Income-tax Reference No. 96 of 1964

Decided on February 22, 1968

The Judgment of the Court was delivered by

P.B Mukharji, J.:— This reference under section 66(2) of the Income-tax Act raises the following question for answer by this court:

“Whether, on the facts and in the circumstances of the case, the sum of Rs. 17,000 was allowable as deduction under section 12(2) of the Indian Income-tax Act, 1922?”

2. The facts giving rise to the above question are briefly as follows:

The assessee is a private limited company owning immovable properties, some leasehold and some shares. The statement of case relates to the assessment year 1958-59, and the corresponding previous year is the financial year ended on the 31st March, 1958. For the assessment year 1958-59, in addition to income from property and shares, the assessee had received Rs. 20,000 as guarantee commission for standing as a guarantor to the Central Bank of India Ltd. in respect of the loans advanced by that bank to Messrs. Bengal Fine Spinning and Weaving Mills Ltd., an associate concern of the assessee-company. The guarantee commission was included in the total income of the assessee-company for the assessment year 1958-59, by the Appellate Assistant Commissioner as a result of disclosure by the assessee. The guarantee given by the assessee-company to the Central Bank of India Ltd. was supported by the security of a building called “Mercantile Building” which belonged to the assessee. Now, in respect of that building the assessee paid municipal taxes aggregating to Rs. 64,863, out of which Rs. 35,291 was allowed in determining the income under the head “property” under section 9 of the Income-tax Act. The assessee contends that the balance of Rs. 29,572 should be allowed as a deduction against the guarantee commission on the ground that the guarantee commission was earned by the assessee-company on the security of the said building. The contention is that in determining the income, profits and gains under section 12 all outgoings relating thereto should be allowed. Therefore, the assessee's case is that the taxes on the “Mercantile Building” had been paid by it for the purpose of making or earning, the guarantee commission on the security of that building and therefore is deductible. The Tribunal applied the Privy Council's decision in Probhat Chandra Barua v. Commissioner of Income-tax 1930 5 I.T.C 1; A.I.R 1930 P.C 209 and upheld the claim of the assessee on the point. What the Tribunal, however, held was that since the whole amount of Rs. 29,572 was not referable to the guarantee commission earned, only a sum of Rs. 17,000 out of the said sum which was so referable, should be allowed as a deduction from the guarantee commission. It is on these facts and such statement of the case that the question now comes up for our decision.

3. The Tribunal at first refused to refer this question on the ground that the point was essentially a question of fact. This court thereupon ordered the Tribunal to state the case with that question. A preliminary point of objection was taken by Mr. Mukherjee appearing for the assessee. His preliminary objection is that the question does not arise out of the order of the Tribunal. We are unable to accept that contention. We are of the opinion that the question does arise on the order of the Tribunal. As already stated, the Tribunal's refusal to state the case was not on the ground that the question itself did not arise out of the order of the Tribunal but on the ground that the question was one of fact.

4. Turning to the order of the Tribunal itself, it is clearly stated by the Tribunal: “His (assessee's) contention was that the income under section 12 can be determined only after all the outgoings relating thereto were allowed for. He also relied on Commissioner of Income-tax v. Raja Sri Sri Kalyani Prasad Deo, Panchkote [1945] 13 I.T.R 17. and Raja Probhat Chandra Barua v. Commissioner of Income-tax, where it was held that in determining the income from royalty under section 12, jama paid on zemindary in respect of lands in which the coal fields were situated was a permissible deduction. The departmental representative, on the other hand, contended that, in order to qualify for deduction under section 12, expenditure must be directly related to the income earned. He also contended that the municipal taxes on the property had to be paid by the assessee whether it earned guarantee commission or not and that was a liability which was incidental to the ownership of the property and had nothing to do with the income earning activity. “This, in our view, raises directly and pointedly this very question whether this sum can be allowed as a deduction under section 12(2) of the Income-tax Act.

5. Mr. Mukherjee made a faint argument on the point that sub-section (2) of section 12 was not expressly mentioned and that it was a case under section 12(1), contending thereby that in calculating profits all outgoings should be deducted and the net profit should be calculated in order to determine that tax. That argument cannot hold good because that order of the Tribunal as quoted above was directly concerned with the question whether the municipal tax was paid by the assessee to earn the guarantee commission or not which can only be a question germane under section 12(2) of the Income-tax Act.

6. Mr. Mukherjee in aid of his argument also referred to the Allahabad High Court decision in Deokinandan Shooshankarlal v. Commissioner of Income-tax . That is a case which says that:

“If the High Court requires the Tribunal to refer a question of law which had not been raised before the Tribunal and which, consequently, the Tribunal was not bound to refer to the High Court under section 66(1), the High Court will be acting in excess of its jurisdiction, and the procedure to be followed by the High Court when the question is referred to it, is to rectify the error it had committed by refusing to answer the question.”

7. Two other decisions cited by Mr. Mukherjee are Bisheshwar Singh v. Commissioner of Income-tax and Khusiram Murarilal v. Commissioner Of Income-Tax, Central, Calcutta [1954] 25 I.T.R 572.

8. It is unnecessary for us in determining this preliminary objection to decide the question whether in a case where this court has by a rule absolute ordered the Tribunal to state a case, this court can again, while hearing the reference it has directed, go back and hold that, although it decided the very point that it was a question of law and that it arose out of the order of the Tribunal, and change its decision by saying on this reference that it is not a question of law and that it did not arise out of the order of the Tribunal.

9. We are satisfied on the facts of this case and by the order of the Tribunal itself that this is a question of law and that it does arise out of order of the Tribunal. It may also be stated that Mr. Mukherjee for the assessee does not dispute this is a question of law. In that view of the matter the decision of the Supreme Court in T.D Kumar and Brothers (P.) Ltd. v. Commissioner of Income-tax is not relevant on the point. Mr. Pal for the Commissioner of Income-tax relied on the Commissioner of Income-tax v. Scindia Steam Navigation Co. Ltd., where the Supreme Court at page 612 observes:

“All that section 66(1) requires is that the question of law which is referred to the court for decision and which the court is to decide must be the question which was in issue before the Tribunal. Where the question itself was under issue, there is no further limitation imposed by the section that the reference should be limited to those aspects of the question which had been argued before the Tribunal. It will be an over-refinement of the position to hold that each aspect of a question is itself a distinct question for the purpose of section 66(1) of the Act. That was the view taken by this court in Commissioner of Income-tax v. Ogale Glass Works Ltd. and in Zoraster & Co. v. Commissioner of Income-tax [1960] 40 I.T.R 552 S.C., and we agree with it. As the question on which the parties were at issue, which was referred to the court under section 66(1), and decided by it under section 66(5) is whether the sum of Rs. 9,26,532 is liable to be included in the taxable income of the respondents, the ground on which the respondents contested their liability before the High Court was one which was within the scope of the question, and the High Court rightly entertained it.”

10. We have no hesitation in holding in the present reference before us that the question referred to was at issue before the Tribunal and the Tribunal decided it.

11. In another Division Bench of this court, to which I was a party, in Commissioner of Income-tax v. Khetan & Co. [1962] 45 I.T.R 170. the same view was taken that:

“While section 66 only confers jurisdiction on the High Court to permit a reference on a question of law arising out of the order of a Tribunal and does not confer jurisdiction on the High Court to decide a different question of law not arising from such order, nevertheless it is possible that the same question of law may involve different approaches for its solution, and the High Court may amplify the question to take in all the approaches.”

12. That view was expressed by me following the decisions of the Supreme Court in New Jehangir Vakil Mills Ltd. v. Commissioner of Income-tax [1959] 37 I.T.R 11 S.C. and Kusumben D. Mahadevia v. Commissioner of Income-tax [1960] 39 I.T.R 540 S.C. at pages 174 and 175 of the report in Commissioner of Income-tax v. Khetan & Co. For the reasons above and on the authorities we reject the contention of Mr. Mukherjee for the assessee that the question does not arise out of the order of the Tribunal and overrule his objection.

13. The question requiring an answer is briefly whether the particular sum paid by way of municipal taxes was deductible under Section 12(2) of the Income-tax Act, 1922. The language of that section therefore is the prime standard of reference by which the question has to be judged and answered. Section 12(2) of the Income-tax Act, inter alia, provides that: “such income, profits and gains shall be computed after making allowance for any expenditure (not being in the nature of capital expenditure) incurred solely for the purpose of making or earning such income, profits or gains…….” Therefore, the crucial test is whether this expenditure by way of payment of municipal taxes was incurred solely for the purpose of making or earning such income, profits or gains. The assessee's contention is that its payment of the municipal taxes was an expenditure incurred solely for the purpose of making or earning the guarantee commission. There is, in our opinion, no substance in this contention at all. The assessee owned this Mercantile Building and as owner had to pay municipal taxes. That it used this building to offer security to a bank only for an advance to its associate company does not make it any-the-less the property of that owner assessee. In fact, unless the assessee continued as owner, he could not give it as a security for a loan or an advance from the bank. The payment of the taxes, therefore, was not incurred solely for the purpose of earning the guarantee commission. That appears to be the plain meaning of that expression used in that section. And as owner of the property, the assessee company was already liable to pay the municipal taxes. He got a maximum of about half the taxes under section 9 of the Income-tax Act under the head “Property” under the third proviso.

14. If the assessee could come after the amendment in 1960-61, he might have got a deduction for the whole of the taxes provided the building was a building constructed before 1950. But, as it is, the asseseee cannot avail of that amendment.

15. The assessee actually obtained this deduction under the head “Property” under section 9 of the Income-tax Act in respect of half of the municipal taxes on the Mercantile Building. The dispute now is about the balance of the municipal taxes. What the assessee is trying to do is to wipe out the balance as a deduction now under section 12(2) of the Income-tax Act. This plainly he cannot do on the authority of a series of decisions which have settled the point more or less. The leading case on the point is the decision of the House of Lords in Mitchell v. Ross. Viscount Simonds at page 832 of the Law Report observed as follows:

“I regard it as fundamental and well settled law that the Schedules to the Income Tax Acts are mutually exclusive, and that the specific Schedules A, B, C & E and the rules which respectively regulate them, afford a complete code for each class of income, dealing with allowances, deductions and exemptions relating to them respectively.”

16. There in deciding the point that was raised, namely, that the expenses incurred in earning the profits and gains assessable under Schedule E of the British Income Tax Act, so far as they were not allowed on that assessment were therefore not deductible for the purpose of assessment of Schedule D liability. Viscount Simonds approved of the famous observations of Lord Atkin in Fry v. Salisbury House Estate Ltd., where Lord Atkin thus observed:

“My Lords, I think that this case should be decided in favour of the respondents upon the simple ground that annual income derived from the ownership of lands, tenements and hereditaments can only be assessed under Schedule A and in accordance with the Rules of that Schedule. In my opinion, it makes no difference that the income so derived forms part of the annual profits of a trading concern. For the purpose of assessing such profits for the purpose of Schedule D, the income so derived is not to be brought into account. The option of the Revenue Authorities to assess under whichever Schedule they prefer, in my opinion, does not exist and is inconsistent with the provisions of the Income Tax Acts throughout their history.”

17. Lord Radcliffe in Mitchell v. Ross made similar observations as Lord Simonds:

“They afford a complete code for each class of income dealing with allowances and exemptions with the mode of assessment and with the officials whose duty it is to make the assessments.”

18. And His Lordship was quoting Lord Atkin there in saying so. Specially at page 839 of the report. Lord Radcliffe observed as follows:

“I do not see how anyone can doubt these propositions today: But, if they are accepted, they seem to me to rule out the idea that, though the respondents' appointments were offices and so chargeable under Schedule E, they could also form a part or a branch of the ‘profession’ that is the subject of charge under Schedule D. And yet that is the whole case. The profession, for this purpose, is a coherent series of activities of a particular character giving rise to assessable profits: it is not an abstract description in a dictionary. If the activities relating to the employment in the office are excluded, as they must be because they belong to Schedule E, the profession, the profits of which are assessable under Schedule D must consist only of the remaining activities. And, if that is so, the rules of Schedule D (see section 137(a) of the Income Tax Act, 1952) prohibit the deduction in that assessment of any expenses incurred in relation to the activities of the office, since such expenses are not wholly and exclusively laid out for the purpose of the profession.”

19. The principle applies with equal force in India. Schedules A, B, C, D and E in the British Income-tax Act are comparable to different heads of income under sections 6 to 11 of the Indian Income-tax Act such as salaries, interest on securities, income from profits, profits and gains of business, profession or vocation, income from other sources, capital gains, etc. These different heads in the Indian Income-tax Act are comparable to the different British schedules. The concept is the same. Indeed, the principles laid out in Fry v. Salisbury House Estate Ltd. have been followed by the Supreme Court in India in United Commercial Bank Ltd. v. Commissioner of Income-tax. At page 697 of that report, the Supreme Court observes:

“We cannot treat anyone of the sections from sections 7 to 10 to be general or specific for the purpose of any one particular source of income. The language shows that they are all specific and deal with the various heads in which the item of income, profits and gains in the case of an assessee falls.”

20. Then, again, at page 702 the Supreme Court lays down:

“Thus on this construction the various heads of ‘income, profits and gains’ must be held to be mutually exclusive, each head being specific to cover the item arising from a particular source.”

21. The Supreme Court in the above case expressly mentioned and followed Fry v. Salisbury House Estate Ltd.

22. The Supreme Court again in East India Housing and Land Development Trust Ltd. v. Commissioner of Income-tax, followed the principle laid down in Fry v. Salisbury House Estate Ltd. at page 52 of that report and observed at page 51 as follows:

“The income derived by the company from shops and stalls is income received from property and falls under the specific head described in section 9. The character of that income is not altered because it is received by a company formed with the object of developing and setting up markets.”

23. On a cognate topic, almost similar in nature, the Supreme Court in Travancore Titanium Products Ltd. v. Commissioner Of Income Tax Kerala on section 10(2)(xv) of the Income-tax Act lays down the principle that “the nature of expenditure or outgoing should certainly be adjudged in the light of accepted commercial practice in trade. But that expenditure must be incidental to the business and must be necessitated or justified by commercial expediency. It must be directly and intimately connected with the business and must be laid out by the tax payer in his character as a trader. To be a permissible deduction, there must be a direct and intimate connection between the expenditure and the business, i.e, between the expenditure and the character of the assessee as a trader and not as owner of assets, even if they are assets of the business.” This is exactly the point in the reference before us.

24. As owner of the property the assessee was already liable to pay the municipal taxes and, as owner of the assets, even if they are used in business, he could not claim the payment of taxes as an expenditure “incurred solely for the purpose of making or earning such income” which in this case is the guarantee commission. A bench of this court took the same view in Kedarnath Jute Manufacturing Co. Ltd.… v. Commissioner Of Income-Tax (Central)…. following the above principle.

25. The assesee could give this property, the Mercantile Building, as security because it was assessee-company's property which meant that as owner of the property it had to pay its liability to keep the property its own which was given as security. Here the tax is an incident of ownership of the property. The payment of municipal tax on the property, therefore, is too remote an expenditure to connect its use with the mortgage by saying that the mortgage was used to earn the guarantee commission. That does not bring it within the expression “incurred solely for the purpose of making or earning such income” within the meaning of section 12(2) of the Income-tax Act. The municipal tax was not paid solely to earn the guarantee commission. It was paid to keep the property of the assessee-company as its owner.

26. Lastly, it cannot be solely incurred for the purpose of earning the guarantee commission in this case because the assessee-company mortgaged this property to secure an overdraft by the bank to its associate company. That means that the equity of redemption, which itself is property, remained with the assessee-company and tax was paid to preserve and keep that equity of redemption with the assessee-company. Therefore, such a tax could not be said to have been paid solely for the purpose of making or earning the guarantee commission.

27. Reading Section 12(2) of the Income-tax Act, it is plain that no allowance can be granted under this sub-section unless four basic conditions are satisfied, namely, (1) the expenditure must be incurred solely for the purpose of making or earning the income, profits or gains; (2) it must not be in the nature of capital expenditure; (3) it must not be in the nature of personal expense of the assessee; and (4) it must be incurred in the accounting year and not in any prior or subsequent year. The case of Eastern Investments Ltd v. Commissioner Of Income Tax, West Bengal is the classic example on this point where the Supreme Court observed at page 7:

“This being an investment company, if it borrowed money and utilised the same for its investments on which it earned income, the interest paid by it on the loans will clearly be a permissible deduction under section 12(2) of the Income-tax Act. Whether the loan is taken on an overdraft, or is a fixed deposit or on a debenture makes no difference in law. The only argument urged against allowing this deduction to be made is that the person who took the debentures was the party who sold the ordinary shares. It cannot be disputed that if the debentures were held by a third party, the interest payable on the same would be an allowable deduction in calculating the total income of the assessee-company. What difference does it make if the holder of the debentures is a shareholder? There appears to be none in principle in view of the fact that no suggestion of fraud is made in respect of the transaction which is carried out between the company and the administrator and which has been sanctioned by the court.”

28. There the assessee was an investment company. There no question of payment of municipal tax as incident of ownership was involved, as it is in the reference before us. The really relevant case is of the Patna High Court in Commissioner of Income-tax v. Maharani Janki Kuar Sahiba. There the assessee claimed to deduct under Section 12(2) of the Income-tax Act, forest cess levied under the Bengal Cess Act, 1880, as applicable to Bihar, on income from forest produce which was assessed as “income from other sources”. The cess, however, was assessed on the annual net profits from immovable property. It was the assessee's contention in that case that the cess was in respect of the land on which the forest grew and that the expenditure by way of cess was incurred to earn the income from the forest, as non-payment of the cess would result in the deprivation of the source of the income itself. The Patna High Court, however, held that as the cess was an imposition on the annual net profits from forest produce, it could not be said that the expenditure aided the assessee in earning the income or that it was incurred for the purpose of earning the income from the forest produce. It came to the decision that the assessee was not therefore entitled to the deduction claimed. It quoted with approval the observations of Dawson Miller C.J, in the Full Bench decision of the Patna High Court in In re Raja Jyothi Prasad Singh stating:

“The liability to pay cesses results from the income having been made and the payment of the cess can hardly be said to form a necessary part in the making of the income which must come into existence before the liability to cess arises. The payment of cess is a necessary expense arising in connection with the ownership of royalties but it is in no sense an expenditure incurred for any purpose incidental to the making of the income.”

29. Here also, in the present reference before us, the assessee company was paying the municipal tax as owner of the property and as such the liability for such expenditure was incurred from before as owner of the property and it was not incurred solely for the purpose of earning the guarantee commission by mortgaging the property. From another point of view the position becomes absurd for the assessee. Half the municipal taxes paid in respect of this Mercantile Building has already been allowed as a deduction under the head “property” under section 9 of the Income-tax Act. The balance of the municipal tax which is now claimed under section 12(2) as deductible not only means changing the heads; which on the authorities we have shown cannot be done; but also is contradictory to the very case of the assessee having got the maximum deduction under the head “property” under section 9, third proviso of the Income-tax Act. The assessee cannot in the same breath contend that the balance of the tax is solely for the purpose of earning the guarantee commission. Obviously then on this position what the assessee is doing is that it is partly deducting tax under the head “property” under section 9 of the Income-tax Act, and partly for the purpose of earning the guarantee commission. This is exactly where the assessee's case is hit by the expression “expenditure incurred solely for the purpose of making or earning the income, profits or gains” under section 12(2) of the Income-tax Act. It also would lead to the very odd result that while the same tax, viz., the payment of the municipal tax can only be claimed as deduction up to the limit of half under section 9, third proviso of the Income-tax Act, the assessee can metamorphose the balance to it as deduction for such balance by using another section of the Income-tax Act. It will mean what one section prevents, another section permits. Both on the authorities and on the facts such a construction seems to us to be impossible.

30. We are constrained to hold that the Tribunal is wrong in applying the decision of the Privy Council in Probhat Chandra Barua v. King Emperor, to the facts of this case. There, while the Bengal Regulations contained assurances against any claim to an increase of the jama, based on an increase of the zamindari income, they contained no promise that the zamindar should in respect of the income which he derived from the zamindari be exempt from liability to any future general scheme of property taxation, or that the income of the zamindari should not be subjected with other incomes to any future general taxation of incomes and where under the Indian Income-tax Act the zamindar of a permanently settled estate was assessable to tax under the Act in respect of income, profits and gains derived from his zamindari, subject however to exemption in section 4(3) of the Income-tax Act, 1922. It was held there that the assessment should be computed after making proper allowance under section 12(2) in respect of the jama assessed and paid. At page 240 this is what Lord Russell, delivering judgment of the Privy Council, observed:

“Before leaving this part of the case their Lordships deem it right, in view of discussions in the course of the arguments before the Board, to make a further statement as to the liability of the appellant to pay income-tax upon the income derived from his zamindari. The tax is upon ‘income, profits and gains’.

It is not a tax on gross receipts. With this fact in view, each section which deals with one of the first five ‘heads’ specified in section 6 contains, where proper, specific provisions for the necessary deductions and allowances to be made for the purpose of arriving at the taxable balance. Section 12, which deals with the general residuary group, is necessarily framed in general terms and authorizes the allowance of any ‘expenditure (not being in the nature of capital expenditure) incurred solely lor the purpose of making or earning such income, profits or gains’.”

31. There in that case the liability was a liability incident to the very zamindari itself and the income from such zamindari. But here, in the reference before us, the liability to pay the municipal tax was a prior and existing liability on the assessee-company as owner of that building and the payment of such tax therefore could by no stretch of argument be said to have been incurred or made to earn the guarantee commission.

32. For the reasons and on the authorities we answer the question in the negative holding that in the facts and the circumstances of the case the sum of Rs. 17,000, was not allowable as deduction under section 12(2) of the Indian Income-tax Act. The assessee will pay the costs of this reference. Certified for two counsel.

K.L Roy, J.:— I agree.