Interest deduction for borrowings used in tax-free securities was denied, while proportional allocation from a common fund was upheld.

Interest on borrowings used to invest in tax-free securities was held not deductible under Section 8 of the Income-tax Act, 1922, because the deduction for borrowed funds was confined to taxable securities and could not be paired with exemption on the securities themselves. Where a co-operative bank mixed capital and deposits in a common investment fund, and the books did not show any specific attribution, the Tribunal's proportional allocation between capital and deposits was accepted as the appropriate method. The assessee received no relief on either issue, and costs were awarded against it.

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Issues: (i) Whether, under Section 8 of the Income-tax Act, 1922, interest paid on borrowings used to invest in tax-free securities was deductible; (ii) whether, where a co-operative bank mixed capital and deposits and made investments from a common fund, the investments should be treated as made proportionately out of capital and deposits.

Issue (i): Whether, under Section 8 of the Income-tax Act, 1922, interest paid on borrowings used to invest in tax-free securities was deductible.

Analysis: The section and its provisos had to be read as a whole so that the proviso allowing deduction for interest on borrowings applied only where the borrowed money was used for taxable securities. The later provisos exempting tax-free securities removed those securities from the operation of Section 8. A construction that allowed deduction while also enjoying exemption on the securities themselves would create an impermissible double advantage.

Conclusion: The deduction was not available where the borrowed funds were invested in tax-free securities; the issue was answered against the assessee.

Issue (ii): Whether, where a co-operative bank mixed capital and deposits and made investments from a common fund, the investments should be treated as made proportionately out of capital and deposits.

Analysis: The books did not disclose any basis for attributing particular investments exclusively to either capital or deposits. No banking practice or legal presumption required the bank to treat deposits and capital differently for investment purposes. In the absence of a better rule, the equitable approach adopted by the Tribunal was to apportion the investments proportionately between capital and deposits.

Conclusion: The proportional basis of allocation was upheld and the issue was answered in favour of the Revenue.

Final Conclusion: The reference was answered by upholding the Tribunal's approach on both questions, resulting in no relief to the assessee and with costs awarded against it.

Ratio Decidendi: Under Section 8 of the Income-tax Act, 1922, the interest deduction for borrowed money used in investment is confined to taxable securities, and where investments are made from a common fund containing both capital and deposits, a proportional allocation may be adopted in the absence of a more definite basis.

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