Venkatachaliah, J.
1. I.T.R.C. NO. 15 of 1974 is a reference under section 19 of the Super Profits Tax Act, 1963, read with section 256(1) of the Income-tax Act, 1961, and I.T.R.C. No. 7 of 1974, I.T.R.C. No. 8 of 1974, I.T.R.C. No. 9 of 1974, I.T.R.C. No. 16 of 1974 and I.T.R.C. No. 17 of 1974 are references under section 18 of the Companies (Profits) Surtax Act, 1964, read with section 256(1) of the Income-tax Act, 1961, made by the Income-tax Appellate Tribunal, Bangalore Bench, referring certain questions of law for the opinion of this court. The first question is common to I.T.R.C. Nos. 15 to 17 of 1974 and so is the second question to all the six references, except, of course, for variations in the sums involved. Accordingly, these references are disposed of by a common order.
2. Since the reference in I.T.R.C. No. 15 of 1974 and the questions of fact and law arising therein are typical and illustrative of the scope of the questions referred, we may deal with I.T.R.C. No. 15 of 1974 first.
3. The questions of law referred for the opinion of this court in the said I.T.R.C. No. 15 of 1974 are the following :
'1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of Rs. 15,50,168 being the provision for the taxation as on April 1, 1962, was not to be included in computing the capital for the assessment year 1963-64, for the purposes of levy of super profits tax
2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of Rs. 4,91,761 outstanding as on April 1, 1962, being the amount advanced by the National & Grindlays Bank Ltd., to the assessee against bills drawn by the assessee on its customers for supplies was not moneys borrowed and outstanding for purposes of the computation of capital under the Super Profits Tax Act, 1963, for the assessment year 1963-64 ?'
4. The assessee is a public limited company carrying on the business of breweries and the reference, I.T.R.C. No. 15 of 1974, respects proceedings for the assessment to super profits tax under the Super Profits Tax Act, 1963, in relation to the assessment year 1963-64, corresponding to the previous year ended on March 31, 1963. I.T.R.C. Nos. 7,8,9,16, and 17 of 1974 relate to assessment years 1969-70, 1967-68, 1968-69, 1966-67 and 1965-66, respectively, and arise out of proceedings for assessment to surtax under the Companies (Profits) Surtax Act, 1964.
So far as the first question which is common in I.T.R.C. Nos. 15 of 1974, 16 of 1974 and 17 of 1974 is concerned, learned counsel on both sides submitted that the question is concluded by the decision of this court in Mysore Electrical Industries Ltd. v. Commissioner of Super Profits Tax (I.T.R.C. No. 11 of 1967 decided on October 28, 1969) and that the question requires to be answered against the assessee and in favour of the revenue. Accordingly, we answer the first question in I.T.R.C. Nos. 15 of 1974, 16 of 1974 and 17 of 1974 in favour of the revenue and against the assessee.
5. The second question in I.T.R.C.No. 15 of 1974 arises out of a dispute in regard to the exclusion of the sum of Rs. 4,91,761 in the computation of the capital in accordance with rules in the Second Schedule to the Super Profits Tax Act, 1963. Corresponding questions in I.T.R.C. Nos. 7, 8, 9, 16 and 17 of 1974 raise the same proposition in the context of analogous provisions contained in the Companies (Profits) Surtax Act, 1964. The charging provisions of these taxing statutes provide that there shall be charged on every company a tax at rates specified in their Schedules for every assessment year in respect of so much of its 'chargeable profits' of the previous year as exceed what is styled the 'standard deduction' in the Super Profits Tax Act, 1963, and 'statutory deduction' in the corresponding successor legislation in the Companies (Profits) Surtax Act, 1964. The expressions 'standard deduction' and 'statutory deduction' are defined in section 2(9) and section 2(8), respectively, of the said two Acts to mean an amount equal to a certain percentage, statutorily fixed - of the capital of the company as computed in accordance with the provisions of the Second Schedule to the said Acts.
6. This sum of Rs. 4,91,761 represented the amount of bills 'discounted' and remaining outstanding as on March 31, 1962, which was claimed by the assessee as representing 'moneys borrowed' by it from its bankers - National & Grindlays Bank Ltd. - and were part of its capital The corresponding figures in I.T.R.C. Nos. 7, 8, 9, 16 and 17 are Rs. 7,21,052, Rs. 4,23,558, Rs. 1,46,147 Rs. 10,91,539 and Rs. 4,71,963, respectively. The Income-tax Officer did not accept this contention but held that the amount represented a liability on the bills discounted and was only a contingent liability and could not constitute moneys borrowed and outstanding as on April 1, 1962.
7. The Appellate Assistant Commissioner to whom the assessee appealed, noticing certain facts in his order dated October 18, 1976, called for a further report from the Income-tax Officer with a view to determining the character in which the said bank received payments in respect of the bills drawn by the assessee. In his report, the Income-tax Officer, relying on the correspondence with the bank on the matter, affirmed his earlier opinion that the nature of the transaction between the assessee and its bankers was a purchase of the bills and that what was given credit to in the account of the assessee was the value of the consideration for the purchase. The assessee, on the contrary, relied on another letter dated March 4, 1967, issued by the bank in which the bank called the facility 'a short-term interest-bearing advance to the company pending realisation of the proceeds of the bills from the drawers'. Finally, the Appellate Assistant Commissioner decided the matter against the assessee holding that the amounts did not represent borrowings and were not includible in the assessee's capital.
8. The assessee preferred a second appeal before the Income-tax Appellate Tribunal, Bangalore bench, and reiterated its contention that the amounts represented moneys borrowed by it from the banking institutions and that the same should have been treated as such. Noticing this argument, the Tribunal, in para. 23 of its order, has had this to say as to the nature of the transactions :
'The assessee had arranged for bill discounting facilities with the National and Grindlays Bank Ltd., in order to ensure that its funds are not blocked in outstanding bills for supply of goods to customers. The facility was arranged primarily in connection with the assessee's sale of goods to Phipson & Co. Ltd., and Herbertsons Ltd. On effecting credit sales to these companies the assessee used to pass the usual entries regarding such sales in the books of accounts and also to draw a bill of exchange on the purchaser. This bill is discounted with the National and Grindlays Bank Ltd. Thereafter, when the bill is collected by the bank the assessee is given credit for the same wiping out the debit standing against its name for the amount given by the bank to the assessee on the discounting of the bill. The bank used to charge the usual commission on the discounting of the bills.'
9. The Tribunal held that the assessee had not established that the amounts in question represented moneys lent by the bank to the assessee. it held that the bank purchased the bills in the course of its banking business and had acquired certain rights in the bills and what was paid to the assessee was a consideration for the acquisition of such rights and should not be characterised as loans. The Tribunal also took the view that the circumstances that if the drawees defaulted, the bank could have recourse to the assessee for the realisation of the amount did not detract from the true nature of the transaction as one under which the bills were purchased by the bank and what was credited to the assessee's account was the consideration therefor. The assessee's appeal before the Tribunal was, thus, unsuccessful.
10. We ought perhaps to notice here another argument urged for the revenue before the Tribunal based on the rule 1(v) of the Second Schedule to the Companies (Profits) Surtax Act, 1964. The Tribunal held, on the basis of said provision, that the amounts in question would, in any event, fall outside the pale of capital. However, by a separate order dated June 24, 1972, the Tribunal, on the admission made by the revenue that reliance on rule 1(v) or the proviso thereto was not opposite, made a record to that effect. It is necessary to record here that the revenue did not seek to support the order on the basis of rule 1(v) of the second Schedule to the Companies (Profits) Surtax Act, 1964.
11. Ramamani, learned counsel for the assessee, contended that the transactions in question were as between a banker and its constituent and were in essence transactions of lending and that the endorsements of the bills drawn on the assessee's two customers - Phipson & Co. Ltd., and Herbertsons Ltd. - constituted collateral security for the advances made by the bank.
12. The question is whether the transaction under which the bills in question were indorsed by the assessee in favour of its bankers - the National and Grindlays Bank Ltd. - amounted to a pledge of the bills as security for the loans advanced by the bank on their security or constituted absolute transfer of the bills, equivalent to discount. A dividing line between the two ideas is sometimes difficult to draw. The presumption in all cases of negotiation is in favour of absolute transfer, and this presumption is heightened when the transfer is by indorsement. The question is, however, one of fact, and the presumption is rebuttable. It may be shown that this indorsement was not by way of transfer, but merely by way of affording the additional security of the pledgor's name in a transaction which was really one of the pledges only (see In re Firth : Ex parte Schofield [1879] 12 Ch D 337 (CA)).
13. The business of buying bills at a discount is well known and is quite distinct from lending of money. It is no doubt true, as contended by Rajasekharamurthy, learned counsel for the revenue, that an agreement, express or implied, between a bank and its constituent that the latter should be allowed to draw against the bills before clearance may entitle the bank to the character of a 'holders for value' in respect of the bills. In such a case the bank receives the sum for itself and not for the customer.
14. In order to ascertain the true nature of the transactions in the present case an advertence to the manner in which it has been treated in the books of account of the assessee may be relevant. The assessee sells its merchandise on credit, amongst others, to two of its customers, viz., Phipson & Co. Ltd., and Herbertsons Ltd. On a credit sale being so effected a bill of exchange is drawn on the purchaser requiring the latter to pay on the stipulated date to or to the order of the National & Grindlays Bank Ltd., in the course of the appellate order, the Appellate Assistant Commissioner of Income-tax has excerpted the nature of entries that are made in the books of account of the assessee in this behalf. The entries illustrative of a case in the year 1961 are as follows :
Rs. Rs.'27-12-61 National & Grindlays Bank Dr. 26,703.69To Herbertsons Ltd., Calcutta Cr. 26,703.69(being bill drawn against invoiceNo. 690/27-12-1961) Cr. 26,703.69 On December 29, 1961, the appellant received from the bank a letter dated December 28, 1961, intimating 'we have today credited your account with Rs. 46,821.64 from your bill in bombay for Rs. 26,703.69
Rs.Less Rs.34.50 26,669.19From your Bill on Calcutta for Rs.20,178.70Less Rs.26.25 20,152.45-----------46,821.64----------- As such, on December 29, 1961, the appellant passed the following entry :
Rs. Rs.Bank charges Dr. 60.75To N & G. Bank Cr. 60.75(being bank charges on bills) On the due date, the bill being paid by the purchaser the appellant passed the following entry :
Interest paid account Dr. 399.48To N & G. Bank Cr. 399.48(being interest on bills realised), this debit made in accordance with the bank's letter dated March 30,1962, to the effect 'we have today debited your account with rupees three hundred ninety nine and paise forty-eight being interest on bill for Rs. 26,703.69 on Herbertsons Ltd., Bombay, paid.'
Again, the assessee is stated to have changed its accounting procedure in 1965 and the entries typical to these transactions are on these lines :
'When hundi is drawn Rs. Rs.9-12-1965 1. Bills receivable Phipsons a/c Cr. 12,728.70To Phipsons & Co. Ltd., Bombay 12,728.70(being hundi drawn againstinv. 885/29-11-65)----------------------------------------------------------------------9-12-1965 2. N & G Bank Current a/c Dr. 12,728.70To N & G Bank Bills a/c 12,728.70(being hundi discounted)----------------------------------------------------------------------11-12-1965 3. Bank charges a/c Dr. 16.87To N & G Bank Current a/c 16.87(being bank charges for discountinghundi)----------------------------------------------------------------------When hundi is retired on due dateRs. Rs.7-3-1966 1. Interested paid Cr. 254.23To N & G Bank Current a/c(being interest debited by bank) 254.238-9-1966 2. N & G Bank - Bills a/c 12,728.70To bills receivable - Phipsons 12,728.70.'(being hundi retired on due date)
Two important elements that characterise these transactions are : first, that the full value of the bill is given credit to in the account of the assessee; and, secondly, that interest on the sums so given credit to is charged to the assessee by the bank till the date of realisation of the bill. The bill was indorsed to the bank in the limited way in which the drawer of a bill negotiate a bill of exchange before acceptance. The question is whether in their true legal significance and effect the transactions are one of purchase of the bills, amounting to discount, by the bankers.
15. In Corpus Juris Secundum, the transaction of discount is described thus :
'A discount is a transaction by which a bank, in making a loan on a promissory note or other paper, deducts the interest in advance, so that the borrower receives only the face value of the obligation less the interest maturity. The term 'discount' is also used to designate the interest which is thus withheld in advance. It has also been considered that the purchase of commercial paper for a sum less than its face value is a discount.......'
(vide volume 9, para 383, at page 798).
16. In American Jurisprudence, volume 10, para 689, at page 660, 'Discount' is defined as follows :
'Discount :- A discount is defined as a loan upon an evidence of debt in which the compensation for the use of the money until the maturity of the debt is deducted from the principal and retained by the lender at the time of making the loan. The term 'discount' has been interpreted to mean a charge for a loan in advance, whether called interest, compensation, or premium, and the 'discounting' of a note by a bank is understood to consist of the lending or money upon it, and deducting the interest of premium in advance. The term 'discount' when used in a general sense, is equally applicable to either business or accommodation paper and is appropriately applied to either loans or sales by way of discount when a sum is counted off or taken from the face or amount of the paper at the time the money is advanced upon it, whether that sum is taken for interest upon a loan or as the price agreed upon a sale.'
17. In Halsbury's Laws of England, fourth edition, volume 3, para. 151 referring to discounting of bills, it is stated :
'Discounting of bills. - When a banker discounts a bill he buys it for its face value less a sum representing interest for the period which the bill has to run. The banker takes the bill as transferee for value, and has the holder's normal right to sue on the bill if it is dishonored. In the case of a customer the amount of the bill, less discount, is normally carried to current account, and if the bill is unpaid, the current account is normally debited and the bill is returned to the customer. If the banker wishes to retain his right of recourse to other parties because his customer's account cannot meet the debit, the banker retains the bill and debits a suspense account. Whether the bill is taken from a customer for collection or as security, or discounted for him, is a question of fact.
The presumption in favour of a bill being taken by way of absolute transfer rather than of pledge or security is not so appropriate in the case of banker and customer as in other cases. Indorsement of a specially indorsed bill is as necessary for collection as for transfer. Even indorsement by the customer of a bill indorsed generally is consistent with his merely putting his name on it as extra security.
There is some doubt whether the entry of the amount of such bills less discount, as cash in the banker's books would be evidence of the banker having taken them as transferee. Possibly inferences might be drawn from whether the bank held itself out as a discounting bank or not. Where the transaction is really one of the discounting, the banker is of course at liberty to deal with the bills as pleases, rediscounting or transferring it.'
18. In Plain and Company Ltd. v. Inland Revenue Commissioners, 175 Law Times Reports 453, the question was whether the transaction whereby a bank advances amounts of the bill to the shippers on receipt of bills of exchange drawn by the shippers was a transaction of loan or sale of the bill. The facts of the case were that a company of shipping merchants who bought goods in England as principals, packed them and shipped them to their customer - or certain Marks - in South Africa. In September, 1944, the company bought certain parts of cycles and caused them to be shipped to their customers in Johannesburg. The price the company charged the customer was 81 4s. Od. plus an amount representing the difference in exchange between sterling and South African currency. The company drew the bill of exchange for the sum 81. 1s. 6d. on the customer payable 60 days after sight, directing the payment to be made to the Standard Bank of South Africa in Johannesburg. On September 7, 1944, the company delivered to the London branch of the same bank the bill of exchange to whether with the documents of titled to the goods. In accordance with the arrangement made with the branch of the bank, the bank subsequently credited the company's account with the sum of 81. 1s. 6d. and simultaneously debited another account of the company with the same sum plus the sum representing interest at 5 per cent. calculated for the period which elapsed before the bill matured and the difference in the exchange. In proceedings for assessment to excess profits tax, the company contended that the sale 81. 1s. 6d. credited to its account was borrowed money, within the meaning of para. 2 of Schedule (VII) to the Finance (No. 2) Act, 1939, which provided that 'no borrowed money shall be deducted for the purpose of excess profits duty'. Wrottesley J., in the King's Bench Division, dealing with the question, observed :
'The answer to the question whether this was a loan or not depends on what the parties, the company and the bank, agreed at the time expressly, if there were an express agreement, and impliedly, if there were no express agreement. When the draft was forwarded by the company to the bank, the bank, it is true, credited the company with the full amount. No deduction was made, as one would expect to find if there had been a discounting. Incidentally, therefore, it is pretty clear, I think, that the bank never discounted the bill. The Inland Revenue Commissioners say that the company sold the bill or the debt to the bank and the bank paid for it an amount of its funds, and so they say the credit is, therefore, not a loan but the purchase price of the assignment of the debt. The books of the bank do not bear this out, for they debited the company's account with 83. 3s. 10d. That is found as a fact. That is the same figure as that endorsed on the bill.......
In this case the bank credited the whole amount and looped to the termination of the transaction by the headquarters in Johannesburg with Mr. Marks to reimburse the branch for that which was either lent or laid out during the currency of this period. That this was merely a loan in the first place is quite obvious from the nature of the transaction. At the stage when the bill was first lodged with the bank with the documents the bill of exchange was incomplete in this sense-it was not accepted. If the Johannesburg customer had declined to accept it when it was presented, the bank had no remedy of any kind against Mark.... I think the argument of the appellants in this case depends upon my accepting the proposition that what took place in this case is an assignment of the debt. I think it is quite clear it is not. It is nothing of the kind. So that the only remedy in the case of non-acceptance here was a claim by the bank against the company -I suppose it would be by the London branch against the company unless the London branch choose to negotiate the bill through their branch in Johannesburg. There would also be to some extend - though it does not become necessary to decide that now - a remedy against the goods. Even when the Johannesburg customer, Marks, had accepted the bill, I do not find anything to indicate that at that stage the bank accepted this as satisfying the loan which appears in the account as 'debited' according to para. 6(n) of the stated case. Both as regards the capital involved and as regards the interest, the bank still had at that stage, as it appears to me, the company's liability, if they desired to resort to it, apart from the bill itself.......
Another point which Hills made was this. He said : If I looked at the company's accounts I shall find that this sum of money and many others like it are described in the company's own accounts as contingent liabilities in the shape of discounted bills at March 31, 1941. That is true. But it seems to me that that is really an accurate description. It is true it is contingent because, of course, they would only in fact be liable to the bank on the bill in the event of the customer either declining to accept it or not meeting the bill at maturity. So I think it is proper description of the liability, but that does not make it any less a liability.....'
19. In the present case as stated earlier, full amount of the bill was given credit to in the account of the assessee with the bank and knows some towards what amounts to a 'discount' was charged. Interest on the amount advanced was charged from the date of the credit till the date of realisation of bills. Besides, at the time of their delivery to the bank, they had not been accepted by the drawees. If the drawees declined to accept them, the bank would have had know recourse to them. The negotiation of the bills in favour of the bank was, obviously, only a financial arrangement between the bank and its constituent -the assessee. It could not also mean that there was transfer in favour of the bank of the property in the goods which the documents of title accompanying the bill represented, as indeed the goods were the subject-matter of a subsisting contract of sale in favour of the drawees. The bank recover payments from the drawees to the credit and on behalf of its constituent, the assessee, and charged the latter interest till the date of such payment.
20. The principles of law merchant that guide us in the matter, applied to the facts of the case, render the conclusion irresistible that the amounts given credit to the assessee upon indorsement of the bills were not the consideration for the 'discounting' of the bills as there was no 'discount'; but that the indorsement of the bills in favour of the bank was only a financial arrangement between the bank and its constituent to avoid freezing on credit to the latter and was done in the course of its usual banking transactions. The contention of S. R. Rajasekharamurthy to the contrary cannot be accepted.
21. We, accordingly, answer the question referred in I.T.R.C. Nos. 7, 8, 9 and the second question referred in I.T.R.C. Nos. 15, 16 and 17 of 1974, in favour of the assessee and against the revenue.
22. The assessee is entitled to its costs. Advocate's fee Rs. 250 one set.