Gujarat State Financial Corpn. vs Commissioner of Income Tax

Abichandani, J.—The assessee is a financial corporation constituted under the State Financial Corporations Act, 1951 with the object of promotion of industrial development in the State by providing long-term finance to medium and small scale industries. By a notification issued u/s 8 of the Provident Fund Act, 1925, that Act was made applicable to the assessee-corporation and in exercise of powers conferred by section 48 of the State Financial Corporations Act, the board of directors of the assessee-corporation constituted a fund known as the "Gujarat State Financial Corporation Employees'' Provident Fund". Under Regulation 4 of the Gujarat State Financial Corporation Employees'' Provident Fund Regulation, 1961 (the Regulations) , the fund was created and as provided in Regulation 5, the fund was to be held by the corporation and administered by a Board of Administrators. Regulation 10 provided for subscribers'' accounts in which the subscriptions, contributions and interest on subscriptions and contributions were to be credited. Under Regulation 11, it was made incumbent upon the corporation to credit interest on the amounts standing to each subscriber''s credit at rate indicated therein. Admittedly, in the assessments which were made for the assessment years 1962-63 to 1971-72, the interest amounts as credited to the accounts of subscribers under Regulation 11 were allowed as reduction in computation of the assessee''s income. Out of the total amount of Rs. 2,05,471 constituting the fund as on 31-3-1971, an amount of Rs. 1,03,000 was invested in fixed deposits with Nationalised Banks as per the policy of the corporation to invest the fund money in fixed deposits with the Nationalised Banks on long-term basis. The balance amount of Rs. 1,02,471 was, however, not invested in the fixed deposits with banks but was invested in the corporation''s business for which no separate accounts were maintained. The interest earned on the investment of the said amount of the fund invested in the corporation''s business did not appear separately in the provident fund account but had got merged in the interest earned by the corporation in its business. It was pointed out by the Audit Note dated 12/ 18-4-1972 that it was necessary to take out the money invested in the corporation''s business and to invest it separately so that the provident fund account may appear as separate. It was suggested that the balance amount of Rs. 1,02,471 invested in the corporation''s business as on 31-3-1971 be taken out and invested u/s 8 of the State Financial Corporations Act with the corporation as a fixed deposit and interest be credited at 71/2 per cent on an assumption that the fund was invested in fixed deposit for a period of 5 years and interest so calculated on the said amount from 1961-62 to 1970-71 upto 31-3-1972 was worked out at Rs. 53,119.08 and the board of directors resolved that the said amount of interest should be credited to the account of the provident fund in the books of the assessee-corporation by way of interest in respect of the utilisation of the monies of the fund by the assessee-corporation for its business in the earlier years. In the returns filed on 28-7-1972 by the assessee, an income of Rs. 28,28,470 was declared and in doing so deduction of Rs. 53,119 was claimed. The ITO, however, held that the payment of interest related to the period from 1961 to 1971 and since the assessee was maintaining accounts on mercantile basis, the liability was incurred in those years and, hence, the claim in respect of the earlier years could not be considered for the assessment year in question. The ITO, therefore, allowed only 10 per cent of the said amount which is Rs. 5,311, being an estimate of interest attributable to the accountable year ending 31-3-1972. The assessee preferred an appeal to the AAC and the AAC held that the legal obligation to pay interest to the fund had arisen only during the accounting year ending 31-3-1972 when the said amount was ascertained and, therefore, deduction of the entire amount of Rs. 53,119 should be allowed. The matter was carried to the Tribunal by the department. The Tribunal found that the only obligation of the assessee-corporation was to credit interest to the account of each of the subscribers as required by Regulation 11 and since that was admittedly done by the assessee-corporation ever since the constitution of the fund and such payment of interest under Regulation 11 was allowed as a deduction in computation of the assessee''s income in all the years, there was no legal liability to pay interest to the fund by reason of the assessee-corporation having utilised the portion of the monies of the fund for the purpose of its business and, therefore, it was not entitled to deduction of the amount of Rs. 53,119. The Tribunal negatived the contention of the assessee that the payment of Rs. 53,119 should be taken to have been made for the purpose of keeping the employees of the corporation contented and for securing their goodwill. The Tribunal held that there was no commercial expediency involved in payment of the interest on the amount of the fund which was utilised by the corporation for its own business. It, therefore, reversed the finding of the AAC in respect of the said claim and restored the order of the ITO. The Tribunal has, in the above background and pursuant to the order of this Court, referred to the High Court for its opinion, the following question u/s 256(2) of the income tax Act, 1961 (the said Act) :

Whether, on the facts and in the circumstances of the case, the applicant is entitled in assessment year 1972-73 to a deduction of Rs. 47,808 as allowable business expenditure on the ground of commercial expediency u/s 37 of the income tax Act, 1961?

Mr. Kazi, the learned advocate appearing for the assessee-corporation, contended that the amount of the fund which was utilised by the corporation for its own business would have normally earned interest if it were put in fixed deposit as per the policy of the corporation and since the fund stood deprived of the interest that would have accrued on such amount, the subscribers to the fund, that is the employees of the corporation, would have been justifiably dissatisfied over the portion of the fund utilised by the corporation for its own business and the corporation need not have waited until actual agitation over the matter by the employees. The Corporation was, therefore, justified in computing the interest that the portion of fund would have earned if it were to be invested on long-term basis in a fixed deposit as per the policy of the corporation reflected in the Audit Note dated 12/ 18-4-1972. He, therefore, submitted that the deduction should have been allowed in its entirety on the ground of commercial expediency. Mr. B. J. Shelat, the learned counsel appearing for the department, on the other hand, contended that there was no legal obligation at all for the assessee-corporation to pay such interest to the fund and the only obligation it had was in respect of interest, under Regulation 11, which admittedly, was paid in the subscriber''s account from time to time and was claimed and allowed by way of deduction in computing the assessee''s income during the relevant years of 1962-63 to 1971-72. Mr. B.J. Shelat submitted that the assessee corporation could not be allowed to benefit for wrongful utilisation of portion of the Fund for its own business, at the cost of the revenue by being allowed deduction of the said interest amount credited to the fund.

u/s 2(e) of the Provident Fund Act, ''provident fund'' means a fund in which subscriptions or deposits of any class or classes of employees are received and held in their individual accounts and includes any contribution and any interest or increment accruing on such subscriptions, deposits or contributions under the regulations of the fund. As noted above, under the regulations of the Fund framed in 1961, on creation of the fund, under Regulation 4 it was required to be administered by the Board of Administrators as provided by Regulation 5 though the fund was to be held by the corporation. There is no dispute about the fact that the fund was to be separately held by the corporation and administered by the Administrators of the fund and that no portion of the fund could have been utilised by the corporation for its business. Admittedly, the policy of the corporation as reflected in the Audit Note dated 12/18-4-1972 was to invest the fund money in fixed deposits with Nationalised Banks on long-term basis. u/s 8 a financial corporation may accept deposits as provided therein. Thus, in normal course, the amounts which were paid in the fund were required to be deposited by the assessee-corporation as per its own policy with the banks or with the corporation u/s 8 as was suggested in the Audit Note in which event the amount so invested would have earned the rate of interest applicable to such fixed deposits on long-term basis. In fact, a portion of the fund as on 31-3-1971 to the tune of Rs. 1,03,000 was invested in fixed deposits with Nationalised Banks. However, the rest of the amount of Rs. 1,02,471 came to be utilised for the corporation''s business without maintaining any separate account of the interest that the amount would have earned. Therefore, when the audit party had drawn the attention of the corporation that the said portion ought to have been put in fixed deposit as was done with the other part of the provident fund, the Board of the corporation found it appropriate to resolve that the interest at the rate of 71/2 per cent should be calculated for the entire period from 1961 to 1971 during which the amount was used by the assessee-corporation for its business, and be credited to the account of the provident fund. It will not be appropriate to view the crediting of interest in this manner only from the angle of Regulation 11 which required the corporation to credit interest on the amounts standing to each subscriber''s credit. In other words, the question of commercial expediency cannot be decided only with reference to Regulation 11. The important aspect which is required to be kept in mind is that the assessee-corporation was trying to set right the matters by giving appropriate credit of interest in the provident fund account in respect of the amount of the provident fund which it had utilised for its own business. This the assessee-corporation was required to do not only on the basis of propriety but also with a view to see that discontent was not fomented amongst the subscribers to the fund. It would have been a matter of concern for every subscriber to the fund if the assessee-corporation continued to use any portion of the fund for its own business and thereby deprive him of the accretions to the fund which would have taken place in normal course by depositing such amount in fixed deposits with banks, etc., on long-term basis. Therefore, we are of the view that it was a matter of commercial expediency, also founded on legal propriety, to pay such interest amount in the fund. Such course was necessary to prevent discontent amongst the employees who had subscribed to the fund. It cannot be suggested that the assessee-corporation had any indirect or ulterior motive in making the said payment and it appears to us that the only motive by which the assessee-corporation was actuated to pay the interest amount on the portion of the fund utilised by it was a purely commercial expediency for the ultimate benefit of the business of the corporation by securing goodwill amongst the employees. The learned counsel for the department tried to distinguish the decision in CIT v. Raipur Mfg. Co. Ltd. [1972] 84 ITR 508 (Guj.) on the ground that in that matter peace would have been endangered in the factory due to strikes, stoppage of work or rowdyism. It is not necessary to wait till an ugly situation arises for commercial expediency to come into picture. Preventing such occurrences by forethought and proper action would be a greater commercial expediency. Therefore, if the assessee-corporation resolved to pay interest on the amount of the fund which it had utilised to ensure that there is no possibility of any discontent among the employees, it would be clear that the payment was made by way of commercial expediency and would be deductible as claimed by the assessee.

Even u/s 36(1)(iii) of the said Act, the amount of interest paid in respect of capital borrowed for the purpose of business or profession can be allowed by way of deduction in computing the income referred to in section 28 of the said Act. Though the fund was required to be held by the corporation, it could not have merged any portion of the fund with its own funds. Therefore, the portion of the fund which the corporation utilised for its own business can be deemed to be an amount borrowed by the corporation for its business and the interest paid thereon would also be covered by clause (iii) of sub-section (1) of section 36. No portion of the provident fund was intended to be gratuitously used by the assessee-corporation and when the assessee-corporation had enjoyed the benefit of a portion of the fund by utilising the same for its business, it was bound to give compensation by paying interest to the fund in respect of the amount used and for the period for which it was used. Such a course would be in consonance with the provisions of section 70 of the Indian Contract Act, 1872. It, therefore, cannot be said that the payment of interest made by the assessee-corporation to the fund in respect of the portion of the fund that it has utilised for its own business was some ex gratia payment as was sought to be contended on behalf of the department. For the foregoing reasons, we are of the view that the Tribunal was in error in holding that the assessee-corporation was not entitled to claim the deduction of the amount of Rs. 53,119 on consideration of commercial expediency. The decision was taken by the Board on the strength of the Audit Note for the first time during the accounting year ended on 31-3-1972 and, therefore, prior to that the amount had not become payable in the earlier years since it was not quantified and no decision was taken in the matter. The said amount was not the interest which was payable under Regulation 11 which had accrued from year to year and which was admittedly credited to the respective accounts and in respect of which deduction was claimed and allowed in those years. In the past years, though the liability for utilising a portion of the fund for its own business was in existence since no gratuitous use of any portion of the fund by the corporation was intended, there was no ascertained liability and it was only when the interest was quantified that the liability got ascertained. Therefore, since the liability accrued in the said accounting year 1971-72, the assessee-corporation became entitled to claim for deduction for that year in respect of the entire amount. We, therefore, hold that the assessee-corporation was entitled in the assessment year 1972-73 to the deduction of the entire amount of Rs. 53,119 as claimed by it and the Tribunal was not justified in setting aside the decision of the AAC allowing the remaining claim of Rs. 47,808 out of the total claim of Rs. 53,119 from which the ITO had initially allowed Rs. 5,311. The question referred to us is, therefore, answered in the affirmative and in favour of the assessee.

Reference stands disposed of, accordingly, with no order as to costs.