Andhra Pradesh H.C : Whether, on the facts and in the circumstances of the case, the Tribunal was right in concluding that a charge on the assets of the company was created on December 2, 1976, within the meaning of s. 40A(8)(b)(ix) ?

Counsel Appeared

Murthy, for the Revenue

V. ANJANEYULU, J. :

Kohinoor Glass Factory (P) Ltd. is a company incorporated under the Companies Act. It would appear that the company mobilised certain deposits aggregating to Rs. 10,96,300 on which interest was paid by the company. In its IT assessment for the year 1977-78 for which the previous year ended on December 31, 1976, the assessee claimed deduction of the interest paid on the deposits relying on the provisions contained in s. 40A(8)(b)(ix) of the Act. It was claimed that the depositors were demanding interest and, consequently, the board of directors of the company passed a resolution on December 2, 1976, stating, inter alia, “the demand of the depositors has been considered and it was resolved to create a charge in favour of all the depositors through a representative who is fully authorised by the members through a resolution”. A copy of the above resolution was lodged with the Registrar of Companies on December 27, 1976, and finally an agreement was executed on March 17, 1977, describing it as a deed of agreement for creating the charge. It was claimed before the ITO that inasmuch as a charge was created in favour of the depositors against the assets of the assessee-company, the interest payable on the deposits/loans is allowable in terms of s. 40A(8)(b)(ix). The ITO declined to accept the assessee’s claim and disallowed the interest on the ground that the claim that an equitable mortgage was created in favour of the depositors was not established. An appeal to the CIT (A) was unsuccessful. The assessee-company thereupon filed a second appeal before the Tribunal and reiterated its contention that the interest corresponding to the charge, after the charge was created, should be allowed by way of deduction. The Tribunal accepted the contention and held that the interest for the quarter ended on December 31, 1976, was paid after the charge was created and, consequently, the interest relating to that quarter should be allowed as deduction in computing the assessee’s income. The CIT was not satisfied with the Tribunal’s direction to allow interest and consequently filed an application under s. 256(1) of the Act and sought a reference of the following question :

” Whether, on the facts and in the circumstances of the case, the Tribunal was right in concluding that a charge on the assets of the company was created on December 2, 1976, within the meaning of s. 40A(8)(b)(ix) ? “

The Tribunal conceded the CIT’s claim for reference and accordingly referred the above question for the consideration of this Court.

Before we refer to the relevant facts, we may first refer to the provisions contained in s. 40A(8). Sub-s. (8) was inserted in s. 40A by the Finance Act, 1975, w.e.f. April 1, 1976. Eventually, this was omitted by the Finance Act, 1985, w.e.f. April 1, 1986, so that from the asst. yr. 1986-87 onwards, the provision is out of the statute book. It is not in dispute that for the asst. yr. 1977-78, sub-s. (8) was very much on the statute book. It provided that where the assessee, being a company, incurs any expenditure by way of interest in respect of any deposit received by it, fifteen per cent of such expenditure shall not be allowed as deduction. Interest, if any, paid in excess of the fifteen per cent is allowable as deduction. Clause (b) of sub-s. (8) defines a deposit as meaning “any deposit of money with, and includes any money borrowed by, a company, but does not include any amount received by the company, inter alia, as a loan from any person where the loan is secured by the creation of a mortgage, charge or pledge of any assets of the company and the amount of the relevant loan, together with the amount of any other prior debt or loan secured by the creation of a mortgage, charge or pledge of such assets, is not more than seventy-five per cent. of the price that such assets would ordinarily fetch on sale in the open market on the date of creation of the mortgage, charge or pledge for the relevant loan”. The ITO relied on this provision and purported to disallow the interest to the extent of fifteen per cent rejecting the assessee’s contention that the sums borrowed by the assessee aggregating to Rs. 10,96,300 were secured by the creation of a mortgage of some of the assets of the company and, consequently, the provision authorising disallowance of the interest to the extent of fifteen per cent goes out of operation.

In order that a company is eligible to claim interest at fifteen per cent, it must show that the deposits or the amounts borrowed by way of loans were secured by the creation of a mortgage. If this fact is established, there is no dispute that the interest is allowable. The ITO points out that in the balance sheet for the year ended on December 31, 1976, of the assessee-company, the entire amount of deposits was shown as unsecured, although the Tribunal which has gone into the question explains it as a mistake on the part of the auditors. Be that as it may, the evidence in support of the creation of the charge, as will be noticed from the facts enumerated above are these : (a) Resolution dated December 2, 1976, passed by the board of directors ; (b) Lodgment of the resolution with the Registrar of Companies on December 27, 1976 ; and (c) Deed of agreement creating charge dated March 17, 1977.

A perusal of the resolution of the board of directors would not indicate that by that resolution any charge is created in favour of the depositors or the persons who lent the monies to the assessee. All that the resolution states is that it was resolved to create a charge in favour of all the depositors. The resolution does not indicate the assets which are proposed to be charged and the manner in which the charge was sought to be created. All that can be said is that it is a step in the direction of taking action at a future date to create a charge, which act bears the authorisation of the board of directors of the company. It is not possible to consider the resolution dated December 2, 1976, itself as creating a charge because it lacks the necessary ingredients of a charge.

The lodgment of the resolution with the Registrar on December 27, 1976, can muchless be considered to be creating a charge in favour of the depositors as the purpose of lodgment of the resolution with the Registrar of Companies is to bring on public record that the whole or a portion of the assets of the company was subject to a charge. The formalities associated with the creation of a charge do not find a place in the intimation sent to the Registrar of Companies. Therefore, the lodgment of the resolution on December 27, 1976, cannot also be considered to be creating a charge. The Registrar issued the certificate on May 2, 1977, acknowledging the fact that pursuant to the provisions contained in s. 132 of the Companies Act, in the records of the Registrar, a charge has been registered against Rs. 10,96,300. This again does not fulfil the requirements of a charge. It may, however, be pointed out that in any event, this document is dated May 2, 1977, which clearly fell after the end of the previous year relevant to the assessment year under consideration. We are, therefore, finally left with the deed of agreement for creating a charge. This deed is executed between the company on the one hand and Sri Mahesh Chand described as an authorised representative of the depositors on the other and states that the company agreed to give security for the deposit of Rs. 10,96,300. The properties agreed to be given as security are specified in the memorandum. Beyond this, there is nothing more in the document which would spell out the creation of a charge against the proposed assets by the assessee-company in favour of the depositors. There is no reference in this document to the deposit of any title deeds relating to the immovable property proposed for the creation of a charge. There is no indication that the delivery of title deeds was effected following the execution of the deed of agreement dated March 17, 1977. Since the assessee’s contention is that an equitable mortgage is created in favour of the depositors, it is imperative that the act of deposit of title deeds is established in order to make the mortgage valid. We may refer to s. 58(f) of the Transfer of Property Act which requires delivery to a creditor or his agent of documents of title to immovable property with intent to create a security thereon in order that an equitable mortgage is created under law. We do not find in the present case any reference in the document to the delivery of any document of title to immovable property. It is, therefore, not possible to consider that even the agreement dated March 17, 1977, created an equitable mortgage or a charge in favour of the depositors. Mr. Satyanarayana, learned counsel appearing for the assessee, contends that the cumulative effect of the resolution dated December 2, 1976, the lodgment of the resolution on December 21, 1976, and the execution of the agreement on March 17, 1977, is an inevitable presumption that the relevant title deeds were deposited in order to create an equitable mortgage in favour of the depositors. We do not think that such a presumption can be spelt out. The factum of deposit of title deeds has to be established by evidence. All that we can say is that the documents placed before us do not indicate the fulfilment of the requirement of essential ingredients. In the circumstances, the ITO was justified in declining to allow interest at fifteen per cent and holding that the exception contained in cl. (ix) to s. 40A(8) is not applicable. In our opinion, the Tribunal was in error in directing the allowance of the expenditure.

Having regard to the above, we answer the question referred in the negative, that is to say, in favour of the Revenue and against the assessee. There shall be no order as to costs.

[Citation : 175 ITR 237]