Tiruchi Varthaga Sangam Bank Limited vs Commissioner of Income Tax, Madras

Srinivasan, J.—The assessee is the Tiruchi Varthaga Sangam Bank Ltd. During the year of account relevant to the assessment year 1958-

59, the assessee realised a gross income from all sources of Rs. 1,27,688. This included a sum of Rs. 2,550 being interest on securities and a

further sum of Rs. 2,500 being the interest on 10 year Treasury Saving Certificates. The bank in the due course of its business paid a sum of Rs.

44,308.88 towards interest on deposits of its customers. It also claimed as expenses allowable u/s 10(2) of the Act an amount of Rs. 41,701.44.

The quantum of these two amount is not in dispute. But what the Income Tax Officer did was to disallow the proportionate part of the interest on

deposit and the expenses attributable to the interest income on the 10 year Treasury Saving Certificates. Such part of the interest payment to

depositors on the sum of Rs. 50,000 invested in the purchase of these saving certificates worked out to Rs. 904 and a like proportion of allowable

expenses in this regard was computed at Rs. 815. The department took the view that, in so far as the income received from these certificates is

concerned, since it is exempt from tax, no portion of either the interest on the deposit or the expenses relevant thereto would be admissible.

Accordingly, the total of the above two sum of Rs. 1,719 was disallowed. When the matter was up in appeal to the Appellate Assistant

Commissioner challenging the propriety of disallowance, the appellate authority took the view that section 10 had no direct application so far as the

income from the source which is not chargeable to Income Tax is concerned. He thought the allowance would amount to double exemption, based

on the ground that the income in question was claimed to fall u/s 4(3) of the Act and also u/s 10(2). He relied upon certain decision which had

special reference to co-operative banks in reaching the conclusion that, to the extent of exempted interest, no allowance either for expenditure or

for interest paid upon borrowed capital could be allowed.

Before the Tribunal, it was urged that section 8 of the Act did not confer any power upon the taxing authorities to allocate the interest and the

expenses, and that it was not open to the department to apply to the process of computation u/s 7 to 12 in regard to income which was wholly

exempt u/s 4(3) of the Act. This contention was negatived, the Tribunal apparently being of the view that what was exempted u/s 4(3) of the Act

was only the net income after the process of computation; that is to say, out of the sum of Rs. 2,500 realised on exempted securities, the

proportionate expense and interest payment attributable to the sum invested in the purchase of securities should be deducted and only the balance

could be exempted from payment of tax. The result was that the disallowance was upheld.

On the application of the assessee, the following question stands referred to us :

Whether, on the facts and in the circumstances of the case, the assessment disallowing a sum of Rs. 1,719 being a proportion of the expenses

allocated by the Income Tax Officer by estimate to interest on the Treasury Saving Certificates exempt u/s 4(3)(xvii) of the Income Tax Act is right

in law ?

During the relevant year, section 8, as amended by the Finance Act of 1956 with effect from 1st April, 1956, was in force. An explanation was

inserted by that Act beside effecting some changes in first proviso to the section. Section 8 deals with the mode of computation of income under

the head ""interest on securities"". The first proviso reads :

Provided that no Income Tax shall be payable under this section by the assessee in respect of any reasonable sum expended by him for the

purpose of realising such interest or in respect of any interest payable on money borrowed for the purpose of investment in the securities by the

assessee....

The explanation deals with the case of a banking company. It is in two parts. The first part deals with the expenses. Broadly stated, what it lays

down is that the expenses of the banking company, as are admissible under certain clauses of sub-section (2) of section 10, should first be

ascertained; and this quantum of expenses should be divided between the gross receipt from interest on securities chargeable to tax and the gross

receipt from other sources. The part of the expenses bearing the same proportion as the gross receipt from interest on securities chargeable to tax

bears to the gross receipt from all sources shall within the meaning of the section be deemed to be the sum reasonably expended by it for the

purpose of realising such interest. The last sentence of this part of the explanation reads :

... and the amount for which allowance is admissible under sub-section (2) of section 10 shall be reduced correspondingly.

The effect of this explanation clearly appears to be that where a banking company doing banking business incurs expenditure which would be

admissible u/s 10(2), a proportion of those expenses should be brought within the ambit of section 8. Expenses dealt with u/s 10(2) would be

expenses incurred by the assessee in the conduct of his business, and would represent expenses attributable to the carrying on of the business. But,

where the income receipt is an item which falls under the head ""interest on securities"", one of the classes mentioned in section 6 of the Act for

which a special mode of computation is prescribed u/s 8, this section, read with the Explanation, has the effect of taking out of the ambit of section

10(2) a part of the business expenditure attributable to interest on securities and bringing it with in the scope of section 8. That part would no

longer be expenditure which would fall within the scope of section 10(2) but has to be had regard to in the computation of the taxable income u/s

8.

The second part of the Explanation deals with money borrowed for the purpose of investment in the securities by the assessee. The first proviso

to section 8 permits the deduction of interest paid on money borrowed for the purpose of investment in the securities. This part of the Explanation

defines what ""money borrowed"" shall mean. It states that, in the case of a banking company, money borrowed (for the purpose of investment in the

securities by the assessee) shall include the moneys received by way of deposits. In so far as the allowance of interest payment on such money

borrowed is concerned, this part of the Explanation also provides that that proportion of the interest payment as is equivalent to the proportion of

the gross receipts from interest on securities chargeable to tax to the gross receipts from all sources shall be deemed to be interest payable on

money borrowed for the purpose of investment in the securities by the assessee. Here again, the last sentence of this part of the section states :

... the amount of such interest for which allowance is due under sub-section (2) of section 10 shall be reduced correspondingly.

The effect of this sentence is merely to transfer from the category of an allowance u/s 10(2) a part thereof to an allowance u/s 8.

The real effect of the Tribunal and the views taken by the departmental officers appear to be that this Explanation has the effect of limiting the

allowance to which the banking company would be entitled u/s 10(2) of the Act to what is specified in the Explanation to section 8. We are unable

to agree. The last sentence in each of the parts of the Explanation which we have extracted does not have the effect of denying the allowance

which is admissible u/s 10(2) of the Act, except to the extent to which a part of it is directed to be brought u/s 8. Mr. Ramamani, learned counsel

for the assessee, is in our opinion right in his contention that what is contemplated by the amendment and effectuated thereby is only to bring an

allowance, such as payment of interest on money borrowed or sum expended for the purpose of realising interest on the securities, in so far as such

payment or expenditure might be incurred by the bank in the course of its business is concerned, and to the extent to which such expenditure

related to the income from securities, u/s 8 as an allowance allowable in the computation of the interest on securities, and not to deny to the

assessee, the banking company, the totality of the expenses which would be allowable to it u/s 10(2) of the Act. What is lawfully allowable u/s

10(2) of the Act under the relevant heads is by means of this section split up into two parts, one to be dealt with u/s 8 and the other u/s 10. The

principle underlying such re-classification of the interest payment or of expenditure appears to be that otherwise the entire expenditure on these

heads would form part of the of the computation u/s 10 leading to the result that it would carry with it the benefit of carry forward in the event of

there being a business loss. To the extent to which a portion of the interest payment and expenses are made allowable u/s 8, that right of carrying

forward as a business loss may not be available to the assessee. It seems to us that only this change was effected by this Explanation and the far-

reaching result claimed by the department that any interest payment or expenditure over and above the figure as computed by the Explanation to

section 8 was intended to be disallowed is not borne out by the clear terminology employed in the Explanation.

In Indian Bank Ltd. v. Commissioner of Income Tax, to which one of us was a party, the question arose whether interest paid to depositors to

the extent that the amount was invested by the bank in tax-free securities is concerned, was allowable u/s 8, as it stood before the amendment in

1956. It was held therein that, as between the depositor and the bank, the relationship of creditor and debtor was established and when the

deposit was received by the bank in the normal course of its business, it would be capital borrowed within the meaning of section 10(2)(iii) of the

Act. In such a case, the further view was that the transaction involving the purchase of securities from out of deposits received by the bank in the

normal course of its banking business could not be viewed as a transaction of borrowing money for the purpose of investment in securities within

the meaning of the proviso to section 8. On the specific question whether interest charges could be allowed u/s 10(2)(iii) of the Act,

notwithstanding that a portion of the income, resulting from the business activities of the assessee was tax-free by reason of purchase of tax-free

securities it was held that there could be no apportionment of the interest charges on any such basis. It seems to us that the Explanation newly

enacted has not in any way affected the principle underlying the above decision. To put it shortly, it is that where the bank received deposits in the

course of its normal banking activities, whether it purchased tax-free securities or not, the interest charges paid by it to its depositors were not

apportionable, and solely for the reason that the income from certain securities was not subject to tax, an expenditure proportionate thereto could

not be denied deduction. The Explanation to our minds has not altered the position in any way and so long as the bank purchased these securities

as part of its normal trading, both the interest payment to its depositors and the expenditure which it had to incur in the normal course of its

business, would under the law be allowable, the only variation effected by the Explanation being that the allowance was brought partly u/s 10 and

partly u/s 8. As pointed out, the phraseology used in the Explanation does not support the view that part other than that described in the

Explanation was intended to be disallowed.

The view taken by the Tribunal and the department that where an item of income comes within the scope of section 4(3)(xvii) the exemption is

operative only to the extent of the income less any allowances which would otherwise be available u/s 10 or u/s 8, as the case may be, wholly fails

to impress us. Section 4(3) states that any income, profits or gains falling within the following classes shall not be included in the total income of the

person receiving them. One of the classes is that specified in clause (17) as ""interest on the 10 year Treasury Savings Deposit Certificates"". What

Mr. Ranganathan, learned counsel for the department, contends is that the total income of person as defined in section 2, clause (15), would mean

the total amount of income, profits gains referred to in sub-section (1) of section 4 computed in the manner laid down in the Act. He accordingly

claims that even in respect of interest on the certificates referred to in clause (17) of section 4(3) a computation is called for Section 4(3) of the Act

was amended in 1939. It previously stated that the Act shall not apply to the classes of income set thereunder. Section 2(15) also defines the total

world income to include all income, profits and gains wherever accruing or arising, except income to which, under the provisions of sub-section (3)

of section 4, this Act does not apply. Despite the amendment of section 4(3) the definition of ""total world income"" in section 2(15) remained

unchanged. The result would appear to be that in so far as the classes of income set out in section 4(3) are concerned the Act would not apply

thereto. The definition of total income does not also refer to income set out in section 4(3) and the computation of total income is called for only in

so far as the amount of income, profits and gains referred to in sub-section (1) of section 4 is concerned. We are, therefore, unable to agree with

the argument advanced by the learned counsel for the department that even in respect of income dealt with u/s 4(3) of the Act a computation is

called for and that only the net income after the deduction of allowances contemplated by the relevant provisions of the Act must be regarded as

exempt from tax.

We are, accordingly, of the view that section 8 of the Act does not either inferentially or in terms justify the disallowance, which is the subject-

matter of the question. The question is answered in the negative and in favour of the assessee. The assessee will be entitled to its costs. Counsels

fee Rs. 250. Question answered in the negative.