Desai, J.:— In this reference the following two questions have been referred to us under s. 256(1) of the Income-tax Act, 1961, at the instance of the Commissioner:

“(1) Whether there was any material before the Tribunal to hold that the transaction of earning interest was connected with the transaction of paying interest?

(2) Whether, on the facts and in the circumstances of the case, it Was rightly held that the assessee was entitled to deduction of Rs. 1,77,741 against the interest income of Rs. 86,910?”

2. The facts are within a narrow compass and may be briefly stated:

The assessee is a, limited company and we are concerned with the assessment year 1963–64, the accounting year being the year ended 31st March, 1963. For this period the assessee showed a loss of Rs. 6,921 and this was on the footing of claiming certain expenses incurred by the assessee during the year. The ITO, however, rejected the assessee's claim on the ground that the business of the assessee was that of manufacturing wire ropes which had not commenced during the year as the assessee was not in a position to manufacture wire ropes. Although the matter was unsuccessfully carried further, we are not concerned in this reference with this item, and hence nothing more will be said about this claim of the assessee.

3. There was, however, another item with which we are very much concerned in this reference. This was the interest received by the assessee in the amount of Rs. 86,910 which was from the amounts kept as short-term deposits with various banks; this was assessed as income from other sources. On the other hand, the assessee had paid interest amounting to Rs. 1,77,741 in respect of foreign exchange loan which it had obtained from the I.C.I.C.I Ltd. It was contended before the ITO that the interest paid on the loan exceeded the interest received and accordingly nothing was chargeable to tax. The ITO did not accept this, contention. According to him, the interest paid on the fixed loan can be capitalised and was not available to be set off against deduction of interest received which had been taxed under the head of “Income from other sources”. However, he allowed the sum of Rs. 2,000 as a deduction on estimate. The matter was carried further by the assessee. The AAC also rejected the contentions advanced on behalf of the assessee observing that the interest paid on the fixed loan was not expenditure wholly and exclusively incurred for the purpose of earning or making the income chargeable to tax under the head “Other sources”. He accordingly rejected the appeal on this point. The assessee carried the matter further to the Tribunal. Before the Tribunal it was urged on behalf of the assessee that the assessee had raised the share capital of about Rs. 53 lakhs and wanted to make payment for import of steel wire rope plant and machinery and other equipment. It was submitted that because of the restrictions imposed by the Govt., of India to remit capital outside India, the assessee had to borrow large amounts and pay interest thereon. The capital raised by the assessee was, therefore, kept with the bank in fixed deposit which earned interest. It was submitted that if there had been no restrictions on remittance of capital outside India, the assessee would have utilised the share capital raised for the payment of the plant and machinery and other equipment and there would have been no question then of either earning interest or paying interest to anyone. It was also submitted that the transaction of earning interest and paying interest was to be regarded as a single individual transaction. Accordingly, it was submitted that the department was not justified in fixing the income earned by the assessee without making an allowance for the interest paid by the assessee.

4. The submissions made on behalf of the assessee on this point appealed to the Tribunal which regarded them as correct and liable to be accepted. According to the Tribunal: “The transaction of earning interest is connected with the transaction of paying interest due to the peculiar circumstances created by the restrictions imposed by the Govt. of India.” In its opinion, therefore, the claim made by the assessee was one which should be allowed and the ITO was directed to allow the same.

5. Before us, Mr. Joshi, on behalf of the revenue, has drawn our attention to the provisions of the agreement between the assessee and the I.C.I.C.I Ltd., part of annex. “D” to the statement of case. If the agreement be properly scrutinised, it is found from cl. (III)(1) that the total cost of the undertaking includes share capital in addition to the foreign exchange loan from the I.C.I.C.I Ltd., and it was submitted that this would negative the contention advanced on behalf of the assessee before the Tribunal that the assessee was compelled to seek the loan by reason of the restrictions on remittance of foreign exchange imposed by the Govt. of India. The total cost of the industrial undertaking is estimated in the aggregate figure of Rs. 103.85 lakhs which sum includes the share capital in the amount of Rs. 59.85 lakhs and the foreign exchange loan from the I.C.I.C.I Ltd., in the amount of Rs. 30 lakhs. The rest is to be made up of deposits and bank borrowings. It was further submitted by Mr. Joshi that the interest earned by the assessee by reason of its fixed deposits kept with banks was chargeable as income from other sources under s. 57 of the I.T Act, 1961, and that only the expenditure laid out or expended wholly and exclusively for the purpose of making or earning such income was allowable as a deduction under cl. (iii) of s. 57. It was submitted that mere connection or co-relation between the expenditure and income would not satisfy the requirements of sub-cl. (iii). In this connection he drew our attention to the observations in the judgment of a Division Bench of this court in Commissioner Of Income-Tax, Bombay City Ii v. Mimraj Manmal Ruia, [1972] 84 ITR 673. In that case the assessee had returned an income of Rs. 27,677 from dividends and claimed against it a deduction of Rs. 18,934 which was made up of interest of Rs. 9,408 paid to the bank in respect of an overdraft account and interest of Rs. 9,526 paid to other creditors. The Tribunal allowed the deduction as a proper deduction against dividend income as in its opinion there can be said to be a co-relation between the dividend income and the interest payment established through the bank account. It was held by the Division Bench that the Tribunal was in error in coming to the conclusion that a co-relationship was established between the income earned and the interest paid. It was observed further that it was also in error in considering that such a co-relationship was sufficient to allow the payment of interest as a deduction.

6. It was submitted by Mr. Joshi that the Tribunal in its order was in error on both counts as was the Tribunal in Mimraj Manmal Ruia's case, [1972] 84 ITR 673 (Bom). According to him, there was no material on the basis of which any co-relationship or interdependence could be concluded and, further, according to him, it could not be held that interest had been paid to I.C.I.C.I Ltd. wholly and exclusively to earn interest from the banks by keeping fixed deposits or short-term deposits with the banks.

7. Before us, Mr. Palkhivala on behalf of the assessee had laid stress principally on the second argument advanced on behalf of the assessee before the Tribunal. According to him, if the agreement and the subsequent correspondence between the assessee, his bankers, viz., the Bank of India and Dena Bank, and the I.C.I.C.I Ltd. are perused, the proper conclusion must be that the transaction of earning interest and paying interest is so closely integrated that it must be regarded as one integral transaction and the interest paid would be required to be set off against the interest earned. In this connection he first drew our attention to the provisions of the agreement between the assessee and the I.C.I.C.I Ltd. for security and submitted that amounts were kept with the banks in short-term deposits pursuant to the provision to give security; and he has submitted that the correspondence will clearly show that these amounts were fully under the control of the I.C.I.C.I Ltd. As a matter of fact he referred us to some letters, which are annexed to the statement of case, to show that even the renewal of the short-term deposits was done by the I.C.I.C.I Ltd. and not by the assessee. Thus, in his submission there was complete control of the I.C.I.C.I Ltd. over these amounts. It was also submitted for our consideration that just as the assessee had no control over these deposits and the full control remained with the I.C.I.C.I Ltd. even over the amounts of the foreign exchange loans granted by the I.C.I.C.I Ltd. to the assessee it was the I.C.I.C.I Ltd. which retained control and which made disbursements as indicated by the assessee. According to him, therefore, the correspondence would clearly establish the totality of the I.C.I.C.I Ltd.'s control over both the amounts lent to the assessee and the amounts kept in deposit with the banks, and this would justify the interest paid being set off against the interest earned.

8. It is true that the correspondence would show that at least some of the amount of the share capital was kept up to July, 1962, as and by way of giving security to the I.C.I.C.I though the initial correspondence is surprisingly not annexed. Between March and July, 1962, there is sufficient correspondence to indicate that about Rs. 20 lakhs or so were kept in fixed deposits with the two banks concerned to the order of the I.C.I.C.I Ltd. There are also one or two letters which would show that payments to foreign suppliers of machinery and plant were directly made by the I.C.I.C.I Ltd, (as required by the assessee). This, however, is a common feature of such foreign exchange loans where payments are to be made in foreign exchange; in such cases the payment would be made by the lender and not by the borrower. This feature, however, would seem to us to have no relevance to the question being considered by us. The only argument which requires some serious consideration is whether it is possible to accept the transactions of making deposits and the transaction of taking loan as one integral transaction by reason of the Various submissions made by Mr. Palkhivala. It is to be noted in the first place that the agreement does not require any amounts to be kept in fixed deposit with the banks and being offered to I.C.I.C.I Ltd. as security. The circumstances under which this was done initially are not available from the correspondence annexed to the statement of case. It is true that we have correspondence suggesting that for a period of four to five months between February and July, 1962, certain amounts were kept by the assessee with the two banks and they were under substantial if not full control of the I.C.I.C.I Ltd. That, however, would not be sufficient to regard the transaction as so integrated as to be called one single composite transaction. It is quite clear that the payment of interest to the I.C.I.C.I Ltd. cannot be set off against the interest earned as a deduction claimable under s. 57(iii); and, indeed, this was not even urged. Further, if it is not possible to regard the transaction of making deposit so closely related with the transaction of loan as to be considered as one single integrated transaction, then, it is clear that the assessee must fail. In the result, the questions referred to us are answered as follows:

Question No. 1.—In the negative and in favour of the revenue.

Question No. 2.—In the negative and in favour of the revenue.

9. The assessee will pay to the Commissioner the costs of the reference.