JUDGMENT By the Court In compliance with this courts direction under section 256(2) of the Income Tax Act, 1961, the Tribunal, Delhi Bench A, has referred the following questions for the opinion of this court :
"1. Whether, on the facts and in the circumstances of the case, the Tribunal was legally justified in taking the view that the interest paid on borrowings has to be treated as interest paid for making or earning income under the head investment even though the investment account showed losses in respect of managing agency of UP Co-operative Society and losses of Mahadev Sugar Mills & Shares?
2. Whether, on the facts and in the circumstances of the case, the Tribunal was in law justified in increasing allowable deduction by another Rs. 18,000 for each of the three years (1961-62, 1962-63 and 1963-64)?"
2. We have heard Sri Rajesh Kumar Agarwal, learned standing counsel for the Commissioner and Shri P.N. Batham, learned counsel for the assessee.
2. We have heard Sri Rajesh Kumar Agarwal, learned standing counsel for the Commissioner and Shri P.N. Batham, learned counsel for the assessee.
The relevant facts giving rise to the aforesaid questions have been stated by the Tribunal in the statement of case as under :
"2. The first contention which is common to all the three years relates to the claim for deduction of interest. The assessee had claimed deduction of interest amounting to Rs. 82,203 for the first year, Rs. 79,909 for the second year and Rs. 67,950 for the third year. The assessees capital account in all the three years showed a debit balance. Regarding the balance sheet as a whole, on the one hand it had shown non-interest bearing loans amounting to 4.9 lakh in the first year, 2.7 lakh in the second year and Rs. 1.9 lakh in the third year. The interest-bearing loans for these years were Rs. 14.5 lakh in the first year, 19.6 lakh in the second year and 18.2 lakh in the third year. The debit balance in the assessees capital account was Rs. 10 lakh in the second year and Rs. 10.4 lakh in the third year. The debits on account of life insurance premia amounted to 9,803 for the first year, Rs. 99,418 for the second year and Rs. 1,05,033 for the third year. The debits in the capital account of the assessee included Rs. 1,25,000 on account of managing agency of D.S. Mills, Rs. 13,610 on account of loans due to abolition of Zamindari, Rs. 53,772 on account of loss in U.P. Co-operative Federation, Lucknow. Rs. 20,491 on account of loss of sale of Mahadev Sugar Mills, Rs. 7,11,472 on account of debit balance brought forward on the opening date, Rs. 1,19,257 on account of H.R. Sugar Factory Ltd. Shares, Rs. 72,278 on account of Mahadev Sugar Mills and Rs. 66,505 on account of litigation regarding Seth Kanshi Ram Bindal.
3. For the assessment year 1961-62, the Income Tax Officer allowed the assessee deduction of interest only to the extent of Rs. 30,000 on the ground that borrowings in respect of bad debt of Tika Ram, managing agency of Dhampur Sugar Mills Ltd., payment of loss to UP Co-operative Federation, loss in Mahadev Sugar Mills, bad debts in the account of M/s Banche and an amount of Rs. 1,068 from National Air Academy were not for purposes of business or for making or earning income from any other source. For the assessment years 1962-63 the Income Tax Officer allowed interest amounting to Rs. 37,988 out of which he related the amount of Rs. 7,303 to the investment in shares and Rs. 30,685 to speculation business. For the assessment year 1963-64 he allowed an amount of Rs. 31,020 only out of which he allocated Rs. 3,156 to income from investments and Rs. 27,864 to speculation business. When the matter went to the Appellate Assistant Commissioner he had to decide the assessments for the years 1962-63 and 1963-64 before the assessment for the year 1961-62. The Appellate Assistant Commissioner approved in principle the action taken by the Income Tax Officer. He allowed interest in respect of certain accounts which allowance is the subject- matter of Departmental appeal, which will be separately considered. In regard to the decision of the Appellate Assistant Commissioner on principle the learned representative for the assessee contended that no amount of interest was liable to be disallowed, that the Tribunal for the assessment year 1959-60 in ITA No. 11773 of 1964-65 had accepted the principle that the assessee was entitled to set off personal expenses and other withdrawals unrelated to any source to his capital and non-interest bearing loans, that the income tax authorities had not applied this principle for the years in question before us, that after the end of the assessee had earned more income during the three years, that there was little or no addition to the debit balance on account of expenditure or personal liabilities, that debit balances on account of losses had necessarily to be taken into account while allowing the interest on borrowings and the borrowings had necessarily to be related to the purpose which actuated the borrowing when the borrowing was first made. It was conceded that interest allowable in respect of speculation business had to be separately allocated. The departmental representative, on the other hand, relied on the orders of the authorities below and on the decision in (1935) 3 ITR 11 (Mad) (FB)."
3. For the assessment year 1961-62, the Income Tax Officer allowed the assessee deduction of interest only to the extent of Rs. 30,000 on the ground that borrowings in respect of bad debt of Tika Ram, managing agency of Dhampur Sugar Mills Ltd., payment of loss to UP Co-operative Federation, loss in Mahadev Sugar Mills, bad debts in the account of M/s Banche and an amount of Rs. 1,068 from National Air Academy were not for purposes of business or for making or earning income from any other source. For the assessment years 1962-63 the Income Tax Officer allowed interest amounting to Rs. 37,988 out of which he related the amount of Rs. 7,303 to the investment in shares and Rs. 30,685 to speculation business. For the assessment year 1963-64 he allowed an amount of Rs. 31,020 only out of which he allocated Rs. 3,156 to income from investments and Rs. 27,864 to speculation business. When the matter went to the Appellate Assistant Commissioner he had to decide the assessments for the years 1962-63 and 1963-64 before the assessment for the year 1961-62. The Appellate Assistant Commissioner approved in principle the action taken by the Income Tax Officer. He allowed interest in respect of certain accounts which allowance is the subject- matter of Departmental appeal, which will be separately considered. In regard to the decision of the Appellate Assistant Commissioner on principle the learned representative for the assessee contended that no amount of interest was liable to be disallowed, that the Tribunal for the assessment year 1959-60 in ITA No. 11773 of 1964-65 had accepted the principle that the assessee was entitled to set off personal expenses and other withdrawals unrelated to any source to his capital and non-interest bearing loans, that the income tax authorities had not applied this principle for the years in question before us, that after the end of the assessee had earned more income during the three years, that there was little or no addition to the debit balance on account of expenditure or personal liabilities, that debit balances on account of losses had necessarily to be taken into account while allowing the interest on borrowings and the borrowings had necessarily to be related to the purpose which actuated the borrowing when the borrowing was first made. It was conceded that interest allowable in respect of speculation business had to be separately allocated. The departmental representative, on the other hand, relied on the orders of the authorities below and on the decision in (1935) 3 ITR 11 (Mad) (FB)."
4. "In our view this question of interest in cases of this kind always bristles with problems especially when interest is paid on borrowings which are used for diverse purposes. The legal principle relevant to the determination of issue of this kind are, however, fairly clear. The unproductive and personal expenditure is first to be related to the assessees own capital. Borrowing does not cease to be borrowing for productive source just because in a particular year the source did not yield income. On the other hand, borrowings in a particular year have necessarily to be examined in the context of assets and liabilities which form the complex of the balance sheet in the year in question. A borrowing may have been undertaken initially for one purpose but with the passage of time that purpose might no longer hold good and the borrowing might have continued business or source of income which were destroyed or discontinued cannot be taken into account for allowance of interest. Bearing in mind these principles we are unable to accept the plea of the learned representative that the whole of the interest claim in these years should have been allowed. The position which obtained in the year for which the Tribunal decided the appeal had radically changed for all the three years in dispute before us. Firstly the credit balance in the capital account was converted into a huge debit balance in the capital account. In the earlier year the Tribunal with respect, rightly set off the credit balance against items of personal expenditure but that set off cannot be allowed for the years in question because there was no more credit balance. The assessees plea that set off made in earlier year was effective for the subsequent years would not be realistic either from the point of view of commercial practice or from the point of view of accountancy. If the assessees pleas were accepted the credit balance would still be shown in the balance sheet for set off against personal expenditure while there will be a larger debit balance in another personal account. Such a position will not be in conformity with the fact of the situation. The credit balance had ceased to exist and was converted into a huge debit balance. The borrowings had, therefore, to be seen in the fresh context of assets and liabilities existing in the relevant years of account. For all these years even the composition of loans, whether interest- bearing or non-interest-bearing had undergone considerable change. Several of the assessees investments had either been lost or had come to nothing. In the circumstances, it was not possible to apply bodily the formula adopted by the Tribunal for the assessment year 1959-60 to the years in question before us. Nor was it possible to accept the position that just because the income in these years was more than the expenditure, the basic position had remained unchanged. The correct approach in these circumstances, in our view, is to take the balance sheet position in each of three years and see whether any of the items on the assets side of the balance sheet represented personal expenditure, personal liability, or losses of discontinued business or sources of income are matched by borrowings on interest. Judged from that point of view, the items considered by the Income Tax Officer except managing agency Rs. 1,19,000. Loss on Zamindari abolition, Rs. 13,610. UP Co-operative Society Rs. 53,772, loss of Mahadev Sugar Mills and shares Rs. 20,491 and Rs. 72,278 were clearly matched by borrowings on which interest cannot be allowed. In respect of the remaining items, we are unable to accept the conclusion of the income-tax authorities that the interest on borrowings relating to the same could not be allowed. All the items represent loss on investments in one form or another. It cannot be suggested that the investment as a source of assessees income had been completely destroyed. The investment as a source of income continued to be source from which income continued to flow. It was not possible to suggest that every item or investment was a separate source. The loss as represented by the items referred to earlier, therefore, represented a loss on investment account and the borrowings which were continued or which were contracted a new, on account of these losses have necessarily to be treated as borrowings related to the source of income called investment. The interest paid on these borrowings had to be treated as interest paid for making or earning income under the head "investment" on an approximate basis, therefore, the assessee would be entitled to a further deduction of Rs. 18,000 in each of the three years. While allocating the interest, the Income Tax Officer has held that bulk of the investments were relatable to the assessees own capital. In view of the change in the structure of assets and liabilities in the three years in question, this presumption does not hold good. Apart from the debit balances represented by personal ......expenditure or personal liabilities, the bulk the borrowing must be related to productive investments other than speculation business. The assessee has allocated interest amounting to Rs. 26,203 in the first year, Rs. 8,915 in the second year and Rs. 15,909 in the third year to speculation business. This allocation seems to us to be a fair one since it takes into account all the other investments both productive and unproductive. We would, therefore, direct that interest allowable in respect of speculation business should be Rs. 26,203 for the first year Rs. 8,915 for the second year and Rs. 15,909 for the third year. The interest allowable in respect of other sources would be the amounts as determined by th Income Tax Officer as increased by Rs. 18,000 in each of the three years. No further relief is due to the assessee in respect of this item on any score".
4. "In our view this question of interest in cases of this kind always bristles with problems especially when interest is paid on borrowings which are used for diverse purposes. The legal principle relevant to the determination of issue of this kind are, however, fairly clear. The unproductive and personal expenditure is first to be related to the assessees own capital. Borrowing does not cease to be borrowing for productive source just because in a particular year the source did not yield income. On the other hand, borrowings in a particular year have necessarily to be examined in the context of assets and liabilities which form the complex of the balance sheet in the year in question. A borrowing may have been undertaken initially for one purpose but with the passage of time that purpose might no longer hold good and the borrowing might have continued business or source of income which were destroyed or discontinued cannot be taken into account for allowance of interest. Bearing in mind these principles we are unable to accept the plea of the learned representative that the whole of the interest claim in these years should have been allowed. The position which obtained in the year for which the Tribunal decided the appeal had radically changed for all the three years in dispute before us. Firstly the credit balance in the capital account was converted into a huge debit balance in the capital account. In the earlier year the Tribunal with respect, rightly set off the credit balance against items of personal expenditure but that set off cannot be allowed for the years in question because there was no more credit balance. The assessees plea that set off made in earlier year was effective for the subsequent years would not be realistic either from the point of view of commercial practice or from the point of view of accountancy. If the assessees pleas were accepted the credit balance would still be shown in the balance sheet for set off against personal expenditure while there will be a larger debit balance in another personal account. Such a position will not be in conformity with the fact of the situation. The credit balance had ceased to exist and was converted into a huge debit balance. The borrowings had, therefore, to be seen in the fresh context of assets and liabilities existing in the relevant years of account. For all these years even the composition of loans, whether interest- bearing or non-interest-bearing had undergone considerable change. Several of the assessees investments had either been lost or had come to nothing. In the circumstances, it was not possible to apply bodily the formula adopted by the Tribunal for the assessment year 1959-60 to the years in question before us. Nor was it possible to accept the position that just because the income in these years was more than the expenditure, the basic position had remained unchanged. The correct approach in these circumstances, in our view, is to take the balance sheet position in each of three years and see whether any of the items on the assets side of the balance sheet represented personal expenditure, personal liability, or losses of discontinued business or sources of income are matched by borrowings on interest. Judged from that point of view, the items considered by the Income Tax Officer except managing agency Rs. 1,19,000. Loss on Zamindari abolition, Rs. 13,610. UP Co-operative Society Rs. 53,772, loss of Mahadev Sugar Mills and shares Rs. 20,491 and Rs. 72,278 were clearly matched by borrowings on which interest cannot be allowed. In respect of the remaining items, we are unable to accept the conclusion of the income-tax authorities that the interest on borrowings relating to the same could not be allowed. All the items represent loss on investments in one form or another. It cannot be suggested that the investment as a source of assessees income had been completely destroyed. The investment as a source of income continued to be source from which income continued to flow. It was not possible to suggest that every item or investment was a separate source. The loss as represented by the items referred to earlier, therefore, represented a loss on investment account and the borrowings which were continued or which were contracted a new, on account of these losses have necessarily to be treated as borrowings related to the source of income called investment. The interest paid on these borrowings had to be treated as interest paid for making or earning income under the head "investment" on an approximate basis, therefore, the assessee would be entitled to a further deduction of Rs. 18,000 in each of the three years. While allocating the interest, the Income Tax Officer has held that bulk of the investments were relatable to the assessees own capital. In view of the change in the structure of assets and liabilities in the three years in question, this presumption does not hold good. Apart from the debit balances represented by personal ......expenditure or personal liabilities, the bulk the borrowing must be related to productive investments other than speculation business. The assessee has allocated interest amounting to Rs. 26,203 in the first year, Rs. 8,915 in the second year and Rs. 15,909 in the third year to speculation business. This allocation seems to us to be a fair one since it takes into account all the other investments both productive and unproductive. We would, therefore, direct that interest allowable in respect of speculation business should be Rs. 26,203 for the first year Rs. 8,915 for the second year and Rs. 15,909 for the third year. The interest allowable in respect of other sources would be the amounts as determined by th Income Tax Officer as increased by Rs. 18,000 in each of the three years. No further relief is due to the assessee in respect of this item on any score".
5. As regards the first question, the connection between the loans and the sources of income is not challenged. The question raised is whether when the investments in respect of which the loans were raised did not yield any income, can be interest paid on such loans be allowed as an expenditure. This controversy stands settled by the Honble Supreme court in CIT v. Rajendra Prasad Moody (1978) 115 ITR 519 (SC) in which the Honble Supreme Court observed as under:
5. As regards the first question, the connection between the loans and the sources of income is not challenged. The question raised is whether when the investments in respect of which the loans were raised did not yield any income, can be interest paid on such loans be allowed as an expenditure. This controversy stands settled by the Honble Supreme court in CIT v. Rajendra Prasad Moody (1978) 115 ITR 519 (SC) in which the Honble Supreme Court observed as under:
"What section 57(iii) requires is that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. It is the purpose of the expenditure that is relevant in determining the applicability of section 57(iii) and that purpose must be making or earning of income. Section 57(iii) does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction. It does not say that the expenditure shall be deductible only if any income is made or earned. There is in fact nothing in the language of section 57(iii) to suggest that the purpose for which the expenditure is made should fructify into any benefit by way of return in the shape of income. The plain natural construction of the language of section 57(iii) irresistibly leads to the conclusion that to bring a case within the section, it is not necessary that any income should in fact have been earned as a result of the expenditure."
Therefore, the first question has to be answered in the affirmative in favour of the assessee.
6. As regards the second question, it raises purely factual controversy inasmuch as the dispute is about the extent of interest allowable as an expenditure. Therefore, the controversy raised in the second question is purely a factual controversy and no question of law arises.
6. As regards the second question, it raises purely factual controversy inasmuch as the dispute is about the extent of interest allowable as an expenditure. Therefore, the controversy raised in the second question is purely a factual controversy and no question of law arises.
In the result the question No. 1 is answered in the affirmative in favour of the assessee and against the revenue and question No. 2 is left unanswered as it is not a question of law. Parties will, however, bear their own costs.