1980 PLP (Trib (PTD)

MUHAMMAD MAZHAR ALI (MEMBER).-These four Appeals, involving the charge years 1968-69 to 1971-72 the relevant previous years being the calender years 1967, 1968, 1969 and 1970, which are directed against the assessments proper framed under section 23(3) of the Income-tax Act, will be disposed of by this consolidated order as they raise identical questions of facts and law. SEAL: The assessee-appellant is a company duly incorporated under the Company's Act, 1913. Its principal business is to provide loans to the industries both in foreign exchange as well as is local currency and the bolding of investments in stocks and shares etc. The first common ground taken in the Memorandum of appeals and urged before us relates to the allegation of interest paid on borrowings against dividend income. The assessee declared dividend incomes in the years under appeal as under :- Rs. 1968-69 35,00,928 1969-70 44,87,943 1970-71 55,98,480 1971-72 44,84,528 The assessee claimed exemption in respect of the aforesaid total gross -receipts without deducting there from any sums on account of expenses incurred for these earnings. The Income-tax Officer, therefore, called upon the assessee to explain why proportionate financial and administrative expenses should not be allocated to these receipts. The assessee's stand before the Income-tax Officer was that no borrowed money was invested in shares which have yielded the dividends because, firstly, it was the policy of the corporation not to do so and, secondly, the amount invested in fact had been equal to or less than "Capital and Reserves" of the corporation i.e. investments have been made out of its own equity and reserves and hence no question of allocation of interest paid on borrowings against dividend income and capital gains from sale of investments arises. With regard to allocating a part of administrative expenses to the earning of dividend income and capital gains, the assessee's stand was that the administrative cost of management of the investment portfolio was very low inasmuch as all investment decisions were taken by the Managing Directors and the Secretary was the Custodian. According to it, a charge equal to 1%, of the gross investment of income and capital Gains could be a fair allocation to such investment and Gain. The Income-tax Officer did not find it possible to accept the above contentions. Conceding that the assessee was granted exemption under section 60 of the Income-tax Act in respect of income from dividends and also that the investment made did not exceed the "Capital and Reserves" of the corporation, the Income-tax Officer was, still of the view that it did not necessarily follow therefrom that the capital borrowed was not utilised in investments. To strengthen his viewpoint he referred to the policy statement dated 10-12-64 issued by the Corporation wherein it was nowhere provided that no borrowed capital shall be utilised in acquisition of investments. Moreover, he noted that the accounts did not specifically indicate that the borrowed money was kept in strict separation from the corporation's own funds. After taking into consideration the modus operandi of the operation he reached the conclusion that part of the interest paid by the corporation is allocable to the dividend income. It seems proper to reproduce here the following observations from the assessment order of the Income-tax Officer relating to assessment year 1968-69 which form the basis for the subsequent three years: "There is nothing in the accounts to indicate that the borrowed money was kept in strict separation from the Corporation's own funds. On the contrary, most of the investments owned by the corporation were acquired through what the corporation calls `conversion rights'. The modus operandi of the corporation is that every time it makes a loan to an industry. It reserves to itself a right (stipulated in the loan agreement) to convert a certain percentage of the loan into shares of the loanee company (which are acquired at par). Thus in fact it is part of the `loan with which these investments arc acquired and this loan is in turn part of the borrowed capital" on which interest is paid by the corporation. Thus, it is the borrowed capital with which most of the investments were acquired. Secondly. there is another aspect which deserves attention. The loans obtained by the corporation (both foreign exchange and local currency) are in turn distributed to the industry. The corporation derives two benefits from the loans it makes to its clients. Firstly it earns interest etc, and secondly it acquires shares of the loanee company at par. But for these loans, no company would sell its shares at par to the Corporation. Had the corporation bought these shares from the open market, its portfolio would have been much less than what it is and so would have been the amount of dividends. Thus, there is a direct and casual relationship between the borrowed capital and the dividends." The Income-tax Officer was further of the view that the concession allocating 1 % of the gross investment income and capital gain as made; by the assessee was extremely low. Keeping in view the tact that majority of the staff employed by the corporation is engaged primarily in the processing of loan which earned interest income and that the interest receipts were not the only benefit which arises from the loans, he took the view that a sum equal to 5 % of the total administrative and other expenses could reasonably be allocated to dividend income. Thus he worked out the administrative expenses at Rs. 1,76,031, Rs. 1,97,501, Rs. 2,51,476 and Rs. 3,24,183 and allocated these expenses to dividend income. The learned counsel for the appellant reiterated the same contentions before us which were advanced before the Assessing Officer. According to him, the investments of the company have been made out of its own equity and reserves. The rupee borrowings from Government, he so pleaded, are subordinated to equity whereas the foreign currency borrowings are re-lent to sub-borrowers in Pakistan and the rupee borrowings from Agency for International Development are given for the specific purpose of re-lending to identified projects in Pakistan. According to the appellant's learned authorised representative these were the normal operations and usual functions of the assessee-Company. During the years under appeal, he sternly maintained, borrowings of PICIC as disclosed by its published annual accounts were not used for financing its investment and as such, in his submission, it will be totally incorrect to allocate any part of the interest on borrowings against dividend income which is exempt from super-tax vide Ministry of Finance Notification S. R. O. 1041/61 dated the 31st October 1971, Part III, (hereinafter referred to as "the said Notification"). He sought to place reliance on a decision of the Bombay High Court in the case of Commissioner of Income-tax, Bombay City-II v. Industrial Investment Trust Co. Ltd. ((1963) 67 I T R 436) to contend that in terms of the Notification where an invest ment Company has dividend income which is exempted by the Notification and also other kinds of income, the Company would be entitled to exemption in respect of the entire amount of that exempted income, without deducting therefrom the proportionate business expenses attributable to such exempted income. The learned Departmental Representative, on the other hand, pleased for the maintenance of the Assessing Officer's order on the same grounds and reasons which have been given in the impugned assessment orders. He also vehemently urged that what has been exempted is only the income from dividends and not the gross receipts from dividends. In his submission, the income from dividends in assessed under section 12 of the Income-tax Act which clearly signifies that all those expenses shall be allowable against the dividend receipts which have been incurred for the earning or making of that income. In terms of section 12 of the Act the interest paid in respect of money borrowed for the purposes of investment in shares is an allowable deduction. He further laid much emphasis on the fact that most of investments owned by the assessee Corpora tion have been acquired by it through what it calls "Conversion Rights". The learned Departmental Representative, therefore, vociferously urged that since these loans are disbursed to the loanees out of the funds borrowed by the Corporation on which it pays interest and since a part of the loan is converted into share investments by the assessee, hence there is full justification for the allocation of interest paid by the appellant to the dividend income derived by it. We have given our earnest consideration to the facts and circumstances of this case as well as to the submissions made by the parties' representa tives before us and have, for the reasons to follow immediately, reached the conclusion that the appellant's contentions must prevail. It is evidently borne out from the figures of `capital and Reserves' and investments of the assessee-corporation in all the relevant accounting years under appeal as submitted before the Assessing Officer and brought to our, notice that the amounts used in equity investments never exceeded the available amounts of `capital and reserves'. This fact has even been conceded by the Income-tax Officer in favour of the assessee by observing in the impugned order: "It is indeed correct that the investment made does not exceed the `Capital and Reserves' of the Corporation." Moreover, it was also brought on record by the assessee that the policy statements as approved by the Board of Directors of the assessee Corporation as far back as 10th December 1964, Inter alia, provided as under :- "It is the intention that the total investment in various enterprises, either made directly or acquired through conversion rights, is normally restricted to the paid up capital and free reserves of the Corporation." What appears to have influenced the mind of the learned Assessing Officer is that the policy Statement dated 10th December, 1963, did not pointedly prohibit the utilization of the borrowed capital in acquisition of investment. But, according to him, it only placed a restriction on the quantum of investment, viz. the total investment should not exceed the `capital and reserves' of the corporation. He, therefore, proceeded to examine the modus operandi of the Corporation and inferred therefrom that there was a direct and casual relationship between the borrowed capital and the dividends and consequently he held that part of the interest paid by the Corporation (assessee) is allocable to dividend income. Here the Income-tax Officer, in oar opinion patently fell into an error. A perusal of the Notification it question clearly indicates that so much of the income of any investments. Company (which falls within the ambit of the Explanation attached thereto) as is derived from dividends shall be exempt from super-tax if the Company paying the dividend has paid or will pay super-tax in respect of the profits out of which such dividends are paid. The words "such dividends", in our opinion, are clearly referable to gross income received by the assessee from dividends which have been exempted from super-tax and not to that amount which results after the process of computation is applied to the said gross income. This very question, as rightly pleaded by the learned authorised representative of the appellant, arose before the Bombay High Court in Commissioner of Income-tax Bombay v. Industrial Investment Trust Co. Ltd' There "the assessee (we quote from the head-notes) an investment trust Company, derived income from dividends to the extent of Rs. 7,61,407, out of which a sum of Rs. 5,86,873 represented dividends paid by other companies "which had paid or would pay super-tax in respect of the profits out of which such dividends were paid, and the balance of Rs. 1,74,534 represented income other than such dividends. The Income-tax Officer took the view that the business loss or expenses, which amounted to Rs. 92,619 had to be spread over the entire income and the exemption under the notification could be allowed only in respect of a sum arrived at by deducting from Rs. 5,86,873 the pro portionate expenses attributable to the said figure and, accordingly, he apportioned the expenses between the two figures of Rs. 5,86,873 and Rs. 1,74,534 which represented the income which was entitled to exemption under the notification and the income which was not so exempted respectively, and ultimately held that the income of the assessee which was liable to pay super-tax was Rs. 1,74,534 less the proportionate business of Rs. 22,544." The High Court of Bombay relying upon the decision of the Supreme Court of India in Commissioner of Income-tax v. South India Bank ((1963) 3 Taxation (Ind.) 463) held that: "In the notification before us the expression used is "income deprived by the assessee from dividends of the specified kind. The income deprived from dividends of the kind specified in the notification would mean the amount received by the assessee-Company as dividends of the specified kind. The object of the notification, it would appear, was to allow exemption in respect of super-tax on the dividends, which before they had been received by the assessee, had been subjected to the payment of super-tax in the hands of the paying Company. That being so, the dividend income received by the assessee and not the said incomes less any further amounts. As has been held by the Supreme Court in the said case, the notification must be regarded as a self-contained one and not controlled by any other provisions of the Act There is, therefore, no warrant to construe the word' "income" in the notification as total income nor to qualify the dividend income specified in the said notification as the dividend income computed under section 12 of the Act, In our opinion, therefore, on a proper construction of the notification the assessee would be entitled to exemption from super-tax on the whole of the dividend income of Rs. 5,86,873 without deducting therefrom the proportionate expenses attributable to the same". The notification in that case was Notifica tion No. 47 of the Governor -General-in-Council of 1933 which contained the same provisions as they are embodied in the Ministry of Finance Notification S. R. O. 1041 (K)/61 dated 31st October 1961, save that the explanation to the notification (which is not material for the decision of this case) had changed since 1953. Respectfully following the reasoning of the Bombay High Court, with which we are in complete agreement, we would decide this issue in favour of the assessee by holding that it was entitled to exemption from super-tax on the whole of the dividend income and the Income-tax Officer was wrong in allocating interest paid on borrowings against the exempted income derived from dividends. The next objection pertaining to the allocation of a part of administrative and other expenses against dividend income as made by the Income-tax Officer is also well founded. In the aforesaid decision in the case of Commissioner of Income-tax v. Industrial Investment Trust Co. Ltd. it was further held by the Bombay High Court that, "on general principles, if expenses are allowable as business expenses they should be deducted from the income of the business which is liable to tax. The circumstance that the business) activity has produced income, a part of which is liable to tax and) a part of which is free from tax, will not permit allocation of the expenses between these two parts of the income and allow only that part which is attributable to the benefit of that taxable income. In this view, apart from the construction of the notification, proportionate expenses cannot be deducted from the exempted income". (We have quoted from the Head Notes). We, therefore, order that the allocation of a sum equal to 5 j of the total administrative and other expenses to dividend income was improper and it shall accordingly stand knocked of. We would like to add that the allocation of the administrative expenses to the earring of dividend income and capital gains is to be decided in accordance with law and not on the basis of the concession, if any, given by the assessee. The only other common objection that falls for our consideration is with regard to the exclusion of exempt dividend income from total income for the purpose of determining the quantum of special reserve to be allowed as a charge against income under section 10(2)(iii-a) of the Income- tax Act. The learned authorised representative of the appellant contended that dividend income is included in total income while being exempted from income-tax. It is further clear from the notification exempting the dividend income from super-tax that it is part of total income because the notification does not exempt it from income-tax. The appellant's representative by referring to the provisions of section 10(2)(iii-a), which, according to him, exempt the amount transferred to special reserve as the words used therein are "the amount not exceeding 10 % of the total income", vociferously argued that the claim to he allowed is to be calculated including the exempt dividend income which form part of the total income with the promise that the amount of claim may be restricted to the amount actually carried to such reserve in the year. It was, on the other hand, maintained by the learned Departmental Representative that since dividend income of the assessee is exempt from tax, therefore, it is not to be included in the total income for the purposes of working out the 10%. Special Reserve allowable under section 10(2)(iii). He also attempted to argue that the allowance under section 10(2(iii-a) was to be restricted to 10% of the total income carried to the said account and the Income-tax Officer while allowing the said reserves at 10% of the total assesses income in each of these years, has allowed excessive relief to the assessee. We have given our earnest consideration to the arguments made by the respective representatives of the parties and after carefully perusal of the relevant provision of law we are clearly of the opinion that the contention raised on behalf of the appellant is not well founded. Any, income which stands exempt under the provisions of the Act is not includable in the total income. The Income-tax Officer was, therefore, justified in excluding exempt dividend income from total income for the purpose of determining the quantum of special reserve to be allowed as a charge under section 10(2)(iii) of the Income-tax Act. We do not feel called upon to record our finding on the alternate plea raised by the learned Departmental Representative in this appeal which has been brought at the instance of the assessee. Consequently, this plea of the appellant fails. In the result, all the four appeals arc allowed to the extent and in the manner indicated above. Appeals allowed.