M.C.DESAI C.J. - (1.) THE Income-tax Appellate Tribunal Delhi, has, at the instance of the assessee, referred a statement of the case to this court for its opinion on the three questions given below : (1) Whether on a true interpretation of the provisions of section 18 and 14(7) of the U. P. Government Encumbered Estates Act, 1934, the liability for the debts and interest thereon due from Wahiduddin had passed on the U. P. Government with the passing of the decree on February 18, 1940, by the special judge appointed under the U. P. Encumbered Estates Ac ? (2) If the answer to question No. 1 is in the affirmative whether on the facts and in the circumstances of the case the surplus of Rs. 79,347 being the difference between the market price of the U. P. Government Encumbered Estate Bonds and the balance of the debt due from Wahiduddin was revenue income liable to ta ? (3) Whether the receipt by the assessee of the sum of Rs. 58,266 in April, 1935, during the execution proceedings of the decree was rightly treated by the Tribunal as receipt towards the principal of the deb ?
(2.) FROM the statement I find that the assessee advanced a loan of Rs. 1,50,000 to two brothers, Wahiduddin and Bashiruddin on a mortgage of the property at a certain rate of interest. In 1930 the assessee field a decree for Rs. 2,27,699 made up as follows : JUDGEMENT_167_ITR49_1963Html1.htm A final decree seems to have been passed and was put into execution. In the course of the execution the assessee on April 25, 1935, realised Rs. 58,266. He is a money-lender by profession and maintains the accounts on cash basis. He did not appropriate the receipt of Rs. 58,266 and odd (which will be referred to as the disputed sum, receipt or payment) either to the principal that was due from the two brothers or to the interest that was due from them. In this accounts he simply entered the receipt on the credit side with the principal of Rs. 1,50,000 entered on the debit side and said nothing in the ledger whether the receipt was on account of interest, principal or costs. He does not maintain any separate interest account and there was therefore, no question of his debiting the interest as it accrued and of crediting any payment of interest. He has adopted the financial year as the accounting year. In his accounts for the financial year 1936-37 he brought over the sum of Rs. 91,734 (Rs. 1,50,00 minus Rs. 58,266). In the return submitted by him for the relevant assessment year 1936-37 he did not show the disputed amount as having been received either as principal or as interest; he did not show it in the return at all. The result was that he was not assessed on the disputed sum. It is conceded that if the disputed he was received by him as principal, it was not liable to assessment and that if it was received by him as principal, it was not liable to assessment and that if it was received as interest, it was, because interest received by a money-lender is revenue income. About this time the U. P. Encumbered Estates Act came into force and the two brothers applied for its benefit. In the proceedings under the Act two simple money decrees were passed under section 14(7) on February 18, 1940, against the two brothers for Rs. 93,625 each, with future interest at 3 1/4 %. The liquidation proceedings were then started under the Act. In November, 1944, the assessee got bonds of the face value of Rs. 1,19,200 payable after 20 years and bearing interest, in satisfaction of the money decree obtained against Bashiruddin. In the corresponding assessment year 1945-46 the assessee was assessed on an income of Rs. 71,809; the income-tax authorities worked out the assessable income as follows : JUDGEMENT_167_ITR49_1963Html2.htm Thus in the assessment for 1945-46 the disputed receipt was treated as receipt towards principal, i.e., as capital receipt. On June 5, 1947, relevant to the assessment year 1948-49, the assessee got bonds of the face value of Rs. 1,32,000 in satisfaction of the money decree obtained against the other brother, Wahiduddin. The Income-tax Officer assessed him on an income of Rs. 79,347, treating Rs. 79,347 out of the value of the bonds as receipt on account of interest. He calculated this amount of interest as follows, after accepting the assessees contention that the bonds were of the market value of Rs. 1,26,743 and that he must be deemed to have received only that sum and not Rs. 1,31,000 on account of the principal, the interest and the costs due from Wahiduddin : JUDGEMENT_167_ITR49_1963Html3.htm The assessment order was upheld by the Appellate Assistant Commissioner and the Tribunal. The assessees contention in these assessment proceedings was that he had appropriated the disputed receipt as receipt on April 25, 1935, on account of interest, that consequently no part of the principal was paid up before the bonds were received by him in discharge of the debts due from the two brothers and the principal due from each of them continued to be Rs. 75,000 and that the amount received through the bonds on account of the interest due from the two brothers should have been calculated after deducting from the amounts of the bonds Rs. 75,000 on account of each brothers share in the principal and Rs. 1,529 on account of each brothers share in the costs. In this way the assessable amount would be reduced by about Rs. 30,000. Question No. 3 is in respect of this contention. A similar contention had been advanced by him in the earlier proceedings for the assessment year 1945-46 and though it had been rejected by the income-tax authorities and the Tribunal, it was accepted by this court in I. T. Misc. Reference No. 117 of 1953 (Ramji Lal v. Commissioner of Income-tax decided on November 29, 1960. The assessee now seeks a similar judgment from this court in respect of the assessment year 1948-49. He also contended that the result of the simple money decrees passed in his favour under section 14(7) of the U. P. Encumbered Estates Act was to substitute the State of U. P. as a debtor in place of the two brothers. This contention give rises to questions Nos. 1 and 2.
(3.) I shall take up the question, No. 1 first. My answer to it is an emphatic no". Before I give reasons I should mention that his contention was not advanced on behalf of the assessee in the earlier assessment proceedings terminating with this courts order in I. T. R. No. 117 of 1953, referred to above. I do not treat this fact as a bar, but the fact that it did not occur to the assessee or his counsel to advance this plea in the earlier proceedings shows that there is not much force in it. Section 14(7) of the Encumbered Estates Act simply provides for the passing of a simple money decree by the special judge after ascertaining the amount due from the debtor-applicant to the creditor. It is deemed to be a decree of a court of a court of competent jurisdiction but not capable of being executed within Uttar Pradesh except as provided in the Act : vide sub-section (8). Section 18 states the effect of the special judges findings. It is to extinguish the previously existing rights, if any, of the claimant (e.g. the creditor), together with all rights, if any, mortgage or lien by which the same are secured and... to substitute for those rights a right to recover the amount of the decree in the manner and to the extent hereinafter prescribed. What is extinguished by the decree is not the right of the creditor to recover the money found due to him from the debtor but simply his right as a mortgagee or lienholder. The debt due to him is not extinguished; it is only the right to the security that is extinguished. The debtor does not cease to be his debtor and of course there is no question of the State being substituted as a debtor. The State is not even referred to in either section 14 or section 18 and I fail to comprehend how the effect of these two provisions can be said to be to substitute in place of the debtor the State of U. P., which is not mentioned in them even impliedly or indirectly. The effect of the decree is simply to alter the previously existing right of the creditor as against the debtor. His right over the money due from the debtor to him remains intact and so also does the debtors obligation to pay the money; only the mode of realising the debt is altered. Chapter V of the Act contains provisions about the execution of a simple money decree passed by the special judge. Section 22 requires the Collector to allow the debtor two months within which to pay into court the whole or any part of the decretal amount; this provision is important in two respects. One is that after the passing of the decree under section 14 the person against whom it is passed is still designated as the debtor. The word debtor is not defined, and given an artificial meaning in the Act; it means the person from whom a debt is owning. Even after the passing of the decree under section 14, the original debtor in his place as a consequence of the passing of the decree and that the State certainly has not become the debtor. The result is that the liability to satisfy the decree continues to rest on the original debtor and is not transferred to the State. If the debtor pays into court the full decretal amount section 23 requires the Collector to discharge all his debts; this confirms that he retains the liability to discharge the debt. Section 24 authorises the Collector to realise the value of the debtors property other than proprietary rights in land and to expend it in discharging the decretal debts. It is only when a creditors decree is not satisfied in this manner that he is given bonds by the State to the extent to which his decree remained unsatisfied and the debtor is required to pay certain instalments to the State. Even when this is done it cannot be said that the State has become a debtor of the creditors in place of the original debtor against whom the decree had been passed. Moreover, this is not the question referred to us; the contention advanced on behalf of the assessee was not that the State has become a debtor in place of Wahiduddin when it issued bonds to the assessee but whether it became in Wahiduddins place when the special judge passed a decree against him and in the assessees favour. Since question No. 1 is answered in the negative, the second question does not arise. We were required to answer it only if it had been answered in the affirmative. My answer to the third question is yes". The assessee has come to this court with absolutely unclean hands. He realised the disputed sum in 1935 but did not appropriate it towards interest. Since the money was received in execution of a decree against the brothers, there was no question of their appropriating it towards the principal it towards the principal due from them or towards the interest due from them and when they could not, and did not, appropriate it the right vested in the assessee to appropriate it. He was free to appropriate it towards the interest or towards the principal. Undoubtedly there was not time limit fixed for his appropriation; he could appropriate it at any time so long as his right of appropriation was not lost by his own act. When neither party makes any appropriation and the question arises in court, the court is required to apply the payment in discharge of the debts in order of time. This is the law contained in sections 59, 60 and 61 of the Contract Act. The law laid down in these provisions has been applied to judgment debts as well and the principle contained in them has been applied to principal and interest treated as distinct debts. These provisions reproduce in a statutory form the common law of appropriation. As between a creditor and his debtor, the law is that the creditor has the right of appropriation up to the very last moment (vide the City Discount Company Ltd. v. McLean and Excyclopaedia of the Laws of England, Vol. I, page 447). The right terminates when the creditor has made an appropriation and communicated it to the debtor. But this law is not necessarily applicable when the question arises between a creditor and another person such as an Income-tax Officer. A creditor may not be allowed to contend that he is not bound by the appropriation made by him because he has not communicated it to his debtor. What happened in this case was that when the assessee received the disputed sum he did not appropriate it as against his debtors but he did appropriate it as against the income-tax authorities by not showing it in his return as a receipt of interest or revenue income. In his own accounts he reduced the principal by the amount of the disputed receipt and brought over in the next years account only the balance as the principal outstanding. He allowed the income-tax authorities to treat the disputed receipt as a receipt towards the principal. Whatever might be the law applicable to this conduct of his as against his debtors, he was certainly bound by his act as against the income-tax authorities and could not be permitted to turn round and contend, as he does now, that the disputed receipt should be appropriated towards the interest and not towards the principal. However much time might have been at his disposal to make the appropriation as against his debtors, he had to make up his mind and appropriate the disputed receipt towards the principal or the interest when the submitted his return for the assessment year 1936-37. He was obliged to treat the disputed receipt either as receipt of interest or as receipt of principal. If he had treated it as receipt of interest he would have been liable to pay income-tax on it. It suited him in 1936-37 to refrain from paying income-tax for it. He was not sure whether he would get his whole debt back from the brothers and he must have thought it better to treat the disputed receipt as receipt of principal and to escape liability for income-tax. His assessment for 1936-37 cannot now be reopened and that is why he turns round and claims that the disputed receipt was on account of interest and not principal. He must be deemed to have made an appropriation as against the income-tax authorities when he treated the disputed receipt as receipt towards the principal and not towards and not towards the interest and cannot be permitted to make a different appropriation now. There is no substance in his claim that he had a right to appropriate only when he received the bonds from the State of U. P. and that at that time he appropriated the disputed receipt towards the interest. He could not cite any authority in support of his contention that he had a right to make the appropriation when he received the bonds. I do not know what connection there is between the supposed right and the receipt of the bonds. The assessee referred us to Order XXXIV, rule 13, Civil Procedure Code, which reads as follows : (1) Such proceeds shall be brought into court and applied as follows : first, in payment of all expenses.......; secondly, in payment of whatever is due to the prior mortgage on account of the prior mortgage ........; thirdly, in payment of all interest due on account of the mortgage in consequence where of the sale was directed, and of the costs of the suit in which the decree directing the sale was made; fourthly, in payment of the principal money due on account of that mortgage .....; This provision deals with the application of particular proceeds and not proceeds in all execution cases. Rule 12 of Order XXIV is as follows : Where any property the sale of which is directed under this Order in subject to a prior mortgage, the court may, with the consent of the prior mortgagee, direct that the property be sold free from the same, giving to such prior mortgagee the same interest in the proceeds of the sale as he had in the property sold. ;