Full Judgment Text
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PETITIONER:
COMMISSIONER OF INCOME-TAX, LUCKNOW
Vs.
RESPONDENT:
BAZPUR CO-OPERATIVE SUGAR FACTORY LTD.
DATE OF JUDGMENT01/05/1989
BENCH:
PATHAK, R.S. (CJ)
BENCH:
PATHAK, R.S. (CJ)
SHARMA, L.M. (J)
CITATION:
1989 AIR 1866 1989 SCR (2) 840
1989 SCC Supl. (2) 240 JT 1989 (2) 562
ACT:
Income Tax Act, 1961: Section 36(1)(iii)--Cooperative
Society-Amounts deposited by members in Loss Equalisation
and Capital Redemption Fund--Whether deduction admissible.
HEADNOTE:
The respondent-assessee is a co-operative society run-
ning a sugar mill. With a view to inducing its members to
make further contribution to its capital it incorporated a
bye-law which provided for the establishment of a ’Loss
Equalisation & Capital Redemption Reserve Fund’. Every
producer-shareholder was required to deposit every year an
amount to this fund which was to be utilised for the purpose
of making the partly paid shares fully paid, and after
defraying the loan taken from the Industrial Finance Corpo-
ration the balance was to be refunded to the members. The
money available in the Fund was utilised by the society for
the purpose of its business. A part of the amount was even-
tually utilised for converting the partly paid shares into
fully paid shares. It was then decided by the society to pay
interest on the balance available in the Fund. The interest
thus paid to its members was sought to be claimed as deduc-
tion in computing the income of the assessee.
The Income Tax Officer rejected the claim holding that
the amount did not represent loans taken by the assessee .or
capital borrowed for the purpose of its business. The Appel-
late Assistant Commissioner confirmed the disallowance. The
Income Tax Appellate Tribunal accepted the second appeal of
the assessee and held that it was not necessary that borrow-
ing must contain an element of payment of interest and that
even if a deposit was made by the members of the society
which waS utilised for the purpose of the business of the
assessee, the funds represented by such deposit would be
’capital borrowed’ for the purpose of s. 36(1)(iii) of the
Income Tax Act, 1961. The High Court agreed with the view
taken by the Appellate Tribunal and answered the questions
referred to it in favour of the assessee and against the
Revenue.
While allowing the appeals and answering the questions
in the negative in favour of the Revenue, this Court.
841
HELD: (1) Section 36(1)(iii) of the Income Tax Act, 1961
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provides that in computing the income chargeable under the
head ’profits and gains of business or profession’ a deduc-
tion shall be allowed of the amount of interest paid in
respect of capital borrowed for the purposes of the business
or profession. [845G,H]
(2) The words ’borrowed money’ should not be given a
strained meaning and it should be considered whether in
ordinary commercial usage the relationship was that of a
borrower and lender and the transactions’were loan transac-
tions. To constitute borrowed money there must be a real
borrowing and a real lending. [846B,D]
(3) It is apparent that the deposits made by the members
cannot be regarded as loans advanced by the members to the
assessee. There was never any intention between the assessee
and its members to treat the deposits made by the members as
loans and that the relationship between the assessee and the
members should be that of borrower and lender., [847F,G]
Port of London Authority v. Commissioner of Inland
Revenue, [1922] 2 KB 599 (CA); Commissioner of Inland Reve-
nue v. Port of London Authority, [1923] AC 507; Inland
Revenue Commissioner v. Rowntree & Co. Ltd., [1948] 1 ALL ER
482 (CA); Commissioner of Income-tax, Gujarat v. Rajkot
Seeds, Oil & Bullion Merchants Association Ltd., [1975] 101
ITR 748; Commissioner of Excess Profits Tax, Central Calcut-
ta v. Bhartia Electric Steel Co. Ltd., [1954] 25 ITR 192;
Bombay Steam Navigation Co. [1953]; Private Ltd. v. Commis-
sioner of Income-tax Bombay, [1965] 56 ITR 52 and Madhav
Prasad Jatia v. Commissioner of Income-tax Uttar Pradesh,
[1979] 118 ITR 200, referred to.
(4) A loan necessarily supposes a return of the money
loaned. The circumstance that there was no certainty that
any balance would remain for refund to the members would in
itself indicate that the deposits could not be regarded as
loans. [847G,H]
JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeals Nos. 1358-61
of 1979.
From the Judgment and Order dated 6.9.78 of the Allaha-
bad High Court in I.T.R. No. 114/78.
B .B. Ahuja, K.C. Dua and Miss. A. Subhashini for the appel-
lants.
842
S.C. Manchanda, Mrs. A.K. Verma and Joel Pares for the
respondent.
The Judgment of the Court was delivered by
PATHAK, CJ. These appeals by special leave are directed
against the judgment of the High Court at Allahabad dispos-
ing of an Income-tax Reference in favour of the assessee and
against the Revenue.
The assessee is a co-operative society running a sugar
mill. For the assessment year 1968-69 it claimed payment of
interest amounting to Rs. 1,81,7 16. This was interest paid
to the accounts of its members, who had deposited certain
amounts with the assessee in accordance with Bye-law No. 50
and it was debited by the assessee to its profit and loss
account. In the initial years of the working of the Society,
certain partly paid shares were allotted to its farmer
members. With a view to inducing these members to make
further contribution to the capital of the Society, bye-law
No. 50 was incorporated in the Bye-laws of the Society. The
bye-law as amended provides:
"50. There shall be established a ’Loss Equalisation &
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Capital Redemption Reserve Fund’ in the society. Every
producer-shareholder shall deposit every year a sum not less
than 0.32 paise and not more than 0.48 paise per quintal of
the sugarcane supplied by him to the society, as may be
determined by the Board until the shares to be subscribed by
the members are fully paid-up. The amount standing to the
credit of this fund presently or to be credited in future,
shall be used for making the partly paid shares fully paid
up. The balance of the said amount shall be refunded to the
members soon after the present loan from the Industrial
Corporation of India is repaid, whereafter the fund shall
cease to exist."
The money available in the ’Loss Equalisation and Capi-
tal Redemption Reserve Fund’ was utilised by the assessee
for the purpose of its business. A part of the amount was
also utilised for converting the partly paid up shares into
fully paid up shares. On 8 September, 1967 the Board of
Directors of the Society decided in their meeting to pay
interest at 6% on the balance available in the aforesaid
Fund to its various members to whom the balance money be-
longed. It was on this account that the Society claimed an
amount of Rs. 1,18,716 for the assessment year 1968-69.
843
The claim was rejected by the Income Tax Officer. He
took the view that the amounts deposited by the members of
the Society in the ’Loss Equalisation and Capital Redemption
Reserve Fund’ did not represent loans taken by the assessee
but constituted a contribution by the members to convert
partly paid up shares into fully paid up shares and they
could not be considered as capital borrowed for the purpose
of its business. He held that s. 36(1)(iii) of the Income-
tax Act did not apply to such interest and that it was not
admissible as a deduction in computing the total income of
the assessee. For the assessment years 1969-70 to 1972-73
the claim to deduction on this account was as follows:
1969-70 ... Rs. 1,34,609
1970-71 ... Rs. 1,34,609
1971-72 ... Rs. 1,34,609
1972-73 ... Rs. 1,34,609
The Income Tax Officer took the same view for these assess-
ment years as he did for the assessment year 1968-69.
In appeals preferred by the assessee the Appellate
Assistant Commissioner of Income-tax confirmed the disallow-
ance for the assessment year 1968-69 on the ground that
Bye-law No. 50 did not provide for the refund of the amount
standing to the credit of the members at any time before the
payment of the loan to the Industrial Finance Corporation of
India, that the loan was still outstanding on 30 June 1967,
the last day of the previous year relevant to the assessment
year 1968-69, and moreover the Bye-law did not provide for
payment of interest at all. He observed that the Directors
could not pay any interest unless the Bye-law was amended by
the members of the assessee. He observed that the interest
paid must be regarded as an exgratia payment to the producer
members of the society who had contributed to the Fund, and
that it was not made for the purpose of the business of the
assessee or on the ground of commercial expediency. The same
order was passed by the Appellate ASsistant Commissioner on
the appeals for the remaining years.
In second appeals filed by the assessee for all the
assessment years the Income Tax Appellate Tribunal held that
the amount standing to the credit of the ’Loss Equalisation
and Capital Redemption Reserve Fund’ which was utilised by
the assessee for the purpose of its business represented
moneys borrowed for the purpose of its business and that
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interest paid on such moneys was eligible for deduction
under
844
s. 36(1)(iii) of the Income-tax Act, 1961. The Appellate
Tribunal negatived the contention of the Revenue that only
such deposits could constitute ’capital borrowed’ within the
meaning of s. 36(1)(iii) of the Act which were initially
borrowed with the stipulation to pay interest thereon. The
Appellate Tribunal observed that the expression ’capital
borrowed’ had not been defined in the Income-tax Act and
that its ordinary meaning would have to be gathered in
construing the meaning of s. 36(1)(iii). It said that it was
not necessary that borrowing must contain an element of
payment of interest and that even if a deposit was made by
the members of the society which was utilised for the pur-
poses of the business of the assessee, the funds represented
by such deposit would be ’capital borrowed’ for the purposes
of s. 36(1)(iii) of the Act. The Appellate Tribunal also
recorded that it was not disputed that the deposits were
taken for the purposes of the business. In the circum-
stances, the Appellate Tribunal held that when the Board of
Directors of the assessee considered it proper to pay inter-
est on those deposits, such interest was admissible under s.
36(1)(iii) of the Act.
During the heating of the appeals for the assessment
years 197071 and 197 1-72, it was pointed out by the Revenue
that the auditors of the assessee had observed in their
audit report that the payment of interest on the ’Loss
Equalisation and Capital Redemption Reserve Fund’ should not
have been made by the assessee in view of s. 57 of the Uttar
Pradesh Co-operative Societies’ Act, which reads:
"Fund not to be divided: Except as otherwise specifically
provided in this Act, no part of the Funds other than the
net profits of a co-operative society shall be paid by way
of bonus or dividend or otherwise distributed among its
members:
Provided that a member may be paid remuneration on
such scale as may be laid down in the bye laws for any
services rendered by him to the co-operative society."
The Appellate Tribunal held that s. 57 was not relevant
as the payment of interest to the shareholders, on the
amounts deposited by them, did not represent any payment by
the Society by way of bonus or dividend or otherwise, of any
part of its funds other than its net profits. The Appellate
Tribunal also observed that the interest paid by the asses-
see to the ’Loss Equalisation and Capital Redemption Reserve
Fund’ was met from out of the net profits of the assessee.
It was found that the assessee had sufficient income out of
which the interest
845
could be paid by it. For these reasons, it held that the
payment of interest was not affected by s. 57 of the Uttar
Pradesh Co-operative Societies Act.
At the instance of the Revenue the following two ques-
tions in respect of the five assessment years were referred
by the Appellate Tribunal to the High Court at Allahabad for
its opinion.
"1. Whether the credit balances in the Loss Equalisation and
Capital Redemption Reserve Fund which were actually used by
the assessee for the purposes of its business represented
capital borrowed by the assessee for the purpose of its
business within the meaning of s. 36(1)(iii) of the Act?
2. Whether the Tribunal was right in law in allowing inter-
est on such balances standing to the credit of the Loss
Equalisation and Capital Redemption Reserve Fund as a deduc-
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tion in computing the total income of the assessee?"
A further question common to the assessment years 1969-
70 to 1972-73 was also flamed. It reads:
"Whether the Tribunal was right in law in holding that the
impugned payments of interest did not contravene the provi-
sions of s. 57 of the Uttar Pradesh Co-operative Societies
Act, 1965?"
The High Court agreed with the view taken by the Appel-
late Tribunal and answered the questions in favour of the
assessee and against the Revenue.
Before us, the parties have confined themselves to the
first two questions and it is requested that we need not
consider the third question.
In these appeals the question is whether the claim to
deduction under s. 36(1)(iii) of the Income-tax Act can be
allowed. Section 36(1)(iii) of the Act provides that in
computing the income chargeable under the head ’profits and
gains of business or profession’ a deduction shall be al-
lowed of the amount of interest paid in respect of capital
borrowed for the purposes of the business or profession. Can
it be said that the credit balance in the ’Loss Equalisation
and Capital Redemp-
846
tion Reserve Fund’ represents capital borrowed by the asses-
see for the purposes of its business? What is ’borrowed
money’ has been construed by the Courts in England in a
number of cases. In Port of London Authority v. Commissioner
of Inland Revenue, [1922] 2 KB 599 (CA). Lord Stemdale, M.R.
observed that in order that there be borrowed money there
must be a borrower and a lender, and later, when the Revenue
took the case in appeal to the House of Lords, the House of
Lords laid down in Commissioners of Inland Revenue v. Port
of London Authority, [1923] AC 507 that to constitute bor-
rowed money there must be "a real borrowing and a real
lending". Again in Inland Revenue Commissioners v. Rowntree
& Co. Ltd., [1948] 1 All ER 482 (CA), the Court of Appeal
considered the meaning of the words ’borrowed money’ and
observed that the words should not be given a strained
meaning and that it should be considered whether in ordinary
commercial usage the relationship was that of a borrower and
a lender and the transactions were loan transactions. These
cases were relied upon by the Gujarat High Court in Commis-
sioner of Incometax, Gujarat Iv. Rajkot Seeds, Oil & Bullion
Merchants Association Ltd., [1975] 101 ITR 748 in support of
the conclusion that on the facts of the case before the High
Court there was no relationship of borrower and lender
between the Rajkot Seeds and Oil and Bullion Merchants
Association and its members in so far as deposits by the
members were concerned. It was held that the amounts were
deposited by way of security taken for the due performance
of the, obligation of a member under the Rules of the Asso-
ciation for the discharge of his obligations to the Associa-
tion and to the other members of the Association. There was
no loan or borrowing at all. This question had in fact been
considered by the Calcutta High Court as long ago as Commis-
sioner of Excess Profits Tax, Central, Calcutta v. Bhartia
Electric Steel Co. Ltd., [1954] 25 ITR 192 in the context of
the third proviso to Rule 5A of Schedule I to the Excess
Profits Tax Act, 1940. The money in question in that case
had been obtained by the issue of shares, and it was held
that it could not possibly be said that the persons who had
taken up the deferred shares had ever intended to grant a
loan or that the Company which had obtained money on the
shares had ever intended to borrow. This Court in Bombay
Steam Navigation Co. (1953) Private Ltd. v. Commissioner of
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Income-tax Bombay, [1965] 56 ITR 52, was dealing with a
claim to deduction under s. 10(2)(iii) of the Indian
Income-tax Act 1922 in a case where under an agreement
certain assets were to be taken over by the assessee from
the Scindia Steam Navigation Company Ltd., and part of the
consideration was paid by the assessee while the balance
remained unpaid. For agreeing to deferred payment of the
balance of the consideration, the Scindias
847
were to be paid interest. This Court observed:
"An agreement to pay the balance of consideration due by the
purchaser does not in truth give rise to a loan. A loan of
money undoubtedly results in a debt, but every debt does not
involve a loan. Liability to pay a debt may arise from
diverse sources, and a loan is only one of such sources.
Every creditor who is entitled to receive a debt cannot be
regarded as a lender. If the requisite amount of considera-
tion had been borrowed from a stranger, interest paid there-
on for the purpose of carrying on the business would have
been regarded as a permissible allowance, but that is wholly
irrelevant in considering the applicability of clause (iii)
of sub-section (2) to the problem arising in this case. The
legislature has under clause (iii) permitted as an allowance
interest paid on capital borrowed for the purposes of the
business: if interest be paid, but not on capital borrowed,
clause (iii) will have no application ."
The point was also discussed by this Court in Madhav
Prasad Jatia v. Commissioner of Income-tax, U.P., [1979] 118
ITR 200 where the question was whether the interest claimed
under s. 10(2)(iii) of the Indian Income-tax Act, 1922
related to borrowing for the purpose of the business.
In the present case, Bye-law No. 50 indicates that
deposits were to be made by the producer members in the
’Loss Equalisation and Capital Redemption Reserve Fund’ for
the purpose of making the partly paid shares fully paid up,
and it was understood that the balance of the amount would
be applied to the loan taken from the Industrial Finance
Corporation of India and thereafter whatever remained would
be refunded to the depositing members resulting in the
extinction of the Fund. It is apparent that the deposits
made by the members cannot be regarded as loans advanced by
the members to the assessee. The moneys deposited represent-
ed contribution by the members for converting the partly
paid up shares into fully paid up shares and thereafter for
delaying the loan taken from the Industrial Finance Corpora-
tion of India. Any balance remaining was to be refunded to
the members. The circumstances that there was no certainty
that any balance would remain for refund to the members
would in itself indicate that the deposits could not be
regarded as loans. A loan necessarily supposes a return of
the money loaned. Even under the original Bye-law No. 50,
which provided for deposits by the members to the
848
’Loss Equalisation and Capital Redemption Reserve Fund’, it
was contemplated that the deposits would be accumulated and
be utilised for repayment of the initial loan taken from the
Industrial Finance Corporation of India and thereafter for
redeeming the ’Government share’, and the balance of the
deposit after meeting losses would be converted into share
capital and each producer member would be issued shares of
the assessee. There was never any intention between the
assessee and its members to treat the deposits made by the
members as loans and that the relationship between the
assessee and the members should be that of borrower and
lender. The High Court erred in holding that the claim to
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deduction on account of interest paid by the assessee to its
members was admissible under s. 36(1)(iii) of the Act.
It is urged by learned counsel for the assessee that if
the claim to deduction cannot be rested on s. 36(1)(iii) of
the Act, it should be regarded as admissible under s. 37 of
the Act. We are not satisfied that all the facts necessary
for considering a claim for deduction under s. 37 are before
us. It will be noticed in Madhay Prasad Jatia (supra) that
the question of law expressly took in the claim to deduction
not only with reference to s. 10(1)(iii) but alternatively
with reference to s. 10(2)(xv) of the Indian Income-tax Act,
1922. Whether or not it is still open to the assessee to
raise that question before the Appellate Tribunal when the
case goes back to it for disposing it of in conformity with
the opinion expressed by this Court in these appeals is a
question on which we propose to express no view at this
stage.
In the result the appeals are allowed, the impugned
judgment of the High Court in all these cases is set aside
and the first and the second questions framed by the Appel-
late Tribunal are answered in the negative, in favour of the
Revenue and against the assessee. There is no order as to
costs.
R.S.S. Appeals allowed.
849