PERFECT THREAD MILLS LTD,MUMBAI vs. DCIT 8(2), MUMBAI

PER AMIT SHUKLA, JM: I have gone through the order proposed by my learned Brother in this appeal and have also discussed the issue with him. However, I am unable to persuade myself to subscribe to the

view proposed by my learned Brother and also unable to agree with the conclusion arrived at on the issue involved. I, therefore, consider it appropriate to express my view and conclusion on the issue by way of passing a separate order.

19 ITA 4964/Mum/2013

issue involved are that, the assessee company had a taken a corporate term loan of Rs. 3.06

crores from Kotak Mahindra Bank Ltd. during the relevant financial year 2008-09 for its

business purpose, which was repayable in 36 monthly installments. The said loan was

secured by mortgaging a part of assessee's factory land. The interest paid on such loan was

otherwise allowed to the assessee or was allowable u/s 36(l)(iii) r.w.s. 43B. Since, assessee

due to cash losses and liquidity constraints could not pay the installments, therefore, the

Kotak Mahindra Bank Ltd. classified the assessee's account as Non-performing Asset

(NPA) and initiated the recovery proceedings u/s 13(2) of the Securitization And

Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2000,

(SARFAESI Act) on the assessee company and personal guarantors. The Bank took

possession of the mortgaged part of the factory land on 07.01.2010, which was divided into

7 plots, out of which 6 plots were sold in March, 2010 for a total sale consideration of Rs.

2,18,00,262/- and was appropriated by the Bank in the following manner :-

Towards interest dues :- Rs. 69,75,629/- Towards principal amount :- Rs. 1, 48,24, 633/- Rs. 2,18,00,262/-

The assessee had duly shown the sale proceeds from the mortgaged asset in its books of

account and also offered the income as 'Long-term capital gain' as per the computation of

income, incorporated at page 3 of the Draft order.

against the principal amount of loan of Rs. 1,48,24,633/- (out of the sale proceeds) as deduction u/s 48(i) as cost by the assessee in the computation of LTCG, being 'expenditure

incurred wholly and exclusively in connection with such transfer'. The assessee's claim was

based on the principle that, act of the Bank taking possession of the land under SARFAESI

Act, constitutes "diversion of income by overriding title". This claim had been denied by

20 ITA 4964/Mum/2013

the AO on the ground that it cannot be reckoned as expenditure u/s 48(i) to be allowed as

cost of acquisition as it was an application of income. In the first appellate proceedings, Ld.

CIT(A) too has rejected the assessee's contention for the claim for deduction mainly relying

upon the decision of Supreme Court in the case of CIT vs. Attili N. Rao [2001] 252 ITR 880; and Allahabad High Court in CIT vs Sharad Sharma [2008] 305 ITR 24 (All.) and held

that there is no diversion of income by overriding title .

the draft order of the Ld. Brother, which are not being reiterated. The core argument of Ld.

Counsel had been that, by virtue of statutory provisions of section 13 of SARFAESI Act, there is a clear cut overriding title on the mortgaged property in favour of the bank and the

income realized by the bank and appropriated from the sale of such property directly,

amounts to diversion of income and, therefore, the said principal amount cannot be held to

be taxable in the hands of the assessee and or is allowable as deduction. He also submitted

that, in wake of the SARFAESI Act, the earlier judicial decisions will no longer be

applicable. At the time of hearing, following decisions were referred and relied upon, some of them will be discussed herein later in this order:-

ST. Cases relied upon Citation No.

1 Sitaladas Tirathdas 41ITR 367 (SC)

2 CIT vs. Attili N Rao 252 ITR 880 (SC)

3 Motilal Chahadamilal Jain vs CIT 190 ITR 1 (SC) 4 CIT vs Mathubhai C Patel 238 ITR 403 (SC)

5 CIT vs Roshanbabu Mohd. Hussein Merc 275 ITR 231 (Bom)

6 CIT vs Sharad Sharma 305 ITR 24 (All)

21 ITA 4964/Mum/2013

7 Raja Bejoy Singh Dudhania 1 ITR 135 (PC)

8 Gopinath Paul and Sons vs DCIT 278 ITR 240 (Cal)

9 Addl. CIT vs Glad Investment vt Ltd. 22 ITD 227 (DEL) 5. Now on these facts, and background the main issue involved here in this appeal are :- Firstly, whether the principal amount of loan of Rs. 1,48,24,6733/- can be allowed

as deduction u/s 48(i) while computing the LTCG from sale consideration of

mortgaged asset appropriated by Kotak Mahindra Bank, after taking possession of

the said secured asset under the SARFAESI Act 2002, on the ground that there was

"diversion of source/ income by overriding title;"

Secondly, whether the entire sums recovered from sale proceeds of the mortgaged

assets and appropriated by the Bank towards 'Security interest' under section 13 of

the SARFAESI Act will not fall within the charging provisions of Income Tax Act

in the hands of the assessee on the principle of "Diversion of income by overriding

title";

Lastly, whether by virtue of SARFAESI Act, the judicial pronouncements and the

decisions available on the issue prior to the commencement of the said act will not

be applicable, in as much as the provisions of the said Act provides for taking over

the possession of the land to secure its security interest and hence overriding title

gets vested with the Bank and consequently income gets diverted.

22 ITA 4964/Mum/2013

to any deduction under section 48, either as a cost of acquisition or cost of improvement or

any kind of expenditure incurred wholly and exclusively in connection with such transfer of

capital asset. This proposition of law has been well settled by the Hon'ble Apex Court in

two cases; R M Arunachalam vs CIT (1997) 227 ITR 222; and VSMR Jagdish

Chandran vs CIT (1997) 227 ITR 240. A clear distinction has been drawn by the Apex

Court that, where the previous owner had created a mortgage on the property in question

and the assessee had inherited the said property along with the mortgage, in that event the

assessee would be entitled to the deduction of the amount spent in getting mortgage

discharged as cost of acquisition u/s 48. However, where the assessee himself has created

the mortgage, then the same consequence will not follow and he would not be entitled for

deduction. The relevant observation of the Hon'ble Court in R M Arunachalam (supra)

laying down this proposition reads as under :-

In taking the view that in a case where the property has been mortgaged by the previous owner during his lifetime and the assessee, after inheriting the same, has discharged the mortgage debt, the amount paid by him for the purpose of clearing off the mortgage is not deductible for the purpose of computation of capital gains, the Kerala High Court has failed to note that in a mortgage there is transfer of an interest in the property by the mortgagor in favour of the mortgagee and where the previous owner has mortgaged the property during his lifetime, which is subsisting at the time of his death, then after his death his heir only inherits the mortgagor's interest in the property. By discharging the mortgage debt his heir who has inherited the property acquires the interest of the mortgagee in the property. As a result of such payment made for the purpose of clearing off the mortgage the interest of the mortgagee in the property has been acquired by the heir. The said payment has, therefore, to be regarded as 'cost of acquisition' under section 48 read with section 55(2) of the Act. The position is, however,

23 ITA 4964/Mum/2013

different where the mortgage is created by the owner after he has acquired the property. The clearing off of the mortgage is created by the owner after he has acquired the property. The clearing off of the mortgage debt by him prior to transfer of the property would not entitle him to claim deduction under section 48 of the Act because in such a case he did not acquire any interest in property subsequent to his acquiring the same. In CIT u. Daksha Ramanlal [1992] 197 ITR 123, the Gujarat High Court has rightly held that the payment made by a person for the purpose of clearing off the mortgage created by the previous owner is to be treated as cost of acquisition of the interest of the mortgage in the property and is deductible under section 48 of the Act". (P. 239) (emphasis added) Thus, the income applied in liquidation of a voluntarily incurred mortgaged debt is

definitely exigible to tax, although the application may be under a legally binding covenant

entered into by the recipient of the income or under a charge created by the debtor on his

property. Hence, in my opinion, the assessee will not get the deduction of the principal

amount of loan u/s 48, as the mortgage debt was created by the assessee itself, to which

assessee was obliged to discharge. Any discharge of debt is nothing but application of

income.

7, Now the moot question is, whether there is a 'diversion of income by overriding title' and

hence the entire sale proceeds appropriated by the Bank towards its security interest is

exigible or chargeable to tax in the hands of the assessee or not.

from earlier times under the Indian Income Tax Law and the concept has been well

established that, where an obligatory charge is imposed by the testator; or by law upon

some property; or charge is otherwise involuntarily created; then the sum so charged

must be excluded from the income of the person in enjoyment of the property. In other

24 ITA 4964/Mum/2013

words, where income is not applied but 'diverted by an 'overriding title' from the

assessee who would have otherwise have received it, it cannot be considered as the

income of the assessee at all. Where the obligation effectively slices away part of the

corpus of the right of the assessee to receive the entire income, it would be a case of

'diversion of income'. But the biggest rider in applying this principle and most

determinative factor in deciding such situations as stressed by the Hon'ble Supreme

Court in several cases from time to time is the nature and effect of the assessee's

obligation in regard to the amount in question, Hon'ble Apex Court in the case of CIT

vs. Sitaldas Tirathdas, [1961] 41 ITR 367, laid down the following test with regard to

'diversion of income by overriding title' in the following manner :-

"In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow, ft is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one's own income, which has been received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable", (emphasis added) 9. Thus, the true tests in deciding the "diversion of income by overriding title" lies in the

nature of the 'obligation' which is the most decisive factor. If the assessee all throughout

had an obligation to discharge his liability out of his income, then under all

circumstances it would remain his obligation and the liability to discharge would be an

application of income. There cannot be a two different limb of a same obligation; in the

first place, there would be an obligation of the assessee to discharge his liability out of

his own income and second, the obligation will get shifted because the title has been

25 ITA 4964/Mum/2013

passed to another person to discharge the liability of the assessee or on his behalf which

still exists before the income reaches to the assessee. Under both the situations it is an

obligation of the assessee and any discharge of obligation is nothing but application of

income and assessee would not be entitled either to claim deduction or claim the amount

as exempt. This principle was again reiterated by the Hon'ble Supreme Court in the case

of CIT vs. Sunil J Kinariwala [2O03] 259 ITR 1O, wherein the Hon'ble Apex Court

reiterated that the nature and effect of the assessee's obligation in regard to the amount

in question is very crucial and determinative factor, whether there is diversion of income

or not. Hence, in all such cases, the nature of obligation is to be examined.

fact that all throughout the obligation was upon the assessee to discharge its debt liability

and to clear the charge on the mortgaged property. This can be gauged by following

facts; the business loan was taken by the assessee for its own business purpose and

liability to repay the loan/debt was on the assessee; interest paid/payable was

claimed/allowable as deduction of expenses incurred for the business purpose in

computation of total income; assessee was under the legally binding covenant to repay

the loan along with the interest; property was mortgaged to the Bank to secure the

debt/loan by the assessee; liability to free the charge on mortgage land was upon the

assessee; Had the loan and interest been waived off by the bank, then assessee would

have shown this as its income u/s 41(1); further, if the assessee would have paid back

the entire loan, then the mortgaged property would have got vested back to assessee.

Thus, the obligation was always upon the assessee and it would not be shifted to the

26 ITA 4964/Mum/2013

bank merely because the bank took possession of the land to enforce and realise its

secured interest.

the parties in this regard (as cited above) and some of them were also filed before us in a

separate compilation. Other than the case laws discussed above, the most relevant

decisions on the issue involved and cited before us are being discussed here under :-

(i) CIT vs Attili N. Rao [2001] 252 ITR 880 (SC) :- Here in this case question of law referred to before the Hon*ble Apex Court were as

under :-

"Whether on the facts and in the circumstances of the case and in law, the Appellate Tribunal was correct in holding that the amount realised by the sale of the assessee's interest in the property was only Rs. 4,33,960 i.e., Rs. 5,62,980 minus Rs. 1,29,020 ? Whether on the facts and in the circumstances of the case and in law, the Appellate Tribunal was correct in holding that the amount realised under the charge or mortgage by the Government by public auction does not partake of the character of 'full value of consideration' envisaged under section 48 of the Income-tax Act ? Whether on the facts and in the circumstances of the case and in law, the Appellate Tribunal was Justified in holding that the amount payable by the assessee in discharge of the mortgage debt to the Government on the sale of property was an expenditure incurred towards the cost of acquisition of the capital asset and deductible under section 48 of the Income-tax Act" ?

The relevant facts of the case were as under :- "The assessment year with which we are concerned is the assessment year 1982-83. The assesses carried on abkari business. In the course of the financial year 1970-71 he mortgaged to the Excise Department of the State of Andhra Pradesh immovable property belonging to him at Waltair, He did so to provide security for the amounts of "kits" which were due by him to the State. The State, in the assessment year with which we are concerned, sold the immovable property by public auction, without the intervention of the court, to realise its dues. A sum of Rs. 5,62,980 was realised at the auction. Thereabout, the State deducted the amount of Rs. 1,29,020 due to it towards "kits" and interest and paid over the balance to the assessee''.

27 ITA 4964/Mum/2013

On these facts their Lordships answered the question in the following manner :- "8, We are of the view that the Tribunal and the High Court were in error. What was sold by the State at the auction was the immovable property that belonged to the assessee. The price that was realised therefore belonged to the assessee. From out of that price, the State deducted its dues towards "/cists" and interest due from the assessee and paid over the balance to him. The capital gain that the assessee made was on the immovable property that belonged to him. Therefore, it is on the full price realised (less admitted deductions) that the capital gain and the tax thereon has to be computed". From the above proposition, it is amply clear that no such deduction of the dues

realized by a creditor from the sale of immovable property of the assessee is allowable from

the computation of capital gain in such cases and circumstances.

(ii) Decision of Bombay High Court in CIT vs Roshanbabu Mohammed Hussein Merchant, [2005] 275 ITR 231 (Bom) In this case, the question of law admitted by the Hon'ble Jurisdictional High Court read as under :- "Whether the repayment of the mortgage debt created by the assessee, is an expenditure incurred in connection with the transfer of mortgaged asset allowable under section 48(i) of the Income Tax Act".” Facts of the case were as under :- During the relevant year, the assessee, after obtaining permission from the bank, sold a part of the aforesaid land for a consideration of Rs. 3,92,000 and deposited the entire amount of Rs. 3,92,000 with the State Bank of Saurashtra towards discharge of the debt. The assessee claimed that the long term capital gain arising on sale of the above land was exempt from capital gains tax. The assessing officer completed the assessment under section 143(3) of the Income Tax Act by rejecting the contention of the assessee and taxed the same. On appeal, the CJT(A) upheld the contention of the assessee. On further appeal filed by the revenue, the Tribunal upheld the order ofCIT(A) on the ground that firstly, the sale proceeds were diverted by an overriding title in favour of the bank and the sale proceeds did not reach the assessee and secondly, the amount paid by the assessee to discharge the debt was an expenditure incurred by the assessee for removing the encumbrance which was

28 ITA 4964/Mum/2013

absolutely essential to effectively transfer the plot and, therefore, the same was deductible under section 48 of the Income Tax Act. Challenging the said order, the present appeal is filed by the revenue. In Tax Appeal No. 603 of 2000, the Tribunal took contrary view and held that the amount paid to discharge the debt was neither diverted by overriding title nor such expenditure can be regarded as an expenditure incurred in connection with transfer. The Hon'ble High Court after discussing the proposition of law reiterated by Hon'ble

Apex Court in the case of R.M. Arunchalam (supra); VSMR Jagdishchandran vs CIT

[supra] and CIT vs Attli N. Rao, held as under :-

" 14. From the aforesaid decisions of the Apex Court, it is clear that there is a distinction between the obligation to discharge the mortgage debt created by the previous owner and the obligation to discharge the mortgage debt created by the assessee himself. Where the property acquired by the assessee is subject to the mortgage created by the previous owner, the assessee acquires absolute interest in that property only after the interest created in the property in favour of the mortgagee is transferred to the assessee that is after the discharge of mortgage debt. In such a case, the expenditure incurred by the assessee to discharge the mortgage debt created by the previous owner to acquire absolute interest in the property is treated as 'cost of acquisition' and is deductible from the full value of consideration received by the assessee on transfer of that property. However, where the assessee acquires a property which is unencumbered, then, the assessee gets absolute interest in that property on acquisition. When the assessee transfers that property, the assessee is liable for capital gains tax on the full value (less admitted deductions) realised, even if an encumbrance is created by the assessee himself on that property and the assessee is under an obligation to remove that encumbrance for effectively transferring the property. In other words, the expenditure incurred by the assessee to remove the encumbrance created by the assessee himself on the property which was acquired by the assessee without any encumbrance is not allowable deduction under section 48 of the Income Tax Act. 15. It is true that in none of the aforesaid cases, the Apex Court has specifically held that repayment of the mortgage debt created by the assessee himself is not an

29 ITA 4964/Mum/2013

expenditure incurred for effectively transferring the property. However, it is implicitly held by the Apex Court that the expenditure incurred to remove the encumbrance created by the assessee himself on a property on which the assessee had absolute interest is not an expenditure incurred for effectively transferring the property as contemplated under section 48 of the Income Tax Act. It is not in dispute that in both the appeals which are before us, the property on which the encumbrance was created by the assessee was acquired by the assessee free from encumbrances. Therefore, in the light of the decisions of the Apex Court referred to hereinabove, it must be held that the assessee is not entitled to the deduction of the expenditure incurred to remove the encumbrance created by the assessee himself. 16. The contention that the assessee has not received a pie front the transfer and the entire sale proceeds realised on transfer of the mortgaged asset has been appropriated towards discharge of mortgage is also without any merit. As held by the Apex Court, when the property belonging to the assessee is sold in discharge of the mortgage created by the assessee himself, then, irrespective of the amount actually received by the assessee, the capital gain has to be computed on the full price realised (less admissible deduction) on transfer of the asset. To illustrate, suppose the assessee mortgages its capital asset and obtains loan of Rs. 1 lakh from a bank. Thereafter, if the assessee transfers the said capital asset with the consent of the bank for Rs. 1 lakh and pays the entire amount of Rs. 1 lakh to the bank to discharge the mortgage created by the assessee, then it is not open to the assessee to contend that the capital gains tax is not leviable on transfer of the property because the assessee has not received a pie on transfer of that capital asset, (emphasis added)” 17. As regards the decisions of this court in the case of Shakuntala Kantilal (supra) followed in the case of Abrar Alvi (supra) and the decisions of the Kerala High Court in the case of Smt. Thressiamma Abraham (supra) which are strongly relied upon by the counsel for the assessee, we are of the opinion that the said decisions are no longer good law in the light of the subsequent decisions of the Apex Court referred to hereinabove. 18. For all the aforesaid reasons, we answer question set out at para 2 in the negative, i.e., in favour of the revenue and against the assessee.

30 ITA 4964/Mum/2013

From the law as discussed and decided by the Hon'ble Jurisdictional High court it is absolutely clear that, firstly, when the assessee himself has created a mortgaged charge, then no deduction is allowable for discharging the charge or encumbrance created by the assessee on mortgaged asset; and secondly, when the property is sold for discharge of such a mortgaged debt, then whether the amount has been actually realized by the assessee or not is immaterial and the whole of the amount of sale realised is to taxed as capital gain in the hands of the assessee. This is evident from the highlighted portion of the judgment and clinches the issue before hand. (Hi) CIT vs Sharad Sharma, [2008] 305 ITR 24 (Allahabad) :- The question of law referred to the Hon'ble High Court for opinion was as under :- "Whether on the facts and circumstances of the case, the Tribunal was justified in holding that there was an overriding charge against the sale proceeds of property and the assessee was not liable for capital gains in respect ofKs. 1,50,000paid to bank in discharge of loan taken by M/s Shanker Traders?"

The Hon'ble Court again after reiterating the similar decisions of Hon'ble Supreme Court as discussed herein above, decided the question in favour of the revenue as under : - "The question with regard to diversion of income on account of overriding title was not decided by the Apex Court in the case of RM. Arunachalam (supra) on the ground that the said question had not been raised either before 'he Tribunal or the High Court, However, in the present case we find that this question had been raised and the Tribunal had taken a view that the Bank had an over-riding title over the property sold. The reasoning given by the Tribunal with regard to over-riding charge over the sale income is not correct for the reason as the assesses had himself created the mortgage by taking a loan from the Bank and the said property had been secured for repayment of loan. It is not a case where the assesses had inherited the property or had acquired the property along with charge but in fact had himself created the charge over the property. In a case of inheritance/acquisition along with the mortgage, perfecting his title by getting mortgage discharged, the assesses would be entitled to get the deduction of the mortgage debt but where the charge is created by the assessee himself, it cannot be said that the amount of mortgage debt out of the sale proceeds be deductible while calculating the capital gains. The present one is a case of application of income by the assessee. Further the Apex Court dealing with the issue of diversion of income by overriding title in the case of Commissioner of Income-Tax v. Sunil J. Kinariwala reported in 2003 (259) ITR 10 held as follows;

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It may be pointed out that under the scheme of the Act, it is the total income of an assessee, computed under the provisions of the Act, that is assessable to income -tax So much of the income which an assessee is not entitled to receive by virtue of an overriding title created in favour of a third party would get diverted at source and the same cannot be added in computing the total income of the assessee. The principle is simple enough but more often than not, as in the instant case, the question arises as to what is the criteria to determine, when does the income attributable to an assessee get diverted by overriding title'? The determinative factor, in our view, is the nature and effect of the assessee's obligation in regard to the amount in question. When a third person becomes entitled to receive the amount under an obligation of an assessee even before he could lay a claim to receive it as his income, there would be a diversion of income by overriding title; but when after receipt of the income by the assessee, the same is passed on to a third person in discharge of the obligation of the asses see, it will be a case of application of income by the assessee and not of diversion of income by overriding title. In view of the discussion made above we find that in the present case the assessee was not entitled to the deduction as claimed on account of discharge of mortgage debt of Rs. 95,000/- to the Bank. In fact the entire amount of sale consideration had been received by the assessee and thereafter part of it applied for discharge of the mortgage debt. It was thus a case of application of income received, (emphasis added).”

it is absolutely clear that if the borrower assessee has created a mortgaged debt by itself

and if for discharge of its debt liability, the mortgaged property has been taken over or

taken into possession by the secured creditor/ lender to realize the loan / debt amount

directly, then neither the deduction of loan amount is allowed u/s 48 nor it is a case of

'diversion of income by overriding title'. The amount appropriated by the Bank after

disposing of the mortgaged property of the assessee is thus, purely an application of

income.

superseding the law propounded and settled by the Hon'ble Apex Court and High Courts

as stated above that, now by virtue of commencement of SARFAESI Act 2002, all such

decisions and law laid down by the Hon'ble Courts on this subject will not be applicable,

32 ITA 4964/Mum/2013

as in wake of the provisions of the said Act, assessee is completely precluded from the

title of the land, as now the Bank / financial institutions for realizing its secured interest

or debt has got all the powers and right to acquire the title on the mortgaged assets,

which amounts to 'diversion of income by overriding title'. The distinction between the

position prior to commencement of the SARFAESI Act and after the commencement,

made by the Ld. Counsel can be summarized in brief as under :-

(i) Prior to the Act, no such method of recovery of overdue or NPA was prescribed, whereas now the Act prescribes three rights/ mode of recovery of NPA viz., securitization; asset reconstruction and enforcement of security without the intervention of the Court; (ii) Prior to the Act, lender could recover its debt from borrower either by filing a monetary suit for recovery or summary suit u/s 37 of the CPC or foreclosure of mortgage. Now the bank/ secured creditor is vested with various kind of rights for either taking over the possession of the securities/secured asset of the borrower or can transfer by way of lease/assignment of sale. It also has right to take over the management of the business of the borrower or can appoint a Manager to manage the asset possession of which has been taken; (iii) Earlier all the options of recovery required intervention of the Courts inasmuch as Civil Suit had to be filed for obtaining the decree in favour of the lender and the Court can adjudicate the amount due and pass the final award whereas, now no intervention of the Court is required and rights have been vested to the bank/secured creditors itself. (iv) The Court earlier use to appoint Receiver to take possession of the secure assets, sell it and appropriate the proceeds towards payment of lender's dues and now under the Act after taking over the possession of the secured assets, the secured creditor can transfer the secure assets by way of lease, assignment or sale in its own right in the capacity of a transferor and not on behalf of the borrower. Secure creditor issues sale certificate to the transferor and the borrower is not required to execute the document, relating to transfer.

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(v) Lastly, earlier the Civil suit for recovery could be filed by the lender if the borrowers have defaulted any payments of dues, whereas now section 13 of the Act has given a huge powers to the lenders and if notice has been issued, the borrower cannot sale, lease or transfer the asset. 14. However, such a distinction as made by the Id. Counsel above are purely superficial and will not make any difference to the legal proposition as discussed in the foregoing paragraphs. Much emphasis has been laid on Section 13 of the SARFAESI Act by the Ld. Counsel before us, in support of his contention that now in view of this section all the earlier law propounded will not be applicable. In my humble opinion, such a proposition and argument of the Ld. Counsel cannot be appreciated at all, firstly, the SARFAESI Act merely prescribes a speedy mode and rights for recovery of the debts / NPA by the Banks and it is not a mode or instrument to acquire the property albeit Bank takes over only the "security interest" on the asset to recover the outstanding Joan liability of the borrower. The Bank assumes the role of an agent or steps into the shoes of the borrower while disposing off the assets, which earlier was very cumbersome and time consuming through the process of Civil Courts under section 37 of Civil Procedure Code; Secondly, even the civil courts restrict the rights of the owner over the mortgaged asset or appoint court receiver to take over the possession of the secured assets and sell or lease the property to realize the debts of the lender or award decree in favour of the lender over the mortgaged asset to realize/ recover the debts; lastly, there is no takeover of obligation of the assessee by the Bank, because the loan is taken against mortgage of property, which means there is an obligation on the borrower assessee to repay the said Joan along with all the interest and other costs. The title of such security interest, that is, mortgaged asset flows from the borrower to the lender or consequent buyer with the sole intent of discharging the obligation of the borrower which comprise of outstanding loan amount along with accrued interest thereon. 15. Now let us examine the relevant provision of SARFAESI Act. The preamble of Act envisages: - "An Act to regulate securitisation and reconstruction of financial assets and enforcement of security interest and for matters connected therewith or incidental thereto. Thus, this Act has been enacted by the Parliament to regulate the securitization and reconstruction of financial assets and to enforce the "security interest" and not for acquisition of the property or the title thereof. Before analyzing section 13, first of all certain definition illustrated in various clauses of Section 2 of the Act which are self explanatory are very relevant to understand the law as envisaged in Section 13, which are reproduced as under:- (f) "Borrower" means any person who has been granted financial assistance by any bank or financial institution or who has given any guarantee or created any mortgage or pledge as security for the financial assistance granted by any bank or financial institution and includes a person who becomes borrower of a securitisation company or reconstruction company consequent upon acquisition by it of any rights or interest of any bank or financial institution in relation to such financial assistance; (j) "default" means non-payment of any principal debt or interest thereon or any other amount payable by a borrower to any secured creditor consequent upon which the account of

34 ITA 4964/Mum/2013

such borrower is classified as non-performing asset in the books of account of the secured creditor; (I) "financial asset" means any loan or advance granted or any debentures or bonds subscribed or any guarantees given or letters of credit established or any other credit facility extended by any bank or financial institution; (I) "financial asset" means debt or receivables and includes- (i) a claim to any debt or receivables or part thereof, whether secured or unsecured; or (ii) any debt or receivables secured by, mortgage of, or charge on, immovable property; or (Hi) a mortgage, charge, hypothecation or pledge of movable property; or (iv) any right or interest in the security, whether full or part underlying such debt or receivables; or (v) any beneficial interest in property, whether movable or immovable, or in such debt, receivables, whether such interest is existing, future, accruing, conditional or contingent; or (vi) any financial assistance; (m) "financial institution" means— (i) a public financial institution within the meaning of section 4A of the Companies Act, 1956 (1 of 1956); (ii) any institution specified by the Central Government under sub-clause (ii) of clause (h) of section 2 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993); (Hi) the International Finance Corporation established under the International Finance Corporation (Status, Immunities and Privileges) Act, 1958 (42 of 1958); (iv) any other institution or non-banking financial company as defined in clause (f) of section 45-1 of the Reserve Bank of India Act, 1934 (2 of 1934), which the Central Government may, by notification, specify as financial institution for the purposes of this Act; (o) "non-performing asset" means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset,— (a) in case such bank or financial institution is administered or regulated by any authority or body established, constituted or appointed by any law for the time being in force, in accordance with the directions or guidelines relating to assets classifications issued by such authority or body; (b) in any other case, in accordance with the directions or guidelines relating to assets classifications issued by the Reserve Bank; (zb) "Security agreement", means an agreement, instrument or any other document or arrangement under which security interest is created in favour of the secured creditor including the creation of mortgage by deposit of title deeds with the secured creditor; (zc) "Secured assets" means the property on which security interest is created; (zd) "Secured creditor" means any bank or financial institution or any consortium or group of banks or financial institutions and includes— (i) debenture trustee appointed by any bank or financial institution; or (ii) securitisation company or reconstruction company, whether acting as such or managing a trust set up by such securitisation company or reconstruction company for the securitisation or reconstruction, as the case may be; or (Hi) any other trustee holding securities on behalf of a bank or financial institution, in whose favour security interest is created for due repayment by any borrower of any financial assistance; (ze) "Secured debt" means a debt which is secured by any security interest: (zf) "Security interest" means right, title and interest of any kind whatsoever upon property, created in favour of any secured creditor and includes any mortgage, charge, hypothecation, assignment other than those specified in section 31; Now in light of these definitions let us examine Section 13 which envisages the enforcement of security interest. The section 13

35 ITA 4964/Mum/2013

reads as under :- (1) Notwithstanding anything contained in section 69 or section 69A of the Transfer of Property Act, 1882 (4 of 1882), any security interest created in favour of any secured creditor may be enforced, |j without the intervention of court or tribunal, by such creditor in 1 accordance with the provisions of this Act. (2) Where any borrower, who is under a liability to a secured creditor under a security agreement, makes any default in repayment of secured debt or any installment thereof, and his account in respect of such debt is classified by the secured creditor as non-performing asset, then, the secured creditor may require the borrower by notice in writing to discharge in full his liabilities to the secured creditor within sixty days from the date of notice failing which the secured creditor shall be entitled to exercise all or any of the rights under subsection (4). (3) The notice referred to in sub-section (2) shall give details of the amount payable by the borrower and the secured assets intended to be enforced by the secured creditor in the event of non-payment of secured debts by the borrower. (3A) If, on receipt of the notice under sub- section (2), the borrower makes any representation or raises any objection, the secured creditor shall consider such representation or objection and if the secured creditor comes to the conclusion that such representation or objection is not acceptable or tenable, he shall communicate within one week of receipt of such representation or objection the reasons for non-acceptance of the representation or objection to the borrower: PROVIDED that the reasons so communicated or the likely action of the secured creditor at the stage of communication of reasons shall not confer any right upon the borrower to prefer an application to the Debts Recovery Tribunal under section 17 or the Court of District Judge under section 17A. (4) In case the borrower fails to discharge his liability in full within the period specified in sub- section (2), the secured creditor may take recourse to one or more of the following measures to recover his secured debt, namely:-- (a) take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset; (b) take over the management of the business of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset: PROVIDED that the right to transfer by way of lease, assignment or sale shall be exercised only where the substantial part of the business of the borrower is held as security for the debt: PROVIDED FURTHER that where the management of whole of the business or part of the business is severable, the secured creditor shall take over the management of such business of the borrower which is relatable to the security for the debt. (c) appoint any person (hereafter referred to as the manager), to manage the secured assets the possession of which has been taken over by the secured creditor; (d) require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt. (5) Any payment made by any person referred to in clause (d) of sub-section (4) to the secured creditor shall give such person a valid discharge as if he has made payment to the borrower. (6) Any transfer of secured asset after taking possession thereof or takeover of management under sub-section (4), by the secured creditor or by the manager on behalf of the secured creditor shall vest in the transferee all rights in, or in relation to, the secured asset transferred as if the transfer had been made by the owner of such secured asset,

36 ITA 4964/Mum/2013

(7) Where any action has been taken against a borrower under the provisions of sub-section (4), all costs, charges and expenses which, in the opinion of the secured creditor, have been properly incurred by him or any expenses incidental thereto, shall be recoverable from the borrower and the money which is received by the secured creditor shall, in the absence of any contract to the contrary, be held by him in trust, to be applied, firstly, in payment of such costs, charges and expenses and secondly, in discharge of the dues of the secured creditor and the residue of the money so received shall be paid to the person entitled thereto in accordance with his rights and interests. (8) If the dues of the secured creditor together with all costs, charges and expenses incurred by him are tendered to the secured creditor at any time before the date fixed for sale or transfer, the secured asset shall not be sold or transferred by the secured creditor, and no further step shall be taken by him for transfer or sale of that secured asset. (9) In the case of financing of a financial asset by more than one secured creditors or joint financing of a financial asset by secured creditors, no secured creditor shall be entitled to exercise any or all of the rights conferred on him under or pursuant to sub-section (4) unless exercise of such right is agreed upon by the secured creditors representing not less than three- fourth in value of the amoux* outstanding as on a record date and such action shall be binding on all the secured creditors: PROVIDED that in the case of a company in liquidation, the amount realised from the sale of secured assets shall be distributed in accordance with the provisions of section 529A of the Companies Act, 1956 (I of 1956): PROVIDED FURTHER that in the case of a company being wound up on or after the commencement of this Act, the secured creditor of such company, who opts to realise his security instead of relinquishing his security and proving his debt under proviso to sub-section (1) of section 529 of the Companies Act, 1956 (1 of 1956), may retain the sale proceeds of his secured assets after depositing the workmen's dues with the liquidator in accordance with the provisions of section 529A of that Act: PROVIDED ALSO that the liquidator referred to in the second proviso shall intimate the secured creditors the workmen's dues in accordance with the provisions of section 529A of the Companies Act, 1956 (1 of 1956) and in case such workmen's dues cannot be ascertained, the liquidator shall intimate the estimated amount of workmen's dues under that section to the secured creditor and in such case the secured creditor may retain the sale proceeds of the secured assets after depositing the amount of such estimated dues with the liquidator: PROVIDED ALSO that in case the secured creditor deposits the estimated amount of workmen's dues, such creditor shall be liable to pay the balance of the workmen's dues or entitled to receive the excess amount, if any, deposited by the secured creditor with the liquidator: PROVIDED ALSO that the secured creditor shall furnish an liquidator to pay the balance of the workmen's dues, if any. Explanation : For the purposes of this subsection,- (a) "record date" means the date agreed upon by the secured creditors representing not less than three-fourth in value of the amount outstanding on such date; (b) "amount outstanding"shall include principal, interest and any other dues payable by the borrower to the secured creditor in respect of secured asset as per the books of account of the secured creditor. (10) Where dues of the secured creditor are not fully satisfied with the sale proceeds of the secured assets, the secured creditor may file an application in the form and manner as may be prescribed to the Debts Recovery Tribunal having jurisdiction or a competent court, as the case may be, for recovery of the balance amount from the borrower. (11) Without prejudice to the rights conferred on the secured creditor under or by this section, the secured creditor shall be entitled to proceed against the guarantors or sell the pledged assets without first taking any of the measures specified in clauses (a) to (d) of subsection (4) in relation to the secured assets under this Act.

37 ITA 4964/Mum/2013

(12) The rights of a secured creditor under this Act may be exercised by one or more of his officers authorised in this behalf in such manner as may be prescribed. (13) No borrower shall, after receipt of notice referred to in subsection (2), transfer by way of sale, lease or otherwise (other than in / the ordinary course of his business) any of his secured assetsreferred to in the notice, without prior written consent of the secured creditor. 16 From the conjoint reading of above provisions relevant key points for the purpose

of our adjudication are as under ;-

(i) Now for the enforcement of security interest, no intervention of court or Tribunal is required by the secured creditors as Banks have been given sufficient powers to enforce its security interest. (ii) If the borrower who is liable or obliged under a 'Security Agreement' to make the payment to the secured creditor, makes any default in repayment of secured debt and his account has been classified as NPA, then Secured Creditor may issue notice under sub- section (2) to the borrower to discharge his full liabilities, in a certain time bound manner as mentioned in the notice. The borrower can raise objections against the notice which the secured creditor has to consider and dispose off in writing setting out the reasons. (iii) In case the borrower fails to discharge his liability in full within the period and in terms of notice, then, the secured creditor may take recourse to various measures as illustrated in the various clauses to sub-section 4 of section 13, to recover his secured debt only. The secured creditor has to take recourse u/s 14(1) of the Chief Metropolitan Magistrate or District Magistrate to take over the possession of the property. Thus, the crucial focus of sub-section (4) is that powers and measures is "to recover the secured debt" only and not over and above. In other words the title in some of the cases is passed for securing the debt and realizing the same. Shift in title is not shift on obligations of the borrower albeit obligation of the borrower is being discharged by the lender. (iv) The measures as illustrated in various clauses of the subsection (4) are purely mechanism to secure the debts like, taking possession of the secured asset (mortgaged asset) including the right to transfer; take over the management of the business of the borrower, appoint any person to manage the secured assets; to give time to person who has acquired the secured assets from the borrower for recovery of money; Thus, all these modes and measures are purely for realization of secured debts, which otherwise borrower was obliged to pay. In other words, all these powers and measures are to facilitate the recovery of debt due from the borrower which earlier was cumbersome and long drawn process through civil courts. (v) Sub-section 7, provides that all the costs, charges and expenses, etc shall be recoverable by the borrower or adjusted first from the money realization. If there is complete passing of the title, then there is no question of recovery of costs. This itself goes to show that secured creditor is realizing its secured debt and nothing beyond. (vi) Sub-section 8 lays down a very important point that, if the dues of the secured creditor along with the costs are tendered to the secured creditors, then no step shall be 17. Thus, the powers had been vested to Banks/ Secured Creditors to recover only the secured debts from the borrower, that is, the title or right on mortgaged asset (secured asset) assumed by the Bank is solely for securing and realizing its debts, which

38 ITA 4964/Mum/2013

otherwise was the obligation of the buyer. The bank only act as legally authorised agents to recover their money, which the borrower has failed to do so. From the scope of section 13 and powers and mode of recovery as enumerated in sub-section (4) read with other provisions, one thing is amply evident that, powers and right has been given to the Bank to recover its secured debt in various forms. The title over the secured asset is passed to the Bank only and only to extent of secured debt and not beyond it. In this context, Ld. Counsel's argument can be negated by following illustration:- 'A' (as a borrower) has borrowed a sum of Rs. 1 crore from Bank 'B' (Lender) after

mortgaging a property or asset worth Rs. 2 crores. 'A' could only pay back Rs. 50 lakhs

on principal amount and interest accrued thereof of Rs. 25 lakhs. Thereafter 'A' commits

default in repayment of balance principal amount of Rs. 50 lakhs and some interest

accrued thereon, say Rs. 10 lakhs. 'B' initiates proceedings under SARFAESI Act and

issues notice u/s 13(2) of Act. 'A' is unable to comply with terms of the notice within 60 days. (B' makes a requisition in terms of section 14 for acquiring the property and sells it

to the outsiders for Rs. 2 crores (on actual value) and from the sale proceeds recovers a

sum of Rs. 50 lakhs plus interest of Rs. 10 lakhs, i.e. the amount of secured debt due. Then, the moot point is, whether (B' is entitled to appropriate all the money of Rs. 2

crores; or the secured interest /debt due of Rs.60 lakhs; or the balance sum of Rs. 1.40

crores is to be paid back to the assessee as this was not part of secured interest or debt

due. No where the SARFAESI Act, provides that the 'B' is entitled to appropriate all,

albeit only to the extent of balance secured debt of Rs. 60 lakhs.

If the contention of the Ld. Counsel is accepted, then the logical proposition would be that, to the extent of Rs. 60 lakhs there was a 'diversion of Income by overriding title'

and for the balance money of Rs. 1.40 crores, there was no such diversion and the title

belonged to the assessee. This would, in my humble opinion would not be correct

proposition, because, the title on the and passes to the bank only to fulfill the obligation

39 ITA 4964/Mum/2013

of the assessee and enable the Bank to recover its own due money/debt. There would be

no deviation of the aforesaid principles, even in the case where the amount realized by sale of mortgaged asset has been appropriated whole as the debt due is more or same as in the present case. It cannot be principally held or accepted that, whenever on the sale of

mortgaged asset the debt amount realized is the same or less then there would be an

overriding title of the mortgage asset to the bank and therefore, the whole of the amount

realized should not be considered in the hands of the borrower and in cases the amount

realized is more on sale of mortgaged asset, the excess of the amount or income will belong

to the assessee. Here in this case, the Ld. Counsel had tried to contend before us that all the

amount has been appropriated by the bank after taking over the possession of the mortgaged

property and, therefore, such an income which has not come to the assessee and

appropriated directly at source by the bank, amounts to 'diversion of income by overriding

title'. Such a contention of the Counsel has to be out rightly rejected, because if for instance,

had the bank realized excess amount from sale of mortgaged asset, then whether the excess

amount too would have been appropriated by the Bank or whether the assessee would have

given up its claim of excess amount in favour of the bank. The answer will be negative.

Under the SARFAESI Act also the bank can only enforce its secure debts and not beyond

that. Therefore, the contention raised by the Ld. Counsel has no legs to stand.

amount from the liability side stands reduced and the asset stands disposed off for the

discharge of liability shown in the balance sheet and accordingly, the relevant entries are

made in the books of account. This precisely the assessee has also done in its books of

account, which is a correct and fair manner. Therefore, the sales of asset reflected in the

books were rightly shown under the head "capital gain" and income was computed under

40 ITA 4964/Mum/2013

"'Lone Term Caprtal Gain". Had there been a case of "diversion of the Income by source or

by overriding title", then the whole of the amount on sale of assets would not have entered

into the charging provisions of the Income Tax Act, at all, that is, would not have been even

entered the computation of total income. But here the assessee had duly disclosed the sale

consideration of the mortgaged asset not only in the books of account but also shown it as

its income as LTCG in the computation of income, albeit claimed a wrong deduction of

principal amount as cost of acquisition. The assessee now cannot plead otherwise. Even if

we go by the proposition that entries in the books of account are not relevant for deciding

the taxability of income, then also the fundamental aspect that permeates in this case is that,

the liability/debt was entered in the books of account and duly reflected in the audited

balance sheet and all throughout the obligation to discharge its self created liability/debt

was upon the assessee which remained its obligation till the end. Hence, such a discharge of

liability/debt even under the action taken by lender under the SARFAES1 Act was nothing

but application of income.

power/right to sell and dispose off the security interest, the obligation of payment of which

was on the borrower and the borrower has not done or played his part of covenant to

discharge his obligation on the outstanding loan. In all such cases, the income on sale of

secured asset by the secured creditor for its secured interest accrues or belongs to the

borrower assessee and here the income has been applied by the lending bank holding the

first charge on such income for specific discharge of obligation of the assessee as per the

legal covenant agreed in a contract between the lender and the borrower. There can be no

diversion of income simply because now the contract between the parties is enforced

through the SARFAESI Act. The Act merely gives more power to the lender banks to

41 ITA 4964/Mum/2013

enforce the contract between the parties and safeguard the security interest of the Bank, which was earlier done through mechanism of long drawn process under CPC through

CiviJ Courts. 20. Hence, in my humble opinion there is no material difference in the position of

law with the enactment of SARFAES1 Act, so as to come to a different conclusion

that law applicable prior to the commencement of the Act will no longer

will be applicable. Therefore, the legal proposition as upheld by the Hon*bJe

Supreme Court and High Court will still hold the ground in such cases. Accordingly,

the claim of deduction of the principal amount of Rs. 1,48,24,633/- made by the

assessee on the principle of 'diversion by overriding title' cannot be upheld and same

is denied to the assessee, because it is neither a case of diversion of income nor a

case for claim of deduction while computing the capital gain, albeit, it's purely a

case of an application of income as it was the assessee's obligation to pay its

debt. Thus, the ground raised by the assessee is dismissed.

In the result, the appeal of the assessee is dismissed.

Sd/-

(AMIT SHUKLA) JUDICIAL MEMBER Mumbai, Date : 23rd October, 2015 REFERENCE UNDER SECTION 255(4) OF INCOME TAX ACT 2. In the backdrop of the divergent views taken by Hon’ble Accountant

Member and Hon’ble Judicial Member, who constituted the Bench, a reference

42 ITA 4964/Mum/2013

was made to the Hon’ble President, vide reference dated 27-08-2015 to

nominate a Third Member to answer the following questions:-

"(i) Whether, on the facts and circumstances of the case, the assessee was justified in claiming the deduction of Rs.1,48,24,633/- out of full value of consideration arising from the transfer of mortgaged capital asset by the Kotak Mahindra Bank, which took over the possession of the said asset under the provisions of the SARFAESI Act, 2002. (ii) Whether, on the facts and circumstances of the case, the entire sale consideration, which is received by the Kotak Mahindra Bank from the transfer of mortgaged assets under the provisions of section 13 of the SARFAESI Act, will not be chargeable to Income tax in the hands of the assessee on the principle of "diversion of income by overriding title".

Member as a Third Member to decide the above questions, vide his order

dated 12-05-2019. The Hon’ble Third Member vide his order dated 10-

05-2019 has decided the issues in the following manner:-

PER G.S.PANNU, VICE PRESIDENT:

“The following points of difference have been referred to me by the Hon’ble President under Section 255(4) of the Income-tax Act, 1961 (in short ‘the Act’) :

“(i) Whether, on the facts and circumstances of the case, the assessee was justified in claiming the deduction of Rs.1,48,24,633/- out of full value of consideration arising

43 ITA 4964/Mum/2013

from the transfer of mortgaged capital asset by the Kotak Mahindra Bank, which took over the possession of the said asset under the provisions of the SARFAESI Act, 2002.

(ii) Whether, on the facts and circumstances of the case, the entire sale consideration, which is received by the Kotak Mahindra Bank from the transfer of mortgaged assets under the provisions of section 13 of the SARFAESI Act, will not be chargeable to Income tax in the hands of the assessee on the principle of “diversion of income by overriding title”.

44 ITA 4964/Mum/2013

KMBL directly received the consideration amounting to `2,18,00,262/- and adjusted the said realisation against the outstanding loan of the assessee, i.e. a sum of `1,48,24,633/- was adjusted against the principal component of the loan and `69,75,629/- was adjusted against the interest component of the loan. While computing the Capital Gain under the Act, assessee treated the entire amount of Rs.2,18,00,262/- received by the bank on sale of plots as sale consideration; however, the amount of `1,48,24,633/- which was apportioned against the principal component of the loan was claimed as deduction under Section 48 of the Act alongwith the indexed cost of acquisition and improvements (`3,43,583/- and other incidental expenses of `6000/- relating to sales). The Assessing Officer disallowed the above claim of the assessee and made an addition of `1,48,24,633/- while computing the income under the head ‘Capital Gains’. On further appeal by the assessee, the CIT(A) upheld the order of the Assessing Officer. Aggrieved by the same, assessee preferred further appeal before the Tribunal.

45 ITA 4964/Mum/2013

property automatically vested with KMBL as per Section 13 of the SARFAESI. Further, KMBL got overriding title and the payments were directly received by KMBL on account of transfer of secured assets. Thus, the doctrine of ‘diversion of income by overriding title’ applied to the facts of the present case. On the other hand, the learned Judicial Member passed an order sustaining the addition made by the Assessing Officer on the ground that the charge on the property was created by the assessee himself and thus, was in the nature of a voluntary charge. The doctrine of ‘diversion of income by overriding title’ is not applicable in the case of voluntary charge, but is applicable only in the case of automatic / compulsory charge. It was also noticed by the learned Judicial Member that if the argument of the assessee is accepted, this modus operandi will be used as a tax evasion method and every assessee will suo-moto create a charge on the property and will default in making payment of loans, and eventually avoid tax on Capital Gain resulting from transfer of asset whose proceeds are used to repay the loan liability. In view of this difference of opinion between the learned Judicial Member and learned Accountant Member, the matter has been referred to me for my opinion.

46 ITA 4964/Mum/2013

47 ITA 4964/Mum/2013

behalf of the assessee. My attention was drawn to the provisions of Section 13(4) of the SARFAESI Act to state that on default by the borrower in repayment of loan within the stipulated time, the property vests with the secured creditor and the creditor obtains the right to sell the property in his own right.

48 ITA 4964/Mum/2013

time of vesting of the property in favour of KMBL and, therefore, the sale of property by KMBL was on account of the assessee. The amount retained by KMBL towards loan liability was merely an application of income by the assessee. In this regard, the learned DR relied on the decision of the Chennai Bench of the Tribunal in the case of Geetha Subrabamiam vs. ITO on ITA Nos. 427 & 428/MDS/2017 dated 27.04.2017. It was further argued that merely by taking over possession of the assets of borrower under SARFAESI Act, the secured creditor does not acquire the ownership of the assets or becomes the owner of the assets. In this regard, he placed reliance on the decision of the Delhi Bench of the Tribunal in the case of Rajasthan Petrosynthetics Ltd in ITA no. 1397/Del/2013 dated 22.08.2014. It was further argued that if KMBL would have realised any amount in excess of the amount of loan liability recoverable by KMBL, the excess would have been returned by KMBL to the assessee. Thus, it cannot be said that the ownership of the assets vested with KMBL only and asset was sold by KMBL on principal to principal basis and not as agent of the assessee.

49 ITA 4964/Mum/2013

[1997] 227 ITR 222 has discussed the above doctrine. The relevant para of the said judgment is reproduced hereunder:

“In taking the view that in a case where the property has been mortgaged by the previous owner during his lifetime and the assessee, after inheriting the same, has discharged the mortgage debt, the amount paid by him for the purpose of clearing off the mortgage is not deductible for the purpose of computation of capital gains, the Kerala High Court has failed to note that in a mortgage there is transfer of an interest in the property by the mortgagor in favour of mortgagee and where the previous owner has mortgaged the property during his lifetime, which is subsisting at the time of his death, then after his death his heir only inherits the mortgagor's interest in the property. By discharging the mortgage debt his heir who has inherited the property acquires the interest of the mortgagee in the property. As a result of such payment made for the purpose of clearing off the mortgage the interest of the mortgagee in the property has been acquired by the heir. The said payment has, therefore, to be regarded as 'cost of acquisition' under section 48, read with section 55(2). The position is, however, different where the mortgage is created by the owner after he has acquired the property. The clearing off the mortgage debt by him prior to transfer of the property would not entitle him to claim deduction under section 48 because in such a case he did not acquire any interest in the property subsequent to his acquiring the same. In Daksha Ramanlal's case (supra) the Gujarat High Court has rightly held that the payment made by a person for the purpose of clearing off the mortgage created by the previous owner is to be treated as cost of acquisition of the interest of the mortgagee in the property and is deductible under section 48.”

(underlined for emphasis by me)

“1. Whether on the facts and in the circumstances of the case and in law, the Appellate Tribunal was correct in holding that the amount realised by the sale of the assessee's interest in the property was only Rs. 4,33,960 i.e., Rs. 5,62,980 minus Rs. 1,29,020 ?

50 ITA 4964/Mum/2013

(underlined for emphasis by me)

While answering the above questions, the Hon'ble Supreme Court held as under:-

“8. We are of the view that the Tribunal and the High Court were in error. What was sold by the State at the auction was the immovable property that belonged to the assessee. The price that was realised therefore belonged to the assessee. From out of that price, the State deducted its dues towards "kits" and interest due from the assessee and paid over the balance to him. The capital gain that the assessee made was on the immovable property that belonged to him. Therefore, it is on the full price realised (less admitted deductions) that the capital gain and the tax thereon has to be computed.”

(underlined for emphasis by me)

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of income by overriding title’. The relevant para of the said judgment is reproduced hereunder:-

“In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one's own income, which has been received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable.”

(underlined for emphasis by me)

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needs to be analysed in the facts of the present case to decide whether the ratio laid down in the case of Attilli N. Rao (supra) still holds good.

“Enforcement of security interest. 13. (1) Notwithstanding anything contained in section 69 or section 69A of the Transfer of Property Act, 1882 (4 of 1882), any security interest created in favour of any secured creditor may be enforced, without the intervention of the court or tribunal, by such creditor in accordance with the provisions of this Act. (2) Where any borrower, who is under a liability to a secured creditor under a security agreement, makes any default in repayment of secured debt or any instalment thereof, and his account in respect of such debt is classified by the secured creditor as non-performing asset, then, the secured creditor may require the borrower by notice in writing to discharge in full his liabilities to the secured creditor within sixty days from the date of notice failing which the secured creditor shall be entitled to exercise all or any of the rights under sub- section (4) : [Provided that— (i) the requirement of classification of secured debt as non- performing asset under this sub-section shall not apply to a borrower who has raised funds through issue of debt securities; and

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(ii) in the event of default, the debenture trustee shall be entitled to enforce security interest in the same manner as provided under this section with such modifications as may be necessary and in accordance with the terms and conditions of security documents executed in favour of the debenture trustee. ] (3) The notice referred to in sub-section (2) shall give details of the amount payable by the borrower and the secured assets intended to be enforced by the secured creditor in the event of non-payment of secured debts by the borrower. [(3A) If, on receipt of the notice under sub-section (2), the borrower makes any representation or raises any objection, the secured creditor shall consider such representation or objection and if the secured creditor comes to the conclusion that such representation or objection is not acceptable or tenable, he shall communicate [within fifteen days] of receipt of such representation or objection the reasons for non-acceptance of the representation or objection to the borrower: Provided that the reasons so communicated or the likely action of the secured creditor at the stage of communication of reasons shall not confer any right upon the borrower to prefer an application to the Debts Recovery Tribunal under section 17 or the Court of District Judge under section 17A.] (4) In case the borrower fails to discharge his liability in full within the period specified in sub-section (2), the secured creditor may take recourse to one or more of the following measures to recover his secured debt, namely :— (a) take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset; [(b) take over the management of the business of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset : Provided that the right to transfer by way of lease, assignment or sale shall be exercised only where the substantial part of the business of the borrower is held as security for the debt : Provided further that where the management of whole of the business or part of the business is severable, the secured creditor

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shall take over the management of such business of the borrower which is relatable to the security for the debt;] (c) appoint any person (hereafter referred to as the manager), to manage the secured assets the possession of which has been taken over by the secured creditor; (d) require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt. (5) Any payment made by any person referred to in clause (d) of sub-section (4) to the secured creditor shall give such person a valid discharge as if he has made payment to the borrower. [(5A) Where the sale of an immovable property, for which a reserve price has been specified, has been postponed for want of a bid of an amount not less than such reserve price, it shall be lawful for any officer of the secured creditor, if so authorised by the secured creditor in this behalf, to bid for the immovable property on behalf of the secured creditor at any subsequent sale. (5B) Where the secured creditor, referred to in sub-section (5A), is declared to be the purchaser of the immovable property at any subsequent sale, the amount of the purchase price shall be adjusted towards the amount of the claim of the secured creditor for which the auction of enforcement of security interest is taken by the secured creditor, under sub-section (4) of section 13. (5C) The provisions of section 9 of the Banking Regulation Act, 1949 (10 of 1949) shall, as far as may be, apply to the immovable property acquired by secured creditor under sub-section (5A).] (6) Any transfer of secured asset after taking possession thereof or take over of management under sub-section (4), by the secured creditor or by the manager on behalf of the secured creditor shall vest in the transferee all rights in, or in relation to, the secured asset transferred as if the transfer had been made by the owner of such secured asset. (7) Where any action has been taken against a borrower under the provisions of sub-section (4), all costs, charges and expenses which, in the opinion of the secured creditor, have been properly incurred by him or any expenses incidental thereto, shall be recoverable from the borrower and the money which is received by the secured creditor shall, in the absence of any contract

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to the contrary, be held by him in trust, to be applied, firstly, in payment of such costs, charges and expenses and secondly, in discharge of the dues of the secured creditor and the residue of the money so received shall be paid to the person entitled thereto in accordance with his rights and interests. [ (8) Where the amount of dues of the secured creditor together with all costs, charges and expenses incurred by him is tendered to the secured creditor at any time before the date of publication of notice for public auction or inviting quotations or tender from public or private treaty for transfer by way of lease, assignment or sale of the secured assets,— (i) the secured assets shall not be transferred by way of lease assignment or sale by the secured creditor; and (ii) in case, any step has been taken by the secured creditor for transfer by way of lease or assignment or sale of the assets before tendering of such amount under this sub-section, no further step shall be taken by such secured creditor for transfer by way of lease or assignment or sale of such secured assets. ] (9) [Subject to the provisions of the Insolvency and Bankruptcy Code, 2016, in the case of] financing of a financial asset by more than one secured creditors or joint financing of a financial asset by secured creditors, no secured creditor shall be entitled to exercise any or all of the rights conferred on him under or pursuant to sub-section (4) unless exercise of such right is agreed upon by the secured creditors representing not less than [sixty per cent] in value of the amount outstanding as on a record date and such action shall be binding on all the secured creditors : Provided that in the case of a company in liquidation, the amount realised from the sale of secured assets shall be distributed in accordance with the provisions of section 529A of the Companies Act, 1956 (1 of 1956) : Provided further that in the case of a company being wound up on or after the commencement of this Act, the secured creditor of such company, who opts to realise his security instead of relinquishing his security and proving his debt under proviso to sub-section (1) of section 529 of the Companies Act, 1956 (1 of 1956), may retain the sale proceeds of his secured assets after depositing the workmen's dues with the liquidator in accordance with the provisions of section 529A of that Act : Provided also that the liquidator referred to in the second proviso shall intimate the secured creditor the workmen's dues in accordance with the

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provisions of section 529A of the Companies Act, 1956 (1 of 1956) and in case such workmen's dues cannot be ascertained, the liquidator shall intimate the estimated amount of workmen's dues under that section to the secured creditor and in such case the secured creditor may retain the sale proceeds of the secured assets after depositing the amount of such estimated dues with the liquidator : Provided also that in case the secured creditor deposits the estimated amount of workmen's dues, such creditor shall be liable to pay the balance of the workmen's dues or entitled to receive the excess amount, if any, deposited by the secured creditor with the liquidator : Provided also that the secured creditor shall furnish an undertaking to the liquidator to pay the balance of the workmen's dues, if any. Explanation.—For the purposes of this sub-section,— (a) "record date" means the date agreed upon by the secured creditors representing not less than [sixty per cent] in value of the amount outstanding on such date; (b) "amount outstanding" shall include principal, interest and any other dues payable by the borrower to the secured creditor in respect of secured asset as per the books of account of the secured creditor. (10) Where dues of the secured creditor are not fully satisfied with the sale proceeds of the secured assets, the secured creditor may file an application in the form and manner as may be prescribed to the Debts Recovery Tribunal having jurisdiction or a competent court, as the case may be, for recovery of the balance amount from the borrower. (11) Without prejudice to the rights conferred on the secured creditor under or by this section, the secured creditor shall be entitled to proceed against the guarantors or sell the pledged assets without first taking any of the measures specified in clauses (a) to (d) of sub-section (4) in relation to the secured assets under this Act. (12) The rights of a secured creditor under this Act may be exercised by one or more of his officers authorised in this behalf in such manner as may be prescribed. (13) No borrower shall, after receipt of notice referred to in sub-section (2), transfer by way of sale, lease or otherwise (other than in the ordinary course

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of his business) any of his secured assets referred to in the notice, without prior written consent of the secured creditor.”

Sub-section (2) of Section 13 of the SARFAESI Act provides that if the borrower defaults in repayment of loan or any instalment thereof and his account is classified as a Non-Performing Asset, then the secured creditor shall issue a notice requiring him to make the payment within sixty days, failing which the secured creditor shall exercise his rights conferred under Sub-section (4) of the SARFAESI Act. Sub-section (4) of SARFAESI Act provides that if the borrower fails to make payment within the time specified in the notice issued under Sub- section (2), the secured creditor shall have right to exercise various options which, inter-alia, includes right to take possession of the secured asset and the right to transfer by way of lease, assignment or sale for realising the secured asset. Thus, Sub-section (4) of Section 13 of SARFAESI Act provides the secured creditor with the right to transfer the secured asset in order to realise the secured debt.

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to part with the secured asset without the prior approval of the secured creditor. Further, on non-repayment of loan or instalment amount within the period specified in the notice issued under Sub-section (2) of Section 13 of the SARFAESI Act, all the rights in the secured asset get vested with the secured creditor and the borrower has no right in the said asset. The borrower is not free to decide even the way in which the secured asset shall be parted with. It is the sole discretion of the secured creditor as to how the secured asset shall be dealt with. This right in favour of the secured creditor is created by virtue of SARFAESI Act; and, this has been interpreted by the learned representative for the assessee to say that the mortgaged property vested with KMBL and, therefore, the property was sold by KMBL in its own right. In my considered opinion, the fall-out of non- compliance envisaged in Sub-section (2) of Section 13 of the SARFAESI Act provides the secured creditor all or any of the rights enumerated in Sub-section (4) thereof. Clause (a) of Sub-section (4) of Section 13 of the SARFAESI Act is being sought to be understood by the assessee to mean taking possession of the secured asset by KMBL as an owner per se. So however, in my considered opinion, the reading of clause (a) of Sub-section (4) of Section 13 of the SARFAESI Act does not justify the aforesaid interpretation. Sub-section (4) of Section 13 of the SARFAESI Act says “In case the borrower fails to discharge his liability ......................... the secured creditor may take recourse ........................... to recover his secured debt .............”. Furthermore, clause (a) of Sub-section (4) of Section 13 of the SARFAESI Act, inter-alia, says “take possession of the secured assets ................... including the right to transfer ......................... for realising the secured asset”. Quite clearly, vesting of the secured asset with the secured creditor is prescribed by SARFAESI Act to enable the secured creditor “to recover his secured debt” including, inter-alia, empowering the secured creditor to take possession and transfer by way of lease, assignment or sale the secured asset

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“for realising the secured asset”. Therefore, in my considered opinion, the stand of the assessee (on the strength of SARFAESI Act) that the mortgaged property vested with KMBL and to say that the consideration received by KMBL on transfer of said property never accrued to the assessee as the asset did not belong to the assessee is untenable given the mandate of the SARFAESI Act.

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condition of disposal of the property by KMBL in case of default in repayment of loan by it. This arrangement, even without force of any law, was clear and unambiguous. Thus, it was only a voluntary action on the part of the assessee to enter into such an obligation and assessee was not compelled by law or any other obligation beyond it’s control to enter into such an arrangement. Once that is so, any action taken by KMBL to enforce it’s right to recover the amount which, in the present case, is right to sell the property to recover amount cannot be said to be transaction beyond the control of the assessee. Thus, the amount recovered by KMBL can by no stretch of imagination be treated as ‘diversion of income by overriding title’. The principle of ‘diversion of income by overriding title’ applies when the transaction is beyond the control of the assessee due to which assessee has to make commitment to either divert it’s income or part with income earned by it in a particular manner. The principle of ‘diversion of income by overriding title’ has been laid down by the courts to overcome the situation wherein an assessee does not have a free hand on the amount earned by it or is in fact not received by an assessee due to circumstances beyond it’s control. Such principle would not be attracted in cases wherein assessee by his own past action creates a future obligation for himself to utilize the amount in a particular manner. Thus, the claim of the assessee cannot be accepted in the facts of the present case.

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default in repayment of loan, assessee still chose to enter into such an arrangement. So it is an action of the assessee, which has created the instant obligation on itself. Insofar as the argument of the learned representative that the instant obligation was not voluntary and was mandated by the SARFAESI Act, in my view, the same is quite misplaced inasmuch as it is only the voluntary act of the assessee of entering into mortgage loan arrangement with KMBL and the subsequent default in repayment which has triggered Sub-section (13) of Section 13 of the SARFAESI Act placing restriction on the assessee to transfer the mortgaged/secured asset by way of sale, lease or otherwise without the prior consent of KMBL. Alternatively, I find that SARFAESI Act merely provides a recovery mechanism and nothing else. The SARFAESI Act cannot be interpreted to mean that it has created right of ‘diversion of income by overriding title’. While interpreting the law, due regard must be given to the intent and purpose of the law. The purpose of SARFAESI Act, and which clearly emerges from the phraseology of Section 13 of SARFAESI Act, is to effectuate and expedite the recovery of secured interest of the secured creditor and certainly not, so far as the present case is concerned, to reduce or to impair the provisions of the Act in determination of income-tax liability of the assessee.

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Sd/- (G.S. PANNU) VICE PRESIDENT

Mumbai, Dated 10th May, 2019”

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Per Pawan Singh, J.M 4. In accordance with the majority view, we hold that the grounds of

appeal raised by the assessee are dismissed.

Order pronounced in the open court on 05-09-2019.

Sd/- Sd/- (Rajesh Kumar ) (Pawan Singh) ACCOUNTANT MEMBER JUDICIALMEMBER Mumbai, Dt : 5th September, 2019 Pk/- Copy to : 1. Appellant 2. Respondent 3. CIT(A) 4. CIT 5. DR /True copy/ By order Asstt. Registrar, ITAT, Mumbai