Commissioner Of Income-Tax (Central), Calcutta v. Model Manufacturing Co. (P.) Ltd.

Sen, J.:— This is a consolidated reference under s. 256(1) of the I.T Act, 1961, at the instance of the Commissioner of Income-tax (Central), Calcutta, and arises out of the assessment of the Model Manufacturing Co. (P.) Ltd., the assessee, for the assessment years 1962–63 and 1963–64. The question referred is as follows:

“Whether, on the facts and in the circumstances of the case, the Tribunal was right in directing the Income-tax Officer to allow interest of Rs. 70,875 and Rs. 1,48,116 against its income from ‘other sources’ for the assessment years 1962–63 and 1963–64, respectively, under section 57 of Income-tax Act, 1961?”

2. The admitted facts and the facts found are, shortly, that the assessee carries on business as selling agents and also in speculation and in other commodities. At the instance of N.L Kanoria, its director, the assessee purchased 10,100 shares in the New City of Bombay Manufacturing Co. Ltd., a well-established cotton mill in Bombay (hereinafter referred to as the Bombay company), in the names of the said N.L Kanoria and one Tulsidas Kanoria for a sum of Rs. 27,77,500 at the rate of Rs. 275 per share. The Kanorias, in turn, sold the said shares to the assessee on the same date. The sellers were paid off to the extent of Rs. 14,29,413 borrowed by the assessee from a concern, M/s. Tulsidas Kanoria & Co., for the purpose of acquiring the said shares. Another 3,400 shares in the Bombay company were also purchased by the assessee in the name of one Biswanath Jhunjhunwala, a relative of the Kanorias. The price of these shares was paid by the assessee by taking another loan of Rs. 4,85,000 from the said Tulsidas Kanoria & Co.

3. In the relevant assessment years, the question arose whether the interest paid on the amounts borrowed by the assessee for purchasing the said shares of the Bombay company was allowable as business expenditure. The ITO found that the said shares were purchased with a view to acquiring controlling interest in the Bombay company, for and on behalf of the Kanorias, who were the directors of the assessee.- The said shares were purchased neither for dealing nor for investment. The said shares were sold subsequently by the assessee to the members and/or nominees of the Kanoria family some of whom became the directors of the Bombay company. Accordingly, in the assessment year 1962–63, the ITO disallowed the deduction claimed by the assessee of the interest paid on the amounts borrowed.

4. In the assessment year 1963–64, the ITO found that the assessee had entered into further transactions in purchase and sale of shares of the Bombay company at cost price without profit or loss unlike other shares which were dealt with on a different basis. The ITO also disallowed the deduction of further interest paid by the assessee during the year on its loans.

5. In the appeal preferred by the assessee against the decision of the ITO, the AAC accepted the finding of the ITO that the said shares had been purchased with a view, to acquiring controlling interest in the Bombay company for and on behalf of the Kanorias who controlled the assessee and that the shares had not been purchased for the purpose of dealing or for investment. In this appeal, the assessee claimed for the first time that, in any event, such interest should be allowed against income from dividends. This claim was also rejected by the AAC on the ground that the assessee had been used merely as a channel for acquiring the control of the Bombay company and, therefore, it could not be held that the shares were investment in themselves.

6. The assessee preferred a further appeal to the Income-tax Appellate Tribunal. It was contended before the Tribunal that the assessee had been held to be a dealer in shares in the earlier assessment year 1958–59, and, therefore, the assessee must be held to be a dealer in respect of these shares; also it was contended further that, in any event, interest should be allowed as an expenditure under s. 57 of the I.T Act, 1961, as a deduction against income from other sources.

7. The revenue reiterated before the Tribunal that the said shares had been purchased with a view to acquiring control of the Bombay company at prices higher than that prevailing in the market and the assessee had no intention to deal in the said shares. The directors of the assessee and their relatives subsequently became the directors of the Bombay company. Against the claim of the assessee that the interest paid should be allowed against the dividend income it was contended that as the assessee did not have any dividend income from the shares of the Bombay company, the question of allowance of such interest did not arise. A decision of this court in the case of Messrs. Madanlal Sohanlal v. Commissioner Of Income-Tax, Calcutta., [1963] 47 ITR 1 (Cal) was relied on in support of this contention.

8. The Tribunal came to the conclusion that the aseessee did not purchase the said shares for the purpose of dealing in them, the apparent object of the assessee being to acquire the controlling interest of the Bombay company either by the Kanorias or by the assessee itself. Purchase of the said shares at a rate higher than the prevailing market price and sale thereof only to the relatives of the Kanorias, the directors of the assessee, were noted by the Tribunal as not being incidents of normal business activity. The Tribunal, therefore, held that the interest paid on the amounts borrowed by the assessee could not be allowed as a business expenditure.

9. In respect of the further contention of the assessee that the interest paid should be allowed against its income from other sources, the Tribunal, however, did not agree with the authorities below. The Tribunal held as follows:

“In our opinion whatever may be the ultimate purpose of the assessee in purchasing the shares of the Bombay company, the expectation of dividend cannot be denied. The hope of getting dividend is implicit in the very nature of the investment and the two cannot be separated. The declaration of dividend is the normal activity of a limited company and so is the right of its shareholders to receive it. We, therefore, hold that the interest is a legitimate deductible expense against dividend income if it is paid on borrowings that have been utilised in the purchase of the shares.”

10. Reading Madanlal Sohanlal's case, [1963] 47 ITR 1 (Cal), the Tribunal came to the conclusion that a deduction could be allowed under s. 12(2) of the earlier Act of 1922 (corresponding to s. 57 of the Act of 1961) if there was such income from other sources. The Tribunal found that in the relevant assessment years the assessee had other dividend income and allowed the deduction of the interest paid against such income.

11. Mr. Bagchi, learned counsel for the revenue, contended before us that the Tribunal having found that the object of aquiring the shares was to allow either the Kanorias or the assessee to acquire the controlling interest in the Bombay company it could not be said that the expenditure incurred, i.e, the interest paid on the borrowed amount, was wholly and exclusively for the purpose of earning income from dividend and, therefore, the assessee was not entitled to claim deduction under s. 57 of the I.T Act, 1961.

12. Mr. Bagchi further contended that the particular shares acquired did not yield any dividend, or income, and, therefore, the interest paid on the amounts borrowed for the purpose of acquiring these shares could not in any event be deducted against income under the head “Other sources”.

13. In support of his contentions, Mr. Bagchi cited a number of decisions. The same are considered in their chronological order hereafter.

(a) Commissioner Of Income-Tax v. Sir Homi M. Mehta, [1943] 11 ITR 142 (Bom). In this case, the assessee, the promoter, managing director and the principal shareholder in a company, made a gift of Rs. 3 lakhs to the said company when the latter was in financial difficulties and claimed deduction of the same from his income under ss. 10, 7 and 12 of the Indian I.T Act, 1922, on the ground that if the assessee had not made the said gift the company would have gone into liquidation and he would have lost, (a) his capital invested in the company, (b) his salary as the managing director of the company, and, (c) his business reputation and credit. On these facts, the Bombay High Court held that the assessee's claim could not be sustained under s. 10 of the Act where allowance could be claimed only for any expenditure (not being in the nature of capital expenditure) incurred solely for the purpose of earning profits or gains. It was held that the assessee had incurred the expenditure partly for the purpose of earning other income, partly for protection of the income of the other shareholders of the company and partly for the protection of his business reputation and as such was a capital expenditure.

(b) Indian Steamship Co. Ltd. v. CIT, [1953] 24 ITR 448 (Cal). The assessee in this case obtained the permission of the Controller of Capital Issues for the issue of shares and debentures on condition that any sum received in excess of a certain amount, should be invested in Govt. securities, pending actual expenditure for the purpose of business. An amount was accordingly invested in Govt. securities and the assessee received interest, assessable under s. 8 of the Act. The assessee contended that the money raised had to be invested in Govt. securities by reason of the condition imposed by the Controller, and, therefore, the debenture interest paid should be allowed to be deducted against the interest received. This claim was disallowed by the revenue authorities on the ground that the object of issuing debentures was certainly not to invest the money, but to employ it in the assessee's business and the condition imposed by the Controller resulting in the investment in securities made no difference to the actual intention of the assessee. On a reference this court upheld the contentions of the revenue.

(c) Messrs. Madanlal Sohanlal v. Commissioner Of Income-Tax, Calcutta., [1963] 47 ITR 1 (Cal), where the facts were that the assessee, a registered firm, obtained a bank loan on overdraft and utilised the same for purchasing shares in several companies. In the relevant year no dividend at all was received from the said shares but interest paid on the overdraft was claimed as deduction in computing the profits of the assessee. On the question, whether such interest paid was allowable as a deduction it was held by this court that in view of the difference in language between s. 10 and s. 12 of the Indian I.T Act, 1922, if there was no income at all under the head “Other sources” and there was no return of any amount whatsoever then there could be no deduction of the interest paid against a notional income or the mere prospect of an income.

(d) CIT v. Jagmohandas J. Kapadia, [1966] 61 ITR 663 (Bom). In this case the assessee, a registered firm carrying on business as share and stock-brokers, borrowed on an overdraft account, paid interest on the said account in the assessment year in question, and claimed a deduction under s. 12(2) of the Indian I.T Act, 1922, of the interest paid against its dividend income. It was found that in the said assessment year, the assessee had income from three sources, namely, (a) business, (b) securities, and (c) dividends. The ITO allowed the deduction against business income of the assessee and not against its dividend income on the ground that the assessee was a dealer in shares and securities and, therefore, s. 12(2) had no application. The AAC upheld the decision of the ITO, but the Tribunal accepted the contention of the assessee. On a reference, the Bombay High Court held on the facts that the assessee was a dealer in shares and that the shares in question were the assessee's stock-in-trade but the interest paid could not be deducted against the dividend income as the amount borrowed could not be said to be for the purpose of earning dividend. The High Court observed as follows (p. 669):

“It would be noticed that what is allowable as expenditure under the said sub-section is only the expenditure incurred solely for the purpose of making or earning dividend income. Emphasis thus appears to be on the object or purpose of incurring of the expenditure. The exclusive object of incurring expenditure has to be the making or earning of the dividend income. The mere fact that income by way of dividend has accrued and that the expenditure incurred is in some manner or other related to the accrual of the dividend income is not sufficient.”

(e) CIT v. Kasturbhai Lalbhai, [1968] 70 ITR 267 (Guj). The facts in this case were that following disputes between the directors of a limited company, the assessees, and the directors of its managing agents, the assessees jointly spent certain amounts in sending out circulars to the shareholders and in collecting proxies for a meeting of the managing agents. The disputes were resolved before the meeting was held. The assessees claimed deduction of the amounts spent under ss. 10 and 12 of the Indian I.T Act, 1922. The Tribunal allowed their claim as a permissible deduction under s. 12(2) but not under s. 10(2)(xv). On a reference, the Gujarat High Court held that the expenditure incurred in issuing the circulars indirectly facilitated the earnings of directors' fees, and as such the same was allowable under s. 12(2), but the expenditure incurred in collecting the proxies were found to be not even indirectly connected with the earning of such fees and was, therefore, held not allowable under the said section.

(f) South Arcot Electricity Distribution Co. Ltd. v. CIT, [1974] 94 ITR 469 (Mad).

14. The facts here were that the assessee's business of supplying electricity was taken over by the Madras Electricity Board under statutory powers with effect from a certain date whereupon the assessee ceased its business and did not derive any income therefrom. The assessee, however, continued to earn income in the form of interest from bank deposits, interest paid by the Government on compensation amount payable to the assessee, and share transfer fees. Against such income, assessed as income from “Other sources”, the assessee claimed allowance for expenditure incurred on account of salaries, rent, sitting fees, travelling expenses of directors and remuneration paid to representatives.

15. On a reference, the Madras High Court held that in order to obtain the benefit of s. 12(2), the assessee had to establish a nexus between the expenditure and the earning of such income. The assessee having ceased its business after the “take over” the expenditure incurred thereafter could neither be said to have been incurred in the course of its business nor solely for earning interest or other income. The High Court found that the expenses incurred had no connection with the earning of interest and were not allowable.

16. Mr. Pranab Pal, learned counsel for the assessee, in reply, submitted that the only contention of the revenue before the Tribunal in respect of s. 57 of the I.T Act, 1961, had been that as the shares in question did not earn any dividends by themselves, therefore, on the authority of Madanlal Sohanlal's case, [1963] 47 ITR 1 (Cal) the claim for deduction should be rejected. No other submission having been made by the revenue, it was not open to the revenue at this stage to make new submissions which necessitated fresh investigation into facts. Mr. Pal further contended that the specific findings of the Tribunal were that the said shares were acquired by way of investment and not as stock-in-trade and further that the assessee had an expectation of dividend. These findings not being challenged, it was not open to the revenue to go further into the motive of the assessee in acquiring the shares.

17. Mr. Pal finally contended that both under s. 12(2) of the earlier Act and s. 57 of the later Act the revenue authorities had to determine total income under the head “Other sources” and not income arising from a particular source. If there was gross income under the head “Other sources” then the expenditure incurred for the purpose of earning any income under this head must be deducted from such gross income, even though the item against which such expenditure was incurred did not yield any income. Mr. Pal submitted that this was the law laid down in the case of Madanlal Sohanlal's case, [1963] 47 ITR 1 (Cal).

18. Mr. Pal also cited a few decisions which are chronologically as follows:

(a) Ormerods (India) P. Ltd. v. CIT, [1959] 36 ITR 329 (Bom). The facts of this case were that the assessee, a company, had purchased shares by obtaining loans to the extent of almost their entire value. The said shares did not yield any income during the relevant period but the assessee claimed to set off the interest paid on the loans against its other income in the relevant assessment years. The Tribunal found that the purchase of the said shares was for the convenience of two persons who controlled the assessee-company and that was the sole purpose of acquiring the shares. But the Tribunal held that the assessee was still entitled to set off the interest paid against its other dividend income in the said years. The question whether such interest could be set off under s. 24(1) of the I.T Act was referred to the Bombay High Court which rejected the contention of the revenue that by reason of the explicit finding of the Tribunal that the sole purpose of the borrowing by the assessee was the convenience of two persons who controlled the assessee, the question must be answered against the assessee. In the judgment, it was observed as follows (pp. 335,336):

“It is indubitably true that the Tribunal has stated that the purchase of these shares by the company has served the purpose of giving facility or convenience to two interested parties. It is equally true that the Tribunal has used the word ‘purpose’ in recording this finding. Evidently there is here the use of an expression which has more than one meaning. ‘Purpose’ may, in some context, suggest object; and purpose may some times suggest motive for a transaction. But under section 12, we have to read the word ‘purpose’ in its legal sense to be gathered from the context in which it appears……

But whatever way we read the word ‘purpose’ it cannot certainly mean a motive for a transaction. Much less can it mean the ulterior motive or the ultimate object of purchasing the shares by the company…………

All that the Tribunal has recorded is that the shares were not purchased with a view to trading in them…………

There is, therefore, in our view, no finding by the Tribunal that these shares were not purchased solely for the purpose of making or earning income, profits or gains. Now the Tribunal has found that these purchases were investments of the assessee-company. On the facts of the case and the finding recorded by the Tribunal the only possible conclusion that we can reach is that these investments were made for the purpose of earning income or dividends or for making profits or gains. In our opinion, the Tribunal has mixed up the concept of the purpose of the purchase of these shares by the company and what in its judgment was the motive for the purchase of the shares…….

That the purchase of the shares was to earn income would seem to be the very basis of that part of the order made by the Tribunal. In our judgment, where the Tribunal has gone wrong is that it has, while appreciating the nature of the purchase of the shares by the assessee-company, given overriding effect to what it concluded was the motive for the purchase of the shares. The motive for the purchase of the shares and the purpose for purchase of the same should not have been allowed to be mixed up in that manner.”

(b) Cit Bihar v. M/S Kirkend Coal Co. , [1969] 74 ITR 67 (SC). This decision was cited by Mr. Pal for the following observation of the Supreme Court (p. 72);

“But in a reference under section 66 of the Indian Income-tax Act, 1922, only the-question which was either raised or argued before the Tribunal may be answered, even if the language of the question framed by the Tribunal may apparently include an enquiry into other matters which could have been, but were not, raised or argued.”

(c) Sutlej Cotton Mills Ltd. v. CIT, [1971] 81 ITR 641 (Cal). This decision was cited for an observation of P.B Mukharji, Actg. C.J (as he then was) explaining Madanlal Sohanlal's case, [1963] 47 ITR 1 (Cal). In explaining his own judgment his Lordship observed as follows (p. 663):

“The ratio of that decision is that, in allowing an expenditure under section 12(2), it is not necessary that the investment should result in a profit but there must be some gross income or return and where there was no income or return at all in the sense that out of such income or return some deduction is to be made, then such an expenditure could not be allowed under section 12(2). The basis is that section 10(2) speaks of ‘after making the following allowances’. Naturally, the allowance is to be made from the profits computed or gains computed. If there is no profit or gain, then there can be no question of making an allowance from anything. That does not, however, mean that each particular share will have to produce a particular return.”

(b) Seth R. Dalmia v. CIT, [1977] 110 ITR 644. In this case, the Supreme Court approved Ormerods (India) P. Ltd., [1959] 36 ITR 329 (Bom) in the following language (p. 652):

“In Ormerods (India) P. Ltd. v. Commissioner of Income-tax, [1959] 36 ITR 329, the Bombay High Court allowed certain sums of money paid as interest on borrowed capital for the purchase of shares and held that the word ‘purpose’ in the expression ‘expenditure incurred solely for the purpose of making or earning such income, profits or gains’ did not mean motive for the transaction, much less can it mean ulterior motive or ulterior object. The court held that as the investments were made for the purpose of earning income, the interest paid thereon would be deductible under section 12(2) of the Act.”

19. We have carefully considered the entire facts and circumstances of the case, the respective submissions of the parties as also the various decisions cited. The Tribunal in the instant case has allowed the interest paid to be deducted under s. 57 of the I.T Act, 1961, on the basis of its finding that the assessee acquired the shares in question by way of investment, and not for the purpose of acquisition of stock-in-trade. This finding is not challenged. The only contention of the revenue before the Tribunal was that the assessee was not entitled to claim deduction under s. 57 as the said shares themselves did not yield any income. This proposition was sought to be supported by the decision in Madanlal Sohanlal's case, [1963] 47 ITR 1 (Cal). The decision in Madanlal Sohanlal read with the later decision in Sutlej Cotton Mills Ltd.'s case, [1971] 81 ITR 641 (Cal), in our view, clearly lays down a proposition to the contrary.

20. Before the Tribunal, the revenue refrained from putting forward the argument that the purpose of the assessee being to obtain the control of the Bombay company, the purchase of the said shares cannot be held to be by way of investment or for earning dividend therefrom. In our view, it is no longer open to the revenue to make that argument at this reference. To resolve this controversy further investigation and appreciation of facts would be necessary. The observation of the Supreme Court in Kirkend Coal Co.'s case, [1969] 74 ITR 67 appear to us to be fully applicable in such circumstances.

21. It also appears to us that, even otherwise, the contention of the revenue cannot be sustained on merits in view of the decision of the Bombay High Court in the case of Ormerods (India) P. Ltd.'s case, [1959] 36 ITR 329, where the High Court made a clear distinction between motive and purpose on facts almost identical to those before us. This decision has been approved by the Supreme Court. We follow the said decision with respect and draw similar distinction between motive and purpose and hold that in the instant case, though the ultimate or ulterior motive of the assessee might have been to confer controlling interest either to itself or to the Kanorias, yet the immediate purpose for acquisition of the shares was to earn income from the dividends thereof. We add that even if the motive of the assessee might have been to obtain control of another company, the consequent purchase of shares may still be treated as investment and the concurrent purpose of the assessee could well have been that of earning further income by acquiring the control of the other company. For the reasons above, the assessee succeeds in this case. The question referred is answered in the affirmative and in favour of the assessee. There will be no order as to costs.

C.K Banerji, J.:— I agree.