales in full and the deposit would be returned to him on the completion of the

delivery under the contract. On these facts, the Supreme Court held that the transaction between the assessees and the customer after 14th

February, 1945, had all the essentials of a contract of loan and, therefore, the deposits received after that date, constituted borrowed money for

the purpose of r. 2A. It was further held that the deposits received by the assessees from 5th May, 1944, to 14th February, 1945, partook more

of the nature of trading receipts than of security deposits, and, therefore, the sums received during this period could not be regarded as borrowed

money for the purposes of r. 2A. Therefore, this decision was rendered on the facts arising in that case.

The provisions of s. 40A(8) of the Act were not the subject-matter in the abovesaid decision.

Reliance was also placed upon the decision in CIT vs. Bazpur Co-operative Sugar Factory Ltd. (supra). In this decision the Supreme Court

held that the moneys deposited represented contribution by the members for converting the partly paid-up shares into fully paid-up shares and

thereafter for defraying the loan taken from the Industrial Finance Corporation of India. Any balance remaining was to be refunded to the

members. The circumstance that there was no certainty that any balance would remain for refund to the members in itself indicated that the

deposits could not be regarded as loans. A loan necessarily supposed a return of the money loaned. There was never any intention on the part of

the society or its members to treat the deposits as loans or that the relationship between the society and the members should be that of borrower

and lender. The interest paid by the society to its members was not admissible as a deduction under s. 36(1)(iii) of the Act. A plain reading of this

decision would also go to show that it was rendered in a different context. Here also the provision of s. 40A(8) of the Act was not the subject-

matter.

Learned counsel appearing for the assessee submitted that a substantial portion of the interest amounts were only interest on interest, and,

therefore, the provisions of s. 40A(8) of the Act would not apply to the facts of this case. It remains to be seen that the deposits were made as

cumulative deposits with compound interest. In such a case, it is not possible to say that the major portion of the deposit amount was interest on

interest. In view of the majority of judgments of the various High Courts cited supra, we hold that the Tribunal was not correct in coming to the

conclusion that s. 40A(8) of the Act is not applicable to the facts of this case. On the other hand, the deposits made by the directors with the

company are deposits under s. 40A(8) of the Act and the interest received thereon is liable to be disallowed under the abovesaid provision.

In the result, we answer the question referred to us in the negative and in favour of the Department. No costs.