ORDER
A. Kalyanasundharam, Accountant Member
1. The revenue has preferred this appeal, objecting to the order of the CIT(A) dt. 10th Mar. 87 and the objection of the revenue is on the deletion of Rs. 3,78,405, the addition made out of the bid expenses made by the Assessing Officer.
2. The D.R. Sh. Kapila, submitted that, the assessee, a limited company carrying on the business of chits had claimed loss on bids made by the company during the accounting year. He pleaded that, the loss was claimed on the basis that, the company had raised the discount on bidding of the chits, which discount was distributed to the various subscribers of the chits. The disallowance was made by the assessing officer on the basis that, the loss or profit can be worked out only on completion of each of the chits. The CIT(A) was of the opinion that, the loss would accrue at the point of each of the bids. He held that, disallowing of the loss was not proper.
3. The counsel Sh. Manian, filed the copy of the Madras Chit Funds Act, 1961 as was extended to the Union territory of Delhi and also the Delhi Chit Fund Rules, 1964 along with the memorandum and articles of the company, balance sheet, note on bid amount with details thereof. He made reference to his paper book pages 8 to 12, wherein he had placed the submissions in this regard as were made before the CIT(A). He pleaded that, the Act and rules allow a subscriber to raise the discount to a maximum of 30% of the chit amount and thereby, he becomes entitled to claim the balance amount of 70% at the bid. The company reserves the right to appropriate 5% of the chit amount as its commission at each of the bids, which is deducted from the discount of 30% and the balance is distributed to all of the subscribers of the particular chit. The subscriber who has made the successful bid continues to contribute the rest of the installments of the chit. The company, acts as the conductor of the chit and is therefore called the foreman. The company is also allowed to contribute as any other subscriber and is also entitled to bid at each auction of the chit,. The company chooses to bid the chit as a prudent businessman, solely with the view of prevent outflow of funds from the company, thus contain the financial liquidity of the company. Since the discount could be raised to a maximum of 30% only, the company has to contain the discount on the bid made by it on its own account to this limit, out of which the 5% is credited to its commission account and the balance 25% is debited to an account styled “Bid amount to own chits” and credit is given to each of the subscriber, which is their dividend. He pleaded that the chits on which bidding was done during the accounting year might be still running, i.e., some more installments may be payable, but, the discount having been raised at the time of making of the bid, the loss had clearly accrued at that point of time. He made submissions with examples and his partner Sh. Ratnam also explained the system of accounting followed by the chit fund companies. Sh. Mania also relied on an article published in the daily “The Hindu” dt. 22nd May, 1990, for the proposition that, there is no published system of accounting in regard to the chit fund business and therefore, each of the system needs to be evaluated on its merit. The Bench put to him, as to how it is possible for a chit fund company to suffer any loss, for the chit amount is a notional amount as was agreed to by the subscribers to be paid in installments; at the time of bid the bidder is agreeable to take a percentage of the chit amount with the condition that he shall continue to pay the rest of the installments; the difference between the notional chit principal and the bid amount only results in the reduction of the amount to be paid by way of installments by the subscribers and finally the chit principal amount itself gets reduced by the amount of the discount. He reiterated his stand once again on the same lines as were made before the first appellate authority and further pleaded that, the company having made the bid, has to give credit to the subscribers of the discount and this was possible only by debiting the loss on its own account He further placed reliance on the decision of the Andhra Pradesh High Court in CIT v. Marauders Chit Funds (P.) Ltd. [1985] 155ITR442,inClTv.KovurTextiles&Co. [1982] 136ITR 61 and in the Supreme Court ruling in CIT v. Chunilal V. Mehta & Sons (P.) Ltd. [1971] 82 ITR 54. He also cited the decision of the Punjab & Harayana High Court in Soda Silicate & Chemical Works [1989] 179 ITR 588/46 Taxman 33 and submitted that, the decision would not apply to the assessee for the reason that in that case, the assessee did not carry on the chits as its business venture.
4. We have given our very careful consideration to the rival submissions and also the documents as were placed before us and relied upon by either side. To appreciate the controversy in view of the nature of business of chit fund which is governed by a separate statute, it would be necessary to go into the provisions of the Madras Chit Funds Act, 1961, as extended to the Union territory of Delhi, for the reason of the company carrying on its chit fund business in Delhi.
4.1 In Chapter II of the Act the manner of starting and conducting of the chit fund business has been provided. The bye-laws of the chit fund are required to be filed with the Registrar, duly signed by the foreman and on such certification by the Registrar, the chit fund shall be permitted to commence the business. It defines the foreman “means the person who under the chit agreement is responsible for the conduct of the chit and includes any other person discharging the functions of the foreman”. From the above, it is obvious that, the foreman is none other than the person who carries on the business of the chit fund and therefore, in the instant case, the foreman is the company itself, of course it carries on its act as foreman through its officers.
4.2 The Act defines the rights, duties and liabilities of a foreman. Section 13 of the Chit Fund Act prescribes the rights of foreman to include, (a) to obtain the chit amount at the installment specified in the chit agreement; (b) commission or remuneration not exceeding 5% of the chit agreement; (c) receive or realize the contributions from the subscribers, distribute the prize amounts to the prized subscribers and the dividend amongst the subscribers; (d) demand sufficient security for future payment of subscription from the prized subscribers; (e) substitute subscribers for defaulters.
The duties of the foreman as provided by Section 14 of the Act are (a) pay to the prized subscriber the prize amount on his providing adequate security towards future subscription; (b) owing to the default of the prized subscriber, the prize amount remaining unpaid, deposit the amount in an approved bank account; (c) intimate to the subscribers about every payment of prize amount, deposit of future subscriptions, deposit of unpaid prize amount in a bank account; (d) not to appropriate for himself any amount in excess of the amount of subscription and the amount of commission or remuneration of 5% of the chit amount except to the extent of interest accruing to the extent of the amount deposited in bank account of unpaid prize amount owing to the default committed by the prized subscriber.
The liability of the foreman towards the subscriber is provided in Section 17 of the Act and it provides that he shall be liable to account for the amount due to the subscribers.
4.3 The Sub-clause (a) of Section 13 indicates that, the foreman is entitled to obtain the chit amount at the installment as specified in the chit agreement. The “chit amount” has been defined in Section 2(4) of the Act as, “the sum total of the subscriptions payable by all the subscribers for any installment of a chit without any deduction of discount or otherwise”. The above seem to indicate that, the foreman could also be a subscriber, for otherwise he could not have the right to claim the chit amount. This observation is based on the fact that, the foreman being the company and the contract being with the members of the chit only, the element of mutuality creeps in. The bye-laws of the company issued in connection with its chit activity under the heading of ‘rights of foreman’ are on similar lines as contained in Section 13(a) of the Act, i.e., permitting the foreman to subscribe for one ticket as and when he or it needs and further to obtain the chit amount at the installment specified in the chit agreement without any auction. The words’ without any auction’ are important. This would mean that, as a matter of right, the foreman can obtain any chit at an installment as specified in the chit agreement without any deduction for discount on the amount of the chit. To put it in other words, the foreman could take the whole of the chit installment for himself, which is not permissible to any other subscriber of the chit.
4.4 The terms which are frequently in use in relation to a chit fund, viz., “chit”, “chit agreement”, “discount”, “dividend”, “prize amount”, “prized subscriber”, “subscriber”, “ticket” have been defined in Section 2 of the Act. “Chit” has been defined as a transaction entered into by a foreman with a number of subscribers, that every one shall subscribe a certain amount for a definite period, in return of which each of them shall be entitled to a prize amount either by draw of lot or auction or tender. The “chit agreement” has been defined as’ a document of understanding between the foreman and the subscriber. The term “discount” has been defined as the amount which the subscriber is willing to forego, which is to be utilized for meeting the expenses of running the chit business or for distribution between the subscribers or for both. The term “dividend” means the share from the discount received by a subscriber, which is normally adjusted towards the amount of subscription payable in the immediately following installment. “Prize amount” means the difference between the chit amount and the discount. “Prized subscriber” means the subscriber who is/has entitled to receive/received the prize amount. “Subscriber” is one who has either subscribed for the chit or a holder of fraction of the ticket or a transferee of a ticket or its fraction. “Ticket” means the share of a subscriber in a chit.
4.5 The bye-laws in relation to the chit gives particulars of the foreman; scheme, object and place of chit; the total number of tickets per chit; total number of installments and the number of subscribers; how to be a subscriber, commencement and termination of chit; place of payment of subscription; place, date and duration of auction; who are eligible to bid; how to determine the successful bidder; procedure to be followed in the event of a tie or there being no bidder; how to pay the prize amount; rights of foreman and other matters as are provided in the Act such as getting security for future subscriptions etc.
The bye-laws relating to the persons who would be eligible to bid has provided that, any subscriber or the foreman on behalf of any subscriber on his written instruction may bid in the auction. In the mode of determining the successful bidder, it has been provided that, the initial discount at the commencement of an auction shall be 5% of the chit value and the highest discount shall be 30% of the chit value and the successful bidder would receive the prize value equivalent to 70% of the chit value. In case of no subscriber forthcoming to bid, the foreman shall take lots at5% discount amongst the non-prized subscriber, who have paid their installments in full, and whosoever is successful in that lot is the successful bidder. The Act has used the term “Chit amount” to mean the sum total of the subscriptions payable by all the subscribers for any installment of a chit without any deduction of discount or otherwise. Since the bye-laws had to be necessarily be in conformity with the Act, the term chit value and chit amount have to be taken to mean the same thing, i.e., sum total of the subscriptions payable by all the subscribers for any installment of a chit without any deduction of discount or otherwise. The above indicates two situations. One, where the subscribers make a bid and the second, where no one bids. In the former case, the initial discount is 5% and the maximum discount is 30%. In the latter case, the discount remains at 5%, for there are no bidders and no one can force any unwilling bidder to raise the discount. The above also provides that the foreman can make a bid on behalf of any subscriber, only on his written instructions and not otherwise. It has added by way of a note that, in case of monthly chits, the foreman’s commission of 5% shall first be deducted from the discount amount and the balance of the discount shall be distributed between the prized and the non-prized subscriber. The foreman shall in all bids would be entitled to appropriate for himself the commission of 5% of the chit amount out of the discount and only the balance shall be available for distribution between the subscribers.
In the rules and regulations of the chits conducted, clause 1 has defined the functions of the foreman. This is reproduced for facility:
The company as foreman conducts Auction of Drawing Chits on or more or less mutual aid or co-operative basis under the following rules and regulations framed to aid saving and to enable the subscriber to obtain financial accommodation on easily repayable terms, while safeguarding the interests of the other subscribers by taking securities from the prized subscribers. In mutual interest therefore, the subscribers shall strictly abide by the rules and regulations of the Chits.
The reading of the above clearly goes to point out the element of mutuality between the foreman and the subscribers and also amongst the subscribers themselves.
4.6 The Act does not mention directly the right of the foreman to bid on his own behalf, except when it deals with the provision of security by a prized subscriber in Section 23 of the Act. The section reads “Before receiving the prize amount without deducting the future subscriptions, every prized subscriber shall furnish and foreman shall take sufficient security for the due payment of future subscriptions and if the foreman is the prized subscriber, he shall give security for the due payment of future subscriptions to the satisfaction of the Registrar”.
4.7 We having outlined the functioning of the chit broadly, we shall now proceed to examine the facts of the assessee’s case as had been placed before us by either party.
4.8 The assessee had floated in all 134 chits at its branches, v/z., Fakirabad, New Delhi and Chandigarh. Of these, 31 are still continuing as at the close of the accounting period. In the 128 chits at Fakirabad branch, the total subscriptions collected had been shown at Rs. 7,48,024. Of these chits, the auctioned chits number 64 and the auction dividend and the prize amount have been shown at Rs. 5,80,000 and Rs. 13,70,000 respectively. The aggregate of the subscriptions Rs. 7,56,500 as received is reflected in the Balance Sheet as contra. The amount shown as due from prized subscriber is shown at Rs. 39,21,389/90, which amount is said to be secured to the extent of Rs. 10,47,844 (note No. 6 which is said to explain this security has however not been filed by the respondent). Rs. 19,55,000 being the total of the auction dividend and the prize amount from all of the chits, has been shown as due to chit account by the company as contra items on the Balance Sheet. The credit side of the profit & loss account shows Rs. 1,90,095 as dividend on own subscription, commission on own chits Rs. 94,075 and Rs. 2,06,500 as commission received. On the debit side, Rs. 5,68,500 has been claimed as expenses under the head “bid amount on own chits”. The net result of the year as per the profit & loss account is the loss of Rs. 6,45,463. The issue in the appeal relates to the three items, two of which are reflected as receipts or income, viz., commission on own chits and dividend on own subscription of Rs. 84,075 and Rs. 1,90,095 respectively and the debit of Rs. 5,68,500.
According to the DR, neither the income or receipt on own chits are taxable nor the bid expenses on own chits allowable. The assessee claims that the receipts are taxable as business income and the expense too is allowable as deduction from the business income. The assessee had submitted that, the company can hold one or more chits in any series. This submission is contrary to the bye-laws Clause (r) which allows the foreman to subscribe for one ticket only in any chit, which means that, the foreman can hold only one ticket per series. The other submission made by the assessee was that, the foreman can make a bid on his own behalf, which appears to be within the ambit of the Act, in view of the provision contained in Section 23 of the Act, as observed above. The bye-laws Clause (r) provided that, the foreman is entitled to obtain the chit amount without deduction of any discount at the installment specified in the chit agreement. When the foreman could receive 100% of the chit amount, then why would he be interested to suffer a loss to the tune of 25% of the chit amount (i.e., discount amount 30% less 5% foreman’s commission)? According to the assessee, this was so opted to ensure the retention of the liquid funds with the company and this was a prudent business decision. As brought out above, out of a total of 128 chits, the company is said to have made its bid with discount of 30% in as many as 64 chits. Some of these chits are said to come from the last year, and some others are said to have been floated in the year and continuing.
The chit amount has been defined as the sum total of the subscription payable by all of the subscribers, and as admitted by the assessee and also accepted by the revenue, the term principal amount of the chit is the same as the chit amount defined in the Act, and this amount is divided by No. of installments, thus arriving at the amount payable per installment. For example, a chit amount of Rs. One lakh payable in 20 installments would result in the installment amount of Rs. 5000. If the chit has twenty subscribers, then at the end of each installment date, the company would have Rs. One lakh (20 X 5000). Therefore, whenever any auction is held, most of the subscribers would have paid their installments till the last date before the auction is to take place, and thereby, the company would have collected by way of subscription 100% of the chit amount at each stage, from which only the prized amount of 70% would become payable and the company would always have retained 30% of the chit amount at the end of every auction. It is to be appreciated that, to the extent of 30%, there is no dilution of any funds, for they are not paid out but, only adjusted towards the immediately following installment of the chit subscription. This could be said to be in the nature of overflow of funds and at the time of the next auction, the amount received from the subscribers in the aggregate would be less to the extent of 25% of the chit amount, i.e., the net amount collected would be 75% of the chit amount. The company which is allowed to meet its expenses from out of 5% commission, always has enough funds to meet its expenditures and can never run short of liquid funds. In addition to these factors, it also needs to be borne in mind that, the foreman is expected to provide security to the satisfaction of the Registrar, whenever he happens to be the prized subscriber, as per Section 23 of the Act. The security provided to the satisfaction of the Registrar and that too as required under Section 12 of the Act, i.e., amount as is held to be sufficient for the realization of the chit amount and in case of there being more than one chit, then in respect of each such chit and which is in relation to the claim of the subscribers on the foreman, as per Balance Sheet is Rs. 55,000 only. Section 23 which talks of providing of security for future payment of installments to the satisfaction of the Registrar, where foreman happens to be a prized subscriber and there is no mention about the security so provided by the foreman in respect of 64 chits whose principal amount or the chit amount or the chit value is to the tune of Rs. 10 lakhs approximately (i.e. 50% of Rs. 19,50,000). In case the company is unable to meet its expenses from out of this 5% commission, then, what purpose it would serve the company to further suffer a loss to the tune of 30%, and also to further reduce the inflow of funds to its till in the future? The subscription collected for these 64 chits are much lower than even the commission amount of 5%. This is evident from the fact that, on a total of 128 chits, the subscription collected has been shown at Rs. 7.56 lakhs only while the chit amounts to Rs. 19.55 lakhs. The liability side of the Balance Sheet indicates that, the company is due to subscribers Rs. 51.98 lakhs and the asset side indicates the amount due from subscribers Rs. 39.21 lakhs. In case we exclude the contra amounts of Rs. 7.56 lakhs – Co.’s contribution to chits, and Rs. 19.55 lakhs – due from company on chit account, then the Balance Sheet would appear as follows:
Balance Sheet of the company as at 30th Oct., 1990
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Liabilities Rs. Assets Rs.
Lakhs Lakhs
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Share capital 03.01 Fixed assets 01.21
Due to chit subscribers 51.98 Due from prized subscribers 39.21
Chit dividend adjustable 03.43 Dividend adjustable 02.65
Other items 01.00 Prized chit adjustable 00.53
Bank & cash balance 06.83
Advances etc. 02.01
Debit balance from P & L a/c 06.98
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Total Rs. 59.42 Total Rs. 59.42
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From the above it can be seen that the company is obviously short of liquid funds and would continue to remain so, might lead itself to the situation of insolvency. The company is very well aware of this position and knowingly why should it do what it purported to have done, i.e., to suffer the discount to the tune of 25% of the chit amount and yet be liable to that extent to the other subscribers. Is the company gratuitous to its subscribers ? The chit bye-laws of the company provides that in the event of none of the subscribers forthcoming for the bid, the discount shall be 5% and if it has to be proceeded on the basis that, none of the subscriber came forward to bid in the 64 auctions held by the company, the discount would have been limited to 5% only, then why should the company bid and lose the additional amount of 25%, and lead itself to insolvency ? These are several questions which need answer to the poser before us, which has not been answered either by the CIT(A) or by the assessing officer.
4.9 The aspect of mutuality has also not been touched upon by the CIT( A). Section 28(iii) of the I.T. Act, 1961 provides for the treating of receipts by mutual associations in respect of specific services rendered by it to its members. The assessee company is a mutual association is not in dispute. The fact of mutuality has been so brought out by the company in its rules and regulations and it is clearly established by the fact that, the company has enlisted subscribers for each of the chits and it is only who could deal in with the company in respect of the chits and no outsiders are entitled to be even present at the time of auction. It is so obvious by the fact that, the discount/dividend is to be shared between the subscribers only and that too of each particular chit, which is indicating the fact of sharing of profit by members only.
Now the question that arises is what is that service which is rendered by the company to its members ? The service rendered by it is the maintenance of various records, conducting of the auction, accounting for the subscription received, etc., for which it has reserved itself the 5% commission, which is clearly its income, which would be liable to tax Under Section 28(iii) of the Income-tax Act.
4.10 The reliance placed on the decision of Andhra Pradesh High Court in the case of Kovur Textiles & Co. (supra) is of no assistance to the assessee, for in that case, the finding of fact was that, the assessee had contributed to the chit with the view to finance its business and when it need funds, had opted to get the prize amount and had to suffer the discount to the tune of 30% of the chit amount, which was in the nature of finance charges, and hence allowable. In the instant case, the assessee has not been able to establish the fact of the need for its business of running of chit but rather the fact goes to indicate that it does not appear to be prudent business tactics. The ruling in Kovur Textiles & Co.’s case (supra) the aspect of mutuality was not raised and therefore, could not be considered. In the instant case, the business expediency has not been established, the aspect of mutuality would survive.
The other ruling in the case of Marauders Chit Funds (P.) Ltd. (supra) by the Andhra Pradesh High Court is also of no assistance to the assessee. In that case, the issue was regarding the taxability of the amount of dividend retained from the defaulting subscribers, which had to be given over the substituted subscribers, was held to be not the co.’s income, for it was being held in fiduciary capacity. The issue of loss on bids by the foreman was never an issue in that case and therefore, this ruling cannot be an authority for the proposition advanced by the company.
The ruling of the Punjab & Haryana High Court in the case of Soda Silicate & Chemical Works (supra) the issue of discount on bidding of chits claimed as a business loss was examined and it was held that, there existed the element of mutuality amongst the contributors and the participators of the chit and therefore, the discount is not allowable as a business loss. They further observed that, neither the income could be brought to tax nor the loss could be allowed as a deduction. To this ruling, the counsel for the assessee had pointed out that, the decision would have no application to the assessee’s case, for the assessee was existing for the sole purpose of carrying on the chit fund business. We are of the view that, though there is no dispute to the fact that, the assessee does carry on the chit fund business, and the receipt for specific services is taxed Under Section 28(iii) of the I.T. Act, but its activity which involve contributing to own chits, bidding of own chits and suffering losses on own chits are all related to mutual transactions between itself and the other subscribers and therefore, the Punjab & Haryana High Court would be applicable on all fours to the assessee’s case. The ruling of the Supreme Court in the case of Chunilal V. Mehta & Sons (P.) Ltd. (supra) which was cited for the proposition that it is for the assessee to choose the manner of maintenance of the accounts and since has adopted mercantile system, the assessing officer was wrong in rejecting the claim of this loss by observing that, the profit or loss on a chit could be derived only on the completion of the chit and not otherwise. There is no dispute to this principle but primarily in the instant case the system of accounting adopted by the assessee would not change the aspect of mutuality on these transactions, therefore, whatever method the assessee chooses, by the very nature of the transactions, the element of mutuality being existing, the character of the expense that it is not allowable cannot undergo any change.
4.11 We are therefore of the opinion that, bid amount on own chits of Rs. 5,68,500 and the commission amounts of Rs. 1,90,095 and Rs. 94,750 being to related to mutuality are therefore outside the ambit of the I.T. Act and hence, neither the expense claimed is allowable nor the income shown to this extent are taxable. The order of the CIT(A) is accordingly set aside.
4.12 In the result, the appeal is allowed.