Citation Codes

Equivalent Citations

citation codes

Case Number

Misc. Civil Case No. 133 of 1980

Attorney(S)

For Respondent— R.C Mukati.
For Assessee— G.M Chaphekar.

Judges

G.G Sohani
K.N Shukla, JJ.

Acts

Section 10(2)(vii) of the Indian I.T. Act, 1922,
Section 10(1) of the Indian I.T. Act, 1922,
Section 15C of the Indian I.T. Act, 1922,
Section 36(1)(iii) of the I.T. Act,
Section 256(1) of the I.T. Act.
Indian I.T. Act, 1922.

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Smart Summary

Structured Summary of the Court Opinion

Factual and Procedural Background

This is a reference by the Income-tax Appellate Tribunal, Indore, under Section 256(1) of the Income-tax Act. The assessee is a co-operative society that carried on two lines of activity: a banking business and consumer stores. Separate books of account were maintained for the two activities. During the previous years relevant to assessment years 1972-73 and 1973-74, the consumer stores unit credited Rs. 11,179 and Rs. 17,956 as interest in the current account of the banking unit; corresponding credits appeared in the banking unit's account showing those sums as interest from the consumer stores unit.

The ITO, in the original assessments, allowed the interest amounts as expenditure on capital borrowed, and because Section 80P(2)(a)(i) exempts income of a society carrying on banking business, the ITO did not assess the interest income in the banking unit. The ITO subsequently issued a notice under Section 148, and after hearing the assessee disallowed the interest deduction and added the amounts to the assessee's total income.

The assessee appealed; the Assistant Commissioner of Income-tax (AAC) allowed the appeal deleting the additions. The Department filed a second appeal to the Appellate Tribunal, which reversed the AAC and restored the ITO's order, holding that the banking and consumer stores businesses were carried on by the same assessee and that effectively interest was paid by the assessee to itself, producing a double benefit if both deduction and exemption under Section 80P were allowed.

At the instance of the assessee two questions were referred to this court for opinion concerning (1) whether the interest credited by the consumer stores unit to the banking department is an allowable expense for arriving at the correct profit of each department, and (2) whether Sub-clause (i) of Clause (a) of Sub-section (2) of Section 80P covers income derived from the business of banking with another department of the same co-operative society.

Legal Issues Presented

Whether, on the facts and circumstances of the case, the interest paid by the consumer stores unit to the banking department to arrive at the correct profit of each department is an allowable expense?
Whether, on the facts and circumstances of the case, Sub-clause (i) in Clause (a) of Sub-section (2) of Section 80P covers the case of a co-operative society regarding the income derived from the business of banking with another department of the same society?

Arguments of the Parties

Assessee's Arguments

The assessee's counsel relied specifically on two decisions to support the allowance of the interest claim: CIT v. Hantapara Tea Co. Ltd., [1973] 89 ITR 258 (SC) and Anil Starch Products Ltd. v. CIT, [1966] 59 ITR 514 (Guj).
Implicit in that reliance was the contention that where an assessee uses its own produce/raw material or internal resources for its business, valuation at market value (or similar principles) may be relevant in computing deductible expenditure for the business.

Revenue / Department's Arguments (as reflected in the Tribunal)

The Department (through the ITO and as ultimately upheld by the Tribunal) asserted that the interest entries represented payments within the same legal person and that the interest could not be treated as an expenditure allowable under Section 36(1)(iii) because the same entity could not be both lender and borrower.
The Tribunal also held that granting a deduction for interest on one hand and allowing exemption of the interest income under Section 80P on the other would result in a double benefit to the assessee and was therefore impermissible.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Kikabhai Premchand v. CIT, [1953] 24 ITR 506 (SC)	The principle that it is artificial and unreal to treat a business and its owner as separate entities to create a fictional profit when, in truth, the business is owned and run by the same person; i.e., one cannot treat a person as selling to himself to create taxable profit.	The court applied the observations from Kikabhai mutatis mutandis to hold that the same entity cannot be treated as lender and borrower and that interest cannot be treated as paid to a separate party when both units are the same assessee.
CIT v. B.M. Kharwar, [1969] 72 ITR 603 (SC)	The rule that legal relations arising from a transaction must be respected and that where two legally distinct entities enter into a contract the transaction will have legal effect even if the persons behind the entities are the same.	The court noted Kharwar's discussion and observed which parts of Kikabhai were referred to and explained; the court used this to clarify that where the same legal person exists (as here), transfer or payment to oneself cannot be treated as a transaction between distinct persons for tax purposes.
CIT v. C. Parakh & Co., [1956] 29 ITR 661 (SC)	The principle that profits from different units or places of business carried on by the same assessee must be aggregated for computing total income and that relevant expenses are to be deducted from the aggregate income.	The court cited Parakh to support the proposition that tax liability is on total income of the assessee (all units together), not on separate business units taken in isolation; this supported the conclusion that intra-assesse payments do not create deductible external interest.
CIT v. A. Suppan Chettiar & Co., [1930] ILR 53 Mad 702; AIR 1930 Mad 124 [SB]	The interpretation that the words "any business" include all businesses put together and that profits and gains should be the aggregate of all businesses.	Used to reinforce that the assessee's different business activities are to be considered together for computing total income; hence intra-assesse interest entries cannot produce allowable deductions against the aggregate income as if dealings were with separate persons.
CIT v. Hantapara Tea Co. Ltd., [1973] 89 ITR 258 (SC)	The rule (in the different factual context of agricultural produce used in manufacture) that where agricultural produce grown in the estate was subject to agricultural income-tax on market value, the market value should be taken for computing deductible expenditure for the tea business.	The court explained that Hantapara was factually different and that its principle (about taking market value of internal produce for computing deductions) was not applicable to the present case; the precedent relied upon by the assessee was therefore distinguished.
Anil Starch Products Ltd. v. CIT, [1966] 59 ITR 514 (Guj)	The issue of valuation (market price vs cost price) of raw material produced by the same company supplied to a new undertaking for the purposes of Section 15C of the Indian I.T. Act, 1922.	The court held that the facts of Anil Starch were different (internal raw material supplied to a new undertaking) and therefore its rule was inapplicable to the present case; the precedent was distinguished and not followed.

Court's Reasoning and Analysis

The court's analysis proceeded along two main strands: (A) the proper interpretation and application of the deduction provision for interest (Section 36(1)(iii) of the Income-tax Act) and (B) the scope and practical operation of Section 80P (deduction in respect of income of co-operative societies).

(A) Interest deduction under Section 36(1)(iii)

The court observed that Section 36(1)(iii) allows a deduction for interest paid "in respect of capital borrowed for the purposes of the business." The words "borrowed and paid" imply two distinct entities — one that lends and another that borrows and pays interest.
It followed from this statutory language that the same legal entity cannot be both lender and borrower; interest cannot, in legal effect, be "paid to self."
The court relied on the reasoning in Kikabhai Premchand v. CIT to underscore that it is artificial to separate a business from its owner (or, by extension, to treat two departments/units of the same assessee as if they were independent parties transacting to create a deductible outgoing and corresponding taxable income).
The court distinguished authorities cited by the assessee (Hantapara and Anil Starch) on the basis that those decisions involved materially different factual questions — valuation of self-produced raw material or agricultural produce used in business — and did not establish a principle that would permit treating intra-assesse interest entries as deductible payments for Section 36(1)(iii) purposes.
The court also pointed to the rule that tax is chargeable on the total income of the assessee (Section 28 and authorities like Parakh and Suppan Chettiar), which supports treating the activities together rather than allowing intra-assesse cross-charges to be efficacious for tax deduction purposes.
On these bases the court concluded that the interest entries represented payments made and received by the same legal person and therefore were not allowable deductions under Section 36(1)(iii).

(B) Scope of Section 80P

The court quoted Section 80P and explained its operative scheme: first compute the gross total income of the co-operative society, and then deduct the income specifically referred to in Sub-section (2).
The court reasoned that if, while computing gross total income, there is no interest income (because intra-assesse interest entries do not constitute taxable income of a separate lending entity), there is nothing available to be deducted under Section 80P(2).
Consequently, Sub-clause (i) of Clause (a) of Sub-section (2) of Section 80P cannot be read as covering income derived from the business of banking with another department of the same society when that supposed income does not legally arise as income from a distinct person.
The court therefore answered the second referred question in the negative, concluding that Section 80P does not cover intra-department banking income within the same co-operative society.

Holding and Implications

Holding: Both questions referred to this court were answered in the negative and against the assessee.

- Question (1): The interest credited by the consumer stores unit to the banking department (i.e., intra-assesse interest) is not an allowable expense for computing the profit of each department; the Tribunal was justified in rejecting the claim.
- Question (2): Sub-clause (i) of Clause (a) of Sub-section (2) of Section 80P does not cover a co-operative society's income derived from banking with another department of the same society.

Implications:

The direct legal effect is that the deduction previously claimed for the interest payments is disallowed and the corresponding additions to the assessee's total income as made by the ITO and restored by the Tribunal are upheld as correct in principle.
The court expressly distinguished the precedents relied upon by the assessee and did not extend or create any new principle of law beyond applying established concepts: (i) that a single legal entity cannot be treated as transacting with itself to generate deductible interest, and (ii) that computation under Section 80P presupposes the existence of gross total income items to be deducted. The opinion did not purport to lay down a novel rule of tax law beyond these applications.
There will be no order as to costs.

This summary is prepared exclusively from the content of the provided opinion and does not add or infer information beyond that text.

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Malwa Mills Karmachari Paraspar Sahakari Sanstha Ltd., Indore Assessee v. Commissioner Of Income Tax, M.P-1, Bhopal .

1. This is a reference by the Income-tax Appellate Tribunal, Indore, under Section 256(1) of the I.T. Act.

2. Assessee is a co-operative society. It appears (that it carries) on banking business and also runs a consumer stores. Separate sets of account books are maintained for the aforesaid business activities. During the previous years relevant to the assessment years 1972-73 and 1973-74, the consumer stores unit of the assessee credited Rs. 11,179 and Rs. 17,956 as interest in the current account of the banking unit and account books of the banking unit showed credit of these sums in the current account of the consumer stores unit. These entries reflected that the banking unit of the assessee advanced loans to its consumer stores unit and interest thereon was credited in the respective account books.

3. The ITO in his original assessments allowed the above amounts as expenditure on capital borrowed. Since under section 80p(2)(a)(i) of the i.t. act the income of a society carrying on banking business is exempt from tax, the ITO did not bring to tax the interest income in the banking unit of the society. The ITO later issued a notice under Section 148 of the Act and after hearing the assessee disallowed the expenditure claimed as deduction on account of payment of interest and added the same in the computation of the assessee's total income.

4. The assessee-society appealed against the order of the ITO. The AAC allowed the appeal and deleted the additions. The Department then filed a second appeal against the order of the AAC before the Appellate Tribunal.

5. The Appellate Tribunal reversed the order of the AAC and restored that of the ITO. The Tribunal held that the banking and consumer stores businesses were carried on by the same assessee and in fact interest was paid by the assessee to itself. It also held that by claiming deduction of interest as expenditure on the one hand and seeking exemption of income under Section 80P of the Act on the other, the assessee got a double benefit.

At the instance of the assessee the following questions have been referred to this court for our opinion :

"(1) Whether, on the facts and circumstances of the case, the interest paid by the consumers stores to banking department to arrive at the correct profit of each department is an allowable expense ?

(2) Whether, on the facts and circumstances of the case, sub-clause (i) in clause (a) of sub-section (2) of section 80p covers the case of a co-operative society regarding the income derived from the business of banking with another department ? "

6. The assessee admittedly carries on banking activities and also runs a consumer stores. Though separate sets of account books are maintained for the above business activities, the tax is chargeable on the total income of the assessee and not on separate business activities. Under Section 36(1)(iii) of the I.T. Act, deduction is allowed for the amount of interest paid in respect of capital borrowed for the purposes of the business or profession. Words " borrowed and paid " in these provisions clearly postulate two different entities, one which lends capital and the other which borrows and pays interest. The same entity cannot be its own lender and borrower, nor interest can be paid to self.

7. In a different context, their Lordships of the Supreme Court dealt with a situation somewhat analogous to one in this reference in Kikabhai Premchand v. CIT, [1953] 24 ITR 506. In the cited case, the assessee, a sole proprietor, had withdrawn his stock-in-trade and settled it on a trust in which he himself was a principal beneficiary. The valuation was made on cost price though the market price was higher. The question was whether income arose from this transaction. Bose J., speaking for the court, observed (p. 509) :

" In the present case disregarding technicalities it is impossible to get away from the fact that the business is owned and run by the assessee himself. In such circumstances we are of opinion that it is wholly unreal and artificial to separate the business from its owner and treat them as if they were separate entities trading with each other and then by means of a fictional sale introduce a fictional profit which in truth and in fact is non-existent. Cut away the fictions and you reach the position that the man is supposed to be selling to himself and thereby making a profit out of himself which on the face of it is not only absurd but against all canons of mercantile and income-tax law."

8. The above observations will apply mutatis mutandis to the facts of the case under reference. Kikabhai's case [1953] 24 ITR 506 (SC) was referred to in CIT v. B.M. Kharwar, [1969] 72 ITR 603 (SC) by the Supreme Court and some of the observations in Kikabhai's case were explained. Those observations which were referred to by the Supreme Court in Kharwar's case are not relevant for deciding the question before us. In Kharwar's case it was held that regard must be had to the legal relations arising from a transaction and not to the substance of the transaction. In Kharwar's case, [1969] 72 ITR 603 (SC), a firm had transferred its assets, machinery, etc., to a private limited company of which the shares were held by the same persons who constituted the firm. Their Lordships held that the balancing charge was payable by the firm under Section 10(2)(vii) of the Indian I.T. Act, 1922, because two different entities had entered into a contract and it did not matter that persons constituting the two different entities were the same. In fact in Kharwar's case the observations made by Bose J. in Kikabhai's case, [1953] 24 ITR 506 (SC) were tacitly approved and it was observed that (p. 608 of 72 ITR)

"the legal effect of the transaction in Kikabhai's case was not to effect a sale or transfer of the business assets from one person to another"

. By converse proposition, in Kharwar's case it was approved that there could not be a transfer of a business asset by the same person to himself.

9. section 28 of the i.t. act specified income chargeable to tax under the head " Profits or gains of business or profession ". Under Section 28(i) the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year shall be chargeable to tax under the same. In CIT v. C. Parakh & Co., [1956] 29 ITR 661 (SC), where the assessee carried on business at a number of places in India and Pakistan, it was held by the Supreme Court that profits earned in India and Karachi were to be thrown together and the expenses including the managing agency commission were to be deducted therefrom. In other words, income from different units could not be considered separately while computing the total income of the assessee from different businesses.

10. In CIT v. A. Suppan Chettiar & Co., [1930] ILR 53. Mad 702; AIR 1930 Mad 124 [SB], it was held that the words "any business" occurring in Section 10(1) of the Indian I.T. Act, 1922, will include all businesses put together and profits and gains should be held to mean the aggregate profits or gains of all the businesses together.

11. Thus, while computing the total income of the assessee in the instant case, the amount of interest claimed as expenditure by the assessee was not allowable because the interest was paid and received by the same person, i. e., the assessee, and in fact there was no payment by one person to another.

12. Learned counsel for the assessee relied on two decisions in support of his case. One is CIT v. Hantapara Tea Co. Ltd., [1973] 89 ITR 258 (SC) and the other is Anil Starch Products Ltd. v. CIT, [1966] 59 ITR 514 (Guj). Perusal of these two cases will show that the facts were entirely different and the statement of law will not be applicable to the facts of the case under reference. In Hantapara Tea Co.'s case the assessee carried on the business of manufacture and sale of tea and for this business used thatch, bamboo and fuel, etc., grown in its tea estate. The Agrl. ITO assessed to agricultural income-tax the market value of the thatch, bamboo and fuel, etc., grown in the tea estate. The assessee claimed deduction of these items on the market value while computing the profits from its tea business under the Indian I.T. Act, 1922. In that context the Supreme Court held that if the assessee had to pay agricultural income-tax on the market value of the agricultural produce raised in its estate and used in its tea business, it stands to reason that while determining the deductible expenditure incurred for the purpose of its business, the market value of the produce should be taken into consideration. Actually the question in the above case for consideration was whether the deduction should be computed on the basis of the market value of the agricultural produce or on the basis of cost of production. Their Lordships of the Supreme Court decided this question in favour of the assessee. Obviously the question was entirely of a different character and the statement of law could not apply to the present case.

13. The other cited case of Anil Starch Products Ltd., [1966] 59 ITR 514 (Guj), also deals with a different problem. The company manufactured industrial starch. Subsequently it set up another plant for producing dextrose and the raw material, i.e., industrial starch produced by the company was supplied for production of dextrose. The question was whether for giving the benefit under Section 15C of the Indian I.T. Act, 1922, to the new undertaking the raw material, i. e., industrial starch, produced by the company, should be charged at the market price or the cost price for the purposes of computing the profits and gains of the new undertaking. Again it is obvious that the question raised and answered was entirely different. In both the cited cases the assessee used raw material produced by itself for manufacturing a new product and, therefore, it was held that the market price of the raw material should be taken into consideration for computing the profits of the assessee's business.

14. We, therefore, hold that the interest paid by the consumer store unit of the assessee to its banking department was not an allowable expense for computing the profit of each department. In our opinion, the Tribunal was justified in rejecting this claim. Question No. (1) is, therefore, answered in the negative and against the assessee.

"80P. Deduction in respect of income of co-operative societies.--(1) Where, in the case of an assessee being a co-operative society, the gross total income includes any income referred to in Sub-section (2), there shall be deducted, in accordance with and subject to the provisions of this section, the sums specified in Sub-section (2) in computing the total income of the assessee."

17. The language makes it clear that what Section 80P contemplates is that first the gross total income of a co-operative society has to be computed and then the income referred to in Sub-section (2) has to be deducted. While computing the gross total income of the assessee-society if there is no interest income, the question of deducting such income will not arise. We, therefore, hold that on the facts and circumstances of this case, Sub-clause (i) of Clause (a) of Sub-section (2) of Section 80P of the Act does not cover the case of a co-operative society regarding income derived from the business of banking with another department of the same society. Question No. (2) is, therefore, answered in the negative and against the assessee.

18. There will be no order as to costs.

Malwa Mills Karmacha... v. Commissioner Of Inco...