Perfect Thread Mills Ltd vs. DCIT (ITAT Mumbai) (Third Member)

ITA 4964/Mum/2013
IN THE INCOME TAX APPELLATE TRIBUNAL
MUMBAI BENCH “C”, MUMBAI
BEFORE SHRI G.S.PANNU VICE PRESEDENT,(AS THIRD MEMBER)
SHRI D. KARUNAKAR RAO, ACCOUNTANT MEMBER, AND
SHRI AMIT SHUKLA, JUDICIAL MEMBER,
SH. PAWAN SINGH JUDICIAL MEMBER AND
SHRI RAJESH KUMAR ACCOUNTANT MEMBER
ITA No. 4964/Mum/2013
(Assessment year : 2010-11)
Perfect Thread Mills Ltd
201, Millenium Plaza
Behind Sakinaka Telephone
Exchange, Andheri Kurla
Road, Andheri (E), Mumbai-
72
PAN: AAACP6449E
vs DCIT, 8(2), Mumbai
APPELLANT RESPONDEDNT
Appellant by Shri Sunil Hirawat
Respondent by Shri Awungshi Gimson, CIT-DR
Date of hearing 21-08-2019
Date of pronouncement 05-09-2019
ORDER UNDER SECTION 255(4) OF THE INCOME TAX ACT, 1961
This appeal was initially heard on 29-07-2015. The Hon’ble Members,
who constituted the bench, have passed the following dissenting orders:-
PER P. KARUNAKARA RAO, AM:
This appeal filed by the assessee on 1.7.2013 is against the order of the CIT(A)-
17, Mumbai dated 29.4.2013 for the assessment year 2010-2011. In this appeal,
assessee raised the following grounds which read as under:
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“1. On the facts and in the circumstances of the case, the Ld CIT (A) has erred in
upholding the order passed by the Ld DCJT, which is bad in law and against justice
and liable to be quashed.
2.(a) On the facts and in the circumstances of the case and in law, the Ld CIT (A)
has erred in upholding the order passed by the Ld ACIT, who has erred in
disallowing the deduction of Rs. I,48,24,633/- being claimed as expenses while
determined the capital gain.
(b) The Ld CIT (A) has failed to appreciate the fact that the sale of land area
was effected by Kotak Mahindra Bank Ltd (KMBL) and out of the sales
consideration received by them they had deducted the said amount towards
principal amount of loans as the bank had existing overriding title on the company’s
assets.
(c) The Ld CIT (A) has failed to appreciate the judicial pronouncement of
Hon’be Calcutta High Court in the case of Gopee Nath Paul & Sons vs. Deputy CIT
[2005] 278 ITR 240 where it was held that on the sale of firm’s business as a going
concern the amount paid to banks to have the charge lifted was treated the
expenses in relation to transfer. ”
2. Briefly stated relevant facts of the case are that the assessee is a
manufacturer of cotton / polyster sewing and industrial threads and also
engaged in processing of cotton yarn. Assessee is in this business for a long
time and filed the return of income for the year under consideration declaring the
total loss of Rs. 64,93,9277-. After completing the scrutiny assessment u/s
143(3) of the Act, the total income is determined at Rs. 49,25,990/-. In the
assessment, AO made adjustment to the claim relating to capital gains and
made addition of Rs. 2,14,50,679/-. This is the point of contention before the
Revenue Authorities as well as in Tribunal. The facts relating to this issue are
given in the following paragraph.
3. Assessee took a corporate term loan of Rs. 306 lakhs from M/s. Kotak
Mahindra Bank Ltd (KMBL) during the Financial Year 2008-2009 relevant to the
assessment year 2009-2010. The loan was repayable in 36 monthly installments
and the assessee complied with the repayment schedule and repaid the loan till
July 2009. However, assessee became a defaulter from August 2009 onwards.
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ITA 4964/Mum/2013
The bank (KMBL) classified the company’s account as NPA (Non-performing
Asset) on 21.11.2009. In this regard, a notice was served on 30.11.2009 as per
the provisions of section 13(2) of Securitization and Reconstruction of Financial
Assets of Security Interest Act (SARFAESI) on the assessee company and its
personal guarantors viz Mr. H.S. Bapna and Mrs. Urmila Bapna. The total
outstanding liabilities at that point of time is 3,40,61,488/-. On 7.1.2010, the bank
took over possession of the factory land of the assessee admeasuring 6,883.517
sq mts. Land was sub-divided into 7 plots and 6 of these sub-plots were sold by
the bank in March, 2010. The bank received directly the consideration
amounting to Rs. 2,18,00,262/-. The bank adjusted the said realization against
the loan of the assessee ie a sum of Rs. 1,48,24,633/- was adjusted against the
principal segment of the loan. Rs. 69,75,629/- was adjusted against the interest
segment of this loan. Assessee claimed this interest liability as an allowable
expenditure in the accounts of the assessee. Accordingly, the net amount of Rs.
1,48,24,633/-, which was appropriated towards principal segment of the loan
was shown in the computation of capital gains arising of those 6 plots of land.
However, the said amount was claimed as deductible u/s 48 of the Act along
with the indexed cost of acquisition and improvements (Rs. 3,43,583;- and other
incidental expenses of Rs. 6000 relating to sales). The manner of computation
given by the assessee in the return of income is extracted as under:
Long Term Capital Gains:
Total amount of sale consideration received by
M/s. Kotak Mahindra Bank Ltd against principal amount of
Loan out of sale proceeds of company’s land taken possession
by them under SARFAESI ACT Rs. 2,18,00,262/-
Less Acquisition Improvements
(i) Cost of land –
Year of acquisition / improvements 1981-82 2006-2007
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ITA 4964/Mum/2013
Cost of acquisition / improvements 47,201/- 37,178/-
Index of year of acquisition / improvements 100/- 519/-
Index for AY 2009-2010 632/- 632/-
Indexed Cost (Rs.) 2,89,310/- 45f273/- 3,43,583/-
(ii) Incidental Expenses for above sale 6 000/-
(iii) Amount adjusted by Kotak Mahindra
Bank Ltd against principal amount of
Loan out of sale proceeds of company’s
Land taken possession by them under
SARFAESI ACT 148.24.633/- 1,51,74,218/-
Long Term Capital Gains 66,26,046’/-
4. In the assessment, AO issued a show cause notice proposing to tax the said
claim of deduction amounting to Rs. 1,48,24,633/- as capital gains. In the reply,
dated 21.11.2012 and 23.11.2012, assessee submitted the KMBL has overriding
title on the mortgaged asset (the said factory land), the bank invoked the
SARFAESI Act and took possession of the said land. Eventually, the bank sold
the said land and transferred the same to the buyers with any participation of the
assessee and received sale proceeds directly to the account of the bank.
Assessee has no role to play in all these events. In principle, the bank has
become the owner of the land. Therefore, it is the case of the “diversion of
income at source by overriding the title”. Since, the assessee has lost the title as
well as has never received the sale proceeds to his account, the sale proceeds
are not taxable in the hands of the assessee. It is a case of diversion of income
at source. Therefore, in the aforementioned computation, assessee reflected the
same as an allowable deduction. Regarding Rs. 69,75,629/-, it is the case of the
assessee that since the assessee claimed interest payable to the bank as
deduction in past, to that extent the same is offered now as taxable portion.
However, the Assessing Officer analyzed the provisions of section 48 of the Act
and held that the claim is not sustainable in law as the gains arose on the sale of
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the factory land of the assessee. AO also mentioned that the assessee received
the sale consideration on sale of the said 6 plots of land. He also mentioned that
what is allowable u/s 48(i) of the Act is only expenditure incurred wholly and
exclusively in connection with such transfer, and not the expenditure of this type.
Without much discussion in para 7.8 of the assessment order, AO rejected the
assessee’s contention that it is a case of “diversion of income at source by
overriding the title”. Contents of para 7.10 of the assessment order are extracted
as under:
“7,10. Accordingly, the bank has recovered its dues, and the liability of the
assessee was reduced by an amount of sale consideration received by the bank on
behalf of the company. Therefore, the assessee has actually repaid its loan to the
bank by selling the land and, therefore, cannot be considered as allowable
expenditure within the meaning of section 48(1) of the Act.”
4.1. Accordingly, the amount of Rs. 1,48,24,633/- was added back to the total
income of the assessee. Aggrieved with the said addition made by the AO,
assessee carried the matter in appeal before the first appellate authority.
5. During the proceedings before the first appellate authority, assessee agitated
against the said addition and made a written submission vide letter dated
26.4.2013, the contents of which are extracted in para 5.2 of the CIT (A)’s order.
In the said submissions, assessee narrated the facts of the case and submitted
that the assessee created charge on the asset in favour of the bank in
connection with the loan of Rs. 306 lakhs. The bank invoked the SARFAESI Act
and took possession of the land. Considering the powers conferred to the bank
by the said SARFAESI Act vide the provisions of section 13(4), the bank sold the
property and realised the proceeds directly without any involvement of the
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assessee. Assessee relied on the judgment of the Calcutta High Court in the
case of Gopee Nath Paul & Sons vs. Deputy CIT [2005] 278 ITR 240, which is
relevant for the proposition that “the expenditure incurred for perfection of title
necessary for effecting sale / transfer is an allowable expenditure”. This is the
case, where the liabilities of the bank were cleared by the sale proceeds of the
assets. It was considered as an expenditure incurred wholly and exclusively in
connection with the transfer. Assessee also relied on the view of the Andhra
Pradesh High Court in such cases. Further, assessee relied on the judgment of
the Apex Court in the case of R.M. Arunchalam Etc vs. CIT [1997] 227 ITR 222
(SC) to support its case. Thus, the assessee submitted that AO failed to the fact
that there was a pre-existing overriding title in favour of the bank by virtue of joint
equitable mortgage created on 5.2.2009 on immovable properties of the
assessee. On considering the above written submissions of the assessee, CIT
(A) did not go with the said submission. The arguments relating to “diversion of
income by overriding title” was also not entertained. Relying on the judgment of
the Hon’ble Supreme Court in the case of CIT vs. Attili N Rao [2001] 252 ITR
880 (SC), as well as the judgment of the Allahabad High Court in the case of CIT
vs. Sharad Sharma (2008) 305 ITR 24 (All), CIT (A) opined that it a case of
application of income and not diversion of income by overriding charges.
Eventually, CIT (A) is of the opinion that the assessee is not entitled to
deduction. CIT (A) also rejected the assessee’s argument that it is a case of
explaining in connection with the transfer of the asset / perfection of the title
before the sale of transaction. He also discussed in para 5.5, the applicability of
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the provisions of section 45(5)(b) and 45(5)(c) of the Act. CIT (A) also rejected
adopting the cost of acquisition of the asset as on 1.4.1981 in view of the fact
that the assessee became the owner of the land only after the date. Further, on
the application of the provisions of section 47(xii) of the Act, the CIT (A) is of the
opinion that the assessee-company is not managed by the worker’s cooperative.
Therefore, the same is outside the scope of the said provisions. Accordingly, CIT
(A) dismissed the appeal of the assessee. Aggrieved with the said decision of
the CIT (A), assessee is in appeal before the Tribunal.
6. During the proceedings before us, Ld Counsel for the assessee filed
written submissions and the same are extracted as follows:
“3.9. The principles of diversion of income by overriding title were explained by the Hon’ble
Supreme Court in the case of Sitaldas Tirathdas (41 ITR 367) by referring to the judgment of
Hon ‘ble Privy Council in the case of Raja Bejoy Singh Dudhuria vs. CIT (1 ITR 135) and P.C.
Mullick (6 ITR 206) with the following observations.
“In our opinion, the true test is whether the amount sought to be deducted, in truth, never
reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the
nature of the obligation which is the decisive fact. There is a difference between an amount
which a person obliged to apply out of his income and an amount which by the nature of the
obligation cannot be said to be a part of the income of the assessee. Where by the obligation
income is diverted before it reaches the assessee, it is deductible; but where the income is
required to be applied to discharge an obligation after such income reaches the assesse, the
same consequence, in law, does not follow. It is the first kind of payment which can truly be
excused and not the second. The second payment is merely an obligation to pay another a
portion of one’s own income, which has been received and is since applied. The first is a case in
which the income never reaches the assessee, who even if he were to collect it, does so, not as
part of his income, but for and on behalf of the person to whom it is payable “.
3.10 The honourable Calcutta High Court held in the case of Gopinath Paul and Sons vs.
D.C.I.T. (278ITR 24O)
5. Section 48(1), as it stood in 1992-93, while providing for computation of capital gains
permitted in clause (i) deduction of the “expenditure incurred wholly and exclusively in
connection with such transfer”. The expression ‘in connection with such transfer’ is wider than
the expression ‘[or the transfer’. Any amount the payment of which is absolutely necessary to
effect the transfer will be an expenditure covered by clause (i) of section 48(1). In other words, if
without removing any encumbrance, sale or transfer could not be effected, the amount paid for
removing that encumbrance will fall under clause (i).
5.1 From the facts as disclosed above, it appears that the amount was received out of the sale of
assets of both the firms under orders of this Court subject to meeting of the liability of the
Allahabad Bank since confirmed only upon prior payment. Inasmuch as, unless this liability was
met, the transferee could not derive any title. In other words, the sale consideration receivable by
the assessee was less the liability of the Allahabad Bank. Thus, meeting this liability of one of the
firms, when the entire assets were being sold, was an absolute necessity to effect the transfer.
In other words, it was an encumbrance without removing which the sale or transfer could not be
effected and the amount spent for removing this encumbrance would definitely attract clause (i)
of section 48(1).
5.2 From the Assessment Order (page 37 of the paper book), it appears that earlier the
assessee used to conduct its business under the name and style of Gobindo Sheet Metal Works
& Foundry. CIT (Appeals) at pages 43-44 of the paper book have found that the short-term
capital gain arising out of the sale of the assets pertaining to the erstwhile business of the
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appellant in the name and style of Gobindo Sheet Metal Works & Foundry and on the sale of the
factory and assets of the erstwhile business through public auction, the total consideration
received was Rs.3,66,24,005. From the details of the expenses and liabilities claimed, it was
seen that an amount of Rs,27,85,523 had been shown as payable to the Allahabad Bank.
However, the CIT (Appeals) found that there was no pre-condition that the appellant could not
sell its assets without settling the dues of the Allahabad Bank and even if it was, it would be a
case of application of the income.
5.3 As discussed above, in this case the sale could not be effected without meeting the liability,
as it appears from the different orders passed by this Court in the latter suit wherefrom it is
apparent that the former suit was transferred to this Court and was ultimately settled between the
parties through Lok Ada/at.
5.4 But from the facts as discussed above, we are of the view that the orders passed by this
Court directing the sale of the assets of the two firms and its confirmation thereof are staring on
the face of the inference drawn by the CIT (Appeals). Thus, we are of the view that the liability
met by the assessee towards the dues of the Allahabad Bank was an expenditure incurred
wholly and exclusively in connection with the transfer.
3.11 From the facts relating to the assessee’s case explained in Para No. 3.1 to 3.5, it is quite
manifest that once Kotak Mahindra Bank Ltd. invoked powers u/s.l3(4) of the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI),
the title over Plot No.P/1, P/2f P/3A, P/3B and P/4 was automatically divested from the assessee
company and vested in Kotak Mahindra Bank Ltd. on 07.01.2010. Further, when the plots were
sold by the bank in March, 2010, the sale deeds were executed between the buyer and the bank
and the entire consideration received from buyer was appropriated towards the outstanding
liability of the bank. The assessee was not at all involved in either the sale of plots or the
execution of sale deeds. Therefore, the sale proceeds to the extent of amount appropriated
towards loan never reached the assessee as its income and was diverted towards discharge of
bank’s obligation.
3.12 As regards reliance placed by the Cl. T.{A). while rejecting the assessee’s claim upon the
judgements of the honourable Supreme Court in the case of Cl. T. vs. Attili N. Rao (252 ITR 880)
and the honourable Allahabad High Court in the case of CL T. vs. Sharad Sharma (305 ITR 24),
it is submitted that these judgements are not applicable to the facts of the assessee’s case.
3.13 In the case of CI.T. vs. Attili N. Rao, the assessee was carrying on abkari business. He
mortgaged his immovable property to the Excise Department of Andhra Pradesh to secure
payment of kist He could not pay the kist Therefore, the excise department sold the immovable
property by way of public auction, deducted its dues towards kist and interest and paid the
balance amount to the assessee. There was no court order for auction of the property and
appropriation of proceeds towards kist and interest. It was simply a case of recovery of mortgage
assets by its auction to recover government dues under the provisions of Andhra Pradesh State
Excise Act. There was no divesting of title from the assessee and vesting thereof with the State
Excise Department. On these facts, the honourable Supreme Court held that the capital gain
was to be computed on the full price realized as reduced by the admitted deduction. The
payment made to the Central Excise Department towards kist and interest was not a deductible
expenditure.
3.14 In the case of CI. T. vs. Sharad Sharma, M/s. Shanker Traders took loan from bank against
mortgage of house property belonging to the partner, Shri Sharad Sharma. The bank enforced
the recovery of loan against M/s. Shanker Traders. Under agreement with the bank, the house
was auctioned by the assessee and after payment of bank loan of Rs.1,50,000/-, the remaining
amount was received by the assessee. It was simply a case of sale of mortgage property and
recovery of outstanding loan of the bank. There was no divesting of ownership of house from
assessee and vesting thereof with the bank. On these facts, the honourable High Court held that
it was not a case of diversion of income by overriding title but application of income towards
repayment of bank loan. In 3 case of inheritance/acquisition along with the mortgage perfecting
his title by getting mortgage discharged, the assessee would be entitled to get the deduction of
the mortgage debt but where the charge is created by the assessee himself, it cannot be said
that the amount of mortgage debt out of the sale proceeds be deductible while calculating the
capital gains.
3.15 The ratio of the aforesaid judgements is not applicable because in the assessee’s case,
Kotak Mahindra Bank Ltd. took possession of 6 plots under SARFAESI Act, 2002. The land was
divested from the assessee and vested with Kotak Mahindra Bank Ltd. After taking possession,
the bank converted these plots into 7 plots. Further, when the plots were sold by the bank in
March, 2010, the sale deeds were executed between the buyer and the bank and the entire
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consideration received from buyer was appropriated towards the outstanding liability of the bank.
The assessee was not at all involved in either the sale of plots or the execution of sale deeds.
3.16 In view of the above, we request your honour to allow the assessee’s claim and exclude
the principal amount of Rs.1,48,24,633/- appropriated by Kotak Mahindra Bank Ltd. towards its
dues while computing Logn-term Capital Gains.”
7. Further, Ld Counsel for the assessee also submitted that the SARFAESI Act,
2002 takes away all the rights of the possession including right to sale the
secured property of the assessee. In this regard, Ld Counsel for the assessee
brought our attention to the provisions of section 13 relating to “Enforcement of
Security Interest” and submitted that vide clause (a) of sub-section 4 of section
13, bank has right to transfer by way of lease, assignment or sale for realising
the secured asset. Further, bringing our attention to sub-section (6) of section
13, Ld Counsel for the assessee read out such transfer of secured asset by the
bank shall have the effect as if the transfer was made by the owner of the
secured asset.
8. On the other hand, Ld DR relied heavily on the order of the AO and the CIT
(A). Elaborating the same, Shri S.K. Mahapatra, Ld DR for the Revenue
submitted that if the case of the assessee is considered as diversion of income
by overriding the title”, the situation may become that the every loan defaulter of
the financial institutions such as Banks shall not make any payment of taxes u/s
48 of the Act on the gains arose on transfer of the capital asset, given as
security, which is eventually sold by the Banks. Further, he mentioned that it is a
case of application of income as assessee’s loans are eventually squared up
with the bank. Further, replying to the Ld DR, Ld Counsel for the assessee
submitted that it is a case where the agreements to transfer the secured assets
were signed by the bank and the transferees never made TDS while making
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payments to the bank. No liability on account of stamp duty was also incurred by
the assessee. However, Ld DR has nothing to say on the fact that the assessee
lost all the rights in the property on becoming a defaulter. The title is therefore
not perfect. Referring to the AO’s erroneous assumption of the fact given in para
7.8 of his order, Ld DR mentioned that the proceeds were not received by the
assessee and they are received by the Bank. In principle the assessee lost the
capital asset and now, in addition, the assessee needs to pay taxes too if the
sale proceeds are subjected to tax.
Decision of the Tribunal:
9. We have heard both the parties on this issue and perused the orders of the
Revenue Authorities, the paper book, written submissions filed before us.
Undisputed facts in this case include (a) the secured asset in question is a
factory land mortgaged to the bank; (b) Considering the undisputed default of
the assessee in making the payments of installments, the assessee’s account
was declared as NPA by the bank; (c) the bank invoked the provisions of the
SARFAESI Act, 2002 on the assets mortgaged to the bank; (d) Thus, there is no
dispute on the fact that the said land in question is not free from encumbrance.
The ownership title of the land is not perfect; (e) Under the SARFAESI Act, when
the bank takes possession of the secured land, the bank gets the ‘right to
transfer’ by way of sale for the purpose of realizing the secured asset vide
section 13(4)(a) of the Act. Thus, the assessee lost the right on the said property
secured to the bank as the assessee is declared as ‘defaulter’ under the said
Act. The Bank acted as a transferor in the said transfer transaction in matters of
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executing the transfer deeds and registration deeds. The Bank got the superior
rights on the property and assessee had no say in the matter in view of its
undisputed default and the provisions of SARFAESI ACT. Further, it is also an
undisputed fact that the transferee of the impugned property made the payment
to the bank directly no amount was received by the assessee on account of the
impugned sale transactions. Thus, we shall now under take to discuss various
facets of the doctrines of (i) Over riding Title, (2) Application of Income; and (3)
Diversion of Income (Dol) in the following paragraphs.
10. Doctrine of Over-riding title: this doctrine visualises the situation that, to
start with, a property is actually owned by the assessee with proper ownership
title. However, in the course of time when the same is secured/mortgaged with
the creditor, the said title undergoes change by virtue of process of law or legal
provisions and the creditor or the Bank gets the ‘overriding title’. In the past, the
Banks may knock the legal forums for getting such overriding title before the
sale/auction. However, with the legislation of the SARFAESI ACT, 2002, such
legal requirements are dispensed with and the creditor gets the over-riding title
subjected to conditions discussed in the following paragraphs. Therefore, we
now proceed to examine the said legislation as follows.
10.1 Provisions of section 13 of the SARFAESI ACT are relevant the same
relating INFORCEMENT OF SECURIT INTEREST read as follows, –
i. SEC J.3. Enforcement of security interest
(2)…..,
(3)……
(3A). …….
(4) In case the borrower fails to discharge his liability in full within the period specified in subsection
(2), the secured creditor may take recourse to one or more of the following measures to
recover his secured debt, namely:–
(a) take possession of the secured assets of the borrower including the right to transfer by way of
lease, assignment or sale for realising the secured asset;
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(b) take over the management of the business of the borrower including the right to transfer by
way of lease, assignment or sale for realising the secured asset: PROVIDED that the right to
transfer by way of lease, assignment or sale shall be exercised only where the substantial part of
the business of the borrower is held as security for the debt:
PROVIDED FURTHER that where the management of whole of the business or part of the
business is severable, the secured creditor shall take over the management of such business of
the borrower which is relatable to the security for the debt.
(c) appoint any person (hereafter referred to as the manager), to manage the secured assets the
possession of which has been taken over by the secured creditor;
(d) require at any time by notice in writing, any person who has acquired any of the secured
assets from the borrower and from whom any money is due or may become due to the borrower,
to pay the secured creditor, so much of the money as is sufficient to pay the secured debt.
(5) Any payment made by any person referred to in clause (d) of sub-section (4) to the secured
creditor shall give such person a valid discharge as if he has made payment to the borrower.
10.2 Interpretation of the above provisions: The provisions of section 13 of the
SARFAESl ACT, 2002 provides for enforcement of security interest. According
to the said provisions, in case the “borrower (of loan) fails to discharge his
liabilities in full’ to the secured creditor/Bank, the same may take to following
recourses to recover the dues, namely, rt take possession of the secured
assets of the borrower including the right to transfer by way of lease,
assignment or sale for realising the secured asset; or (b) take over the
management of the business of the borrower including the right to transfer by
way of lease, assignment or sale for realising the secured asset” or (c) appoint
any person (hereafter referred to as the manager), to manage the secured
assets the possession of which has been taken over by the secured creditor (d)
require at any time by notice in writing, any person who has acquired any of
the secured assets from the borrower and from whom any money is due or may
become due to the borrower, to pay the secured creditor, so much of the
money as is sufficient to pay the secured debt”. There are conditions specified
section 13(4)(a) of the Act are relevant for the cases of takeover of the
management of the business of the borrower’. Of course, the provisions of this
clause (b) are irrelevant to the facts of the present case, where only the secured
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assets of the borrower is taken possession of as per the provisions of the said
clause (a). We shall elaborate the provisions of the said clause (a) as under;
10.3 The above provisions of section 13(4)(a) of the Act explains the various
rights available to the bank when it takes over the possession of the secured
asset of the borrower. To elaborate the said clause (a), the same is extracted
as follows,-
“13(4) In case the borrower fails to discharge his liability in full within the period specified
in sub-section (2), the secured creditor may take recourse to one or more of the following
measures to recover his secured debt, namely:–
(a) take possession of the secured assets of the borrower including the right to transfer by
way of lease, assignment or sate for realising the secured asset;…………… ”
10.4 The Bank is empowered by the said Act to take possession of the secured
assets of the borrower. This right to take possession includes the Right to
transfer’. This right to transfer includes various modes of transfer. The said Act
empowers the Bank to transfer the asset by way of sale of the secured
asset. However, the Bank is under statutory obligation to fulfil certain obligations
and one such obligation relates to establishing the fact of ‘borrower’s fa/lure to
discharge his liability in ft///’as mentioned in subsection (4) of section 13 of the
SARFAESI ACT, 2002. In other words, the bank assumes the right to take
possession, right to transfer, right to sale for realising the secured asset on
establishing the “borrower’s failure to discharge his liability’. Of course, there are
administrative and legal procedures to be followed by the Bank involving the
principles of natural justice such as issuing the notices, declaring in books the
said unrealised liabilities as NPAs and consequent write-off etc. Of course, the
assessee-borrower has certain rights and can question the initiatives of the Bank
to take possession of the secured asset.
10.5 However, in the instant case, the borrower gave in the said rights and has
not questioned the bank’s initiatives to sell the secured property in any legal
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forums. In other words, on the facts of the borrower’s failure to discharge the
liability to the lender-bank, the assessee’s title of ownership is subjected to the
rights of the Bank, conferred by the said SARFAESI ACT. Thus, the provisions
of the said Act provides to the lender-bank the ‘over riding title’ on the secured
property. This is done by the process as per the provisions of law ie the
SARFAESI ACT, 2002. These are the ingredients of the doctrine of overriding
title.
10.6 Prior to the legislation of the SARFAESI ACT, 2002: It is not out of place to
mention that in the period prior to the said Act, the lender banks are under
obligation to get such over-riding title on such secured or mortgaged assets from
the courts through the process of judgmental law. In other words, in cases of
litigation, the Bank needs to obtain the orders from the Courts or DRT, as the
case may be, before initiating the ‘act of transfer’ of the secured assets of the
borrower for realising the liabilities.
11. In the instant case, the bank intimated the borrower’s failure to discharge
its liabilities in full as the ‘principles of justice’ and they are in tune with the
provisions of the SARFAESI ACT. Borrower has not objected to the same
and the same is evident from the fact that it did not start any litigation in any
court of law against the steps of the lender-Bank. Thus, in effect, the
assessee subjected its rights on the ownership title of the said property to the
Bank. The Bank took possession of the same and sub-divided the lands
before the same are transferred to the buyers in the open market. It is also
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relevant to mention that the assessee was not signatory to the sale deeds and
it is the bank which transferred the property to the buyers. This fact cements
the Bank’s undisputed fact of overriding title over the property. Assessee has
not played any role, whatsoever, in the sale transactions of the secured/
possessed land by the lender-Bank. Therefore, we are of the opinion, this
is undoubtedly a case of the overriding title. Thus, having dealt with the
doctrine of ‘over-riding title’ till now, we shall now take up the other limb ie
doctrine of ‘diversion of income’ (DOI).
12. The provisions of the said clause (a) to section 13(4), extracted above,
expressly mention that the bank has the right to take possession of the asset
of the borrower, the assessee. This right to take possession includes right to
transfer also. The said transfer can be affected by way of sale. These are the
undisputed facts in the present case. When the right to take possession, right
to transfer, right to sale are with the bank, nothing is left with the assessee,
the borrower, except the weak ownership title on the said asset. Thus, the
ownership title is overridden by the Bank’s power conferred by SARFAESI
Act. In that sense of the mater, we find the legal provisions are very clear
that the bank has got overriding title on the asset. This SARFAESI Act
secures / guarantees the rights of the transferee, who purchases the assets
from the banks.
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13. Doctrine of Diversion of Income: We have also gone through the
various decisions cited by both the parties relating to the diversion of
income (DOI) versus application of income (Aol). In matters relating to
claim of deduction for property are not deductible as the case of DOI by ORT.
It is the case there is no process of law involved and the Government never got
an absolute overriding title. There is dispute over the sale of land, and assessee
never objected to the said sale in any court of law. In this case, AP Government
acted on the concessions of the assessee and it never got any overriding title on
the land by way of any judgment from any Court/Tribunal. Para 13 of the said
High Court’s judgment is relevant.
19. Therefore, the legal proposition of law is that when the sale proceeds of
mortgaged property are paid to the creditor of the assessee, the same are not
deductible in computing the capital gains on the said property. Therefore, the
payments made by the buyers of the property to the creditors directly does not
make in any difference so long as there is never a overriding title over the
mortgaged property. The underlying rationale of the same, in our opinion, is that,
in all the above cases, the creditor/ Bank/Government never got the overriding
title on the said property either by way of process of law or by an act of law such
as the SARFAESI ACT, which provides for unfettered powers over the property
to the creditor/Banks. Mere making payment by the buyer directly to the
creditors without routing through the bank accounts of the land owner, does not
grant any right for making claim of deduction. No claim of deduction is allowed
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unless the creditor gets the overriding title and payments are directly paid to the
creditors without routing through the owner’s accounts. Otherwise, it will be a
case of ‘application of income’ only and not deductible. Therefore, the Hon’ble
courts have rightly held against the assessees in the said cases. As such, there
are not judgmental law involving the sale of secured property, which are
mortgaged under the provisions of the SARFAESI ACT. In our opinion, the only
objection of the DRs for Revenue is that it may become a tax planning device for
some tax payers, (ie to become a defaulter of taxes, allow the properties to be
sold by the Banks / creditors and avoid paying capital gains tax on the sale
proceeds), is not sustainable in law. It is commonsensical to think that no
assessee wilfully wants to lose their properties for tax reasons.
20. Therefore, the provisions of section 13 of the said SARFAESI ACT, 2002
makes all the difference for such transaction of sale of the mortgaged properties
these days. Diversion of income by overriding title has two clear limbs required
for the assessees to fulfil when they successfully want to claim
deduction/exemption of capital gains. These two limbs are interlinked and both
the limbs are required to be fulfilled before any taxpayer claiming
deduction/exemption.
21. It is relevant to mention here that procedurally, most of the sale transactions
of the mortgaged properties by the Banks prior to the year 2002, are executed
with the active involvement of the assessee, who is often a signatory to the said
sale transactions of the said properties and therefore, the creditors/Banks per
$e, do not have the power either to sign on the transfer deeds and to register
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them in the names of the transferees. Thus, the creditors/Banks are never the
transferors.
22. Therefore, considering the above settle legal propositions by virtue of the
judgmental laws and also in view of the binding statutory provisions of section 13
of the SARFAESI ACT, 2002, and on the facts of this case (ie Bank got the
overriding title and the payments are directly received by the bank from the
buyer of the secured properties with they were first credited to the accounts of
the assessee), we are of the opinion in principle, the doctrine of ‘diversion of
income by overriding title’ applies to the facts of the present case. Therefore, the
claim of deduction is sustainable in law. Accordingly, the grounds raised by the
assessee are allowed.
23. In the result, the appeal of the assessee is allowed.
Order pronounced in the open court on September, 2015.
xxxx sd/-
(AMIT SHUKLA) (D. KARUNAKARA RAO)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Mumbai; .9.2015
PER AMIT SHUKLA, JM:
I have gone through the order proposed by my learned Brother in this appeal and have also
discussed the issue with him. However, I am unable to persuade myself to subscribe to the
view proposed by my learned Brother and also unable to agree with the conclusion arrived
at on the issue involved. I, therefore, consider it appropriate to express my view and
conclusion on the issue by way of passing a separate order.
2. So far as the facts of the case and arguments put forth by the parties, as discussed in the
draft order, there is not much dispute. However, to put succinctly, the relevant facts qua the
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ITA 4964/Mum/2013
issue involved are that, the assessee company had a taken a corporate term loan of Rs. 3.06
crores from Kotak Mahindra Bank Ltd. during the relevant financial year 2008-09 for its
business purpose, which was repayable in 36 monthly installments. The said loan was
secured by mortgaging a part of assessee’s factory land. The interest paid on such loan was
otherwise allowed to the assessee or was allowable u/s 36(l)(iii) r.w.s. 43B. Since, assessee
due to cash losses and liquidity constraints could not pay the installments, therefore, the
Kotak Mahindra Bank Ltd. classified the assessee’s account as Non-performing Asset
(NPA) and initiated the recovery proceedings u/s 13(2) of the Securitization And
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2000,
(SARFAESI Act) on the assessee company and personal guarantors. The Bank took
possession of the mortgaged part of the factory land on 07.01.2010, which was divided into
7 plots, out of which 6 plots were sold in March, 2010 for a total sale consideration of Rs.
2,18,00,262/- and was appropriated by the Bank in the following manner :-
Towards interest dues :- Rs. 69,75,629/-
Towards principal amount :- Rs. 1, 48,24, 633/-
Rs. 2,18,00,262/-
The assessee had duly shown the sale proceeds from the mortgaged asset in its books of
account and also offered the income as ‘Long-term capital gain’ as per the computation of
income, incorporated at page 3 of the Draft order.
3. However, the main bone of contention was the claim of amount adjusted by the Bank
against the principal amount of loan of Rs. 1,48,24,633/- (out of the sale proceeds) as
deduction u/s 48(i) as cost by the assessee in the computation of LTCG, being ‘expenditure
incurred wholly and exclusively in connection with such transfer’. The assessee’s claim was
based on the principle that, act of the Bank taking possession of the land under SARFAESI
Act, constitutes “diversion of income by overriding title”. This claim had been denied by
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ITA 4964/Mum/2013
the AO on the ground that it cannot be reckoned as expenditure u/s 48(i) to be allowed as
cost of acquisition as it was an application of income. In the first appellate proceedings, Ld.
CIT(A) too has rejected the assessee’s contention for the claim for deduction mainly relying
upon the decision of Supreme Court in the case of CIT vs. Attili N. Rao [2001] 252 ITR
880; and Allahabad High Court in CIT vs Sharad Sharma [2008] 305 ITR 24 (All.) and held
that there is no diversion of income by overriding title .
4. The contention made by the Ld. Counsel and Id. DR has been elaborately dealt with in
the draft order of the Ld. Brother, which are not being reiterated. The core argument of Ld.
Counsel had been that, by virtue of statutory provisions of section 13 of SARFAESI Act,
there is a clear cut overriding title on the mortgaged property in favour of the bank and the
income realized by the bank and appropriated from the sale of such property directly,
amounts to diversion of income and, therefore, the said principal amount cannot be held to
be taxable in the hands of the assessee and or is allowable as deduction. He also submitted
that, in wake of the SARFAESI Act, the earlier judicial decisions will no longer be
applicable. At the time of hearing, following decisions were referred and relied upon, some
of them will be discussed herein later in this order:-
ST.
No.
Cases relied upon
Citation
1
Sitaladas Tirathdas
41ITR 367 (SC)
2
CIT vs. Attili N Rao
252 ITR 880 (SC)
3
Motilal Chahadamilal Jain vs CIT
190 ITR 1 (SC)
4
CIT vs Mathubhai C Patel
238 ITR 403 (SC)
5
CIT vs Roshanbabu Mohd. Hussein Merc
275 ITR 231 (Bom)
6
CIT vs Sharad Sharma
305 ITR 24 (All)
21
ITA 4964/Mum/2013
7
Raja Bejoy Singh Dudhania
1 ITR 135 (PC)
8
Gopinath Paul and Sons vs DCIT
278 ITR 240 (Cal)
9
Addl. CIT vs Glad Investment vt Ltd.
22 ITD 227 (DEL)
5. Now on these facts, and background the main issue involved here in this
appeal are :-
Firstly, whether the principal amount of loan of Rs. 1,48,24,6733/- can be allowed
as deduction u/s 48(i) while computing the LTCG from sale consideration of
mortgaged asset appropriated by Kotak Mahindra Bank, after taking possession of
the said secured asset under the SARFAESI Act 2002, on the ground that there was
“diversion of source/ income by overriding title;”
Secondly, whether the entire sums recovered from sale proceeds of the mortgaged
assets and appropriated by the Bank towards ‘Security interest’ under section 13 of
the SARFAESI Act will not fall within the charging provisions of Income Tax Act
in the hands of the assessee on the principle of “Diversion of income by overriding
title”;
Lastly, whether by virtue of SARFAESI Act, the judicial pronouncements and the
decisions available on the issue prior to the commencement of the said act will not
be applicable, in as much as the provisions of the said Act provides for taking over
the possession of the land to secure its security interest and hence overriding title
gets vested with the Bank and consequently income gets diverted.
6. First of all, on the first issue, undisputedly the assessee had taken a business term loan
after creating a voluntarily incurred mortgage debt in favour of the Bank under a legally
binding covenant under which the assessee was obliged to discharge the mortgage debt. It is
a trite law that once the assessee himself has created the mortgage, he would not be entitle
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to any deduction under section 48, either as a cost of acquisition or cost of improvement or
any kind of expenditure incurred wholly and exclusively in connection with such transfer of
capital asset. This proposition of law has been well settled by the Hon’ble Apex Court in
two cases; R M Arunachalam vs CIT (1997) 227 ITR 222; and VSMR Jagdish
Chandran vs CIT (1997) 227 ITR 240. A clear distinction has been drawn by the Apex
Court that, where the previous owner had created a mortgage on the property in question
and the assessee had inherited the said property along with the mortgage, in that event the
assessee would be entitled to the deduction of the amount spent in getting mortgage
discharged as cost of acquisition u/s 48. However, where the assessee himself has created
the mortgage, then the same consequence will not follow and he would not be entitled for
deduction. The relevant observation of the Hon’ble Court in R M Arunachalam (supra)
laying down this proposition reads as under :-
In taking the view that in a case where the property has been mortgaged by the previous owner
during his lifetime and the assessee, after inheriting the same, has discharged the mortgage
debt, the amount paid by him for the purpose of clearing off the mortgage is not deductible for
the purpose of computation of capital gains, the Kerala High Court has failed to note that in a
mortgage there is transfer of an interest in the property by the mortgagor in favour of the
mortgagee and where the previous owner has mortgaged the property during his lifetime, which
is subsisting at the time of his death, then after his death his heir only inherits the mortgagor’s
interest in the property. By discharging the mortgage debt his heir who has inherited the
property acquires the interest of the mortgagee in the property. As a result of such payment
made for the purpose of clearing off the mortgage the interest of the mortgagee in the property
has been acquired by the heir. The said payment has, therefore, to be regarded as ‘cost of
acquisition’ under section 48 read with section 55(2) of the Act. The position is, however,
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different where the mortgage is created by the owner after he has acquired the property. The
clearing off of the mortgage is created by the owner after he has acquired the property. The
clearing off of the mortgage debt by him prior to transfer of the property would not entitle
him to claim deduction under section 48 of the Act because in such a case he did not acquire
any interest in property subsequent to his acquiring the same. In CIT u. Daksha Ramanlal
[1992] 197 ITR 123, the Gujarat High Court has rightly held that the payment made by a
person for the purpose of clearing off the mortgage created by the previous owner is to be
treated as cost of acquisition of the interest of the mortgage in the property and is deductible
under section 48 of the Act”. (P. 239) (emphasis added)
Thus, the income applied in liquidation of a voluntarily incurred mortgaged debt is
definitely exigible to tax, although the application may be under a legally binding covenant
entered into by the recipient of the income or under a charge created by the debtor on his
property. Hence, in my opinion, the assessee will not get the deduction of the principal
amount of loan u/s 48, as the mortgage debt was created by the assessee itself, to which
assessee was obliged to discharge. Any discharge of debt is nothing but application of
income.
7, Now the moot question is, whether there is a ‘diversion of income by overriding title’ and
hence the entire sale proceeds appropriated by the Bank towards its security interest is
exigible or chargeable to tax in the hands of the assessee or not.
8. This principle of “diversion of income by overriding title” has been applied and tested
from earlier times under the Indian Income Tax Law and the concept has been well
established that, where an obligatory charge is imposed by the testator; or by law upon
some property; or charge is otherwise involuntarily created; then the sum so charged
must be excluded from the income of the person in enjoyment of the property. In other
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words, where income is not applied but ‘diverted by an ‘overriding title’ from the
assessee who would have otherwise have received it, it cannot be considered as the
income of the assessee at all. Where the obligation effectively slices away part of the
corpus of the right of the assessee to receive the entire income, it would be a case of
‘diversion of income’. But the biggest rider in applying this principle and most
determinative factor in deciding such situations as stressed by the Hon’ble Supreme
Court in several cases from time to time is the nature and effect of the assessee’s
obligation in regard to the amount in question, Hon’ble Apex Court in the case of CIT
vs. Sitaldas Tirathdas, [1961] 41 ITR 367, laid down the following test with regard to
‘diversion of income by overriding title’ in the following manner :-
“In our opinion, the true test is whether the amount sought to be deducted, in truth,
never reached the assessee as his income. Obligations, no doubt, there are in every
case, but it is the nature of the obligation which is the decisive fact. There is a
difference between an amount which a person is obliged to apply out of his
income and an amount which by the nature of the obligation cannot be said to be
a part of the income of the assessee. Where by the obligation income is diverted
before it reaches the assessee, it is deductible; but where the income is required to
be applied to discharge an obligation after such income reaches the assessee, the
same consequence, in law, does not follow, ft is the first kind of payment which can
truly be excused and not the second. The second payment is merely an obligation to
pay another a portion of one’s own income, which has been received and is since
applied. The first is a case in which the income never reaches the assessee, who
even if he were to collect it, does so, not as part of his income, but for and on behalf
of the person to whom it is payable”, (emphasis added)
9. Thus, the true tests in deciding the “diversion of income by overriding title” lies in the
nature of the ‘obligation’ which is the most decisive factor. If the assessee all throughout
had an obligation to discharge his liability out of his income, then under all
circumstances it would remain his obligation and the liability to discharge would be an
application of income. There cannot be a two different limb of a same obligation; in the
first place, there would be an obligation of the assessee to discharge his liability out of
his own income and second, the obligation will get shifted because the title has been
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ITA 4964/Mum/2013
passed to another person to discharge the liability of the assessee or on his behalf which
still exists before the income reaches to the assessee. Under both the situations it is an
obligation of the assessee and any discharge of obligation is nothing but application of
income and assessee would not be entitled either to claim deduction or claim the amount
as exempt. This principle was again reiterated by the Hon’ble Supreme Court in the case
of CIT vs. Sunil J Kinariwala [2O03] 259 ITR 1O, wherein the Hon’ble Apex Court
reiterated that the nature and effect of the assessee’s obligation in regard to the amount
in question is very crucial and determinative factor, whether there is diversion of income
or not. Hence, in all such cases, the nature of obligation is to be examined.
10. If we apply the above principle of law, then here in this case, there cannot be denying
fact that all throughout the obligation was upon the assessee to discharge its debt liability
and to clear the charge on the mortgaged property. This can be gauged by following
facts; the business loan was taken by the assessee for its own business purpose and
liability to repay the loan/debt was on the assessee; interest paid/payable was
claimed/allowable as deduction of expenses incurred for the business purpose in
computation of total income; assessee was under the legally binding covenant to repay
the loan along with the interest; property was mortgaged to the Bank to secure the
debt/loan by the assessee; liability to free the charge on mortgage land was upon the
assessee; Had the loan and interest been waived off by the bank, then assessee would
have shown this as its income u/s 41(1); further, if the assessee would have paid back
the entire loan, then the mortgaged property would have got vested back to assessee.
Thus, the obligation was always upon the assessee and it would not be shifted to the
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ITA 4964/Mum/2013
bank merely because the bank took possession of the land to enforce and realise its
secured interest.
11. At the time of hearing catena of judicial decisions were cited from the side of both
the parties in this regard (as cited above) and some of them were also filed before us in a
separate compilation. Other than the case laws discussed above, the most relevant
decisions on the issue involved and cited before us are being discussed here under :-
(i) CIT vs Attili N. Rao [2001] 252 ITR 880 (SC) :-
Here in this case question of law referred to before the Hon*ble Apex Court were as
under :-
“Whether on the facts and in the circumstances of the case and in law, the Appellate
Tribunal was correct in holding that the amount realised by the sale of the
assessee’s interest in the property was only Rs. 4,33,960 i.e., Rs. 5,62,980 minus Rs.
1,29,020 ?
Whether on the facts and in the circumstances of the case and in law, the Appellate
Tribunal was correct in holding that the amount realised under the charge or
mortgage by the Government by public auction does not partake of the character of
‘full value of consideration’ envisaged under section 48 of the Income-tax Act ?
Whether on the facts and in the circumstances of the case and in law, the Appellate
Tribunal was Justified in holding that the amount payable by the assessee in
discharge of the mortgage debt to the Government on the sale of property was an
expenditure incurred towards the cost of acquisition of the capital asset and
deductible under section 48 of the Income-tax Act” ?
The relevant facts of the case were as under :-
“The assessment year with which we are concerned is the assessment year 1982-83.
The assesses carried on abkari business. In the course of the financial year 1970-71
he mortgaged to the Excise Department of the State of Andhra Pradesh immovable
property belonging to him at Waltair, He did so to provide security for the amounts
of “kits” which were due by him to the State. The State, in the assessment year with
which we are concerned, sold the immovable property by public auction, without the
intervention of the court, to realise its dues. A sum of Rs. 5,62,980 was realised at
the auction. Thereabout, the State deducted the amount of Rs. 1,29,020 due to it
towards “kits” and interest and paid over the balance to the assessee”.
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ITA 4964/Mum/2013
On these facts their Lordships answered the question in the following manner :-
“8, We are of the view that the Tribunal and the High Court were in error. What
was sold by the State at the auction was the immovable property that belonged to the
assessee. The price that was realised therefore belonged to the assessee. From out
of that price, the State deducted its dues towards “/cists” and interest due from the
assessee and paid over the balance to him. The capital gain that the assessee made
was on the immovable property that belonged to him. Therefore, it is on the full
price realised (less admitted deductions) that the capital gain and the tax thereon
has to be computed”.
From the above proposition, it is amply clear that no such deduction of the dues
realized by a creditor from the sale of immovable property of the assessee is allowable from
the computation of capital gain in such cases and circumstances.
(ii) Decision of Bombay High Court in CIT vs Roshanbabu Mohammed
Hussein Merchant, [2005] 275 ITR 231 (Bom)
In this case, the question of law admitted by the Hon’ble Jurisdictional High
Court read as under :-
“Whether the repayment of the mortgage debt created by the assessee, is an
expenditure incurred in connection with the transfer of mortgaged asset
allowable under section 48(i) of the Income Tax Act”.”
Facts of the case were as under :-
During the relevant year, the assessee, after obtaining permission from the bank,
sold a part of the aforesaid land for a consideration of Rs. 3,92,000 and deposited
the entire amount of Rs. 3,92,000 with the State Bank of Saurashtra towards
discharge of the debt. The assessee claimed that the long term capital gain arising
on sale of the above land was exempt from capital gains tax. The assessing officer
completed the assessment under section 143(3) of the Income Tax Act by rejecting
the contention of the assessee and taxed the same. On appeal, the CJT(A) upheld the
contention of the assessee. On further appeal filed by the revenue, the Tribunal
upheld the order ofCIT(A) on the ground that firstly, the sale proceeds were diverted
by an overriding title in favour of the bank and the sale proceeds did not reach the
assessee and secondly, the amount paid by the assessee to discharge the debt was an
expenditure incurred by the assessee for removing the encumbrance which was
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ITA 4964/Mum/2013
absolutely essential to effectively transfer the plot and, therefore, the same was
deductible under section 48 of the Income Tax Act. Challenging the said order, the
present appeal is filed by the revenue. In Tax Appeal No. 603 of 2000, the Tribunal
took contrary view and held that the amount paid to discharge the debt was neither
diverted by overriding title nor such expenditure can be regarded as an expenditure
incurred in connection with transfer.
The Hon’ble High Court after discussing the proposition of law reiterated by Hon’ble
Apex Court in the case of R.M. Arunchalam (supra); VSMR Jagdishchandran vs CIT
[supra] and CIT vs Attli N. Rao, held as under :-
” 14. From the aforesaid decisions of the Apex Court, it is clear that there is a
distinction between the obligation to discharge the mortgage debt created by the
previous owner and the obligation to discharge the mortgage debt created by the
assessee himself. Where the property acquired by the assessee is subject to the
mortgage created by the previous owner, the assessee acquires absolute interest in
that property only after the interest created in the property in favour of the
mortgagee is transferred to the assessee that is after the discharge of mortgage debt.
In such a case, the expenditure incurred by the assessee to discharge the mortgage
debt created by the previous owner to acquire absolute interest in the property is
treated as ‘cost of acquisition’ and is deductible from the full value of consideration
received by the assessee on transfer of that property. However, where the assessee
acquires a property which is unencumbered, then, the assessee gets absolute interest
in that property on acquisition. When the assessee transfers that property, the
assessee is liable for capital gains tax on the full value (less admitted deductions)
realised, even if an encumbrance is created by the assessee himself on that property
and the assessee is under an obligation to remove that encumbrance for effectively
transferring the property. In other words, the expenditure incurred by the assessee
to remove the encumbrance created by the assessee himself on the property which
was acquired by the assessee without any encumbrance is not allowable deduction
under section 48 of the Income Tax Act.
15. It is true that in none of the aforesaid cases, the Apex Court has specifically held
that repayment of the mortgage debt created by the assessee himself is not an
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expenditure incurred for effectively transferring the property. However, it is
implicitly held by the Apex Court that the expenditure incurred to remove the
encumbrance created by the assessee himself on a property on which the assessee
had absolute interest is not an expenditure incurred for effectively transferring the
property as contemplated under section 48 of the Income Tax Act. It is not in dispute
that in both the appeals which are before us, the property on which the
encumbrance was created by the assessee was acquired by the assessee free from
encumbrances. Therefore, in the light of the decisions of the Apex Court referred to
hereinabove, it must be held that the assessee is not entitled to the deduction of the
expenditure incurred to remove the encumbrance created by the assessee himself.
16. The contention that the assessee has not received a pie front the transfer and
the entire sale proceeds realised on transfer of the mortgaged asset has been
appropriated towards discharge of mortgage is also without any merit. As held by
the Apex Court, when the property belonging to the assessee is sold in discharge
of the mortgage created by the assessee himself, then, irrespective of the amount
actually received by the assessee, the capital gain has to be computed on the full
price realised (less admissible deduction) on transfer of the asset. To illustrate,
suppose the assessee mortgages its capital asset and obtains loan of Rs. 1 lakh from
a bank. Thereafter, if the assessee transfers the said capital asset with the consent of
the bank for Rs. 1 lakh and pays the entire amount of Rs. 1 lakh to the bank to
discharge the mortgage created by the assessee, then it is not open to the assessee to
contend that the capital gains tax is not leviable on transfer of the property because
the assessee has not received a pie on transfer of that capital asset, (emphasis
added)”
17. As regards the decisions of this court in the case of Shakuntala Kantilal (supra)
followed in the case of Abrar Alvi (supra) and the decisions of the Kerala High
Court in the case of Smt. Thressiamma Abraham (supra) which are strongly relied
upon by the counsel for the assessee, we are of the opinion that the said decisions
are no longer good law in the light of the subsequent decisions of the Apex Court
referred to hereinabove.
18. For all the aforesaid reasons, we answer question set out at para 2 in the
negative, i.e., in favour of the revenue and against the assessee.
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From the law as discussed and decided by the Hon’ble Jurisdictional High
court it is absolutely clear that, firstly, when the assessee himself has created a
mortgaged charge, then no deduction is allowable for discharging the charge
or encumbrance created by the assessee on mortgaged asset; and secondly,
when the property is sold for discharge of such a mortgaged debt, then
whether the amount has been actually realized by the assessee or not is
immaterial and the whole of the amount of sale realised is to taxed as capital
gain in the hands of the assessee. This is evident from the highlighted portion
of the judgment and clinches the issue before hand.
(Hi) CIT vs Sharad Sharma, [2008] 305 ITR 24 (Allahabad) :-
The question of law referred to the Hon’ble High Court for opinion was as
under :-
“Whether on the facts and circumstances of the case, the Tribunal was justified in
holding that there was an overriding charge against the sale proceeds of property
and the assessee was not liable for capital gains in respect ofKs. 1,50,000paid to
bank in discharge of loan taken by M/s Shanker Traders?”
The Hon’ble Court again after reiterating the similar decisions of Hon’ble
Supreme Court as discussed herein above, decided the question in favour of
the revenue as under : –
“The question with regard to diversion of income on account of overriding title was
not decided by the Apex Court in the case of RM. Arunachalam (supra) on the
ground that the said question had not been raised either before ‘he Tribunal or the
High Court, However, in the present case we find that this question had been raised
and the Tribunal had taken a view that the Bank had an over-riding title over the
property sold. The reasoning given by the Tribunal with regard to over-riding
charge over the sale income is not correct for the reason as the assesses had himself
created the mortgage by taking a loan from the Bank and the said property had been
secured for repayment of loan. It is not a case where the assesses had inherited the
property or had acquired the property along with charge but in fact had himself
created the charge over the property. In a case of inheritance/acquisition along with
the mortgage, perfecting his title by getting mortgage discharged, the assesses
would be entitled to get the deduction of the mortgage debt but where the charge is
created by the assessee himself, it cannot be said that the amount of mortgage debt
out of the sale proceeds be deductible while calculating the capital gains. The
present one is a case of application of income by the assessee.
Further the Apex Court dealing with the issue of diversion of income by
overriding title in the case of Commissioner of Income-Tax v. Sunil J. Kinariwala
reported in 2003 (259) ITR 10 held as follows;
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It may be pointed out that under the scheme of the Act, it is the total income of
an assessee, computed under the provisions of the Act, that is assessable to
income -tax So much of the income which an assessee is not entitled to receive
by virtue of an overriding title created in favour of a third party would get
diverted at source and the same cannot be added in computing the total
income of the assessee. The principle is simple enough but more often than
not, as in the instant case, the question arises as to what is the criteria to
determine, when does the income attributable to an assessee get diverted by
overriding title’? The determinative factor, in our view, is the nature and
effect of the assessee’s obligation in regard to the amount in question. When
a third person becomes entitled to receive the amount under an obligation of
an assessee even before he could lay a claim to receive it as his income, there
would be a diversion of income by overriding title; but when after receipt of
the income by the assessee, the same is passed on to a third person in
discharge of the obligation of the asses see, it will be a case of application
of income by the assessee and not of diversion of income by overriding
title.
In view of the discussion made above we find that in the present case the assessee
was not entitled to the deduction as claimed on account of discharge of mortgage
debt of Rs. 95,000/- to the Bank. In fact the entire amount of sale consideration had
been received by the assessee and thereafter part of it applied for discharge of the
mortgage debt. It was thus a case of application of income received, (emphasis
added).”
12. Thus, from the proposition of law and ratios as culled out from the above decisions,
it is absolutely clear that if the borrower assessee has created a mortgaged debt by itself
and if for discharge of its debt liability, the mortgaged property has been taken over or
taken into possession by the secured creditor/ lender to realize the loan / debt amount
directly, then neither the deduction of loan amount is allowed u/s 48 nor it is a case of
‘diversion of income by overriding title’. The amount appropriated by the Bank after
disposing of the mortgaged property of the assessee is thus, purely an application of
income.
13. A very different proposition has been canvassed by the Ld. Counsel before us,
superseding the law propounded and settled by the Hon’ble Apex Court and High Courts
as stated above that, now by virtue of commencement of SARFAESI Act 2002, all such
decisions and law laid down by the Hon’ble Courts on this subject will not be applicable,
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as in wake of the provisions of the said Act, assessee is completely precluded from the
title of the land, as now the Bank / financial institutions for realizing its secured interest
or debt has got all the powers and right to acquire the title on the mortgaged assets,
which amounts to ‘diversion of income by overriding title’. The distinction between the
position prior to commencement of the SARFAESI Act and after the commencement,
made by the Ld. Counsel can be summarized in brief as under :-
(i) Prior to the Act, no such method of recovery of overdue or NPA was prescribed,
whereas now the Act prescribes three rights/ mode of recovery of NPA viz.,
securitization; asset reconstruction and enforcement of security without the intervention
of the Court;
(ii) Prior to the Act, lender could recover its debt from borrower either by filing a
monetary suit for recovery or summary suit u/s 37 of the CPC or foreclosure of
mortgage. Now the bank/ secured creditor is vested with various kind of rights for either
taking over the possession of the securities/secured asset of the borrower or can transfer
by way of lease/assignment of sale. It also has right to take over the management of the
business of the borrower or can appoint a Manager to manage the asset possession of
which has been taken;
(iii) Earlier all the options of recovery required intervention of the Courts inasmuch as
Civil Suit had to be filed for obtaining the decree in favour of the lender and the Court
can adjudicate the amount due and pass the final award whereas, now no intervention of
the Court is required and rights have been vested to the bank/secured creditors itself.
(iv) The Court earlier use to appoint Receiver to take possession of the secure assets,
sell it and appropriate the proceeds towards payment of lender’s dues and now under the
Act after taking over the possession of the secured assets, the secured creditor can
transfer the secure assets by way of lease, assignment or sale in its own right in the
capacity of a transferor and not on behalf of the borrower. Secure creditor issues sale
certificate to the transferor and the borrower is not required to execute the document,
relating to transfer.
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(v) Lastly, earlier the Civil suit for recovery could be filed by the lender if the
borrowers have defaulted any payments of dues, whereas now section 13 of the
Act has given a huge powers to the lenders and if notice has been issued, the
borrower cannot sale, lease or transfer the asset.
14. However, such a distinction as made by the Id. Counsel above are purely superficial
and will not make any difference to the legal proposition as discussed in the foregoing
paragraphs. Much emphasis has been laid on Section 13 of the SARFAESI Act by the
Ld. Counsel before us, in support of his contention that now in view of this section all
the earlier law propounded will not be applicable. In my humble opinion, such a
proposition and argument of the Ld. Counsel cannot be appreciated at all, firstly, the
SARFAESI Act merely prescribes a speedy mode and rights for recovery of the debts /
NPA by the Banks and it is not a mode or instrument to acquire the property albeit Bank
takes over only the “security interest” on the asset to recover the outstanding Joan
liability of the borrower. The Bank assumes the role of an agent or steps into the shoes
of the borrower while disposing off the assets, which earlier was very cumbersome and
time consuming through the process of Civil Courts under section 37 of Civil Procedure
Code; Secondly, even the civil courts restrict the rights of the owner over the mortgaged
asset or appoint court receiver to take over the possession of the secured assets and sell
or lease the property to realize the debts of the lender or award decree in favour of the
lender over the mortgaged asset to realize/ recover the debts; lastly, there is no takeover
of obligation of the assessee by the Bank, because the loan is taken against mortgage of
property, which means there is an obligation on the borrower assessee to repay the said
Joan along with all the interest and other costs. The title of such security interest, that is,
mortgaged asset flows from the borrower to the lender or consequent buyer with the sole
intent of discharging the obligation of the borrower which comprise of outstanding loan
amount along with accrued interest thereon.
15. Now let us examine the relevant provision of SARFAESI Act.
The preamble of Act envisages: –
“An Act to regulate securitisation and reconstruction of financial assets and enforcement of
security interest and for matters connected therewith or incidental thereto.
Thus, this Act has been enacted by the Parliament to regulate the securitization and
reconstruction of financial assets and to enforce the “security interest” and not for
acquisition of the property or the title thereof. Before analyzing section 13, first of all
certain definition illustrated in various clauses of Section 2 of the Act which are self
explanatory are very relevant to understand the law as envisaged in Section 13, which are
reproduced as under:-
(f) “Borrower” means any person who has been granted financial assistance by any bank or
financial institution or who has given any guarantee or created any mortgage or pledge as
security for the financial assistance granted by any bank or financial institution and includes a
person who becomes borrower of a securitisation company or reconstruction company
consequent upon acquisition by it of any rights or interest of any bank or financial institution in
relation to such financial assistance;
(j) “default” means non-payment of any principal debt or interest thereon or any other
amount payable by a borrower to any secured creditor consequent upon which the account of
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such borrower is classified as non-performing asset in the books of account of the secured
creditor;
(I) “financial asset” means any loan or advance granted or any debentures or bonds
subscribed or any guarantees given or letters of credit established or any other credit facility
extended by any bank or financial institution; (I) “financial asset” means debt or receivables
and includes- (i) a claim to any debt or receivables or part thereof, whether secured or
unsecured; or (ii) any debt or receivables secured by, mortgage of, or charge on, immovable
property; or (Hi) a mortgage, charge, hypothecation or pledge of movable property; or (iv) any
right or interest in the security, whether full or part underlying such debt or receivables; or (v)
any beneficial interest in property, whether movable or immovable, or in such debt, receivables,
whether such interest is existing, future, accruing, conditional or contingent; or (vi) any
financial assistance;
(m) “financial institution” means—
(i) a public financial institution within the meaning of section 4A of the Companies Act, 1956 (1
of 1956);
(ii) any institution specified by the Central Government under sub-clause (ii) of clause (h) of
section 2 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of
1993);
(Hi) the International Finance Corporation established under the International Finance
Corporation (Status, Immunities and Privileges) Act, 1958 (42 of 1958);
(iv) any other institution or non-banking financial company as defined in clause (f) of section
45-1 of the Reserve Bank of India Act, 1934 (2 of 1934), which the Central Government may, by
notification, specify as financial institution for the purposes of this Act;
(o) “non-performing asset” means an asset or account of a borrower, which has been
classified by a bank or financial institution as sub-standard, doubtful or loss asset,— (a) in case
such bank or financial institution is administered or regulated by any authority or body
established, constituted or appointed by any law for the time being in force, in accordance with
the directions or guidelines relating to assets classifications issued by such authority or body;
(b) in any other case, in accordance with the directions or guidelines relating to assets
classifications issued by the Reserve Bank;
(zb) “Security agreement”, means an agreement, instrument or any other document or
arrangement under which security interest is created in favour of the secured creditor including
the creation of mortgage by deposit of title deeds with the secured creditor;
(zc) “Secured assets” means the property on which security interest is created;
(zd) “Secured creditor” means any bank or financial institution or any consortium or group of
banks or financial institutions and includes—
(i) debenture trustee appointed by any bank or financial institution; or
(ii) securitisation company or reconstruction company, whether acting as such or managing a
trust set up by such securitisation company or reconstruction company for the securitisation or
reconstruction, as the case may be; or
(Hi) any other trustee holding securities on behalf of a bank or financial institution, in whose
favour security interest is created for due repayment by any borrower of any financial
assistance;
(ze) “Secured debt” means a debt which is secured by any security interest:
(zf) “Security interest” means right, title and interest of any kind whatsoever upon property,
created in favour of any secured creditor and includes any mortgage, charge, hypothecation,
assignment other than those specified in section 31;
Now in light of these definitions let us examine Section 13 which envisages the
enforcement of security interest. The section 13
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reads as under :-
(1) Notwithstanding anything contained in section 69 or section 69A of the Transfer of Property
Act, 1882 (4 of 1882), any security interest created in favour of any secured creditor may be
enforced,
|j without the intervention of court or tribunal, by such creditor in
1 accordance with the provisions of this Act.
(2) Where any borrower, who is under a liability to a secured creditor under a security
agreement, makes any default in repayment of secured debt or any installment thereof, and his
account in respect of such debt is classified by the secured creditor as non-performing asset,
then, the secured creditor may require the borrower by notice in writing to discharge in full his
liabilities to the secured creditor within sixty days from the date of notice failing which the
secured creditor shall be entitled to exercise all or any of the rights under subsection (4).
(3) The notice referred to in sub-section (2) shall give details of the amount payable by the
borrower and the secured assets intended to be enforced by the secured creditor in the event of
non-payment of secured debts by the borrower. (3A) If, on receipt of the notice under subsection
(2), the borrower makes any representation or raises any objection, the secured
creditor shall consider such representation or objection and if the secured creditor comes to the
conclusion that such representation or objection is not acceptable or tenable, he shall
communicate within one week of receipt of such representation or objection the reasons for
non-acceptance of the representation or objection to the borrower: PROVIDED that the
reasons so communicated or the likely action of the secured creditor at the stage of
communication of reasons shall not confer any right upon the borrower to prefer an application
to the Debts Recovery Tribunal under section 17 or the Court of District Judge under section
17A.
(4) In case the borrower fails to discharge his liability in full within the period specified in subsection
(2), the secured creditor may take recourse to one or more of the following measures to
recover his secured debt, namely:–
(a) take possession of the secured assets of the borrower including the right to transfer by way
of lease, assignment or sale for realising the secured asset;
(b) take over the management of the business of the borrower including the right to transfer by
way of lease, assignment or sale for realising the secured asset: PROVIDED that the right to
transfer by way of lease, assignment or sale shall be exercised only where the substantial part
of the business of the borrower is held as security for the debt: PROVIDED FURTHER that
where the management of whole of the business or part of the business is severable, the secured
creditor shall take over the management of such business of the borrower which is relatable to
the security for the debt.
(c) appoint any person (hereafter referred to as the manager), to manage the secured assets the
possession of which has been taken over by the secured creditor; (d) require at any time by
notice in writing, any person who has acquired any of the secured assets from the borrower and
from whom any
money is due or may become due to the borrower, to pay the secured creditor, so much of the
money as is sufficient to pay the secured debt.
(5) Any payment made by any person referred to in clause (d) of sub-section (4) to the secured
creditor shall give such person a valid discharge as if he has made payment to the borrower.
(6) Any transfer of secured asset after taking possession thereof or takeover of management
under sub-section (4), by the secured creditor or by the manager on behalf of the secured
creditor shall vest in the transferee all rights in, or in relation to, the secured asset transferred
as if the transfer had been made by the owner of such secured asset,
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(7) Where any action has been taken against a borrower under the provisions of sub-section
(4), all costs, charges and expenses which, in the opinion of the secured creditor, have been
properly incurred by him or any expenses incidental thereto, shall be recoverable from the
borrower and the money which is received by the secured creditor shall, in the absence of any
contract to the contrary, be held by him in trust, to be applied, firstly, in payment of such costs,
charges and expenses and secondly, in discharge of the dues of the secured creditor and the
residue of the money so received shall be paid to the person entitled thereto in accordance with
his rights and interests.
(8) If the dues of the secured creditor together with all costs, charges and expenses incurred by
him are tendered to the secured creditor at any time before the date fixed for sale or transfer,
the secured asset shall not be sold or transferred by the secured creditor, and no further step
shall be taken by him for transfer or sale of that secured asset.
(9) In the case of financing of a financial asset by more than one secured creditors or joint
financing of a financial asset by secured creditors, no secured creditor shall be entitled to
exercise any or all of the rights conferred on him under or pursuant to sub-section (4) unless
exercise of such right is agreed upon by the secured creditors representing not less than threefourth
in value of the amoux* outstanding as on a record date and such action shall be binding
on
all the secured creditors: PROVIDED that in the case of a company in liquidation, the amount
realised from the sale of secured assets shall be distributed in accordance with the provisions
of section 529A of the Companies Act, 1956 (I of 1956): PROVIDED FURTHER that in the
case of a company being wound up on or after the commencement of this Act, the secured
creditor of such company, who opts to realise his security instead of relinquishing his security
and proving his debt under proviso to sub-section (1) of section 529 of the Companies Act,
1956 (1 of 1956), may retain the sale proceeds of his secured assets after depositing the
workmen’s dues with the liquidator in accordance with the provisions of section 529A of that
Act: PROVIDED ALSO that the liquidator referred to in the second proviso shall intimate the
secured creditors the workmen’s dues in accordance with the provisions of section 529A of the
Companies Act, 1956 (1 of 1956) and in case such workmen’s dues cannot be ascertained, the
liquidator shall intimate the estimated amount of workmen’s dues under that section to the
secured creditor and in such case the secured creditor may retain the sale proceeds of the
secured assets after depositing the amount of such estimated dues with the liquidator:
PROVIDED ALSO that in case the secured creditor deposits the estimated amount of
workmen’s dues, such creditor shall be liable to pay the balance of the workmen’s dues or
entitled to receive the excess amount, if any, deposited by the secured creditor with the
liquidator: PROVIDED ALSO that the secured creditor shall furnish an liquidator to pay the
balance of the workmen’s dues, if any. Explanation : For the purposes of this subsection,- (a)
“record date” means the date agreed upon by the secured creditors representing not less than
three-fourth in value of the amount outstanding on such date; (b) “amount outstanding”shall
include principal, interest and any other dues payable by the borrower to the secured creditor
in respect of secured asset as per the books of account of the secured creditor.
(10) Where dues of the secured creditor are not fully satisfied with the sale proceeds of the
secured assets, the secured creditor may file an application in the form and manner as may be
prescribed to the Debts Recovery Tribunal having jurisdiction or a competent court, as the case
may be, for recovery of the balance amount from the borrower.
(11) Without prejudice to the rights conferred on the secured creditor under or by this section,
the secured creditor shall be entitled to proceed against the guarantors or sell the pledged
assets without first taking any of the measures specified in clauses (a) to (d) of subsection (4) in
relation to the secured assets under this Act.
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(12) The rights of a secured creditor under this Act may be exercised by one or more of his
officers authorised in this behalf in such manner as may be prescribed.
(13) No borrower shall, after receipt of notice referred to in subsection (2), transfer by way of
sale, lease or otherwise (other than in / the ordinary course of his business) any of his
secured assetsreferred to in the notice, without prior written consent of the secured creditor.
16 From the conjoint reading of above provisions relevant key points for the purpose
of our adjudication are as under ;-
(i) Now for the enforcement of security interest, no intervention of court or
Tribunal is required by the secured creditors as Banks have been given sufficient powers
to enforce its security interest.
(ii) If the borrower who is liable or obliged under a ‘Security Agreement’ to make the
payment to the secured creditor, makes any default in repayment of secured debt and his
account has been classified as NPA, then Secured Creditor may issue notice under subsection
(2) to the borrower to discharge his full liabilities, in a certain time bound
manner as mentioned in the notice. The borrower can raise objections against the notice
which the secured creditor has to consider and dispose off in writing setting out the
reasons.
(iii) In case the borrower fails to discharge his liability in full within the period and in
terms of notice, then, the secured creditor may take recourse to various measures as
illustrated in the various clauses to sub-section 4 of section 13, to recover his secured
debt only. The secured creditor has to take recourse u/s 14(1) of the Chief Metropolitan
Magistrate or District Magistrate to take over the possession of the property. Thus, the
crucial focus of sub-section (4) is that powers and measures is “to recover the secured
debt” only and not over and above. In other words the title in some of the cases is passed
for securing the debt and realizing the same. Shift in title is not shift on obligations of
the borrower albeit obligation of the borrower is being discharged by the lender.
(iv) The measures as illustrated in various clauses of the subsection (4) are purely
mechanism to secure the debts like, taking possession of the secured asset (mortgaged
asset) including the right to transfer; take over the management of the business of the
borrower, appoint any person to manage the secured assets; to give time to person who
has acquired the secured assets from the borrower for recovery of money; Thus, all these
modes and measures are purely for realization of secured debts, which otherwise
borrower was obliged to pay. In other words, all these powers and measures are to
facilitate the recovery of debt due from the borrower which earlier was cumbersome and
long drawn process through civil courts.
(v) Sub-section 7, provides that all the costs, charges and expenses, etc shall be
recoverable by the borrower or adjusted first from the money realization. If there is
complete passing of the title, then there is no question of recovery of costs. This itself
goes to show that secured creditor is realizing its secured debt and nothing beyond.
(vi) Sub-section 8 lays down a very important point that, if the dues of the secured
creditor along with the costs are tendered to the secured creditors, then no step shall be
17. Thus, the powers had been vested to Banks/ Secured Creditors to recover only the
secured debts from the borrower, that is, the title or right on mortgaged asset (secured
asset) assumed by the Bank is solely for securing and realizing its debts, which
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ITA 4964/Mum/2013
otherwise was the obligation of the buyer. The bank only act as legally authorised agents
to recover their money, which the borrower has failed to do so. From the scope of
section 13 and powers and mode of recovery as enumerated in sub-section (4) read with
other provisions, one thing is amply evident that, powers and right has been given to the
Bank to recover its secured debt in various forms. The title over the secured asset is
passed to the Bank only and only to extent of secured debt and not beyond it. In this
context, Ld. Counsel’s argument can be negated by following illustration:-
‘A’ (as a borrower) has borrowed a sum of Rs. 1 crore from Bank ‘B’ (Lender) after
mortgaging a property or asset worth Rs. 2 crores. ‘A’ could only pay back Rs. 50 lakhs
on principal amount and interest accrued thereof of Rs. 25 lakhs. Thereafter ‘A’ commits
default in repayment of balance principal amount of Rs. 50 lakhs and some interest
accrued thereon, say Rs. 10 lakhs. ‘B’ initiates proceedings under SARFAESI Act and
issues notice u/s 13(2) of Act. ‘A’ is unable to comply with terms of the notice within 60
days. (B’ makes a requisition in terms of section 14 for acquiring the property and sells it
to the outsiders for Rs. 2 crores (on actual value) and from the sale proceeds recovers a
sum of Rs. 50 lakhs plus interest of Rs. 10 lakhs, i.e. the amount of secured debt due.
Then, the moot point is, whether (B’ is entitled to appropriate all the money of Rs. 2
crores; or the secured interest /debt due of Rs.60 lakhs; or the balance sum of Rs. 1.40
crores is to be paid back to the assessee as this was not part of secured interest or debt
due. No where the SARFAESI Act, provides that the ‘B’ is entitled to appropriate all,
albeit only to the extent of balance secured debt of Rs. 60 lakhs.
If the contention of the Ld. Counsel is accepted, then the logical proposition would be
that, to the extent of Rs. 60 lakhs there was a ‘diversion of Income by overriding title’
and for the balance money of Rs. 1.40 crores, there was no such diversion and the title
belonged to the assessee. This would, in my humble opinion would not be correct
proposition, because, the title on the and passes to the bank only to fulfill the obligation
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of the assessee and enable the Bank to recover its own due money/debt. There would be
no deviation of the aforesaid principles, even in the case where the amount realized by
sale of mortgaged asset has been appropriated whole as the debt due is more or same as in
the present case. It cannot be principally held or accepted that, whenever on the sale of
mortgaged asset the debt amount realized is the same or less then there would be an
overriding title of the mortgage asset to the bank and therefore, the whole of the amount
realized should not be considered in the hands of the borrower and in cases the amount
realized is more on sale of mortgaged asset, the excess of the amount or income will belong
to the assessee. Here in this case, the Ld. Counsel had tried to contend before us that all the
amount has been appropriated by the bank after taking over the possession of the mortgaged
property and, therefore, such an income which has not come to the assessee and
appropriated directly at source by the bank, amounts to ‘diversion of income by overriding
title’. Such a contention of the Counsel has to be out rightly rejected, because if for instance,
had the bank realized excess amount from sale of mortgaged asset, then whether the excess
amount too would have been appropriated by the Bank or whether the assessee would have
given up its claim of excess amount in favour of the bank. The answer will be negative.
Under the SARFAESI Act also the bank can only enforce its secure debts and not beyond
that. Therefore, the contention raised by the Ld. Counsel has no legs to stand.
18. As per the accounting entry, in the books of account of the borrower assessee, the loan
amount from the liability side stands reduced and the asset stands disposed off for the
discharge of liability shown in the balance sheet and accordingly, the relevant entries are
made in the books of account. This precisely the assessee has also done in its books of
account, which is a correct and fair manner. Therefore, the sales of asset reflected in the
books were rightly shown under the head “capital gain” and income was computed under
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ITA 4964/Mum/2013
“‘Lone Term Caprtal Gain”. Had there been a case of “diversion of the Income by source or
by overriding title”, then the whole of the amount on sale of assets would not have entered
into the charging provisions of the Income Tax Act, at all, that is, would not have been even
entered the computation of total income. But here the assessee had duly disclosed the sale
consideration of the mortgaged asset not only in the books of account but also shown it as
its income as LTCG in the computation of income, albeit claimed a wrong deduction of
principal amount as cost of acquisition. The assessee now cannot plead otherwise. Even if
we go by the proposition that entries in the books of account are not relevant for deciding
the taxability of income, then also the fundamental aspect that permeates in this case is that,
the liability/debt was entered in the books of account and duly reflected in the audited
balance sheet and all throughout the obligation to discharge its self created liability/debt
was upon the assessee which remained its obligation till the end. Hence, such a discharge of
liability/debt even under the action taken by lender under the SARFAES1 Act was nothing
but application of income.
19. To conclude, under the SARFAESI Act the Bank merely gets a statutory enforceable
power/right to sell and dispose off the security interest, the obligation of payment of which
was on the borrower and the borrower has not done or played his part of covenant to
discharge his obligation on the outstanding loan. In all such cases, the income on sale of
secured asset by the secured creditor for its secured interest accrues or belongs to the
borrower assessee and here the income has been applied by the lending bank holding the
first charge on such income for specific discharge of obligation of the assessee as per the
legal covenant agreed in a contract between the lender and the borrower. There can be no
diversion of income simply because now the contract between the parties is enforced
through the SARFAESI Act. The Act merely gives more power to the lender banks to
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enforce the contract between the parties and safeguard the security interest of the Bank,
which was earlier done through mechanism of long drawn process under CPC through
CiviJ Courts.
20. Hence, in my humble opinion there is no material difference in the position of
law with the enactment of SARFAES1 Act, so as to come to a different conclusion
that law applicable prior to the commencement of the Act will no longer
will be applicable. Therefore, the legal proposition as upheld by the Hon*bJe
Supreme Court and High Court will still hold the ground in such cases. Accordingly,
the claim of deduction of the principal amount of Rs. 1,48,24,633/- made by the
assessee on the principle of ‘diversion by overriding title’ cannot be upheld and same
is denied to the assessee, because it is neither a case of diversion of income nor a
case for claim of deduction while computing the capital gain, albeit, it’s purely a
case of an application of income as it was the assessee’s obligation to pay its
debt. Thus, the ground raised by the assessee is dismissed.
In the result, the appeal of the assessee is dismissed.
Sd/-
(AMIT SHUKLA)
JUDICIAL MEMBER
Mumbai, Date : 23rd October, 2015
REFERENCE UNDER SECTION 255(4) OF INCOME TAX ACT
2. In the backdrop of the divergent views taken by Hon’ble Accountant
Member and Hon’ble Judicial Member, who constituted the Bench, a reference
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ITA 4964/Mum/2013
was made to the Hon’ble President, vide reference dated 27-08-2015 to
nominate a Third Member to answer the following questions:-
“(i) Whether, on the facts and circumstances of the case, the assessee
was justified in claiming the deduction of Rs.1,48,24,633/- out of full value
of consideration arising from the transfer of mortgaged capital asset by
the Kotak Mahindra Bank, which took over the possession of the said
asset under the provisions of the SARFAESI Act, 2002.
(ii) Whether, on the facts and circumstances of the case, the entire sale
consideration, which is received by the Kotak Mahindra Bank from the
transfer of mortgaged assets under the provisions of section 13 of the
SARFAESI Act, will not be chargeable to Income tax in the hands of the
assessee on the principle of “diversion of income by overriding title”.
3. The Hon’ble President was pleased to nominate Hon’ble Accountant
Member as a Third Member to decide the above questions, vide his order
dated 12-05-2019. The Hon’ble Third Member vide his order dated 10-
05-2019 has decided the issues in the following manner:-
PER G.S.PANNU, VICE PRESIDENT:
“The following points of difference have been referred to me by the Hon’ble
President under Section 255(4) of the Income-tax Act, 1961 (in short ‘the Act’) :

“(i) Whether, on the facts and circumstances of the case, the assessee was justified
in claiming the deduction of Rs.1,48,24,633/- out of full value of consideration arising from the transfer of mortgaged capital asset by the Kotak Mahindra Bank, which took
over the possession of the said asset under the provisions of the SARFAESI Act, 2002.
(ii) Whether, on the facts and circumstances of the case, the entire sale
consideration, which is received by the Kotak Mahindra Bank from the transfer of
mortgaged assets under the provisions of section 13 of the SARFAESI Act, will not be
chargeable to Income tax in the hands of the assessee on the principle of “diversion of
income by overriding title”.
2. Briefly put, the relevant facts are that the assessee is a company
incorporated under the Companies Act, 1956 and, is inter-alia, engaged in the
business of manufacture of cotton / polyester sewing and industrial threads and
also engaged in the processing of cotton yarn. It filed its return of income
declaring a loss of
`
64,93,927/-. In the return of income so filed, the assessee
claimed deduction of
`
1,48,24,633/- from its income computed under the head
Capital Gains. The facts in this regard are that the assessee took a corporate loan
of
`
306 lakhs from M/s. Kotak Mahindra Bank Ltd. (‘KMBL’) during the financial
year 2008-09 relevant to Assessment Year 2009-10 for its business. The said loan
was repayable in 36 monthly instalments. From August 2009 onwards assessee
defaulted in repayment of loan, and KMBL classified assessee’s account as a Non-
Performing Asset (‘NPA’) on 21.11.2009. In this regard, a notice was served on
30.11.2009 as per the provisions of Section 13(2) of the Securitisation and
Reconstruction of Financial Assets of Security Interest Act, 2002 (in short
‘SARFAESI Act’) on the assessee company and its personal guarantors, viz. Mr. H.
S. Bapna and Mrs. Urmila Bapna. The total outstanding liability to KMBL at that
point of time was
`
3,40,61,488/-. On 07.01.2010, KMBL took over possession of
the factory land of the assessee admeasuring 6,883.517 sq. mtrs. which was subdivided
into 7 plots and 6 of these sub-plots were sold by KMBL in March, 2010.
44
ITA 4964/Mum/2013
KMBL directly received the consideration amounting to
`
2,18,00,262/- and
adjusted the said realisation against the outstanding loan of the assessee, i.e. a
sum of
`
1,48,24,633/- was adjusted against the principal component of the loan
and
`
69,75,629/- was adjusted against the interest component of the loan. While
computing the Capital Gain under the Act, assessee treated the entire amount of
Rs.2,18,00,262/- received by the bank on sale of plots as sale consideration;
however, the amount of
`
1,48,24,633/- which was apportioned against the
principal component of the loan was claimed as deduction under Section 48 of
the Act alongwith the indexed cost of acquisition and improvements (
`
3,43,583/-
and other incidental expenses of
`
6000/- relating to sales). The Assessing Officer
disallowed the above claim of the assessee and made an addition of
`
1,48,24,633/- while computing the income under the head ‘Capital Gains’. On
further appeal by the assessee, the CIT(A) upheld the order of the Assessing
Officer. Aggrieved by the same, assessee preferred further appeal before the
Tribunal.
3. When the matter came up before the Division Bench, the appellant
contended that the consideration received by KMBL on sale of plots, to the
extent it was adjusted by KMBL towards principal component of the loan, never
accrued to the assessee and was in the nature of ‘diversion of income by
overriding title’ and, therefore, the same should be allowed as deduction while
computing the income under the head Capital Gains. The learned Accountant
Member concurred with the submissions advanced on behalf of the assessee on
this issue and ordered deletion of addition made on this account. In deleting the
addition, the learned Accountant Member observed that the property was
mortgaged with KMBL and on default by the assessee in repayment of loan, the
45
ITA 4964/Mum/2013
property automatically vested with KMBL as per Section 13 of the SARFAESI.
Further, KMBL got overriding title and the payments were directly received by
KMBL on account of transfer of secured assets. Thus, the doctrine of ‘diversion of
income by overriding title’ applied to the facts of the present case. On the other
hand, the learned Judicial Member passed an order sustaining the addition made
by the Assessing Officer on the ground that the charge on the property was
created by the assessee himself and thus, was in the nature of a voluntary
charge. The doctrine of ‘diversion of income by overriding title’ is not applicable
in the case of voluntary charge, but is applicable only in the case of automatic /
compulsory charge. It was also noticed by the learned Judicial Member that if the
argument of the assessee is accepted, this modus operandi will be used as a tax
evasion method and every assessee will suo-moto create a charge on the
property and will default in making payment of loans, and eventually avoid tax on
Capital Gain resulting from transfer of asset whose proceeds are used to repay
the loan liability. In view of this difference of opinion between the learned
Judicial Member and learned Accountant Member, the matter has been referred
to me for my opinion.
4. The questions to be answered by me in this order, as framed by the two
learned Members of the Division Bench, and reproduced above, is whether
assessee was justified in making deduction of
`
1,48,24,633/- from the full value of
consideration of the property mortgaged with KMBL, which took over possession
of the said property as per provisions of SARFAESI Act; and, whether the entire
sale consideration received by KMBL on sale of asset will not be chargeable to tax
in the hands of the assessee on the principle of ‘diversion of income by overriding
title’.
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ITA 4964/Mum/2013
5. At the outset, I make it clear that as regards the facts which are relevant to
decide the dispute, there is no difference between the learned Members
constituting the Division Bench, and therefore the same are not being repeated
by me for the sake of brevity.
6. Before me, the learned representative attempted to support the order
passed by the learned Accountant Member. At the outset, it was argued that
even the learned Judicial Member has accepted the fact that because of the
default in payment of loan by the assessee to KMBL, the mortgaged property
vested with the bank. Once that is so, the consideration received on transfer of
said property never accrued to the assessee as the asset itself did not belong to
the assessee. It was further contended that the property was sold by KMBL in its
own right and not as the agent of the assessee. There was no principal-agent
relationship between KMBL and the assessee. My attention was drawn to clause
nos. 9, 11 and 12 of the notice issued by KMBL under Section 13(2) of the
SARFAESI Act dated 30.11.2009, possession notice by KMBL dated 07.01.2010
and the sale certificate by KMBL. In the possession notice dated 07.01.2010, it
was pointed out that the assessee had expressed its inability to repay the loan
and KMBL has in clear terms stated that they have taken over the possession of
the mortgaged property and assessee was asked not to deal with the said
property. Further, it was pointed out that as per sale certificate, the property
was sold by the authorised officer on behalf of KMBL and not on behalf of the
assessee. According to him, this clearly shows that at the time of sale of asset,
the same did not belong to the assessee but it was the property of the KMBL, and
KMBL sold the same on principal to principal basis and not as the agent of the
assessee. It was also pointed out that the learned Judicial Member on one hand
accepts the fact that the sale is by KMBL and on the other hand states it is on
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ITA 4964/Mum/2013
behalf of the assessee. My attention was drawn to the provisions of Section
13(4) of the SARFAESI Act to state that on default by the borrower in repayment
of loan within the stipulated time, the property vests with the secured creditor
and the creditor obtains the right to sell the property in his own right.
7. Per contra, the learned DR contended that the computation of Capital
Gains is to be made as per the scheme of the Act and not as per the SARFAESI
Act. The provisions of SARFAESI Act cannot override the provisions of the Act. He
further contented that the real owner of the property remains the assessee even
at the time of sale of the property by the secured creditor. He further argued
that there is no change in position of law after the introduction of SARFAESI Act.
It was further argued that if KMBL is treated as the real owner, KMBL should have
paid the capital gains tax, which is not the case. It was further argued that the
object of SARFAESI Act is to facilitate the recovery and not to mitigate Capital
Gains tax. My attention was also drawn to the provisions of Section 13(6) of the
SARFAESI Act which states that on transfer of asset by the secured creditor to the
transferee, the transferee will get all right, title and interest in the said property
as if the transfer is made by the borrower. It was thus argued that the property
at the time of sale belonged to the assessee and thus, the sale of property by
KMBL was on behalf of the assessee and, therefore, the amount recovered by
KMBL shall not be allowed as deduction while computing Capital Gain in the
hands of the assessee.
8. The learned DR further argued that the contention of the assessee that
assessee lost ownership of the property at the time of vesting of property in
favour of KMBL is incorrect as at the time of second transaction of property sale
by KMBL, the loan account of the assessee got settled, which was not so at the
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ITA 4964/Mum/2013
time of vesting of the property in favour of KMBL and, therefore, the sale of
property by KMBL was on account of the assessee. The amount retained by
KMBL towards loan liability was merely an application of income by the assessee.
In this regard, the learned DR relied on the decision of the Chennai Bench of the
Tribunal in the case of Geetha Subrabamiam vs. ITO on ITA Nos. 427 &
428/MDS/2017 dated 27.04.2017. It was further argued that merely by taking
over possession of the assets of borrower under SARFAESI Act, the secured
creditor does not acquire the ownership of the assets or becomes the owner of
the assets. In this regard, he placed reliance on the decision of the Delhi Bench
of the Tribunal in the case of Rajasthan Petrosynthetics Ltd in ITA no.
1397/Del/2013 dated 22.08.2014. It was further argued that if KMBL would have
realised any amount in excess of the amount of loan liability recoverable by
KMBL, the excess would have been returned by KMBL to the assessee. Thus, it
cannot be said that the ownership of the assets vested with KMBL only and asset
was sold by KMBL on principal to principal basis and not as agent of the assessee.
9. I have carefully considered the rival submissions, perused the respective
orders passed by the learned Judicial Member and learned Accountant Member
and the material placed on record. The two aspects which I find are relevant on
the facts of the present case are that doctrine of ‘diversion of income by
overriding title’ and implication of SARFAESI Act on the doctrine of ‘diversion of
income by overriding title’. Since the facts are not in dispute and are already
dealt with exhaustively in the respective orders passed by learned Accountant
Member and learned Judicial Member, the same are not discussed again for the
sake of brevity. Firstly, I shall deal with the doctrine of ‘diversion of income by
overriding title’ in cases wherein the mortgage has been created by the assessee
himself. The Hon’ble Supreme Court in the case of R M Arunachalam vs CIT
49
ITA 4964/Mum/2013
[1997] 227 ITR 222 has discussed the above doctrine. The relevant para of the
said judgment is reproduced hereunder:
“In taking the view that in a case where the property has been mortgaged by
the previous owner during his lifetime and the assessee, after inheriting the
same, has discharged the mortgage debt, the amount paid by him for the
purpose of clearing off the mortgage is not deductible for the purpose of
computation of capital gains, the Kerala High Court has failed to note that in a
mortgage there is transfer of an interest in the property by the mortgagor in
favour of mortgagee and where the previous owner has mortgaged the
property during his lifetime, which is subsisting at the time of his death, then
after his death his heir only inherits the mortgagor’s interest in the property.
By discharging the mortgage debt his heir who has inherited the property
acquires the interest of the mortgagee in the property. As a result of such
payment made for the purpose of clearing off the mortgage the interest of the
mortgagee in the property has been acquired by the heir. The said payment
has, therefore, to be regarded as ‘cost of acquisition’ under section 48, read
with section 55(2). The position is, however, different where the mortgage is
created by the owner after he has acquired the property. The clearing off the
mortgage debt by him prior to transfer of the property would not entitle him
to claim deduction under section 48 because in such a case he did not acquire
any interest in the property subsequent to his acquiring the same. In Daksha
Ramanlal’s case (supra) the Gujarat High Court has rightly held that the
payment made by a person for the purpose of clearing off the mortgage
created by the previous owner is to be treated as cost of acquisition of the
interest of the mortgagee in the property and is deductible under section 48.”
(underlined for emphasis by me)
10. Further, in the case of CIT vs. Attilli N. Rao [2001] 252 ITR 880 (SC) the
question before the Hon’ble Supreme Court was as under:
“1. Whether on the facts and in the circumstances of the case and in law, the
Appellate Tribunal was correct in holding that the amount realised by the sale
of the assessee’s interest in the property was only Rs. 4,33,960 i.e., Rs.
5,62,980 minus Rs. 1,29,020 ?
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ITA 4964/Mum/2013
2. Whether on the facts and in the circumstances of the case and in law, the
Appellate Tribunal was correct in holding that the amount realised under the
charge or mortgage by the Government by public auction does not partake of
the character of ‘full value of consideration’ envisaged under section 48 of the
Income-tax Act ?
3. Whether on the facts and in the circumstances of the case and in law, the
Appellate Tribunal was justified in holding that the amount payable by the
assessee in discharge of the mortgage debt to the Government on the sale of
property was an expenditure incurred towards the cost of acquisition of the
capital asset and deductible under section 48 of the Income-tax Act?
4. Whether on the facts and in the circumstances of the case and in law, the
Appellate Tribunal was correct in holding that the assessee was not vested
with full interest in the property sold and capital gains be computed only with
reference to the price realised towards his interest with property ?”
(underlined for emphasis by me)
While answering the above questions, the Hon’ble Supreme Court held as
under:-
“8. We are of the view that the Tribunal and the High Court were in error.
What was sold by the State at the auction was the immovable property that
belonged to the assessee. The price that was realised therefore belonged to
the assessee. From out of that price, the State deducted its dues towards
“kits” and interest due from the assessee and paid over the balance to him.
The capital gain that the assessee made was on the immovable property
that belonged to him. Therefore, it is on the full price realised (less admitted
deductions) that the capital gain and the tax thereon has to be computed.”
(underlined for emphasis by me)
11. Further, the Hon’ble Supreme Court in the case of CIT vs. Sitaldas
Tirathdas [1961] 41 ITR 367 has laid down following test with regard to ‘diversion
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ITA 4964/Mum/2013
of income by overriding title’. The relevant para of the said judgment is
reproduced hereunder:-
“In our opinion, the true test is whether the amount sought to be deducted, in
truth, never reached the assessee as his income. Obligations, no doubt, there
are in every case, but it is the nature of the obligation which is the decisive
fact. There is a difference between an amount which a person is obliged to
apply out of his income and an amount which by the nature of the obligation
cannot be said to be a part of the income of the assessee. Where by the
obligation income is diverted before it reaches the assessee, it is deductible;
but where the income is required to be applied to discharge an obligation
after such income reaches the assessee, the same consequence, in law, does
not follow. It is the first kind of payment which can truly be excused and not
the second. The second payment is merely an obligation to pay another a
portion of one’s own income, which has been received and is since applied.
The first is a case in which the income never reaches the assessee, who even if
he were to collect it, does so, not as part of his income, but for and on behalf
of the person to whom it is payable.”
(underlined for emphasis by me)
12. It is evident from the aforesaid rulings of the Hon’ble Supreme Court,
which have been relied by the learned Judicial Member, that when the charge on
the property has been created by the assessee himself, he cannot claim
deduction of the principal amount of the loan either as expenditure under
Section 48 of the Act or as ‘diversion of income by overriding title’. To this extent,
I concur with the view of the learned Judicial Member. In the case of Attilli N.
Rao (supra), the Hon’ble Supreme Court, while arriving at the conclusion,
observed that at the time when the property was sold, the property belonged to
the assessee and, therefore, the sale consideration of the said property also
belonged to the assessee and denied the deduction claimed by the assessee
from the full value of consideration received on sale of property. This aspect
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ITA 4964/Mum/2013
needs to be analysed in the facts of the present case to decide whether the ratio
laid down in the case of Attilli N. Rao (supra) still holds good.
13. In the case of Sitaldas Tirathdas (supra), the Hon’ble Supreme Court has
laid down the test that it is the nature of obligation which is the decisive test.
Ostensibly, there is a difference between the nature of an amount which an
assessee is obliged to apply out of his income and the amount which does not
reach the assessee’s hands so as not to form part of the total income of the
assessee.
14. The learned representative for the assessee has also drawn my attention
to the provisions of Section 13 of the SARFAESI Act, which read as under:-
“Enforcement of security interest.
13. (1) Notwithstanding anything contained in section 69 or section 69A of the
Transfer of Property Act, 1882 (4 of 1882), any security interest created in
favour of any secured creditor may be enforced, without the intervention of
the court or tribunal, by such creditor in accordance with the provisions of this
Act.
(2) Where any borrower, who is under a liability to a secured creditor under a
security agreement, makes any default in repayment of secured debt or any
instalment thereof, and his account in respect of such debt is classified by the
secured creditor as non-performing asset, then, the secured creditor may
require the borrower by notice in writing to discharge in full his liabilities to
the secured creditor within sixty days from the date of notice failing which the
secured creditor shall be entitled to exercise all or any of the rights under subsection
(4) :
[Provided that—
(i) the requirement of classification of secured debt as nonperforming
asset under this sub-section shall not apply to a
borrower who has raised funds through issue of debt
securities; and
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ITA 4964/Mum/2013
(ii) in the event of default, the debenture trustee shall be
entitled to enforce security interest in the same manner as
provided under this section with such modifications as may
be necessary and in accordance with the terms and
conditions of security documents executed in favour of the
debenture trustee. ]
(3) The notice referred to in sub-section (2) shall give details of the amount
payable by the borrower and the secured assets intended to be enforced by
the secured creditor in the event of non-payment of secured debts by the
borrower.
[(3A) If, on receipt of the notice under sub-section (2), the borrower makes any
representation or raises any objection, the secured creditor shall consider such
representation or objection and if the secured creditor comes to the conclusion
that such representation or objection is not acceptable or tenable, he shall
communicate [within fifteen days] of receipt of such representation or
objection the reasons for non-acceptance of the representation or objection to
the borrower:
Provided that the reasons so communicated or the likely action of the secured
creditor at the stage of communication of reasons shall not confer any right
upon the borrower to prefer an application to the Debts Recovery Tribunal
under section 17 or the Court of District Judge under section 17A.]
(4) In case the borrower fails to discharge his liability in full within the period
specified in sub-section (2), the secured creditor may take recourse to one or
more of the following measures to recover his secured debt, namely :—
(a) take possession of the secured assets of the borrower including the
right to transfer by way of lease, assignment or sale for realising
the secured asset;
[(b) take over the management of the business of the borrower
including the right to transfer by way of lease, assignment or sale
for realising the secured asset :
Provided that the right to transfer by way of lease, assignment or
sale shall be exercised only where the substantial part of the
business of the borrower is held as security for the debt :
Provided further that where the management of whole of the
business or part of the business is severable, the secured creditor
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ITA 4964/Mum/2013
shall take over the management of such business of the borrower
which is relatable to the security for the debt;]
(c) appoint any person (hereafter referred to as the manager), to
manage the secured assets the possession of which has been taken
over by the secured creditor;
(d) require at any time by notice in writing, any person who has
acquired any of the secured assets from the borrower and from
whom any money is due or may become due to the borrower, to
pay the secured creditor, so much of the money as is sufficient to
pay the secured debt.
(5) Any payment made by any person referred to in clause (d) of sub-section
(4) to the secured creditor shall give such person a valid discharge as if he has
made payment to the borrower.
[(5A) Where the sale of an immovable property, for which a reserve price has
been specified, has been postponed for want of a bid of an amount not less
than such reserve price, it shall be lawful for any officer of the secured
creditor, if so authorised by the secured creditor in this behalf, to bid for the
immovable property on behalf of the secured creditor at any subsequent sale.
(5B) Where the secured creditor, referred to in sub-section (5A), is declared to
be the purchaser of the immovable property at any subsequent sale, the
amount of the purchase price shall be adjusted towards the amount of the
claim of the secured creditor for which the auction of enforcement of security
interest is taken by the secured creditor, under sub-section (4) of section 13.
(5C) The provisions of section 9 of the Banking Regulation Act, 1949 (10 of
1949) shall, as far as may be, apply to the immovable property acquired by
secured creditor under sub-section (5A).]
(6) Any transfer of secured asset after taking possession thereof or take over
of management under sub-section (4), by the secured creditor or by the
manager on behalf of the secured creditor shall vest in the transferee all rights
in, or in relation to, the secured asset transferred as if the transfer had been
made by the owner of such secured asset.
(7) Where any action has been taken against a borrower under the provisions
of sub-section (4), all costs, charges and expenses which, in the opinion of the
secured creditor, have been properly incurred by him or any expenses
incidental thereto, shall be recoverable from the borrower and the money
which is received by the secured creditor shall, in the absence of any contract
55
ITA 4964/Mum/2013
to the contrary, be held by him in trust, to be applied, firstly, in payment of
such costs, charges and expenses and secondly, in discharge of the dues of the
secured creditor and the residue of the money so received shall be paid to the
person entitled thereto in accordance with his rights and interests.
[ (8) Where the amount of dues of the secured creditor together with all costs,
charges and expenses incurred by him is tendered to the secured creditor at
any time before the date of publication of notice for public auction or inviting
quotations or tender from public or private treaty for transfer by way of lease,
assignment or sale of the secured assets,—
(i) the secured assets shall not be transferred by way of lease
assignment or sale by the secured creditor; and
(ii) in case, any step has been taken by the secured creditor for transfer
by way of lease or assignment or sale of the assets before tendering
of such amount under this sub-section, no further step shall be taken
by such secured creditor for transfer by way of lease or assignment
or sale of such secured assets. ]
(9) [Subject to the provisions of the Insolvency and Bankruptcy Code, 2016, in
the case of] financing of a financial asset by more than one secured creditors
or joint financing of a financial asset by secured creditors, no secured creditor
shall be entitled to exercise any or all of the rights conferred on him under or
pursuant to sub-section (4) unless exercise of such right is agreed upon by the
secured creditors representing not less than [sixty per cent] in value of the
amount outstanding as on a record date and such action shall be binding on
all the secured creditors :
Provided that in the case of a company in liquidation, the amount realised
from the sale of secured assets shall be distributed in accordance with the
provisions of section 529A of the Companies Act, 1956 (1 of 1956) :
Provided further that in the case of a company being wound up on or after the
commencement of this Act, the secured creditor of such company, who opts to
realise his security instead of relinquishing his security and proving his debt
under proviso to sub-section (1) of section 529 of the Companies Act, 1956 (1
of 1956), may retain the sale proceeds of his secured assets after depositing
the workmen’s dues with the liquidator in accordance with the provisions of
section 529A of that Act :
Provided also that the liquidator referred to in the second proviso shall
intimate the secured creditor the workmen’s dues in accordance with the
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ITA 4964/Mum/2013
provisions of section 529A of the Companies Act, 1956 (1 of 1956) and in case
such workmen’s dues cannot be ascertained, the liquidator shall intimate the
estimated amount of workmen’s dues under that section to the secured
creditor and in such case the secured creditor may retain the sale proceeds of
the secured assets after depositing the amount of such estimated dues with
the liquidator :
Provided also that in case the secured creditor deposits the estimated amount
of workmen’s dues, such creditor shall be liable to pay the balance of the
workmen’s dues or entitled to receive the excess amount, if any, deposited by
the secured creditor with the liquidator :
Provided also that the secured creditor shall furnish an undertaking to the
liquidator to pay the balance of the workmen’s dues, if any.
Explanation.—For the purposes of this sub-section,—
(a) “record date” means the date agreed upon by the secured
creditors representing not less than [sixty per cent] in value of the
amount outstanding on such date;
(b) “amount outstanding” shall include principal, interest and any
other dues payable by the borrower to the secured creditor in
respect of secured asset as per the books of account of the
secured creditor.
(10) Where dues of the secured creditor are not fully satisfied with the sale
proceeds of the secured assets, the secured creditor may file an application in
the form and manner as may be prescribed to the Debts Recovery Tribunal
having jurisdiction or a competent court, as the case may be, for recovery of
the balance amount from the borrower.
(11) Without prejudice to the rights conferred on the secured creditor under or
by this section, the secured creditor shall be entitled to proceed against the
guarantors or sell the pledged assets without first taking any of the measures
specified in clauses (a) to (d) of sub-section (4) in relation to the secured assets
under this Act.
(12) The rights of a secured creditor under this Act may be exercised by one or
more of his officers authorised in this behalf in such manner as may be
prescribed.
(13) No borrower shall, after receipt of notice referred to in sub-section (2),
transfer by way of sale, lease or otherwise (other than in the ordinary course
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ITA 4964/Mum/2013
of his business) any of his secured assets referred to in the notice, without
prior written consent of the secured creditor.”
Sub-section (2) of Section 13 of the SARFAESI Act provides that if the borrower
defaults in repayment of loan or any instalment thereof and his account is
classified as a Non-Performing Asset, then the secured creditor shall issue a
notice requiring him to make the payment within sixty days, failing which the
secured creditor shall exercise his rights conferred under Sub-section (4) of the
SARFAESI Act. Sub-section (4) of SARFAESI Act provides that if the borrower fails
to make payment within the time specified in the notice issued under Subsection
(2), the secured creditor shall have right to exercise various options
which, inter-alia, includes right to take possession of the secured asset and the
right to transfer by way of lease, assignment or sale for realising the secured
asset. Thus, Sub-section (4) of Section 13 of SARFAESI Act provides the secured
creditor with the right to transfer the secured asset in order to realise the
secured debt.
15. Further, on perusal of Sub-section (13) of Section 13 of SARFAESI Act, I find
that once the borrower receives notice under Sub-section (2) of the SARFAESI
Act, his right to part with the property is restricted; and, the borrower cannot
transfer the secured asset by way of sale, lease or otherwise without prior
written consent of the secured creditor.
16. Thus, in sum and substance, I find that once the borrower defaults in
repayment of loan or instalment and the secured creditor issues the notice
specified in Sub-section (2) of Section 13 of the SARFAESI Act, the right of the
borrower with respect to the secured asset gets restricted, and he is not allowed
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to part with the secured asset without the prior approval of the secured creditor.
Further, on non-repayment of loan or instalment amount within the period
specified in the notice issued under Sub-section (2) of Section 13 of the SARFAESI
Act, all the rights in the secured asset get vested with the secured creditor and
the borrower has no right in the said asset. The borrower is not free to decide
even the way in which the secured asset shall be parted with. It is the sole
discretion of the secured creditor as to how the secured asset shall be dealt with.
This right in favour of the secured creditor is created by virtue of SARFAESI Act;
and, this has been interpreted by the learned representative for the assessee to
say that the mortgaged property vested with KMBL and, therefore, the property
was sold by KMBL in its own right. In my considered opinion, the fall-out of noncompliance
envisaged in Sub-section (2) of Section 13 of the SARFAESI Act
provides the secured creditor all or any of the rights enumerated in Sub-section
(4) thereof. Clause (a) of Sub-section (4) of Section 13 of the SARFAESI Act is
being sought to be understood by the assessee to mean taking possession of the
secured asset by KMBL as an owner per se. So however, in my considered
opinion, the reading of clause (a) of Sub-section (4) of Section 13 of the SARFAESI
Act does not justify the aforesaid interpretation. Sub-section (4) of Section 13 of
the SARFAESI Act says “In case the borrower fails to discharge his liability
……………………. the secured creditor may take recourse ……………………… to
recover his secured debt ………….”. Furthermore, clause (a) of Sub-section (4) of
Section 13 of the SARFAESI Act, inter-alia, says “take possession of the secured
assets ………………. including the right to transfer ……………………. for realising the
secured asset”. Quite clearly, vesting of the secured asset with the secured
creditor is prescribed by SARFAESI Act to enable the secured creditor “to recover
his secured debt” including, inter-alia, empowering the secured creditor to take
possession and transfer by way of lease, assignment or sale the secured asset
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“for realising the secured asset”. Therefore, in my considered opinion, the stand
of the assessee (on the strength of SARFAESI Act) that the mortgaged property
vested with KMBL and to say that the consideration received by KMBL on
transfer of said property never accrued to the assessee as the asset did not
belong to the assessee is untenable given the mandate of the SARFAESI Act.
17. I find that in the present case the assessee defaulted in repayment of loan
to KMBL and KMBL classified the account of the assessee as Non-Performing
Asset which is the precondition before issuing notice under Sub-section (2) of
Section 13 of the SARFAESI Act. The assessee was thus issued notice under Subsection
(2) of Section 13 of the SARFAESI Act dated 30.11.2009. The assessee
failed to make payment to the secured creditor within the period specified in the
notice issued under Sub-section (2) of Section 13 of the SARFAESI Act. Thus, by
virtue of Sub-section (4) of Section 13 of the SARFAESI Act, KMBL was vested
with the option to sell the secured asset, which is represented by plots, in the
present case. KMBL invoked the SARFAESI Act and accordingly took possession
of the plots, sold them and recovered the amount of loan liability outstanding
from the assessee.
18. The situation can also be seen de hors the SARFAESI Act. The assessee in
the present case availed mortgage loan from KMBL and, one of the condition was
that if the assessee defaults in repayment of loan and interest, the mortgaged
property will be sold by KMBL to recover the outstanding loan and interest
amount from the assessee. The assessee and KMBL, both were aware of this fact
at the time of advancing of loan by KMBL to the assessee; and, the assessee
voluntarily chose to enter into such an arrangement wherein property owned by
it was mortgaged to the bank as security; admittedly, assessee agreed to the
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condition of disposal of the property by KMBL in case of default in repayment of
loan by it. This arrangement, even without force of any law, was clear and
unambiguous. Thus, it was only a voluntary action on the part of the assessee to
enter into such an obligation and assessee was not compelled by law or any
other obligation beyond it’s control to enter into such an arrangement. Once
that is so, any action taken by KMBL to enforce it’s right to recover the amount
which, in the present case, is right to sell the property to recover amount cannot
be said to be transaction beyond the control of the assessee. Thus, the amount
recovered by KMBL can by no stretch of imagination be treated as ‘diversion of
income by overriding title’. The principle of ‘diversion of income by overriding
title’ applies when the transaction is beyond the control of the assessee due to
which assessee has to make commitment to either divert it’s income or part with
income earned by it in a particular manner. The principle of ‘diversion of income
by overriding title’ has been laid down by the courts to overcome the situation
wherein an assessee does not have a free hand on the amount earned by it or is
in fact not received by an assessee due to circumstances beyond it’s control.
Such principle would not be attracted in cases wherein assessee by his own past
action creates a future obligation for himself to utilize the amount in a particular
manner. Thus, the claim of the assessee cannot be accepted in the facts of the
present case.
19. Section 13 of the SARFAESI Act cannot come to the rescue of the assessee.
I find that at the time of entering into mortgage agreement assessee was well
aware of the consequences of non-payment of loan amount which, inter-alia,
included procedure of recovery of amount and sale of mortgage asset by the
secured creditor. It is not something new or some unforeseen event which
assessee was not aware of. Having complete knowledge of the consequences of
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default in repayment of loan, assessee still chose to enter into such an
arrangement. So it is an action of the assessee, which has created the instant
obligation on itself. Insofar as the argument of the learned representative that
the instant obligation was not voluntary and was mandated by the SARFAESI Act,
in my view, the same is quite misplaced inasmuch as it is only the voluntary act
of the assessee of entering into mortgage loan arrangement with KMBL and the
subsequent default in repayment which has triggered Sub-section (13) of Section
13 of the SARFAESI Act placing restriction on the assessee to transfer the
mortgaged/secured asset by way of sale, lease or otherwise without the prior
consent of KMBL. Alternatively, I find that SARFAESI Act merely provides a
recovery mechanism and nothing else. The SARFAESI Act cannot be interpreted
to mean that it has created right of ‘diversion of income by overriding title’.
While interpreting the law, due regard must be given to the intent and purpose
of the law. The purpose of SARFAESI Act, and which clearly emerges from the
phraseology of Section 13 of SARFAESI Act, is to effectuate and expedite the
recovery of secured interest of the secured creditor and certainly not, so far as
the present case is concerned, to reduce or to impair the provisions of the Act in
determination of income-tax liability of the assessee.
20. In my considered opinion, so far as the instant dispute is concerned, the
legal position prevailing prior to SARFAESI Act is also germane even after the
enactment of SARFAESI Act. The law laid down by the Hon’ble Courts with
respect to ‘diversion of income by overriding title’ and deduction to be claimed
under Section 48 of the Act while computing the income from Capital Gains,
which are discussed by the ld. Judicial Member and also relied upon by the ld.
DR, are still good law, and is fully applicable in the instant case.
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21. In view of the above reasoning, I hold that in the present case there was
no diversion of sale proceeds by overriding title, but on the contrary, there is
only a mere application of the sale proceeds realised on sale of plots towards the
discharge of outstanding loan liability of the assessee. I also hold that assessee
cannot claim any part of such application as deduction for the purpose of
computing Capital Gain in terms of Section 48 of the Act.
22. I thus agree with the view taken by the learned Judicial Member that the
consideration from sale of property to the extent of principal component of loan
adjusted by the bank cannot be treated as ‘diversion of income by overriding title’
and was thus not deductible from the total consideration accrued to the
assessee from sale of property.
23. In view of the foregoing discussion, the questions put forth before me are
answered in negative, and against the assessee. The decision arrived at by
learned Judicial Member is the correct view, and I concur with the view adopted
by the learned Judicial Member on this issue.
24. The Registry of the Tribunal is directed to list the appeal before the
Division Bench for passing the final order in accordance with the majority view.
Sd/-
(G.S. PANNU)
VICE PRESIDENT
Mumbai, Dated 10th May, 2019”
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Per Pawan Singh, J.M
4. In accordance with the majority view, we hold that the grounds of
appeal raised by the assessee are dismissed.
3. In the result, appeal filed by the assessee is dismissed.
Order pronounced in the open court on 05-09-2019.
Sd/- Sd/-
(Rajesh Kumar ) (Pawan Singh)
ACCOUNTANT MEMBER JUDICIALMEMBER
Mumbai, Dt : 5th September, 2019
Pk/-
Copy to :
1. Appellant
2. Respondent
3. CIT(A)
4. CIT
5. DR
/True copy/ By order
Asstt. Registrar, ITAT, Mumbai