The Stock Exchange, Bombay vs. V.S. Kandalgaonkar & Ors. (2014) 368 ITR 296 (SC)
By a notice dated 29th June 1994, the Stock Exchange, Bombay declared one Shri Suresh Damji Shah as a defaulter with immediate effect as he had failed to meet his obligations and discharge his liabilities. By a notice dated 5th October 1995 issued u/s. 226 (3) of the Incometax Act, the Income-tax Department wrote to the Stock Exchange and told them that Shri Shah’s membership card being liable to be auctioned, the amount realised at such auction should be paid towards Income-tax dues of Assessment Year 1989-90 and 1990-91 amounting to Rs.25.43 lakh. The Stock Exchange, Bombay by its letter dated 11th October, 1995 replied to the said notice and stated that under Rules 5 and 6 of the Stock Exchange the membership right is a personal privilege and is inalienable. Further, under Rule 9 on death or default of a member his right of nomination shall cease and vest in the Exchange and accordingly the membership right of Shri Shah has vested with the Exchange on his being declared a defaulter. This being the case, since the Exchange is now and has always been the owner of the membership card, no amount of tax arrears of Shri Shah are payable by it. By a prohibitory order dated 10th May, 1996, the Incometax Department prohibited and restrained the Stock Exchange from making any payment relating to Shri Shah to any person whomsoever otherwise than to the Incometax Department. The amount claimed in the prohibitory order was stated to be Rs. 37.48 lakh plus interest. On 18th July, 1996, the Solicitors of the Stock Exchange, Bombay wrote to the Income-tax Department calling upon them to withdraw the prohibitory order dated 10th May, 1996 in view of the fact that the membership right of the Exchange is a personal privilege and is inalienable. By a letter dated 27th December, 1996, the Tax Department wrote back to the Bombay Stock Exchange refusing to recall its prohibitory order. Meanwhile, Shri Shah applied to be re-admitted to the Stock Exchange which application was rejected by the Stock Exchange on 13th February, 1997.
The Stock Exchange then filed a Writ Petition being Writ Petition No. 220 of 1997 dated 24th December, 1997.
By a judgment dated 27th March 2003, most of the contentions of the Stock Exchange were rejected and the Writ Petition was dismissed.
The judgment set out two main issues which according to it arose for determination. They were:
[A] Whether, on the facts and circumstances of this case, the TRO was right in attaching the sale proceeds of the nomination rights of the Defaulter-Member. If not, whether the TRO was entitled to attach under Rule 26(1) of Schedule–II to the Income-tax Act, the Balance Surplus amount lying with BSE out of the sale proceeds of the nomination rights of the Defaulter-Member under rule 16(1)(iii) framed by BSE r/w the Resolution of the General Body of BSE dated 13-10-1999?
[B] Whether deposits made by the Defaulting Member under various Heads such as Security Deposit, Margin Money, Securities deposited by Members and Others are attachable u/s. 226(3)(i)(x) read with Rule 26(1)(a)(c) of Schedule-II to the Income-tax Act?
Issue A was answered by saying that though a defaulting member had no interest in a membership card and that the Income-tax Department was not right in attaching the sale proceeds of such card, still money which is likely to come in the hands of the garnishee, that is the Bombay Stock Exchange, for and on behalf of the assessee is attachable because the requisite condition is the subsistence of an ascertained debt in the hands of the garnishee which is due to the assessee, or the existence of a contractual relationship between the assessee and the Stock Exchange consequent upon which money is likely to come in the hands of the garnishee for and on behalf of the assessee.
Issue B was answered by saying that even on vesting of all the assets of the assessee in the defaulter’s committee, all such assets continued to belong to the assessee. Section 73(3) Civil Procedure Code mandates that Government debts have a priority and that being so they will have precedence over other dues. It was further held that the lien that the Stock Exchange may possess under Rule 43 does not make it a secured creditor so that debts due to the Income-tax Department would have precedence.
The judgment then went on to say:
“11. To sum up, we hereby declare:
(a) That, the Other Assets (as described in Issue B hereinabove) are attachable and recoverable under provisions of section 226(3)(i)(x) read with Rule 26(1) (a)(c) of Schedule-II to the Income Tax Act.
(b) That, the Government and Other Creditors such as BSE, the Clearing House and Other Creditor-Members under Rules and Bye-laws of the Stock Exchange are creditors of equal degree and u/s. 73(3), Civil Procedure Code, the Government dues shall have priority over other such creditors.
(c) That, in the matter of application of Defaulters’ Asset under bye-law 400, the Defaulters’ Committee shall give priority to the debt due to the Government and the balance, if any, shall be distributed in terms of the Bye-laws 324 alongwith Byelaw 400 of the BSE.
(d) That, a sum of Rs. 34,06,680 representing Balance Surplus lying with the Exchange out of sale proceeds of the nomination rights of the Defaulter-Member is attachable under the above provisions of the Income -tax Act read with Rule 16 of the BSE Rules and consequently, the said amount is directed to be paid over to the TRO under the impugned Prohibitory Order.
(e) We hereby direct the BSE also to hand the securities lying in Members Security Deposit Accounts to the TRO, who would be entitled to sell and appropriate the sale proceeds towards the claim of the Income-tax Department against the Defaulting Broker-Member. If the TRO so direct, those securities could also be sold by BSE and the realised value, on the date of the sale, could be handed over to the TRO. It is for the TRO to decide this point. We further direct credit balance its the Clearing House of Rs. 1,53,538/- to be paid over to the TRO and that the TRO would be entitled to appropriate the said amount towards the dues of the Department. In short, we are directing BSE to pay a sum of Rs. 35,60,218/- to the TRO and in addition thereto, the TRO would be entitled to the realised value of the Securities as on the date of sale. In this case, the Prohibitory Order is before the date of insolvency of the Broker concerned.
(f) In future, the principles laid down by this judgment should be followed by BSE and the TRO would to attach such Other Assets and appropriate the amounts towards its claim under the Income Tax Act.”
A Special Leave Petition was filed against the said judgment being SLP(Civil) No. 8245 of 2003 in which, by an order dated 7th May 2003, the operation of the judgment was not stayed to the extent that it specifically directed the petitioner to make certain payments and handover securities to the Income-tax Department. However, in so far as the judgment declared law, the operation of such declaration of law was stayed.
The Counsel appearing on behalf of the Stock Exchange made essentially three submissions:
(i) By virtue of the judgment in Stock Exchange, Ahmedabad vs. Asstt. Commisioner of Income Tax, Ahmedabad, [(2001) 248 ITR 209 (SC)], the sale proceeds of a membership card and the membership card itself being only a personal privilege granted to a member cannot be attached by the Income-tax Department at any stage. The moment a member is declared a defaulter all rights qua the membership card of the member cease and even his right of nomination vests in the Stock Exchange. The High Court was therefore not correct in saying that though a membership card is only a personal privilege and ordinarily the Income-tax Department cannot attach the sale proceeds, yet since these amounts came into the hands of the Stock Exchange for and on behalf of the assessee they were attachable.
(ii) On conjoint reading of Rule 38 and 44 it was argued that all securities in the form of shares that are given by a member shall be transferred and held either in the name of the trustees of the Stock Exchange or in the name of a Bank which is approved by the Governing Board. By operation of Rule 44, on termination of the membership of a broker, whatever remains by way of security after clearing all debts has to be “transferred” either to him or as he shall direct or in the absence of such direction to his legal representatives. The argument therefore is that what is contemplated is a transfer of these shares by virtue of which the member ceases to be owner of these shares for the period that they are “transferred” and this being so, the Income- tax Department cannot lay their hands on these shares or the sale proceeds thereof as the member ceases to have ownership rights of these shares.
(iii) It was also argued that by virtue of Rule 43, the Stock Exchange has a first and paramount lien for any sum due to it, and that this made it a secured creditor so that in any case income tax dues would not to be given preference over dues to secured creditors.
The Supreme Court dealt with each one of the contentions and held as under:
Re.: (1)
A reading of Rules 5 and 9 lead to the conclusion that a membership card is only a personal permission from the Stock Exchange to exercise the rights and privileges that may be given subject to Rules, Bye-Laws and Regulations of the Exchange. Further, the moment a member is declared a defaulter, his right of nomination shall cease and vest in the Exchange because even the personal privilege given is at that point taken away from the defaulting member.
Further, the rules and the bye-laws also make this clear. Under Rule 16(iii), whenever the Governing Board exercises the right of nomination in respect of a membership which vests in the Exchange, the ultimate surplus that may remain after the membership card is sold by the Exchange comes only to the Exchange – it does not go to the member. This is in contrast with bye-law 400 (ix) which, deals with the application of the defaulting member’s other assets and securities, and in this case ultimately the surplus is paid only to the defaulting member, making it clear that these amounts really belonged to the defaulting member.
The conclusion of the High Court that the proceeds of a card which has been auctioned can be paid over to the Income-tax Department for the dues of the member by virtue of Rule 16 (iii) is incorrect as such member at no point owns any property capable of attachment, as has been held in the Ahmedabad Stock Exchange case(supra).
Re: (2)
Rules 36 to 46 belong to a Chapter in the Rules entitled “Membership Security”. Rule 36 specifies that a new member shall on admission provide security and shall maintain such security with the Stock Exchange for a determined sum at all the times that he carries on business. Rule 37 deals with the form of such security and states that it may be in the form of a deposit of cash or deposit receipt of a Bank or in the form of security approved by the Governing Board. Rule 38 deals with how these securities are held. Rule 41 enables the member to withdraw any security provided by him if he provides another security in lieu thereof of sufficient value to the satisfaction of the Governing Board. Rule 43 states that the security provided shall be a first and paramount lien for any sum due to the Stock Exchange and Rule 44 deals with the return of such security under certain circumstances. On a conjoint reading of these Rules what emerges is as follows:
(i) The entire Chapter deals only with security to be provided by a member as the Chapter heading states;
(ii) The security to be furnished can be in various forms. What is important is that cash is in the form of a deposit and securities are also “deposited” with the Stock Exchange under Rule 37;
(iii) Rule 38 which is crucial provides how securities are to be “held” which is clear from the marginal note appended to it. What falls for construction is the expression “securities shall be transferred to and held”. Blacks Dictionary defines “transfer” as follows:
“Transfer means every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor’s equity of redemption.”
It is clear therefore that the expression “transfer” can depending upon its context mean transfer of ownership or transfer of possession. It is clear that what is transferred is only possession as the member only “deposits” these securities. Further, as has been held in Vasudev Ramchandra Shelat vs. Pranlal Jayanand Thakur & Ors., 1975 (2) SCR 534 at 541, a share transfer can be accomplished by physically transferring or delivering a share certificate together with a blank transfer form signed by the transferor. The transfer of shares in favour of the Stock Exchange is only for the purposes of easy liquidity in the event of default.
(iv) The expression “transferred” must take colour from the expression “lodged” in Rule 38 when it comes to deposits of cash. Understood in this sense, transfer only means delivery for the purposes of holding such shares as securities;
(v) This is also clear from the language of Rule 38 when it says “such deposit shall be entirely at the risk of the member providing the security ………..” Obviously, first and foremost the cash lodged and the shares transferred are only deposits. Secondly, they are entirely at the risk of the member who provides the security making it clear that such member continues to be the owner of the said shares by way of security for otherwise they cannot possibly be at the member’s risk;
(vi) Under Rule 41 a member may withdraw any security provided by him if he satisfies the conditions of the Rules. This again shows that what is sought to be withdrawn is a security which the member owns;
(vii) By Rule 43 a lien on securities is provided to the Stock Exchange. Such lien is only compatible with the member being owner of the security, for otherwise no question arises of an owner (the Stock Exchange, if the Counsel is right) having a lien on its own moveable property;
(viii) Therefore, when Rule 44 speaks of repayment and transfer it has to be understood in the above sense as the security is being given back to the member under the circumstances mentioned in the Rule;
(ix) Bye-law 326 and 330 also refer to securities that are “deposited” by the defaulter and recovery of securities and “other assets” due. Obviously, therefore, securities which are handed over to the exchange continue to be assets of the member which can be liquidated on default.
(x) The Counsel’s argument would also create a dichotomy between “cash lodged” and Bank Deposit Receipts and securities “transferred.” The form a particular security takes cannot possibly lead to a conclusion that cash lodged, being only a deposit, continues to belong to the member, whereas Bank Deposit Receipts and securities, being “transferred” would belong to the Stock Exchange.
Though the judgment in Bombay Stock Exchange vs. Jaya I. Shah [(2004) 1 SCC 160] had no direct application to the facts it did held that after the assets of the defaulting member are pooled together and amounts are realized, the payments that would be made from such pool would be from the assets of the defaulting member. To that extent, therefore, the aforesaid judgment reinforces what has been stated above.
Re: (3)
The first thing to be noticed is that the Income Tax Act does not provide for any paramountcy of dues by way of income tax. This is why the Court in Dena Bank’s case [(2001) 247 ITR 165 (SC)] held that Government dues only have priority over unsecured debts and in so holding the Court referred to a judgment in Giles vs. Grover (1832)(131) English Reports 563 in which it has been held that the Crown has no precedence over a pledgee of goods.
In the present case, the common law of England qua Crown debts became applicable by virtue of Article 372 of the Constitution which states that all laws in force in the territory of India immediately before the commencement of the Constitution shall continue in force until altered or repealed by a competent legislature or other competent authority. In fact, in Collector of Aurangabad and Anr. vs. Central Bank of India and Anr. [(1968 21 STC 10 (SC)] after referring to various authorities held that the claim of the Government to priority for arrears of income tax dues stems from the English common law doctrine of priority of Crown debts and has been given judicial recognition in British India prior to 1950 and was therefore “law in force” in the territory of India before the Constitution and was continued by Article 372 of the Constitution (at page 861, 862).
In the present case, the lien possessed by the Stock Exchange makes it a secured creditor. That being the case, it is clear that whether the lien under Rule 43 is a statutory lien or is a lien arising out of agreement does not make much of a difference as the Stock Exchange, being a secured creditor, would have priority over Government dues.
The Supreme Court answered the three issues as above. The Supreme Court allowed the Stock Exchange’s appeal and the set aside the impugned judgment passed by the Division Bench of the Bombay High Court.
