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Issues: (i) Whether a valid charge or mortgage was created by the deed of hypothecation trust dated 1 August 1981. (ii) Whether part of the interest on fixed deposits received from the public was liable to be disallowed under section 40A(8) of the Income-tax Act, 1961.
Issue (i): Whether a valid charge or mortgage was created by the deed of hypothecation trust dated 1 August 1981.
Analysis: The deposits were secured by a second charge over the company's fixed assets, the transaction was sanctioned by corporate resolution, and the charge was registered under the Companies Act. The absence of registration under the Indian Registration Act did not, on the facts, negate the existence of a charge. A charge could be created orally or inferred from the conduct of the parties, and the written deed was not the sole source of the security arrangement.
Conclusion: A valid charge was created, in favour of the assessee.
Issue (ii): Whether part of the interest on fixed deposits received from the public was liable to be disallowed under section 40A(8) of the Income-tax Act, 1961.
Analysis: Once the borrowings were secured by a valid charge on the company's assets and the statutory requirements for exclusion from the definition of deposit were satisfied, the amounts could not be treated as deposits attracting disallowance under section 40A(8). The security arrangement brought the case within the relevant exclusion for secured loans.
Conclusion: No part of the interest was disallowable, in favour of the assessee.
Final Conclusion: The reference was answered for the assessee on both questions, and the disallowance under section 40A(8) was held to be unsustainable.
Ratio Decidendi: For purposes of section 40A(8), a loan is not treated as a deposit where a valid charge on company assets exists, and such charge may be established by the parties' conduct and corporate acts even if the hypothecation deed is not registered under the Indian Registration Act.
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