The central legal point established in the judgment is that the deduction of interest on borrowings under S. 8, Income-tax Act, is contingent upon the investment of borrowed funds in securities on which tax is payable by the assessee.

FACTS :- The following questions were referred to the High Court :

(1) Whether in the circumstances of the case the interest on borrowings, for the purpose of S. 8, Income-tax Act, should be computed on the basis of the average working capital or on the basis of the average deposits in the bank ?

(2) Whether in the circumstances of the case the interest deductible under the first proviso should be apportioned between the taxable and tax-free securities on the basis of their values ?

The facts leading to these questions will be found in the judgment of the High Court.

Chagla, C.J. :- The assessee is a co-operative bank, and its working capital in the year of account was roughly Rs. 34,00,000 and the average deposits about Rs. 29,00,000. This bank had invested in tax-free securities and taxable securities as large an amount as a sum approximately between Rs. 14,00,000 and Rs. 19,00,000. On the deposits that the bank maintained it paid as interest in the year of account a sum of Rs. 61,788; and two questions arise for our determination in this reference. One is with regard to the true effect of proviso 1 to s. 8, Income-tax Act to the extent that it is applicable to the facts of this case. Now, s. 8 deals with one of the heads which are chargeable to income-tax and that head is "interest on securities." and the section provides that the tax shall be payable by an assessee on interest on securities, in respect of the interest receivable by him on any security of the Central or Provincial Government. The rest of the section is not material. Then we come to proviso 1, and to the extent that it is material, it provides that no income-tax shall be payable respect of any interest payable on money borrowed for the purpose of investment in the securities by the assessee. Now, I might straightaway point out that this part of the proviso with which I am dealing is extremely clumsily drafted. The proviso suggests as if income-tax was payable on an outgoing but the true meaning - and that is not disputed - of this part of the proviso is that it contemplates a permissible deduction in the case of interest received under the head of securities and the permissible deduction is that if an assessee has borrowed moneys in order to invest them in securities and if he has to pay interest on those borrowings, then the interest can be deducted by the assessee from the tax that he has to pay under the head "interest on securities." Then there are two more provisos to this section. Proviso 2 deals with securities of the Central Government which are tax-free, and enacts that no income-tax shall be payable on the interest receivable on such tax-free securities of the Central Government; and proviso 2 deals with the securities of the Provincial Government, and that also enacts that no income-tax shall be payable by the assessee in respect of the tax-free Provincial Government securities, but income-tax shall be payable by the Provincial Government itself.

2. Now, the question that has been mooted at the bar is whether an assessee is entitled to deduct interest paid by him on his borrowings if he invests the sums so borrowed in tax-free securities. In other words, is it permissible to an assessee to borrow moneys, invest them in tax-free securities, receive interest on those securities, pay no tax on those securities, and still claim a deduction in respect of the interest which he has paid on the moneys borrowed by him ? Sir Jamahedji contends that s. 8 must be construed in the light of proviso 1 and that provisos 2 and 3 must be given effect to after due effect has been given to proviso 1. He says that the Legislature has put in these provisos in their due and proper order and they must be construed and given effect to in that order. Therefore, according to Sir Jamshedji, proviso is in essence absolute and it gives an absolute right to the assessee to deduct interest provided he utilizes the moneys borrowed by him on which interest is payable in the in