Case Study: CIT v. V. MR. P. Firm Muar, (1965) 1 SCR 815

SIGNIFICANCE

This case was a landmark judgement by the Supreme Court on the issue of the scope of liability to tax on the principle of estoppel. The case deals with the doctrine of ‘Approbate and Reprobate’ which in layman’s terms translates to “you can’t have your cake and eat it too.” It is further based on the rule of estoppel. The doctrine of ‘approbate and reprobate’ is only a species of estoppels; it applies only to the conduct of parties. As in the case of estoppels, it cannot operate against the provisions of a statute. If a particular income is not taxable under the Income-tax Act, it cannot be taxed based on estoppels or any other equitable doctrine. The judgement further deals with the principle that equity is out of place in tax law. A particular income is either eligible to tax under the taxing statute or is not. If it is not, the Income-tax Officer has no power to impose a tax on the said income.

The importance of this case has to do with the fact that any arrangement or agreement between the taxpayer and the Income Tax authorities providing for a basis of assessment different in any respect or particular from that laid down in the Act cannot estop either party, even if it has been acted upon in the past from relying in any year upon the proper construction of the relevant provisions of the statute. The judgement of this case law holds significance because it established that the Income Tax Act holds precedence over the principle of estoppel and if income isn’t taxable under the Income Tax Act, then it can’t be taxed based on estoppel or equitable doctrine.

FACTS

i) Overview

During World War II, Malaya was occupied by Japan between the period of February 1942 and September 1945. Japan introduced its currency in dollars and though both the currencies were in vogue, the Japanese currency introduced into Malaya began to depreciate after January 1963. This resulted in a situation where debts that were paid off and received in such currency, ended up being a loss to the creditors. In 1945, the British Government re-occupied Malaya and the Malayan currency was introduced as legal tender in place of Japanese currency. Indian nationals carrying on business in Malaya during the Japanese occupation suffered losses and were hit adversely.

ii) Notification by Govt. of India

To help these Indian businessmen, the Government of India, by a notification issued in 1947, put forth a scheme to give relief to Indian nationals carrying on business in Malaya, and the Central Board of Revenue further provided directions on the scheme. The scheme allowed such Indian nationals to set off the losses incurred by them during the 5 Assessment Years (from 1942-43 to 1946-47) against the profits of Assessment Years 1942-43 and 1941-42.

iii) Debtor and Creditor (Occupation Period) Ordinance No. XLII of 1948, of Malaya

In 1948, the Malayan Legislature passed the Debtor and Creditor (Occupation Period) Ordinance No. XLII of 1948, of Malaya, declared that payments made in Japanese currency by debtors to their creditors with regards to debts incurred before and during the Japanese occupation were to be valued and scaled-down per the schedule affixed to the Ordinance. The effect of the Ordinance was that the debt was revived in proportion to the depreciation of Japanese currency in relation to the Malayan currency as laid down by the schedule so that payment in Japanese currency would be a valid discharge of debt only to the extent of such revaluation. The creditor’s right to recover the debt to the said extent and the liability of the debtor to pay the same revived.

iv) Decision by Income Tax Tribunal

When brought before the Income Tax Tribunal, the Income Tax Officers held that during the period of Japanese occupation the debts were discharged and that the receipt of additional amounts under the Ordinance was, in fact, assessable to tax. They also held that in the case of an assessee who was a debtor no deduction was permissible on the ground that the amounts paid represented only repayment of capital and not business expenditure. On appeal to the Appellate Assistant Commissioner, it was held that the receipts by the assessee in respect of the revived debts were the only realization of the original amounts lent and, therefore, could not be regarded as income. On further appeal to the Tribunal, in the case of receipts, it held that the assessee by claiming benefits under the scheme and in including all its cash and bank balances in the Malayan business as part of the losses incurred therein in effect indirectly wrote off the debts to them and, therefore, the recoveries under the Ordinance were only a subsequent realization of the written-off bad debts and, therefore, assessable to income tax. In those appeals relating to deductions, the Tribunal confirmed the orders of the Appellate Assistant Commissioner.

v) Case filed before High Court of Madras

When the case was brought out before the High Court of Madras two questions were asked, namely (i) whether amounts, recovered by creditors who had accepted the scheme, from their debtors, in terms of the Ordinance, were liable to income-tax; and (ii) whether the debtors could claim the payments made by them as deductions. To answer it, the High Court held, (i) that the assesses who had received payments would not be liable to tax in respect of amounts they had received towards the principal, but they would be so liable in respect of sums of money which they had received towards interest; and (ii) that those assesses who had made payments towards the debts, would be entitled to deduct from their income, and claim exemption from tax only such amounts as they had paid on account of interest, but they would not be entitled to deduct any payment made on account of principal. The High Court also gave directions that open payments should be appropriated according to the law of appropriation of payments.

vi) Parties involved

The respondent in Civil Appeal Nos. 722 to 735 of 1963 is a firm carrying on a business of money lending in Kampar in Federated Malaya State. It had applied for relief under the special scheme after incurring a loss of Rs. 1,33,125 for the aforesaid four years. For the years 1941-42 and 1942-43 it received a profit of Rs. 53,010 and Rs. 35,753 respectively. These profits were set off against the losses and the taxes paid by the business for the years 1941-42 and 1942-43 were refunded back. Once the Ordinance was passed, the respondent recovered $ 6,437 during the year 1952, corresponding to Assessment Year 1952-53.

Civil Appeals Nos. 518 to 520 of 1963 dealt with the contrary case. The appellant in that appeal was a Hindu undivided family carrying on a money-lending business in the Federated Malaya States. In the course of its business, it had taken money as deposits from various persons before April 12, 1942. During the period of occupation, it has discharged its liability to various creditors but after the publication of the Ordinance, it had to pay again to the creditors $ 6214.58 in the previous year ending April 12, 1950; $ 28,586 for the previous year ending April 12, 1951; and $ 11,547 for the previous year ending April 12, 1952. The aforesaid amounts were claimed by the appellant as deductions respectively for Assessment Years 1950-51, 1951-52, and 1952-53.

The table below lays down the claims of the assessees as debtors or creditors, as the case may be:

vii) Appeal before Supreme Court

The High Court stated that the main reason for its judgement was that the Ordinance aimed to revive the old debts and the question of eligibility of the income to tax can be only decided by the provisions of the Income Tax Act and not by the directions of the Ordinance. Thus, 16 appeals were filed against the judgment of the High Court of Judicature at Madras before the Supreme Court.

ISSUES

1. Whether amounts, recovered by creditors who had accepted the scheme, from their debtors, in terms of the Ordinance, were liable to income-tax?

2. Whether the debtors could claim the payments made by them as deductions?

PROVISIONS OF LAW

1. Income Tax-Debtor and Creditor (Occupation Period) Ordinance (Malaya Ord. No. XLII of 1948)

2. Section 4 of Income Tax Act, 1961

ASSESSEES CONTENTIONS

There were two cases of the assessee’s contentions: one illustrating the claim of an assessee against the imposition of income tax in respect of the income he realized by the revival of the debts and the other illustrating that of an assessee to an allowance on the ground that he paid the scaled-down debts over again. The assessees contended that since they opted to accept the scheme, they derived benefit thereunder, and agreed to exclude their discharged debts from the assets side in the balance sheet subject to the condition that recoveries subsequent by them would be taxable income.  They pleaded that they are now precluded on the principle of “approbate and reprobate”, and further pleaded that the income they derived subsequently by the realisation of the revived debts is not taxable.

REVENUES CONTENTIONS

The learned Solicitor General, appearing for the Revenue, raised the following three points:

(1) Sub-section (2) of Section 4 of the Ordinance on which reliance was placed by the High Court applies only to preoccupation capital debts and the debts with which the appeals are concerned are not pre-occupation capital debts and, therefore, they are not revived thereunder.

(2) The assessees having taken benefit under the scheme propounded by the Government of India which contained a condition that if any recoveries subsequently made would be taken as income, they are now precluded from contending that the amounts realized towards the revived debts are not taxable on the principle of approbate and reprobate.

(3) On a reasonable construction of the relevant sections of the Ordinance it should be held that there was no revival of the debts but only that the State had provided for compensation for the losses incurred during the occupation period by the assessees.

DECISION

The Bench consisting of Honourable Justices Subbarao, K., K. Shah, J.C. Sikri, S.M. passed a unanimous judgement in this case.

The appeals were dismissed on the following grounds[1]:

• The creditor-assessees were not barred on the principle of “approbate and reprobate” from pleading that the income they had derived subsequently, by the realisation of the revived debts, was not taxable income. The doctrine was only a species of estoppel and cannot operate against the statute. If a particular income is not taxable under the Income-tax Act, it cannot be taxed on the basis of estoppel or any other equitable doctrine.
• Under the Ordinance, the discharged debts became enforceable to the extent of the balance of the amount due after the scaling down of the 816 payments, and the contention of the Revenue that the State provided for compensation for the loss incurred by the creditor-assessees could not be accepted.
• The Income-tax Officer could only impose income tax on the income recovered by the assessees thereafter towards their debts if such income was taxable under the provisions of the Act. So too regarding the payments made by the Assessees towards such debts, they could claim relief by way of deduction only if such deductions were permissible under the Act.

ANALYSIS OF THE JUDGEMENT

The first question put forth by the revenue had not been raised at any stage of the proceedings before the Tribunal and the High Court. Nor did it find a place in the statement of the case. Therefore, the court did not allow it to be presented before it.  The second question also has not been raised in the High Court in the form it was presented before the Supreme Court. The scheme proposed by the Government of India contained the following provisions:

i) No assessee was under any compulsion to accept the scheme. If he desired to opt for it, he was required to opt-in within one month of receiving information about the scheme.

ii) An assessee was allowed to include in his expenses certain items which would be inadmissible under the Indian Tax Act.

iii) All losses suffered by the assessee during the five Assessment Years 1942-43 to 1946-47 were to be aggregated.

iv) An assessee was permitted to include in his expenses certain items which would be inadmissible under the Indian Income Tax Act.

v) The losses suffered by an assessee during the five years relevant to Assessment Years 1942-43 to 1946-47 were to be aggregated.

vi) The assessee was allowed to carry backward the aggregated loss and set off against profits for the Assessment Year 1942-43.

vii) Any loss which was still unabsorbed could be carried back to the Assessment Year 1941-42.

viii) Any excess tax which was found to have been paid after re-calculating the income of the assessed by carrying backward his loss could be refunded back to him.

ix) The loss could not be carried forward.

Further instructions were issued by the Central Board of Revenue on the above scheme and one of its instructions was that all the debts that were due to the assessee if paid in Japanese currency would be taken to have been satisfied to that extent and excluded from the assets side of the balance sheet, provided that if any recovery was subsequently made, it would be taken as income.

With regards to the doctrine of “approbate and reprobate” is only a species of estoppel; it applies only to the conduct of the parties. As in the case of estoppel, it cannot operate against the provisions of a statute.  If a particular income is not taxable under IT Act, it cannot be taxed under the equitable doctrine. Equity is out of place in tax law. A particular income is either eligible to tax under the taxing statute or is not. If it is not, the Income Tax Officer has no power to impose a tax on the said income.

Revenue placed reliance on the case Amarendra Narayan Roy v. CIT[2]. However, this has no significance as in that case, the case related to the quantification of taxable income but in the present case, what was sought to be taxed is not a taxable income. It was observed that the assessee in such a case can raise the plea that his income is not taxable under the Income Tax Act. The Supreme Court rejected this plea.

Concerning the third argument put forth by the Revenue, it is necessary to analyse the Ordinance which was issued by the Malayan Government to regulate the relationship between the debtor and creditor in respect of debts incurred before and during the period of occupation. Under the said Ordinance payments in Japanese currency were to be valued and scaled down in accordance with the Schedule appended to the Ordinance. If a debtor was paid his debt in depreciated Japanese currency, he was required to pay over again a certain amount to be ascertained by the application of the provisions of the Schedule. Sub-section (2) of the Ordinance said that the payment in Japanese currency shall be a valid discharge of such debt only to the extent of such revaluation. When the payments made towards debts were scaled down, the debts were revived regarding the balance of the debt. After the making of the Ordinance, the creditor could enforce his debt to the extent not discharged and the debtor had the obligation to discharge the same. On the express terms of the Ordinance, it is impossible to accept the contention that the State provided for compensation for the losses incurred by the assessees. Indeed the State did not pay any compensation at all. The legal relationship of the creditor and debtor was not created by the Ordinance but it was regulated based on the pre-existing relationship. Thus, the Supreme Court, agreed with the High Court on its observation that under the Ordinance the discharged debts became enforceable to the extent of the balance of the amount due after the scaling down of the payments. If so, the Income Tax Officer could only impose a tax on the income recovered by the assessees thereafter towards their debts if such income was taxable under the provisions of the Act. For these reasons above, the Supreme Court upheld the decision of the High Court and dismissed the appeal.

PROBABLE GROUNDS FOR REVERSAL

To observe possible grounds for reversal of the judgement, Section 4(2) of the Ordinance is relevant namely,

“4. Discharge during occupation period of pre-occupation debts.—

(1) Subject to the provisions of sub-section (2) of this section, where any payment was made during the occupation period in Malayan currency or occupation currency by a debtor or by his agent or by the Custodian or a liquidation officer purporting to act on behalf of such debtor, to a creditor, or his agent or to the Custodian or a Liquidation Officer purporting to act on behalf of such creditor, and such payment shall be a valid discharge of such pre-occupation debt to the extent of the face value of such payment.

(2) In any case— (a) where the acceptance of such payment in occupation currency was caused by duress or coercion; or (b) where such payment was made after the thirty-first day of December 1943, in occupation currency in respect of a pre-occupation capital debt, exceeding two hundred and fifty dollars in amount, which— (i) was not due at the time of such payment; or (ii) if due, was not demanded by the creditor or by his agent on his behalf and was not payable within the occupation period under a time essence contract; (iii) if due and demanded as aforesaid was not paid within three months of demand or within such extended period as was mutually agreed between the creditor or his agent and the debtor or his agent, or (c) … such payment shall be revalued in accordance with the scale set out in the Schedule to this Ordinance and shall be a valid discharge of such debt only to the extent of such revaluation.

Sub-section (2) of Section 4 of the Ordinance on which reliance was placed by the High Court applied only to preoccupation capital debts and the debts with which the appeals are concerned are not pre-occupation capital debts and, therefore, they are not revived thereunder. While this contention wasn’t taken by the Supreme Court since it hadn’t been raised before the High court, if the Revenue had raised this issue in the High Court itself, there could have been possible grounds of reversal.

[1]CIT v. V. MR. P. Firm Muar, (1965) 1 SCR 815.

[2]Amarendra Narayan Roy vs Commr. Of Income-Tax, West Bengal, AIR 1954 Cal 271.