Commissioner of Income Tax, Gujarat vs Indumati Ratanlal

Bhagwati, C.J.—This reference arises out of an assessment made upon the assessee as an individual for the assessment year 1962-63, the

relevant account year being the calendar year 1961. The assessee''s husband, Ratanlal, died on 17th January, 1957, leaving a will under which he

bequeathed one-half of his estate to the assessee and the other half to his minor son, Pankaj. The estate consisted mostly of shares and securities

but there was also an immovable property situate in Ahmedabad which belonged to the estate. Since the estate estate passed on the death of

Ratanlal, estate duty became payable on the principal value of the estate under the provisions of the Estate Duty Act and such estate duty came to

Rs. 2,78,979-87. Ps. In order to pay this estate duty, the assessee, on behalf of herself and her minor son, Pankaj, raised an aggregate loan of Rs.

2,78,000 from the Bank of India Ltd. and the Central Bank of India Ltd. and the estate duty was paid in different amounts on diverse dates

between 4th December, 1957 and 4th January, 1961. A part of the loan was repaid by the assessee and her son out of the income of the estate

received under the will and at the commencement of the relevant previous year, the amount of the loan due from the assessee and her son to the

banks was Rs. 1,98,022 and this amount as further reduced to Rs. 1,95,022 at the close of the relevant previous year. Now admittedly the amount

of the loan during the relevant previous included a withdrawal of Rs. 60,889 for the construction of an immovable property, but the construction of

the immovable property was not completed and no income was received from the immovable property in the relevant previous year. The income

of the assessee in the relevant previous year consisted principally of dividends from shares and a small amount by way of interest and income from

immovable property and admittedly this entire income was derived from the properties received by the assessee under the will of her husband. The

assessee in the cause of her assessment to Income Tax for the assessment year 1962-63 claimed to deduct in the computation of her assessable

income Rs. 15,397 being one-half of the interest paid to the banks on moneys borrowed and utilised in payment of estate duty. The claim was

founded on section 57(iii) of the Income Tax Act, 1961, corresponding to section 12(2) of the Income Tax Act, 1922. The Income Tax Officer

and the Appellate Assistant Commissioner disallowed the claim but on appeal the Tribunal held that the claim was well-founded and allowed the

deduction. Hence, the present reference at the instance of the Commissioner.

Since the claim of the assessee for deduction is based on section 57(iii), it is necessary first to look at the section itself. Section 57(iii) is

substantially in the same terms as section 12(2) of the old Act and, therefore, the decisions on the construction of section 12(2) must also govern

the construction of section 57(iii) Section 57(iii) provides that income from other source shall be computed after making allowance for any

expenditure laid out or expended wholly and exclusively for the purpose of making or earning such income. The deduction that is permissible u/s

57(iii) is an expenditure laid out or expended wholly and exclusively for the purpose of making or earning the income which is subjected to tax.

Therefore, in order to decide whether an expenditure is a permissible deduction u/s 57(iii), we have to examine the nature of the expenditure. The

purpose for which the expenditure is incurred must be in order to earn the income and here we must not confuse purpose with notice. What section

57(iii) emphasizes is the purpose for which the expenditure is incurred and the word ""purpose"" should not be equated with the motive for the

transaction. The motive which may have operated on the mind of the assessee in making the expenditure is wholly irrelevant : See Bai Bhuriben

Lallubhai v. Commissioner of Income Tax and Ormerods (India) Private Ltd. v. Commissioner of Income Tax. The expenditure in order to fall

within section 57(iii) must, therefore, be incurred wholly and exclusively for the purpose of making of earning the income sought to be assessed.

There must be a connection between the expenditure and the earning of the income. The connection may be direct or it may even be indirect But

howsoever indirect the connection may be, there must be a connection or nexus between the expenditure incurred and the income earned. This is

the test which we must apply to the facts of the case and applying the test we must see whether the expenditure incurred by the assessee in

payment of interest to the banks on the moneys borrowed for payment of estate duty has any connection received under the will of her husband.

The argument of revenue was that the liability for payment of estate duty was a personal liability of the assessee and the moneys were borrowed

by her to discharge such personal liability and there was accordingly no connection, direction or indirect, between the borrowing of the moneys

and the earning of income from shares received by her under the will of her husband. The purpose of borrowing moneys and payment of interest

there on was, it was contended on behalf of the revenue, to discharge the personal liability of the assessee for payment of estate duty and this

purpose had no connection whatever with the income earned by the assessee on the shares. The analogy of money borrowed for payment of

Income Tax was invoked on behalf of the revenue and it was urged, relying on two decision, one a decision of the Bombay High Court In Bai

Bhuriben Lallubhai v. Commissioner of Income Tax, and the other a decision of the Calcutta High Court in Mannalal Ratanlal v. Commissioner of

Income Tax that, just as payment of interest on money borrowed for payment of Income Tax is not regard of expenditure incurred for the purpose

of earning income from income producing assets belonging to the assessee, equally, on a parity of reasoning, payment of interest on moneys

borrowed for payment of estate duty cannot be regarded as expenditure or like nature and in this connection strong reliance was also placed on

certain observation of the Supreme Court in Commissioner of Income Tax v. Malayalam Plantation Limited. We shall presently refer to these

decision but before we do so, let us first examine the arguments on Principle.

The argument of the revenue was founded on the premise that the liability for payment of estate duty was a personal liability of the assessee of

the same nature as the liability for Income Tax, but the validity of this premise was disputed on behalf of the assessee and if was contended that the

liability for payment of estate duty was not a personal liability of the assessee but was a liability of the estate received by the assessee. The first

question which, therefore arises for consideration on the argument of the revenue is as to the nature of the liability of the assessee for payment of

estate duty and that calls for a consideration of the relevant provisions of the Estate Duty Act, 1953. Section 2(12) of the Act defines ""legal

representative"" to mean a person who in law represents the estate of a deceased person and includes, (i) an executor, (ii) as regards any obligation

under the Act, any person who takes possession of, or inter-meddles with, the estate of a deceased person or any part thereof, and (iii) where the

deceased was a coparcener of a Hindu family, the manager for the time being of the family. Section 5, which is the charging section, provides that

in the case of every person dying after the commencement of the Act, there shall, subject to certain exceptions which are immaterial, be levied and

paid upon the principle value of all property, settled or not settled, which passes on the death of such person, a duty called ""estate duty"" at the

rates fixed in accordance with section 35. Now, though the estate duty is levied upon the principle value of the property passing on the death of the

deceased, it has to be paid by somebody : some person has to be made liable for payment of it and that is done by section 53, sub-section (1).

Section 53, sub-section (1), lays down who shall be liable for payment of estate duty to the State and according to that sub-section, where any

property passes on the death of the deceased, (a) every legal representative to whom such property so passes for any beneficial interest in

possession or in whom any interest in the property so passing is at any time vested, (b) every trustee, guardian, committee or other person in whom

any interest in the property so passing or the management thereof is at any time vested, and (c) every person in whom any interest in the property

so passing is vested in possession by alienation or other derivative title, shall be accountable for the whole of the estate duty on the property

passing on the death. Section 53, sub-section (5), provides that where two or more persons are accountable for estate duty in respect of any

property passing on the death of the deceased, their liability shall be joint and several. But there is a limitation on the liability of every person

accountable for estate duty and that limitation is that such person shall not be liable for any duty in excess of assets of the deceased which are

actually received by him or which, but for his own neglect or default, he might have received. The liability of every accountable person is thus a

personal liability, though it is limited in extent to the assets of the deceased actually or constructively received by him; qualitatively it is a personal

liability and not a liability payable only out of the assets of the deceased : the assets of the deceased actually or constructively received merely

constitute the limit of the liability.

But, apart from this personal liability of every accountable person, a charge is also created on the movable and immovable property passing on

the death of the deceased to the extent set out in section 74. Section 74, sub-section (1) provides that subject to the provisions of section 19

(which relates to the collection that incidence of duty u/s 17 in respect of controlled companies) the estate duty payable in respect of property,

movable or immovable, passing on the death of the deceased, shall be a first charge on the immovable property so passing, in whomsoever it may

vest on his death after the debts and encumbrances allowable under Part VI. So far as movable property passing on the death is concerned,

section 74, sub-section (2) says that a retable part of the estate duty on an estate, in proportion to the value of any beneficial interest in possession

in movable property which passes to any person (other than the legal representative of the deceased) on the death of the deceased shall be a first

charge on such interest. There is thus a charge on movable property also in the case of immovable property, but the charge extends ratably in

proportion to the value of the beneficial interest in possession passing to the person against whom the charge is claimed provided of course he is

not a legal representative of the deceased. If the person to whom the movable property passes for a beneficial interest in possession is a legal

representative of the deceased, there is no charge and the liability of the legal representative as an accountable person remains a personal liability.

If, therefore, the assessee was a legal representative of her deceased husband at the date when she paid the estate duty on behalf of herself and

her minor son with moneys borrowed from the banks, there would be no charge at that date on the shares passing to her for a beneficial interest in

possession and her liability would be purely a personal liability as an accountable person. But if, on the other hand, the assessee did not at that date

occupy the character of a legal representative of her deceased husband, the shares passing to her for a beneficial interest in possession would be

subject to a first charge for a ratable part of the estate duty in proportion to her beneficial interest in possession. The borrowing of the moneys in

the former case would be merely for the purpose of discharging a personal liability of the assessee whereas in the latter case it would be for the

purpose of clearing a first charge on the shares to the extent of a retable part of the estate duty. The question is : would it make any difference to

the allowability of the expenditure incurred in payment of interest on the borrowed moneys whether the case falls within the former category or the

latter ?

The argument of the assessee was that even if the moneys were borrowed by her for the purpose of discharging a purely personal liability as an

accountable person, interest paid on borrowed moneys was expenditure incurred for the purpose of earning dividend on the shares received by her

under the will of her deceased husband and the reasoning on which the argument proceeded was that if moneys had not been borrowed, the

assessee would have had to sell some of the shares for payment of estate duty-since she had no other moneys of her own - and in that event, she

would have lost the dividend on those shares and it was for the purpose of earning such dividend that moneys were borrowed and interest paid by

her. Now this reasoning does, prima facie, appear to be attractive but it is fallacious in that it confuses the purpose of the borrowing with the

motive. It may be that the assessee''s motive in borrowing moneys for payment of estate duty was to save the shares and dividend accruing from

them but that is not a relevant consideration. What we are concerned with for the purpose of section 57(iii) is not the motive but the purpose of the

borrowing and we must see what was the purpose for which the moneys were borrowed by the assessee. It is undoubtedly true that if moneys had

not been borrowed by the assessee but the assessee had chosen to see the shares and pay the estate duty out of the sale proceeds, her income

from dividend would have been reduced but it does not therefore follow that the purpose for which she borrowed moneys was to maintain or

preserve the shares and help her to earn dividend on the shares. The moneys were borrowed by the assessee in order to discharge her personal

liability and this purpose had obviously no connection, direct or indirect, with the earning of dividend on the shares. As a matter of fact, apart from

shares, the deceased husband of the assessee also left an immovable property and if the argument of the assessee were valid, it could equally be

said that the purpose of borrowing moneys was to earn income from the immovable property, for if money had not been borrowed, the assessee

would have had to sell the immovable property and that would have caused loss of income from the immovable property. On this argument what

would be the purpose of borrowing moneys ? Would it be to earn dividend on the shares or to earn income from the immovable property or if

there were any other income-producing assets of the assessee, to earn income from such asset ? The question clearly exposes the fallacy of the

argument and shows that there is no connection, direct or indirect, between the borrowing of the moneys and the earning of the income.

If the argument of the assessee were pressed to its logical conclusion, the result would be that whenever moneys are borrowed for payment of

any liability, it would always be possible to say, save in the rare case where moneys sufficient to meet the liability are lying idle with the assessee

without earning any interest, that if the moneys had not been borrowed, some income producing asset of the assessee, which include even cash

lying on interest, would have had to be sold or realised, and that would have meant loss of income and, therefore, interest paid on borrowed

moneys is for the purpose of earning such income and is deductible against it. Even payment of interest on moneys borrowed for discharge of

Income Tax liability would be as permissible deduction. But this conclusion is plainly contrary to the decision of the Bombay High Court in Bai

Bhuriben Lallubhai v. Commissioner of Income Tax. The question which arose for decision in this case was whether interest paid by the assessee

on moneys borrowed, inter alia, for the purpose of payment of advance tax was deductible as an allowable item of expenditure u/s 12(2). The

argument of the assessee was the same as we have here before us, namely, that if she had not borrowed the moneys, she would have had to

liquidate her fixed deposit which was earning interest and that would have meant loss of interest on the fixed deposits and, therefore, interest paid

on borrowed moneys was for the purpose of earning interest on the fixed deposit. But this argument was rejected by the Bombay High Court in

the following words :

.... there must be a connection or a nexus between the expenditure incurred and the income earned. If we apply this test to the facts of this case, it

is clear that the expenditure incurred by the assessee, which she claims as a deduction under sub-section (2), has no connection whatsoever

whether direct or indirect with the income she has earned on her fixed deposit..... It cannot be said that if she had not borrowed the money in order

to pay... the advance tax, she would have lost the interest on the fixed deposit. The interest would have continued and the fixed deposit would have

been maintained if she.... had not paid advance tax.

These observations which are binding upon us afford a complete answer to the argument of the assessee.

The same view, we find, has also been taken by the Calcutta High Court in Mannalal Ratanlal v. Commissioner of Income Tax. There the

moneys were borrowed for payment of Income Tax liability of the previous years and the assessee claimed to deduct interest paid on the

borrowed moneys. The assessee contended that, if he had not borrowed the moneys, he would have been compelled to liquidate part of his

income yielding assets and the borrowing was, therefore, for the purpose of maintaining income yielding assets and there was a direct or at any rate

indirect connection between the income and the expenditure. It was the same contention as in the present case and the Calcutta High Court

rejected it summarily in a few words.

The decision of the Supreme Court in Commissioner of Income Tax v. Malayalam Plantations Ltd. also points in the same direction. That was

a case which related to payment of estate duty u/s 84 of the Estate Duty Act by a resident company incorporated outside India on the death of

shareholders not domiciled in India and the question was whether the amounts paid by way of estate duty were deductible u/s 10(2) (xv) as

expenditure incurred wholly and exclusively for the purpose of the business of the company. The Supreme Court held that though the amounts paid

by way of estate duty were ""expenditure"", they could not be said to be laid out or expended wholly and exclusively for the purpose of the business

of the assessee. Subba Rao J., as he then was, specking on behalf of the Supreme Court, said :

The payments have nothing to do with the conduct of the business. The fact that on his default, if any, in the payment of the dues, the revenue may

realise the amounts from the business assets is a consequence of the default of the assessee in not discharging his statutory obligation, but it does

not make the expenditure any the more expenditure incurred in the conduct of the business. It is manifest that the amounts in question were paid by

the assessee as a statutory agent to discharge a statutory duty unconnected with the business, though the occasion for the imposition arose because

of the territorial nexus afforded by the accident of its doing business in India.

On a parity of reasoning we must reject the argument that if the estate duty had not been paid by the assessee by borrowing moneys, the

revenue might have realised the amount of the estate duty from the shares or the shares might have had to be sold for payment of estate duty and,

therefore, payment of interest on borrowed moneys was for the purpose of earning dividend on the shares.

The assessee, however, contended that there was a difference between a case of borrowing of moneys for payment of Income Tax liability and

a case of borrowing of moneys for payment of estate duty. The argument was that whereas in the former case the liability is purely a personal

liability, in the latter case the liability is inseparably connected with the estate passing in death : the estate is received coupled with an obligation to

pay estate duty or, in other words, to quote the Tribunal, ""payment of estate duty is virtually an outlay or expenditure wholly and exclusively,

incurred for the purpose of making or earning the very assets, i.e., the source of income"". But this argument is unsustainable and cannot be

accepted. The liability of an accountable person for payment of estate duty is, as pointed out above, a personal liability and is not different in

quality are character from that of an assessee liable to pay Income Tax. In the one case the estate passes to an accountable person on the death of

the deceased and the accountable person, therefore, becomes liable to pay estate duty in respect of the estate so passing, while in the other,

income accrues to an assessee and the assessee, therefore, becomes liable to pay Income Tax. The incidence of the liability arises in the same

manner in both cases : in the former case because the estate passes to the accountable person and in the latter, because the income accrues to the

assessee. Just it is not correct to say that Income Tax is paid by the assessee for the purpose of making of earning the income, so also it is not

correct to say that estate duty is paid for the purpose of making of earning the assessee. The distinction sought to be drawn by the assessee is,

therefore, unwarranted and unjustified.

Reliance was then placed on behalf of the assessee on the position obtaining under the income tax law in Australia. It was pointed out that in

Australia too, as In India, interest paid on moneys borrowed for discharge or in Income Tax liability was not a permissible deduction but a

distinction was made by the Australia cases in regard to interest paid on money borrowed for paying succession and estate duties and such interest

was always held to be an admissible deduction and the same deduction, it was pleaded, should also he recognized by us. In support of this

contention the assessee landed heavily on the following observation in Mr. Gunn''s Commonwealth Income Tax Law and Practice, seventh edition,

Page 684, Paragraph 1741 :

1741. Interest on money borrowed to pay death duties - In Begg v. Deputy Federal Commissioner of Taxation, it was held that interest paid on,

moneys borrowed to pay succession and estate duties, legacies and other outgoings was deductible.

In public trustee v. C. of T. (N. Z.), it was held that interest payable upon money borrowed for the purpose of paying death duties charged upon

the estate of the estator, is deduction in computing the assessable income of the estate, but apportionment of the interest is required where both

assessable and non-assessable income is derived. See extract from the judgment of Myers, C.J., in (1402). It follows from the these decision that

interest paid direct to the crown on unpaid death duties is deductible (1742)"".

Now it is undoubtedly true that the Australian decision have made a distinction between interest paid on moneys borrowed for payment of

Income Tax liability and interest paid on moneys borrowed for payment of estate duty and held the former inadmissible while the latter admissible

but for reasons already stated we do not think there is any valid basis for this distinction. As a matter of fact even in Australia this distinction has

been criticised as illogical by commentators like Mr. Gun says at page 684 of his above-quoted book in paragraph 1743 :

It is considered that on the authority of Begg v. Deputy Federal Commissioner of taxation 2 and Public Trustee v. Commissioner of Taxation (N.

Z.) (1741), the whole of the interest paid on moneys borrowed to pay Commonwealth and State income taxes is deductible. Applying the dicta of

Myers C.J. in public Trustee v. Commissioner of Taxation (N. Z.) the money borrowed enable the taxation to be paid, and left the money so

borrowed or its equivalent in the estate to be employed in the production of assessable income.... In this view, the deduction in 2 C. T. B. R. (N.

S.) Case 13 was claimed, and the case was decided, on a wrong footing.

The reasoning of Myers C.J. in Public Trustee v. Commissioner of Taxation (N. Z.), in support of the view that interest paid on moneys

borrowed for payment of estate duty was a permissible deduction was, to quote the worlds of the learned Chief justice himself :

The true inference, I think, in the present case is that the money borrowed enable the trustee to pay out of the estate the amount of the death

duties and left the money so borrowed or its equivalent in capital assets in the estate to be employed in the production of income.

Now if this reasoning were valid, it should, as pointed out by Mr. Gun, equally apply where interest is paid on moneys borrowed for payment

of Income Tax and such interest must be held to be admissible expenditure. But, as already stated, the position so far as we are concerned, is well-

settled that interest paid on moneys borrowed for payment Income Tax is not allowable expenditure and this reasoning cannot, therefore, avail and

the assessee cannot draw any support from the Australian decision. Moreover, it must be noted that this reasoning, though permeably justified by

the terms of section 51 of the Australian Income Tax Act - a matter with which we are not concerned - has no validity in the determination of a

claim for deduction u/s 57(iii) of our Act. We have already discussed this aspect of the matter sufficiently and nothing more need be said about it.

We must, therefore, reach the conclusion that if moneys were borrowed by the assessee for the purpose of discharging what was purely a

personal liability as an accountable person to pay estate duty, interest paid on the borrowed moneys would not be an allowable expenditure u/s

57(iii). The question then arises : Does it make any different if there was a charge on the shares for payment of estate duty and moneys were

borrowed by the assessee for the purpose of clearing the charge ? We cannot assent to the broad proposition canvassed on behalf of the assessee

that whenever liability is charged on a property, and moneys are borrowed for clearing the charge, interest paid on the borrowed moneys would

necessarily be an allowable expenditure in computing the assessable income from the property. Whether it constitutes an allowable expenditure or

not would depend on the facts of each case. But one thing is clear that if property is received by an assessee subject to a charge for payment of a

liability and moneys are borrowed for clearing the charged by discharging the liability, interest paid on the borrowing would be to save the property

by freeing it from the encumbrances and thus to facilitate the earning of the income and there would accordingly be the requisite connection or

nexus between the borrowing of the moneys and the earning of the income. To illustrate the point, take a case where property is received by an

assessee subject to a charge for payment of money with growing interest. Would the interest paid by the assessable income from the property ? it

would be an outgoing in respect of the property just like a municipal if, instead, moneys are borrowed moneys ? If, therefore, at the date when the

estate duty was paid by the assessee, the shares were charged with payment of liability for estate for estate duty, we must hold that interest paid on

the borrowed, moneys would be an admissible expenditure u/s 57(iii).

Now it appears that the matter has not been approached from this point of view and the Tribunal has, therefore, not investigated whether at the

date when the assessee paid the estate duty on behalf of herself and her minor son with moneys borrowed from the banks, she occupied the

character of legal representative of her deceased husband. It is, therefore, not possible to give a categorical answer to the question referred to us

one way or the other. We will have to leave it to the Tribunal to apply the law stated by us to the facts of the case and decide whether the interest

paid by the assessee on moneys borrowed for payment of estate duty is an allowable expenditure or not.

Before we close we must refer to two small points raised on behalf of the revenue. Both the points have no merit and must straightaway be

rejected. One point was that since a part of the moneys borrowed from the banks in the overdraft accounts, namely, the sum of Rs. 60,889, was

utilised for the construction of an immovable property, interest paid to the banks in the overdraft accounts could not be said to be expenditure

incurred solely for the purpose of making or earning dividends on the shares and was, therefore, not a permissible deduction. But this point

overlooks the fact that, though undoubtedly the sum of Rs. 60,889 was utilised for the construction of an immovable property, the rest of the

moneys borrowed from the banks in the overdraft accounts were admittedly utilized exclusively for payment of estate duty and there was no

indiscriminate utilisation of the borrowed moneys for different purposes as was the case in Commissioner of Income Tax v. Jagmohandas J.

Kapadia. The position was as if there were two borrowings from the same lenders, one borrowing being for the purpose of construction of an

immovable property and the other borrowing being for the purpose of payment of estate duty and it is in reference to the latter borrowing that we

have to see whether there was any connection between the borrowing and the earning of the dividends on the shares. The second point raised on

behalf of the revenue sought to make a distinction between ""income"" and ""source of income"" and the argument was that what section 57(iii)

contemplates is expenditure incurred for the purpose of making or earning the income sought to be assessed and it is not enough if the expenditure

is incurred merely for the purpose of maintaining the source of income. This point is also without substance for it is now well-settled by several

decisions of the Bombay High Court of which we may mention only two, namely, Commissioner of Income Tax v. Sir Purshottamdas Thakurdas

and Ormerods (India) Private Ltd. v. Commissioner of Income Tax, that expenditure incurred for the purpose of maintaining or preserving the

source of income is expenditure incurred for the purpose of making or earning the income arising from that source and is an allowable deduction in

computing the income from that source.

We, therefore, answer the question referred to us as follows : If the assessee was a legal representative of her deceased husband at the date

when she paid the estate duty on behalf of herself and her minor son with moneys borrowed from the banks, she would not be entitled to a

deduction of her 1/2 share of the interest paid on the amount borrowed relatable to the payment of estate duty but if on the other hand she did not

at that date occupy the character of a legal representative of her deceased husband, she would be entitled to a deduction of her 1/2 share of the

interest paid on the amount borrowed to the extent to which it was utilised in payment of the estate duty. There will be no orders as to costs of the

reference.