Commissioner Of Income-Tax, Madras vs Indian Bank Ltd

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 1095 of 1963

Decision Date: 26 October 1964

Coram: S.M. Sikri, J.C. Shah

In the matter titled Commissioner of Income‑Tax, Madras versus Indian Bank Ltd., the Supreme Court delivered its judgment on 26 October 1964. The opinion was authored by Justice S. M. Sikri, who was joined by Justices Subbarao, K. Shah and J. C. Shah. The case is reported in the 1965 volumes of the All India Reporter (AIR 1473) and the Supreme Court Reports (SCR (1) 833), and it is also cited in the Revenue Forum reference RF 1971 SC2434 (8). The dispute concerned the application of Section 10(2)(iii) of the Indian Income‑Tax Act, 1922 (Eleventh Amendment), which deals with the deductibility of interest expense incurred on money borrowed for the purpose of acquiring securities that generate tax‑free income. The petitioner, the Commissioner of Income‑Tax for Madras, challenged the respondent, Indian Bank Ltd., a banking institution based in Madras, on the basis that the bank had claimed a full deduction for the interest paid to its depositors on funds that had been invested in Mysore Government securities, which were exempt from both income tax and super‑tax.

The factual matrix revealed that Indian Bank Ltd., in the ordinary course of its banking business, received deposits from its customers and, among other investments, placed those funds in the aforementioned Mysore Government securities. The bank sought to deduct the entire amount of interest it paid to its depositors under the provision of Section 10(2)(iii). The assessing officer partially disallowed this deduction, reasoning that interest paid on money invested in tax‑exempt securities could not be treated as an allowable expense. This decision was affirmed by the Appellate Assistant Commissioner and subsequently by the Income‑Tax Appellate Tribunal. At the request of the Commissioner of Income‑Tax, a reference under Section 66(1) of the Act was made to the Madras High Court, which ruled in favor of the bank. The Revenue then appealed to this Court by special leave, maintaining that a deduction should be permissible only when the portion of the business to which the expenditure relates is capable of generating taxable income or profit under the Act.

The Court held that statutory interpretation must begin with a strict adherence to the language of the provision. Only when the wording is ambiguous may established principles of construction be invoked; it is impermissible to manufacture an artificial ambiguity and then resolve it by general principles. The Court observed that Section 10 of the 1922 Income‑Tax Act contains no language suggesting that an expenditure falling within its ambit must satisfy any additional condition before deduction is allowed. Sub‑section (1) of Section 10 merely states that a taxpayer is liable to tax on the profits and gains of his business, while Sub‑section (2) mandates that all allowances permissible under the section be deducted. There is no statutory requirement to examine whether an expense, once it falls within Sub‑section (2), directly or indirectly produces taxable income. The Court surmised that the legislature likely presumed that expenditures wholly and exclusively incurred for business purposes would, in the ordinary course, contribute to the generation of taxable income, whether directly or indirectly. Consequently, the deduction claimed by Indian Bank Ltd. for the interest on funds invested in tax‑free securities was deemed permissible under the statute.

In the instant case, it was contested that the profits and losses arising from the purchase and sale of the securities at issue had been taken into account in the assessment. This contention led to the conclusion that those securities were capable of generating taxable income, and therefore the Revenue’s appeal could be rejected solely on that basis. The Court referred to the decision in Hughes v. Bank of New Zealand, 21 T.C. 472, which was relied upon, and approved the authority in Chellappa Chettiar v. Commissioner of Income‑tax, Madras. The Court distinguished the authorities Commissioner of Income‑tax v. Somasundaran Chettiar, 1 A.I.R. 1928 Mad. 487; Provident Investment Co. Ltd. v. C.I.T., Bombay, 6 I.T.C. 21; and Indore Malwa Mills v. C.I.T. (Central) Bombay, 45 I.T.R. 210.

The matter before the Court was a civil appeal numbered 1095 of 1963, filed by special leave against the judgment dated 9 November 1960 of the Madras High Court in Taxation Case No. 41 of 1959. Counsel for the appellant included the Solicitor‑General together with additional counsel, while counsel for the respondent were also appointed. The judgment was delivered by Justice Sikri. The appeal challenged the High Court’s answer to a question referred under Section 66(1) of the Indian Income Tax Act, 1922 (the Act), which concerned whether, on the facts of the case, the Bank could claim a deduction for the entire interest it paid on fixed deposits either under Section 10(2)(iii) or Section 10(2)(xv). The respondent, Indian Bank Ltd., Madras, identified as the assessee, was engaged in the banking business. In the ordinary course of its business the Bank received deposits from its customers and paid interest on those deposits. It also invested a substantial amount in securities issued by both the Central and State Governments, including securities of the Mysore Government. Interest earned on the Mysore Government securities was exempt from income tax and super tax pursuant to a notification issued under Section 60 of the Act. The Bank bought and sold these securities, and the gains and losses resulting from those transactions were duly incorporated in the computation of the assessee’s income under the head “Business.” For the assessment year 1951‑52 (calendar year 1950) the Bank claimed a deduction of Rs 25,91,565 as interest paid to various depositors under Section 10(2)(iii) of the Act. The assessing officer, the Appellate Assistant Commissioner, and the Income Tax Appellate Tribunal each disallowed a portion of that interest, allowing only Rs 2,80,194. That reduced amount was derived by calculating the proportionate interest that would be payable on money borrowed specifically for the purchase of Mysore securities amounting to Rs 2,49,93,511. The Court noted that the precise formula used for this calculation need not be reproduced, as it did not affect the substantive issue. The Tribunal’s reasons for disallowing the proportionate interest were twofold: first, it characterized the interest as “income from” securities, which it claimed could be taxed only under Section 8, and consequently any allowance related to that income should also fall under Section 8 and not elsewhere; second, it argued that prevailing authority supported the view that the assessee should not receive a double benefit of (i) exemption from tax on certain securities and (ii) a deduction of interest on the money employed to acquire those securities.

The Tribunal had held that “securities can be taxed only under section 8, the allowance that could be a charge on that income can only come under that section and no other”, and further observed that “the trend of authorities also seems to be in favour of Department’s view that the assessee is not entitled to a double benefit, (i) exemption from tax in respect of certain securities, and (ii) to an allowance of interest on the money utilised to purchase those securities”. On the assessee’s application, the Tribunal referred this issue to the High Court. The High Court answered in favour of the assessee, holding that the entire interest paid by the Bank was a permissible deduction under section 10(2)(iii) of the Act. Both parties agreed that section 8 of the Act was not applicable to the present facts.

Counsel for the Revenue argued that a general principle governs deductions: no expenditure may be deducted from business profits unless the portion of the business to which the expenditure relates is capable of producing income or profit that is liable to tax under the Act. He explained that, if a part of the business yields profit that is not taxable, then any expenditure incurred to earn that profit cannot be allowed as a deduction. He further contended that this principle was reinforced by the amendments made by the Amending Act of 1939, particularly section 4, which assigns a taxable character to all income accruing or deemed to accrue to a resident person. Consequently, he asserted, if a particular income lacks taxable quality, it also loses the quality required for the related expenditure to be allowable under section 10.

Counsel for the assessee responded that even if the Revenue’s proposition were accepted, it would not aid the Revenue in the present case. He pointed out that it was not disputed that the profits and losses arising from the purchase and sale of the securities had been taken into account in the assessment, and therefore the tax‑free securities were capable of generating profits and losses. He argued that this observation gave force to his client’s position and that, on this ground alone, the appeal should fail. Nevertheless, the Court noted that the issue had already been examined by the High Court and, consequently, it would not base its decision solely on this narrow point.

The Court then asked whether the principle articulated by the Revenue’s counsel truly existed, and if so, whether it could be used to restrict the clear language of section 10(2)(iii), which expressly permits a deduction of interest on capital borrowed for business purposes. In the Court’s view, interpretation of the statute must stay close to its wording. If any ambiguity exists in the terms of a provision, the appropriate recourse is to refer to established rules of construction rather than to create an artificial ambiguity and then resolve it by invoking a general principle.

In addressing the question of construction, the Court observed that while reference may be made to well‑established principles of interpretation, it is impermissible to first manufacture an artificial ambiguity and then attempt to resolve that invented uncertainty by invoking a general rule. The matter before the Court concerned the meaning of section 10 of the statute, and therefore the Court began by examining the precise wording of that provision. Sub‑section (1) of section 10 commands that an assessee be taxed on the profits and gains arising from any business that the assessee carries on. Consequently, the first task was to determine what constitutes the assessee’s business. The Court asked whether the assessee is engaged in a single business, two distinct businesses, or whether, in addition to the business, the assessee pursues an activity that does not qualify as a business. If the latter situation exists, the Court held that the receipts from that non‑business activity must be excluded from the account of assessable income; this was identified as the initial step in the analytical process. The second step required the Court to turn to section 10(2) and to allow all deductions that are expressly permissible under that sub‑section. In considering whether a permissible deduction should be granted, the Court noted that a question might arise as to whether the expenditure in question possesses the quality of directly or indirectly generating taxable income. The Court answered this question in the negative for two principal reasons. First, Parliament has not instructed the tribunal to conduct such an inquiry; there is no language in section 10(2) that mandates an examination of the income‑producing character of the expense. Moreover, the statutory text itself points in the opposite direction. Section 10(2)(xv) requires that the enquiry be limited to whether the expenditure has been laid out or expended wholly and exclusively for the purpose of the business, and the legislature stops short of demanding an assessment of whether the outlay actually produced or will produce taxable income. The Court further explained that Parliament appears to have assumed that expenditures incurred wholly and exclusively for business purposes will, in most cases, either directly or indirectly yield taxable income, and that pursuing a detailed trace of each expense to a specific income stream would impose an unreasonable administrative burden. Accordingly, the Court concluded that nothing in the language of section 10 can be fairly interpreted as imposing an additional condition that an expense or allowance must satisfy before it may be deducted. To support this view, the Court referred to the English decision in Hughes v. Bank of New Zealand, where all the Judges held that interest paid by a bank on capital borrowed for business use and employed in acquiring tax‑free securities must be allowed as a deduction in computing taxable profit, even though the interest earned on the tax‑free securities itself could not be taxed. Lord Thankerton summed up the reasoning by observing that the Crown could find no statutory provision to uphold its contention, whereas the respondents could rely fully on the express terms of the statute.

Rule 3 of the rules that apply to cases I and II of Schedule D was examined. That rule corresponds closely to section 10(2)(xv) of the Indian Income‑Tax Act. After reproducing the wording of the rule and observing its operation, the Court stated that it was indisputable that, in the present matter, the investments under consideration formed part of the respondents’ trade and that the expenditure incurred in connection with those investments was incurred wholly and exclusively for the purposes of that trade. The Court further explained that an expense incurred in the course of a trade, even if it does not generate immediate revenue, is still a proper deduction provided it is wholly and exclusively incurred for trade purposes, and that a deduction does not depend on the existence of a corresponding credit‑side receipt. The Court noted that, although the Master of the Rolls gave weight to the Crown’s argument, he could locate no language in the English statute that allowed a portion of the expenses of an indivisible trade to be excluded. In a similar vein, Justice Greene observed that the statute’s language offered no basis for the Crown’s contention. He remarked that when the statute declares interest to be exempt, it cannot be read as implying that some other provision of the Act must be altered as a consequence. He could find no statutory requirement to treat the exempt interest as a “trade within a trade,” a notion the Crown sought to advance by arguing that the interest, although recorded as a receipt, should be separated out with apportioned expenses as if it were a distinct trade. Counsel for the petitioner, Mr Sastri, argued that the precedent set by the earlier decision had been undermined by the case of Mitchell and Edon (HM Inspectors of Taxes) v Ross, but the Court declined to accept that submission. The point raised in that case was that the authority of Fry v Salisbury House Estate had been qualified by the decision in Hughes v Bank of New Zealand; the Court rejected that proposition. The Court then turned to a series of Indian authorities that had been cited. The Madras High Court’s judgment in Commissioner of Income‑Tax v Somasundaran Chettiar did not aid Mr Sastri. In that case the taxpayer operated businesses in Madras, where the head office was located, and in Ipoh in the Federated Malay States. Money was borrowed in Madras and a portion of it was transferred to Ipoh to serve as capital for the Ipoh operations. The High Court held that interest on the portion of the borrowed funds used in Ipoh could not be allowed as a deduction because the taxable business was the Madras business, not the Ipoh enterprise, and no exception could be applied to that conclusion.

The Court observed that the earlier decision does not help the appellant because the matter before this Court involves a single, indivisible business. The Court then referred to the case of Provident Investment Co. Ltd. v. C.I.T. Bombay, where the assessee was an Indian finance company that borrowed money in India, used the proceeds to purchase sterling securities and kept those securities in India. The Bombay High Court had held that the interest on the borrowed money could not be claimed as a deduction. The High Court reasoned that the capital employed by the company was being used outside British India and was retained outside British India, and therefore the business was not being carried on in a manner that would generate profits assessable to Indian income tax; consequently, the interest could not be allowed under section 10(2)(iii). The Court noted that the Bombay High Court appeared to separate the undertaking into two distinct businesses. In contrast, the Court emphasized that the present assessee’s operations cannot be split into two separate businesses; they constitute one, indivisible enterprise. The Court then considered the decision in Chellappa Chettiar v. Commissioner of Income Tax, Madras. In that case the assessee was engaged in the business of money‑lending, having borrowed money and subsequently advanced it to borrowers. The borrowers were required to repay the loans by transferring agricultural land to the money‑lender. The issue before the Court was whether the money‑lender could claim a deduction for the interest paid on the capital represented by the agricultural lands. Relying on Hughes v. Bank of New Zealand, the Court held that the deduction was permissible even though the agricultural income derived from the lands was not taxable under the Income Tax Act. The appellant’s counsel argued that this ruling was erroneous and that the Rangoon High Court had dissented in C.I.T. Burma v. N.S.A.R. Concern. The Rangoon judge, Dunkley J., had distinguished Hughes v. Bank of New Zealand on the ground that the Burma Income Tax Act was fundamentally different from the English Income Tax Act of 1918. He observed that in England a person is assessed to income tax on his income, whereas under the Burma Act the tax is on the income itself, and that the English Act imposes no class of income outside its scope, while section 4(3) of the Burma Act excludes certain classes of income. He further explained that the English Act merely provides exemptions for a person’s income up to a certain amount or of certain kinds, similar to the exemptions granted to specific classes of income by sections 8 and 9 of the Burma Act. He also pointed out the difference in wording between section 10(2)(ix) of the Burma Act and the comparable provision in the English Act. Nevertheless, the Court stated that it could not accept the view that those textual differences required the rejection of the principle established in Hughes v. Bank of New Zealand.

The Court observed that the Indian Income Tax Act indeed imposed tax on income, but the tax was not levied in a vacuum; it was applied to the income of a particular person. The Court noted that in England the interest earned on securities that were exempt from tax enjoyed a similar exemption as in India, and the identity of the holder of those securities was irrelevant to the exemption. The Court held that the decision in Hughes v. The Bank of New Zealand (1) could not be set apart on the basis advanced by the Rangoon High Court. Referring to its own earlier judgment, the Court stated that the ruling in Chellapa Chettiar v. C.I.T., Madras (3) had been correctly decided. Conversely, the Court found the earlier decision of this Court in Malwa United Wills v. C.I.T. (Central), Bombay (4) to be distinguishable. The Court explained that the distinction arose because sections 14(2)(c) and 4(1)(a) and (c) were in force at the relevant time, which limited the expression “profits and gains” in section 24 to those profits and gains that would have been assessable under the law of British India or the taxable territories. The Court cited the relevant authorities as follows: (1) 21 T.C. 472; (2) (1938) 6 I.T.R. 194; (3) (1937) 5 I.T.R. 97; and (4) [1962] Supp. 3 S.C.R. 310. The Court further quoted the observations of Justice Das, stating that when section 24(1) refers to “profits or gains,” it speaks of taxable profits and gains – that is, profits and gains that would have been assessable in British India or the taxable territories – and does not refer to income arising outside British India or outside the taxable territories that would not be liable to assessment for non‑residents. The Court clarified that no general principle could be drawn from this judgment that any portion of a business’s income that is tax‑free would automatically place the related expenditure outside the scope of section 10. After considering the arguments, the Court agreed with the High Court that the answer to the issue was affirmative. Accordingly, the appeal was dismissed with costs, and the order of dismissal was affirmed.