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Citation Codes
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Case Number
Judges
  • M.C Chagla, C.J
  • Desai, J.
Acts
  • s. 12(2) of the Indian Income-tax Act.
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Cites
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Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • M.C Chagla, C.J
  • Desai, J.
Acts
  • s. 12(2) of the Indian Income-tax Act.
See more information ...
Smart Summary

Summary of Opinion by Chagla, C.J.

Factual and Procedural Background

The reference concerns an assessee who, for assessment years 1949–1950 and 1950–1951, earned interest on fixed deposits which was assessed under s. 12 as income from "other sources." The amounts of interest received were Rs. 2,256-0-0 for 1949–1950 and Rs. 2,904-0-0 for 1950–1951. In those years the assessee borrowed money to meet household expenses, to purchase jewellery and to pay advance tax; she paid interest on those borrowings amounting to Rs. 1,648-0-0 in 1949–1950 and Rs. 2,530-0-0 in 1950–1951. The assessee sought to deduct those interest payments from the interest received on the fixed deposits, relying on s. 12(2) of the Indian Income-tax Act. The Tribunal rejected the claim, and the assessee filed the present reference. The Attorney for the applicant was S.P. Mehta and for the respondent N.K. Petigara. The court gave its answer in the negative and ordered the assessee to pay costs.

Legal Issues Presented

  1. Whether interest paid on moneys borrowed to meet household expenses and to purchase jewellery is deductible from interest earned on fixed deposits under s. 12(2) of the Indian Income-tax Act as expenditure "incurred solely for the purpose of making or earning" that income.
  2. Whether interest paid on moneys borrowed to make advance tax payments (where such advance tax payments themselves attracted interest to the assessee) is deductible under s. 12(2), at least to the extent of the interest the assessee would earn on the advance tax payment.

Arguments of the Parties

Appellant's Arguments (as presented by S.P. Mehta)

  • The assessee claimed that interest paid on borrowings for household expenses, purchase of jewellery and payment of advance tax should be deductible under s. 12(2) because those borrowings preserved the fixed deposit and thereby preserved the source of the interest income.
  • Specifically, it was argued that the assessee had an option: (a) withdraw from the fixed deposit (reducing the income) or (b) borrow and pay interest in order to preserve the fixed deposit and its interest. By choosing (b), the assessee preserved the source of income and the expenditure should therefore be deductible.
  • With respect to advance tax, Mr. Mehta argued that because the advance tax payment earned interest (2%), if the assessee borrowed to pay that advance tax and thereby earned that 2%, she should at least be allowed a deduction corresponding to that interest cost.
  • He relied on authorities including Eastern Investments Ltd. v. Commissioner of Income-tax and Commissioner of Income-Tax, Bombay v. Tata Sons Ltd., invoking principles that indirect facilitation of earning income and commercial expediency can suffice to bring an expenditure within s. 12(2).

The opinion does not contain a detailed account of the respondent's oral arguments beyond the Tribunal's rejection and the formal representation by counsel N.K. Petigara.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Eastern Investments Ltd. v. Commissioner of Income-tax, 1951 20 I.T.R. 1 The decision includes the principle that expenditure need not be of necessity or give a direct and immediate benefit; it is sufficient if voluntarily incurred on grounds of commercial expediency and in order indirectly to facilitate the carrying on of the business. The court considered the quoted principle but held it inapplicable: the payments in the present case were not made on grounds of commercial expediency, nor did the borrowings or interest payments indirectly facilitate the carrying on of the "business" (here, maintenance of a fixed deposit yielding interest). The test in Eastern Investments was not satisfied by the facts before the court.
Commissioner Of Income-Tax, Bombay v. Tata Sons Ltd., 1938 41 Bom. L.R. 362 The case stands for the proposition that payment of part of a commission to a third person (or similar sacrifice) may be deductible if, on a commercial basis, it was necessary to arrange finance so that the assessee could continue to earn the income; the question depends on facts and commercial necessity. The court distinguished Tata Sons: in that case the assessee had no practical alternative except to incur the expenditure if it wished to earn the income. In the present case, the court found no such necessary alternative linking the expenditure to the earning of the fixed deposit interest; personal motives and optional choices (e.g., purchasing jewellery) did not render the expenditure deductible under s. 12(2).

Court's Reasoning and Analysis

The court began by construing s. 12(2): the subsection permits deduction only for expenditure "incurred solely for the purpose of making or earning the income" which is taxed. The crucial requirement is a purpose-based nexus between the expenditure and the earning of the income; an expenditure must be incurred for the purpose of earning that income. While the connection may be indirect, some nexus is required.

Applying this test, the court found no connection — direct or indirect — between the interest paid on the borrowings and the interest earned on the fixed deposits. The borrowings were used to buy jewellery, meet household expenses, and pay advance tax. The court analyzed the appellant's central contention (that borrowing rather than withdrawing preserved the fixed deposit and thus served the purpose of earning income) and rejected it as an improper focus on motive rather than on the actual purpose of the expenditure.

The court emphasized that s. 12(2) is concerned with the actual purpose for which money was expended. The mere fact that an assessee could have reduced income by drawing on the fixed deposit does not convert a personally motivated borrowing into expenditure incurred for earning the interest income. The choice to borrow rather than withdraw funds does not, by itself, establish the requisite nexus.

On the specific point about advance tax, the court addressed the submission that because advance tax payments attracted interest (2%), borrowing to pay advance tax should allow a corresponding deduction. The court noted that the purpose of borrowing to pay advance tax was to discharge a statutory obligation, not to earn the interest on the advance payment. The court applied a simple test proposed in the opinion: if no interest had been payable on the advance tax payment, the assessee could not have claimed deduction of interest paid on borrowed funds for that purpose; the presence of incidental interest receipt does not change the underlying purpose of the borrowing. Mr. Mehta conceded that if no interest were payable on advance tax, the deduction could not be claimed; the court used that concession to reinforce that the incidental receipt of interest does not alter the purpose of the expenditure.

The court then considered the authorities relied upon by the appellant. Eastern Investments was considered and its language about indirect facilitation was noted, but the court held the facts did not meet that test (no commercial expediency, no facilitation). Tata Sons was considered: there, the expenditure was necessary in a commercial sense to continue earning the income; in contrast, here the alternatives faced by the assessee were not alternatives that connected the expenditure to the earning of the income. Because the borrowings were optional and driven by personal considerations, they fell outside s. 12(2).

On the basis of these analyses the court concluded that the Tribunal's negative view of the deduction claim was correct.

Holding and Implications

Holding: The reference is answered in the negative: the interest paid on the borrowings for household expenses, purchase of jewellery and for payment of advance tax is not deductible under s. 12(2) of the Indian Income-tax Act against the interest income from the fixed deposits.

Implications:

  • Direct effect on the parties: The assessee's claim for deduction of the interest payments was rejected and the Tribunal's decision was affirmed; the assessee was ordered to pay the costs of the reference.
  • Scope: The court's decision turned on the absence of a purpose-based nexus between the expenditures and the earning of the assessed income. The opinion distinguished prior authorities relied upon by the assessee, and confined their application to situations where the expenditure is commercially necessary or otherwise connected to earning the income. The opinion does not announce a novel statutory principle beyond that construction and application of s. 12(2); it declines to treat personally motivated or optional borrowings as deductible merely because they preserve a source of income.

Attorneys noted in the opinion: S.P. Mehta for the applicant; N.K. Petigara for the respondent.

Show full summary ...

    Bai Bhuriben Lallubhai v. The Commissioner Of Income Tax Bombay North

    Chagla, C.J:— This reference raises a fairly short and simple question. The assessee for the assessment years 1949–1950 and 1950–1951 had various sources of income and one of the sources of income was interest on fixed deposit. That income was assessable to tax under s. 12 as being an income from “other sources.” In the year 1949–1950, she received interest on fixed deposit in the sum of Rs. 2,256-0-0 and in the year 1950–1951 she received a sum of Rs. 2,904-0-0. Now in these two years, she borrowed various sums of money for the purpose of meeting her household expenses, purchasing jewellery and meeting advance tax payment and she had to pay interest on these borrowings. In the year 1949–1950, she paid Rs. 1,648-0-0 as interest and in the year 1950–1951 she paid Rs. 2,530-0-0 as interest. The assessee claimed to deduct these two sums from the interest earned by her from her fixed deposit and her claim was based on s. 12(2) of the Indian Income-tax Act. The Tribunal has negatived her claim and the assessee has come on this reference.

    2. Before we examine the facts, it is necessary, first, to turn to the section itself. The deduction which is permissible under sub-s. (2) of s. 12 is an expenditure incurred solely for the purpose of making or earning the income which has bee subjected to tax. Therefore, in order to decide whether a deduction is permissible under sub-s. (2), 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. The expenditure may be incurred for any commercial purpose. The connection between the expenditure and the earning of the income may not be direct. However indirect the connection may be, 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 sh claims as a deduction under sub-s. (2), has no connection whatsoever whether direct or indirect with the income she has earned on her fixed deposit. For the sake ??? argument, confining ourselves to the case of jewellery, the position put simply this: The assessee wants to purchase some jewellery, she has no spare cash with her, she borrows money to purchase jewellery and on the borrowing she has to paid interest. It is this interest which she pays which she claims is a permissible deduction under sub-s. (2) of s. 12. Now, the purpose for which this interest was paid was in order that she should have money to buy the jewellery. This is clearly the purpose and obviously that purpose has no connection whatever direct or indirect with the income which she earns from her fixed deposit. The purchase of jeweller does not facilitate the earning of the income. Her fixed deposit is not affected by the fact of her purchasing the jewellery or not purchasing the jewellery. But what is rather ingeniously urged by Mr. Mehta is that the assessee had the option either of taking the money from the fixed deposit and thereby reducing the income or borrowing money and paying interest on it. Inasmuch as she exercised the option of borrowing money, she preserved the source of the income and therefore this expenditure is an allowable expenditure.

    3. Now, what sub-s. (2) emphasises is the purpose for which the expenditure is incurred. The Court is not concerned with the motive of the assessee, and what Mr. Mehta in fact asks us to do is to probe into the motive of the assessee. It may be that the assessee's motive was to save her fixed deposit and interest accruing from it and to purchase jewellery by means of loan borrowed from so person or other. But that consideration is entirely irrelevant. What we ??? concerned with is the actual action on the part of the assessee and not the action she could have taken under the circumstances. If she had chosen to purchase this jewellery by withdrawing money from the fixed deposit, then undoubtedly her income would have been reduced and to that extent the tax on that income would also be reduced. But because she chose to borrow money to buy the jewellery, it does not establish the purpose, namely that she borrowed money in order to maintain or preserve the fixed deposit or help her to earn interest. It is suggested by Mr. Mehta that whatever may be the position, with regard to the jewellery and household expenses, the position is different with regard to the advance tax which she had to pay, and Mr. Mehta says that if she earned 2 per cent interest on the advance payment and inasmuch she had to borrow money in order to pay this advance tax and earn 2 per cent interest, she should have been allowed deduction at least to that extent. It may be that if an assessee borrows money in order to purchase securities which would earn interest, the interest which she may have to pay on the loan would be a permissible deduction. But then the purpose of borrowing the money is to purchase securities which is the source of the income. In this case, the purpose of borrowing the money in order to pay advance tax was not to earn 2 per cent interest. Obviously the purpose was to discharge the statutory obligation which was upon the assessee to make the advance tax payment. The simple test that may be applied is whether the assessee could have claimed this deduction if no interest was payable to her on the advance tax payment. Mr. Mehta had to concede that if no interest was payable, the assessee could not have claimed the payment of interest on the moneys borrowed for the purpose of paying this tax as a permissible deduction. If she could not have claimed interest paid by her on the loan borrowed for the purpose of making advance tax payment if no interest was payable on the advance tax payment, it is difficult to understand how on principle she can claim this deduction merely because the Legislature provided that she should receive interest on he advance tax payment. Payment of interest is purely incidental, so is the receipt of the interest. The only purpose which the assessee had in mind when he borrowed the money was, as we said before, to discharge her statutory obligation.

    4. Now, let us see whether the authority cited by Mr. Mehta can put any different complexion upon the view that we have taken on the question raised in this reference. Mr. Mehta, has relied on a decision of the Supreme Court reported in Eastern Investments Ltd. v. Commr. of Inc.-tax . 1951 20 I.T.R 1., and what he relies on re certain observations in the judgment of Mr. Justice Bose. The learned Judge enunciates certain relevant principles for determining whether a particular expenditure comes within the ambit of 12(2), and what is relied upon by Mr. Mehta ??? the third principle and this is how the learned Judge puts it (p. 4):

    “it is enough to show that the money was expended not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the ground of commercial expediency, and in order indirectly to facilitate the carrying on of the business”,

    5. And what is emphasized by Mr. Mehta is that Mr. Justice Bose had laid down that the payment need not directly facilitate carrying on of business, even indirect facility given to the carrying on of the business shall be sufficient. Applying this test to the facts of the present case, it is clear that the test will not be satisfied. In the first place the payment is not made on the ground of commercial expediency, no commercial expediency was involved in the purchasing of jewellery or the payment of household expenses or the payment of advance tax, nor was the carrying on of the business facilitated either directly or indirectly by the borrowing of the loan or the payment of the interest of the loan. In the particular case with which we are concerned the only business which realises the income was the fact that the assessee maintained a fixed deposit and earned interest on it. As we have pointed out, it is jewallary difficult to understand how the earning of the income was facilitated by the borrowing of this loan or the payment of interest on that loan.

    6. The next authority on which reliance is placed is a well known decision of this court reported in Commissioner Of Income-Tax, Bombay v. Tata Sons Ltd. . 1938 41 Bom. L.R 362. ??? John Beaumont C.J at p. 367 deals with the question of the assessees having paid part of a commission to which they were entitled in order to arrange to finance he managed company through F.E Dinshaw and this is what the learned Chief Justice says:

    “…The question whether the payment of part of a commission to a third person can be regarded as expenditure incurred solely for the purpose of earning that commission is a question which must be answered on the facts of each case and on a commercial basis. Now, it is to my mind clear in this case that the assessees were bound either to lose the commission which they were getting from the Tata Iron and Steel Co., Ltd., or to arrange for financing that Company, and we must assume that the arrangement, which they made as to finance was the wisest which could be made in the circumstances.”,

    7. And Mr. Mehta says that in the case before the learned Chief Justice the assessee was confronted with these alternatives that either he had to lose the commission or to pay a share of the commission so that finance may be available and he may continue to earn the income.

    8. In the case before us also the assessee was confronted with the same alternatives. In our opinion the facts of the case in The Tata Sons Ltd. were entirely different from the facts before us. It cannot be said that if she had not borrowed the money in order to pay for the jewellery or the household expenses ??? 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 bought no jewellery, had incurred no household expense, and had not paid advance tax. Therefore, the alternatives which the learned Chief Justice was considering must be alternatives which must connect the incurring of the expenditure with the carrying on of the business. If an assessee has no option except to incur an expenditure in order to make the earning of an income possible, then undoubtedly the exercise of that option is compulsory and any expenditure incurred by reason of the exercise of that option would come within the ambit of s. 12(2). But where the option has no connection with the carrying on of the business or the earning of the income and the option depends upon personal considerations or upon motives of the assessee that expenditure cannot possibly come within the ambit of s. 12(2). In our opinion, therefore, the Tribunal was right in the view that it took and the answer we proceed to give to the question submitted to us is in the negative.

    9. The assessee to pay the costs.

    Attorney for applicant: S.P Mehta.

    Attorney for respondent: N.K Petigara.

    10. Answer accordingly.

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    Bai Bhuriben Lallubhai v. The Commissioner Of Income Tax Bombay North
    (Apr 21, 1955)