Kantawala, C.J:— At the instance of the assessee the following two questions were initially referred by the Income-tax Tribunal for our determination:
“1. Whether, on the facts and in the circumstances of the case, interest paid by the assessee-firm on Rs. 9,41,344 borrowed by it could be disallowed in determining its business profits for the assessment year 1951–52?
2. Whether, on the facts and in the circumstances of the case, the proviso to section 13 was attracted to the trading results in the assessee's Coonoor branch for the assessment years 1951–52 and 1952–53 and its branch called Eastern Stores for the assessment year 1952–53?”
2. These were the only two questions referred to by the Tribunal for the two assessment years even though in its application the assessee desired that for the assessment year 1951–52, 13 questions ought to be referred to and for the assessment year 1952–53, three more questions should be referred to. After the reference was filed in this court the assessee took out a notice of motion for directing additional questions to be raised by the Tribunal which it desired to raise. That motion was partly allowed by this court and the court directed the two additional questions to be referred to by the Tribunal and a supplementary statement of case to be submitted. These two additional questions are as under:
“1. Whether the income-tax department and/or the Tribunal were justified in disallowing the payment of interest under section 10(2)(iii) of the Act, if the amount was initially borrowed for purposes of the assessee's business and subsequently spent or utilised for the purposes of meeting the tax liability of partner?
2. Whether there was any evidence and/or material before the Tribunal to hold that the amounts aggregating to Rs. 77,000 could in law be added as the undisclosed income of the Bombay head office?”
3. At the outset, it may be stated that the original question No. 1, which has been referred to by the Tribunal has not been pressed by the assessee in view of additional question No. 1 directed to be referred to this court pursuant to the above order. So far as the original question No. 2 is concerned, counsel of both the parties are agreed that the point therein is covered by the decision of this court in I.T Reference No. 92 of 1965— Kishinchand Chellaram v. Commissioner of Income-tax, given on December 3, 1974 (See page 671 infra) and, accordingly, it should be answered in the affirmative. Messrs. Kishinchand Chellaram, the assessee, is a registered firm carrying on business in the manufacture of silk and silk goods with its head office at Bombay and with several branches in India and abroad. It appears from the balance-sheet and the profit and loss account filed by the for the relevant assessment years that it was its uniform practice to accept deposits from outsiders and utilise the sums so received for its own business and for the business of its sister concerns. It appears from the balance-sheet and profit and loss account of the head office as on April 2, 1951, that the total liabilities of the assessee aggregated to Rs. 92,27,618. Out of this, an aggregate sum of Rs. 21,22,872 was a capital contribution of three of its partners as under:
Rs.
Lachhmibai Seth Shewakram
6,62,281
Seth Lokumal Seth Kishinchand
9,18,248
Seth Murlidhar Seth Tahilram
5,42,343
4. The fourth partner, Kishinchand Chellaram, had a debit balance of Rs. 6,96,535 being the amount overdrawn by him. At the end of the accounting year relevant to the assessment year 1951–52, the assessee, in all, had paid an aggregate sum of Rs. 23,67,679 against its income-tax and excess profits tax liabilities. This amount was shown as an asset in its balance-sheet as at the end of the accounting year. It included an amount of Rs. 18,58,116 for income-tax and super-tax and Rs. 5,49,565 for excess profits tax deposit. After taking into account the debit balance of one of the partners, Kishinchand Chellaram, the net capital of the four partners at the end of the accounting year taken together came to Rs. 14,26,337. It is the case of the taxing authorities that the total amount paid by the assessee-firm as at the end of the accounting year against income-tax and excess profits tax liabilities exceeded the aggregate net capital of the four partners by a sum of about Rs. 9,41,344. The taxing authorities felt that this amount of tax liabilities of the partners was paid out of the borrowed deposits and interest referable thereto ought not to be permitted as a deduction while calculating income, profits and gains of the business. The Income-tax Officer in his order took the view that the total liabilities of the assessee-firm amounted to Rs. 92,27,618 which was made up of these two items, viz., Rs. 21,22,874, partners capital account, and Rs. 71,04,746, deposits from creditors. He felt that the total interest paid to the creditors came to Rs. 1,43,243. According to him, the entire borrowings made by the assessee-firm were not fully utilised for the business activities of the firm but they had been partly applied for certain activities not connected with the business of the assessee-firm. In the extract annexed to his order he pointed out that funds to the extent of an aggregatesum of Rs. 18,85,630 were used by the assessee for non-business purposes and out of the total interest paid by the firm he disallowed an amount of Rs. 32,047 on the ground that the interest to that extent was referable to the utilisation of the brrrowings made by the firm for non-business purposes.
5. In an appeal preferred by the assessee, some of the claims of the assessee were accepted but the Appellate Assistant Commissioner confirmed the disallowance in so far as it related to borrowed moneys being utilised for payment of taxes amounting to Rs. 9,41,344. It was urged before the Appellate Assistant Commissioner that interest pertaining to the sum of Rs. 9,41,344 ought not to be disallowed but it was rejected by him. According to him, tax came after income had been earned and the interest proportionate to monies utilised by the assessee for payment of taxes cannot, therefore, be regarded as laid out in the course of the business. He clearly took the view that proportionate interest to be disallowed would be limited to monies expended on charity of Rs. 32,189 and partners net debit balance of Rs. 9,41,344 (in all Rs. 9,73,533).
6. In a further appeal by the assessee before the Tribunal it was contended on its behalf that the firm had paid both income-tax and excess profits tax under protest; that considerable amount of taxes was in dispute and ultimately the firm got a refund of about Rs. 6 lakhs. The firm in the meantime debited the taxes account in the balance-sheet and showed it as a fictitious asset in the balance-sheet keeping the credit balances in the partners’ accounts intact. It was urged on behalf of the assessee before the Tribunal that failure on the part of the firm and the partners to pay taxes would have resulted in the closure of the business and it was, therefore, absolutely necessary for the firm to pay the taxes and carry on the business even though the net effect was that a part of the borrowed money was used for paying the taxes of the firm and the partners. On the other hand, it was contended on behalf of the revenue before the Tribunal that for purposes of income-tax, a firm and partners were separate entities and the money borrowed by the firm after paying interest could not be transferred to partners without charging interest. The Tribunal upheld the disallowance of interest. In its order, the Tribunal pointed out that the short question to be considered is whether the amount of Rs. 9,41,344 which was disbursed by the firm against its tax liabilities and those of the partners out of its borrowed money could be said to have been an outlay for purposes of the firm's business. The Tribunal pointed out that with regard to the amounts paid against the partners’ taxes, they were obviously not laid out for the purposes of the firm's business and the interest on borrowing referable to that expenditure is clearly inadmissible. Ordinarily, it is true that in general law there is no distinction between a firm and the partners, but for purposes of income-tax they are separate entities and even according to general law, investments in the name of the individual partners do not necessarily belong to the firm. Similarly, income-tax liabilities of individual partners do not arise only out of their relation with the firm but they also arise out of the sources of income other than the firm itself. Even otherwise, amounts borrowed for the purpose of meeting tax liabilities cannot be said to be capital borrowed for the purpose of business, profession or vocation carried on by the assessee. After all, taxes are levied only after incomes or profits are determined and ordinarily they can be paid out of the income or profits to which they relate. It would not be necessary to borrow moneys in order to pay taxes because they ordinarily relate to the income that is earned and that is available for the payment of taxes. The Tribunal further pointed out that there would have been no need to borrow funds for discharging tax liabilities if the profits earned by the firm and the partners had been retained with the firm and not taken out of the firm by way of investments of individual partners. It took the view that the interest paid on moneys borrowed for meeting tax liabilities even of the firm itself, therefore, could not be allowed. The Tribunal ultimately took the view that interest on borrowings referable to the tax payments of Rs. 9,41,344 was rightly disallowed as deduction in determining the profits of the firm.
7. Additional question No. 1 above referred to arises from this part of the order of the taxing authorities and the Tribunal. It was urged by Mr. Kolah that if regard be had to the balance-sheet and the profit and loss account of the assessee-firm for the relevant years, then it is quite evident that it was a part of its business to accept deposits from outsiders. Such deposits were taken or moneys were borrowed for the purposes of business. He submitted that having regard to the provisions of section 10(2)(iii) of the Indian Income-tax Act, 1922, if it is established that capital is borrowed for the purposes of business, profession or vocation, then the amount of interest paid in respect of such capital will be a permissible deduction in computing the profits and gains of such business. According to his submission, what is required to be seen is the purpose for which the amount is borrowed and it is unnecessary to apply one's mind to the object or the purpose for which the money was used or utilised either wholly or partially. He clearly submitted that if capital is borrowed for the purpose of business, then even if moneys are utilised for purposes other than that of the business, the interest payable in relation to the capital so used is a permissible allowance in computing profits and gains of business under section 10(2)(iii). Secondly, he submitted that in the present case not only amounts were borrowed for the purpose of business, but they were also utilised or used for the purpose of business of the assessee-firm when part of the borrowed amount was utilised for paying tax liabilities of the firm and/or its partners. Such user, according to him, is necessary to save the business; otherwise coercive measures or steps will be adopted by the taxing authorities for recovery of the tax dues. In any event according to his submission, utilisation of moneys borrowed for the purposes of business is incidentally for the purposes of business and must be allowed as a deduction falling under section 10(2)(iii) in computing the profits and gains of business. Mr. Joshi, on the other hand, on behalf of the revenue, submitted that it is not enough that the capital is borrowed for the purposes of business. In order that an allowance may be claimed under section 10(2)(iii) it must further be established that the capital that is borrowed is utilised for the purposes of business and if that is not done the interest referable to capital not used for purposes of business is not a permissible deduction under section 10(2)(iii). He emphasised that liability to pay tax is not an expenditure incurred for the purpose of business. According to his submission such liability arises for the first time after income has accrued and any utilisation of income after it is accrued cannot be regarded as a permissible deduction for computing the profits and gains of business.
8. The provisions as regards liability to pay tax in respect of profits or gains of business are contained in section 10 of the Act. The relevant part of that section is as under:
“10. Business.— (1) The tax shall be payable by an assessee under the head ‘Profits and gains of business, profession or vocation’ in respect of the profits or gains of any business, profession or vocation carried on by him.
(2) Such profits or gains shall be computed after making the following allowances, namely:—…
(iii) in respect of capital borrowed for the purposes of the business, profession or vocation, the amount of the interest paid:……”
9. There is a proviso and Explanation to this clause but they are irrelevant for the present purpose.
10. It was urged by Mr. Kolah that the principles relevant for construction of section 10 are clearly laid down by the Supreme Court and he relied upon the decision of the Supreme Court in Commissioner Of Income Tax, Madras v. Indian Bank Limited, Madras, [1965] 56 ITR 77. At page 79, the principle is laid down by the Supreme Court as under:
“In our opinion, in construing the Act, we must adhere closely to the language of the Act. If there is ambiguity in the terms of a provision, recourse must naturally be had to well-established principles of construction but it is not permissible first to create an artificial ambiguity and then try to resolve the ambiguity by resort to some general principle.”
11. The issue in this reference will depend upon the correct interpretation of the expression “capital borrowed for the purposes of the business”. This expression has been construed on more than one occasion. It came up for construction before a Full Bench of the Madras High Court in Commissioner of Income-tax v. Somasundaram Chettiar, AIR 1928 Mad 487. At page 488, the Full Bench lays down that the only reasonable construction of the section is to construe ‘capital borrowed for the purposes of the business’ as meaning capital borrowed and used for the purposes of the business. This interpretation put upon this expression by the Full Bench of the Madras High Court has been accepted by this court. Reference can be had to the decision of a Division Bench of this court in Calico Dyeing and Printing Works v. Commissioner of Income-tax, [1958] 34 ITR 265 (Bom). The real question that came up for consideration before the Division Bench in this case was, when capital was used in the year of account to purchase machinery but the machinery was not used in the year of account, can the interest on such capital be permitted as a deduction under section 10(2)(iii) ? In that case, the assessee-firm which carried on the business of bleaching, dyeing and printing cloth borrowed money in the year of account in order to extend its business, purchased land and erected additional plant and machinery and paid interest on the borrowed capital. In its assessment to income-tax in the relevant assessment year the claim of the assessee to deduction of the interest so paid under section 10(2)(iii) of the Act was rejected on the ground that the plant and machinery were not used for the business in the year of account. On a reference before the High Court, the Division Bench took the view that the assessee was entitled to the deduction claimed, even though the plant and machinery were not used in the year of account. The High Court pointed out the circumstances in which the provisions of section 10(2)(iii) will be attracted. According to the High Court, where the assessee claims deduction of interest paid on capital borrowed under section 10(2)(iii) of the Indian Income-tax Act, all that the assessee has to show is that the capital which was borrowed was used for the purposes of the business of the assessee in the relevant year of account. It does not matter whether the capital is borrowed in order to acquire a revenue asset or a capital asset. If the capital is used in the year of account and the use is for the purpose of the business of the assessee, it is immaterial whether the user of the capital actually yielded profit or not and it is not open to the department to reject the claim of the assessee in respect of the interest paid on that capital merely because the use of the capital is unremunerative. At page 270, Chagla C.J pointed out:
“We are prepared to agree with Mr. Joshi that, looking to the whole scheme of sub-section (2), the capital which is borrowed must be used in the year of account. If the capital is used in the year of account and the use is for the purpose of the business, then it is immaterial whether the user of capital actually yields profit or not. What sub-clause (iii) emphasises is the user of the capital and not the user of the asset which comes into existence as a result of the borrowed capital.”
12. In this case, the learned Chief Justice has referred to the Full Bench decision of the Madras High Court in Somasundaram Chettiar's case, AIR 1928 Mad 487, and pointed out that it should be noted that what the Madras High Court emphasised was the user of the capital and not the user of the asset which had come into existence as a result of the borrowed capital. Thus, the interpretation that has been put by the Full Bench of the Madras High Court has been approved by this court in this case.
13. That such is the normal requirement before the provisions of section 10(2)(iii) are attracted is also evident from another decision of this court in the case of Commissioner of Income-tax v. Bombay Samachar Ltd., [1969] 74 ITR 723 (Bom). In this case, the Division Bench of this court has cited with approval a decision of the Madhya Pradesh High Court which laid down the conditions required to be fulfilled before invoking the provisions of section 10(2)(iii). However, it is quite evident that those conditions must exist in the light of other observations in the judgment and the facts before the court. The Division Bench in this case laid down that the conditions required to be satisfied in order to enable the assessee to claim a deduction in respect of interest on borrowed capital under section 10(2)(iii) are firstly, that money must have been borrowed by the assessee; secondly, it must have been borrowed for the purpose of business; and, thirdly, the assessee must have paid interest on the said amount and claimed it as a deduction. It is not the requirement of the provision that the assessee must further show that the borrowing of the capital was necessary for the business so that if at the time of borrowing the assessee had sufficient amount of its own, the deduction could not be allowed. The above ingredients as laid down by the Madhya Pradesh High Court in Ram Kishan Oil Mills Ltd. v. Commissioner of Income-tax, [1965] 56 ITR 186 were approved by this court, but at page 730 of the report, it is quite evident that at more than one place this court was careful enough to point out that the capital borrowed by the assessee from outsiders was admittedly used by the assessee for the purposes of business. Further, it also cited with approval a quotation from the case of Calico Dyeing and Printing Works, [1958] 34 ITR 265 (Bom) referred to above. Thus, it is quite evident that the court proceeded on the footing that the amounts borrowed from outsiders on which interest has been paid have been used for the purposes of the business of the assessee.
14. Even in the Madhya Pradesh High Court judgment (Ram Kishan Oil Mills Ltd. v. Commissioner of Income-tax, [1965] 56 ITR 186) above referred to, the facts of the case clearly show that the capital that was borrowed in respect of which payment of interest was claimed as a deduction was in fact used for the purposes of business. Actually, the capital borrowed was utilised by the assessee for purchase of a capital asset, namely, the assessee's brother's interest in the family business on a partition of the family assets. Even the Madhya Pradesh High Court has been careful enough to point out in its judgment that they are in full agreement with the decision of this court in the case of Calico Dyeing and Printing Works, [1958] 34 ITR 265 (Bom). Thus, so far as this court is concerned, it is quite clear that under section 10(2)(iii) interest paid on borrowed capital will be allowed as a deduction only if the capital was borrowed and used for the purposes of business. If it is used for a purpose other than that of business, then interest to the extent to which the capital was so used will not be allowed as a permissible deduction under section 10(2)(iii).
15. Mr. Kolah has relied upon the reasons given by this court for discharging the rule in Income-tax Application No. 83 of 1976 [Commissioner of Income-tax v. Kishinchand Chellaram, [1977] 109 ITR 569 (Bom)] in the case of this very assessee for the subsequent years. The rule was discharged by this court by its order dated November 30, 1976, to which my learned brother was a party. At the outset we may point out that we have carefully gone through the reasons given by this court and it is quite apparent that the question whether capital borrowed for the purposes of business must be used for the same before interest in respect thereof could be allowed as a deduction under section 10(2)(xv) was neither argued nor arose for consideration before the Division Bench. Thus, in our opinion, the order for discharging the rule nisi relied upon by Mr. Kolah does not prevent this court to consider this question when the matter is argued at length by both the sides.
16. Reference was made by Mr. Kolah to a decision of the Andhra Pradesh High Court in the case of Commissioner of Income-tax v. Gopi-krishna Muralidhar, [1962] 47 ITR 469. In that case, a Hindu undivided family which carried on business on an extensive scale with a capital of about Rs. 20 lakhs, made large borrowals during the relevant year for the purposes of the business and paid interest amounting to Rs. 93,611. In the course of the year, monies amounting to Rs. 1,77,984 were withdrawn from time to time for household expenses. The question was whether a part of the interest paid on borrowed capital could be disallowed. The Andhra Pradesh High Court took the view that as the amounts were borrowed for the purposes of the business of the family and as no particular sum purporting to be borrowed on behalf of the business was spent for household expenses and the family was entitled to withdraw from the capital supplied by it thereby depleting the capital, the fact that part of the amounts borrowed was later on used for personal expenses did not deprive the assessee of the benefit of deduction of the entire interest paid on borrowed capital under section 10(2)(iii) and a part of the interest could not, therefore, be disallowed. With respect to the learned judges, it may be said that in the judgment not much reasons are assigned. It does not appear to have been argued before the High Court that the correct interpretation of the expression “capital borrowed for the purposes of business” is capital borrowed and used for the purposes of business and, therefore, the question was not considered from that point of view. Further, even on the facts before them the learned judges were careful enough to point out that the family was surely entitled to withdraw from the capital supplied by it resulting in the capital being depleted. It is this aspect of the matter which has primarily affected the decision in the case. In the present case, such aspect has not been overlooked by the taxing authorities and the Tribunal. Even though an aggregate sum of Rs. 23,87,679 has been paid at the end of the accounting year towards income-tax, super-tax and excess profits tax liabilities, still the Tribunal has been conscious of the net amount standing to the credit of the capital account of the partners’ accounts. From the sum of Rs. 23,87,679 the net amount standing to the credit of the capital account of the partners was deducted and interest was only disallowed on the balance utilised for payment of income-tax, supertax and excess profits tax liabilities. That was not the case in the case before the Andhra Pradesh High Court.
17. Reference was also made by Mr. Kolah to a decision of the Calcutta High Court in the case of Commissioner of Income-tax v. Tingri Tea Company Ltd., [1971] 79 ITR 294. In that case, the assessee, a sterling company, owned tea gardens in India. As a non-resident company, it had remitted profits from time to time to the United Kingdom for the purpose of declaration of dividends to its shareholders and the surplus balance, after paying dividends, was kept with the bank in the United Kingdom as deposits: During the relevant accounting years the assessee-company paid interest accruing on its overdrafts to the banks in India and the assessee claimed deduction of the amounts paid as interest on money borrowed for the purpose of its business. In that case, the Tribunal had taken a view contrary to the one that was taken by the taxing authority. The Income-tax Officer rejected the claim for each of the years on the ground, that the overdrafts from the banks were not incurred wholly and exclusively for the assessee's business. The Appellate Assistant Commissioner found that the assessee-company made remittances to the United Kingdom by taking overdrafts from the banks in India and the borrowings from the banks in India were partly invested in earning interest income in the United Kingdom. He sustained a disallowance of Rs. 18,920 for the assessment year 1958–59 and also maintained in full the disallowance by the Income-tax Officer of the claims for interest for the other years. The Tribunal was of the opinion that, on the facts, the correct way to interpret the transaction would be that the remittances to the United Kingdom came out of the profits earned in India and that the bank overdrafts in India had in fact been utilised in carrying on the assessee's business and the income-tax authorities were not justified in disallowing any part of the bank interest paid by the assessee in India on its bank overdrafts. On a reference before the High Court, the High Court confirmed the view that was taken by the Tribunal. The High Court took the view that the inference of the Tribunal that remittances to the United Kingdom came out of the profits earned in India and the bank overdrafts in India had, in fact, been utilised in carrying on the assessee's business, was sustainable in law, and on such inference or finding of fact, the Tribunal was right in holding that the income-tax authorities were not justified in disallowing any part of the bank's interest on the overdrafts. In this case, Commissioner of Income-tax v. Tingri Tea Co. Ltd., [1971] 79 ITR 294, the Calcutta High Court has pointed out that if the test of the purpose of the business is satisfied in respect of the capital borrowed on which the amount of interest is earned, then the court should not impose any further conditions or considerations for allowing that interest in computing the profits. The subsequent fact that those monies after paying such dividends had a Temnant or residue in the bank, which produced interest, cannot alter or modify the purpose of the business for which it was sent. The taxing authorities in this case were persuaded to disallow interest on the footing that the dividends remitted in the United Kingdom to the shareholders continued to remain in banks in the United Kingdom and earned interest and, therefore, on the borrowings in India interest should either partly or entirely be disallowed. Both the Tribunal as well as the High Court rejected that narrow view of the matter and pointed out that payment of dividend is itself within the meaning of the expression “the purpose of the business” and the fact that subsequently after the payment of the dividend to shareholders of the sterling non-resident assessee some money remained as residue in the banks in the United Kingdom which earned interest, does not affect, modify or alter the purpose for which the money was sent, namely, to pay dividends which was the purpose of the business within the meaning of section 10(2)(iii). Looking at from that point of view interest becomes an item which should be allowed under section 10(2)(iii) as a deduction. This decision, in our opinion, does not support the contention of Mr. Kolah that even if capital borrowed for business is utilised for a purpose other than that of business, even then the interest to the extent to which the capital is so utilised is also a permissible deduction under section 10(2)(iii).
18. The next contention of Mr. Kolah is that the sum of Rs. 9,41,344 which was utilised for payment of income-tax and excess profits tax liabi lities of the partners and the firm out of the borrowed capital was income utilised for the purposes of business, because unless the taxes are paid it will not be possible for the assessee to continue to carry on its business and coercive measures will be adopted for recovery of the amount demanded by way of taxes. He, therefore, submitted that even when any amount from the borrowed capital is utilised for the purpose of paying taxes such user is for the purposes of business and directly falls under section 10(2)(iii) and interest in respect thereof can be claimed by way of deduction.
19. Reliance was placed by him on a decision of the Supreme Court in the case of Commissioner of Income-tax v. Malayalam Plantations Ltd., [1964] 53 ITR 140. In this case, the Supreme Court has taken the view while considering the provisions of section 10(2)(xv) of the Act that the expression “for the purpose of the business” is wider in scope than the expression “for the purpose of earning profits”. Its range is wide; it may take in not only the day-to-day running of a business but also the rationalisation of its administration and modernisation of its machinery; it may include measures for the preservation of the business and for the protection of its assets and property from expropriation, coercive process or assertion of hostile title; it may also comprehend payment of statutory dues and taxes imposed as a pre-condition to commence or for the carrying on of a business; it may comprehend many other acts incidental to the carrying on of the business. The Supreme Court has further pointed out that, however wide the meaning of the expression may be, its limits are implicit in it. The purpose shall be for the purpose of the business, that is to say, the expenditure incurred shall be for the carrying on of the business and the assessee shall incur it in his capacity as a person carrying on the business. Relying upon the ratio of this decision the submission of Mr. Kolah is that the Supreme Court has regarded payment of taxes imposed as a pre-condition to commence or for the carrying on of a business as permissible deduction. Therefore, amounts paid towards the tax liability of the firm and its partners can be regarded as having been utilised for the purposes of the business. It may be said that such a view as contended by Mr. Kolah has not been taken by the Supreme Court in this case. Payment of income-tax or excess-profits tax is not a pre-condition to commence or for carrying on of a business. Normally, liability to pay taxes will arise after income has accrued and naturally the income earned on which taxes are levied will be available for discharge of tax liability. An individual or a firm carrying on business has to distribute the profits earned after making provision for tax liability because having regard to the law in force it will be always necessary for anybody carrying on business to pay taxes on his profits and gains.
20. It will not be out of place in this context to refer to the decision of the Patna High Court in the case of Maharajadhiraj Sir Kameshwar Singh v. Commissioner of Income-tax, [1961] 42 ITR 774. The Patna High Court has taken the view that the amount of income-tax paid by an assessee cannot be deducted as a business expenditure. The reason is that income-tax is not a deduction before you arrive at the net profits of the assessee. It is not an expenditure for the purpose of earning profits; it is, on the contrary, a case of application of profits after they have been earned and not expenditure necessary to earn such profits. Interest on money borrowed for payment of tax is not a legitimate deduction in computing business profits. At page 777, it is pointed out:
“It is a well established proposition that the amount of income-tax paid by an assessee cannot be deducted as a business expenditure. The reason is that income-tax is not a deduction before you arrive at the net profits of the assessee. It is said in an English case that income-tax represents ‘the Crown's share of the profits’. It is not an expenditure for the purpose of earning profits. It is, on the contrary, a case of application of profits after they have been earned and not expenditure necessary to earn such profits.”
21. Reliance was placed by the Patna High Court in the above case on a decision of the House of Lords in Ashton Gas Co. v. Attorney-General, [1906] AC 10 At page 12, the Lord Chancellor states in the course of his speech as follows:
“My Lords, so presented the case appears to me to be perfectly clear. The fallacy has been in arguing as if you can deduct from the income tax which you have got to pay something which alters what is the real nature of the profit. Now the profit upon which the income tax is charged is what is left after you have paid all the necessary expenses to earn that profit. Profit is a plain English word; that is what is charged with income tax. But if you confound what is the necessary expenditure to earn that profit with the income tax, which is a part of the profit itself, one can understand how you get into the confusion which has induced the learned counsel at such very considerable length to point out that this is not a charge upon the profits at all. The answer is that it is. The income tax is a charge upon the profits; the thing which is taxed is the profit that is made, and you must ascertain what is the profit that is made before you deduct the tax—you have no right to deduct the income tax before you ascertain what the profit is. I cannot understand how you can make the income tax part of the expenditure.”
22. An identical principle has been expressly embodied in section 10(4) of the Income-tax Act, which states as follows:
“Nothing in clause (ix) or clause (xv) of sub-section (2) shall be deemed to authorise the allowance of any sum paid on account of any cess, rate or tax levied on the profits or gains of any business, profession or vocation or assessed at a proportion of or otherwise on the basis of any such profits or gains;…”
23. In view of the statutory provisions it is quite clear that it is a necessary corollary that a deduction of interest on money borrowed for payment of tax is not a legitimate deduction.
24. Thus, in our opinion, the additional question No. 1 above referred to should be answered in the affirmative in favour of the revenue.
25. That takes us to the facts relevant for additional question No. 2. In the relevant year of account the assessee had a branch in Karachi and a ginning factory at Pithore near Karachi. In the head office books of the assessee at Bombay there were credits totalling Rs. 77,000 in the names of the following persons. They were received and repaid as under:
Name of the Depositor
Amount
Date of Deposit
Date of withdrawal
Rs.
1.
Chandiram Kirpaldas, Ajmer
16,000
26-3-51
16-6-51
2.
Khushiram Khushaldas, Ajmer
14,000
26-3-51
16-6-51
3.
Rijumal Satramdas, Jaipur
26,000
21-3-51
19-6-51
4.
Sunderdas Rupchand, Hardwar
21,000
31-3-51
20-6-51
26. These amounts were passed by way of adjustment through journal entries the credits being given to these parties and the corresponding debits being given to the assessee's branch at Pithore. The first two credits were made on March 26, 1951, as of March 19, 1951. The third credit was made on March 21, 1951, as of March 21, 1951 and the last credit was made on March 31, 1951, as of March 27, 1951.
27. The Income-tax Officer did not accept these deposits as genuine and added to the aggregate amount of Rs. 77,000 to the total income of the assessee as undisclosed profits on the following grounds:
1. That the assessee-firm has not produced the deposit receipts in connection with these deposits, when it is the usual practice of the assessee to give a receipt for the amount deposited with them, which are subsequently returned to the assessee duly discharged on repayment of the deposit. This procedure does not appear to have been followed in these cases;
2. The signatures in the sahi book alleged to be of the depositors do not bear any stamp;
3. The deposits were repaid by means of bearer cheques and in two cases mentioned at Nos. 3 and 4 they have been encashed by persons other than those who have deposited the amounts;
4. Where the depositor himself is purported to have signed in the sahi book of the assessee-firm, the cheque has been encashed by another person on the same day, whose identity is not known;
5. Neither the depositors nor the persons who encashed the cheques are traceable and the deposits, therefore, cannot be independently verified.
28. In the appeal by the assessee, the Appellate Assistant Commissioner accepted the contention of the assessee and deleted the addition of this amount as income from undisclosed sources. He pointed but that none of the clerks in the know of these transactions was at the time when the assessment order was passed in the service of the assessee. He further took the view that the deposits were taken at Pithore and not at Bombay and the addition, if any, must be made with reference to the Pithore branch and not Bombay Pedhi.
29. In a further appeal by the revenue, the Tribunal set aside the finding of the Appellate Assistant Commissioner and confirmed the additions that were made by the Income-tax Officer on the following grounds: Firstly, the books of accounts of the Pithore branch were not available and entries only in Bombay books were relied on by the assessee. Secondly, there was not even an advice note from Pithore to Bombay speaking about the deposits in Pakistan of amounts payable in India. Thirdly, the parties were also - not traceable and the assessee was not in a position to give their present whereabouts. The Tribunal also added that it was not inclined to presume in favour of a transaction which was in contravention of the exchange regulations of the two countries. Mr. Kolah on behalf of the assessee contended that not one of the grounds relied upon by the Income-tax Officer or the Tribunal is sustainable having regard to the facts and circumstances of the case. He submitted that there was no evidence whatsoever on record which enabled the Income-tax Officer to take the view that it was customary for the assessee-firm to give deposit receipts at the time when the deposits were made and the same were returned by the depositors when they were discharged. He further said that in the entire sahi book the signature of the depositor is taken when the amounts due under the deposits are paid to him without there being revenue stamp. Such stamp is hardly to be found at 2 or 3 places while at no other place the depositor has affixed the revenue stamp before he signed the same. He also pointed out that even much larger amounts than these deposited by these depositors have been paid either in cash or by bearer cheques as appears from the sahi book. He also emphasised the fact that if these deposits are repaid within a period of less than three months from the date of the deposit there would be no earthly reason for the assessee to bring it as an undisclosed profit of his business. If regard be had to the common course of natural events then ordinarily a businessman if he wants to use undisclosed profits in business he will do so for a reasonably long period and not for a few weeks only. Alternatively, he submitted, if at all this is to be treated as undisclosed profits, it is that of the Pithore branch at Karachi and not of the Bombay branch because only by book entry the credit is given to these parties in the Bombay firm. On the other hand, Mr. Joshi on behalf of the revenue submitted that each one of the circumstances that has been relied upon by the Income-tax Officer as well as the Tribunal justified in coming to the conclusion that this was undisclosed profit which was liable to be added as profits and gains of business. At the outset it may be stated that, having regard to the facts and circumstances of the case, each one of the circumstances that has been referred to by the Income-tax Officer and the Tribunal for taking the view that this is undisclosed profits is based upon equivocal circumstances. Mr. Joshi was unable to point out any evidence on record which permitted the Income-tax Officer to come to the view that it was the normal practice of the Bombay firm to issue a deposit receipt when an amount was deposited and such deposit receipt was returned by the depositor when it was discharged. The sahi book that was produced before the taxing authorities and the Tribunal was also brought in court and it shows that in the entire book which contains hundreds of signatures, revenue stamps are affixed only in two or three cases and the rest of the amounts were paid without taking the signatures of the depositor on revenue stamp. The sahi book further shows that even payments to the tune of lakhs of rupees had been made in cash. In other cases large amounts have been paid by bearer cheques. The genuineness of such deposits has not been doubted either by the Income-tax Officer or the Tribunal. Further, Mr. Joshi is unable to point out any circumstance to show why if this was really income from undisclosed source the assessee-firm should have kept the amount with the firm only for a period of less than three months. A businessman who is out to bring in black market money into business will of course take a longer time. It is not a case where it can be urged even by the revenue that by process of deposit and withdrawal income from undisclosed sources is converted into earned income which has been subjected to tax, because if the deposits are not genuine then the payments are made to persons who are not genuine and similarly no good reason was suggested by Mr. Joshi why the assessee which had an aggregate borrowing exceeding Rs. 71 lakhs should have only received such a petty amount as income from undisclosed sources when at least the taxing authorities as well as the Tribunal accepted the remaining deposits as genuine. In fact not one circumstance of this evidence is pointed out by Mr. Joshi which will reasonably enable any judicial authority to come to the conclusion that these deposits or any one of them was income from undisclosed sources. In that view of the matter, it was unnecessary to consider the alternative contention of Mr. Kolah that in any event this should be regarded as income of the Pithore branch and not of the Bombay branch. Accordingly, our answer to additional question No. 2 is in the negative and in favour of the assessee.
30. As both the parties have partly succeeded in this reference, each party will bear its own costs.