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PETITIONER: COMMISSIONER OF INCOME-TAX, LUCKNOW

       Vs.

RESPONDENT: BAZPUR CO-OPERATIVE SUGAR FACTORY LTD.

DATE OF JUDGMENT01/05/1989

BENCH: PATHAK, R.S. (CJ) BENCH: PATHAK, R.S. (CJ) SHARMA, L.M. (J)

CITATION:  1989 AIR 1866            1989 SCR  (2) 840  1989 SCC  Supl.  (2) 240 JT 1989 (2)   562

ACT:     Income  Tax Act, 1961:  Section  36(1)(iii)--Cooperative Society-Amounts  deposited by members in  Loss  Equalisation and Capital Redemption Fund--Whether deduction admissible.

HEADNOTE:     The  respondent-assessee is a co-operative society  run- ning  a sugar mill. With a view to inducing its  members  to make  further contribution to its capital it incorporated  a bye-law  which  provided for the establishment  of  a  ’Loss Equalisation  &  Capital  Redemption  Reserve  Fund’.  Every producer-shareholder  was required to deposit every year  an amount to this fund which was to be utilised for the purpose of  making  the  partly paid shares fully  paid,  and  after defraying the loan taken from the Industrial Finance  Corpo- ration  the balance was to be refunded to the  members.  The money available in the Fund was utilised by the society  for the purpose of its business. A part of the amount was  even- tually  utilised for converting the partly paid shares  into fully paid shares. It was then decided by the society to pay interest on the balance available in the Fund. The  interest thus paid to its members was sought to be claimed as  deduc- tion in computing the income of the assessee.     The  Income Tax Officer rejected the claim holding  that the amount did not represent loans taken by the assessee .or capital borrowed for the purpose of its business. The Appel- late Assistant Commissioner confirmed the disallowance.  The Income Tax Appellate Tribunal accepted the second appeal  of the assessee and held that it was not necessary that borrow- ing must contain an element of payment of interest and  that even  if  a deposit was made by the members of  the  society which  waS utilised for the purpose of the business  of  the assessee,  the  funds represented by such deposit  would  be ’capital  borrowed’ for the purpose of s. 36(1)(iii) of  the Income  Tax Act, 1961. The High Court agreed with  the  view taken  by the Appellate Tribunal and answered the  questions referred  to  it in favour of the assessee and  against  the Revenue.     While  allowing the appeals and answering the  questions in the negative in favour of the Revenue, this Court. 841     HELD: (1) Section 36(1)(iii) of the Income Tax Act, 1961

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provides  that in computing the income chargeable under  the head ’profits and gains of business or profession’ a  deduc- tion  shall  be allowed of the amount of  interest  paid  in respect of capital borrowed for the purposes of the business or profession. [845G,H]     (2)  The  words ’borrowed money’ should not be  given  a strained  meaning  and it should be  considered  whether  in ordinary  commercial  usage the relationship was that  of  a borrower and lender and the transactions’were loan  transac- tions.  To  constitute borrowed money there must be  a  real borrowing and a real lending. [846B,D]     (3) It is apparent that the deposits made by the members cannot  be regarded as loans advanced by the members to  the assessee. There was never any intention between the assessee and its members to treat the deposits made by the members as loans and that the relationship between the assessee and the members should be that of borrower and lender., [847F,G]     Port  of  London  Authority v.  Commissioner  of  Inland Revenue, [1922] 2 KB 599 (CA); Commissioner of Inland  Reve- nue  v.  Port  of London Authority, [1923]  AC  507;  Inland Revenue Commissioner v. Rowntree & Co. Ltd., [1948] 1 ALL ER 482  (CA);  Commissioner of Income-tax,  Gujarat  v.  Rajkot Seeds, Oil & Bullion Merchants Association Ltd., [1975]  101 ITR 748; Commissioner of Excess Profits Tax, Central Calcut- ta  v. Bhartia Electric Steel Co. Ltd., [1954] 25  ITR  192; Bombay Steam Navigation Co. [1953]; Private Ltd. v.  Commis- sioner  of  Income-tax Bombay, [1965] 56 ITR 52  and  Madhav Prasad  Jatia v. Commissioner of Income-tax  Uttar  Pradesh, [1979] 118 ITR 200, referred to.     (4)  A loan necessarily supposes a return of  the  money loaned.  The circumstance that there was no  certainty  that any balance would remain for refund to the members would  in itself  indicate that the deposits could not be regarded  as loans. [847G,H]

JUDGMENT:     CIVIL APPELLATE JURISDICTION: Civil Appeals Nos. 1358-61 of 1979.     From the Judgment and Order dated 6.9.78 of the  Allaha- bad High Court in I.T.R. No. 114/78. B .B. Ahuja, K.C. Dua and Miss. A. Subhashini for the appel- lants. 842     S.C.  Manchanda, Mrs. A.K. Verma and Joel Pares for  the respondent. The Judgment of the Court was delivered by     PATHAK, CJ. These appeals by special leave are  directed against the judgment of the High Court at Allahabad  dispos- ing of an Income-tax Reference in favour of the assessee and against the Revenue.     The  assessee is a co-operative society running a  sugar mill. For the assessment year 1968-69 it claimed payment  of interest amounting to Rs. 1,81,7 16. This was interest  paid to  the accounts of its members, who had  deposited  certain amounts with the assessee in accordance with Bye-law No.  50 and  it was debited by the assessee to its profit  and  loss account. In the initial years of the working of the Society, certain  partly  paid  shares were allotted  to  its  farmer members.  With  a  view to inducing these  members  to  make further contribution to the capital of the Society,  bye-law No. 50 was incorporated in the Bye-laws of the Society.  The bye-law as amended provides: "50.  There  shall  be established a  ’Loss  Equalisation  &

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Capital  Redemption  Reserve  Fund’ in  the  society.  Every producer-shareholder shall deposit every year a sum not less than 0.32 paise and not more than 0.48 paise per quintal  of the  sugarcane  supplied by him to the society,  as  may  be determined by the Board until the shares to be subscribed by the  members are fully paid-up. The amount standing  to  the credit  of this fund presently or to be credited in  future, shall  be used for making the partly paid shares fully  paid up. The balance of the said amount shall be refunded to  the members  soon  after the present loan  from  the  Industrial Corporation  of India is repaid, whereafter the  fund  shall cease to exist."     The money available in the ’Loss Equalisation and  Capi- tal  Redemption Reserve Fund’ was utilised by  the  assessee for  the purpose of its business. A part of the  amount  was also utilised for converting the partly paid up shares  into fully  paid  up shares. On 8 September, 1967  the  Board  of Directors  of  the Society decided in their meeting  to  pay interest  at  6% on the balance available in  the  aforesaid Fund  to its various members to whom the balance  money  be- longed.  It was on this account that the Society claimed  an amount of Rs. 1,18,716 for the assessment year 1968-69. 843     The  claim  was rejected by the Income Tax  Officer.  He took  the view that the amounts deposited by the members  of the Society in the ’Loss Equalisation and Capital Redemption Reserve Fund’ did not represent loans taken by the  assessee but  constituted  a contribution by the members  to  convert partly  paid  up shares into fully paid up shares  and  they could not be considered as capital borrowed for the  purpose of  its business. He held that s. 36(1)(iii) of the  Income- tax  Act did not apply to such interest and that it was  not admissible  as a deduction in computing the total income  of the  assessee. For the assessment years 1969-70  to  1972-73 the claim to deduction on this account was as follows:       1969-70             ...       Rs. 1,34,609       1970-71             ...       Rs. 1,34,609       1971-72             ...       Rs. 1,34,609       1972-73             ...       Rs. 1,34,609 The Income Tax Officer took the same view for these  assess- ment years as he did for the assessment year 1968-69.     In  appeals  preferred  by the  assessee  the  Appellate Assistant Commissioner of Income-tax confirmed the disallow- ance  for  the assessment year 1968-69 on  the  ground  that Bye-law No. 50 did not provide for the refund of the  amount standing to the credit of the members at any time before the payment of the loan to the Industrial Finance Corporation of India, that the loan was still outstanding on 30 June  1967, the last day of the previous year relevant to the assessment year  1968-69, and moreover the Bye-law did not provide  for payment  of interest at all. He observed that the  Directors could not pay any interest unless the Bye-law was amended by the  members of the assessee. He observed that the  interest paid must be regarded as an exgratia payment to the producer members of the society who had contributed to the Fund,  and that it was not made for the purpose of the business of  the assessee or on the ground of commercial expediency. The same order was passed by the Appellate ASsistant Commissioner  on the appeals for the remaining years.     In  second  appeals filed by the assessee  for  all  the assessment years the Income Tax Appellate Tribunal held that the amount standing to the credit of the ’Loss  Equalisation and  Capital Redemption Reserve Fund’ which was utilised  by the  assessee  for the purpose of its  business  represented moneys  borrowed  for the purpose of its business  and  that

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interest  paid  on such moneys was  eligible  for  deduction under 844 s.  36(1)(iii)  of the Income-tax Act, 1961.  The  Appellate Tribunal  negatived the contention of the Revenue that  only such deposits could constitute ’capital borrowed’ within the meaning  of  s. 36(1)(iii) of the Act which  were  initially borrowed  with the stipulation to pay interest thereon.  The Appellate  Tribunal  observed that the  expression  ’capital borrowed’  had  not been defined in the Income-tax  Act  and that  its  ordinary  meaning would have to  be  gathered  in construing the meaning of s. 36(1)(iii). It said that it was not  necessary  that borrowing must contain  an  element  of payment  of interest and that even if a deposit was made  by the  members of the society which was utilised for the  pur- poses of the business of the assessee, the funds represented by such deposit would be ’capital borrowed’ for the purposes of  s.  36(1)(iii) of the Act. The Appellate  Tribunal  also recorded  that  it was not disputed that the  deposits  were taken  for  the  purposes of the business.  In  the  circum- stances, the Appellate Tribunal held that when the Board  of Directors of the assessee considered it proper to pay inter- est on those deposits, such interest was admissible under s. 36(1)(iii) of the Act.     During  the  heating of the appeals for  the  assessment years 197071 and 197 1-72, it was pointed out by the Revenue that  the  auditors of the assessee had  observed  in  their audit  report  that  the payment of interest  on  the  ’Loss Equalisation and Capital Redemption Reserve Fund’ should not have been made by the assessee in view of s. 57 of the Uttar Pradesh Co-operative Societies’ Act, which reads: "Fund  not to be divided: Except as  otherwise  specifically provided  in this Act, no part of the Funds other  than  the net  profits of a co-operative society shall be paid by  way of  bonus  or dividend or otherwise  distributed  among  its members:          Provided that a member may be paid remuneration  on such  scale  as  may be laid down in the bye  laws  for  any services rendered by him to the co-operative society."     The Appellate Tribunal held that s. 57 was not  relevant as  the  payment  of interest to the  shareholders,  on  the amounts deposited by them, did not represent any payment  by the Society by way of bonus or dividend or otherwise, of any part of its funds other than its net profits. The  Appellate Tribunal also observed that the interest paid by the  asses- see to the ’Loss Equalisation and Capital Redemption Reserve Fund’  was met from out of the net profits of the  assessee. It was found that the assessee had sufficient income out  of which the interest 845 could  be  paid by it. For these reasons, it held  that  the payment  of interest was not affected by s. 57 of the  Uttar Pradesh Co-operative Societies Act.     At  the instance of the Revenue the following two  ques- tions in respect of the five assessment years were  referred by the Appellate Tribunal to the High Court at Allahabad for its opinion. "1. Whether the credit balances in the Loss Equalisation and Capital Redemption Reserve Fund which were actually used  by the  assessee for the purposes of its  business  represented capital  borrowed  by the assessee for the  purpose  of  its business within the meaning of s. 36(1)(iii) of the Act? 2. Whether the Tribunal was right in law in allowing  inter- est  on  such balances standing to the credit  of  the  Loss Equalisation and Capital Redemption Reserve Fund as a deduc-

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tion in computing the total income of the assessee?"     A further question common to the assessment years  1969- 70 to 1972-73 was also flamed. It reads: "Whether  the Tribunal was right in law in holding that  the impugned payments of interest did not contravene the  provi- sions  of s. 57 of the Uttar Pradesh Co-operative  Societies Act, 1965?"     The High Court agreed with the view taken by the  Appel- late  Tribunal and answered the questions in favour  of  the assessee and against the Revenue.     Before  us, the parties have confined themselves to  the first  two  questions and it is requested that we  need  not consider the third question.     In  these appeals the question is whether the  claim  to deduction  under s. 36(1)(iii) of the Income-tax Act can  be allowed.  Section  36(1)(iii) of the Act  provides  that  in computing the income chargeable under the head ’profits  and gains  of business or profession’ a deduction shall  be  al- lowed  of the amount of interest paid in respect of  capital borrowed for the purposes of the business or profession. Can it be said that the credit balance in the ’Loss Equalisation and Capital Redemp- 846 tion Reserve Fund’ represents capital borrowed by the asses- see  for  the purposes of its business?  What  is  ’borrowed money’  has  been construed by the Courts in  England  in  a number of cases. In Port of London Authority v. Commissioner of Inland Revenue, [1922] 2 KB 599 (CA). Lord Stemdale, M.R. observed  that in order that there be borrowed  money  there must be a borrower and a lender, and later, when the Revenue took the case in appeal to the House of Lords, the House  of Lords  laid down in Commissioners of Inland Revenue v.  Port of  London Authority, [1923] AC 507 that to constitute  bor- rowed  money  there  must be "a real borrowing  and  a  real lending". Again in Inland Revenue Commissioners v.  Rowntree &  Co. Ltd., [1948] 1 All ER 482 (CA), the Court  of  Appeal considered  the  meaning of the words ’borrowed  money’  and observed  that  the  words should not be  given  a  strained meaning and that it should be considered whether in ordinary commercial usage the relationship was that of a borrower and a lender and the transactions were loan transactions.  These cases were relied upon by the Gujarat High Court in  Commis- sioner of Incometax, Gujarat Iv. Rajkot Seeds, Oil & Bullion Merchants Association Ltd., [1975] 101 ITR 748 in support of the conclusion that on the facts of the case before the High Court  there  was  no relationship of  borrower  and  lender between  the  Rajkot  Seeds and Oil  and  Bullion  Merchants Association  and  its members in so far as deposits  by  the members  were concerned. It was held that the  amounts  were deposited  by way of security taken for the due  performance of the, obligation of a member under the Rules of the  Asso- ciation for the discharge of his obligations to the Associa- tion and to the other members of the Association. There  was no loan or borrowing at all. This question had in fact  been considered by the Calcutta High Court as long ago as Commis- sioner  of Excess Profits Tax, Central, Calcutta v.  Bhartia Electric Steel Co. Ltd., [1954] 25 ITR 192 in the context of the  third  proviso to Rule 5A of Schedule I to  the  Excess Profits  Tax Act, 1940. The money in question in  that  case had  been obtained by the issue of shares, and it  was  held that it could not possibly be said that the persons who  had taken  up the deferred shares had ever intended to  grant  a loan  or  that the Company which had obtained money  on  the shares  had  ever intended to borrow. This Court  in  Bombay Steam Navigation Co. (1953) Private Ltd. v. Commissioner  of

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Income-tax  Bombay,  [1965] 56 ITR 52, was  dealing  with  a claim  to  deduction  under  s.  10(2)(iii)  of  the  Indian Income-tax  Act  1922  in a case where  under  an  agreement certain  assets were to be taken over by the  assessee  from the  Scindia Steam Navigation Company Ltd., and part of  the consideration  was  paid by the assessee while  the  balance remained  unpaid.  For agreeing to deferred payment  of  the balance of the consideration, the Scindias 847 were to be paid interest. This Court observed: "An agreement to pay the balance of consideration due by the purchaser  does not in truth give rise to a loan. A loan  of money undoubtedly results in a debt, but every debt does not involve  a  loan.  Liability to pay a debt  may  arise  from diverse  sources,  and a loan is only one of  such  sources. Every  creditor who is entitled to receive a debt cannot  be regarded as a lender. If the requisite amount of  considera- tion had been borrowed from a stranger, interest paid there- on  for the purpose of carrying on the business  would  have been regarded as a permissible allowance, but that is wholly irrelevant in considering the applicability of clause  (iii) of sub-section (2) to the problem arising in this case.  The legislature has under clause (iii) permitted as an allowance interest  paid on capital borrowed for the purposes  of  the business: if interest be paid, but not on capital  borrowed, clause (iii) will have no application ."     The  point  was also discussed by this Court  in  Madhav Prasad Jatia v. Commissioner of Income-tax, U.P., [1979] 118 ITR 200 where the question was whether the interest  claimed under  s.  10(2)(iii)  of the Indian  Income-tax  Act,  1922 related to borrowing for the purpose of the business.     In  the  present  case, Bye-law No.  50  indicates  that deposits  were  to be made by the producer  members  in  the ’Loss Equalisation and Capital Redemption Reserve Fund’  for the purpose of making the partly paid shares fully paid  up, and  it was understood that the balance of the amount  would be  applied  to the loan taken from the  Industrial  Finance Corporation of India and thereafter whatever remained  would be  refunded  to  the depositing members  resulting  in  the extinction  of  the Fund. It is apparent that  the  deposits made by the members cannot be regarded as loans advanced  by the members to the assessee. The moneys deposited represent- ed  contribution  by the members for converting  the  partly paid up shares into fully paid up shares and thereafter  for delaying the loan taken from the Industrial Finance Corpora- tion  of India. Any balance remaining was to be refunded  to the  members. The circumstances that there was no  certainty that  any  balance would remain for refund  to  the  members would  in  itself indicate that the deposits  could  not  be regarded  as loans. A loan necessarily supposes a return  of the  money loaned. Even under the original Bye-law  No.  50, which provided for deposits by the members to the 848 ’Loss Equalisation and Capital Redemption Reserve Fund’,  it was contemplated that the deposits would be accumulated  and be utilised for repayment of the initial loan taken from the Industrial  Finance Corporation of India and thereafter  for redeeming  the  ’Government share’, and the balance  of  the deposit  after meeting losses would be converted into  share capital  and each producer member would be issued shares  of the  assessee.  There was never any  intention  between  the assessee  and its members to treat the deposits made by  the members  as  loans  and that the  relationship  between  the assessee  and  the members should be that  of  borrower  and lender.  The High Court erred in holding that the  claim  to

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deduction on account of interest paid by the assessee to its members was admissible under s. 36(1)(iii) of the Act.     It is urged by learned counsel for the assessee that  if the claim to deduction cannot be rested on s. 36(1)(iii)  of the Act, it should be regarded as admissible under s. 37  of the  Act. We are not satisfied that all the facts  necessary for considering a claim for deduction under s. 37 are before us.  It will be noticed in Madhay Prasad Jatia (supra)  that the question of law expressly took in the claim to deduction not  only with reference to s. 10(1)(iii) but  alternatively with reference to s. 10(2)(xv) of the Indian Income-tax Act, 1922.  Whether  or not it is still open to the  assessee  to raise  that question before the Appellate Tribunal when  the case goes back to it for disposing it of in conformity  with the  opinion expressed by this Court in these appeals  is  a question  on  which we propose to express no  view  at  this stage.     In  the  result the appeals are  allowed,  the  impugned judgment  of the High Court in all these cases is set  aside and the first and the second questions framed by the  Appel- late Tribunal are answered in the negative, in favour of the Revenue  and against the assessee. There is no order  as  to costs. R.S.S.                                      Appeals allowed. 849