1981 PLP 49 (PTD)

3. During the Assessment year 1964‑65, the Assessee paid Rs. 6,00,000 as fixed dividend on the preference shares. Such payment stood at Rs. 3,00,000 for each of * the two subsequent Assessment years. In the 'returns filed by the assessee for these three assessment years, in the first instance, these payments were declared as part of the dividend income of the company, chargeable to tax, but subsequently, it filed revised returns changing these amounts as interest to the profits and loss account and claimed the same as admissible deduction under section 10(2)(iii) of the Act. The Income‑tax Officer maintained that the distribution of the dividend on the preference shares could not be debited to the profit and loss account and thus by his three separate orders he rejected the Assessee's claim. The fact that formerly the company charged these payments to the appropriation account, also weighed with him.

4. In appeals before the Income‑tax Appellate Tribunal, it was contended that the payments in question were in the nature of fixed interest payable by the Assessee to the Colony Textile Mills, who under a contractual obligation held the Assessee's preference shares. The submission was that in the proper sense these payments were not dividend but interest on borrowed capital within the meaning of clause (iii) of subsection (2) of section 10, which could be adjusted against the income, The Tribunal, however, repelled these contentions and held that these amounts constituted dividend on the preference shares and were covered by the term "dividend" as defined in the Income‑tax Act. The appeal for the Assessment year 1964‑65 was thus decided on 19‑10‑1971, whereas the appeals relating to the years 1965‑66 and 1966‑67 were disposed of by two separate orders dated 20‑10‑1971. It is under these circumstances that the aforesaid question of law has been referred to us by the Assessee.

5. The learned counsel for the Assessee argued that the money invested by the preference share‑holders, without participation in the Management of the company is in reality money lent to the Assessee‑Company and to highlight the role of the shareholders, in controlling the affairs of the company, of which under the Articles of Association, the holders of preference share, are deprived, he referred to Commissioner of Income‑tax v. E. V. Miller P L D 1959 S C (Pak.)

219. On the authority of two precedents from the English jurisdiction reported as Henry v. The Great Northern Railway Company L 3 R 27 Ch. 1 and Mathew v. The Grant Northern Railway Company L J R 8 Ch. 375, it was canvassed that the guaranteed payment to preference shareholders is in substance, interest chargeable on the profits of the Company. It was further argued that the expression "interest" is susceptible of wide connotation and the amounts in dispute legitimately fall within the ambit of section 10(2) (iii) to warrant a set off against the profits of the company. For his this submission, the learned counsel sought assis tance from Edupuganli Pitchayya and others v. Gonuguntia Venkata Ranga Row A I R 1944 Mad. 243.

6. On behalf of the Income‑tax Department their learned counsel adopted the reasoning which influenced the decision of the Tribunal. He contended that the preference shareholder are members of the company and on the strength of the Articles of Association, further urged that there is no difference in the dividend paid to the ordinary shareholders and the holders of preference shares. It was argued that the distribution to the pre ference shareholders being from the profits of the company could not escape the liability.

7. We have perused the record and considered the submissions made by the learned counsel for the parties, Section 10 of the Act permits certain allowances, in computing the profits and gains of business, profession or vocation, carried on by an assessee. The deduction prescribed by clause (iii) of subsection (2) of section 10 of the Act is: "in respect of capital borrowed for the purposes of the business, pro fession or‑ vocation . . . . . the amount of the interest paid." This clause necessarily postulates the borrowing and lending of money on the condition of repayment of money with interest. The term "capital borrowed" as employed in this clause, contemplates the existence of relation ship of the borrower and lender between the assessee and the recipient of the payments, sought to be exempted from the chargeability. It cannot be disputed that the preference shareholders, whose names are entered in the register of members of the company, maintained under section 30 of the Companies Act, 1913 like the holders of ordinary shares, are the members of the company. Indeed the connotation of the "shareholder" as given in the "Articles of Association" is also to the same effect. There is no gainsay in that a company is constituted by its members and the preference shares form part of the share capital of the assessee‑Company. The capital subscribed by these shareholders, therefore, can neither bear the character of "borrowed capital" nor the constituents of the Company be considered as lenders of the capital within the meaning of clause (iii) of subsection (2) of section 1 of the Act. It is axiomatic that a Company cannot borrow its own capital.

8. There is no substance in the argument that the distribution made to preference shareholders can be reckoned as interest to earn the exemption from taxability. A reference to Article 5(a) will provide that a fixed cumula tive preferential dividend at the rate of 6 per cent has been guaranteed on the preference shares. Article 156 lays down that no dividend shall be paid otherwise than out of the profits of the Company. Thus, what the preference shareholders received was not the interest but the dividend declared and distributed by the company. They got their share, in the net profits of the Company in accordance with the Articles thereof. The character of the payment did not change, merely because a fixed cumulative preferential dividend, at a particular rate was guaranteed to them. The Compulsory retention of preference shares or the assessee‑Company by the Colony Textile Mills, under some contractually obligation and consequential distribution of guaranteed dividend to then even if found correct, does not affect the chargeability of the payments.

9. We have perused the case‑law cited by the petitioner's learned counsel. The ruling in Edupuganti Pitchayya and others v. Gonuguntla Venkata Ronga Row, deals with a case under the Madras Agriculturists Relief Act, 1938, in which a learned Single Judge; relying on the English Money Lenders Act, described the `interest' as profit or advantage of the creditor which he gets by giving the use of his money to another. In Henry's case, the preference shareholders, who did not receive the full amount of their dividends, claimed the deficiency and sued for an injunction against the directors to restrain the declaration of dividend on the ordinary stock, in disregard of the right of preference shareholders pursuant to section 120 of the Companies Clauses Consolidation Act, it was laid down that the directors were bound to prepare a scheme appropriating the sum realized, among all the share holders according to their respective rights. In the course of judgment the Lord Chancellor observed that the word "dividend" as used in this and similar other cases is never used with strict accuracy and held that what was guaranteed the preference shareholder was substantially interest chargeable on the profits of the company. The proposition determined in Mathews' case was, whether on the facts of that case, the short payment of the guaranteed dividend, could be made good out of dividend declared for the subsequent years. The report in Henry v. The Great Northern Railway Company, was considered in this judgment but was distinguished. It is to be noticed that in none of these cases the taxability of the dividend income of the Company was in issue, We do not think that these precedents render any assistance to the assessee. It may be observed that the provisions granting exemptions should receive strict interpretation. In Muhammadi Steamship Co. Ltd. v. The Commissioner of Income‑tax (Central) Karachi P L D 1966 S C 828 it was laid down :‑‑

"Provisions ranting exemption or privileges have to be construed strictly against the persons claiming the exemption or pri vilege." Section 10 (2) (iii) is, therefore, not amenable to liberal consideration. Applying this rule of interpretation to clause (iii), we have no hesitation in holding that the petitioner's claim is unsustainable.

10. Reliance by the assessee's learned counsel on the Commissioner of Income‑tax v. Miller is also misconceived. The absence of voting power does not denude the preference shareholders of their status as members of the company.

11. We are of the view that the payments in question did not lose their character as taxable dividend income of the company and thus could not be allowed as permissible allowance under section 10(2) (iii) of the Income tax Act. 12. ‑We accordingly answer the questions in all the Tax References, in favour of the Revenue and direct the petitioner to bear the costs of the respondent. Reference answered in the affirmatively.