1945 (12) TMI 3 - HC - Income Tax

Summary

Issues Involved:
1. Deduction of interest paid on borrowed money for the purpose of investment in securities.
2. Allocation of borrowed funds between taxable and tax-free securities.
3. Interpretation of provisos to Section 8 of the Income-tax Act.
4. Computation of taxable income considering the interest on borrowed capital.

Issue-Wise Detailed Analysis:

1. Deduction of Interest Paid on Borrowed Money for the Purpose of Investment in Securities:
The assessee, a provincial co-operative bank, borrowed money to invest in both tax-free and taxable securities, incurring an interest expense of Rs. 1,58,515. The core issue was whether this interest could be deducted from the bank's income to determine its taxable income. The Tribunal found it difficult to allocate specific borrowings to specific investments due to the changing nature of investments, a finding accepted as binding by the High Court.

2. Allocation of Borrowed Funds Between Taxable and Tax-Free Securities:
The assessee claimed its taxable income should be calculated by deducting the entire interest expense from the total income, arguing that the interest on borrowed capital should be deducted under proviso 1 to Section 8, and the interest from tax-free securities should be excluded under proviso 2. The department, however, contended that since the assessee could not specify which borrowings were for which investments, no part of the interest expense should be deductible. Alternatively, the department suggested apportioning the interest expense between taxable and tax-free securities proportionately, resulting in a split of Rs. 51,750 for tax-free securities and Rs. 1,06,705 for taxable securities.

3. Interpretation of Provisos to Section 8 of the Income-tax Act:
The High Court emphasized that the Income-tax Act is a fiscal measure with arbitrary provisions, and its duty was to interpret these provisions plainly, favoring the subject in case of ambiguity. Section 8 states that tax is payable under the head 'Interest on securities' for interest receivable on any government security, without distinguishing between taxable and tax-free securities. Proviso 1 to Section 8 allows for the deduction of interest payable on money borrowed for investment in securities, while proviso 2 excludes the interest on tax-free securities from taxable income.

4. Computation of Taxable Income Considering the Interest on Borrowed Capital:
The High Court held that the provisos should be read independently and both deductions should apply. Proviso 1 allows for the deduction of the entire interest expense on borrowed capital, and proviso 2 excludes the interest on tax-free securities from taxable income. The Court rejected the department's practice of splitting the interest expense, stating that it results in taxing outgoings or tax-free interest, contrary to the Act's provisions.

Conclusion:
The High Court concluded that the assessee's income had not been properly computed. The Court determined that:
1. The splitting of the interest on borrowed capital and apportioning it between taxable and tax-free securities was not justified.
2. Under proviso 1 to Section 8, the entire interest on borrowed capital should have been deducted.
3. Under proviso 2, the entire interest on tax-free securities should have been excluded in addition to the deduction for interest on borrowed capital.

The Court's decision underscores the principle that fiscal enactments should be construed in favor of the taxpayer when ambiguity exists, ensuring that outgoings and tax-free interests are not inadvertently taxed.