COMMISSIONER OF INCOME TAX Vs. VEECUMSEE

JUDGEMENT

(1.) THE assessee in this case is a registered firm of five partners carrying on business in the manufacture and sale of jewellery. Earlier to the assessment years 1967-68 to 1969-70, the assessee was carrying on business in the exhibition of films in their theatre "Safire" along with the jewellery business. For the construction of the said theatre, the assessee had made borrowals and has been paying interest thereon. However, the said business of exhibition of films as also the "Safire" theatre was transferred by the assessee as a going concern to a new partnership concern with effect from July 31,1965. THE investment in the "Safire" theatre made by the assessee-firm to the extent of Rs. 12.39 lakhs was treated by the new firm as a fixed deposit of the assessee firm and interest was paid thereon by the new firm to the assessee-firm at 5% p. a. THE interest earned by the assessee on the said deposit from the new firm was assessed under the head "Other sources" in the assessee's hands. So long as the assessee ran the business of exhibition of films in Safire theatre as its own business, the interest paid on the borrowals for the construction of the said theatre was being allowed as a deduction. However, for the assessment years 1967-68 to 1969-70, the assessee's claim for deduction as business expenditure in respect of interest paid on the borrowals referred to above was rejected by the ITO holding that the business of exhibition of films under the name of Safire theatre was not in existence during the respective years of account and, therefore, the interest on borrowals attributable to that particular business cannot be allowed as a deduction in computing the profits of the jewellary business.

(2.) THE assessee took the matter in appeal to the AAC contending that once the monies are borrowed and used for business, they can never lose their character, that the interest paid thereon should be allowed as a business expenditure relying on the decisions in AL. A.R. Brothers v. CIT [1928] 3 ITC 209 (Mad) and Mitapchand R. Shah v. CIT [1965] 58 ITR 525 (Mad) and that the interest attributable to the investments in M/s. Safire THEatre should be considered under the head "Business" only and not under the head "Other sources". THE AAC accepted the assessee's contention and held that as the borrowals at the time when they were made were only for the business, the disallowance of the claim for deduction merely because the borrowed funds lost their identity at a later period of time cannot be justified in law especially when the monies had been borrowed for, and had been used in, the construction of the theatre, the income from which was assessed in the earlier years under the head "Business". He also held that the decisions above referred to as also the decision of the Bombay High Court in Mills Store Company v. CIT [1971] 80 ITR 225 (Bom), supported the assessee's contention. He alternatively held that the business in jewellery and the exhibition of films should be taken to be the same business and so long as the jewellery business is continued, the interest paid on the borrowings for the purpose of the construction of the theatre is to be allowed as a deductions as part of the same business being carried on.

(3.) COMING to the first question, it involves two aspects, (1) whether the interest paid on the borrowals made by the assessee for the construction of the Safire theatre could or whether it should be allowed under the head "Other sources" as claimed by the Revenue, and (2) whether the investment of amounts borrowed for the purpose of construction of the Safire theatre after its sale which clearly amounts to a diversion of the funds and whether the interest paid on the same is to be allowed assuming that the jewellery business as well as the cinema business are one and entire. In view of our finding on the second question that the jewellery business and the cinema business are two separate businesses, the borrowings made by the assessee for the construction of the theatre cannot be allowed as a deduction under the head "Business" after the business of running the cinema theatre had been closed as a result of the sale of the theatre on July 31, 1965, as a going concern to a different firm. Once the assessee has ceased to carry on that business for which the amount was borrowed, the interest payments cannot be deducted as a business expenditure as admittedly the business had been stopped and no income accrued therefrom. Now we come to the alternative contention put forward by the Revenue that even if the two businesses are taken to be the same and the assessee is taken to have carried on the same business even after July 31, 1965, still the amounts borrowed for the construction of the theatre, after the transfer of the theatre to a different concern, has been used for investment, the interest payments cannot be treated in any sense a business expenditure. The learned counsel of the Revenue, in support of the said contention, refers to an unreported decision of this court in CIT v. Sujani Textiles Private Ltd. (T.C. Nos. 130 to 134 of 1978 and T.Cs. No. 408 of 1978 - since reported in [1985] 151 ITR 653). In that case, the assessee which is a limited company borrowed certains funds from the public by inviting deposits for the purpose of purchasing shares. However, shares were not purchased in the name of the company but were purchased in the names of its directors and in the books of account of the company respective amounts were shown as having been advanced to them by the company. The company claimed deduction in respect of the interest paid on the amounts borrowed and the lower authorities having rejected that claim on the ground that the amount borrowed has been used for non-business purposes, that is for the purpose of investments and that, therefore, the borrowed amount cannot be said to have been used for the purpose of the business. When the matter reached this court, this court held that since the amount borrowed stands diverted to a non-business purpose, the interest paid on the borrowings cannot be claimed as a deduction under s. 36(1)(iii) of the Act. In that case, it has been specifically pointed out that once there is a diversion of the funds either for investment or for non-business purposes, the interest payments cannot be claimed as deduction under s. 36(1)(iii). Following the said decision, we have to hold that the Tribunal is in error in this case in accepting the assessee's claim for deduction under s. 36(1)(iii) when the entire amount borrowed, though originally utilised for the construction of the theatre, now stands invested in the firm which had purchased the cinema theatre from the assessee and that in view of such a diversion, it cannot be taken that the accounts borrowed have been used in the business in the relevant assessment years so as to attract s. 36(1)(iii) of the Act.