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Gujarat Ginning And Mfg. Co. Ltd. v. Commissioner Of Income-Tax, Gujarat I.
Factual and Procedural Background
This reference arises from a question posed by the assessee as to whether the assessee-company was entitled to deduct the entire amount of interest paid on a mortgage that covered both buildings and machineries under section 24(1)(iii) of the Income-tax Act, 1961. The assessments in issue relate to assessment years 1962-63 to 1967-68 (relevant previous years 1961–1966).
During the relevant accounting years the assessee paid interest on loans secured by a mortgage over properties whose annual value was included in the assessee's total income; the mortgage covered the buildings together with machineries kept in those properties (a composite mortgage). The assessee claimed deduction of the entire interest under section 24(1)(iii). The Income-tax Officer apportioned interest between the properties and the machineries and allowed deduction only for the interest attributable to the mortgaged properties (the parts whose annual value was charged to tax). The assessee appealed: the Appellate Assistant Commissioner confirmed the Income-tax Officer's order, and the Appellate Tribunal upheld the view that only interest attributable to the mortgaged properties (the house property) could be deducted under section 24(1)(iii).
At the instance of the assessee the following question was referred to the Court for opinion:
"Whether, on the facts and in the circumstances of the case, the assessee-company is entitled to deduction of the entire amount of interest paid on the mortgage of the buildings and machineries under section 24(1)(iii) of the Income-tax Act, 1961?"
Legal Issues Presented
- Whether, under section 24(1)(iii) of the Income-tax Act, 1961 (as it stood prior to its deletion with effect from April 1, 1969), the assessee is entitled to deduct the entire amount of interest payable on a composite mortgage covering both buildings (house property) and machineries, or whether the interest must be apportioned and only that part attributable to the house property (buildings and lands appurtenant thereto) may be deducted.
Arguments of the Parties
Appellant's (Assessee's) Arguments — summarized from the opinion
- Mr. Shah (for the assessee) contended that the phrase "interest on such mortgage or charge" in section 24(1)(iii) means the entire interest payable in respect of any mortgage on the property, so there is no scope for apportionment between machineries and the house property.
- He relied on the law under the Transfer of Property Act that a composite mortgage of a building together with the machineries embedded in or kept in the building is one and indivisible, and argued that the same principle should apply for income-tax purposes.
- He relied on several decisions of the Supreme Court and High Courts to support the proposition that interest cannot be apportioned, and argued that where the legislature intends apportionment it does so expressly (citing other statutory provisions and rules as examples where apportionment is provided for explicitly).
- He submitted that the wording of section 24(1)(iii) (as it then stood) was intentionally framed to preclude apportionment of interest on a composite mortgage of house property and machineries.
Revenue's Position / Tax Authorities — summarized from the opinion
- The Income-tax Officer apportioned interest between the mortgaged buildings (house property) and the machineries and allowed deduction only in respect of interest attributable to the buildings/house property (the annual value of which was included in the assessee's total income).
- The Appellate Assistant Commissioner and the Appellate Tribunal confirmed the apportionment, holding that the language of section 24(1)(iii) read with sections 22 and 23 supports deduction only of interest attributable to mortgage of those properties the annual value of which is included in the assessee's total income.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For (as stated in the opinion) | Application by the Court (as stated in the opinion) |
|---|---|---|
| Commissioner of Income Tax, Madras v. Indian Bank Limited, Madras, [1965] 56 ITR 77 (SC) | Relied upon by the assessee to support the proposition that interest cannot be apportioned. | The opinion records it among authorities relied upon by the assessee but notes that, having regard to the scheme of the Income-tax Act, those authorities did not specifically apply to the instant case in the view taken by the Court. |
| Commissioner of Income-tax v. South Indian Bank Ltd., [1966] 59 ITR 763 (SC) | Relied upon by the assessee for the proposition that there cannot be apportionment of interest. | Considered as one of the decisions relied upon by Mr. Shah; the Court found such authorities not specifically applicable given the scheme of sections 22, 23 and 24(1)(iii). |
| Commissioner of Income-tax v. Maharashtra Sugar Mills Ltd., [1968] 68 ITR 512 (Bom); [1971] 82 ITR 452 (SC) | Relied upon to support the no-apportionment proposition. | Included among the cases considered previously by the Court; not treated as controlling for the factual and statutory scheme in this reference. |
| Hanuman Sugar & Industries Ltd. v. Commissioner of Income-tax, [1970] 76 ITR 603 (Cal) | Relied upon by the assessee for the proposition against apportionment. | Counted among the authorities examined by the Court; ultimately not found to dictate the result in this statutory context. |
| Commissioner of Income-tax v. Radha Swami Bank, [1972] 85 ITR 136 (All) | Relied upon by the assessee to support non-apportionment. | Noted by the Court as one of the cases relied upon by Mr. Shah but not treated as determinative. |
| Commissioner of Income-tax v. Industrial Investment Trust Co. Ltd., [1968] 67 ITR 436 (Bom) | Relied upon for the proposition that interest cannot be apportioned. | Included among cases the Court reviewed; the Court did not accept them as controlling given the statutory scheme it analysed. |
| Commissioner of Income-tax v. Bhopal Sugar Industries Ltd., [1970] 78 ITR 209 (MP) | Relied upon by the assessee for the no-apportionment proposition. | Mentioned among the authorities but not applied as controlling precedent by the Court. |
| Hughes v. Bank of New Zealand, [1938] 21 T.C. 488 (C.A.), 512 (H.L.) (also reported in the opinion as 6 ITR 541 (C.A.), 636 (H.L.)) | Quoted for observations (Lord Wright M.R. and Greene L.J.) that, in order to give effect to tax law, bifurcation and apportionment of expenditure may be necessary. | The opinion refers to and relies on these observations as an authority supporting the principle that apportionment may be required to give effect to the relevant taxing statute. |
| Commissioner of Income-tax v. Sabarkantha Zilla Kharid Vechan Sangh Ltd., [1977] 107 ITR 447 (Guj) | Established the principle (in the Court's earlier judgment) that composite overhead expenses should be bifurcated between taxable and non-taxable activities, and that the rule of three could be used in the absence of specific material. | The Court relied on its earlier decision as the controlling authority for the present question; it applied the principles from Sabarkantha to conclude that apportionment of interest between machineries and house property was required under the scheme of sections 22, 23 and 24(1)(iii). |
Court's Reasoning and Analysis
The Court's analysis proceeded from a construction of the relevant provisions governing income from house property and the statutory language of section 24(1)(iii) as it then stood.
Key steps in the Court's reasoning (as stated in the opinion):
- Statutory scheme: Sections 22–27 (inclusive) make provision for computation of income from house property. Section 14 classifies heads of income and head "Income from house property" is defined by section 22; section 23 determines the annual value (sum for which the property might reasonably be expected to let from year to year).
- Definition of "the property": Reading sections 22 and 23 together, the Court concluded that "the property" for the purpose of income from house property refers only to buildings and lands appurtenant thereto, and specifically excludes portions occupied by the assessee for the purposes of any business or profession whose profits are chargeable to income-tax.
- Scope of section 24(1)(iii): Section 24 provides deductions from income from house property; clause (iii) (as it stood prior to April 1, 1969) permitted deduction of "the amount of any interest on such mortgage or charge" where the property is subject to a mortgage. The Court read the phrase "the property" in section 24(1)(iii) as referencing the house property defined under sections 22 and 23 (i.e., buildings and lands appurtenant thereto) and not other assets such as machineries.
- Effect of the Transfer of Property Act: The Court acknowledged that under the Transfer of Property Act a composite mortgage covering both building and machinery may be one and indivisible. However, the Court emphasized that the general law of mortgages (Transfer of Property Act) is subordinate to the specific provisions of the Income-tax Act for the purpose of computing taxable income. Thus, even if the mortgage is indivisible in transfer law, the Income-tax Act's scheme controls deduction of interest for tax purposes.
- Apportionment principle and authority: The Court relied on its prior decision in Sabarkantha Zilla Kharid Vechan Sangh Ltd. (1977) where it held that composite overheads/expenditures must be bifurcated between taxable and non-taxable components when the statute's language requires it, and that the rule of three may be used to effect such apportionment in the absence of specific material. It also invoked observations from Hughes v. Bank of New Zealand supporting the need for apportionment to give effect to a taxing statute.
- Application to facts: Applying this statutory construction, the Court concluded that section 24(1)(iii) contemplates deduction only of interest attributable to the house property (buildings and lands appurtenant thereto) whose annual value is brought to tax. Consequently, where interest is paid under a composite mortgage covering machineries as well, apportionment between the machineries and the house property is required and only the portion attributable to the house property is deductible under section 24(1)(iii).
- Evaluation of authorities relied upon by the assessee: The Court noted the several decisions relied upon by Mr. Shah that supported non-apportionment, but observed that those authorities were considered in the earlier Sabarkantha judgment and that, on the facts and statutory scheme before the Court now, those cases did not specifically apply; the Sabarkantha principles were followed instead.
Holding and Implications
Holding (core ruling emphasized):
The assessee is not entitled to deduction of the entire amount of interest paid on a composite mortgage covering buildings and machineries; apportionment is required and deduction under section 24(1)(iii) is available only in respect of that portion of interest attributable to buildings and lands appurtenant thereto (i.e., the house property whose annual value is charged to tax).
Implications and consequences (as stated in the opinion):
- Direct effect on the parties: The Court answered the referred question in the negative (against the assessee and in favour of the revenue). The apportionment carried out by the Income-tax Officer, the Appellate Assistant Commissioner and the Appellate Tribunal was held to be correct.
- Method of apportionment: The opinion endorses the principle (from Sabarkantha) that apportionment may be effected and that the rule of three can be used where the enactment requires apportionment and no specific material identifying the exact split is available.
- Precedential effect: The Court followed and applied its earlier reasoning in Sabarkantha Zilla Kharid Vechan Sangh Ltd. The opinion does not purport to create a new departure from that approach; rather, it applies that established approach to the statutory scheme of sections 22, 23 and 24(1)(iii).
- Costs: The assessee was ordered to pay the costs of this reference to the Commissioner.
This summary is prepared strictly from the content of the provided opinion and does not add information beyond what is contained therein.
Divan, C.J.
1. In this case, at the instance of the assessee, the following question has been referred to us for our opinion :
"Whether, on the facts and in the circumstances of the case, the assessee-company is entitled to deduction of the entire amount of interest paid on the mortgage of the buildings and machineries under section 24(1)(iii) of the Income-tax Act, 1961 ?"
2. We are concerned in this case with assessment years 1962-63 to 1967-68, the relevant previous years being calendar years 1961 to 1966. During the accounting years relevant to the assessment years under reference, the assessee-company paid interest on the amount of loan secured by the mortgage of properties, the annual value of which was included in its total income and the mortgage was on the properties together with the machineries kept in those properties. The assessee-company claimed deduction of the entire amount of interest for the mortgage and in this connection he wanted relief under section 24(1)(iii) of the Income-tax Act, 1961. It may be mentioned at this stage that with effect from April 1, 1969, by virtue of the provisions of the Finance Act, 1968, section 24(1)(iii) has been deleted. The Income-tax Officer apportioned the amount of interest between the properties on the one had and the machineries on the other and allowed deduction of only interest attributable to the mortgage of the properties, the annual value of which was included in the company's total income. The following table shows the total claim of interest paid by the assessee, claim of interest on joint mortgage of buildings and machineries and the claim allowed by the Income-tax Officer.
____________________________________________________________________ Asstt. Amount of Claim of interest of joint Claim Year interest paid mortgage of buildings and allowed machineries _____________________________________________________________________ Rs. Rs. Rs.
1962-63 43,658 27,193 18,129 1963-64 35,654 18,860 13,380 1964-65 29,403 11,667 8,200 1965-66 25,723 7,504 5,347 1966-67 22,077 3,440 2,341 1967-68 31,007 35 Disallowed in full ________________________________________________________________________
3. Against the decision of the Income-tax Officer the assessee took the matter in appeal and the Appellate Assistant Commissioner dismissed the appeals and confirmed the order of the Income-tax Officer. Against the decision of the Appellate Assistant Commissioner, the assessee preferred appeals to the Appellate Tribunal. The Tribunal held that having regard to the language of section 24(1)(iii) read with sections 22 and 23, it was obvious that only interest attributable to mortgage of the properties, the annual value of which was included in the assessee-company's total income, was to be deducted. Thereafter, at the instance of the assessee the question set out hereinabove has been referred to us for our opinion.
4. Under Sections 22 to 27, both inclusive, of the Income-tax Act, 1961, provision is made for computation of income from house property. section 14 of the Income-tax Act, 1961, provides for classification of income for the purpose of charge of income and computation of total income and head "C" is "Income from house property". section 22 provides that the annual value of property consisting of any buildings or lands appurtenant thereto of which the assessee is the owner, other than such portions of such property as he may occupy for the purpose of any business of profession carried on by him the profits of which are chargeable to income-tax, shall be chargeable to income-tax under the head "Income from house property". section 23 provides for determination of annual value and says that for the purposes of section 22, the annual value of any property shall be deemed to be the sum for which the property might reasonably be expected to let from year to year. It is thus clear, reading sections 22 and 23 together, that only the annual letting value, that is, the sum for which the property might reasonably be expected to let from year to year, has to be considered only in respect of property other than such portions of the property as the assessee may occupy for the purpose of business or profession carried on by him, the profits of which are chargeable to income-tax, and hence the portions occupied by the assessee for the purposes of his business or profession are not to be considered for arriving at the sum for which the property might reasonably be expected to let from year to year. Thus, this scheme of sections 22 and 23 requires the apportionment of income between the portions occupied by the assessee for the purposes of any business or profession carried on by him, the profits of which are chargeable to income-tax, and the rest of the property. Section 24 provides for deductions from income from house property and lays down that income chargeable under the head "Income from house property" shall, subject to the provisions of sub-section (2), be computed after making the following deductions. Clause (iii) of section 24(1) as it stood prior to April 1, 1969, was in the following terms :
"(iii) where the property is subject to a mortgage or other capital charge, the amount of any interest on such mortgage or charge."
5. Mr. Shah contends that the words "interest on such mortgage or charge" means the entire amount of interest which is required to be paid by the assessee in respect of any mortgage on the property and, hence, according to him, there is no scope for apportionment of the interest between machineries on the one hand and the rest of the house property on the other. In this connection Mr. Shah contended that under the Transfer of Property Act, whenever there is a mortgage of a building together with the machineries embedded in the building or kept in the building, the mortgage is one and indivisible and, hence even under the income-tax law, the same principle of the mortgage being one and indivisible must apply. Mr. Shah has relied upon several decisions of the Supreme Court and other High Courts of the proposition that there cannot be apportionment of interest. He also contended that wherever the legislature wants to make provision for apportionment, it does so expressly and in this connection be referred to section 44F of the Indian Income-tax Act, 1922, and to sections 11(1)(b), 159(4), section 159(6) and Explanation (a) to section 9(1)(i), rules 7 and 8 of the Income-tax Rules and section 24(1)(ix) and 27(1)(iii) of the Act. of 1961. He contended that the wording of section 24(1)(iii) as it stood at the relevant time was intentionally so kept by the legislature as to indicate that it did not want any any apportionment of interest payable in respect of mortgage on the property where there was a composite mortgage of house property together with machineries.
6. Mr. Shah's attention was drawn to sub-clauses (ii) and (iv) of sub-section (1) of section 24 where obviously apportionment of the relevant amount has to be made. Section 24(1)(ii) provides for the deduction of amount of any premium paid to insure the property against risk of damage or destruction and under clause (iv) where the property is subject to an annual charge, the amount of such charge. Mr. Shah contended that unlike Clause (iii) of section 24(1), clauses (ii) and (iv) on the other, apportionment which may be permissible under clause (ii) or under clause (iv) is not permissible under clause (iii). In our opinion, the solution to the problem lies in the very language of section 24(1)(iii) which refers to "the property" being subject to a mortgage or capital charge meaning thereby the house property, the income of which is under consideration. That house property, by the very scheme of section 22, means the portions of the house property other than the portions occupied by the assessee for the purpose of any business or profession carried on by by him, the profits of which were chargeable to income-tax. Thus, so far as section 24(1)(iii) is concerned, when it uses the words "the property" it contemplates only the house property, that is, buildings or lands appurtenant thereto and nothing else, and it is only interest payable in respect of mortgage or capital charges on buildings or lands appurtenant thereto other than such portions of the house property as the assessee may occupy for the purposes of any business or profession carried on by him, that can be deducted under section 24(1)(iii). No other meaning appears to us to be possible on the language of these sections.
7. Mr. Shah has relied on the following decisions in support of his contention : Commissioner Of Income Tax, Madras v. Indian Bank Limited, Madras., [1965] 56 ITR 77 (SC), Commissioner of Income-tax v. South Indian Bank Ltd., [1966] 59 ITR 763 (SC), Commissioner of Income-tax v. Maharashtra Sugar Mills Ltd., [1968] 68 ITR 512 (Bom), this being a Bombay decision, and the decision of the Supreme Court in the same case on appeal against the decision of the Bombay High Court being the decision in Commissioner of Income-tax v. Maharashtra Sugar Mills Ltd., [1971] 82 ITR 452 (SC). He has also relied upon the decision of the Calcutta High Court in Hanuman Sugar & Industries Ltd., v. Commissioner of Income-tax [1970] 76 ITR 603 (Cal), the decision of the Allahabad High Court in Commissioner of Income-tax v. Radha Swami Bank [1972] 85 ITR 136 (All), the decision of the Bombay High Court in Commissioner of Income-tax v. Industrial Investment Trust Co. Ltd., [1968] 67 ITR 436 (Bom) and the decision of the Madhy Pradesh High Court in Commissioner of Income-tax v. Bhopal Sugar Industries Ltd., [1970] 78 ITR 209 (MP). He relied upon these decisions in support of the proposition that the apportionment of income between different items, as for example in the instant case, apportionment of interest between machineries on the one hand and rest of the house property on the other could not be made and he contended that there could not be any bifurcation of interest in the manner in which the Income-tax Officer, the Appellate Assistant Commissioner and the Tribunal have done in the instant case. All these decisions which he has relied upon and several others were considered by us in Commissioner of Income-tax v. Sabarkantha Zilla Kharid Vechan Sangh Ltd., [1977] 107 ITR 447 (Guj), Income-tax Reference No. 24 of 1974, which was decided along with two other references by a common judgment on September 3, 1975. There the question before us was whether receipts from exempted activity carried on by a co-operative society engaged in exempted business activities as well as taxable business activities could be bifurcated and separated as between the exempted income and the taxable income, we held, after considering all those authorities that composite overhead expenses have to be bifurcated [proportionately between exempted receipts and taxable receipts. Such bifurcation can be on the basis of the rule of three in the absence of any material to indicate whether any expense related specifically to taxable or exempted activity. We relied in that case on the observations of Lord Wright M. R. In the case decided by the court of Appeal in England and the decision of the Court of Appeal being ultimately approved by the House of Lords and we also relied upon the observations of Greene L. J. in Hughes v. Bank of New Zealand [1938] 21 TC 488 (CA), 512 (HL); 6 ITR 541 (CA), 636 (HL) that, in order to give effect to the Income-tax Act, bifurcation and apportionment of expenditure had got to be resorted to. We held that the scheme of the Income-tax Act required that profits and gains from non-taxable activities and taxable activities, both of which were components which had entered into the total income as known to income-tax law should be separated and that separation of these two components which had entered into the total income could only be done by finding out the proportionate net income, that is, after deducting from the amount of gross profits both for taxable activities as well as for non-taxable activities all expenditure attributable to these two different categories of cases. We said that it would be advisable to resort to the rule of three in finding out the proportionate net income out of the total income of the assessee. Thus, it has been held in Sabarkantha Zilla Kharid Vechan Sangh Ltd.,'s case [1977] 107 ITR 447 (Guj), that apportionment of expenditure between taxable activities and non-taxable activities must be made in view of the specific language of the relevant sections, namely, sections 28, 66, 81(1)(d) and 110. In the instant case we are concerned with apportionment of interest which the income-tax authorities want to carry out between interest payable in respect of house property and interest payable in respect of machineries though the total amount of interest is paid on a mortgage which is a composite mortgage over both properties and machineries. The principle which has been culled out from the authorities is that, if the language of the particular enactment gives a clear indication apportionment will be permissible and not only will it be permissible but in order to give effect to the Income-tax Act, it would be necessary to carry out such apportionment of income.
8. In view of what we have stated in the earlier judgment in Sabarkantha Zilla Kharid Vechan Sangh Ltd.,'s case [1977] 107 ITR 447 (Guj), it is not necessary for us to refer once again to all the authorities relied upon by Mr. Shah before us. The scheme of Sections 22 and 23 and 24(1)(iii) of the Act of 1961 has to be considered and the question that we have to ask ourselves is, whether under this scheme, apportionment of income of the kind which is asked for in the instant case is clearly indicated. It is only the buildings or lands appurtenant thereto which constitute the house property, the annual value of which is brought to tax under the head" Income from house property" and under section 24(1), it is only while computing the income from such house property that the question of any deduction respect of interest paid on a mortgage or other capital charge has to be deducted. The deduction is from the income of the property and "the property" in the light of section 22 means the property consisting of buildings and lands appurtenant thereto. It is only that property consisting of buildings and such lands the income of which has to be ascertained in accordance with section 23, namely, the sum for which this property consisting of buildings and lands appurtenant thereto might reasonably be excepted to let from year to year. Therefore, it is only the income, namely the sum for which the property might reasonably be expected to let from year to year in respect of buildings and lands appurtenant thereto from which deduction of interest paid in respect of mortgage in respect of the property has to be made. Undoubtedly, under the Transfer of Property Act, as Mr. Shah has rightly contended, there is only one and indivisible mortgage when there is a composite mortgage burdening the building as well as the machineries kept in the building. It is possible, as Mr. Shah contends, that very often the machinery has to be embedded in the floor of the building but what is material is not the provisions of the Transfer of Property Act and the general law under the Transfer of Property Act by the specific provisions of the Income-tax Act, 1961. These provisions clearly indicate, according to the scheme of sections 22 and 23 and 24, that the deductions under section 24(1)(iii) are to be in respect of the amount of interest paid on the mortgage or capital charge on "the property", that is, on the buildings and lands appurtenant thereto. Under these circumstances, even though under the general law relating to transfer of property, a composite mortgage of the kind before us covers both lands and the machineries, under the Income-tax Act, we are only concerned with the income from buildings and lands appurtenant thereto and not with any other Income. It is from the annual value thus arrived at that the deduction by way of interest has to be made from the income of the property. In view of what has been stated in Sabarkantha Zilla Kharid Vechan Sangh Ltd.,'s case [1977] 107 ITR 447 (Guj), the apportionment of income between machineries on the one hand, and the buildings and lands appurtenant thereto on the other, can be made by applying the rule of three if the language of the enactment clearly requires it to be done. In the instant case, we find that by the very scheme of sections 24(1)(iii), 22 and 23, this apportionment of income is clearly indicated. Under these circumstances, none of the authorities relied upon by Mr. Shah specifically applied to the case before us and we will follow the principles laid down in Sabarkantha Zilla Kharid Vechan Sangh Ltd.,'s case [1977] 107 ITR 447 (Guj).
9. It is therefore, obvious that, so far as the instant case is concerned, we must hold that apportionment of interest between machineries on the one hand and the rest of the properties on the other as has been done by the Income-tax Officer, the Appellate Assistant Commissioner and the Tribunal was the correct conclusion. Under these circumstances we answer the question referred to us in the negative, that is, against the assessee and in favour of the revenue. The a-company is not entitled to deduction of the entire amount of interest paid on the mortgage of buildings and machineries. Under section 24(1)(iii) of the Act of 1961, as it stood prior to its repeal with effect from April 1, 1969, the bifurcation and apportionment of interest was required to be done and after apportionment deduction could be granted only in respect of interest paid on buildings and lands appurtenant thereto.
10. The assessee will pay the costs of this reference to the Commissioner.
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