JUDGMENT
Jeevan Reddy, J.
1. Two questions are referred for opinion under s. 256(1) of the I.T. Act, one at the instance of the assessee and the other at the instance of the Revenue. The questions referred are :
2. At the instance of the assessee :
“Whether, on the facts and in the circumstances of the case, investment in securities made by the assessee in pursuance of s. 24 of the Banking Regulation Act being a statutory obligation can be treated as a transaction in the course of carrying on of trade ?”
3. At the instance of the Revenue :
“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is justified in holding that an amount of Rs. 9,95,621 is allowable as a deduction towards gratuity ?”
4. The assessee is the State Bank of Hyderabad, a subsidiary of the State Bank of India. It is a banking company whose activity is regulated, inter alia, by the Banking Regulation Act, 1949. Section 24 of the Banking Regulation Act, 1949, requires every banking company to “maintain in India in cash, gold or unencumbered approved securities, valued at a price not exceeding the current marker price, an amount which shall not at the close of business on any day be less than 20 per cent. of the total of its time and demand liabilities in India.”
5. In accordance with the said provision, the assessee has been investing various amounts in Government securities. It has been redeeming the same as and when they get matured, and the difference, if any, was being returned by it under the head “Capital gains”.
6. The Revenue has been accepting this practice over certain years in the past. For the assessment year 1971-72, however, the Revenue took a different stand holding that the difference is liable to be taxed as income from the business of the assessee. This was disputed by the assessee and the matter came up to the Tribunal. The Tribunal held following its order in ITA No. 1073 (Hyderabad) 74/75, dated April 12, 1977, that the difference represents revenue and is taxable as the business income of the assessee. Thereupon, the assessee asked for and obtained reference of the first question.
7. So far as the second question is concerned, it is not necessary for us to state the facts relevant thereto or to discuss the law with respect to the said legal question for the reason that the standing counsel for the Revenue has fairly stated before us that the said question is concluded in favour of the assessee and against the Revenue by the decision of this court in ITC No. 89 of 1982, dated June 30, 1983 (CIT v. Warner Hindusthan Ltd. [1985] 151 ITR 701) as also the decision of the Bombay High Court in Tata Iron & Steel Co. Ltd. v. Bapat, ITO [1975] 101 ITR 292. The decision of the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559, also affirms the principle enunciated in the aforesaid two decisions. For the above reasons, the second question which has been referred to us at the instance of the Revenue is answered in the affirmative, i.e., in favour of the assessee and against the Revenue.
8. We shall now proceed to discuss the first question : Parliament has enacted the Banking Regulation Act, 1949, to consolidate and amend the law relating to banking. The Act contains several provisions regulating the conduct of banking business. Section 24 thereof is one such piece of regulatory legislation. It says that every banking company shall maintain, in India, either in cash, or in the shape of gold, or in the shape of unencumbered approved securities, 20 per cent. of its total time and demand liabilities at any given point of time. It is not necessary to refer to the other provisions of s. 24 which merely elucidate how to compute the 20 per cent. It is necessary to reiterate that according to s. 24, it is not necessary for a bank to keep the said 20 per cent. amount in the shape of unencumbered approved securities. It is entitled to keep it in the shape of cash or gold, as the case may be. Discretion lies with the banking company either to keep it in cash, or to keep it in the shape of gold, or unencumbered approved securities. The question is whether the difference that is earned by a banking company on the maturing of unencumbered approved securities constitutes its business income or capital gain.
9. The main business of a banking company is to accept deposits and to advance loans to appropriate persons or institutions. Money constitutes its stock-in-trade. Every prudent banker would necessarily keep certain portion of deposits in cash with him to enable him to honour any possible demands of depositors at any given point of time. Indeed, he is expected to do so. This normal prudent business principle has been given statutory recognition by s. 24 of the Banking Regulation Act, 1949, in the interest of the public and the larger interest of banking industry itself. The amount which is required to be kept in India in the form of cash, gold or unencumbered securities is part of the stock-in-trade of the assessee. Mr. Srinivasa Murthy, learned counsel for the assessee, could not dispute that, if the assessee had voluntarily kept a portion of its deposits in India (partly or wholly in the shape of unencumbered approved securities), any difference accruing on the maturing/redeeming of securities would have constituted its business income and not a capital gain; his whole emphasis is on, what he calls, the statutory compulsion imposed by s. 24(1). The submission is that, inasmuch as the assessee is obliged to keep a portion of stock-in-trade in India in the shape of cash or gold or securities by virtue of a statute and thereby the assessee is denied the use of that amount, it must be held that it has become a capital asset. We are unable to agree. As we have observed hereinbefore, in the case of a banking company, money itself constitutes its stock-in-trade. All that s. 24 does is to insist on observance of a normal prudent banking business practice. It does not require that that amount should necessarily be invested in approved securities; it can as well be in the shape of cash. In this case, the assessee chose voluntarily to put the money in securities instead of keeping it in the shape of cash. We are unable to see how this statutory requirement converts what is the assessee’s stock-in-trade into a capital asset. We can also look at it from a different angle : Suppose, s. 24 is deleted or the percentage specified therein is reduced, what becomes of the money so released ? The answer cannot but be that it would remain and continue to be the deposits of the bank-and not its capital asset.
10. Mr. Srinivasa Murthy stressed repeatedly that the assessee is not dealing in securities, that dealing in securities is not its business, that these securities are acquired only because of the aforesaid legal requirement and, hence, the profit arising from such securities cannot constitute its business income. This argument, in our opinion, is not sustainable. It is not necessary that the assessee should be dealing in securities. If it were dealing in securities, this question would not have at all arisen, for, in such a case, income derived from the business of dealing in securities would be its business income. It is not necessary for the purpose of this case to decide under which head of income would it fall; it is sufficient to hold that it would not be a capital gain.
11. In Punjab Co-operative Bank Ltd. v. CIT [1940] 8 ITR 635, the Privy Council was dealing with a case of a co-operative bank. There, the bank had kept a part of its deposits in the shape of certain easily realizable securities to meet possible demands of depositors. Certain income arose from such securities. The question was whether it constituted its income ? The Privy Council observed that in the ordinary case of a bank, business consists in its essence, of dealing with money and credit; that a banker has always to keep enough cash or easily realizable securities to meet any probable demand by depositors and that if some of the securities are realised in order to meet withdrawal by depositors, it is a normal step in carrying on banking business; and that, therefore, income arising from engagement (sic) of securities would be its income. It was observed that it is not necessary for this purpose that the bank should be engaged in a separate business of buying or selling securities. It held that the purchase of securities in that case was so linked with the deposits and withdrawal by customers that it constituted a part of the assessee’s income from banking, and hence, profits arising therefrom were assessable to income-tax. The principle of this decision was reiterated by the Supreme Court in Sardar Indra Singh and Sons Ltd. v. CIT [1953] 24 ITR 415. That was, no doubt, not a case of a banking company, but the assessee therein was carrying on business, inter alia, of bankers and financiers. The assessee – a limited company – was empowered to purchase or otherwise acquire, and to sell stock, share, business concerns and undertakings and to invest and deal with the monies of the company not immediately required for its business upon such securities and in such manner as might from time to time be determined. The question was whether the profit realized by the assessee by sale of certain shares was assessable to income-tax ? While dealing with the said question, the Supreme Court observed as follows (p. 418) :
“The principle applicable in all such cases is well settled and the question always is whether the sales which produced the surplus were so connected with the carrying on of the assessee’s business that it could fairly be said that the surplus is the profits and gains of such business. It is not necessary that the surplus should have resulted from such a course of dealing in securities as by itself would amount to the carrying on of a business of buying and selling securities. It would be enough if such sales were effected in the usual course of carrying on the business or, in the words used by the Privy Council in Punjab-Co-operative Bank Ltd. v. Income-tax Commissioner [1940] 8 ITR 635 (PC), if the realisation of securities is a normal step in carrying on the assessee’s business. Though that case arose out of the assessment of a banking business, the test is one of general application in determining whether the surplus arising out of such transactions is a capital receipt or a trading profit. The question is primarily one of fact and there are numerous cases falling on either side of the line but illustrating the same principle. On the facts found in regard to the nature and course of the company’s business, there can be no doubt that the present case falls on the Revenue’s side of the line.”
12. It is relevant to notice the principles enunciated by the Supreme Court. It is observed that it is not necessary that the surplus should have resulted from a course of dealing in securities which by itself would amount to carrying on of business of buying and selling securities, and that it is enough if such sales are effected in the usual course of carrying on business. In other words, it is observed that, if the realisation of securities is a normal step in the carrying on of the business of the assessee, it must be held that the sales are so connected with the carrying on of the assessee’s business that the surplus constitutes its profits and gains of business. Applying these principle to the facts before us, it would be evident that though the assessee herein is not dealing in securities, yet the acquisition of the securities was normal step and the usual method of carrying on of its business. It needs no reiteration that a banking company has to carry on its business in accordance with the provisions of the Banking Regulation Act, 1949; and the business so carried on is the normal and usual method of carrying on banking business. As we have pointed out above, s. 24 does not even compel a banking company to necessarily invest moneys in approved securities and that it is open to a banking company to keep the said amount in the shape of cash itself. However, if it chooses to put money in unencumbered approved securities, it is only one mode of keeping a portion of its deposits in ready cash or readily-convertible-into-cash securities. Any income arising from such securities must be held to be closely connected with the banking business so as to constitute its business income.
13. It is brought to our notice that the Kerala High Court has taken an identical view in Malabar Co-operative Central Bank Ltd. v. CIT [1975] 101 ITR 87. Malabar Co-operative Central Bank Limited – the assessee concerned therein – was also governed by the Banking Resolution Act, 1949. It was required to keep 1/5th of its assets in the form of securities on any given day. The question that arose was whether the income arising from these securities constituted capital gains or business income ? Govindan Nair, Chief Justice, speaking for the Bench, made the following observations which we think are apposite in the present context (p. 90) :
“A banking institution, as we understand it, as a part of its business activity will have to have ready resources to meet its liabilities the extent of which can never be foreseen. It must, therefore, have liquid resources which, of course, will normally be cash, and, secondly, easily realisable securities. This is in the interest of the banking institution and it is in the interest of the public that deal with the bank. Taking the latter aspect into consideration, the legislature has stepped in and has made it obligatory that the banking institutions must maintain a certain percentage (one-fifth of its assets) in the form of securities on any given day. This is one of the legislative restrictions on the otherwise unlimited freedom of a banking institution to conduct its business in any manner it liked. Any prudent banking institution will so invest in securities even without legislative compulsion. If it did, holding of securities cannot be presumed to be not a part of its business, nor can it be said that the securities held are not part of its stock-in-trade. The fact that law now insists that the business must be run in a prudent manner by holding a specified part of its readily realisable resources in securities does not detract from the provision that in so holding securities the bank is carrying on its business and securities so held are stock-in-trade. Further, we do not think that the securities so held by a banking institution must be dealt with daily or often in order that those securities might become stock-in-trade. Supposing the institution kept a few lakhs of rupees either in its safe to meet emergent calls on the banks by the depositors or it maintained cash in the form of short-term deposits in other banking institution, can it be said that it was not doing its business, that the cash was actually not in circulation, and, therefore, it did not form circulating capital and was, therefore, not part of its stock-in-trade ? Certainly not;….”
14. Before concluding, however, we must deal with the Full Bench decision of the Madras High Court in CIT v. Madras Central Urban Bank, AIR 1929 Mad 387 [FB], upon which strong reliance has been placed by the learned counsel for the assessee. In this case, a co-operative society carrying on banking business was required by law to keep fluid assets to the extent of 40 per cent. of its total liabilities in the form of Government securities. The question that arose was whether the income arising from the sale or encashment of securities constitutes its business income. The Madras High Court held that it does not, for the reason that it is not a part of the business of the co-operative society to invest in securities. While, this case undoubtedly tends to support the proposition urged by the assessee, we find it not possible to apply or follow its principle for it is directly in conflict with the principle of the decision of the Supreme Court in Sardar Indra Singh’s case [1953] 24 ITR 415 as also the decision of the Privy Council in Punjab Co-operative Bank’s case [1940] 8 ITR 635 (PC). We are of the opinion that the view taken by the Full Bench does not represent the correct view of law.
15. A similar view has been taken by us in the case of A.P. State Financial Corporation, R.C. No. 230 of 1978 dated July 5, 1984 (since .
16. For the above reasons, we answer the first question referred to us in the affirmative, i.e., in favour of the Revenue and against the assessee. There shall be no order as to costs.
