Capital gain tax liability on sale of mortgaged asses by the bank and adjustment of sale proceeds against the loan

 

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:

“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 instalments and the assessee complied with the repayment schedule and repaid the loan till July 2009. However, assessee became a defaulter from August 2009 onwards.

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

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

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

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

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 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 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

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

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;

(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

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

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

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.

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

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

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

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

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)

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

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,

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

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

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

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”.

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

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

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.

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;

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, 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.

(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
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
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,

(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.

(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

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 thi