I. T. A. NO. 6022/6-B OF 1979-80, DECIDED ON 6TH MARCH, 1984. Versus I. T. A. NO. 6022/6-B OF 1979-80, DECIDED ON 6TH MARCH, 1984.
ORDER
This is an appeal filed by an individual who derived income in this assess ment year only from salary as a Director of R. C. Ltd., L. He claimed an. interest of Rs. 7,432 on borrowed capital as an expense against salary income. This claim was made on the ground that the assessee had obtained loan from Bank to invest for the purchase of shares of M/s. R. C. Ltd. The I.‑T. O rejected the claim for the reason that such an allowance is admissible only when the‑re is as income under section 12 of the Repealed Income‑tax Act (hereinafter to be referred as Act). Since no income was declared by the assessee under section 12, that section was not applicable.
2. On appeal, the learned A. A. C. maintained the order of the I. T. O. hence this appeal.
3. The learned counsel for the assessee contended that in order to claim an allowance u/s 12(2) of the Act it does not require any kind of income assessable u/s 12(1) of the Act. According to him, what is necessary is that interest on borrowed capital, must be for the purpose of acquisition of part of the share capital of a company. Since, it was contended admittedly the loan obtained by the assessee was for the purpose of acquisition of share capital of a company he was entitled to claim the interest admittedly paid by him to the Bank, as an admissible deduction. In support of his contention the learned counsel has relied upon two cases of Bombay High Court and Allah abad High Court namely, Ormerods (India) Private Ltd. v. C.I.T (1959) 36I T R 3Z9) and Chhail: Behari Lal v. C. I T. (1960) 39 I T R 696). In the first case the Bombay High Court took the view which supports the assessee's case. In that case, it Has held that the admissibility of interest paid on capital borrowed for the purchase of shares was not dependent on the earning of income from that source and therefore, even where no income is declared u/s 12 such a claim was admissible against other heads of income. It was further held in that case that since the invest ments were made for the purpose of earning income, profits or gains, interest paid on money borrowed for the purchase of shares should be set off against the assessee's other income u/s 24 (1) of the Act. In the case of Chhail Behari Lal, the Allahabad High Court simply followed the Bombay High Court's view and did not give its own reasons. Consequently, the Allahabad High Court, before whom a contrary view of Patna High Court expressed in Maharajadhiraj Sir Kameshwar Singh v. C. I. T. (1957) 32 I T R 377), was presented preferred the Bombay High Court's view and observed as follows :‑
"Since the reasons which led us to take the view have already been mentioned in detail in the judgment of the Bombay High Court, we do not consider it‑necessary to express them Again in this judgment and we think it is enough for us to say that, with respect, we agree with the reasons as well as the decision of the Bombay High Court in the case cited above."
The same view was sub‑consequently followed by. Madras High Court in K Appa Rao v. C. I. T., Madras (1962) 46I T R 511). In that case too it was held that interest paid on borrowed capital for the purchase of shares was deductable u/s 12 of the Act, even though no dividend income was declared by the assessee. In this case too the reliance was placed on the earlier decisions of the Bombay High Court and Allahabad High Court referred to above. In this case it was observed by the High Court.
"In the present case, as it is not denied that the assessee is in receipt of income which also falls under the head income from other sources'. It should follow that the interest payment being an allowable item of expenditure u/s 12 (2) can be set off or adjusted against the other income under the same head before the assessable income u/s 12 is reached."
No doubt this judgment followed the earlier views expressed by the Bombay High Court and Allahabad High Court but this case is distinguishable and has no application in the facts and circumstances of the case under discussion because in that case there was some income which was assessible u/s 12 other than the devidend income. The last case which is in favour of the assessee is again of Madras High Court namely P. V. Muhammad Ghouse v. C, I.T. Madras (1963) 49I T R 127). In that case after taking into consideration the earlier decisions of the High Courts it was held that interest paid on borrowed capital for the purchase of shares, though not allowable u/s 10 (2) (iii) of the Act, yet it was allowable against the income u/s 12 as a loss, even though the assessee, had no assessable income falling u/s 12.
4. The contrary views have been expressed by the Patna High Court and the Calcutta High Court which however did not find favour in the cases quoted above. Before dealing with these cases I may point out here that in all the cases quoted above, the High Courts have based their views on the ob. servations of the Supreme Court in Eastern Investments Ltd. v. C. I. T. (1951) 20I T R 1). That in act is the judgment on which all the subsequent judgments are based. In that case, while explaining the true construction of section 12(2) of the Act, the Supreme Court enunciated four principles of law as relevant. One such principle which was relied upon to the subsequent cases referred to above was :‑
"It is not necessary to show that any expenditure was profitable or that, in fact, any profit was earned. "This principle was based on two English decisions in Moore v. Stewarts (1906) 6 Tax Case 501) anal Eloyds Ltd., (1915) A C 433. However, this judgment is not relevant to the proposition under consideration. Firstly, the two English cases relied upon by the Supreme Court had laid down these principles while interpreting the language which is different from the one which is used in section 12 (2) of the repealed Income‑tax Act. In those cases the provision in English Act Schedule‑D, Rule‑I was under consideration which reads as under :‑
"No sum shall be set against or deducted from or allowed to be set against or deducted from such profits or gains for any disbursements or expenses whatever not being money wholly and exclusively laid out or expended for the purpose of such trade.
This language has no similarity with the language used in section 12 (2) of the Act. Here it would be expedient to reproduce section 12 (1) and (2) of the Income‑tax Act, 1922.
"(1) The tax shall be payable by an assessee under the head income from other sources in respect of income or profits and gains of every kind which may be included in his total income (if not included under any of the preceeding heads).
(2) Such income, profits and gains shall be computed after making allowance for the amount of interest paid in respect of money borrowed for the purpose of acquisition of part of the share capital of a company and for any expenditure (not being in the nature of capital expenditure) incurred solely for the purpose of making or earning such income, profits or gain provided that no allowance shall be made account of."
It would be seen that section 12 (2) of the Income‑tax Act is not parti materia with the provision in English law. Therefore, the principle laid down by the Supreme Court, with utmost respect, was not applicable on construction of section 12 (2) as the language was entirely different from the English Law on which the principle had been enunciated. Secondly, the observation of the Supreme Court was obiter dicta as the question involved in that case was entirely different and for which the laying down of this principle was not necessary. Thirdly in that case there was some kind of income declared by the assessee u/s 12 and it was in that context that the observation was made. Therefore, the facts of that case were not similar as in the other cases in which the Supreme Courts judgment was followed in these cases no income whatso ever was either declared or shown to have been earned u/s 12. The Madras High Court as well as Allahabad High Court, who followed the judgment of the Supreme Court, completely ignored the point that the question of applica tion of subsection (2) only arises where subsection (1) applies. In order to attract subsection (1) of section 11 there must be some kind of income under that section. In order to bring into operation subsection (1) three condition are necessary :‑
(1) There must be some sort of income or profits and gains
(2) It should be includable in the assessee's total income.
(3) Such income should be taxable.
5. Where there is no income of any kind whatever, there is no question of its being includable in the total income of the tax‑payer. And where sub section (9) is not applicable the application of subsection (2) will be absolutely' illogical as subsection (2) is corollary and subservient to Subsection (1) and it starts with the words "such income, profits and gains shall be computed .. Subsection (2) referes to computation of income under subsection (1) and that too which is taxable. Thus, it is only while making the computation of income of an assessee under subsection (1) that an allowance for the amount of interest on borrowed capital can be considered. Here, I would like to point out that the words "the amount of interest paid in respect of money borrowed for the purpose of acquisition of part of a share capital of money and for "were added in 1968 This fact alone makes to the Indian case in applicable which interpreted the subsection (2) as is stood earlier. The language of section 12 (2) as it stands now was not there. The case of Eastern Inverments Ltd. (supra) came under discussion of Patna High Court in Maharajadhiraj Sir Kameshwar Singh (supra) who distinguished the facts and illustrated the Supreme Court observation in the following words :‑
"In the Supreme Court's case, the interest was paid by the company on the money borrowed by it and utilized for investment which earned income and as such it was held that although the loan was taken on overdraft, which was utilized for investment on which the company earned income, the interest paid by company on such loan was a permissible deduction u/s 12 (2) of the Act."
This case however was dissented to by the Bombay High Court in Ormerods (India) Private Ltd.'s case. Later the Calcutta High Court in Madanlal Sohanlal v. C, I.T. Calcutta (1963) 47 I T R 1) discussed the conflict of judgment in detail and referring to the principle laid down by the Supreme Court Eastern Investment's case observed that no doubt the expenditure incurred by an assessee u/s 12 (2) need not be profitable or even shown as such in fact to be profitable. How ever, this principle cannot be extended where the question is not of actual profit but where there is no return of income at all whatever. The. Calcutta High Curt observed in that case :‑
"That in our view, would be to tax not an income or to allow a deduc tion not against an income but to tax a. prospect of an income and to allow a deduction against such a mere prospect. This is not permis sible, in our view, in the context and interpretation of section 12 of the Income‑tax Act.
To my mind the view taken by the Calcutta High Court lays down the correct law and true constructions of section 12. Somewhat similar view, though in different situation was taken by Privy Council in C. I. T. v. Basant Rai Takht Singh (1953) 1I T R 197) where the Judicial Committee observed :‑
"In their Lordships view on the true construction of t at subsection, allow ance for any expenditure incurred must be an allowance for expenditure incurred in the year in respect of which arise the income profits and gains forming the basis of the assessment. Upon that footing, therefore, there can be no justification for deducting from the profits and gains something in respect of expenditure whether it be regarded as capital expenditure or not which occurred many years before."
In the wake of these conflicting decisions it is to be noted that all the decisions which are favourable to the assessee are based on the Supreme Court's one observation in Eastern Investment Limited and it has been shown above that the observations of the Supreme Court had hot been understood in correct purspective. Secondly in all the cases the learned Judge of the High Court have assumed that the provisions of section 12 were applicable. In none of the cases any attempt was made to examine whether subsection (I) of section 12 was attracted in the facts and circumstances of that case. The question of applicability of subsection (2) only arises if there is an income from other source under subsection (1) of section 12. No doubt if there is any income of as assessee other than the specified sources under sections 7, 8, 9 and 10 the pro vision of section 12 (1) would immediately be attracted, and in that case subsection (2) will apply automatically. Thus, it could be safely said that the cases relied upon by the counsel for the assessee are in fact irrelevant and had no application on the facts and circumstances of the case. The view taken in Madanlal Sohanlal's case by the Calcutta High Court is the correct view and true construction of section 12 (2).
6. The learned counsel has laid considerable stress that concept of income includes loss. There is no dispute to this proposition. However, there must be something for computation of profit or loss. Even the loss cannot be l computed without there being any receipt and expenditure. There could be cases where the assessee declares some receipt u/s 12 (1) and claims an expendi ture under subsection (2) of section 12 which may exceed the receipts. Such an expenditure cannot be disallowed on the ground that the assessee has not earned any profit or that the expenditure was not for purpose of earning profits. The law only lays down that the object of investment should be to earn profit which object may or may not be achieved. However, where their is no receipts whatsoever, there is no question of any computation and there, fore neither any profit nor any loss can be worked out. Such is the situation in the present case, where there is no receipt against which the expenditure is being claimed. As was held by the Calcutta High Court in Madanlal Sohanlal's case the assessee wants the department to allow the expenditure against the prospect of income under subsection (1), which is not permissible.
7. Lastly the learned counsel has relied upon a Circular of C. B. R. bearing No. 10 of 1967 dated 1st August, 1967. Para. 1 of the Circular is reproduced below :‑
"It has been brought to the notice of the Central Board of Revenue that the claim of interest paid by the assessee to the banks on pledging to shares are being rejected by the Income‑tax Officers on the ground that no dividend has been received from the companies whose shares are in pledge. This point has been examined and the Central Board of Revenue is of the view that the question of admissibility of interest in such circumstances can be examined under sub‑clause (iii) of subsec tion (2) of section 10 of the Income‑tax Act and under subsection (2) of section 12 of the Income‑tax Act. If the capital is borrowed for purpose of business, profession or vocation the amount of interest paid there is an admissible expense under section 10 (2) (iii)."
8. The Circular issued by the C. B.R. has no application in the circum stances of the present case. As has been laid down above, in a case where no income has been declared by the assessee from other sources, the law does nor permit any expenditure to be allowed under subsection (2) of section 12 and the Circular issued by the C.B.R. being against law has no legal effect and therefore cannot be followed. Since the assessee is not being taxed under section 10, there is no question of allowing interest under section 10 (2) (iii).
9. For the foregoing reasons the appeal filed by the assessee fails and is hereby rejected.
M.B. A. Appeal rejected.