1. Dispute regarding whether security deposits received from customers constitute borrowed money under Rule 2-A of the Second Schedule to the Excess Profits Tax Act, 1940. (Para 2 )
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1953 Supreme(SC) 7
SUPREME COURT OF INDIA
M. Patanjali Sastri, CJI., B. K. Mukherjea, N. Chandrasekhara Aiyar, Vivian Bose, Ghulam Hasan, JJ.
K. M. S. Lakshmanier and Sons – Appellant
Versus
Commissioner of Income-tax and Excess Profits Ta, Madras – Respondent
Appeal No. 71 of 1952
Decided On : 23-01-1953
Advocates appeared
Shri G. S. Pathak, Senior Advocate (Shri G. R. Jagadisan, Advocate, with him), instructed by Shri Naunit Lal, Agent, for Appellants; Shri M. C. Setalvad, Attorney-General, of India (Shri G. N. Joshi, Advocate with him), instructed by Shri G. H. Rajadhyaksha, Agent, for Respondent.
Shri G. S. Pathak, Senior Advocate (Shri G. R. Jagadisan, Advocate, with him), instructed by Shri Naunit Lal, Agent, for Appellants; Shri M. C. Setalvad, Attorney-General, of India (Shri G. N. Joshi, Advocate with him), instructed by Shri G. H. Rajadhyaksha, Agent, for Respondent.
Security deposits that are fixed sums, carry interest, and are repayable upon termination of a business relationship—rather than being advance payments for goods—constitute "borrowed money," regardless of their purpose as security for collateral contracts.
Headnote:(A) Excess Profits Tax Act, 1940 - Rule 2-A of the Rules in the Second Schedule - Computation of average capital - "Borrowed money" - Security deposits received from customers - Whether such deposits constitute borrowed money for the purpose of calculating excess profits tax - If the deposit is a fixed sum held as security for the performance of contracts, carrying interest and repayable upon termination of business connection, it possesses the essential elements of a contract of loan and constitutes borrowed money (Paras 9, 10).
(B) Nature of Deposits - A deposit of money is not confined to a bailment of specific currency to be returned in specie but may involve the creation of a debtor-creditor relationship, constituting a loan under conditions - The fact that a deposit is intended to provide security for the due performance of a collateral contract does not alter its character as a loan (Para 10).
(C) Trading Receipts vs. Borrowed Money - Amounts received as advance payments to be adjusted against the price of goods delivered under contracts are trading receipts and not borrowed money (Paras 7, 14).
Facts of the case:
Merchants carrying on business in yarn received sums from customers as security deposits under different arrangements during the chargeable accounting period. The first two arrangements involved advance payments adjusted against the price of goods. The final arrangement involved a fixed sum deposited as security for the performance of forward contracts, which carried interest and was repayable at the end of the business connection. The tax authorities rejected the claim that these were "borrowed money" under Rule 2-A, leading to an appeal after the High Court ruled against the assessee.
Findings of Court:
The sums received under the final arrangement (from 14-2-1945 to 12-4-1945) constitute borrowed money as they were not related to the price of goods and were repayable upon termination of the business connection. Sums received under previous arrangements were trading receipts and not borrowed money.
Issues: Whether the moneys deposited by customers as security deposits were "borrowed money" within the meaning of Rule 2-A of the Second Schedule to the Excess Profits Tax Act, 1940.
Ratio Decidendi: A transaction where one party pays money to another who agrees to return an equivalent sum subsequently is a loan, regardless of whether it is termed a "deposit" or intended as security for a collateral contract. If the money is not an advance payment for goods but a sum held and later returned, it is "borrowed money" in the legal sense.
Result: Order of the Court below set aside; question answered in the affirmative for the period 14-2-1945 to 12-4-1945 and in the negative for the rest of the period.
Legal Category Hierarchy
Table of Contents
2. Whether deposits intended as security for contract performance, where the amount is fixed by the recipient, constitute real borrowing or lending. (Para 10 , 11 )
3. Analysis of deposit arrangements to distinguish between advance payments for goods and loans provided as security for the duration of a business relationship. (Para 7 , 9 , 10 , 11 , 12 , 13 , 14 , 15 )
4. A security deposit that is a fixed sum, carries interest, and is repayable upon termination of a business connection constitutes borrowed money regardless of its purpose. (Para 9 , 10 )
5. Order set aside; deposits from 14-2-1945 to 12-4-1945 held as borrowed money, while deposits for the preceding period are not. (Para 16 )
6. When does a security deposit constitute borrowed money?
A security deposit is borrowed money if it is a fixed sum, carries interest, is used by the recipient for business, and is repayable upon termination of the business relationship, regardless of whether it serves as security for a collateral contract. (Para 9 , 10 )
7. Does the purpose of a deposit as security for contract performance change its legal character as a loan?
No. The object of the depositor or the fact that the deposit provides security for the due performance of a collateral contract does not alter the essential character of the transaction as a loan. (Para 10 )
8. How are advance payments for goods distinguished from borrowed money?
Advance payments intended to be adjusted against the price of goods delivered under a contract are trading receipts and do not constitute borrowed money. (Para 7 , 14 )
9. What constitutes a real borrowing and lending relationship in the context of deposits?
A real borrowing exists when a deposit creates a debtor-creditor relationship where the recipient agrees to return an equivalent sum subsequently, even if the repayment is conditioned on the fulfillment of obligations under a collateral contract. (Para 10 , 11 , 12 )
Judgement
Patanjali Sastri, C.J.I. : This appeal arises out of a reference made by the Income-tax Appellate Tribunal, Madras Bench under S.21, Excess Profits Tax Act, 1940 (hereinafter referred as to the Act.)
2. The appellants are merchants carrying on business in yarn in Madura and are the sole-selling, agents for yarn manufactured by the Madura Mills Co., Ltd., distributing yarn to several constituents under forward contracts in respect of which they obtained advances of moneys from their constituents. During the chargeable accounting period (18-5-1944 to 12-4-1945) the appellants received from their customers sums amounting to Rs. 7,69,569 and they claimed before the Excess Profits Tax Officer that the said sum should be treated as "borrowed money" within the meaning of R. 2-A of the Rules in the Second Schedule to the Act and, on that footing, no excess profits-tax was payable by them for the chargeable accounting period.
The Excess Profits Tax Officer rejected the claim and assessed them to excess profits-tax of Rs. 25,404, holding that, having regard the terms of the agreement under which the amounts were received, they could not in law be regarded as "borrowed money" within the meaning of that Rule. Appeals to the Appellate Assistant Commissioner and the Income-tax Appellate Tribunal having failed, the appellants applied to the Tribunal for reference of the question of law in the case to the High Court at Madras for its determination, and the Tribunal accordingly referred the following question:
"Whether, in the circumstances of this case, the moneys deposited by customers with the assesses firm as security deposits were borrowed money within the meaning of R. 2-A of the Second Schedule to the Excess Profits Tax Act, 1940 either throughout the chargeable accounting period ended 12-4-1945 or during any part of that chargeable accounting period? "
The reference was heard by the Division Bench of the Court (Satyanarayana Rao and Viswantatha Sastri JJ.) and the learned Judges by their judgment dated 9-6-1950 decided question against the appellants but granted them leave to appeal to this Court.
3. As is well known, during the period of the war, profits arising from a trade or business were much higher than the pre- war standard of profits and the State wanted to catch a portion of such profits which it deemed to be in excess of the normal or "standard" profits. The Act accordingly charges a tax on the "excess profits" earned under war conditions and makes provision inter alia, for cases where, as here, there is an increase of capital used for purposes of the business in the chargeable accounting period. In such cases the standard profits are to be increased by an amount calculated by applying the "statutory percentage" (varying from 8 to 12 per cent in different classes of cases) to the increase in capital. Thus, with the increase in the capital employed in the chargeable accounting period, there would be an increase in the standard profits and a decrease in the "excess profits."
Where the increase in the capital is brought about with borrowed money, it is but fair that such money, which plays its part in earning the larger profits, of which the State claims a substantial share, should not be deducted in computing the average capital used for the purposes of the business. Rule 2-A of the Rules in the Second Schedule to the Act accordingly provides that in computing the average capital during the chargeable accounting period and the relative standard period "no deduction shall be made in respect of borrowed money." In the present case, the appellants having admittedly received no security deposits during the standard period, the increase in the average capital employed in the chargeable accounting period would be much greater than what it has been computed to be, if the security deposits received, which were all used for the appellants business, were treated as borrowed money and part of the average capital of their business fo
