JUDGMENT
S. Ranganathan, J.
1. This is an income-tax reference in the case of Dalmia Dadri Cement Ltd. For the assessment year 1962-63, for which the relevant previous year was the year which ended on December 31, 1961. Four questions have been referred for the decision of this court :
“1. Whether, on the facts and in the circumstances of the case, the amount of Rs. 4,45,618 realised by the assessed should be treated as the assessed’s business profits for the assessment year 1962-63 ?
2. Whether, on the facts and in the circumstances of the case, the amount of Rs. 67,067, being interest paid on income-tax arrears, Rs. 7,680, being commission paid on shares borrowed for the purpose of pledging them as security against income-tax demands, are permissible deductions under the provisions of the Income-tax Act, 1961 ?
3. Whether, on the facts and in the circumstances of this case, the sum of Rs. 37,359, being the gratuity payable to certain employees of the assessed-company in terms of a scheme dated April 8, 1955, was a permissible deduction while computing profits and gains of the business carried on by the assessed-company ?
4. Whether, on the facts and in the circumstances of the case, the amount of Rs. 21,110 could be deducted while determining the income of the company ?”
2. It will be convenient to take up the second and third questions for disposal at the outset as there is not much controversy about them. The assessed paid a sum of Rs. 67,067 by way of interest on its income-tax arrears. In order to obtain a stay of recovery of the tax demand raised against it, the company had to offer security to the Government. For this purpose, it persuaded M/s.Bhriguraj Charity Trust to pledge certain shares belonging to them by way of security and for this service the said Trust was paid a sum of Rs. 7,680 as commission. The question raised was whether the amount of interest paid on income-tax arrears and the commission paid on shares borrowed for the purpose of pledging them as security against the income-tax demand raised against the assessed are permissible deductions against the assessed’s income from business under the provisions of the I.T. Act.
3. Mr. G. C. Sharma, learned counsel for the assessed, contended, relying upon the decisions of the Supreme Court in Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT [1965] 56 ITR 52, India Cement Ltd. v. CIT [1966] 60 ITR 52 and Indian Aluminium Co. Ltd. v. CIT [1972] 84 ITR 735, and the provisions contained in s. 40(b) of the I.T. Act, 1961, that the assessed is entitled to the deduction of the above expenditure. The same question has come up for consideration for earlier years in the case of the assessed. We have discussed the matter in I.T.R. 34/71 (Dalmia Dadri Cement Ltd. v. CIT [1980] 125 ITR 425), which was disposed of by us a few days ago. For the reasons set out, in our judgment dated November 12, 1979, in I.T.R. 34/71 we hold that the assessed is not entitled to the deduction of the above amounts.
4. The third question arises in the following circumstances. The assessed-company and its employees had entered into a settlement on April 8, 1955, in respect of certain disputes between them. Under the settlement, the assessed agreed to implement a scheme of gratuity with effect from April 8, 1955. Broadly speaking, under the said scheme, the assessed agreed to pay gratuity to its employees on their retirement or death in the following circumstances : where the employee had completed fifteen years of service; where the employee died while in the service of the company : where the employee retired on his sown accord due to continuous ill health duly certified by the company’s medical officer; where the employee’s services were terminated by the company for a reason other than dismissal or discharge due to inefficiency or misconduct and where the employee’s services were terminated on his attaining the age of 60 years. The scale of gratuity payable was 3/4th of a month’s basic wage for each completed year of service subject to the proviso that, where the employee’s services were terminated for reasons of misconduct or inefficiency, he would be entitled as gratuity to an amount equal to 7 days’ basic wages for each completed year of service. The assessed debited in its books during the calendar year 1961 a sum of Rs. 52,882 to the P & L Account as provision for retirement gratuity. During the period of account a sum of Rs. 15,526 was actually disbursed as gratuity to certain employees who retired during the year. Deducting this amount the balance of Rs. 37,359 (sic) was credited to a provision account. The assessed claimed the whole sum of Rs. 52,882 as a deduction in its assessment for the assessment year in question. The ITO, however, allowed only the sum of Rs. 15,526 actually paid and disallowed the balance of the amount as representing a contingent liability which had not crystallized into an expenditure or into an accrued liability. Before the Tribunal it was contended on behalf of the assessed that the allowance should have been made at least to the extent that the provisions covered amounts relating to employees who had already completed fifteen years of service. But according to the Tribunal even in respect of such persons there were contingencies in which the gratuity was not payable. The Tribunal held that the amount which was not actually paid during the period of account was not an allowable deduction. The assessed has, therefore, sought a reference to this court for a decision of the question whether the assessed is entitled to a deduction of a sum of Rs. 37,359 provided for towards retirement gratuity.
5. This question has been set at rest by a large number of decisions. Though the Supreme Court held in the Standard Mills’ case [1967] 63 ITR 470 (in the context of the W.T. Act) that the liability for payment of gratuity in circumstances somewhat similar to the present case was only a contingent liability which could not be treated as a debt for the purposes of the W.T.Act, it was also indicated that an allowance in respect of this liability can be made in the computation of the profits of a business in the commercial sense of that term. This is laid down in the decision of the House of Lords in the case of Southern Railway of Peru [1957] 32 ITR 737 as well as the decision of the Supreme Court in Metal Box case [1969] 73 ITR 63; 39 Comp Case 410. These decisions make it clear that, for income-tax purposes, a trader, who is under a definite obligation to make to his employees, for their services in a year, an immediate payment and also a future payment in some subsequent year, may properly deduct not only the immediate payment but also the present value of the future payment provided such present value can be satisfactorily determined or fairly estimated. Following this principle, it has been held by several High Courts that where an assessed makes an actuarial valuation of the present value of this future liability, he is entitled to deduct such present value in arriving at his business profits for each accounting year. We may refer in this connection to the decisions in India United Mills Ltd. v. CIT , Tata Iron & Steel Co. Ltd. v. D. V. Bapat, ITO , CIT v. High Land Produce Co. Ltd. [1976] l102 ITR; 803 (Ker), CIT v. Laxmi Sugar and Oil Mills Ltd. and CIT v. Standard Furniture Co. Ltd. [1979] 116 ITR 751 (Ker)[FB].
6. Reference may also be made to the decision of the Delhi High Court in the case of Delhi Flour Mills Co. Ltd. [1974] 95 ITR 151 in which the entry regarding the expenditure claimed was slightly different. In that case, what the assessed did was that, on the basis of a settlement arrived at with its employees, it credited each employee with the addition to the amount of gratuity to which he would normally be entitled at the end of his service referable to his service in that particular year. The amounts thus credited to the accounts of several employees were debited to P & L Account and claimed as a deduction. The court found that the contingencies of an employee not being entitled to a gratuity were remote and that, having regard to the terms of the settlement, the method of accounting employed by the assessed properly reflected the liability incurred by the assessed in the year of account towards the payment of gratuity and that the assessed was entitled to claim the deduction in question.
7. The above decisions clearly show that even though the liability of the company to pay gratuity is a future and contingent liability, an assessed is entitled to claim deduction for income-tax purposes where he ascertains the present value of such liability in some satisfactory manner. This can be done either by arriving at an actuarial valuation as has been done in some of the cases referred to above or by actually crediting the amount of each employee with gratuity attributable to a particular year on the assumption that the gratuity would be so payable to him. We, therefore, hold that in the present case also the department was not justified in disallowing the claim made by the assessed. We are not able to ascertain from the statement of facts and the orders of the authorities the basis on which the assessed debited Rs. 52,882 to the P & L account. The correctness of this basis has not been examined. That apart, in our opinion, even if the basis on which the assessed has claimed the amount may not be correct, it is open to the assessed to claim, in view of the decisions above mentioned, that the present value of the future liability ascertained on the basis of an actuarial valuation should be allowed to be deducted by him. We, therefore, answer the question referred to us by saying that the assessed is entitled to deduct towards gratuity payable to its employees an amount equal to the present value of the liability under the settlement referable to the calendar year 1961 arrived at on an actuarial basis. We leave it open to the authorities, while implementing the judgment of this court, to give an opportunity to the assessed to establish the extent to which the claim can be allowed. The third question is answered accordingly.
8. We shall now take up the first question. The amount involved is somewhat substantial but the relevant facts fall within a very narrow compass. The assessed, as its name indicates, is a company which carries on business in the manufacture and sale of cement. The cement manufactured by the assessed was packed and sold in gunny bags. The assessed was required by the law to packed the cement in new gunny bags and so the assessed had to enter into contracts in advance for the purchase of the very large number of gunny bags needed by it. Between May/August and September, 1960, it entered into contracts with a firm in Calcutta for the supply of the requisite number of bags for delivery between December, 1960, and March, 1961. Though these contracts had been entered into in advance, it is not the case of the department or the assessed that they were speculative contracts. They were contracts entered into with the intention that the assessed should take delivery of the bags between December, 1960, and March, 1961, and use the same for the purposes of its business.
9. However, during the calendar year 1961, an unexpected development took place, possibly on account of the scarcity of jute and jute products. In December, 1960, the company was informed by the Government that it was permitted, as a temporary measure, to use second-hand jute bags for packing cement from January 1, 1961, to August 30, 1961. The terms and conditions subject to which this permission was granted were set out in the letter of the Ministry of Commerce and Industry dated December 17, 1960, addressed to the assessed. This letter also makes it clear that packing charges payable to cement producers for cement packed in new and second-hand bags for the period from January 1, 1961, to June 30, 1971, would be Rs. 13 per ton.
10. On receiving the above permission from the Government, the company came to the conclusion that the new gunny bags which it had contracted to buy were not necessary. The company’s decision was arrived at partly because it was permitted to use second-hand bags and partly because the anticipated production, on the basis of which the contracts had been made, did not materialise. The company implemented this decision in the following manner. The contracts for the gunny bags were not cancelled. Only the new gunny bags contracted for were not taken delivery of but were disposed of by the suppliers on the company’s behalf. In the meantime, the prices of gunny bags had risen and the result of the above arrangement was that the suppliers paid to the assessed an amount of Rs. 4,45,618, being obviously the difference between the price at which the assessed had agreed to purchase the gunny bags and the price for which the suppliers had been able to dispose of them in compliance with the directions of the assessed. In other words, as a result of the above decision and transaction the assessed made a profit or surplus of Rs. 4,45,618 in the purchase and sale of gunny bags.
11. The above sum of Rs. 4,45,618 was included by the ITO as a part of the assessed’s business profits for the assessment year 1962-63.He rejected the assessed’s claim that this was a casual and non-recurring receipt. He held, that the contracts for the supply of gunny bags had been entered into by the assessed in the course of its business in the manufacture and sale of cement and that the profit earned by not taking delivery of the gunny bags, but having the same disposed of, was in the ordinary course of business.
12. The AAC confirmed the assessment in this respect, rejecting the contention urged before him that as the assessed was not carrying on a business in the purchase and sale of gunny bags and as the profit was made on account of accidental circumstances which rendered it unnecessary for the assessed to take delivery of the bags which had been required for the business, the surplus could not be described as profit of the business but was a profit which was produced by chance and was fortuitous. The AAC wrote :
“It seems to me that all the arguments of the appellant’s counsel proceeded on the assumption that the advance contracts for the purpose of gunny bags were severable from its business of manufacturing and selling cement and that the entering into of the advance contracts for the purchase of gunny bags was a venture by itself and the activity did not amount to carrying on the business. I am, in this connection, referring not only to arguments advanced before me but also, the letter dated 29-11-1966, addressed by the appellant to the ITO. It appears to me that the arguments have not been founded on sound premises. I do not find any valid justification for taking the view that the advance contracts were a venture by itself and not a part of the business operations of the company. The appellant required gunny bags as an essential item in conducting its sales, so much so, that even the quality of bags to be used was regulated by the Government orders. It has not been denied that the re-sale of gunny bags was made by Becker Gray & CO. (P.) Ltd. On the instructions of the appellant and in fact they had even charged their commission (attherat) 3/4% on the re-sale value. The purchase of gunny bags was, therefore, directly related to the operations of business of the appellant. The transactions of advance contracts were entered into in the ordinary course of and for the purposes of the appellant’s business, and were, therefore, a part of the trading operations of the appellant. As the appellant was allowed to pack cement in second-hand gunny bags which were cheaper it decided to buy less costly items of stores and to realise the profit on the more costly items of stores already contracted for. The profit made by the appellant on the re-sale of gunny bags, which were like any other stores, was a profit made in the operation of the appellant’s business. The agreements by virtue of which the profit arose were not by themselves casual but were being regularly entered into. In all these circumstances there was no question of treating these contracts as a separate venture and in treating the profit arising on the re-sale of the gunny bags as a profit not liable to tax as a part of the business profit of the appellant. The contention is, therefore, rejected.”
13. The above view was confirmed by the Tribunal. The Tribunal held :
“We are inclined to uphold the addition made by the Income-tax authorities. The transactions clearly arose as an integral part of the assessed’s business. It was incidental to the assessed’s business not in the narrow sense. It was incidental to the assessed’s business in the sense that it arose as a normal incident of the day-to-day carrying on of the assessed’s business. As the departmental representative rightly pointed out, the original of the transaction as well as its conclusion and settlement both sprang directly in the process of carrying on of the assessed’s business from day-to-day. The transaction clearly concerned stores useful for the assessed for packing its final product. These stores were as consumable as any other stores like dyes and Chemicals and lubricants. For the purposes of accountancy and according to commercial usage in the matter of determining profits these items are put on a part with the trading stock. They are incorporative in the trading account either in the opening stock or in the closing stock or as an item of stores consumed. They are completely outside the category of fixed assets or fixed capital which are outside the pale of trading account. They cannot, according to any established accounting convention or established commercial practice, be confused with fixed assets or fixed capital. Any transaction entered into in relation to the stores was clearly relevant to the trading account and trading account only. It was also not correct to say that it ceased to have any relevance to the trading account because it was not the assessed’s normal business to sell gunny bags or because the surplus was realised without actually taking delivery of the goods or because the assessed had no intention to sell the gunny bags at the time the contract for purchase was entered into. It was enough for the purposes of treating the surplus as the assessed’s business profit if the gunny bags were purchased in the course of carrying on of its normal business, namely, manufacture and sale of cement. Disposal of packing material not wanted at a particular time is as much a normal business operation as the use of such packing material in packing one’s own goods. It was not necessary that there should have been an intention to sell the gunny bags in order to invest their subsequent sales with the character of a business transaction. Similarly, the fact that the assessed realised the surplus by settling the contract instead of taking delivery and disposing of them itself did not change the essential nature of the transaction. The important fact was that the transaction originated as a routine transaction of the assessed’s day-to-day business and its settlement in the light of business exigencies was equally a routine operation of the business. The contract which yielded a surplus, it must be stated at the risk of repetition, was a routine contract of the assessed’s business. It was as routine as the purchase of raw material like limestone and hand. It had nothing whatsoever to do with the company’s permanent apparatus for running the business. On the other hand, it had everything to do with the process of profit earning which required adequate supplies of packing material and their effective disposal when their stocks had piled up. It was also not possible to carry the surplus as casual or accidental. Fluctuations in the prices of raw material and stores including packing material is a normal hazard of the trade and ensuring of adequate supplies in advance and getting rid of excessive supplies is a part of the normal working of any trade. Profits realised on account of rise in prices and losses suffered on account of fall in prices, whether in respect of raw materials or stores or packing materials, is not a casual or incidental affirm. It is a matter of daily occurrence and the calculations of businessmen take into account all these matters. Moreover, even if the surplus were characterised as casual it cannot by any stretch of imagination be taken as anything but receipts arising from business and, therefore, even on that count the amount was not entitled to exclusion. All things considered, therefore, we are inclined to agree with the conclusion of the income-tax authorities that the amount in question was rightly treated as the assessed’s profit from business.”
14. We are in complete agreement with the reasoning and conclusion of the Tribunal. As pointed out by the Tribunal, the transactions arose as a normal incident of the carrying on of the assessed’s business in the manufacture and sale of cement. Fluctuations in the prices of raw materials, stores or packing material is a normal hazard of the trade and in the case of large manufactuers, it is a part of the normal trading operations to take steps in advance to ensure adequate supplies and equally to dispose of excessive supplies found to be unnecessary. Indeed, the price of the gunny bags is also built into the sale price of cement and so, sale of gunny bags can rightly be described as part of the assessed’s business operations.
15. Shri G. C. Sharma, appearing for the assessed, however, contended that the assessed was carrying on business only in the manufacture and sale of cement and that only the profits from this activity could be treated as the profits of the business. According to counsel, there is no such concept as a profit incidental to the business carried on by the assessed. This contention cannot be accepted as it proceeds on too simplistic an analysis of the nature of a business. A business in the manufacture and sale of a commodity involves various kinds of varieties of trading operations and any gain accruing to an assessed in the course of such operations, except to the extent they pertain to capital assets, would be revenue receipts arising from the business. Shri Sharma suggested that packing materials like gunny bags should be treated as capital assets but this suggestion is untenable. As rightly observed by the Tribunal, packing material, in accountancy and commercial practice, are put on a par with trading stock and they are outside the pale of fixed or capital assets. It is well settled that the losses incurred by an assessed would be treated as eating into the profits of a business where they are revenue in nature and arise out of or are incidental to the business. It should correspondingly follow that profits, though not strictly arising from the main operation of the business, really go to augment those profits when they arise out of the normal trading operations. An example of this is seen, for example, where surpluses arise in the course of trading operations due to fortuitous factors such as devaluation of currency which, it is now settled law, would constitute trading receipts : [vide CIT v. Canara Bank and Sutlej Cotton Mills Ltd. v. CIT . The argument of counsel that these profits cannot be taken as part of the business profits cannot, therefore, be accepted.
16. Shri Sharma also contended that, unless it is found as a fact that the assessed had been indulging in such sales of packing material year after year or habitually, the profits arising out of such sales could not be treated as revenue receipts. In view of the discussion above, it is not possible to accept this contention which seeks to isolate one of a series of inter-connected and mutually dependent trading operations of a business and tries to apply to such an operation the tests as to whether the assessed can be said to be carrying on a separate business therein. This, in our opinion, is not a correct approach to the problem. The business, as carried on by the assessed, has to be considered in all its ramifications and operations and if one of the operations incidental to such business yields a surplus, such surplus would be taxable as the profits of the business carried on by the assessed. In this view of the matter, the decision of the Supreme Court in State of Gujarat v. Raipur Manufacturing Co. Ltd. [1967] 19 STC 1, relied upon by Shri Sharma, is clearly distinguishable as, in that case, the court was concerned with laying down the circumstances in which an assessed could be said to be a dealer in certain goods, i.e., could be said to be carrying on a business in the purchase or sale of those goods. That decision, however, can be of no help in answering the question before us. Here a surplus arises out of a contract entered into in the normal course of trade and we agree that such surplus would be taxable and this would not depend upon whether such surplus has resulted only once or has arisen frequently, as the transaction is part of the trading operations and there is nothing in its nature to preclude its recurrence having regard to the nature and activities of the business. Even if by any stretch of imagination it could be treated or considered to be a receipt of a casual and non-recurring nature it will not be exempt under s. 10(3) as it is a receipt arising from business.
17. We, therefore, answer the first question in the affirmative and against the assessed.
18. We now come to the fourth and last question which raises a very interesting issue. The assessed-company had issued debentures, the interest on which was payable half yearly on 30th June and 31st December. During the calendar year 1961, the assessed purchased its own debentures on various dates at lump sum prices as below :
—————————————————–
Date No. of Purchase Face
debentures price value
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30-4-61 310 3,14,960 3,10,000
27-6-61 290 3,00,150 2,90,000
23-10-61 300 3,06,000 3,00,000
----------- ---------- ---------
900 9,21,110 9,00,000
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19. It was claimed before the ITO that, since the debentures had been purchased with interest and since the face value of the debentures as only Rs. 9,00,000, the additional sum of Rs. 21,110 paid for these debentures was deductible as interest on borrowed capital in the form of debentures. The question whether this claim could be accepted was answered by the ITO and the Tribunal in the negative though the AAC was inclined to answer it affirmatively.
20. Before dealing with this question, it is necessary to make a reference to the confusion created by the entries made by the assessed in its books in regard to this transaction. Originally, the assessed credited the various parties from whom the debentures were purchased with Rs. 9,21,110 and debited the investment account with Rs. 9,21,110. Subsequently, the investment account was credited with this amount, the contra entries being to the debentures account to the extent of Rs. 9,00,000 and loss on investment account to the extent of Rs. 21,110. In other words, the books reflected Rs. 21,110 as a loss on investment.
21. Subsequently, it was said, at the time of finalisation of accounts, it was realised that the debentures purchased were the debentures of the assessed itself on which the company was liable to pay interest to the debenture-holders “up to the date of purchase”. Such interest was computed as follows :
Interest on
Rs. Rs. P.
3,10,000 from 1-1-61 to 29-04-61 7,015.34
2,90,000 from 1-1-61 to 27-06-61 9,844.11
3,00,000 from 1-7-61 to 23-10-61 6,558.90
----------
23,418.35
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22. Thus, Rs. 23,418.35 was treated as interest on debentures and Rs. 21,110 as loss on debentures and the difference of Rs. 2,308.25 was accounted for as sundry receipts. In a letter to the ITO, the company subsequently explained that even these entries were not correct for there was, and could be, no loss on debentures at all and that the de facto and correct position would be :
Dr. Cr.
Debentures 9,00,000
Interest on debentures 23,418.35
To parties 9,21,110.00
To sundry receipts 2,308.35
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9,23,418.35 9,23,418.35
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23. We need not bother with these entries except to note that, having initially shown Rs. 21,110 as a capital loss, the assessed has finally recorded the transaction by showing that, having paid only Rs. 9,21,110 in respect of debentures of the face value of Rs. 9 lakhs and an accrued interest of Rs. 23,418 to the debenture-holders, the assessed had earned a surplus of Rs. 2,308.
24. The ITO noticed that, though the assessed had debited the interest account with Rs. 23,418, a sum of Rs. 21,110 had been set off there against and Rs. 2,308 had been credited to sundry receipts. He was of opinion that Rs. 21,110 was a capital loss liable to be disallowed. His disallowance of this amount thus brought Rs. 23,418 to tax. The AAC observed that the overall result of the transaction had to be taken into account. It could not be that, where interest receivable on the debentures was taken into account, the interest surrendered by the appellant proportionate to time could be disallowed. In other words, the loss which had been suffered was equivalent to the interest already earned by the other party and in all fairness such loss should have been set off against the income receivable by the appellant. He, therefore, deleted the addition of Rs. 21,110.
25. Throughout there was no controversy regarding the assessment of Rs. 23,418 as interest on debentures receivable by the assessed and we need not express any opinion on that issue. The only issue considered by the Tribunal, and also referred to us, is whether Rs. 21,110 can be said to be interest paid to the outgoing against the sum of Rs. 23,418 assessed in the assessed’s an hands. The Tribunal has answered this issue in the negative.
26. The answer given by the Tribunal would be clearly correct in the case of an assessed who is not a dealer in debentures. Thus, if A (such an assessed) were to purchase debentures of a company of the face value of Rs. 5 lakhs, at say Rs. 5,20,000 the entire sum of Rs. 5,20,000 would be a capital outlay being the price paid for the debentures. Although the extra price is paid because the debentures are pregnant with some accrued interest, no interest actually has become payable on the debenture until the due dates arrive. Thus, in between two payment dates, the extra payment made would only be part of the purchase price. When eventually A becomes assessable on the interest he receives on the debentures, he cannot seek to set off against such income the extra amount paid by him in purchasing the debentures by treating it as a payment towards “accrued” interest. Similarly, a seller of securities-cum-interest is not assessable in respect of the amount he receives “towards interest” from the purchaser. As Rowlatt J. observed in Wighmore v. Thomas Summerson and Sons Ltd. [1925] 9 TC 577, 581 (KB) :
“The truth of the matter is that the seller does not receive ‘interest’ and ‘interest’ is the subject matter of the taxation. He receives the price of the expectancy of interest, and that is not the subject of taxation….”
27. This position is clear from the decisions referred to by the Tribunal : viz., Haveli Shah Sardari Lal v. CIT [1936] 4 ITR 297 (Lah) and Rajniti Prasad Singh v. CIT [1929] 4 ITC 264 (Pat) [FB] and other decisions.
28. The only question for consideration is whether it makes any difference that the debentures purchased by the assessed were the debentures, not of some other company but of itself. The position was that the company was liable to pay Rs. 9 lakhs to the debenture-holders along with interest at the specified rate on the specified dates. Though on the dates on which the debentures were “purchased” no interest had fallen due, the debenture-holder would not part with the debentures or agree to allow the assessed to purchase the same (where a company is otherwise financially all right) unless he also gets payment of the accrued interest up to the date of such purchase. But where a company acquires its own debentures from one of the debenture-holders, the expressions “purchase” or “repurchase” of debentures has no meaning for, unlike some other purchaser of its debentures from one of the debenture-holders, a company cannot become its own debenture-holder or creditor; such a transaction can only mean that the company has redeemed the debentures and the transaction thus resulted in wiping off the company’s liability to the debenture-holder. This is quite clear from the decisions in Hummel v. George Routledge & Sons Ltd. [1904] 2 Ch 474 (Ch D) and Hoare v. W. Tasker & Sons Ltd. [1905] 2 Ch 283 (Ch D). This being the legal position, since the company owes the debenture-holder only the amount of the principal of the debentures and the interest payable thereon, the transaction means that this has been paid and so the excess payment over and above the principal can be attributed only to interest.
29. Pausing here, it is necessary to observe that the decisions in Routledge [1904] 2 Ch 474 (Ch D) and Tasker [1905] Ch 283 (Ch D) had been rendered despite the fact that in company law the debentures of a company were generally considered as having an entity or existence independent of the company. Though a debenture means only a debt borrowed by the company and the document evidencing the same, debentures have always been treated as assets, capable of being transferred from person to persons by mere delivery (when issued to bearer) or by endorsement and delivery (Cf. s. 108 of the Companies Act, 1956, in India, and s. 75 of the English Companies Act, 1948). They could be deposited by the company as security for loans (see s. 90 of the English and s. 121 of the Indian Companies Act). The two decisions above referred to and the decision in Samuel v. Jarrah Timber and Wood Paving Corporation Ltd. [1904] AC 323 (HL), show a commercial practice under which (a) debentures were issued merely as security for smaller amounts of loans advanced to the company by a creditor; (b) such debentures were got back by the company with blank transfers and were subsequently issued in favor of third parties who advanced full amounts by filling up their names therein; (c) they were transferred to and got registered in the name of the company and then transferred by the company to third parties for consideration received. These practices were declared to be of no avail by Routledge [1904] 2 Ch 474 (Ch D) and, if the matters stood there, the assessed might have been entitled to claim a deduction for the reason already stated.
30. However, the above position of extinguishment of liability no longer prevails. The legislature considered it necessary to intervene by the introduction of a specific provision which finds its present counterparts in s. 90 of the English Act of 1948 and s. 121 of the Indian Act of 1956 which are almost in pari materia. Section 121 of the Indian Act may be set out here for convenient reference :
“121. Power to re-issue redeemed debentures in certain cases – (1) Where either before or after the commencement of this Act, a company has redeemed any debentures previously issued, then,-
(a) unless any provision to the contrary, whether express or implied, is contained in the articles, or in the condition of issue, or in any contract entered into by the company; or
(b) unless the company has, by passing a resolution to that effect or by some other act, manifested its intention that the debentures shall be cancelled;
the company shall have, and shall be deemed always to have had, the right to keep the debentures alive for the purposes of re-issue; and in exercising such a right, the company shall have, and shall be deemed always to have had, power to re-issue the debentures either by re-issuing the same debentures or by issuing other debentures in their place.
(2) Upon such re-issue, the person entitled to the debentures shall have, and shall be deemed always to have had, the same rights and priorities as if the debentures had never been redeemed.
(3) Where with the object of keeping debentures alive for the purpose of re-issue, they have, either before or after the commencement of this Act, been transferred to a nominee of the company, a transfer from that nominee shall be deemed to be a re-issue for the purposes of this section.
(4) Where a company has, either before or after the commencement of this Act, deposited any of its debentures to secure advances from time to time on current account or otherwise, the debentures shall not be deemed to have been redeemed by reason only of the account of the company having ceased to be in debit whilst the debentures remained so deposited.
(5) The re-issue of a debenture or the issue of another debenture in its place under the power by this section given to, or deemed to have been possessed by, a company, whether the re-issue or issue was made before or after the commencement of this Act, shall be treated as the issue of a new debenture for the purposes of stamp duty, but it shall not be so treated for the purposes of any provision limiting the amount or number of debentures to be issued :
Provided that any person lending money on the security of a debenture re-issued under this section which appears to be duly stamped may give the debenture in evidence in any proceedings for enforcing his security without payment of the stamp duty or any penalty in respect thereof, unless he had notice or, but for his negligence, might have discovered, that the debenture was not duly stamped; but in any such case the company shall be liable to pay the proper stamp duty and penalty.
(6) Nothing in this section shall prejudice –
(a) the operation of any decree or order of a court of competent jurisdiction pronounced or made before the twenty-fifth day of February, 1910, as between the parties to the proceedings in which the decree or order was made;
(b) where an appeal has been preferred against any such decree or order, the operation of any decree or order passed on such appeal, as between the parties to such appeal; or
(c) any power to issue debentures in the place of any debentures paid off or otherwise satisfied or extinguished reserved to a company by its debentures or the securities for the same.”
31. It will be seen at once that the above specific statutory provision has a significant impact on the issue in the present case. It recognises and validates the practice of the debentures being dealt with by the company itself and saves the debentures from extinguishment on merely being purchased by the company. They are declared to be alive for reissue unless there is a specific provision to the contrary in the articles, or the conditions of issue of the debentures or a contract or a positive act or resolution on the part of the company cancelling them or putting an end to them on redemption. In the present case, neither does the statement of case disclose any such document, act or resolution nor has our attention been drawn to any such act, resolution, contract or other circumstance that would have the effect of extinguishing the debentures. The position, therefore, is that, even subsequent to the purchase by the company, the debentures retain their existence and individuality and are capable of issue or endorsement to another creditor of the company and, if this is done, such creditor will have “the same rights and priorities as if the debentures had never been redeemed”. Suppose, for instance, the company in the present case had reissued the 300 debentures purchased by it on October 23, 1961, to some third party (say X) in the next few weeks, the interest on the debentures for the period July 1, 1961 to December 31, 1961, would have been payable to and receivable by X. In such an eventuality, it will be clear that no portion of the payment made by the company while purchasing the debentures on October 23, 1961, could be attributed to the interest between July 1, 1961, and October 23, 1961, as contended for by the assessed. We have given the illustration only to clarify the position. It is not necessary, for deciding the issue here, to examine on facts whether any such issue was made by the company or not. The above discussion would show that except in the eventuality of the debentures having to be treated as cancelled, for the reasons given in s 121(1), the debentures, despite their purchase by the company, retain their separate existence. The company is, again, except in the above eventuality, in the same position vis-a-vis the debentures as any outside purchaser thereof. The records of the case do not indicate any facts to show cancellation and so we think the Tribunal was justified, in applying to the facts, the principles laid down by Rowlatt J. In Thomas Summerson and Sons [1925] 9 TC 577 (KB) and in the other cases referred to in it and disallowing deduction of the sum of Rs. 21,110.
32. Our attention was invited to the treatment to be accorded in books on accountancy to cases of redemption of debentures and their reissue. Shukla and Grewal, in their Advanced Accounts (1977), deal with the topic in detail. At p. 661, after referring to the fact that one of the three ways of redeeming debentures is by purchasing them in the open market (and this, as Palmer at p. 393 of his 21st Edn. states, can be done either by purchasing in the open market or by inviting individual holders to tender their holdings or a part thereof to the company at prices which they are prepared to accept) the entries to be made in the books are explained as follows :
“The basic entry to make, when debentures are deemed, is to debit the Debentures Account (because the liability is extinguished) and to credit Bank. But since sometimes the amount actually paid is more than, and, sometimes less than, the face value of the debentures, the above simple entry will not do. Only in case the amount paid is exactly equal to the face value of the debentures, the above entry will suffice. The various entries are given below :
Debentures Dr. The nominal value of the
To Bank Account debentures.
If the amount paid is more than the face value (at a
premium), the entry would be:
Debentures Dr. The nominal value of the
debentures.
Premium on Redemption of Premium paid on redemption
Debentures Account (representing loss on
redemption)
To Bank Account Actual amount paid.
If the debentures are redeemed at a discount, that is, the
amount paid is less than the face value of debentures, the
entry will be:
Debentures Dr. The nominal value of the
debentures.
To Bank Account The amount paid.
To Profit on Redemption The discount earned or
of Debentures Account profit made.
The profit on redemption of debentures is a capital profit but, if at the time of the issue of the debentures there was a discount and if such discount has not yet been written off, the profit, the profit on redemption of debentures may be used to write off the discount on debentures."
33. The entries made in the present case by the company in the first instance correspond to the above entried.
34. However, the above authors point out, debentures may not be purchased on the due date for payment of interest. These may be purchased in between the two dates of payment. In such cases, the purchase may be cum-interest in which case the seller will receive only the sale price and nothing more. Or the purchase may be ex-interest in which case the purchaser will have to pay interest in addition to the purchase price. In the former situation, in a case where 1- six-per cent. debentures of the face value of Rs. 100 each are purchased for Rs. 98 each on 1st October (the due dates for payment of interest being 30th June and 31st December) the entries will be as follows, say the authors (at p. 663) :
Rs.
"6% Debentures Dr. 10,000 Interest on Debentures Dr. 150 (between 1st July & 30th September) To Bank Account 9,800 To Profit on Redemption of 350." Debentures Account 35. It is explained that though the price being cum-interest, nothing is payable for interest : "... nevertheless, for making entry in books the purchaser has to calculate the interest to the date of purchase and debit the amount to the interest account, only the remaining amount being treated as the proper purchase price. The company purchasing its own debentures must follow the same rule." 36. The final entries passed by the assessed in this case correspond to these entries. 37. We would also like to extract two more passages from the above book which throw light on the treatment of debentures when purchased by the company as investments and subsequently cancelled. At p. 664, the authors say :
“Purchase of debentures as investment. – It is not necessary for a company to always immediately cancel its own debentures bought by it. In fact often companies buy their own debentures as investment because then it would be saving the interest which would otherwise have been payable. Such debentures are kept alive and can again be disposed of in the market. When a company buys its own debentures as investment and not for cancellation, an account called ‘own debentures account’ or ‘investment in own debentures account’ will be debited with the amount actually paid, disregarding the nominal value of debentures purchased. This account is an asset.
When own debentures are bought and kept as investment, the interest on such debentures should be calculated and credited to the profit & loss account, the debit being given to the interest on debentures account. In this manner the interest on debentures account will show the full amount due on outstanding debentures. The credit to the profit and loss account shows the gain made by the purchase of own debentures.”
and at p. 665, they point out :
“cancellation of own debentures – After the company has held some of its debentures, it may decide to cancel them. At that time the debentures account should be debited and ‘own debentures account’ credited. The debentures account should be debited with the face value of cancelled debentures, any difference between this and the value of ‘own debentures’ being debited to ‘loss on redemption of debentures account’ (if it is a loss) or credited (if it is a profit) to ‘profit on redemption of debentures account’. It should be noted that profit or loss on redemption of debentures arises only on cancellation of debentures.”
38. These are not directly relevant here, as no entries have been passed in the books on this basis, but these passages show that, in company practice, a company does often purchase its own debentures for several reasons and may also market it, as and when found necessary and, as pointed out above, this is also legally permissible now.
39. Relying upon the passages quoted above from pp. 661 to 663 it is contended for the assessed that the sum of Rs. 21,110 is property allowable as interest paid on the debentures. We are, however, unable to accept the contention for two reasons. In the first place, there is nothing on record to indicate that the purchase was ex or cum interest. All that is known is that the assessed purchased the debentures of Rs. 9 lakhs for Rs. 9,21,110. This being so, the first set of the entries made by the company were the correct entries to make. In this context, it will be noticed that the amount of accrued interest was Rs. 23,481 whereas the assessed had paid only Rs. 21,110. There is nothing to show that it was intended to be a purchase of the securities-cum-interest (by paying the face value as price and Rs. 21,110 towards interest as against Rs. 23,481 accrued till then). But, even otherwise, whatever may be the justification from the point of view of accountancy principles, in making notional entries towards interest calculated as having accrued up to the point of sale, in order to ensure that the company’s liability towards the interest payable in respect of debentures gets fully reflected in the books, we think, for the reasons already discussed, that, in law, the entire payment made by the assessed was capital in nature being the price paid for the debentures.
40. We, therefore, answer the last question referred to us in the negative and against the assessed.
41. To sum up, the questions are answered as follows :
Q. No. 1. Yes.
Q. No. 2. No.
Q. No. 3. Yes. But only to the extent indicated.
Q. No. 4. No.
42. In the circumstances, however, we make no order as to costs.
