National Newsprint and Paper Mills Ltd. Vs. Commissioner of Income-tax - Court Judgment

K.K. Dube, J.

1. The following questions of law are referred to us under Section 256 of the Income-tax Act, 1961 :

'(1) Whether, on the facts and in the circumstances of the case, the assessee was entitled in law to claim as a deduction from its income the whole of the amount of Rs. 75,83,183 as interest payable on the loans taken by it in the assessment year 1957-58 ?

(2) Whether the liability of the assessee for payment of interest arose only on May 14, 1957, i.e., on receipt by the assessee of the letter from the State Government informing the assessee of the rates of interest which the State Government had decided to charge ?

(3) Whether in any event the quantum of the interest payable by the assessee became ascertainable only on May 14, 1957, or before that date?'

2. Briefly stated, the facts as they appear from the statement of the case are as follows :

3. The assessee-company was floated as a public limited company in the year 1947. It was soon realised by all concerned that the company would require large funds before it came into production. The Government stepped in and took over the management and at all material times, it was a Government undertaking. The assessee-company borrowed loans to the extent of Rs. 4,78,00,000 from the Government. The loans were taken on different dates during the accounting year 1949-50. Since the assessee required funds immediately it was understood that the terms of the loan as to the rate of interest and the mode of payment would be settled later. The Tribunal has found that the loan has not been granted under the scheme of C.P. and Berar State Aid to Industries Act, 1933. The Government by its letter dated February 28, 1952, for the first time, informed the assessee that the interest on loans would be payable at the rate of 3 1/4 per cent. per annum for the loan borrowed up to 1950-51, and at the rate of 1/2% over and above the State Government's rate of borrowings on the loans advanced after that date. The assessee-company represented against the terms of loan as also against the rate of interest and wanted the same to be reduced. Since the question in the case is as to when an enforceable interest liability against the applicant accrued, it would be necessary to refer to a series of correspondence between the assessee and the Government. This correspondence forms part of the statement of the case. The important and the relevant letters are :

(1) Letter dated November 14, 1949, addressed by the company to the Government of Madhya Pragesh regarding requirement of funds.

(2) Letter dated February 28, 1952, from the Government of M.P. to the assessee-company regarding terms and conditions of the grant of loan.

(3) Minutes of the board meeting dated March 31, 1952, authorising the chairman to negotiate terms and conditions of loan by the Government of Madhya Pradesh.

(4) Letter dated 3rd October, 1952, from the Government of Madhya Pradesh to the assessee-company stating that though no definite decision was reached as regards terms and conditions, approval of the board to letter dated February 28, 1952, be obtained.

(5) Letter dated December 14, 1956, addressed to the Ministry of Finance, Government of India, regarding conversion of loan into share capital and waiver of interest.

(6) Letter dated March 12, 1957, from the Government of Madhya Pradesh stating that no final decision regarding the interest was taken.

(7) Final decision of Government on March 27, 1957, regarding (i) the fixation of interest and (ii) conversion of the loan and interest into share capital.

4. The Government was vitally interested in the ultimate success of the project and was, therefore, willing to not only advance the required money but was thinking of capitalising the loans advanced into equity shares of the assessee-company. A committee headed by Shri A. D. Shroff was asked to enquire and recommend as to how best to put the company into sound financial position. The committee recommended conversion of a part of the loan into non-cumulative preference shares and debentures. Shri Ramaswami Mudaliar, chairman of the board of directors, however, was of the view that the interest should be waived and the entire loan should be capitalised into equity shares. The State Government as also the Central Government agreed to the proposal of converting the loan into equity shares of the company. The two Governments, however, did not agree to waive the interest. They wanted that the amount of interest should also be converted into equity shares. It, therefore, became necessary for the State Government to find out as to what was the amount of interest that they should charge. Shri B. Pandey, the Finance Secretary recorded a note-sheet (annexure 'D-16') to the effect that since the interest has to be converted into share capital it was necessary that the rate of interest should be fixed.'The rate may well be 1/2% above our own rate of borrowing and, in any case, not less than the borrowing rate itself'. The Finance Minister endorsed the note that it be placed before the cabinet for approval. The Government thus took a decision on March 27, 1957, and communicated its decision. The communication was made on May 14, 1957, by which the Government indicated the rate of interest which was to be charged to the company for the years 1949 to 1957. It was also stated that the board of directors' acceptance of the proposal may be obtained and communicated to the Government.

5. In the annual profit and loss accounts of the company up to the assessment year 1956-57, the interest liability on loans from Government was not shown as the rate of interest and the terms of the loan were undecided. The assessee follows the mercantile system of accounting and the case pertains to the assessment year 1957-58, i.e., the accounting year ending with March 31, 1957. The assessee claimed before the Income-tax Officer a sum of Rs. 75,80,183 representing interest payable on loans in the accountingyears 1949-50 to 1956-57 as allowable deduction from income of the financial year 1956-57 (assessment year 1957-58). The Income-tax Officer disallowed the claim of Rs. 57,75,365 against the total claim of Rs. 75,80,183 on the ground that this amount pertained to the earlier years and as such would not be allowed during the relevant assessment years. He allowed a sum of Rs. 1 8,07,819 being the amount of interest payable for the year 1956-57. The order is dated November 1, 1961.

6. On an appeal before the Appellate Assistant Commissioner of Income-tax, the whole amount was allowed as a deduction. The Appellate Assistant Commissioner was of the view that, during the earlier years, the amount was not ascertainable and since the liability was determined only during the assessment year, the same was an allowable item during the accounting year relevant to the assessment year 1957-58. The order is dated December 24, 1962.

7. On an appeal by the department before the Tribunal, it was contended that the amount of Rs. 57,75,365 could not be treated as allowable expenditure since it related to an earlier period. The Tribunal directed the Appellate Assistant Commissioner to place on record all the relevant materials and, after consideration of the correspondence, passed the order which has given rise to this reference.

8. Shri K. A. Chitaley, learned counsel for the assessee, contended that the question of rate of interest on the loan advanced to the assessee remained in a fluid state till 14th May, 1957, and thus the interest liability could not be shown in the books of accounts being unascertained. What had transpired between the Government and the assessee till then were the proposals, discussions and considerations which did not result in any contract. The assessee-company was not sure even of the amount of principal on which interest would be calculated and, therefore, the assessee was not bound till May 14, 1957, to provide for the interest liability in the account books. The department's contention, on the other hand, is that the loan was not given gratuitously and from February, 1952, onwards the rates of interest were fixed. The terms as to the repayment were to be settled with the company but as regards the rates of interest the position was made clear by the Government by their communication dated February 28, 1952. Moreover, after the rates of interest were communicated by the State Government the company continued to accept the amounts without any protest. The company has, therefore, impliedly accepted the rates of interest by its conduct. Particularly, having regard to Section 8 of the Contract Act, the company, having accepted the consideration, would be deemed to have accepted the reciprocal promise to pay the interest at the rates indicated in the letter dated February 28, 1952. It was also stressed that the company was following the mercantile system of accounting andwas thus bound to show the interests as it accrued year after year in the relevant accounting year. Therefore, the sum of Rs. 57,75,365 being for earlier years has rightly been disallowed as expenditure for the financial year ending March 31, 1957.

9. The Tribunal found that the loan was not granted under the scheme of the C. P. and Berar State Aid to Industries Act, 1933. Could it be said then that the interest ought to have been debited at the end of each of the financial year prior to 1957 as a result of a contract between the parties A postponement of the date of payment of interest may not necessarily result in suspension of the liability to the postponed date. We have, therefore, to see whether the company was in a position to debit in its account books with the amount of interest which could be said to have accrued and had become enforceable in the financial years prior to 1957. In order that the amount of interest could be claimed as deduction in a particular year, the assessee ought to have undertaken unconditionally to pay it to the Government. We have, therefore, to see whether the rate of interest between the company and the Government was ascertained at any time before the letter of May 14, 1957.

10. Soon after the company was taken over by the Government it became known to the Government that large sums would have to be advanced to the company as loan before the company could start producing the newsprint. It would appear that the Government wanted that this venture should succeed as it was calculated to supply one-third of the demand of India's newsprint. The Government also desired that it should not fail as it would otherwise demoralise the investing public. The managing director of the company requested the Government to give the necessary loan, the terms of which were to be settled later.

11. By a letter dated 14th November, 1949 (annexure 'D-1'), addressed to the Finance Secretary, Shri Kamath, the managing director of the company, wrote that the company be advanced a loan and that the terms on which the payment was to be made may be settled at a later date. In response to this, by a letter dated 23rd December, 1949 (annexure 'D-2'), the Government directed the Accountant-General to release the loan and also informed that the terms of loan will be communicated later. No rate of interest was proposed by the Government despite the fact that they had by now advanced substantial amount of money running into more than two crores to the company. For the first time by their letter dated 28th February, 1952 (annexure 'D-3'), the Government indicated the rate of interest and the terms on which repayment was to be made by the company. The rate of interest indicated in this letter has already been referred to earlier. The arrears of interest, according to this communication, wereto be paid in equal annual instalments. The first instalment was to be paid from the year in which the production started. It was stated that the approval of the board of directors of the company to the terms and conditions stated may be obtained and communicated to the Government. The company placed this communication in their board of directors' meeting dated March 31, 1952, at Bombay. The board did not agree to the rate of interest. They referred to the recommendations of Shri A. D. Shroff Committee, wherein the committee had recommended a major part of the loan to be converted into non-cumulative preference shares and debentures. The board was definitely of the view that the interest must be waived by the Government or, in the alternative, substantially reduced to 1% per annum. The board of directors authorised the chairman to negotiate the terms and conditions with the Government of Madhya Pradesh. By their letter dated 3rd October, 1952, addressed to the managing director of the company, it would appear that no final decision as regards the rate of interest was taken. The Government, however, was insisting on the rates indicated by their letter dated 28th February, 1952. It would appear from the above correspondence that the company was all the time pressing the Government to waive the interest in the interest of the success of the company. Thereafter, Sir Ramaswami Mudaliar, Chairman of the company, was able to convince the Government to convert the loan into equity shares. Sir Ramaswami was also of the view that the interest should be waived. We, therefore, think that the company which was to pay the interest three years after it had reached its full production was justified in thinking that the rate of interest till then was not settled. They had every hope that the Government would waive the interest or, in any case, substantially reduce it. In view of such uncertainty as to the rate of interest on the loan advanced to them, they could not have shown the liability on account of interest in their profit and loss account. The company had, therefore, stated in their profit and loss account that the liability for interest could not be shown as the rate of interest was not settled. The company was also uncertain as to what would be the extent of loan that would be converted into share capital and whether the interest accrued on such loan would also be charged to them.

12. Sir Ramaswami Mudaliar's proposal to convert the loan into equity shares was accepted but the State Government as also the Central Government did not agree to waive the interest. The two Governments wanted that the amount of interest so far accrued should also be converted into equity shares. It became, therefore, necessary to find out the liability of interest accrued on the loan advanced. It was, therefore, necessary to come to a settlement as regards the rate of interest. This is how the liability as to the interest on the loan was worked out. Since the companyhad not to part with this amount in cash, the company did not bargain for the rates at this stage and agreed to the scheme of capitalisation of the loan as also the interest into equity shares.

13. In a mercantile system of accounting, the entries are to be made in account books on the dates on which the monies fall due and not on the dates when they are paid or received. The rate of interest being in a fluid state, the company mentioned in their profit and loss accounts that they were not taking into consideration the interest liability on the amount advanced by the Government. They could not do better than that as it would not be proper to calculate the liability on the basis of the letter of the Government dated February 28, 1952, as the company had not accepted those terms. The circumstances would indicate that the question of interest remained in a melting pot till the Government thought of converting the amount of interest accruing on the loan into equity shares. The liability of interest, therefore, remained unascertained till May, 1957, and we think that the assessee was justified in treating it as a contingent liability till then. In case of a contingent liability, the law is well-settled that it need not be claimed until it has ripened into an enforceable liability.

14. The assessee could, therefore, claim the interest as an allowable expenditure in the assessment year when it crystallized into an acer-tamablo liability and became enforceable. Looking to the circumstances of the case and the correspondence of the assessee with the Government, it would appear clear to us that the company had not accepted the rate of interest proposed by the Government and they were making representations that it should be totally waived or substantially reduced. Eventually, when the Government decided to convert the interest into equity shares, they calculated the amount of interest and it is at this time that the liability was crystallized for the first time. Therefore, even following the mercantile system of accounting, the company could have shown this as a liability for the first time in the financial year 1957. It may be observed here that it is not in dispute that the entire liability of Rs. 75,80,183 could be claimed as allowable expenditure by the company. The only dispute is as to when this liability accrued and whether it ought to have been claimed in earlier years as the assessee followed the mercantile system of accounting.

15. We may now proceed to examine the other aspects of the matter as to whether by conduct or by force of the provisions of the Contract Act, a contract had come into being enjoining upon it to set apart the liability of interest in each year separately after the Government had informed the company of their rates of interest by their letter dated February 28, 1952. The contention of the department is that, by virtue of Sections 7, 8 and 9 of the Indian Contract Act, as soon as the company accepted further loansfrom the Government, a resulting contract came into being as it would be in acceptance of reciprocal promise to pay interest in terms of the Government's letter dated 28th February, 1952. It was also contended that the company having accepted large amounts without any protest even after the Government had fixed their rates of interest, they could not be heard to contend that they had accepted the loans without the rate of interest having been fixed. The argument takes into consideration Sections 7, 8 and 9 of the Contract Act and the conduct of the party in not protesting against the rate of interest as communicated by the letter of the Government dated 28th February, 1952. It may be observed here that by February, 1952, the company had already taken the loan to the tune of more than two crores and they had continued to take loans from the Government ever after 1952. The question that, calls for consideration here would be whether the company having taken the loans from the Government after 1952 could be said to have acquiesced in the terms as to the rate of interest and whether in the absence of any protest before accepting the amount, they could, in law, be said to have accepted the term as to the rates of interest.

16. The case in point where Section 8 of the Contract Act was considered would be Haridas Ranchhoddas v. Mercantile Bank of India [1920] LR 47 IA 17 (PC). In that case, the bank had agreed to charge an yearly rate of interest on the daily balance of the overdraft. The bank was submitting pass books regularly showing that at the end of every month interest was added to the amount then due and the resultant balance which included the interest was carried forward to the debit of the customer as the balance due on the first of the following month. The customer did not raise any objection to such charging of interest. From this, the Judicial Committee observed that the fact that the defendant had not objected to the charge of compound interest in accounts which for several years he had annually received from the plaintiff afforded sufficient evidence of a promise by him to pay interest in that manner. Such a conduct would not be analogous to the case in question. In the Privy Council case, the rate was settled and the interest was then being charged at compound rate. The customer did not object to it. The company here had not settled the rate with the Government and it was an accepted position that the amount was to be advanced irrespective of the settlement of the terms. In such a situation when the rates were proposed by the Government by their letter dated February 28, 1952, it could not be anything but in the form of a proposal and even if the company had accepted the amounts of loan from the Government, it was not precluded from bargaining. It is this aspect of the case that the bargaining continued, that is material for our purpose in this case. We do not think, in a case as the present one, it would be appro-priate to apply Section 8 of the Contract Act, as till May, 1957, both the Government and the company were trying to come to a settlement.

17. Again in Bata Krishna Pramanik v. Bhawanipore Banking Corporation Ltd., AIR 1932 Cal 521, where the question was whether the bank was entitled to charge compound interest and the only evidence adduced by the bank was entries in the pass-book which could show that compound interest with monthly rests was being charged without any objection by the customer, the Calcutta High Court held that from continued and persistent acquiescence of this character, the existence of an agreement may be presumed.

18. It would be clear that these cases refer to an acquiescence as resulting into an agreement. The bargaining clearly militated against acquiescence. It may be that no protests in the form that they did not agree to a particular rate were made by the company, yet, if the negotiations were made and the proposals were of the nature indicated above, it could reasonably be concluded that the rates of interest were in a fluid state rather than to infer an agreement by acceptance of the loan. We do not think it would be proper to consider from the view-point of a resulting contract by acquiescence in a case of the present nature where the Government was keen to help the company so that it came out of its teething trouble and grew into a productive unit supplying the country a vital commodity. The loan, it would be seen, was necessary for the existence of the company.

19. In Gaddarmal v. Tata Industrial Bank, AIR 1927 All 407, the question was whether the bank was entitled to realise interest at the rate of 8 1/2 per cent. which was originally agreed upon or at the rate of 10 per cent. to which it was subsequently raised. The bank intimated its intention to raise the interest to 10 per cent. with effect from April 21, 1922, to which the customer, who was the plaintiff, made no reply and the question that arose for the consideration of the court was whether, in the circumstances of the case, there was an implied agreement on the part of the plaintiff to pay interest at the higher rate. In that case, the notice was an intimation to raise the rate of interest with effect from the date of notice. Their Lordships of the High Court of Allahabad held that the sending of the notice was not sufficient by itself to render the customer liable to pay interest at the higher rate; but nevertheless their Lordships held that, since the customer had taken further advances from the bank even after the receipt of the notice, there was an implied agreement to pay the higher rate of interest. This conclusion was based upon a consideration of Sections 7, 8 and 9 of the Indian Contract Act relating to implied agreement. The case is distinguishable as the loan had been expressly taken from the bank on a rate of interest agreed to by the parties. When the rate was enhanced it was a unilateral act on the part of the bank and the customer was notbound by it. Further, even after such notice, if he continued to draw overdrafts, he did so at the enhanced rate as there was an implied agreement resulting by virtue of Section 8. As already indicated, the essence of the matter here is the rate of interest which was to be settled. The loan in that sense was not granted as a condition precedent to charge interest at a particular rate. Therefore, the drawal of further loans could not change the character of the loan as fixing a term as to the rate of interest. If the earlier loans were given on the understanding that the rates could be settled, the subsequent loans would carry the same concession that the rate was to be mutually settled and not to be imposed unilaterally. In our opinion, Sections 7, 8 and 9 of the Indian Contract Act do not help in arriving at a correct conclusion as, in the instant case, the considerations as to the implied contract would be wholly out of context.

20. It follows, therefore, that the answers to the questions would all be in the affirmative and in favour of the assessee. We are of the opinion that on the facts of the case, the assessee was entitled to claim as a deduction from its income the whole amount of Rs. 75,80,183 as interest payable on loans taken by it in the assessment year 1957-58. The second question is also answered in the affirmative. The liability of the assessee for payment of interest arose on May 14, 1957, when the assessee received the letter from the State Government informing the interest liability against the company payable to the Government. As regards the third question, we find that the quantum of interest payable by the assessee became ascertain-able only on May 14, 1957, and not before that date. We, however, makeno order as to costs.