TaxTMI 
TaxTMI 
2003 (3) TMI 95
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....ip card allotted to the broker for doing business and his accounts in the books of the BSE were attached/frozen. Being aggrieved by the aforestated two orders, the stock exchange has filed this petition. Facts The petitioner is a stock exchange recognized by the Central Government under the Securities Contracts (Regulation) Act, 1956, and constituted with the main object of protecting, in public interest, the status of brokers, dealers and investors and in order to assist, regulate and control, in public interest, dealings in securities in order to ensure fair dealing, integrity and to protect equitable principles of trade and business. Respondent No. 1 is the Assessing Officer having jurisdiction over income-tax assessment of the broker who was a member of the stock exchange up to June 29, 1994, when he was declared a "defaulter" under the rules. Suresh D. Shah was declared insolvent on November 4, 1997. Respondent No. 5 is the official assignee of the estate and effects of the broker. Respondent No. 2 is the Tax Recovery Officer who has issued the above mentioned prohibitory order dated May 10, 1996, which is impugned in this petition. This prohibitory order has been issued....
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....apportion a part of the amount realised from the auction for the purposes of meeting outstanding income-tax dues. Accordingly, the stock exchange was called upon by the Assessing Officer to issue a cheque in favour of the RBI in respect of outstanding demands. By the said letter, the Assessing Officer further stated that he would be issuing notice under section 226(3) of the Income-tax Act on receiving intimation from the stock exchange regarding auctioning of the membership card. By letter dated October 11, 1995, a reply was given by the stock exchange to the Assessing Officer, inter alia, stating that under rules 5 and 6 of the Bombay Stock Exchange Rules, the membership right was a personal privilege and was, therefore, inalienable. That, under rule 9, on death or default of a member, the right of nomination ceased and vested in the exchange and, consequently, the membership right of Suresh Shah had vested with the exchange when he was declared a defaulter on June 29, 1994. Therefore, the stock exchange regretted its inability to issue its cheque in favour of the Reserve Bank of India towards the outstanding arrears of tax, amounting to Rs. 25,43,651 for the years ending March 3....
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....; Rs. I. Clearing house account : (a) Vallan (settlement account) 16,799 (credit) (b) General charges (expenses) account 63,268 (debit) (c) Defaulters' account 1,98,055 (credit) II. Membership security deposit (securities) 1,37,100 III. Membership security deposit (in cash) 44,000 IV. Interest-free deposit for construction account (for office space)  ....
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....ffidavit, the clearing house of the stock exchange also maintains a clearing house account in the name of the member-broker in which payments made to other members and the amounts received from/paid to the defaulters' committee and realisation of the securities deposited by the members, are reflected. According to the stock exchange, after adjusting the realisations towards liability of the broker to the stock exchange, clearing house, creditor-members and clients, the surplus, if any, is handed over to the broker or to his family members in the event of his death or to the official assignee in the event of the broker being declared insolvent. A statement is handed over by the stock exchange to the court indicating the surplus amount lying with the exchange out of sale proceeds of the nomination right of the defaulter-member and other assets. That statement reads as under : &nb....
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....ehalf of the Department. According to this affidavit, the Tax Recovery Officer had computed the tax arrears of Suresh Shah as on January 31, 2003, and had intimated the same to the Bombay Stock Exchange vide letter dated February 20, 2003, along with a notice under section 226(3) requiring the stock exchange to pay Rs. 87,66,290 to the Income-tax Department out of the money held by the stock exchange for or on account of the broker. By the said affidavit, the above facts were reiterated. In short, the notice under section 226(3), dated February 20, 2003, was in respect of the revised arrears demand. According to this affidavit in reply, the Income-tax Department had a priority claim over other creditors of Suresh Shah and, therefore, it was obligatory on the part of the stock exchange to discharge the liability of the Department towards the tax arrears of Suresh Shah. By the said affidavit, it was pointed out that the stock exchange was holding deposits of Suresh Shah under the following heads, viz., security deposit, margin money, securities deposited by the member, which was in addition to the realised sale proceeds of the membership card of Suresh Shah. Along with this affidavit....
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....ating the debts of the broker to the stock exchange, to the clearing house, etc. the surplus amount lying with the stock exchange, as of today, out of the sale proceeds of the nomination right of the defaulter-member, stood at Rs. 47,85,199.93, which has been kept aside as per the interim order passed by this court. Mr. Dastur further submitted that under the bye-laws, every member was required to pay 5 per cent. to the investors' protection fund and also to the brokers' contingency fund. Therefore, after adjusting further amounts to the investors' protection fund and the brokers' contingency fund as indicated above, the balance surplus payable to the broker/official assignee was Rs. 34,06,680. He contended that this balance surplus lying with the exchange out of the sale proceeds of the nomination rights of the defaulter-member became payable to the broker/official assignee only by virtue of a general body resolution of the stock exchange dated October 13, 1999. That, in the absence of such a resolution, the said amount of Rs. 34,06,680 would not have become payable to the broker/official assignee because the entire sale proceeds of the nomination rights vested in the defaulters' ....
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.... and, therefore, the Tax Recovery Officer was required to specify the particulars of the debt which the broker was not entitled to recover and so also, the Tax Recovery Officer was required to tell the stock exchange that it ought not to pay its debt to the broker. That, without furnishing the particulars of the account, the prohibitory order was bad in law. That, the prohibitory order was vague. That, rule 26 of Schedule II to the Income-tax Act required the Tax Recovery Officer to specify the debt. Mr. Dastur further contended that section 226(3) was different from rule 26 of Schedule II. That section 226(3) contemplates issuance of garnishee notice, whereas rule 26 refers to attachment of debt and, therefore, in the case of section 226(3), the particulars of debt may not be relevant, but in the context of rule 26, particulars of debt owed by the stock exchange to the broker needs to be specified and since it has not been specified, the prohibitory order is bad in law. According to learned counsel, in this case section 226(3) has not been invoked. Mr. Dastur further contended that section 226(3) is one of the modes of recovery just as attachment under rule 26 is also a mode of re....
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....editor-members as also admitted claims of the clients is credited to the funds of the exchange. However, the exchange, in the general body meeting at its absolute discretion, may direct that the surplus be disposed of or applied in such other manner as it may deem fit in terms of rule 16 of the Stock Exchange Rules. That the governing body, in its meeting held on August 27, 1999, had considered the matter and it recommended to the general body to pass an appropriate resolution to give 90 per cent. of the surplus consideration realised from the auction of the membership right to the defaulter as ex gratia payment, after appropriating 5 per cent. of the surplus towards the customers protection fund (now known as the investors' protection fund) and 5 per cent. of the surplus amount towards the brokers' contingency fund. Mr. Dastur, therefore, submitted that the balance surplus (ex gratia payment) was required to be handed over to the broker and in the present case, the stock exchange has no objection to hand over the said amount either to the official assignee or to the Income-tax Department as the court may direct. Mr. Dastur contended that the stock exchange has no objection to pay ....
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....ply furnishing details of the various accounts of the defaulter in the books of the stock exchange has been given and, ultimately, therefore, the Tax Recovery Officer passed the prohibitory order on May 10, 1996, attaching the membership card allotted to the defaulter for doing business and all accounts of the broker in the books of the stock exchange. He contended that in such circumstances, it is not open to the stock exchange to argue that the impugned prohibitory order was bad for want of particulars of the debt, which has been attached under rule 26 of Schedule II. He contended that under the above circumstances, the Tax Recovery Officer was justified in issuing the impugned prohibitory order, restraining the stock exchange from dealing with all accounts of the broker in the books of the stock exchange. He contended that there is no denial that brokers' accounts existed in the books of the stock exchange. He contended that in the light of the prohibitory order dated May 10, 1996, the BSE was not entitled to distribute any amount. That in the light of the prohibitory order, the BSE was not entitled to liquidate the liability of the broker to the stock exchange, to the clearing ....
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....no reason for leaving the entire sale proceeds distribution to the stock exchange. He contended that there is no reason why the Income-tax Department should be at the mercy of the stock exchange in the matter of distribution of such sale proceeds. That, in any event, the stock exchange was required to give priority to the claims of the Income-tax Department vis-a-vis other claims of the BSE, clearing house, creditor-members, etc. Mr. R. V. Desai contended that, notwithstanding the priority given in rule 16, the Government dues must be paid first in point of time. Mr. Desai contended that there is no merit in the argument of the stock exchange that on declaration of a broker as a defaulter, all his assets under the above accounts vest in the stock exchange. Mr. Desai contended that even according to the stock exchange, the balance surplus out of the sale proceeds of the nomination rights of the defaulter member is payable to the broker and, consequently, he submitted that the membership card was the property of the broker-member. He contended that if the membership card was only a privilege, then on forfeiture of that card on the member being declared defaulter, nothing was payab....
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....ded that such realised value was attachable under rule 26 of Schedule II to the Act. He contended that under the rules, a member could be expelled by the stock exchange and on expulsion, his rights stood forfeited. He contended that in cases where a member surrendered his card or in cases where the member was expelled, there was forfeiture. He contended that under the rules, in a matter of distribution, the realised value on auction of the membership card was treated as a receipt by the stock exchange on behalf of the member and it is for this reason that the stock exchange maintains a separate defaulters' account under which the stock exchange treats the sale proceeds as belonging to the member and, accordingly, the rules provide for distribution, allocation and payment of liability on behalf of the broker by the stock exchange. That, such sale proceeds are applied to discharge the liability of the member-broker to the stock exchange ; to the clearing house and to other creditor-members with whom the defaulter had entered into various contracts. Therefore, it was argued that the sale proceeds of the nomination rights of the defaulter-member belong to the member and it was certainl....
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....mitted that credit balances in the security deposit account of the broker, margin money account, security account and credit balance in the defaulter's account were all attachable in addition to the auction proceeds. Mr. Desai contended that in this case, the Income-tax Department is not going to attach the investors' protection fund, the, brokers contingency fund and the trade guarantee fund on the ground that credit balances in those accounts belong to the stock exchange. That, the Department seeks to attach the funds of the broker in the hands of the stock exchange and that they do not seek to attach funds belonging to the stock exchange. In rejoinder, Mr. Dastur appearing on behalf of the stock exchange contended that the Bombay Stock Exchange was for a charitable purpose. That the object of the Bombay Stock Exchange was to maintain public confidence. That, the stock exchange plays a very important role in the development of the economy. That the stock exchange protects the rights of the investors also. That, at the end of the settlement period, every broker's account with the stock exchange needs to be adjusted and settled. That, in cases where the brokers fail to discharge th....
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....rivilege. He contended that, that privilege belongs to the stock exchange, but it is conferred to the broker. That, when the broker is declared a defaulter, that privilege vests in the stock exchange and, therefore, the sale proceeds from auction of that privilege cannot have a different character. Mr. Dastur further contended that under the rules and the bye-laws there is a distinct dichotomy between distribution of the sale proceeds of the membership card and distribution qua the credit balances in various accounts of the brokers in the books of the Bombay Stock Exchange. He contended that in the case of distribution of sale proceeds of the nomination rights, the balance surplus ordinarily vests in the stock exchange, but as a matter of exception, in view of the resolution of the general body meeting, such balance surplus is paid over to the broker, whereas in the case of credit balances in the accounts of the broker in the books of the stock exchange, the balance surplus is automatically handed over to the broker and in such cases, the resolution of the general body is not required. He, however, contended that the judgment of the Supreme Court in the case of Stock Exchange, A....
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....ity is given to the Income-tax Department over the first lien in favour of the stock exchange, then the BSE would not be able to secure performance of the obligations by the broker-members and further, the confidence of the public in the stock exchange would be shattered, particularly in cases where huge demands of exaggerated nature are sometimes made by the Income-tax Department. Under the circumstances, he contended that the lien of the stock exchange must be satisfied first in point of time, prior to the satisfaction of the dues of the Income-tax Department. It is for this reason that under rule 44 it is declared that after the stock exchange exercises its lien and after liquidating the liability for which the lien is created, the surplus would go to the members. Mr. Dastur contended that rule 16 deals with sale and distribution of the sale proceeds of the defaulter's card, whereas rules 43 and 44 deal with other security. That, in the case of rule 16, the balance surplus is handed over to the broker in terms of the resolution of October, 1999, but that does not apply to distribution of balance surplus in the case of other securities. Mr. Dastur contended that under rule 326, t....
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....ould be handed over by the stock exchange, either to the Official Assignee or the Department as the court may direct under rule 43. That, in the case of other securities, the balance surplus is payable under rule 43 and rule 44 to the broker. Therefore, in such an eventuality, such balance surplus could be paid to the Official Assignee or to the Department, as the court may direct and in such cases, there was no need for a resolution. Consequently, Mr. Dastur submitted on the facts of this case that the BSE would hand over the balance surplus amounting to Rs. 35,60,218 plus realised value of the securities as and when those securities are sold, either to the Official Assignee or to the Department, as this court directs. Scope of rules and bye-laws framed by the BSE : The main object of establishing the BSE is to support and protect in public interest the character and status of brokers and dealers and to further the interest both of brokers and dealers and of public interested in securities and to assist, regulate and control, in public interest, dealings in securities in order to maintain high standards of commercial honour and integrity and to inculcate just and equitable p....
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...., which dealt with appropriation of surplus amount of consideration of the membership right vested in the exchange. In the said AGM, the general body of the BSE has accepted the recommendation of the governing board of the BSE that such surplus amount, after paying the dues and liabilities under rule 16, shall be appropriated in the manner mentioned in the minutes of the AGM. As per the said resolution, after deducting 5 per cent. of the surplus for the customers' protection fund and 5 per cent. of the surplus for the brokers' contingency fund, the residual 90 per cent. of the surplus was to be paid as ex gratia amount to the defaulter. Under rule 16A, when the governing board has exercised the right of nomination in respect of the membership which has vested in the BSE on the member being declared a defaulter then the consideration received shall be paid by the governing board to the defaulters' committee to be applied for the purposes and in the order of priority specified in the bye-laws of the exchange. Rule 16 is required to be read with bye-law Nos. 338, 342, 342A and 400. Byelaw No. 338 lays down that the defaulters' committee shall keep a separate account in respect of moni....
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....h a security either in the form of cash or in the form of deposit receipt of a bank or in the form of securities approved by the governing board and every such member has to maintain the value of such securities at not less than Rs. 2 lakhs by providing further security to the satisfaction of the governing board. Rule 43 provides for a lien. Rule 43 lays down that the security provided by the member under rule 37 shall be subject to a paramount lien for any sum due to the exchange or to the clearing house and for due fulfilment of his engagements, obligations and liabilities which may accrue to a member out of bargains, dealings, transactions and contracts made as per the rules and bye-laws. Under rule 44, on termination of membership, the security shall be returned. Rule 53 falls under the Chapter "Default and Re-admission to Membership". It lays down that a member who is declared a defaulter shall cease to be a member of the exchange and he shall cease to enjoy rights and privileges of membership but the rights of his creditor-members against him shall remain unimpaired. Under rule 170(a)(ii), the governing board shall every year appoint a defaulters' committee. Under bye-law No.....
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....hile right of membership as the same does not belong to the defaulter and the defaulter has no right, title or interest therein. Therefore, when it comes to distribution of the consideration received by the Governing Board for exercising the right of nominating the surplus, if any, belongs to the BSE and, therefore, the exchange has a right to dispose of the surplus in the manner it deems fit. However, the exchange has no such right when it comes to distribution of surplus arising on the sale of the defaulter's other assets. This is the basic contention advanced on behalf of the BSE on the above rules. Scope of section 226(3)(i) and (x) read with section 222 to section 225 read with rule 26 of Schedule II to the Income-tax Act, 1961 In this case, we are concerned with the period after April 1, 1989. Section 222 to section 226 fall in Chapter XVII of the Income-tax Act, which deals with collection and recovery. Section 226 falls under the caption "Other modes of recovery". Section 226(1), inter alia, provides that where no certificate has been drawn up under section 222, the Assessing Officer may recover the tax by any one or more of the modes provided in section 226. Section ....
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.... of a defaulter by name, Mukesh Kothari. On reading that account, the applicability of the rules bye-laws is demonstrated. It shows that the deposits made by the brokers for car parking, office space, etc., stands transferred to his defaulter's account and similarly, the amount of credit balance of interest on defaulter's account stands transferred to the defaulter's account. In short, under the rules, on vesting, the defaulters' committee shall call in and realise the security, margin money and securities deposited by the defaulter and recover all monies, securities and other assets due, payable or deliverable to the defaulter by any other member in respect of the transaction/dealing made under the rules/bye laws and such assets shall vest in the defaulters' committee for the benefit and on account of the creditors-members (see rule 36). Bye-law No. 400 deals with application of the defaulter's assets. In other words, bye-law No. 326 read with bye-law No. 400 deals with the defaulter's assets, other than the membership card which, as held by the Supreme Court, belongs to the BSE. In this case, we are concerned with the former under Issue No. 2. However, the rules and the accounts ....
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....ceived by the stock exchange on the exercise of the right of nomination vesting in it, is to be applied in the manner provided in rule 16. A card of membership of the BSE cannot be sold for the benefit of the creditors of a member on his becoming bankrupt. In the case of Official Assignee of Bombay v. K. R. P. Shroff [1931] 1 Comp Cas 371 (Bom); AIR 1931 Bom 225, it has been held by the Bombay High Court that under the rules of the stock exchange, the member has got, by virtue of membership, the privilege of going to the exchange and dealing in the exchange, but there is no power in the member to sell that right. That, if he is in default, the directors of the association can cancel his membership and they can sell thereafter, the right of nomination to the vacant seat and they must deal with the proceeds under the rules of the stock exchange, but the defaulting-member takes no interest in such sale proceeds. Therefore, the insolvent has no right of property therein, which can be said to vest on his insolvency, in the Official Assignee. In that case, it has been held that the BSE was merely a voluntary association resembling a members' club and formed in order to see that its me....
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....ained debt in the hands of the garnishee (BSE) due to the assessee-broker or existence of a contractual relationship between broker and the BSE consequent upon which, money is likely to come in the hands of the garnishee for and on behalf of the assessee-broker. Therefore, even if the broker-member has no right, title and interest in the membership card, still in view of rule 16(1)(iii) of the stock exchange rules, the balance surplus would become payable to the Tax Recovery Officer as the said amount came into the hands of BSE for and on behalf of the assessee-broker in the course of administration of assets and allocation under rule 16(1)(iii) read with the general body resolution, dated October 13, 1999. This balance surplus comes to Rs. 34,06,680. Therefore, we are directing this amount of balance surplus to be paid over by the BSE to the Tax Recovery Officer as per the impugned show cause notice under section 226(3)(i). Findings on issue No. 2 : It has been urged vehemently on behalf of the BSE that when the broker-member becomes a defaulter, the security, margin money and securities deposited by the defaulter and all monies, securities and other assets due, payable or d....
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....ing various accounts of the defaulting broker in the books of the BSE. The Tax Recovery Officer had called upon the BSE to furnish the particulars of those accounts. The Tax Recovery Officer also called upon the BSE to furnish the particulars of its liability to the broker. However, those particulars were not given which resulted in the Tax Recovery Officer issuing prohibitory orders. When the matter came before the court, the court directed the BSE to file an affidavit giving particulars of the accounts maintained by the defaulter-broker in the books of the BSE and the clearing house as also the credit balance standing in each of those accounts on May 10, 1996, i.e., on the date when the impugned prohibitory order came to be issued. Pursuant to the directions of the High Court, an affidavit came to be filed by the BSE under which it has been disclosed that the credit balance in the settlement account on May 10, 1996, was Rs. 16,799 and an amount of Rs. 1,98,055 was the credit balance in the defaulter's account on May 10, 1996. Similarly, securities worth Rs. 1,37,100 were available with the BSE on May 10, 1996, under the membership security deposit account, whose value stood at Rs....
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....ating the liability of the defaulting broker to the stock exchange, the clearing house and other members, surplus, if any, shall be paid to the defaulter and since the said surplus is payable to the defaulter, if the court directs, it will be paid to the Tax Recovery Officer. Therefore, the BSE under bye-law No. 400 keeps out the Crown debts from administration of assets. We do not find any merit in this part of the case of the BSE. Rule 5 to rule 16 fall under the Chapter "Membership". Rule 16, as stated above, deals with the application of sale proceeds of the nomination rights of the defaulter-member. Rule 36 to rule 44 read with bye-law No. 326, bye-law 7 No. 342 and bye-law No. 400 deal with security, margin money and securities deposited by the defaulter, recovery of all receivables on behalf of the defaulting-broker ; and application of those assets to liquidate the liability of the defaulting-broker to the BSE, the clearing house and other members. Therefore, there is a clear dichotomy under the rules and bye-laws between the sale of membership card and recovery of defaulter's other assets and application thereof. In our view, even on vesting of such other assets in the ....
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....ds. The common law doctrine states that if the debts due to the Crown are of equal degree to the debts due to a private citizen then the Crown must have a priority against the private citizen. Therefore, debts due to the State are entitled to a priority over all other debts, Section 73 of the Civil Procedure Code, comes under Chapter XXI, Civil Procedure Code, which deals with distribution of assets. Chapter XXI deals with proceeds of execution sale to be rateably distributed amongst the decree holders under section 73 of the Civil Procedure Code. In our view, therefore, the rules and bye-laws of the BSE will not override section 73(3) of the Civil Procedure Code, and the debts due to the Government would be entitled to priority over the dues due to the stock exchange, the clearing house and other members under the rules/bye-laws of the BSE. If the argument of the BSE is to be accepted it would lead to total obliteration of the concept of priority of Government dues. As stated hereinabove, under bye-law No. 400, the assets of the defaulting-broker are applied to liquidate his liabilities to the BSE, the clearing house and other creditor members and if there is no surplus under thos....
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....ld be total disruption in the function of various funds which, in turn, would have an adverse effect on the working of the stock exchange. In support of this argument numerous authorities were relied upon. However, at the outset, we may point out that none of those authorities deal with the priority given to the Crown debts vis-a-vis liability of the broker under rules and bye-laws of the BSE. In this matter, we are not concerned with the validity of the rules/bye-laws of the BSE. In the case of Vinay Bubna v. Mumbai Stock Exchange [1999] 97 Comp Cas 874 (SC), the facts were as follows. On May 10, 1995, a sum of Rs. 21,81,635.50 was due and payable by the share broker. However, the payment was not made. Therefore, Vinay Bubna filed an arbitration petition against the share broker before the Bombay High Court. In the said proceedings an application was filed for appointment of court receiver. The court did not grant to the appellant any relief in respect of the membership card of the share broker on the ground that the membership card was not a property of the broker. The broker was declared a defaulter under the rules/ bye-laws of the stock exchange on December 10, 1996, and therea....
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....orders under the Income-tax Act. Therefore, the tenant filed an application before the court seeking a direction as to whom the rent should be paid to. The learned single judge held that the effect of the order of the court in the final decree amounted to creating a charge in favour of the judgment-creditor and, therefore, he negatived the claim of the Income-tax Department for priority on the ground that the Crown debt had priority over other debts. The matter came before the High Court, which took the view that under the decree, a charge had been created over the rent and mesne profits to be realised from the mortgaged property in favour of the judgment-creditor and the judgment-creditors could not be said to be creditors of equal degree and, therefore, the State dues could not have priority over the rights of the judgment-creditor. In our view the judgment of the Gujarat High Court has no application. In that matter, the High Court found creation of a charge over rent and mesne profits in favour of the judgment-creditor and, therefore, the High Court found that the judgment-creditor could not be said to be creditors of equal degree vis-a-vis the State. It was a case where the pr....