(On appeal from the judgment and order of the High Court of Sindh dated 25-11-1986 in I.T.C. Nos. nil, 55 and 56 of 1976).

(a) Income Tax Act (XI of 1922)---

----S. 10(2)(iii)---Constitution of Pakistan (1973), Art. 185(3)---Leave to appeal was granted in a case wherein the assessee's claim under S.10(2)(iii) for deduction of the interest paid on borrowed capital was disallowed.

(b) Income-tax---

----Res judicata, principles of---Principles of res judicata do not apply to the cased on assessments under the income-tax law in the same manner as they are applied in civil proceeding---Restrictions on applicability on principles of res judicata enumerated.

Principles of res judicata cannot be applied to the cases on assessments under the Income Tax Act in the same manner as they are applied in civil proceedings.

Applicability of principles of res judicata has been restricted as follows:--

A previous decision of an Income Tax Authority will not be a bar in the following cases:

(i) where the earlier decision is clearly open to some objection;

(ii) if it is a decision which is not reached after proper enquiry;

(iii) if it is a decision as could not reasonably have been reached on the material before the authority;

(iv) it is a decision which suffers from such a defect which falls within the purview of the grounds mentioned in section 100, C.P.C. and liable to correction thereunder in second appeal, if it were a decision of civil Court; and

(v) if fresh evidence having a material bearing on the point decided in the previous decision is available.

C.I.T. v. Waheeduzzaman P L D 1965 SC 171 fol.

(c) Income Tax Act (XI of 1922)---

----S. 10(2)(iii)---When an assessee is entitled to claim allowance under S.10(2)(iii) of interest as capital borrowed.

The assessee would be entitled to claim allowance under section 10(2)(iii) Income Tax Act, 1922 provided it satisfies that (i) he has borrowed capital, (ii) such borrowed capital was for the purposes of business, profession or vocation and (iii) that interest has been paid on such borrowed capital. The borrowing of capital should be genuine and not merely a sham or illusory.

(d) Income Tax Act (XI of 1922)---

----S. 10(2)(iii)---Assessee claiming allowance under S.10(2)(iii) of amount paid as interest ---Assessee is entitled to the allowance if the borrowing is not a colourable device for taking benefits under Section 10(2)(iii)---Tribunal while refusing such allowance to assessee observed that assessee had surplus deposit amounts and no prudent businessman would keep a loan and pay a higher interest while receiving a lesser amount of interest for his deposits---Held, by making such observations and without giving any finding that the amount was not borrowed and employed or utilized for business purposes the conclusion drawn by the Tribunal was based on mere surmises and conjectures---Adapting legal modes which could result in reduction of tax and the same if covered by law could not be challenged on the grounds of prudence, advisibility or business practice. .

In the present case the factors which had influenced the opinion of the Tribunal were that the assessee had surplus deposit amounts and no prudent businessman would keep a loan and pay a higher interest while receiving a lesser amount of interest for his deposits. By making such observations and without giving any finding that the amount was not borrowed and employed or utilised for business purposes the conclusion drawn by the Tribunal was based on mere surmises and conjectures. An assess is entitled to manage his own affairs to the best of his benefit even by adopting legal modes which may result in reduction of tax and the same if covered by the provisions of law cannot be challenged on the ground of prudence, advisibility or business practice. In business deficit financing, borrowing loans of huge amounts while keeping reserve funds or deposits for fixed period and running business on such loans and borrowed capital are not uncommon. An assessee is entitled to the allowance if the borrowing is not a colourable device for taking benefits under the said provision. It should be a real borrowing of capital utilized in the business on which interest has been paid. Without relying on the past treatment by the department the fact remains that the amount was taken as a loan and had been employed in the business. If the assessee had generated funds, earned huge profit out of which deposits or reserve funds had been created without utilizing them in the business, it did not change the character of the loan.

The entire observation of the Tribunal is based on the advisibility and possible conduct of a prudent businessman and nowhere it has been held in clear terms that the borrowed amount was not utilised for business purposes.

The assessee had challenged the order of the Tribunal on the plea that the Income Tax Appellate Tribunal had misdirected itself in law in disallowing interest. The question as framed was wide enough and challenged the finding of the Tribunal as well. It was not based on the finding of the Tribunal but had termed the decision of the Tribunal as a result of misdirection in law which would include the challenge to the finding of fact if based on no evidence.

(e) Income Tax Act (XI of 1922)--

----S. 10(2)(iii)---Claim of assessee as allowance under S.10(2)(iii) of interest paid on capital borrowed---Fact that assessee was receiving 'lesser interest @ 4-1/2% while paying higher interest @ 9% to its creditors could not be a ground to presume that the transaction was sham or had lost the character of loan.

CIT v. Pudukothai 84 ITR 788; East India Industries v. CIT 311 T R 803; Birla v. CIT 44 I T R 847; Bansidhar v. CIT 58 I T R 462; Amna Bai v. CIT 51 I T R 835; Ramkishan v. CIT 56 I T .R 186 and CIT v. Bombay Samachar 74 I T R 723 ref.

(f) Income Tax Act (XI of 1922)---

----Ss. 66 & 10(2)(iii)---Reference---Assessee had challenged the order of the Tribunal on the plea that the Tribunal had misdirected itself in law in disallowing interest---Question as framed was wide enough and challenged the finding of Tribunal as well---High Court had not based its order on the finding of the Tribunal but had termed the decision of the Tribunal as a result of misdirection in law which would include the challenge to the finding of fact based on no evidence.

Shaikh Haider, Advocate Supreme Court for Appellant. Nemo for Respondent.

Date of hearing: 27th October, 1991.

JUDGMENT

SALEEM AKHTAR, J.---Leave was granted to the appellant against the judgment of the High Court of Sindh whereby the respondent's claim under section 10(2)(iii) of the Income-tax Act, hereinafter referred to as `the Act', for deduction of the interest paid on borrowed capital was disallowed.

2. The respondent borrowed Rs.2,00,000 in the year 1959-60 from two of its shareholders on interest at 9% per annum. From that very period the respondent was claiming deduction of interest paid on this borrowed capital under section 10(2)(iii) of the Act. This deduction was allowed by the Income Tax Officer from 1959-60 to 1967-68 continuously. In the assessment year 1968-69 the claim for deduction of interest was disallowed on the ground that in the accounts of the assessee/respondent the amount lying in FDR it was receiving interest @ 4-1/2% per annum whereas it was paying interest at 9% per annum on the borrowed amount of Rs.3,00,000. The respondent preferred an appeal before the Tribunal which was allowed. The department then filed application for reference in the High Court bearing No. I.T.R. 288 of 1974 and the same was answered in favour of the respondent.

3. Again in the years 1969-70, 1970-71 and 1971-72 the Income Tax Officer disallowed interest claimed by the respondent. The respondent preferred an appeal but after examining the accounts, facts, records and the balance-sheet of the relevant years the Tribunal dismissed the same holding that the loan was not for the purposes of business of the assessee. The respondent filed reference application under section 66 for reference of question of law but the Tribunal refused holding that the question raised is a question of fact and no question of law arises. The respondent then filed application raising the following question before the High Court in ITR Nos.54 of 1976 and 55 of 1976 which were heard by a Division Bench:

"Whether the Income Tax Appellate Tribunal misdirected itself in law in disallowing interest payment of Rs.27,000."

There was a difference of opinion between the learned Judges of the Bench. One learned Judge upholding the finding of the Tribunal concluded that the loan was illusory, colourable and was not obtained for the purposes of business of the respondent. The other learned Judge observed that interest was continuously being allowed by the department and also relying upon the past history held that the assessee had borrowed Rs.3,00,000 for the purposes of business, as observed by the judgment of the High Court rendered earlier in TTR No.288 of 1974. Thereafter, the matter was referred by the learned Chief Justice to the third learned Judge who after hearing the parties answered the question in the affirmative. While seeking leave, to appeal several questions were raised viz. principle of res judicata is not applicable to income-tax proceedings, the finding of fact is against the respondent which could not be disturbed and no question of law was raised. However, the main question remains the same as raised before the High Court which will cover all the controversies.

4. Mr. Shaikh Haider has appeared on behalf of the appellant while respondent has remained absent. Mr. Shaikh Haider, the learned counsel for the appellant, contended that principles of res judicata do not apply to the income tax proceedings and any finding given in the previous year cannot be relied upon to debar the assessing officer from investigating the same facts in the subsequent assessment years. It is now well-settled that principles of res judicata cannot be applied to the cases on assessments under the Income fax F Act in the same manner as it is applied in civil proceedings. Reference can be made to C.I.T. v. Waheeduzzaman P L D 1965 SC 171, which was followed in a recent judgment namely Commissioner of Income Tax, Central Zone `B' v. Farrokh Chemical Industries, CAs. Nos.104 to 111-K of 1984. In both the cases the applicability of principles of res judicata was restricted and in the later case following Waheeduzzaman's case it was observed as follows:--

"It may be reiterated that a previous decision of an Income Tax Authority will not be a bar in the following cases:

(i) where the earlier decision is clearly open to some objection;

(ii) if it is a decision which is not reached after proper enquiry;

(iii) if it is a decision as could not reasonably have been reached on the material before the authority;,

(iv) it is a decision which suffers from such a defect which falls within the purview of the ground mentioned in section 100, C.P.C. and liable to correction thereunder in second appeal, if it were a decision of a civil Court; and

(v) if fresh evidence having a material bearing on the point decided in the previous decision is available: "

We entirely agree with the observations and need not further dilate upon this aspect of the case.

5. The learned counsel for the appellant contended that the loan was not obtained for the purposes of business and in any event during the assessment years in question it had lost the character of a loan and the respondent was not entitled to the allowance claimed by it. Section 10(2)(iii) reads as follows:--

"Section 10-----------------------

(2) Such profits or gains shall be computed after making the following allowances, namely:--

(i)..................................................................

(ii) ..................................................................

(iii) in respect of capital borrowed for the purposes of the (business, profession or vocation) *** the amount of the interest paid:

(Provided that no allowance shall be made under this clause in any case for any interest chargeable under this Act which is payable without (Pakistan) not being interest on a loan issued for public subscription before the 1st day of April, 1938, except interest on which tax has been paid or from which tax has been deducted under section 18 or in respect of which there is an agent in (Pakistan) who may be assessed under section 43 or, in the case of a firm, for any interest paid to a partner of the firm).

Explanation---Recurring subscriptions paid periodically by shareholders or subscribers in such Mutual Benefit Societies as may be prescribed, shall be deemed to be capital borrowed within the meaning of this clause."

The assessee would be entitled to claim allowance under this provision provided it satisfies that (i) he has borrowed capital, (ii) such borrowed capital was for the purposes of business, profession or vocation and (iii) that interest has been paid on such borrowed capital. The borrowing of capital should be genuine and not merely a sham or illusory. The Tribunal while rejecting the claim of the respondent observed as follows:--

"The loan was taken by this Private Limited Company from two of its shareholders sometime in 1959-60. Each of the shareholders loaned out Rs.1,50,000. The appellant has been paying this interest year after year although there was no need to have the loan in these three years. Income Tax Officer found that the assessee had fined deposits exceeding the loans in each of the years concerned. In 1969-70 and 1970-71 fixed deposit amounted to Rs.4,15,000 and in 1971-72 there was a surplus of each of Rs.8,65,000. The Income Tax Officer could not believe that this could be a business loan also on the ground that no prudent businessman would keep a loan and pay interest at 9% when he was receiving from the bank for fixed deposit interest only at the rate of Rs.4 %. It was not the rate of interest which was the subject of dispute but the very loan itself or the advisibility of having the loan when it could be repaid as the creditors were shareholders. It was difficult to imagine why the loans were not being repaid."

While considering the aforesaid observation the learned Judge of the High Court observed as follows:--

"A careful reading of the above reasoning by the Income Tax Tribunal will show that it was of the opinion that the assessee have been paying interest on the borrowed capital year after year in spite of the fact that there was no need to have the loan in these years; that the assessee had surplus deposit exceeding the amount of loan on which they were getting return of 4 % whereas they were paying interest on the borrowed capital at the rate of Rs.9% and that it was not the rate of interest which is subject of dispute but the very loan itself or the advisibility of having the loan. The above reasons given by the Appellate Tribunal deal more with the advisability and desirability as the loan taken by the assessee than holding that the loan was not taken for purposes of the business of applicant. I am satisfied after reading the order of the Tribunal that the claim of the assessee was not disallowed on the ground that the loan was not utilized for the business purposes but on the ground that it was no more advisable for the company to keep a loan on which the company was paying interest at the rate of 9% while on its own surplus kept in the FDR the company was receiving only 4 % interest. These considerations as pointed out earlier were not relevant for disallowing a claim for deduction under section 10(2)(iii) of the Act. It may be mentioned here that mere fact that a company had surplus capital which it invested in some security which is less profitable than the interest paid by it on the borrowed capital is not a sufficient circumstance to hold that borrowed capital was not needed for business purposes. There is no finding either by the Income Tax Officer or by the Income Tax Appellate Tribunal that the money which was initially borrowed by the company in the year 1959 for business purposes was not applied for business purposes for the assessment years under review."

6. It seems clear that from the years 1959-60 to 1968-69 borrowing of capital by the respondent for the purposes of business and payment of interest thereon was accepted by the department. In the year 1968-69 it was challenged by the Department but did not succeed. Again for the years 1969-70 and 1970-71 the department came to the conclusion that the loan which was borrowed in the year 1959, lost its characteristic of loan during these years under review and could not any longer be treated as a loan. The factors which had influence had this opinion were that the respondent had surplus deposit amounts and no prudent businessman would keep a loan and pay a higher interest while receiving a lesser amount of interest for his deposits. By making such observations and without giving any finding that the amount was not borrowed and employed or utilised for business purposes the conclusion drawn by the Tribunal seems to be based on mere surmises and conjectures. An assess is entitled to manage his own affairs to the best of his benefit even by in adopting legal modes which may result in reduction of tax and the same if covered by the provisions of law cannot be challenged on the ground ofprudence, advisibility or business practice. In business deficit financing, borrowing loans of huge amounts while keeping reserve funds or deposits for fixed period and running business on such loans and borrowed capital are not uncommon. An assessee is entitled to the allowance if the borrowing is not a colourable device for taking benefits under the said provision. It should be a real borrowing of capital utilized in the business on which interest has been paid. Without relying on the past treatment by the department the fact remains that the amount was taken as a loan and has been employed in the business. If the respondent has generated funds, earned huge profit out of which deposits or reserve funds have been created without utilizing them in the business, it does not change the character of the loan. Here it may be advantageous to refer to C.I.T. v. Sh. Muhammad Ismail & Co. 1986 S C M R 968. In this case the assessee had paid huge interest to banks from which overdraft had been secured. The Managing Director of the assessee/company had borrowed substantial amount from the company free of interest. The Income Tax Officer rejected assessee's claim for deduction of interest under section 10(2)(iii) holding that loan had been diverted to the Managing Director and thus the entire interest paid by the assessee could not be treated as paid on capital borrowed for purposes of business. The Assessee ultimately succeeded in appeal filed before the Tribunal. In reference the High Court agreed with the Tribunal. In appeal the Supreme Court observed:--

"It seems that according to the above provision an assessee is free to carry on a business with his own capital or from money borrowed from any bank or other financial institution and it is only in case where the assessee chooses to run his business with borrowed capital that he would be entitled to deduction in respect of amount paid for and on account of interest. Thus, the only eventuality which might disentitle an assessee to claim deduction of the whole or any part of interest is where the amount is not shown to have been used as capital in the business carried on by the assessee. In this case, the entire account including the cash books and the bank accounts were before the Income Tax Officer who completed the assessment under subsection (3) of section 23 but he failed to show that any part of the borrowed money was not used in business and was diverted to the personal use of Mian Aziz A. Shaikh. Indeed, a finding of fact has been recorded by the Tribunal that the whole of the capital which was borrowed was used for the purposes of the company. It appears that no provision exists in the Income Tax Act, 1922, to prevent a company from advancing money to a Director or shareholder which could operate as a bar to the making of advances by companies to their Directors. In order to overcome this lacune a provision has been made in the new Income Tax Ordinance, 1979, namely, clause (7) of section 12 ... "

7. The fact that the respondent was receiving lesser interest @ 4 % while paying higher interest @ 9% to its creditors cannot be a ground to presume that the transaction was sham or has lost the character of a loan. In C.I.T. v. Pudukothai 84 I T R 788, it was held that mere charging of interest at a lower rate on the money earned by the assessee is not sufficient to disentitle an assessee from claiming allowance under section 10(2)(iii). In East India Industries v. C.I.T. 311 T R 803, Birla v. C.I.T. 44 1 T R 847 and Bansidhar v. C.I.T. 58 I T R 462, it was observed that in case of genuine business borrowings the department cannot disallow any part of the interest on the ground that the interest is unreasonably high. In Amna Bai v. C.I.T. ' 51 I T R 835, it was observed that if the assessee had enough funds the same cannot be made a ground for rejection that he needed no borrowing. Similar view was expressed in Ramkishan v. C.I.T. 56 I T R 186 and C:I.T v. Bombay Samachar 74 I T R 723. The entire observation of the Tribunal is based on the advisibility and possible conduct of a prudent businessman and nowhere it has been held in G clear terms that the borrowed amount was not utilised for business purposes. Mr. Shaikh Haider, the learned counsel for the appellant, has contended that as the Tribunal had given a finding of fact and the same not having been challenged it was not open to the High Court to have subjected the facts to scrutiny and come to a different conclusion. The respondent had challenged the order of the Tribunal on the plea that the Income Tax Appellate Tribunal had misdirected itself in law in disallowing interest. It may be observed that the question as framed is wide enough and challenges the finding of the Tribunal as well. It was not based on the finding of the Tribunal but had termed the H decision of the Tribunal as a result of misdirection in law which will include the challenge to the finding of fact if based on no evidence. We do not find any force in this contention.

8. We, therefore, dismiss the appeal.

M.BA./C-104/SAppeal dismissed.