DCIT, CIRCLE, PATIALA vs. M/S PUNJAB STATE POWER CORPORATION LTD., PATIALA

In the opposition the learned Departmental Representative reiterated the reasoning given in the impugned order for holding that interest on income tax refund was assessable under the head `Income from other sources'. He submitted that for an income to fall under the head `Profits and gains of business or profession', it was necessary that it should arise out of some real, substantial and systematic or organized course of activity. It was argued that the income-tax is levied after the income is earned and not before it. To support his contention that income tax is liability of personal nature, he relied on the judgment of the Hon'ble juri ictional High Court in the case of CIT Vs. Ghatkopar Estate & The Maharashtra State Co-op. Bank Limited Finance Corpn. (P) Ltd. [(1989) 177 ITR 222 (Bom.)] in which it was held that interest on income-tax liability was not allowable deduction because it was a liability of personal nature. He also relied on the judgment of the Hon'ble Supreme Court in Bharat Commerce Industrial VS. CIT (1998) 230 ITR 733 (SC) to state that the payment of income-tax could never be for the purpose of preserving or promoting the business. As the payment of income-tax could not be with the intention of earning income, he submitted that there was no question of treating the interest on income tax refund as falling under the head `Profits and gains of business or profession'. He further stated that once tax is paid, the money so paid ceases to be circulating capital as the payment of tax is personal liability determined after the ascertainment of taxable income. Accordingly he put forth the argument that the interest on income-tax refund could never assume the character of income coming under the head "Profits and gains of business or profession", whether or not the assessee is in banking business or the money is or not the circulating capital of the business. In his opinion, the test devised by the learned A.R., being utilization of business funds was not appropriate to hold any income resulting there from as going down under the head `Profits and gains of business or profession'. He relied on the order passed by the Pune Bench of the Tribunal in Salgaocar Mining Industries Vs. DCIT [(1997) 61 ITD 105] in which it was held that the interest on income-tax refund is assessable as income from other sources. For the same proposition he also relied on the orders passed in Eicher Goodearth Limited Vs. DCIT [(2001) 71 TTJ (Delhi) 841] and Shah Originals Vs. ACIT [(2007) 112 TTJ (Mum.) 754]. He also relied on the judgments in CIT Vs. Travancore Tea & Estate Limited [(1994) 207 ITR 242 (Ker.)] and Smt. B. Seshamma VS. CIT (1979) 119 ITR 314 (Mad) holding that the interest on income-tax refund was liable to be assessed as `Income from other sources'.

Section 14 falling in Chapter IV provides that all income shall, for the purposes of charge of income-tax and computation of total income, be classified under the existing five heads of income. Each head further contains certain sections. In the present appeal we are concerned only with two heads of income. Chapter

Now we have to determine as to whether the interest on income-tax refund can be said to be falling under the head `Profits and gains of business or profession'. Before we advert to this question it is necessary to consider the nature of income-tax. For that purpose the judgment of the Hon'ble Supreme court in the case of East India Pharmaceutical Works Ltd. Vs. CIT [(1997) 224 ITR 627 (SC)] is relevant, in which the question was about the deductibility or otherwise of interest on money borrowed for payment of income-tax. In that case the assessee had an overdraft account with a bank. It claimed that a sum of Rs.28,488 was allowable expenditure u/s.37(1) of the Act as representing the interest which it had to pay on the overdraft account taken for the payment of income-tax. The ITO disallowed the deduction by holding that the payment of income-tax could not be for the purpose of business. It was claimed before the Tribunal that if the tax liability had not been discharged, then the entire business would have crippled and therefore, interest on such overdraft account be allowed as an expenditure for business purposes. The Tribunal refused to interfere with the view taken by the authorities below. Similar opinion was formed by the Hon'ble High Court by holding that a trader carries on business for the purpose of earning profit and not for the purpose of paying income-tax. No business is ever carried on nor can it be carried on with the object of paying the income-tax. Though the earning of profits and payment of taxes are not isolated and independent activities of a business, it cannot be said that the expenditure incurred or laid out for the purpose of payment of income-tax shall fall within the scope of the expression "for the purpose of business". It was, therefore, laid down that the amount paid as income-tax was not an expenditure at all, not even a business expenditure and hence it could not even be argued that the interest paid by trader on the moneys borrowed for the payment of income-tax was a business expenditure. Still in another judgment in Bharat Commerce Industrial Ltd. (supra), the Hon'ble Supreme Court has held : "the liability in the case of payment of income-tax and interest for delayed payment of income-tax or advance tax arises on the computation of profits and gains of business. The tax which is payable on the assessee's income is after the income is determined". It was held that the interest paid for not paying the requisite payment of income-tax could not be considered as an expenditure for the purpose of earning any income or profit. From the above two judgments it is manifested that the payment of income-tax is payable after the income is determined. Section 40(a)(ii) provides that "any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, `any such profits or gains'" shall not be deducted in computing the income chargeable under the head `Profits and gains of business or profession'. On a conjoint reading of section 40(a)(ii) along with the above referred two Apex Court judgments, it can be noticed that not only the payment of income-tax is not deductible but also the interest paid by the assessee for non/delayed payment of income-tax, be it directly payable to the Income-tax department or on loans taken for paying income tax, cannot be allowed as deduction. It cannot be considered as an expenditure which is incurred for the purpose of business so as to qualify for consideration in computing profits of the business. Thus the payment of income- tax or the interest thereon or in relation to that is a step away from the carrying on of the business on year to year basis. In contrast to that, any indirect tax which is paid in the course of carrying on of the business, is deductible for arriving at the net profit for the relevant year. It, therefore, follows that the payment of income-tax or interest thereon or relating to such tax is an event which takes place after the determination of the profits of the business for the relevant year. Even though there is relation between the earning of profits and payment of income tax, but that would not make it deductible under the head `Profits and gains of business or profession'.

Coming back to section 28(i) it is noted that only the profits and gains of any business which was carried on by the assessee at any time during the year shall be chargeable to income-tax under the head `Profits and gains of business or profession'. Thus in order to qualify for an item of income to be classified under this head, it is important that such income must be earned from the business which is carried on by the assessee. Turning to the facts of the instant case it is observed that the income-tax was paid by the assessee in earlier years, which was certainly not "for the purpose of business" and hence not deductible under this head. As the said tax liability was discharged not in the carrying on of the business for the relevant years but after the determination of income, it was an event not taking place in carrying on the business of the assessee. Eventually when the amount of income-tax was refunded along with interest u/s.244A that would also, naturally, be an event after the determination of income on year to year basis and hence would fail to fall u/s.28(i).

This position can be viewed from another angle also. We have noted above the meaning of "business" as some real, substantial and systematic or organized course of activity or conduct with the intention of earning income. Therefore, it follows that an income to result from business should be from the doing of some systematic or regular course of activity conducted with the intention of earning income. We have noted above that the payment of income-tax is a statutory liability which falls upon the assessee after the determination of income i.e. after the business is carried on for a particular year. In that view of the matter the payment of income-tax cannot be held to be a business activity or a transaction done during the carrying on of the business, which is a pre-requisite condition for the inclusion of any item of income within the fold of `Profits and gains of business or profession'. When the payment of income-tax is an event post- ascertainment of income, naturally the refund thereof or interest would also be an event post- ascertainment of income and not during the carrying on of the business.

Further we have noted supra that the second necessary ingredient for an income to fall under this head is that there should be an intention to earn income. If the intention to earn income is lacking but some income still results, it will not fall under the head `Profits and gains of business or profession'. There cannot be any dispute on the proposition that the payment of income tax is discharge of statutory liability. There is not and cannot be any intention of the assessee to earn income by paying the income-tax. Thus when the statutory liability is created on the assessee with the passing of the assessment order, such liability is to be discharged by making the payment thereof. It cannot be said that the assessee paid income-tax with the intention of earning income from the interest which shall become due if the assessment order is modified or overturned to his advantage. Thus it is apparent that there cannot be an intention to earn income from the payment of income-tax.

The learned Counsel for the assessee has overemphasized on the point that in the case of a banking business the money available at the disposal of the assessee was its stock in trade and when such stock in trade was wrongly taken away it retained the character of its circulating capital and on the refund of such amount the circulating capital stood restored and for wrongful deprivation of such money, the interest so earned should be considered as falling under the head `Profits and gains of business or profession'. We are not agreeable with this contention. The criteria to determine the head under which a particular income shall fall is not to ascertain whether or not the circulating capital of the assessee was invested but what the nature and character of income which results from such deployment of circulating capital. If for example the assessee a bank, utilizes its circulating capital in the purchase of a building or land appurtenant thereto, the annual value of such building shall fall under the head `Income from house property', and not `Profits and gains of business or profession' for the reason that the nature of income which results from the purchase of building falls under the head of rental income. It is seen that even in the instant case the assessee earned income from house property to the tune of Rs.18,985, which was held by the Assessing Officer to be falling under the head `Income from house property', which action has not been assailed in further appeals thereby allowing the finality to attach to that aspect of the matter. It is not the case of the assessee that the building from which rental income was earned, was not purchased by investing its money. Proceeding further supposing the building whose annual was assessed under Chapter IV-C, is subsequently transferred and there results income on such transfer. Going by the yardstick of the ld. AR, such gain should also be assessed under the head of business income because the circulating capital of the business was utilized for its purchase. Obviously it is not so as the resultant income on the transfer of building, being the capital asset, shall fall under the head `Capital gains'. Going still further if the assessee parks some of its money, being the circulating capital of its banking business, in some non-banking business, the income so resulting would not become income from the banking business, so as to be eligible for deduction u/s 80P. In the like manner if the assessee, engaged in banking business, comes into the possession of some funds which are not its circulating capital and the same are utilized in the banking business, the income from the user of such funds shall retain the character of income from banking business notwithstanding the fact that the money so used was not its circulating capital. It will be income from banking business eligible for deduction u/s 80P subject to the fulfillment of the other conditions of the section. The Hon'ble Summit Court in the case of CIT Vs. Karnataka State Co-operative Apex Bank [(2001) 251 ITR 194 (SC)] has held to this extent by laying down that "the placement of such funds being imperative for the purpose of carrying on the banking business, the income derived there from would be income from assessee's business. There is nothing in the phraseology of that provision which makes it applicable only to income derived from working or circulating capital". From this judgment it can be noticed that the deployment of circulating capital or non- circulating capital is not a relevant factor in determining the head under which the income shall fall. It is, in fact, the nature and character of income. When income results for carrying on of business, it falls under the head `Profits and gains of business or profession'. The Hon'ble Supreme court in the case of Mehsana District Central Co-operative Bank Ltd. Vs. ITO [(2001) 251 ITR 522 (SC)] has held that the locker rent received by the assessee was a part of ordinary banking business as shown by section 6(1)(a) of the Banking (Regulation) Act, 1949 and, therefore, the income derived by the assessee bank from hiring out of safe deposit vaults was income from banking business and deductible u/s.80P(2)(a)(i). From these judicial pronouncements it can be discerned that if the income results from the activities specified in the Banking (Regulation) Act, 1949, the same would fall under the head "Profits and gains of business or profession". We have also perused the relevant part of Banking Regulation Act, 1949. The ld. AR could not point out any clause treating the payment of income- tax as part of banking business, which obviously cannot be the case.

We do not find any substance in the contention of the learned A.R. that return by the Income-tax Department of its circulating capital along with interest would amount to the dropping of interest on such refund under the head `Profits and gains of business or profession' for the sole reason that if the department had not taken away its circulating capital, then it would have been deployed for the purpose of banking business and income from which would have been characterized as the business income. In our considered opinion the material consideration is to see what has actually happened and not what could have happened. It is possible that instead of discharging income-tax liability, the assessee had utilized such amount alternatively on the purchase of any building or for some non-banking activity or may not have at all deployed it in the business for the one reason or the other. In these situations either no income would have resulted at all or it would have fallen under any other head of income. Hence no hypothetical situation can be contemplated for taking the decision as to what sort of income could have resulted if the funds had been used in one way or the other by completely disregarding the nature of actual income earned. It is, in fact, the real character and nature of the resulting income which needs to be examined in preference to the imaginary situation.

From the above discussion it is crystal clear that the consideration for determining the head under which a particular income shall fall is not the utilization of circulating capital but the nature and character of income which arises from the exploitation of such funds. As discussed above, there are presently five heads of income. For an income to plunge under the head `Salaries' what is essential is that it should fit into any of the three clauses of section 15, such as, it should be due from an employer or former employer. Once the conditions of this section are satisfied, the matter ends and the amount becomes chargeable to tax under this head. Similarly an income to fall under the head `Income from house property', it is vital that the same should be the annual value of property consisting of any building of land appurtenant thereto, of which the assessee is owner. Thus the conditions of section 22 should be fulfilled. When such conditions are satisfied, there remains no need to examine any thing further. In a case where the assessee, a builder let out his property for some time pending sale, the dispute arose about the head under which such rental income shall fall. The Hon'ble Supreme Court in East India Housing & Land Development Trust Ltd. VS. (SC) held that such income was taxable under the head `Income from house property' and not `business income'. Thus it can be seen that once the conditions of section 22 are satisfied, the income has to be classified under that head and other matters, even if having some bearing, go out of consideration. Similarly an income to come with the ambit of Chapter IV-E, it is fundamental that it should be profit or gain arising from the transfer of capital asset. If there is income from the transfer of capital asset, the same is taxable under this head, notwithstanding the fact that the funds for the acquisition of such capital asset were business or non-business. In the like manner for an income to be charged under the head `Profits and gains of business or profession' under Chapter IV-D it is required that the same should be covered in any of the clauses of section 28, unless it is the case of some special provisions of this Chapter. When the income falls under any of the above four heads exclusively, it is classified accordingly. If however there is income of any other kind which is not to be excluded from the total income under the Act, the same is chargeable to income tax under the residual head,

Sub-section (1) of section 56 is couched generally to bring within its purview any such income which is chargeable to income-tax but does not fall under any of the heads specified in section 14 items A to E. Sub-section (2) of section 56 enlists items mentioned in clauses (i) to (viii), which shall be charged to income-tax under the last head of income, without prejudice to the generality of the provisions of sub-section (1). From the above discussion it is discernible that income is included in any of the first four heads, if the conditions of the relevant sections are satisfied. If however the income results, which is otherwise not excluded from total income, but is not includible in the above specific heads, then it is chargeable under the residual head of `Income from other sources'.

Coming back to the point in question we find that the interest on income-tax does not satisfy the conditions of section 28(i). It is not the case of the assessee nor it can be, that it is governed by any other clause of section 28 . In view of the fact that interest on income-tax refund is not excluded from the total income under this Act, it shall be subjected to tax under the last head of `Income from other sources'.

Now we will deal with other contentions raised on behalf of the assessee to bolster his submission that interest on income tax refund is taxable under the head `Profits and gains of business or profession'. The learned Counsel for the assessee heavily banked upon the judgments in Donald Miranda & Ors. (supra) and R.B.Jodhamal Kuthiala (supra) holding that the interest on income tax refund shall draw its colour from the nature of payment and since the tax when paid was deductible expenditure under the business head and accordingly the refund of such tax with interest shall also fall under the head of business income and not the miscellaneous head of income. It is beyond doubt that in the case of R.B. Jodhamal Kuthiala (supra) it has been held that the interest on refund of tax shall fall under the head of business income and not the residual head. But it is important to note the background of facts in which it was so held. In the case of Donald Miranda & Ors.(supra) the firm was carrying on the business and was assessed to income-tax under the provisions of Income-tax Act, 1918. It was dissolved in 1945. In respect of the chargeable accounting period from 24 March 1944 to 24 March 1945, the firm was taxed to excess profit tax under the Excess Profits Tax Act, 1940. In accordance with the provisions of Excess Profit Tax Act, the firm became entitled to refund of portion of excess profit tax. The share of three partners was determined. The assessee claimed that the amount refunded was business profit and hence exempt from tax u/s.25(4) of the Act. The ITO rejected the submission. The Tribunal held that the sum which was refunded was income from business and was therefore exempt from income- tax u/s.25(4) of the Act. The High Court held that the amount so refunded was income from other sources. When the matter finally came up before the Hon'ble Supreme Court, it was held that the amount of refund would be income from business assessable u/s.10 of the Income-tax Act and not income from other sources u/s.

It is relevant to consider that the amount of excess profit tax payable in respect of business for chargeable accounting period was allowable by way of relief in computing the profits and gains of the business and was deductible as an expense incurred in that period. It was in the light of these facts that the Hon'ble Supreme Court held that when it was deposited with the Central Government it was a portion of the profit of the business of the assessee and when it was returned to the assessee it must be restored to the character of being part of the profits of the business. From the facts of that case it can be seen that the ratio decidendi of the judgment is qua the treatment of refund of income-tax and not interest on such income-tax refund. The tax payable by the assessee was deductible from business profits and it was only when the excess amount was refunded that it was held to be income from business. In the case of R.B.Jodhamal Kuthiala (supra) the Hon'ble Punjab & Haryana High Court followed the judgment of the Hon'ble Supreme Court in the case of Donald Miranda & Ors.(supra) and held that the excess profit tax paid was deductible and when refund was received there from, it would be the income from business. Apart from refund, the assessee was also granted interest which was held to be falling under the head income from business. It is significant to note that these two judgments are based on Indian Income Tax Act, 1922 and Excess Profit Tax Act, 1940. When the provisions of the relevant statute provided for allowing deduction on the payment of excess profit tax against the "business income", it was natural that the refund of excess tax or interest on such refund, drawing colour from such refund, would also fall under the same head. It is simple and plain that when a particular deduction is claimed in excess, the reversal of such deduction shall lead to the enhancement of the same income. For example, if there is a business income of Rs. 100 after the claim for deduction on account of salaries of Rs. 25 and subsequently it comes to the notice that the correct salary payable was to the tune of Rs. 20 only, the refund of Rs.5 will augment the business income to Rs. 105. The income, if any, under other heads will remain unaltered with this receipt of the refund of Rs.

Applying the same analogy to the above two judgments, we find that when the assessee paid tax (equal to Rs. 25 in our above example), the same was allowed as deduction against the business income. However when subsequently the refund of the excess tax paid or interest thereon (equal to Rs. 5 in our above example) was received, it was but natural that the business income, that was earlier compressed stood swelled accordingly. However in the present appeal we are considering the provisions of Income-tax Act, 1961 in which payment of income-tax is not deductible under the head `Profits and gains of business or profession'. Logically the refund of income-tax would also not become liable for taxation under the same head. In that view of the matter the interest on income-tax refund would also form part of income-tax refund which can not be charged to tax under the head `Profits and gains of business or profession'. If the amount of income tax had been allowable against the business income under the Income tax Act, 1961, then clearly the refund of tax and interest on such refund should have been chargeable under the head of business income. It is no body's case that the interest on income-tax refund is not chargeable to income-tax. The controversy is centered only on the determination of the head under which such interest shall fall. As the interest in income-tax refund is otherwise chargeable to income-tax but does not satisfy the conditions of section 28, it will come to be recognized under the head `Income from other sources'.

The learned A.R. has contended with vehemence that the payment of income tax was in relation to the carrying on the banking business and hence interest on refund of income should also be considered as business income. If it is accepted and taken to a logical conclusion then it would mean that a person having the only source of income as `Salaries' should also classify the interest on income- tax refund under the head "salaries" and claim standard deduction

The learned Departmental Representative has also placed on record an argument, through written submissions, that that the interest income specifically falls u/s.56(2)(id) of the Act and hence there is no question of considering such income under the head `Profits and gains of business or profession'. Clause (id) of section 56(2) provides that "income by way of interest on securities, if the income is not chargeable to income-tax under the head 'Profits and gains of business or profession' " shall be chargeable to income-tax under the head `Income from other sources'. A bare perusal of this provision indicates that what is referred to in this clause is interest on securities and not other interest. Section 2(28B) defines "interest on securities" to mean, - (i) interest on any security of the Central Government or a State Government; (ii) interest on debentures or other securities for money issued by or on behalf of a local authority or a company or a corporation established by a Central, State or Provincial Act;"