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PETITIONER: MADRAS CO-OPERATIVE CENTRAL LAND MORTGAGE BANK LTD.

       Vs.

RESPONDENT: COMMISSIONER OF INCOME-TAX, MADRAS

DATE OF JUDGMENT: 19/07/1967

BENCH: SHAH, J.C. BENCH: SHAH, J.C. SIKRI, S.M. RAMASWAMI, V.

CITATION:  1968 AIR   55            1968 SCR  (1)  30

ACT: Indian  Income-tax Act (11 of 1922), ss. 8. Explanation  and 14(3)--Cooperative  Society  not  doing  banking   business- Interest from government securities-Apportionment of  income under taxable and. non-taxable heads.

HEADNOTE: The Income-tax Act, 1922, as originally enacted did not give to  a cooperative society any exemption from payment of  tax in  respect  of  income from its  business  activities.   By departmental  instructions  issued under s. 60 of  the  Act, exemption from payment of tax in respect of certain receipts of  a  co-operative society were  given.   The  notification provided inter alia that as regards interest received by  it from  government securities, an amount which bears the  same proportion to the total interest paid on debentures etc.  as the  capital invested in government securities bears to  the total  working capital, shall be deducted from the  interest on  government  securities as being exempt  from  tax.   The departmental  instructions were later withdrawn  and  sub-s. (3)  was  added to s. 14 of the Act, by which,  with  effect from April 1, 1955, a cooperative society was not liable  to pay  tax  in respect of the profits and. gains  of  business carried  on by it.  In 1956, an Explanation,  applicable  to banking  companies,  was added to s. 8. Clause  (a)  of  the Explanation  provided  for the allocation  of  business  ex- penditure  between  different sources of income  of  banking companies; and cl. (b) provided for allocation of  outgoings in  respect of " money borrowed" including  money  deposited with the bank [33BH; 34C-F] Thus, in spite of s. 14(3), for the assessment year 1956-57, there  were  no  departmental  instructions  governing   the apportionment  of income from government securities  between business  and  non-business sources of income; and,  in  the case  of  a cooperative society which did not carry  on  the business  of a banking company. there was no statutory  rule for  such apportionment, the Explanation to s. 8  not  being applicable.  Therefore, in the case of a cooperative society which was not carrying on the business of a banking  company a   rule   of  apportionment  consistent   with   commercial accounting  for  determining  the  income  from   government

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securities  attributable  to the business  activity  of  the society had to be evolved. [35H; 35A-B] The  appellant  was a cooperative society  not  carrying  on business of banking and for the assessment year 1956-57;  it claimed  that out of its gross income from securities,  only Rs.  13,578  was chargeable to tax on the principle  of  the departmental  instruction.  The Appellate  Tribunal  applied the  principle of the Explanation to S. 8 and  computed  the taxable income at Rs. 59,498.  The High Court held that  the benefit  of the departmental notification was not  available to  the  appellant, because it must be deemed to  have  been withdrawn and that, the Explanation to s. 8 did not in terms apply to the appellant. 31 In appeal to this Court, Held:In the absence of a statutory rule and departmental in- structions, a rule of appointment which dismembers income in pro"portion  to the business and non-business components  of the  source  from which it arises would be  more  consistent with principles of commercial accounting.  The proportion of income  from securities which is exempt from taxation  under s.  14(3) will be that proportion which the capital  of  the Society  used for the purposes of the business bears to  the total working capital, and according to this rule, the gross income from securities which would be liable to tax was only Rs.  13,578.   It was not open to the appellant  to  contend that even this amount was not taxable.  Such a question  was never  raised either before the department or the  Tribunal. [33C-D; 36F-H] The  principles  laid  down  in cls.  (a)  and  (b)  of  the Explanation to s, 8 are not Applicable.  The rule in cl. (a) is  not a rule of apportionment for the purpose of  taxation of composite income which is partly taxable and partly  not. It is an artificial rule, specially evolved for  determining the  appropriate  outgoings  for the  purpose  of  realising interest  .,from  securities held by a  banking  company  in computing  income chargeable to tax.  Clause (b) deals  with the  proportion in which the outgoings are  allocable.   The problem  arising  under  s. 14(3) is  not  one  relating  to allocation  of outgoings to deter. mine taxable income,  but of apportionment of income under the taxable and non-taxable heads. [36C-E]

JUDGMENT: CIVIL APPELLATE JURISDICTION: Civil Appeal No. 1975 of 1966. Appeal  by special leave from the judgment and  order  dated July 11, 1962 of the Madras High Court in Tax Case No. 84 of 1960. S. Swaminathan and R. Gopalakrishnan, for the appellant. Veda  Vyasa, A. N. Kirpal, R. N. Sachtliey and S. P.  Nayar, for the respondent. The Judgement of the Court was delivered by Shah, J.-This is an appeal with special leave. The appellant is a Society registered under the Co-operative Societies Act, 1912.  The following table sets out the  data relating  to  the earnings,  investments,  working  capital, outgoings and expenditure of the Society for the year ending June 30, 1955, relevant to the assessment year 1956-57:- (i)Interest from Government securi- ties.                              Rs.4,310,453.00 (ii) Total gross earnings.....          Rs.21,00,99(4.00 (iii) Investments  in Government securities.....                         Rs.130,60,653-00

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(iv) Total working. capital...          Rs.473,42,603-00 (v)  Interest paid on debentures, depo- sits and other accounts                 Rs.  15,09,490-00 (vi) Total overhead expenses and es- tablishment overhead charges    Rs.       3,01,102-00 32 In  a proceeding for assessment of the total income  of  the Society  to  tax for the year 1956-57 it  was  claimed  that under S. 14 (3) of the Indian Income-tax Act, 1922 (as added by S. 10 of the Finance Act, 1955, with effect from April 1, 1955)  the  income of the Society from business  was  exempt from  payment  of  tax,  and that  in  accordance  with  the instructions issued under S. 60 of the Act, out of the gross income  from  securities amounting to  Rs.  4,30,053/-,  Rs. 4,16,475/- being income attributable to the assets  utilized in  the  business,  only  the  balance  of  Rs.   13,578/was chargeable  to  tax.  In support of its claim  the  ’Society ’relied  upon the instructions published in  the  Income-tax Manual,  1946.  In the view of the  Income-tax  Officer  the Society  could  not claim the benefit  of  the  Departmental Instructions, since in the relevant year of assessment those instructions had ceased to operate, and the Society’s  claim was  governed by the Explanation to s. 8 of  the  Income-tax Act as incorporated by the Finance Act of 1956, with  effect from  April  1, 1956.  He accordingly computed  the  taxable income  under the head--"interest on securities" in the  sum of  Rs.  59,498/-.   The  Appellate  Assistant  Commissioner modified the order of the Income-tax Officer and reduced the taxable  income under the head "interest on  securities"  to Rs.  13,578/-  applying the Departmental  Instructions.   He held  that  the Explanation to s. 8 of the  Act  applied  to Banking Companies and not to Co-operative Societies. In  appeal by the Commissioner of Income-tax  the  Appellate Tribunal  reversed  the  order of  the  Appellate  Assistant Commissioner,  and  restored  the order  of  the  Income-tax Officer.  In the view of the Tribunal, the Explanation to s. 8  of  the Act cannot be invoked as the Society  was  not  a Banking,  Company, but the principle of the Explanation  may well  be  called in aid and that the relief granted  by  the Income-tax Officer was the only relief to which the  Society was entitled. The following question of law was submitted by the  Tribunal to the High Court of Madras:               "Whether  the Tribunal is justified in law  in               holding   that  the  taxable  income  of   the               assessee  from interest on securities  is  Rs.               59,498/-?"               The High Court reframed the question to read:               "Whether  the taxable income of  the  assessee               from interest on securities is Rs. 13,578/- as               contended by the assessee and as worked out on               the  basis  of the  Departmental  instructions               contained at pages 248 and 249 in Part III  of               the year 1946?", and answered it in favour of the Commissioner. 33 Counsel  for  the Society in the first  instance,  contended relying  upon the judgment of this Court in Commissioner  of Incometax    Andhra  Pradesh  v.  Cocanada  Radhaswami   Bank Ltd.,(1)  contended  that  no  part of  the  income  of  the Society,  even if it be earned from  Government  securities, was liable to be taxed.  It may be recalled that the Society had  claimed  before the Departmental  authorities  and  the Tribunal  that according to the instructions issued  by  the Central  Government under s. 60 of the Income-tax  Act  only

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Rs.  13,578/ - out of the income from Government  securities were chargeable to tax.  The Income-tax Officer and the Tri- bunal  held that Rs. 59,498/- were chargeable to  tax.   The decision  in Cocanada Radhaswami Bank’s case(1)  relates  to the  right of a Bank to carry forward the net loss  incurred by  a Banking Company and to set it off in subsequent  years against  income from securities held as part of its  trading assets.   It  is not a decision under s. 14(3) of  the  Act. Again  it  is not open to the Society in this  reference  to contend  that  the  amount of Rs.  13,578/-  itself  is  not taxable.   Such  a  question was  never  raised  before  the Tribunal and cannot be permitted to be raised in this Court. The  Income-tax  Act, 1922, as originally enacted,  did  not give to a Co-operative Society exemption from payment of tax in  respect of income from its business activities.  But  by Departmental  Instructions  issued under s. 60 of  the  Act, certain  exemptions were given by a notification  issued  on August 25, 1925 and modified by notifications dated June 25, 1927,  October  20,  1934 and August 18,  1945.   Among  the classes of income exempt from liability to pay tax under the notification was:               "(2)  The profits of any  cooperative  society               other  than  . . . or the dividends  or  other               payments  received by the members of any               such society out of such profits.               Explanation-For this purpose the profits of  a               cooperative  society  shall not be  deemed  to               include any income, profits or gains from:--               (1)  investments  in  (a)  securities  of  the               nature referred to in section 8 of the  Indian               Income-tax Act, or               (b).....               (2)   dividends, or               (3)   the  ’other  sources’  referred  to   in               section 12 of the Indian Income-tax Act". By the notification, profits of a Co-operative Society  were exempt  from tax, but those profits were not to Include  any income,  profits  or  gains from securities  of  the  nature referred to in s. 8 of the (1)157 I.T.R. 306. N)ISCI-4 34 Indian  Income-tax  Act.  The Legislature by s.  10  of  the Finan  Act of 1955 added sub-sec. (3) to s. 14,  whereby  it was enacted. inter alia, that:-               "The  tax  shall  not  be  payable  by  a  co-               operative  society, including a,  co-operative               society carrying on the business of banking-               (i)   in  respect  of  profits  and  gains  of               business carried on by it,               (ii)  in  respect  of interest  and  dividends               derived  from its investments with  any  other               cooperative society; A  co-operative society since the enactment of  the  Finance Act, 1955, with effect from April 1, 1955, was therefore not liable, by the express provisions in the Act, to pay tax  in respect  of the profits and gains of business carried on  by it.   Under s. 8 of the Incometax Act, 1922, tax is  payable by  an assessee under the head "Interest on  securities"  in respect of the interest receivable by him on any security of the  Central  Government  or of a State  Government,  or  on debentures  or  other securities for money issued by  or  on behalf  of  a  local  authority or  a  company,  subject  to exemption,  inter alia, in respect of any sum deducted  from such  interest  by way of commission by a  banker  realizing

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such  interest on behalf of the assessee, or in  respect  of any  interest payable on money borrowed for the  purpose  of investment   in  the  securities  by  the   assessee.    The Parliament  by  the  Finance Act,  1956  amended  the  first proviso, and added an Explanation to s. 8 providing for  the computation  of the sum reasonably spent for the purpose  of realising interest and of interest paid on sums borrowed for the  purpose  of  investment  by  a  Banking  Company.   The Explanation provides:               "Explanation-In   the   case  of   a   banking               company,-               (a)   the amount which bears to the  aggregate               of  its expenses as are admissible under  sub-               section (2) of section 10, other than  clauses               (iii),    (vi),   (vi-a),   (vi-b),     (vii),               (viii),   (xi),    (xii),    (xiii) and (xiv)     th ereof,               the same proportion as the gross receipts from               interest   on  securities  inclusive  of   tax               deducted  at source) chargeable to  tax  under               this section bears to the gross receipts  from               all  sources which are included in the  profit               and  loss  account of the  company,  shall  be               deemed to be the sum reasonably expended by it               for  the purpose of realising such  interest,,               and   the  amount  for  which   allowance   is               admissible under sub-section (2) of section 10               shall be reduced correspondingly; and               (b)   money  borrowed  shall  include   moneys               received  by way of deposits; and that  amount               which bears to the amount of interest  payable               on moneys borrowed the same proportion as  the               gross  receipts  from interest  on  securities               (inclusive   of   tax  deducted   at   source)               chargeable to tax under this section bears  to               the gross receipts from all sources which  are               included in the profit and loss account of the               company,  shall  be  deemed  to  be   interest               payable  on money borrowed for the purpose  of               investment in the securities by the  assessee,               and  the  amount of such  interest  for  which               allowance  is  due under  sub-section  (2)  of               section 10 shall be reduced  correspondingly."               and                                     35               (b)   money  borrowed  shall  include   moneys               received  by way of deposits; and that  amount               which bears to the amount of interest  payable               on moneys borrowed the same proportion as  the               gross  receipts  from interest  on  securities               (inclusive   of   tax  deducted   at   source)               chargeable to tax under this section bears  to               the gross receipts from all sources which  are               included in the profit and loss account of the               company,  shall  be  deemed  to  be   interest               payable  on money borrowed for the purpose  of               investment in the securities by the  assessee,               and  the  amount of such  interest  for  which               allowance  is  due under  sub-section  (2)  of               section 10 shall be reduced correspondingly." Broadly  stated, under-cl. (a) the sum reasonably  spent  is computed as that proportion of the aggregate of the expenses admissible under the various clauses of sub-s. (2) of s.  10 mentioned therein which the gross receipts from interest  on securities  bear  to  the gross receipts  from  all  sources

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included  in  the  profit and loss account  of  the  banking company.  Similarly under cl. (6) interest payable on  money borrowed  for  the  purpose  of  investment  in   Government securities is that proportion of the total interest paid  on borrowings  which  gross receipts from  securities  bear  to gross receipts from all sources. Income  of  the  Society from  its  trading  activity  being exempt from tax, its income from Government securities  had, it  was  common  ground, to be  apportioned  between  income earned  from investments for trading purposes and  for  non- trading purposes.  The Income-tax Officer applied the  first proviso read with the Explanation to s. 8 of the  Income-tax Act.  The Income-tax Appellate Tribunal held that in  terms, the  Explanation to s. 8 did not apply because  the  Society was  not  a  banking  company,  but  the  principle  of  the Explanation  furnished, after the Departmental  Instructions had  been withdrawn, a reasonable basis  for  apportionment. In  the view of the Tribunal, the principle embodied in  the Explanation was an "improvement on the instructions",  since it co-related the income chargeable under the head with  the expenditure  and also provided for proportionate  allocation of  overhead charges.  The High Court held that the  benefit of  the departmental notification was not available  to  the Society in the year of assessment, because it must be deemed to be withdrawn and the Explanation to s. 8 did not in terms apply to the Society. It  was common ground between the parties in this Court  and the  High Court that Explanation to s. 8 has no  application to  a  co-operative  society which does  not  carry  on  the business of a  banking  company.  There is also  no  dispute that  the  departmental  notification  relied  upon  by  the company  was withdrawn before the relevant assessment  year. There  is, therefore, no statutory rule, and nor  there  are departmental  instructions, governing the  apportionment  of income from Government securities between business 36 and non-business sources of income.  It was never urged, and it  cannot be urged, that in the absence of a specific  rule for   apportionment,  the  entire  income  from   Government securities  should be brought to tax.  Any attempt to  bring the entire income from Government securities would  infringe S.  14(3)  of the Act.  A rule of  apportionment  consistent with  commercial accounting must be evolved for  determining the  income  from  Government  securities  attributable   to business activity of the Society.  The rule contained in cl. (a)  of the Explanation to S. 8 has specially  been  evolved for determining the appropriate outgoings for the purpose of realizing interest from securities held by a Banking Company in computing income’ chargeable to tax; it seeks to  exempt, on  the footing that it is deemed to be the  sum  reasonably expended  for  the  purpose of realizing  interest,  a  part thereof  which  is equal to the proportion which  the  gross receipts from interest on securities chargeable to tax, bear to  the  gross receipts from all sources.  The  rule  is  an artificial rule for allocating business expenditure  between different sources of income of Banking Companies.  It is not a  rule  for apportionment for the purpose  of  taxation  of composite  income  which is partly taxable and  partly  not. Clause  (b) provides for allocation of outgoings in  respect of   "money  borrowed",  which  expression  includes   money deposited with the Bank.  Interest payable on borrowings  is directed  to be allocated in the proportion in which  income is received from investments from securities and from  other sources.   This  clause also deals with  the  proportion  in which  the  outgoings are allocable.   The  problem  arising

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under  s. ’14(3) is of apportionment of income  under  heads taxable  and  nontaxable: it is not a  problem  relating  to allocation of outgoings to determine taxable income. In  our judgment, a rule of apportionment  which  dismembers income  in  proportion  to  the  business  and  non-business components  of the single source from which it arises  would be more consistent with principles of commercial accounting. The  proportion  of income from securities which  is  exempt from  taxation  under  S. 14 (3) of the  Act  will  be  that proportion  which  the capital of the Society used  for  the purpose of the business bears to the total working capital. It  is admitted that Rs. 13,578/- is the gross  income  from securities which is, according to that rule, liable to  tax. No question was raised in the High Court about any deduction to  be  made in respect of expenses for collection  of  that amount,  and admissibility of deduction on that  score  does not fall to be considered. The  appeal is allowed.  Answer to the question as  reframed by  the  High  Court is that Rs. 13,578 /-  are  taxable  as income  of the Society received from  Government  securities under s. 8 of the Income-tax Act.  The Commissioner will pay the costs of the Society in this Court. V.P.S.                                                Appeal allowed. 37