ORDER
S. Kannan, Accountant Member
1. The short delay of 16 days in the filing of the appeals is condoned after hearing both the sides.
2. These two appeals by the assessee are directed against the common order in revision passed by the Commissioner of Income-tax, Tamil Nadu V, Madras, on 19-2-1992 under Section 263 of the I.T. Act, 1961.
3. The factual matrix necessary for the resolution of the issue before us may briefly be indicated. The assessee-corporation was established for the specific purpose of financing and developing industries in the Union Territory of Pondicherry. At the relevant point of time, its authorised capital stood at Rs. 15 crores and the paid-up capital at Rs. 14.47 crores. It receives applications for term and other loans from eligible persons, processes them and sanctions and disburses loans to them. It also sets up industrial complexes. Apart from its share capital, the major source of its finance is refinance from the Industrial Development Bank of India. It also takes loans from the IDBI under various schemes such as New Debt Insurance Scheme.
4. With a view essentially to improving the financial position in general and the working capital requirements in particular of which institution the Deposit Insurance and Credit Guarantee Corporation (DICGC for short) evolved a scheme called ‘Small Loans (Small Scale Industries) Guarantee Scheme, 1981’. The objective of the said scheme was to provide ‘guarantees to a substantial extent in respect of loans to borrowers engaged in industrial activity on a small scale and also in respect of credit facilities granted to organisations which may be assisting workers, artisans and other self-employed persons engaged in industrial activity’. Under the scheme, eligible credit institutions (the assessee before us, it is common ground, is one such institution) were provided by the DICGC a guarantee on account of the credit facility, that is to say, financial assistance, including a loan or advance, cash credit, etc. provided by the eligible credit institutions to persons engaged in the manufacture, processing or preservation of goods or functioning as servicing and repair workshops in specified lines or as ‘custom service units’ in the small scale industrial or small scale ancillary industrial sectors.
Broadly stated, the modus operandi is that the eligible credit institutions will, in the first instance, assess the extent to which the credit provided by them have become bad or doubtful of recovery. Based on such assessment, they would approach the DICGC for guarantee. The precise details of the working of the scheme need not detain us here. Suffice it to note that for the purpose of securing the said guarantee, the credit institutions entered into an agreement with DICGC. The extent of the guarantee provided by ranged from 50% through 75% to 90%, depending upon the categorisation done by DICGC in paragraph 9 of the scheme.
When the eligible credit institutions invoked the guarantee, the DICGC would process the matter and release necessary funds in accordance with the provisions of the scheme. On such release of funds, DICGC shall, to the extent of the amount paid by it on account of any facility to a borrower granted under the scheme, be subrogated to the rights of the credit institution and every amount which may be recovered by the credit institution from a borrower in respect of whom a claim has been paid shall, after deducting therefrom the expenses, if any, incurred after the payment of the claim for recovering the amount, be shared between DICGC and the credit institution in the ratios referred to supra. To make the said subrogation effective, the scheme obligated the credit institutions to take legal steps for the recovery of the debts in question which could not be written off by the credit institutions without the specific previous approval of DICGC. The scheme also provided a further safeguard. Under the scheme, if a particular eligible credit institution had advanced to the eligible borrowers more than one item of credit facility, some of which are covered by the scheme and some of which are not, the recoveries made by the eligible credit institutions from the credit facilities not covered by the scheme shall also be shared in accordance with the ratios referred to above.
5. As pointed out earlier, the assessee before us participated in the scheme. And obtained in the previous year relevant to the assessment years 1987-88 and 1988-89, which are now before us, guarantee funds from the DICGC as detailed below:
Asst. Year 1987-88 (previous year ending on 31-3-1987) ... Rs. 16,48,657 Asst. year 1988-89 (previous year ending 3,52,079 on 31-3-1988) ... Rs.
It may here be highlighted that the DICGC released guarantee funds neither in a lump sum nor in time-based installments. It used to release quarantee funds against each item of credit facility provided by the assessee which, according to the assessee, had become bad or doubtful of recovery and in respect of which the assessee had entered into an agreement with DICGC.
6. From the very nature of its operation, the major source of the assessee’s income was interest received by it on the credit facilities provided by it to eligible persons. The assessee also derived income by way of rent and miscellaneous income such as investigation fees, supervision charges and the like. The assessee filed its return of income for the assessment years 1987-88 and 1988-89 disclosing its income under the three heads aforesaid. In the assessments for the said two assessment years, which were completed respectively on 30-8-1989 and 5-5-1990, the Assessing Officer did not at all advert to the guaranteed sums received by the assessee from DICGC.
Subsequently, invoking the powers vested in him by and under Section 263 of the I.T. Act, 1961, the Commissioner of Income-tax called for and examined the assessment records of the assessee. On such an examination, he found that the assessment orders relating to the assessment years 1987-88 and 1988-89 were erroneous in that they were prejudicial to the interests of the revenue. In this regard, the following considerations weighed with him:
(i) The guaranteed sums received by the assessee had been shown by the assessee under the head ‘Current liabilities’.
(ii) Since money is the stock-in-trade of the assessee, the sums received by the assessee under the guarantee scheme were very much insurance money received against loss of stock-in-trade and consequently, the receipt was on revenue account.
(iii) By the same token, the amounts received by the assessee ought to have been credited to the Profit & Loss A/c. of the assessee and brought to charge.
(iv) The Assessing Officer had omitted to do so.
Accordingly, he put the assessee on notice of his intention to pass suitable orders in revision.
7. The assessee responded by making the following points:
(i) At the stage of assessment proceedings, the details of the sums received by the assessee from DICGC had been called for by the Assessing Officer and examined. Since the Assessing Officer did not treat the sums as receipts on revenue account, he did not make any addition on that count. Therefore, this was not a fit case to invoke the provisions of Section 263. The sums received by the assessee from DICGC were on capital account and not on revenue account.
(ii) Even if it is assumed that the sums were received on revenue account, no addition would be called for because the assessee would be entitled to a revenue deduction in respect of the stock-in-trade lost, namely, the debts that had become bad or doubtful of recovery. In such a situation, the provisions of Section 36(1)(vii) read with Section 36(2) would not apply.
8. In relation to the assessment for the assessment year 1987-88, an alternative contention was also raised. It was claimed that the aggregate sum of Rs. 16,48,657 received by the assessee from DICGC during the year of account ending 31-3-1987 included credit items aggregating Rs. 5,41,622 which had in the earlier year(s) of account been written off as bad and doubtful debts. Therefore, if at all any addition was called for in the assessment for the assessment year 1987-88, it should be restricted to the sum of Rs. 5,41,622 by virtue of the provisions of Section 41(4) of the Act.
No such claim was made in relation to the assessment year 1988-89 because, we are told, the aggregate sum of Rs. 4,52,079 received during the previous year relevant to that assessment year did not include any such items of credit in respect of which deduction had earlier been claimed under Section 36(1)(vii) of the Act.
9. None of the aforesaid contentions found favour with the C.I.T. starting from the proposition that money constituted the stock-in-trade of the assessee, the C.I.T. went on to hold that the sums received by the assessee from DICGC were nothing but insurance money received for loss of stock-in-trade and that consequently, it was a revenue receipt taxable as such. Secondly, the assessee’s claim for deduction on account of bad and doubtful debts (that is, stock-in-trade lost) cannot be allowed because the bad and doubtful debts in question had not been written off in the books of account of the assessee.
10. In view of the foregoing, therefore, he passed the impugned common order in revision directing the Assessing officer “to revise and enhance the assessments made in the assessee’s case for the assessment years 1987-88 and 1988-89 by bringing to charge the insurance receipts of Rs. 12,51,687 and Rs. 4,52,079 respectively for the two years and raise income-tax demands arising consequent to such revision.”
11. Two points need to be emphasised here. First, the figure Rs. 4,52,079 is clearly a typographical error for the figure of Rs. 3,52,079.
Secondly, as pointed out earlier, -in the previous year relevant to the assessment year 1987-88, the assessee had received an aggregate sum of Rs. 16,48,657 from DICGC. During the said previous year, it had also paid DICGC a sum of Rs. 3,96,970. It was, therefore, that the Commissioner directed the Assessing Officer to enhance the assessment for the assessment year 1987-88 by the net figure of Rs. 12,51,687 (Rs. 16,48,657 minus Rs. 3,96,970).
12. It is in these circumstances that the assessee is now before us.
13. Shri Philip George, the learned counsel for the assessee, took us through the facts and circumstances of the case and contended that the rationale behind the scheme was to provide funds to the assessee so that it could carry on its business of promoting and developing industries, without being hampered in any fashion by the bad and doubtful debts which arise from time to time. Given the basic purpose for which the assessee -corporation was set up and given the nature of its activities, bad and doubtful debts do arise. Had the assessee not entered into any refinancing/guarantee agreements, the bad and doubtful debts would have eroded its financial structure and brought its business to a grinding halt. The re financing/guarantee schemes are designed to prevent the aforesaid eventuality, by providing necessary finance from time to time so that the assessee could carry on its activities. Properly viewed, the scheme was designed to inject into the assessee’s business funds necessary to carry on its activities. Consequently, the funds thus injected could not be treated as the assessee’s income.
In relation to the financing activities of the assessee, the interest received by it is income that is chargeable to tax. And the assessee has been returning interest income on cash basis. According to Shri Philip, the funds received by the assessee under the scheme is qualitatively different from interest income which is chargeable to tax.
14. In view of the foregoing, therefore, contended Shri Philip George, the C.I.T. was not justified in passing the impugned order in revision.
15. As before the C.I.T., so before us, the assessee’s counsel raised an alternative contention in relation to the assessment for the assessment year 1987-88. He contended that the aggregate sum of Rs. 16,48,657 received by the assessee from DICGC included an aggregate sum of Rs. 5,41,622 which related to bad and doubtful debts which had been written off in the books of account of the assessee and in respect of which revenue deduction had been allowed to the assessee in the earlier year (s). According to Shri Philip George, if at all any addition was called for in the assessment for the assessment year 198788, the addition should be restricted to the said sum of Rs. 5,41,622, by virtue of the provisions of Section 41(4) of the Act.
As a corollary to the aforesaid proposition, Shri Philip George contended that the balance amount relating to the assessment year 1987-88 and the entirety of the sum of Rs. 3,52,079 relating to the assessment year 1988-89 could not be brought to tax because no deduction was allowed in respect of bad and doubtful debts (principal plus interest) represented by the said sums in any of the earlier assessment years.
16. Shri Philip George then contended that strictly speaking the sums received by the assessee under the scheme could not be equated to the insurance money under a policy relating to loss of stock-in-trade. It is true money is the stock-in-trade of the assessee; even so, the essential feature of the scheme was to provide funds to the assessee so as to enable to carry on with its activities, undeterred by the bad and doubtful debts that occur during the course of its activities.
17. In view of the foregoing, therefore, contended Shri Philip George, the assessee is entitled to succeed.
18. On his part, Shri Argal, the learned Departmental Representative, strongly supported the impugned order in revision. He first drew our attention to the fact that the assessee had exhibited the sums received by it from the DICGC under the scheme in question under the head ‘Current liability’. According to him, the sum in question not being in the nature of a loan could not be regarded as a current liability of the assessee. For a fact, no insurance amount is ever re-payable.
19. Turning then to paragraph XIV occurring under the caption “Subrogation of rights and recoveries on account of claims paid (paragraph 12 of the scheme)” of the Explanatory Note to the scheme, Shri Argal drew our attention to the fact that under the scheme, even collections out of non-guaranteed credits is sharable by the assessee with DICGC. According to him, the provisions relating to the sharing of the amounts collected by the assessee from its debtors after it had received the guaranteed amount from the DICGC (whether the collection related to guaranteed loans or non-guaranteed loans), are very much like provisions relating to the salvage value of the goods insured. This would mean that the scheme in question in essentially an insurance scheme. It should, therefore, follow that the funds received by the assessee from DICGC is insurance money relating to the assessee’s stock-in-trade namely, cash. Consequently, as has been rightly held by the C.I.T., the receipt is on revenue account and is, therefore, taxable as such.
20. Shri Argal then contended that the fact that under the scheme the assessee could not write off bad and doubtful debts without the previous approval of DICGC is neither here nor there. Under the scheme of the Income-tax Act, a revenue deduction is not available to the assessee unless the bad and doubtful debts are written off in the books of account of the assessee. In this case, the major part of the loans relating to the assessment year 1987-88 and the entirety of the loans relating to the assessment year 1988-89 had not been written off by the assessee in its books of account. Therefore, the assessee cannot get the benefit of revenue deduction in respect of bad and doubtful debts in question. Finally, Shri Argal summed up his arguments as follows :
(i) The funds received by the assessee from DICGC was nothing but insurance amount relating to the assessee’s stock-in-trade, namely, money..
(ii) Consequently, the receipts is question were on revenue account and are taxable as such.
(iii) The “salvage value”, that is the amounts recovered by the assessee from its debtors after it had received the funds from the DICGC are no doubt to be shared by the assessee with said Corporation; but that is separate and distinct from the insurance amount, namely, the guarantee amount received by the assessee.
21. In his reply, Shri Philip George, reiterated his position that the basic purpose of the scheme was to provide funds to the assessee so that the assessee could carry on its activities. The funds thus received cannot be regarded as the assessee’s income. When the assessee deploys the funds as and by way of disbursement of loans to eligible persons and earns interest thereon, then and then only, the assessee could be regarded as having earned taxable income, namely, interest income.
22. According to Shri Philip George, the provisions contained in paragraph 12 of the Scheme (Subrogation of rights and recoveries on account of claims paid), read with paragraph XIV of the Explanatory Note to the scheme, are designed to safeguard the interests of DICGC and to prevent foul play on the part of the eligible credit institutions which participate in the scheme. It is too much to equate the said provisions with the provisions relating to salvage value under ordinary insurance policies.
23. In view of the foregoing, contended Shri Philip George, the assessee is entitled to succeed.
24. We have looked into the facts of the case. We have heard the rival submissions.
25. In our view, the key to the issue before us is to be found in the legal consequences of the provisions of the Guarantee Scheme of 1981 under which the transactions in question had arisen. Before examining the issue in the said light, we may clear the decks as it were by dealing with the arguments advanced by both the assessee’s counsel and the Departmental Representative.
26. The basic contention of the assessee’s counsel was that the said Scheme was designed to inject working capital into the assessee’s financial system and that consequently, the guaranteed sums received by the assessee, which went to augment the working capital of the assessee, could not be regarded as the taxable income of the assessee. As we see it, this augment is too general to be accepted. May be, the Scheme was designed to augment the working capital of the assessee. The Scheme might have actually had the desired effect. Even so, neither the purpose of the Scheme nor its efficaciousness can decide the issue. As pointed out earlier, the issue will have to be decided in the light of the legal consequences of the Scheme.
27. The second argument of the assessee’s counsel was that if the guaranteed sums received by the assessee were to be brought to charge, then the assessee should be given the benefit of deduction under Section 36(1)(VII) of the Act, even though the majority of the bad debts covered by the guaranteed sums received by the assessee were not written off in its books of account. This is particularly because of the fact that under the scheme, the assessee could not write off the debts in question as bad or doubtful of recovery without the prior approval or consent of the Corporation.
This argument also will have to be rejected, because it too fails to take into account the legal consequences of the Scheme.
28. The case of the Department, it may be recalled, proceeds on the basis of setting up a parallel between the sums received under an insurance policy on the one hand, and the guaranteed sums received by the assessee under the Scheme, on the other. The said parallel is sought to be drawn on the ground that money is the stock-in-trade of the assessee and that the insurance sum received under a policy of insurance to guard against loss of stock-in-trade is a receipt on revenue account. The parallel is taken to its logical conclusion to argue that the provisions of paragraph 12 (which contemplates sharing between the DICGC and the eligible credit institution the monies recovered by the latter from the borrower after it had received the guaranteed sums from the DICGC) are akin to provisions of an insurance policy relating to salvage value of the goods insured.
29. As we see it, the parallel that the Department seeks to draw cannot be overdone.
Now, where goods are stock-in-trade, the cost to the assessee of the goods which he trades in is debited to the trading account. In other words, the sum debited relates to revenue account. When the assessee sells the goods, the sale proceeds are credited to the trading account so as to arrive at the true profits of the assessee. However, when goods, which are the stock-in-trade of the assessee, are say, destroyed by fire, and the assessee had taken an insurance to meet such contingencies, the insurance amount will necessarily have to be credited to the trading account. That is to say, the insurance amount relates to revenue field. If the insurance amount is not credited to the trading account, the purchase price of the goods destroyed by fire having earlier been debited to the trading account, the true profits of the assessee could not be deduced. In other words, as the purchase price of stock-in-trade relates to revenue account, so too the insurance amount received on loss of stock-in-trade relates to revenue account. From the point of view of the trader, for tax purposes, there is no difference between the proceeds of goods sold and insurance monies received in respect of goods destroyed. This precisely was the ratio laid down by the House of Lords as far back as in 1929 in the case of Green v. Gliksten & Son Ltd. 14 TC 364.
30. Now, in a case of a moneylender, debts that have become bad or doubtful of recovery stand on a different footing. When a moneylender gives a loan to a borrower, the outplay clearly is on capital account. Similarly, when the borrower returns the sum in question, the receipt is on capital account. It is the interest which the moneylender receives relates to revenue account and is, on that basis, chargeable to tax.
True, in a case of a moneylender or a banker, the loss occasioned by embezzlement or theft of money or even by bad debts has been held to be revenue deductible on the ground that for a moneylender money or cash is stock-in-trade. This concept has a limited application, namely, to allow a revenue deduction to a moneylender or banker in respect of the losses of the type referred to above. But the parallel cannot be extended to the extent canvassed by the Department.
31. Similarly, the treatment to be given to salvage value of the goods or assets insured cannot be extended to the case of a moneylender.
32. In view of the foregoing, therefore, we reject the contentions of both the assessee’s counsel and the Department, and proceed to resolve the issue before us in the light of the legal consequences of the 1981 Scheme and the transactions put through thereunder.
33. The genesis and rationale of the Scheme is not far to seek. The assessee was set up to promote industrial development particularly in the small-scale sector. The said objective was sought to be achieved by a two-pronged approach. The first was to provide finance as and by way of term and other loans to eligible persons. The said loans carry interest which, in the hands of the assessee, is clearly taxable.
The second approach was to up infrastructural facilities in the form of industrial complexes and to let on rent factory sheds put up in the said complexes. The rental income is also taxable in the hands of the assessee.
The assessee used to receive other types of income such as supervision charges, investigation fees, commitment charges, etc., all of which relate to revenue field.
34. The major activity of the assessee is to disburse various types of loans to eligible persons. Since these loans are being advanced for the specific purpose of promoting industrial development in the small-scale sector, these loans are usually given to new entrants in the small-scale sector. Given the fact situation, the financing activities of the assessee are risk-prone in that bad and doubtful debts occur to a larger extent than would normally be the case. These would mean that if the assessee were to rely on its share capital and the loans and other funds that it had received from the IDBI, a good portion of the funds would get locked up in bad and doubtful debts with the result the amount available for re-cycling would get gradually diminished. If a solution to this problem is not found, a situation might arise when the assessee might face such a severe cash crunch that it may not be able to meet even its commitments relating to salary, wages, etc. It was to prevent such a contingency that the Guarantee Scheme of 1981 was evolved by the DICGC.
35. The said Scheme was designed to provide guarantees, to the stipulated extent, in respect of loans advanced by eligible credit institutions (such as the assessee before us) to borrowers engaged in industrial activity on a small scale and also in respect of credit facilities granted to organisations which may be assisting workers, artisans and other self-employed persons engaged in industrial activity. The guarantee is given by the DICGC. The guarantee contemplated by the Scheme is applicable to the “amount in default” which has been defined under the Scheme as the amount due on account of any eligible credit facility outstanding in the account of the borrower, as on the date these dues have become bad or doubtful of recovery. By definition, the amount in default includes interest and any other charges that had become due and payable by the borrower to the eligible credit institution.
36. Paragraph 7 of the Scheme stipulates that for purposes of availing the facility of guarantee provided by the DICGC, the eligible credit institutions will have to enter into an agreement with the said Corporation. In relation to the amount in default, the guarantee provided by DICGC is not 100%. The percentage of guarantee varies from 50% through 75% to 90% as stipulated in paragraph 9 of the Scheme.
37. When an eligible credit institution finds that a loan advanced by it has become bad or doubtful of recovery, it invokes the guarantee in terms of paragraph 10 of the Scheme. To invoke the guarantee, the eligible credit institution participating in the Scheme will have to make a claim in the prescribed proforma. Thereafter, the DICGC processes the application, determines the guarantee amount to be paid to the applicant, inter alia, in accordance with the provisions of paragraph 9 of the Scheme and pays the amount thus determined to the applicant. It may here be highlighted that separate applications will have to be made in respect of each loan that has become bad or doubtful of recovery.
38. One other feature of the Scheme is to be noticed and that is the provision of the guarantee by the DICGC to the eligible credit institutions is subject to the stipulation that the latter shall not, without the previous approval and consent of the Corporation, write off the bad or doubtful debts and that they will take all steps necessary to recover the sums due from the borrowers.
39. We then come to paragraph 12 of the Scheme which is designed to safeguard the interests of DICGC. The said paragraph reads as under :
12. Subrogation of rights and recoveries on account of claims paid.
(1) The Corporation shall, to the extent of the amount paid by it on account of any facility to a borrower guaranteed under the Scheme, be subrogated to the rights of the credit institution and every amount which may be recovered by the credit institution from a borrower in respect of whom a claim has been paid shall, after deducting therefrom the expenses, if any, incurred after the payment of the claim for recovering the amount, be shared between the Corporation and the credit institution in the ratios specified in paragraph 9 of the Scheme, till the dues of the Corporation are paid in full.
(2) In the event of a borrower owing several distinct and separate debts to a credit institution and making payments towards any one or more of the same, whether the account towards which the payment is made is covered by the guarantee of the Corporation or not, such payments shall, for the purpose of this clause, be deemed to have been appropriated by the credit institution to the debt covered by the guarantee and in respect of which a claim has been preferred and paid, irrespective of the manner of appropriation indicated by such borrower or the manner in which such payments are actually appropriated.
(3) Every amount recovered and due to be paid to the corporation shall be paid without avoidable delay, and if any amount due to the Corporation remains unpaid beyond a period of one month from the date on which it was first recovered, interest shall be payable to the Corporation by the credit institution at the Bank Rate for period for which the payment remains outstanding after the expiry of the said period of one month.
Paragraph 14 of the Explanatory Note to the Scheme reads as follows:
XIV. Subrogation rights and recoveries on account of claims paid (Paragraph 12 of the scheme).
14. The settlement of a claim does not absolve the credit institution of its responsibility to effectively pursue with the borrowers, sureties, etc. the recovery of the dues and it should take all feasible steps including enforcement of the security. Any recoveries effected, irrespective of whether these relate to the guaranteed account or a non-guaranteed account of the borrower, and also irrespective of the manner of their actual appropriation, shall after deducting reasonable expenses incurred in that connection, be shared with the Corporation in the manner and to the extent indicated in Clauses (1) to (3) of paragraph 12.
40. As we see it, read as a whole the Scheme makes it clear that the guarantee provided by the DICGC which covers a specified percentage of the “amount in default” (including interest and other fees that had become due and payable by the borrower) is somewhat akin to a bank guarantee. True, the guarantee is not obtained and Drovided by the borrower to the credit institution but, as a matter of State policy, the DICGC provides the guarantee directly to the credit institution. The contingency on the occurrence of which the guaranteed amount is payable under the scheme is the default committed by the borrower to pay to the concerned credit institution the amounts (including interest) by the due date(s).
41. Now, what, in the context of the Guarantee Scheme of 1981, is the nature of the guaranteed amounts received by eligible institutions from the DICGC ? As we see it, given the significant fact that the guarantee operates in relation to the “amount in default”, the amount paid by the Corporation to the eligible credit institution is nothing but a payment towards the “amount in default”. Under the Scheme, privity of contract exists between the eligible credit institution on the one hand and the DICGC on the other. There is no privity of contract between the defaulting borrower and the DICGC. Even so, under the Scheme, the DICGC steps in and pays the guaranteed sum to the eligible credit institutions, after satisfying itself that the loan covered by the Guarantee Scheme has become bad or doubtful of recovery. We will not be far wrong in saying that the DICGC, in a manner of speaking, pays the guaranteed sums to the eligible credit instituitions for and on behalf of the defaulting borrower, the absence of privity of contract between DICGC and the defaulting borrower notwithstanding.
42. We have already seen that the Guarantee Scheme of 1981 operates in relation to “amount in default”; and that, by definition, “amount in default” includes not only the principal but also the interest due thereon and the other charges due as on the stipulated date. Further, in relation to each outstanding debt, the guaranteed sum (which is received in relation to the amount in default) is an open payment on account. The Scheme does not contain any provision relating to the apportionment of the lump sum amount (i) principal (ii) interest, and (iii) other charges, The assessee before us also has not apportioned the said sum in any manner. All that it has done is to take them to a suspense account as it were. Thus, we have before us, in essence, an open payment on account. The question that arises for consideration is: What is the tax treatment to be given to such open payment on account ?
43. In olden days, as between a creditor and his debtor, such open payments were governed by the common law of appropriation. When neither the debtor nor the creditor made any appropriation and the question arose in court, the court was required to apply the payment in discharge of the debts in order of time. This common law was incorporated in Sections 59, 60 and 61 of the Indian Contract Act, 1872.
Though the provisions of the said sections deal with the order of priority in which an open payment will be adjusted against a plurality of outstanding debts and though they do not expressly mention appropriation towards interest they have been applied to principal and interest, by treating them as distinct debts. Thus, where interest is outstanding on a principal sum due and the creditor receives an open payment from the debtor without any appropriation of the amount as between capital and interest, the sum received is first appropriated to interest and only thereafter to capital. The rationale behind the said principle is that it is to the creditor’s advantage to attribute payments to interest in the first place, leaving the interest-bearing capital intact.
44. The said proposition, it is well-settled, applies to transactions as between a creditor and a debtor. Where, however, it is a question between an assessee to tax and the revenue, the aforesaid rule of appropriation has no universal application. As has been pointed out by Lord Macmillan in the Privy Council case of CIT v. Maharqjadhirqja Kameshwar Singh of Darbhanga [1933] 1 ITR 94, “there is authority for the proposition that in a question with the revenue the taxpayer is entitled to appropriate payments as between capital and interest in the manner least disadvantageous to himself: Smith v. Law Guarantee and Trust Society, Ltd.”
45. At the first blush, it would appear that the said proposition is of universal application where it is a question between a taxpayer and the revenue. The position in law is, however, different. In the case of CIT v. T.S. PL. P. Chidambaram Chettiar [1971] 80 ITR 467, the Supreme Court had occasion to consider and explain the said observations of Lord Macmillan in Maharajadhiraja Kameshwar Singh’s case (supra). Explaining the above observations, the Supreme Court observed : “Evidently, their Lordships bore in mind the possibility of the assessee not being able to realise the debts under the head notes. Under those circumstances it was advantageous to the assessee to appropriate the money value of the properties received towards the capital otherwise there was a possibility of his having to pay income-tax on a receipt which ultimately may not prove to be an income.”
(Emphasis supplied)
The Supreme Court then went on to observe :
In our opinion the High Court was in error in thinking that the decision of the Judicial Committee in Kameshwar Singh’s case has laid down a firm rule that whenever an assessee receives a payment and does not appropriate the same either towards the principal or interest, he must be deemed to have appropriated the same towards the principal. The decision in question, in our opinion does not lay down the rule that, whenever any amount is received by a creditor which he has not specifically appropriated either towards the principal or the interest due to him, the taxing authorities should proceed on the the basis of the presumption that it has been appropriated towards the principal. On the facts of that case it was clear that it was advantageous to the creditor to appropriate the receipt towards the principal.
46. In its application to transactions between a creditor and his debtor involving open payments, the rule of appropriation may be summarised as follows: (a) The ordinary rule is that it is first applied to interest and the balance, if any, to the principal; and (b) in cases where the recovery of the principal amount itself is in jeopardy, and where it is a question between a taxpayer and the revenue, the special rule is that the taxpayer is entitled to appropriate payments as between capital and interest in the manner least disadvantageous to himself.
47. The case before us is, no doubt, one of open payment. But it is not one between the creditor and his debtor. In this case, the open payment came to be made by the DICGC. But as we have already pointed out, the DICGC has, in essence, paid the guaranteed sums for and on behalf of the debtors. In the circumstances, therefore, we are of the opinion that we would be justified In applying to the facts of the case before us the general rule of appropriation.
48. The question that then arises for consideration is whether the normal, rule of appropriation is to apply or the special rule. As we see it, having regard to the fact that the recovery of the principal itself is in jeopardy, we would be justified in applying the special rule. That is to say, the guaranteed sums would first be appropriated towards the principal-component of the amount in default and the excess, if any, will thereafter be appropriated towards the interest and other charges-component of the amount in default. We hold accordingly.
49. There is a related matter that needs to be dealt with now. Since we have held that in the facts and on the circumstances of the case the assessee is entitled to appropriate the guaranteed sums first towards principal and only thereafter towards interest and/or other charges, it should logically follow first that that part of the guaranteed sums appropriated towards principal cannot be treated as the assessee’s income. Secondly, to that extent, the assessee cannot claim deduction under Section 36(1)(vii) read with Section 36(2) of the Act, even when on a later date it writes off the amount in its books of account with the previous approval or concurrence of DICGC. Thirdly, in cases where any part of the guaranteed sum in relation to each debt is available for appropriation towards interest and other charges, tax will be exigible to the extent, as they are clearly receipts on revenue account. For a fact, as pointed out earlier, the assessee is accounting for interest and other charges on cash basis.
We hold accordingly.
50. To sum up, we hold
– first that the guaranteed sums received by the assessee cannot in their entirety be treated as its income;
– secondly that the assessee is entitled to appropriate the guaranteed sums received by it in a manner least disadvantageous to it. That is to say, it is entitled to appropriate the said sums first towards principal. By the same token, there is no question of treating that part of the guaranteed sums appropriated towards principal as the assessee’s income;
– thirdly and concomitantly there is no question of treating the sums thus appropriated towards principal as bad or doubtful debts for purposes of Section 36(1)(VII) read with Section 36(2) even when at a later point of time; the assessee writes off the amount in its books of account with the previous approval or concurrence of DICGC;
– fourthly and finally, that the interest and other charges component of the guaranteed sum, if any, appropriated towards interest and/or other charges will be brought to tax on receipt basis.
51. We, therefore, cancel the impugned order in revision and direct the Assessing Officer to decide the issue involved on the lines indicated above.
52. In the result, both the assessee’s appeals are partly allowed.