Vildirect: IncomeTax-caselaws-2003-VIL-346-BOM-DT

2003-VIL-346-BOM-DT

Equivalent Citation: [2003] 261 ITR 577, 181 CTR 30, 129 TAXMANN 237, [2003] 44 SCL 254 (BOM.)

BOMBAY HIGH COURT

WRIT PETITION NO. 220 OF 1997

Date: 27.03.2003

STOCK EXCHANGE, MUMBAI

VS. KANDALGAONKAR AND OTHERS.

BENCH

Judge(s) : S. H. KAPADIA., J. P. DEVADHAR.

JUDGMENT

The judgment of the court was delivered by

S. H. KAPADIA J. -By this petition, the Stock Exchange, Mumbai, seeks to challenge a notice under section 226(3) of the Income-tax Act, 1961, dated October 5, 1995, as also a prohibitory order dated May 10, 1996, under section

222 of the Income-tax Act served on the petitioner whereby the stock exchange is restrained from making any payment of the debt due to Suresh Shah, member-broker on the Bombay Stock Exchange (the BSE), on the ground that the said broker had failed to pay arrears of income-tax amounting to Rs. 37,48,651. In other words, the Bombay Stock Exchange is the garnishee who is prohibited from making payment of the debt to the assessee in default-Suresh D. Shah. Under the said prohibitory order dated May 10, 1996, the stock exchange membership card allotted to the broker for doing business and his accounts in the books of the BSE were attached/frozen. Being aggrieved by the aforestated two orders, the stock exchange has filed this petition.

Facts

The petitioner is a stock exchange recognized by the Central Government under the Securities Contracts (Regulation) Act, 1956, and constituted with the main object of protecting, in public interest, the status of brokers, dealers and investors and in order to assist, regulate and control, in public interest, dealings in securities in order to ensure fair dealing, integrity and to protect equitable principles of trade and business. Respondent No. 1 is the Assessing Officer having jurisdiction over income-tax assessment of the broker who was a member of the stock exchange up to June 29, 1994, when he was declared a "defaulter" under the rules. Suresh D. Shah was declared insolvent on November 4, 1997. Respondent No. 5 is the official assignee of the estate and effects of the broker. Respondent No. 2 is the Tax Recovery Officer who has issued the above mentioned prohibitory order dated May 10, 1996, which is impugned in this petition. This prohibitory order has been issued pursuant to certificates forwarded to the broker under section 222 of the Income-tax Act. The said broker failed to pay arrears of income-tax due from him under a certificate, dated March 29, 1996, amounting to Rs. 37,48,651. Since the broker had failed to meet his obligations and discharge his liabilities, the Governing Board of the Stock Exchange declared Suresh Shah a defaulter at a meeting held on June 29, 1994. On December 28, 1994, Suresh Shah made an application for re-admission as a member. Along with his application, he forwarded to the stock exchange, a demand draft for Rs. 30 lakhs towards his dues to the stock exchange, dues to the clearing house, dues to his clients and dues in respect of arbitration allowance. The petition was filed around December 24, 1996. Apart from the demand draft of Rs. 30 lakhs, on the date when Suresh Shah was declared a defaulter, a sum of Rs. 1,41,241 was lying in the petitioner's defaulters' committee account. It may be noted that investigations were carried out by the defaulters' committee of the stock exchange, both in respect of the conduct of the broker and his application for re-admission and during the interregnum, out of Rs. 30 lakhs, Rs. 9,93,594 were appropriated towards broker's liability for Vallan and general charges and a sum of B Rs. 18,65,165 was paid to the members on account of arbitration allowance obtained by them against the broker. On the date of the filing of the petition, therefore, Rs. 1,41,241 remained to be appropriated against dues on account of arbitration awards obtained by the members, the claim of members pending in arbitration, arbitration awards obtained by the clients of the said broker and claims of the clients pending in arbitration. In short, as against Rs. 1,41,241 and securities valued at Rs. 95,435, lying with the stock exchange, arbitration awards to the extent of Rs. 67,93,000 remained to be discharged. This was apart from claims pending in arbitration, amounting to Rs. 11,41,575 as on December 19, 1996.

By letter dated October 5, 1995, the Assessing Officer informed the stock exchange that since the broker was declared a defaulter by the stock exchange n June 29, 1994, his membership card may be auctioned. By the said letter, the stock exchange was informed that the said broker was in arrears of income-tax to the tune of Rs. 25,43,551 and, therefore, it was necessary to apportion a part of the amount realised from the auction for the purposes of meeting outstanding income-tax dues. Accordingly, the stock exchange was called upon by the Assessing Officer to issue a cheque in favour of the RBI in respect of outstanding demands. By the said letter, the Assessing Officer further stated that he would be issuing notice under section 226(3) of the Income-tax Act on receiving intimation from the stock exchange regarding auctioning of the membership card. By letter dated October 11, 1995, a reply was given by the stock exchange to the Assessing Officer, inter alia, stating that under rules 5 and 6 of the Bombay Stock Exchange Rules, the membership right was a personal privilege and was, therefore, inalienable. That, under rule 9, on death or default of a member, the right of nomination ceased and vested in the exchange and, consequently, the membership right of Suresh Shah had vested with the exchange when he was declared a defaulter on June 29, 1994. Therefore, the stock exchange regretted its inability to issue its cheque in favour of the Reserve Bank of India towards the outstanding arrears of tax, amounting to Rs. 25,43,651 for the years ending March 31, 1990, and March 31, 1991, on the ground that the membership right of the defaulter was not attachable. On March 29, 1996, the Assessing Officer forwarded a certificate under section 222 of the Income-tax Act to the Tax Recovery Officer and pursuant to that certificate, the Tax Recovery Officer (respondent No. 2) issued a prohibitory order under rule 26(1) of Schedule 11 to the Income-tax Act. The prohibitory order was issued on May 10, 1996, which is the subject-matter of challenge in this writ petition. On February 11, 1997, the governing body of the Bombay Stock Exchange rejected the application of Suresh Shah for re-admission. Basically, in this petition, therefore, the stock exchange has challenged the prohibitory order dated May 10, 1996, on the ground that the membership card was B not attachable.

This writ petition came for final hearing on February 15, 2003, before this court. On that date, this court directed the stock exchange to file an affidavit, inter alia, stating the credit balances in the accounts of the defaulting broker in the books of the Bombay Stock Exchange. The matter was adjourned to enable the stock exchange to file its affidavit in reply. The court also ordered the stock exchange to give to the court, the list of accounts which a broker was required to maintain in the books of the Bombay Stock Exchange before he was declared a defaulter. This order was passed by us because the prohibitory order dated May 10, 1996, is not restricted to the attachment of the member ship card. It also seeks to attach credit balances in the account of the broker in the books of the stock exchange. Pursuant to this direction, the stock exchange has filed two affidavits. By affidavit dated February 25, 2003, filed by the chief executive officer of the petitioner, it has been disclosed that the clearing house operated through Bank of India Share Holdings Ltd. That the clearing house was not a part of the Bombay Stock Exchange. That BOI Share Holding Ltd. was a company incorporated under the Companies Act in which the Bombay Stock Exchange held 49 per cent. and the Bank of India held 51 per cent. By the said affidavit, the title of accounts maintained by the stock exchange and the balances in the said accounts as on May 10, 1996 (i.e., the date on which the prohibitory order was issued), has been disclosed as follows :

Rs.

I. Clearing house account :

(a) Vallan (settlement account) 16,799 (credit)

(b) General charges (expenses) account 63,268 (debit)

II. Membership security deposit (securities) 1,37,100

III. Membership security deposit (in cash) 44,000

IV. Interest-free deposit for construction account

(for office space) 1,25,000

As per the said affidavit, the balance surplus of Rs 37,85,199.93 was lying with the stock exchange as on February 25, 2003, after adjusting the liability of the defaulting broker to the clearing house and to the creditor-members of the stock exchange and also after paying to the clients of the defaulting broker, the amounts in terms of arbitration allowance. This was in addition to other assets lying in the account of the defaulter, viz., credit balance of Rs. 1,53,538.10 with the clearing house as on February 17, 2003, plus securities in membership security deposit, valued on February 7,2003, at Rs. 1,11,220. In other words, an amount of Rs. 40,49,958.03 was payable by the stock exchange to the defaulting broker on February 25, 2003, when the stock exchange filed its affidavit as per the directions of the court. According to the stock exchange, pursuant to the member being declared a defaulter, his membership right vested in the stock exchange and so also the membership security deposit, office deposit, etc., vested in the stock exchange. That the stock exchange was maintaining an account titled "Stock Exchange Mumbai Defaulters' Account". According to the stock exchange, the assets belonging to a defaulter vest in the Defaulters' Committee of the Stock Exchange and that the Defaulters' Committee realises various assets vested in it and out of such realisations, that committee distributes amounts towards outstanding liabilities of the defaulting member to the stock exchange, to the clearing house of the stock exchange; to the creditor-members and to the clients of the broker who succeed in the arbitration and the surplus, if any, is paid over to the broker. According to this affidavit, the credit in the defaulters' account represented amounts realised from the exercise of the right of nomination and proceeds of various deposits that stood vested in the stock exchange and the debits represent payments made to the clearing house for discharging the liabilities of the defaulter to the other members of the stock exchange; payments made to the clients of the defaulter towards their liabilities and, lastly, payments to the Bombay Stock Exchange. Consequently, a separate ledger account was maintained in respect of each defaulter. As per this affidavit, the clearing house of the stock exchange also maintains a clearing house account in the name of the member-broker in which payments made to other members and the amounts received from/paid to the defaulters' committee and realisation of the securities deposited by the members, are reflected. According to the stock exchange, after adjusting the realisations towards liability of the broker to the stock exchange, clearing house, creditor-members and clients, the surplus, if any, is handed over to the broker or to his family members in the event of his death or to the official assignee in the event of the broker being declared insolvent. A statement is handed over by the stock exchange to the court indicating the surplus amount lying with the exchange out of sale proceeds of the nomination right of the defaulter-member and other assets. That statement reads as under :

Rs.

"Surplus amount presently lying with the exchange

out of the sale proceeds of the nomination right

of the defaulter member 37,85,199.93

Less : (i) 5 per cent. to be paid to investors'

protection fund as per general body

resolution 1,89,259.00

(ii) 5 per cent. to be paid to brokers

contingency fund as per general body

resolution 1,89,259.00

(A) Balance surplus payable to official assignee

pursuant to general body resolution dated

October 13, 1999 34,06,680.00

(B) Other assets :

(i) Membership security deposit (securities)

valued as at February 7, 2003, and not as

yet realized 1,11,220.00

(ii) Credit balance with the clearing house as

on February 17, 2003 1,53,538.00

(A+B) Therefore, Rs. 35,60,218 plus the realized value of the securities to

be handed over to the official assignee, Bombay, pursuant to the general

body resolution."

In short, the basic point which arises for determination in this case is twofold. Firstly, whether the Income-tax Department was entitled to attach the membership card of the broker and, secondly, whether the Income-tax Department was entitled to attach and recover the credit balances in the various accounts of the broker in the books of the Bombay Stock Exchange as in this case, the prohibitory order issued by the Tax Recovery Officer seeks to attach the membership card as also accounts of the broker in the books of the Bombay Stock Exchange.

On February 25, 2003, an affidavit-in-reply has been filed on behalf of the Department. According to this affidavit, the Tax Recovery Officer had computed the tax arrears of Suresh Shah as on January 31, 2003, and had intimated the same to the Bombay Stock Exchange vide letter dated February 20, 2003, along with a notice under section 226(3) requiring the stock exchange to pay Rs. 87,66,290 to the Income-tax Department out of the money held by the stock exchange for or on account of the broker. By the said affidavit, the above facts were reiterated. In short, the notice under section 226(3), dated February 20, 2003, was in respect of the revised arrears demand. According to this affidavit in reply, the Income-tax Department had a priority claim over other creditors of Suresh Shah and, therefore, it was obligatory on the part of the stock exchange to discharge the liability of the Department towards the tax arrears of Suresh Shah. By the said affidavit, it was pointed out that the stock exchange was holding deposits of Suresh Shah under the following heads, viz., security deposit, margin money, securities deposited by the member, which was in addition to the realised sale proceeds of the membership card of Suresh Shah. Along with this affidavit, a letter, dated October 11, 2000, has been annexed. It is a letter from the Tax Recovery Officer to the Bombay Stock Exchange. By the said letter, a query has been raised by the Tax Recovery Officer calling upon the stock exchange to supply to the Tax Recovery Officer, particulars of the liability of the stock exchange. At this stage it may be mentioned that at the time of admission of this writ petition, the Division Bench had passed the following order :

"Pending the hearing and final disposal of this petition, it Would be open to the stock exchange to auction the membership card of the defaulter and from the amount realised and recovered on behalf of the defaulter, a sum of Rs. 37.50 lakhs would be kept separately as a deposit with the stock exchange."

In view of the said interim order, the Tax Recovery Officer, vide letter dated October 11, 2000, called upon the stock exchange to give particulars of the liability of the stock exchange and also to furnish the particulars of the realised value of the membership card, if auctioned, as per the directions of the High Court.

Therefore, in this petition, the important issue which arises for determination is : whether the Department was entitled to attach and recover its dues from the sale proceeds of the membership card and whether the Department was entitled to attach the deposits of Suresh Shah (broker) under the above mentioned various heads on the ground that the Income-tax Department had a priority claim over all other creditors of Suresh Shah, including the BSE and the clearing house.

Arguments :

Mr. Dastur learned senior counsel appearing on behalf of the Bombay Stock Exchange, contended that the membership card was a privilege conferred on the member by the stock exchange. That the broker was declared a defaulter on June 29, 1994. That, on his being declared a defaulter, the membership card vested in the stock exchange and, therefore, the realised value of that card, on auction, also accrued to the stock exchange and it did not belong to the broker. Mr. Dastur contended that the letter of the Assessing Officer, dated October 5, 1995, was only an intimation. It was not a notice under section 226(3) to the garnishee and, therefore, on October 5, 1995, there was no attachment. It was only a proposal. That, the card was auctioned by the stock exchange for Rs. 1,34,26,482.50 and after liquidating the debts of the broker to the stock exchange, to the clearing house, etc. the surplus amount lying with the stock exchange, as of today, out of the sale proceeds of the nomination right of the defaulter-member, stood at Rs. 47,85,199.93, which has been kept aside as per the interim order passed by this court. Mr. Dastur further submitted that under the bye-laws, every member was required to pay 5 per cent. to the investors' protection fund and also to the brokers' contingency fund. Therefore, after adjusting further amounts to the investors' protection fund and the brokers' contingency fund as indicated above, the balance surplus payable to the broker/official assignee was Rs. 34,06,680. He contended that this balance surplus lying with the exchange out of the sale proceeds of the nomination rights of the defaulter-member became payable to the broker/official assignee only by virtue of a general body resolution of the stock exchange dated October 13, 1999. That, in the absence of such a resolution, the said amount of Rs. 34,06,680 would not have become payable to the broker/official assignee because the entire sale proceeds of the nomination rights vested in the defaulters' committee under the rules and bye-laws of the stock exchange on June 29, 1994, when the broker was declared a defaulter. That, the defaulter committee was even entitled in future to distribute such balance surplus in any other manner if the rules and the bye-laws so provide. However, Mr. Dastur contended that in the facts and circumstances of this case, as of today, the general body resolution dated October 13, 1999, is in force and as per that resolution, the surplus amount lying with the exchange out of sale proceeds of the nomination right is required to be paid over to the broker and, therefore, if this court directs, the stock exchange has no objection to handing over the said amount to the Income-tax Department. However, Mr. Dastur reiterated the caveat that the entire surplus amount belonged to the stock exchange and the balance surplus is being offered to the department/official assignee only in view of the resolution dated October 13, 1999, and that too, after appropriating/adjusting/setting off amounts payable by the broker to the stock exchange, clearing house and other creditor members/clients in whose favour arbitration awards have been given. Mr. Dastur contended that the membership card was not a debt under rule 26(1)(a). That, the card was not the property of the broker. Therefore, rule 26(1)(a) did not apply to the membership card. He further contended that in this case, there was only an intention to issue notice under section 226(3) of the Act. That the notice under section 226(3) was never issued, and, therefore, the prohibitory order, dated May 10, 1996, issued by the Tax Recovery Officer under section 220(2) was bad in law. He further contended that the impugned prohibitory order, dated May 10, 1996, was also bad in law because the Tax Recovery Officer has not specified the account of the defaulter in the books of the Bombay Stock Exchange in the prohibitory order. It is contended that the Bombay Stock Exchange was required to know as to what the attachment related to. That rule 26 of Schedule II to the Income-tax Act refers to the debt of the defaulter, and, therefore, the Tax Recovery Officer was required to give particulars of the debt sought to be attached. Otherwise, the attachment was bad in law. That the prohibitory order, dated May 10, 1996, also prevented Suresh Shah from receiving the debt allegedly due from the stock exchange and, therefore, the Tax Recovery Officer was required to specify the particulars of the debt which the broker was not entitled to recover and so also, the Tax Recovery Officer was required to tell the stock exchange that it ought not to pay its debt to the broker. That, without furnishing the particulars of the account, the prohibitory order was bad in law. That, the prohibitory order was vague. That, rule 26 of Schedule II to the Income-tax Act required the Tax Recovery Officer to specify the debt. Mr. Dastur further contended that section 226(3) was different from rule 26 of Schedule II. That section 226(3) contemplates issuance of garnishee notice, whereas rule 26 refers to attachment of debt and, therefore, in the case of section 226(3), the particulars of debt may not be relevant, but in the context of rule 26, particulars of debt owed by the stock exchange to the broker needs to be specified and since it has not been specified, the prohibitory order is bad in law. According to learned counsel, in this case section 226(3) has not been invoked. Mr. Dastur further contended that section 226(3) is one of the modes of recovery just as attachment under rule 26 is also a mode of recovery. He contended that rule 26 of Schedule II is pursuant to the power of the Tax Recovery Officer under section 222(1)(a). He, therefore, contended that in the case of section 226(3), the particulars of the debt need not be specified, but when it comes to attachment of movables under rule 26, the debt needs to be particularised and in this case, the debt has not been particularised and, therefore, the prohibitory order was invalid and bad in law. He further contended that the debt was not required to be specified for the purposes of section 226(3) because that section only refers to money due and payable by the garnishee to the assessee, whereas rule 26 refers to the debt which is attached as a property and, therefore, that property needs to be particularised which, in this case, has not been done and, therefore, the prohibitory order is bad in law because without identification of the debt, the prohibitory order under rule 26 is bad in law. It was contended that the Tax Recovery Officer in this case should have addressed a letter to the stock exchange enquiring as to whether that broker was maintaining any accounts in the books of the stock exchange. That, no such letter was addressed and, therefore, the particulars of accounts have not been collected from the stock exchange. He contended that rule 26 requires particulars of the account to be mentioned and in the absence of such particulars, the prohibitory order was bad in law. Mr. Dastur relied upon the judgment of the Supreme Court in the case of Stock Exchange, Ahmedabad v. Asstt. CIT [2001] 248 ITR 209 ; [2001] 3 SCC 559, in support of his contention that the membership card was a privilege conferred on the broker ; that the membership card was not the property of the broker and when the broker was declared a defaulter, the right of nomination stood vested in the stock exchange and, therefore, even the balance surplus out of the sale proceeds of the nomination rights of the defaulter-member should ordinarily vest in the stock exchange, but which is being offered to the broker only in terms of the resolution dated October 13, 1999. He contended that the surplus amount of consideration of the membership rights vested in the exchange. That when such membership rights were auctioned, the surplus consideration after settlement of all liabilities of the defaulter to the stock exchange, clearing house, creditor-members as also admitted claims of the clients is credited to the funds of the exchange. However, the exchange, in the general body meeting at its absolute discretion, may direct that the surplus be disposed of or applied in such other manner as it may deem fit in terms of rule 16 of the Stock Exchange Rules. That the governing body, in its meeting held on August 27, 1999, had considered the matter and it recommended to the general body to pass an appropriate resolution to give 90 per cent. of the surplus consideration realised from the auction of the membership right to the defaulter as ex gratia payment, after appropriating 5 per cent. of the surplus towards the customers protection fund (now known as the investors' protection fund) and 5 per cent. of the surplus amount towards the brokers' contingency fund. Mr. Dastur, therefore, submitted that the balance surplus (ex gratia payment) was required to be handed over to the broker and in the present case, the stock exchange has no objection to hand over the said amount either to the official assignee or to the Income-tax Department as the court may direct. Mr. Dastur contended that the stock exchange has no objection to pay over to the Department, 90 per cent. of the surplus consideration realised from the auction after appropriating 5 per cent. of the surplus towards customer's protection fund and 5 per cent. of the surplus towards brokers' contingency fund as long as the right of the Bombay Stock Exchange to fix the priority is protected. He contended that in future, the general body can even pass a resolution that no part of the surplus should be paid over to the defaulter because even that surplus belongs to the stock exchange. However, in this case, in view of the resolution of October, 1999, the surplus became payable to the broker as an exception to the general rule. Mr. Dastur further clarified that 90 per cent. of the surplus consideration realised from the auction of the membership right would become payable to the defaulting broker only in the event of there being a surplus. That, in cases of deficits, no amount would become payable to the broker-member and in such cases, there would be no question of handing over the balance to the Department. He, therefore, contended that even the resolution of October, 1999, would apply only in cases of surplus on account of sale of membership rights. He contended that as far as distribution of the sale proceeds of the nomination rights of the defaulter is concerned, the same is required to be applied strictly as per the priority in rule 16. At this stage, it may be mentioned, once again, that in this case, we are concerned with the sale proceeds of the nomination rights of the defaulter and credit balances in the abovementioned accounts of the broker in the books of the stock exchange. Therefore, these two are distinct and different items of distribution. As stated above, the stock exchange holds deposits of the brokers under various heads. Therefore, the question before the court is : whether such deposits can be attached under rule 26 of Schedule II to the Act, apart from the sale proceeds which the exchange fetches on auctioning of the nomination rights of the defaulter. In support of his arguments, Mr. Dastur has relied upon numerous rules and bye-laws of the stock exchange, which we will discuss at the appropriate stage.

Mr. R. V. Desai, learned senior counsel appearing on behalf of the Department, contended that despite the letter from the Tax Recovery Officer dated October 5, 1995, addressed to the stock exchange, no reply furnishing details of the various accounts of the defaulter in the books of the stock exchange has been given and, ultimately, therefore, the Tax Recovery Officer passed the prohibitory order on May 10, 1996, attaching the membership card allotted to the defaulter for doing business and all accounts of the broker in the books of the stock exchange. He contended that in such circumstances, it is not open to the stock exchange to argue that the impugned prohibitory order was bad for want of particulars of the debt, which has been attached under rule 26 of Schedule II. He contended that under the above circumstances, the Tax Recovery Officer was justified in issuing the impugned prohibitory order, restraining the stock exchange from dealing with all accounts of the broker in the books of the stock exchange. He contended that there is no denial that brokers' accounts existed in the books of the stock exchange. He contended that in the light of the prohibitory order dated May 10, 1996, the BSE was not entitled to distribute any amount. That in the light of the prohibitory order, the BSE was not entitled to liquidate the liability of the broker to the stock exchange, to the clearing house, etc., because in the priority, the Income-tax Department was entitled to be paid its dues in the first instance. He contended that the stock exchange was not entitled to distribute any amount, irrespective of the fact whether it had surplus or deficit in any of the above accounts. He contended that if the argument of the stock exchange was accepted, then the dues of the Income-tax Department, which have a priority over all other claims, would be defeated. He contended that the priority mentioned in rule 16 cannot override the provisions of the Income-tax Act. He contended that the membership card was the property of the broker and, therefore, the sale proceeds of the nomination rights of the defaulter should be first utilised to discharge the claims of the Income-tax Department before it is paid over to the stock exchange for distribution under rule 16. Mr. Desai contended that the judgment of the Supreme Court in the case of Stock Exchange, Ahmedabad [2001] 248 ITR 209 was only confined to the nature of the right of the broker qua membership card. He contended that the Supreme Court was not concerned in that case with the attachment of the accounts of the broker in the books of the stock exchange. He contended that in that judgment, the Supreme Court was not concerned with the attachment of deposits of the defaulting broker held by the stock exchange under various heads. He, therefore, contended that the point arising in this petition is res integra because the Supreme Court judgment does not deal with forfeiture of security deposits as also deposits held under various heads like margin money, securities deposited by the member in the form of physicals and in the form of cash, etc. He contended that in terms of the impugned prohibitory order, the credit balance in each of the above accounts should come to the Department. He contended that even the defaulters' account in the books of the stock exchange, after the broker is declared a defaulter, belonged to the member and, therefore, the credit balance in that account on the date on which the prohibitory order is issued should come to the Department. Mr. Desai contended that in the above judgment of the Supreme Court in the case of Stock Exchange, Ahmedabad [2001] 248 ITR 209, the question of distribution of sale proceeds on auction of the nomination rights was not in issue. He contended that there is no reason for leaving the entire sale proceeds distribution to the stock exchange. He contended that there is no reason why the Income-tax Department should be at the mercy of the stock exchange in the matter of distribution of such sale proceeds. That, in any event, the stock exchange was required to give priority to the claims of the Income-tax Department vis-a-vis other claims of the BSE, clearing house, creditor-members, etc. Mr. R. V. Desai contended that, notwithstanding the priority given in rule 16, the Government dues must be paid first in point of time.

Mr. Desai contended that there is no merit in the argument of the stock exchange that on declaration of a broker as a defaulter, all his assets under the above accounts vest in the stock exchange. Mr. Desai contended that even according to the stock exchange, the balance surplus out of the sale proceeds of the nomination rights of the defaulter member is payable to the broker and, consequently, he submitted that the membership card was the property of the broker-member. He contended that if the membership card was only a privilege, then on forfeiture of that card on the member being declared defaulter, nothing was payable to the Bombay Stock Exchange, clearing house, etc., but that is not so because on default, the membership card is auctioned and the sale proceeds are utilised to liquidate the claims of the stock exchange, clearing house, etc., which shows that the membership card was the property of the broker-member. He contended that when the membership card is forfeited, the member-broker has no claim against the Bombay Stock Exchange and yet, after auction, the sale proceeds become the subject of distribution by the Bombay Stock Exchange, who distributes the amount to liquidate the liabilities of the defaulting member and, therefore, it cannot be said that the entire sale proceeds belong to the BSE and they can do what they like with such sale proceeds. That, on forfeiture, the defaulting member has no right of action against the BSE and yet, on forfeiture, the stock exchange distributes the sale proceeds amongst itself, clearing house, member-creditors, etc. In the circumstances, he contended that there was no absolute vesting of the card and the accounts in the stock exchange when the member is declared a defaulter. In short, the contention advanced on behalf of the Department is that if the membership card was the property of the stock exchange, then on the sale of such property, the sale proceeds could not have been used for discharging the liabilities of the broker to the stock exchange, to the clearing house, to the creditor-members, etc., and since the sale proceeds are utilised for that purpose, but the membership card was the property of the member-broker. Mr. Desai further submitted that even the judgment of the Supreme Court in the case of Vinay Bubna v. Stock Exchange, Mumbai [1999] 97 Comp Cas 874 has not decided the points which arise in this case. That the Supreme Court has not examined the question of accounts and distribution of assets of the defaulting broker in the case of Stock Exchange, Ahmedabad [2001] 248 ITR 209 (SC) as also in the case of Vinay Bubna's case [1999] 97 Comp Cas 874 (SC). That the Supreme Court has only discussed the nature of the rights of the members. That, it has not gone into the question of realisation and distribution of assets. That, in the matter of distribution, the rules and bye-laws of the stock exchange proceed on the basis that the realized value of the membership card belongs to the broker and, therefore, he contended that such realised value was attachable under rule 26 of Schedule II to the Act. He contended that under the rules, a member could be expelled by the stock exchange and on expulsion, his rights stood forfeited. He contended that in cases where a member surrendered his card or in cases where the member was expelled, there was forfeiture. He contended that under the rules, in a matter of distribution, the realised value on auction of the membership card was treated as a receipt by the stock exchange on behalf of the member and it is for this reason that the stock exchange maintains a separate defaulters' account under which the stock exchange treats the sale proceeds as belonging to the member and, accordingly, the rules provide for distribution, allocation and payment of liability on behalf of the broker by the stock exchange. That, such sale proceeds are applied to discharge the liability of the member-broker to the stock exchange ; to the clearing house and to other creditor-members with whom the defaulter had entered into various contracts. Therefore, it was argued that the sale proceeds of the nomination rights of the defaulter-member belong to the member and it was certainly attachable by the Department because the dues of the Income-tax Department should get priority and that priority cannot be overruled by the bye-laws and rules framed by the stock exchange. He also invited our attention to rule 270 under which, on expulsion of a member-broker, the rights of the creditors of such broker remain unimpaired. Mr. Desai, therefore, contended that even under the rules and bye-laws of the stock exchange, for the purposes of distribution, the realised value on the sale of nomination rights of the member belonged to the member and, therefore, the sale proceeds of the nomination rights of the defaulter-member belonged to the defaulter-member and, therefore, such realised value was attachable under rule 26 of Schedule II to the Act. Mr. Desai, therefore, contended that the various rules and bye-laws of the stock exchange indicate that once a member is declared to be a defaulter, the stock exchange receives the monies, which it uses to discharge the various liabilities of the defaulters to the stock exchange, clearing house and other creditor-members. That, even after forfeiture or vesting of the assets in the defaulters' committee, the proceeds are applied by the stock exchange to discharge the liabilities of the defaulter to the stock exchange, clearing house and other members. That the stock exchange treats the said sale proceeds for distribution proceedings as belonging to the defaulter and, accordingly, it is the stock exchange who discharges the liability of the defaulting-member to the stock exchange, clearing house and other members.

Mr. Desai further contended that on auction, the sale proceeds of the nomination rights of the defaulting member undergo a change in character and such sale proceeds become money held by the stock exchange on account of the defaulting members. That once the personal privilege stands auctioned, the proceeds belonged to the defaulting member for the purposes of distribution, and such proceeds are treated by the stock exchange under the bye-laws as proceeds belonging to the defaulter and, therefore, even the credit balance in the defaulters' account on the date of the prohibitory order was attachable under rule 26 and that amount was also payable in the first instance to the Income-tax Department because the Crown debts are required to be discharged, first in point of time. Mr. Desai accordingly submitted that credit balances in the security deposit account of the broker, margin money account, security account and credit balance in the defaulter's account were all attachable in addition to the auction proceeds. Mr. Desai contended that in this case, the Income-tax Department is not going to attach the investors' protection fund, the, brokers contingency fund and the trade guarantee fund on the ground that credit balances in those accounts belong to the stock exchange. That, the Department seeks to attach the funds of the broker in the hands of the stock exchange and that they do not seek to attach funds belonging to the stock exchange. In rejoinder, Mr. Dastur appearing on behalf of the stock exchange contended that the Bombay Stock Exchange was for a charitable purpose. That the object of the Bombay Stock Exchange was to maintain public confidence. That, the stock exchange plays a very important role in the development of the economy. That the stock exchange protects the rights of the investors also. That, at the end of the settlement period, every broker's account with the stock exchange needs to be adjusted and settled. That, in cases where the brokers fail to discharge their obligations, the stock exchange secures performance of outstanding contracts by the concerned brokers. That the role of the stock exchange is confidence building of investors. In this connection, he relied upon the judgment of the Bombay High Court in the case of Vinay Bubna v. Bombay Stock Exchange vide Writ Petition No. 1177 of 1997 which has carved out the objects of the Bombay Stock Exchange. Mr. Dastur contended that when a broker is declared a defaulter, all his above assets vest in the defaulters' committee and it is the defaulters' committee which applies the sale proceeds and credit balances to discharge the liability of the defaulting member to the stock exchange, to the clearing house and to other creditor-members. He contended that the very fact that the stock exchange is required to apply the service to liquidate the liabilities of the broker shows that all proceeds belong to the stock exchange and not to the defaulter. He contended that every broker-member places security in the form of cash, shares, etc., with the stock exchange. That, under rule 43, there is a lien in favour of the stock exchange on such security, which is taken from the broker-member to secure fulfilment of the obligations by the broker-member, not only to the stock exchange, but also to his client (investors) and under rule 43, the first lien is in favour of the stock exchange. He contended that Vinay Bubna had challenged the validity of these rules and they have been upheld not only by the Bombay High Court, but also by the Supreme Court in the above judgment reported in Vinay Bubna v. Stock Exchange [1999] 97 Comp Cas 874 ; [1999] 5 JT 164, para. 11. He further contended that the stock exchange is not a trader. In this connection, he relied upon the judgment of the Bombay High Court in the case of V. V. Ruia v. S. Dalmia [1968] 38 Comp Cas 572 ; AIR 1968 Bom 347. Mr. Dastur contended that in view of the judgment of the Supreme Court in the case of Stock Exchange, Ahmedabad [2001] 248 ITR 209 it is not open to the Department to argue that the membership card is the property of the broker. He contended that it is a privilege conferred by the stock exchange on the broker. He contended that on auction of the nomination rights of the broker, money springs from this privilege and, therefore, the said amount of sale proceeds cannot have a different character from that of a privilege. He contended that, that privilege belongs to the stock exchange, but it is conferred to the broker. That, when the broker is declared a defaulter, that privilege vests in the stock exchange and, therefore, the sale proceeds from auction of that privilege cannot have a different character.

Mr. Dastur further contended that under the rules and the bye-laws there is a distinct dichotomy between distribution of the sale proceeds of the membership card and distribution qua the credit balances in various accounts of the brokers in the books of the Bombay Stock Exchange. He contended that in the case of distribution of sale proceeds of the nomination rights, the balance surplus ordinarily vests in the stock exchange, but as a matter of exception, in view of the resolution of the general body meeting, such balance surplus is paid over to the broker, whereas in the case of credit balances in the accounts of the broker in the books of the stock exchange, the balance surplus is automatically handed over to the broker and in such cases, the resolution of the general body is not required. He, however, contended that the judgment of the Supreme Court in the case of Stock Exchange, Ahmedabad [2001] 248 ITR 209 not only dealt with the nature of the right in the membership cards, but it also covers attachment of margin money account and it also covers attachment of deposits of the brokers in the hands of the stock exchange. Mr. Dastur, therefore, contends that the judgment of the Supreme Court in Stock Exchange, Ahmedabad [2001] 248 ITR 209 covers all the three points which arise for determination in this case. He contended that in the above judgment, the Supreme Court has held that no amount on account of a defaulter was due from the stock exchange or held by the stock exchange and, therefore, notice under section 226(3) was invalid. Mr. Dastur contended that in that case, the Department had sought to attach the auction proceeds, margin money and security, deposit by invoking section 226(3) and that particular impugned notice was struck down. He, therefore, contended that on all points, the judgment of the Supreme Court was applicable to this case.

Mr. Dastur next submitted that the Income-tax Department had no right over the sale proceeds of the nomination rights of the defaulting member unless there remained a balance surplus after meeting all obligations of the broker. That ordinarily, such balance surplus vested in the stock exchange but as an exception, in view of the resolution of October, 1999, the balance surplus became payable to the broker. That, but for the resolution, the balance surplus vested in the stock exchange and it was not attachable. Mr. Dastur contended that the object of the BSE is not to make profits. That, the BSE was there to keep public confidence in the stock exchange. That, the BSE provided a comfort to investors. That, the clearing house was not a part of the Bombay Stock Exchange. That, the operations of the clearing house were handled by the BOI Share Holdings Ltd., which was a company incorporated under the Companies Act and in which the BSE holds 49 per cent. whereas the Bank of India holds 51 per cent. He contended that under rule 43 priority is given by way of first lien to the stock exchange because the broker's act for the investors and in order to secure performance of the broker's obligation and in order to protect the investors, the rules provide for first lien in favour of the stock exchange. He contended that if the submission of the Income-tax Department in this case is accepted and if priority is given to the Income-tax Department over the first lien in favour of the stock exchange, then the BSE would not be able to secure performance of the obligations by the broker-members and further, the confidence of the public in the stock exchange would be shattered, particularly in cases where huge demands of exaggerated nature are sometimes made by the Income-tax Department. Under the circumstances, he contended that the lien of the stock exchange must be satisfied first in point of time, prior to the satisfaction of the dues of the Income-tax Department. It is for this reason that under rule 44 it is declared that after the stock exchange exercises its lien and after liquidating the liability for which the lien is created, the surplus would go to the members. Mr. Dastur contended that rule 16 deals with sale and distribution of the sale proceeds of the defaulter's card, whereas rules 43 and 44 deal with other security. That, in the case of rule 16, the balance surplus is handed over to the broker in terms of the resolution of October, 1999, but that does not apply to distribution of balance surplus in the case of other securities. Mr. Dastur contended that under rule 326, the defaulter's assets vest in the defaulters' committee. That, distribution is a subject-matter of rule 342 in which the first priority is given to the dues of the clearing house and the balance becomes distributable pro rata amongst creditor-members in cases where the balance surplus is insufficient. However, in this case rule 342 is not applicable because the balance surplus has a positive figure. He contended that sub-clause (ix) of rule 400 refers to distribution of balance surplus. However, clause (ix) applies to credit balance in the member security account and in the clearing house account. It does not apply to surplus on account of auction of nomination rights. He contended that the investors' protection account and trade guarantee account were the funds belonging to the stock exchange. That, under the resolution of the stock exchange, every member is required to contribute 5 per cent. to each of these funds, and, therefore, while calculating the balance surplus, these debits have also been taken into account.

Mr. Dastur next contended that the bye-laws, rules and regulations of the stock exchange have been approved by the Central Government. That, they have been approved under the Securities Contracts (Regulation) Act. That, they have a force of law in Hemendra V. Shah v. Stock Exchange [1996] 87 Comp Cas 258 ; [1995] 2 Mah LJ 770. He contended that the stock exchange has a paramount lien and, therefore, the priority of the State cannot rank against the stock exchange so as to deprive it of this paramount lien. In this connection, Mr. Dastur placed reliance on the judgment of the Gujarat High Court in the case of P. I. Shukla v. Tribhovandas Hargovandas [1988] 173 ITR 624. He contended that this paramount lien in favour of the stock exchange is for retaining public confidence in the stock exchange.

In conclusion, Mr. Dastur contended that the balance surplus of the sale proceeds of the nomination rights of the defaulting member would be handed over either to the Department or to the official assignee as the court may direct. This was in view of the resolution of the BSE of October, 1999. That, in future, the stock exchange can withdraw that resolution and retain the balance surplus from the sale proceeds of the nomination rights of the defaulting member. That, similarly, the balance surplus with the stock exchange in case of other securities would be handed over by the stock exchange, either to the Official Assignee or the Department as the court may direct under rule 43. That, in the case of other securities, the balance surplus is payable under rule 43 and rule 44 to the broker. Therefore, in such an eventuality, such balance surplus could be paid to the Official Assignee or to the Department, as the court may direct and in such cases, there was no need for a resolution. Consequently, Mr. Dastur submitted on the facts of this case that the BSE would hand over the balance surplus amounting to Rs. 35,60,218 plus realised value of the securities as and when those securities are sold, either to the Official Assignee or to the Department, as this court directs.

Scope of rules and bye-laws framed by the BSE :

The main object of establishing the BSE is to support and protect in public interest the character and status of brokers and dealers and to further the interest both of brokers and dealers and of public interested in securities and to assist, regulate and control, in public interest, dealings in securities in order to maintain high standards of commercial honour and integrity and to inculcate just and equitable principles of trade and business, to discourage and suppress malpractices, to settle disputes and decide all questions of usage, custom and courtesy in the conduct of trade and business (see rule 4(i)). Under rule 4(xi), the BSE is required to establish and maintain a clearing house for the object and purpose of the BSE. Under rule 5 it is declared that the membership shall constitute a personal permission from the BSE to exercise rights and privileges attached thereto subject to rules, bye-laws and regulations of the exchange. Under rule 6, the right of membership is inalienable. Under rule 7, a member has a right of nomination which is personal and non-transferable. Under rule 8, the right of nomination is not exercisable by a former member who has been expelled or who has ceased to be a member under any rule, bye-law or regulation. Under rule 9, on death or default of a member, his right of nomination shall cease and vest in the exchange. Under rule 10, when a right of membership is forfeited or vested in the BSE, such right shall belong absolutely to the exchange free of all rights, claims or interest of such member or any person claiming through such member and the governing board shall be entitled to deal with or dispose of such right of membership as it may think fit. Rule 16 deals with allocation in order of priority. It lays down that in cases where the governing board has exercised the right of nomination in respect of a membership vesting in the exchange, the consideration received therefor shall be applied in the following order of priority, namely, (a) dues of exchange and clearing house, (b) liabilities relating to contracts, and (c) surplus. In the matter of payment of the surplus, if any, accruing to the funds of the exchange, absolute discretion is given to the BSE for disposal of such surplus. The BSE is free to apply such surplus in any manner as it may deem fit. However, under rule 16(2), it is laid down that rule 16(1) which refers to allocation in order of priority shall not apply in cases where the governing board has exercised the right of nomination in respect of a membership which has vested in the exchange upon a member having been declared a defaulter on or subsequent to such date as the governing board may specify in this behalf. In the present case, we are furnished with extracts of the minutes of the AGM held on October 13, 1999, which dealt with appropriation of surplus amount of consideration of the membership right vested in the exchange. In the said AGM, the general body of the BSE has accepted the recommendation of the governing board of the BSE that such surplus amount, after paying the dues and liabilities under rule 16, shall be appropriated in the manner mentioned in the minutes of the AGM. As per the said resolution, after deducting 5 per cent. of the surplus for the customers' protection fund and 5 per cent. of the surplus for the brokers' contingency fund, the residual 90 per cent. of the surplus was to be paid as ex gratia amount to the defaulter. Under rule 16A, when the governing board has exercised the right of nomination in respect of the membership which has vested in the BSE on the member being declared a defaulter then the consideration received shall be paid by the governing board to the defaulters' committee to be applied for the purposes and in the order of priority specified in the bye-laws of the exchange. Rule 16 is required to be read with bye-law Nos. 338, 342, 342A and 400. Byelaw No. 338 lays down that the defaulters' committee shall keep a separate account in respect of monies, securities and other assets payable to a defaulter which are received by the defaulters' committee. Under bye-law No. 342, application of assets of the defaulter remaining in the hands of the defaulters' committee is provided for. It lays down that the defaulters' committee shall apply the net assets in satisfying firstly the claim of the exchange and the clearing house and then rateably such admitted claims of members against the defaulters arising out of contracts entered into in the market. Bye-law No. 400 deals with application of defaulters' assets and other amounts. It lays down that the defaulters' committee shall realise and apply all the money, rights and assets of the defaulter which have vested in the defaulters' committee for the following purposes and in the order of priority mentioned therein. Sub-clause (ix) of bye-law No. 400 states that surplus, if any, shall be paid to the defaulter. It is clarified that bye-law No. 400 does not apply to the amount paid by the governing board to the defaulters' committee under rule 16A in respect of consideration received by the governing board for exercising the right of nomination in respect of the defaulters' erstwhile right of membership as the same does not belong to the defaulter and as the defaulter has no claim right, title or interest therein. Under bye-law No. 401, it is laid down that in the event of the defaulters' assets and other amounts mentioned in bye-law No. 400 being insufficient to pay the amounts mentioned in bye-law No. 400 then the amount paid to the defaulters' committee under rule 16A in respect of the defaulters' erstwhile right of membership shall be applied by the defaulters' committee for the purposes and in the order of priority mentioned in clauses (i) to (vii) of bye-law No. 400 and the surplus, if any, shall be paid to the exchange provided that the exchange in the general body may at its absolute discretion direct that such surplus be disposed of or applied in such other manner as it may deem fit. Under rule 36, a new member, on admission, is required to provide security on admission. The amount is to be decided by the governing board. The security to be furnished by such a member shall be either in cash or in the form of a deposit receipt of a bank or in the form of securities approved by the governing board (see rule 37). Therefore, every incoming member has to furnish a security either in the form of cash or in the form of deposit receipt of a bank or in the form of securities approved by the governing board and every such member has to maintain the value of such securities at not less than Rs. 2 lakhs by providing further security to the satisfaction of the governing board. Rule 43 provides for a lien. Rule 43 lays down that the security provided by the member under rule 37 shall be subject to a paramount lien for any sum due to the exchange or to the clearing house and for due fulfilment of his engagements, obligations and liabilities which may accrue to a member out of bargains, dealings, transactions and contracts made as per the rules and bye-laws. Under rule 44, on termination of membership, the security shall be returned. Rule 53 falls under the Chapter "Default and Re-admission to Membership". It lays down that a member who is declared a defaulter shall cease to be a member of the exchange and he shall cease to enjoy rights and privileges of membership but the rights of his creditor-members against him shall remain unimpaired. Under rule 170(a)(ii), the governing board shall every year appoint a defaulters' committee. Under bye-law No. 91 of the BSE, the exchange is required to maintain a clearing house. This clearing house is not a part of the BSE. In the present case, as stated above, the clearing house is handled by the Bank of India Shareholding Ltd. in which the BSE holds 49 per cent. and the BOI holds 51 per cent. The clearing house acts as a common agent of the members for clearing contracts between members and for delivering securities and for receiving securities from and for receiving or paying any amount payable to or payable by such members in connection with any of the contracts entered into by the members on the stock exchange. Under bye-law No. 316, grounds are given for declaring a member a defaulter. Under bye-law No. 326, the defaulters' committee is empowered to call for and realise the security and margin money and securities deposited by the defaulter. The defaulters' committee is also empowered to recover all monies, securities and other assets due, payable or deliverable to the defaulter by any other member of the stock exchange in respect of the transactions or dealings carried out on the floor of the stock exchange. Under bye-law No. 326, it is further provided that all such assets of the broker shall vest in the defaulters' committee for the benefit of creditor-members. We have already discussed the remaining bye-laws Nos. 338, 342, 342A, 400 and 401.

The important thing which is required to be noted is rule 16 on the one hand and rule 43 and rule 44 on the other hand. According to the petitioners, rule 16 deals with sale and distribution of the defaulter's membership card and proceeds therefrom whereas, rule 43 and rule 44 deal with other securities given by the member at the time of admission. According to the petitioners, in cases falling under rule 16, the surplus belongs to the exchange and the exchange is vested with the absolute discretion to dispose of such surplus in the manner as it may deem fit. However, when it comes to the application of defaulters' assets (other securities) under bye-law No. 400, the surplus, if any, has to be paid to the defaulter. In fact, there is a clarification to bye-law No. 400. It states that bye-law No. 400 does not apply to the amounts paid to the defaulters' committee under rule 16A in respect of the consideration received by the governing board for exercising the right of nomination in respect of the defaulters' erstwhile right of membership as the same does not belong to the defaulter and the defaulter has no right, title or interest therein. Therefore, when it comes to distribution of the consideration received by the Governing Board for exercising the right of nominating the surplus, if any, belongs to the BSE and, therefore, the exchange has a right to dispose of the surplus in the manner it deems fit. However, the exchange has no such right when it comes to distribution of surplus arising on the sale of the defaulter's other assets. This is the basic contention advanced on behalf of the BSE on the above rules.

Scope of section 226(3)(i) and (x) read with section 222 to section 225 read with rule 26 of Schedule II to the Income-tax Act, 1961

In this case, we are concerned with the period after April 1, 1989. Section 222 to section 226 fall in Chapter XVII of the Income-tax Act, which deals with collection and recovery. Section 226 falls under the caption "Other modes of recovery". Section 226(1), inter alia, provides that where no certificate has been drawn up under section 222, the Assessing Officer may recover the tax by any one or more of the modes provided in section 226. Section 226(3) provides for one such mode. It, inter alia, contemplates issuance of a garnishee notice. It states that a garnishee notice may be directed to any person from whom money is due or money becomes due to the assessee or to any person who holds money or who may subsequently hold money on account of the assessee. The requisite condition is that at the time of the service of the garnishee notice, there must be subsisting, an ascertained debt in the hands of the garnishee due to the assessee or there should be some contractual relationship as a consequence of which, money is likely to come in the hands of the garnishee for and on behalf of the assessee. Under section 226(3)(x) if the garnishee fails to pay to the Tax Recovery Officer/Assessing Officer, the garnishee shall be deemed to be an assessee-in-default and further proceedings may be taken against him for the realisation of the amount in the manner provided in sections 222 to 225 and the notice under section 226(3)(x) shall constitute attachment of a debt by the Tax Recovery Officer under section 222 of the Income-tax Act. By reason of section 226(3)(x) read with section 222, the provisions of rule 26 of Schedule II to the Income-tax Act stand attracted. Rule 23 of Schedule II to the Income-tax Act provides for attachment and sale of movables in the possession of the defaulter, whereas rule 26 deals with attachment and sale of movables in the possession of some other person. Rule 26(1), inter alia, states that in the case of a debt, not secured by a negotiable instrument, the attachment shall be by a written order, prohibiting the garnishee from making payment to its creditor (see rule 26(1)(a)), whereas rule 26(1) refers to attachment of other movable property, not in the possession of the defaulter. In such a case, under rule 26(1)(iii), the attachment will be by a written order, prohibiting the person in possession from handing over the movable to the defaulter. In this case, we are concerned with attachment of a debt and attachment of any other movable property. In this case, the Tax Recovery Officer has invoked section 226(3)(i), (x) read with rule 26(1)(a) and (c).

In this case, in order to check the applicability of the rules, we had directed the BSE to furnish a sample of the ledger account of any defaulter. Pursuant to our direction, the BSE filed its affidavit, enclosing the ledger account of a defaulter by name, Mukesh Kothari. On reading that account, the applicability of the rules bye-laws is demonstrated. It shows that the deposits made by the brokers for car parking, office space, etc., stands transferred to his defaulter's account and similarly, the amount of credit balance of interest on defaulter's account stands transferred to the defaulter's account. In short, under the rules, on vesting, the defaulters' committee shall call in and realise the security, margin money and securities deposited by the defaulter and recover all monies, securities and other assets due, payable or deliverable to the defaulter by any other member in respect of the transaction/dealing made under the rules/bye laws and such assets shall vest in the defaulters' committee for the benefit and on account of the creditors-members (see rule 36). Bye-law No. 400 deals with application of the defaulter's assets. In other words, bye-law No. 326 read with bye-law No. 400 deals with the defaulter's assets, other than the membership card which, as held by the Supreme Court, belongs to the BSE. In this case, we are concerned with the former under Issue No. 2. However, the rules and the accounts show that the security, margin money and securities deposited by the defaulter and all receivables (hereinafter referred to as "other assets") belong to the defaulter and not to the BSE. That the vesting in the defaulters' committee is only to enable the BSE to apply such assets and receivables in the order of priority under bye-law No. 400. The limited question, which we are required to answer is : whether income-tax dues will have precedence over the claims of the BSE, the clearing house and other creditor members as provided under the general law, viz., section 73(3) of the Civil Procedure Code.

Issues :

Two main issues arise for determination in this petition. They are as follows :

(A) Whether, on the facts and circumstances of this case, the Tax Recovery Officer was right in attaching the sale proceeds of the nomination rights of the defaulter-member. If not, whether the Tax Recovery Officer was entitled to attach under rule 26(1) of Schedule 11 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 the BSE read with the resolution of the general body of BSE, dated October 13, 1999 ?

(B) Whether deposits made by the defaulting member under various heads such as security deposit, margin money, securities deposited by the members and others are attachable under section 226(3)(i), (x) read with rule 26(l)(a), (c) of Schedule II to the Income-tax Act ?

Findings on issue No. 1

At the outset, we may point out that in this case, we are concerned with two assets, viz., membership card of a broker and other assets such as security, margin money, securities deposited by the defaulter and receivables which is termed as defaulter's assets under bye-law No. 326. Issue No. 1 deals with the membership card, whereas Issue No. 2 deals with other assets.

In the case of Stock Exchange, Ahmedabad v. Asst. CIT [2001] 248 ITR 209 (SC), it has been held by the apex court that the right of membership is a personal privilege granted to a member. It is not transferable. It is incapable of alienation except to the limited extent as provided in the rules and the byelaws of the stock exchange. That, on the right of nomination vesting in the stock exchange under the rules, that right belongs to the stock exchange absolutely and the consideration received by the stock exchange on the exercise of the right of nomination vesting in it, is to be applied in the manner provided in rule 16.

A card of membership of the BSE cannot be sold for the benefit of the creditors of a member on his becoming bankrupt. In the case of Official Assignee of Bombay v. K. R. P. Shroff [1931] 1 Comp Cas 371 (Bom); AIR 1931 Bom 225, it has been held by the Bombay High Court that under the rules of the stock exchange, the member has got, by virtue of membership, the privilege of going to the exchange and dealing in the exchange, but there is no power in the member to sell that right. That, if he is in default, the directors of the association can cancel his membership and they can sell thereafter, the right of nomination to the vacant seat and they must deal with the proceeds under the rules of the stock exchange, but the defaulting-member takes no interest in such sale proceeds. Therefore, the insolvent has no right of property therein, which can be said to vest on his insolvency, in the Official Assignee. In that case, it has been held that the BSE was merely a voluntary association resembling a members' club and formed in order to see that its members, shares and stock brokers by profession, are admitted for their character and position. That the transaction of the members, inter se, were for the benefit of several participants. That by the rules of the association, a member was given a card, without which he is not entitled to do business. That in case of default, his card is forfeited and sold and the sale proceeds are distributed among his exchange creditors. Therefore, the effect of the rules was that the defaulting member himself had no interest in the result of the sale of the card nor could he require a sale to be made. In view of the above two judgments, we hold that the sale proceeds from the auction of the nomination rights of the defaulter-member vested in the defaulters' committee of the BSE and such sale proceeds became distributable under rule 16 of the BSE rules.

However, in this case, a garnishee notice has been issued by the Tax Recovery Officer under section 226(3)(i). As stated above, the requisite condition for serving the garnishee notice is that there must be subsisting an ascertained debt in the hands of the BSE due to the assessee (defaulting-broker) or there should be some contractual relationship, as a consequence of which, money is likely to come in the hands of the BSE (garnishee) for and on behalf of the assessee-broker. Therefore, either of the two conditions, if satisfied, would attract section 226(3)(i), which is one of the modes of recovery prescribed under the Income-tax Act.

Now, in the present case, there existed a contractual relationship between the broker and the BSE. However, on June 29, 1994, the broker was declared a defaulter under the rules of the BSE and his right of membership stood vested in the exchange on his being declared a defaulter. Under issue No. 1, we are concerned with attachment of the BSE membership card allotted to the broker. As held hereinabove, the defaulting-member had no interest in the membership card or its sale. Therefore, the Tax Recovery Officer was not right in attaching such sale proceeds. However, as stated above, the Tax Recovery Officer has issued notice under section 226(3)(i) and (x) and, as a consequence money, which is likely to come in the hands of the garnishee-BSE for and on behalf of the assessee-broker, is attachable because the requisite condition for service of the garnishee notice is subsistence of an ascertained debt in the hands of the garnishee (BSE) due to the assessee-broker or existence of a contractual relationship between broker and the BSE consequent upon which, money is likely to come in the hands of the garnishee for and on behalf of the assessee-broker. Therefore, even if the broker-member has no right, title and interest in the membership card, still in view of rule 16(1)(iii) of the stock exchange rules, the balance surplus would become payable to the Tax Recovery Officer as the said amount came into the hands of BSE for and on behalf of the assessee-broker in the course of administration of assets and allocation under rule 16(1)(iii) read with the general body resolution, dated October 13, 1999. This balance surplus comes to Rs. 34,06,680. Therefore, we are directing this amount of balance surplus to be paid over by the BSE to the Tax Recovery Officer as per the impugned show cause notice under section 226(3)(i).

Findings on issue No. 2 :

It has been urged vehemently on behalf of the BSE that when the broker-member becomes a defaulter, the security, margin money and securities deposited by the defaulter and all monies, securities and other assets due, payable or deliverable to the defaulter by any other member in respect of the transaction made under the rules/bye-laws (hereinafter referred to as "other assets"), shall vest in the defaulters' committee for and on account of creditor members and, consequently, such other assets belong to the BSE when a broker-member is declared a defaulter. We do not find any merit in this argument of the BSE. As discussed hereinabove, on the broker-member being declared a defaulter, such other assets are applied under the rules/bye-laws, for discharging the broker's liabilities to the BSE, the clearing house and other members. This is indicated by bye-law No. 326 read with bye-law No. 400. It is also indicated by the manner in which the defaulter's account is maintained in the books of the BSE. These rules and accounts show that what is called in are the assets of the broker, which is applied to discharge his liabilities. In our view, therefore, such other assets are of the defaulters and they vest in the committee only to enable the committee to administer, distribute and apply the same in the order of priority in bye-law No. 400. In this case, we are concerned with attachment and recovery of income-tax dues. The question posed before us is : whether the Tax Recovery Officer is entitled to attach, vide prohibitory order, such other assets of the defaulting member-broker. In order to answer this question we may also mention that every broker of the BSE maintains various accounts in the books of the BSE. They are clearing house account; security account; membership security deposit account (securities), membership security deposit account (cash), etc. In this case, the Tax Recovery Officer has sought to attach credit balances in these accounts on May 10, 1996. On behalf of the BSE, it is argued that these accounts were not attachable as they belong to the BSE. In the alternative it is argued that even if these accounts were attachable, only the surplus, if any, could be paid to the Income-tax Department, after liquidating the liabilities of the defaulting broker as provided in bye-law No. 400.

We do not find any merit in the argument advanced on behalf of the BSE. At the outset it may be mentioned that none of the earlier judgments of the Supreme Court have dealt with the question which arises in this case. In this case, the Tax Recovery Officer has issued prohibitory orders attaching various accounts of the defaulting broker in the books of the BSE. The Tax Recovery Officer had called upon the BSE to furnish the particulars of those accounts. The Tax Recovery Officer also called upon the BSE to furnish the particulars of its liability to the broker. However, those particulars were not given which resulted in the Tax Recovery Officer issuing prohibitory orders. When the matter came before the court, the court directed the BSE to file an affidavit giving particulars of the accounts maintained by the defaulter-broker in the books of the BSE and the clearing house as also the credit balance standing in each of those accounts on May 10, 1996, i.e., on the date when the impugned prohibitory order came to be issued. Pursuant to the directions of the High Court, an affidavit came to be filed by the BSE under which it has been disclosed that the credit balance in the settlement account on May 10, 1996, was Rs. 16,799 and an amount of Rs. 1,98,055 was the credit balance in the defaulter's account on May 10, 1996. Similarly, securities worth Rs. 1,37,100 were available with the BSE on May 10, 1996, under the membership security deposit account, whose value stood at Rs. 1,11,220 on February 7, 2003, on account of the price fluctuation in the share market. Till today, these securities have not yet been realised as the matter is sub-judice. Similarly, on May 10, 1996, the credit balance in membership security deposit account (cash) was Rs. 45,000, whereas the credit balance in the interest-free deposit account was Rs. 1,25,000. To sum up, the balance surplus lying with the BSE out of sale proceeds of the nomination rights of the defaulter as of date is Rs. 34,06,680 after taking into account 5 per cent. paid to IPF and 5 per cent. paid to BCF. In addition to the said sum of Rs. 34,06,680, the other assets lying in the account of the defaulter are to the tune of Rs. 2,64,758.10 as mentioned in para. 4(D) of the affidavit filed on behalf of the BSE, dated February 25, 2003, pursuant to the directions of this court, dated February 15, 2003. Therefore, in all, an amount of Rs. 35,60,218 plus the realised value of the securities in membership security deposit account is claimed by the Tax Recovery Officer from the BSE.

In this case, an issue of importance arises. As stated above, broadly, we are concerned with two assets, viz., the membership card and other assets. The short point which arises for determination under Issue No. 2 is whether such other assets were attachable and whether the proceeds thereof have to be applied under bye-law No. 400, subject to payment of income-tax dues.

According to the BSE, in the matter of attachment, there is no difference between a membership card and other assets. According to the BSE, the issue is no more res integra. According to the BSE, the issue is covered by the judgment of the Supreme Court in the case of Stock Exchange, Ahmedabad [2001] 248 ITR 209. According to the BSE, both these assets belong to the BSE. According to the BSE, both these assets stood vested in the defaulters' committee when the broker was declared a defaulter by the BSE on June 29, 1994, according to its rules and bye-laws. According to the BSE, therefore, the surplus, if any, after liquidating the liability of the defaulting-broker to the BSE, the clearing house and the creditor-members became payable to the defaulting-member. According to the BSE, bye-law No. 400 of the BSE contemplates application of the defaulter's other assets. According to the BSE, bye-law No. 400(9), inter alia, states that after liquidating the liability of the defaulting broker to the stock exchange, the clearing house and other members, surplus, if any, shall be paid to the defaulter and since the said surplus is payable to the defaulter, if the court directs, it will be paid to the Tax Recovery Officer. Therefore, the BSE under bye-law No. 400 keeps out the Crown debts from administration of assets. We do not find any merit in this part of the case of the BSE.

Rule 5 to rule 16 fall under the Chapter "Membership". Rule 16, as stated above, deals with the application of sale proceeds of the nomination rights of the defaulter-member. Rule 36 to rule 44 read with bye-law No. 326, bye-law 7 No. 342 and bye-law No. 400 deal with security, margin money and securities deposited by the defaulter, recovery of all receivables on behalf of the defaulting-broker ; and application of those assets to liquidate the liability of the defaulting-broker to the BSE, the clearing house and other members. Therefore, there is a clear dichotomy under the rules and bye-laws between the sale of membership card and recovery of defaulter's other assets and application thereof. In our view, even on vesting of such other assets in the defaulters' committee, such other assets continue to belong to the member-broker for the purposes of distribution, which is for the benefit of the BSE, the clearing house and other creditor-members so that these other creditor-members' dues could be recovered expeditiously. In our view, the Tax Recovery Officer was, therefore, entitled to attach such other assets.

However, the question remains as to whether the dues of the BSE, the clearing house and other members would get precedence over the Crown debts with regard to the proceeds realised by encashing such other assets of the defaulter. In this connection, we may point out that under the rules/bye-laws, when a broker is declared a defaulter, there is an assignment of such other assets in favour of the defaulters' committee. The question before this court is whether such assignment overrides section 73(3) of the Civil Procedure Code. Section 73(3) of the Civil Procedure Code is in the nature of a proviso to section 73 of the Civil Procedure Code. It recognises the English common law doctrine that Crown debts are entitled to priority and that the State is not relegated to rateable distribution along with other decree-holders and the State can claim priority over them. In fact, under section 73 of the Civil Procedure Code, the court will refuse to make an order for rateable distribution if it is brought to its notice that certain Government dues are outstanding against the judgment debtor. Under the rules and bye-laws of the BSE, the liability of the broker to the BSE and the clearing house is required to be discharged, first in point of time, and if there is no surplus remaining thereafter to meet the liability of other members in seriatim, then the rules provide for rateable distribution. In our view, the rules and bye-laws of the BSE cannot override the mandate of section 73(3) of the Civil Procedure Code. The doctrine of rateable distribution, therefore, as provided under the rules and bye-laws, will not prejudice the rights of the Government vis-a-vis priority. In fact, section 73(3) protects that priority from being overridden by the principle of rateable distribution. The basic justification for priority of debts due to the Government is that the State must be able to discharge its primary governmental function and in order to discharge those functions, it must be in possession of the necessary funds. The common law doctrine states that if the debts due to the Crown are of equal degree to the debts due to a private citizen then the Crown must have a priority against the private citizen. Therefore, debts due to the State are entitled to a priority over all other debts, Section 73 of the Civil Procedure Code, comes under Chapter XXI, Civil Procedure Code, which deals with distribution of assets. Chapter XXI deals with proceeds of execution sale to be rateably distributed amongst the decree holders under section 73 of the Civil Procedure Code. In our view, therefore, the rules and bye-laws of the BSE will not override section 73(3) of the Civil Procedure Code, and the debts due to the Government would be entitled to priority over the dues due to the stock exchange, the clearing house and other members under the rules/bye-laws of the BSE. If the argument of the BSE is to be accepted it would lead to total obliteration of the concept of priority of Government dues. As stated hereinabove, under bye-law No. 400, the assets of the defaulting-broker are applied to liquidate his liabilities to the BSE, the clearing house and other creditor members and if there is no surplus under those heads, then nothing is payable to the defaulter and if nothing is payable to the defaulter, then no amount would be paid towards the Government dues and that would defeat the concept of priority qua Government dues. Under bye-law No. 400 there are nine sub-clauses. All these sub-clauses deal with application of the defaulter's assets. Bye-law No. 400 indicates that the abovementioned other assets continue to remain the assets of the defaulting-broker and, therefore, those other assets are applied to liquidate his liability to the BSE, the clearing house and other creditor-members. We do not find any merit in the argument of the BSE that on a broker being declared a defaulter, such other assets cease to be defaulter's assets and they become the assets of the BSE. If that was so, then such other assets could not have been applied to discharge the liabilities of a defaulting-broker. Such other assets vest in the defaulters' committee only to enable the committee to liquidate the liability of the defaulting-broker under the rules. However, such other assets continue to belong to the defaulter and they are used to discharge his liabilities to the BSE, the clearing house and other creditor-members. Therefore, such other assets are attachable under section 226(3) read with rule 26(1) of Schedule II to the Income-tax Act. This is also borne out by the defaulters' account which the stock exchange is required to maintain (see affidavit of the BSE, dated February 25, 2003, in which the defaulter ledger account-Mukesh Kothari is reproduced). Therefore, the Government dues will have to override all other dues.

It was, however, urged on behalf of the BSE that such other assets are under lien in favour of the BSE and the purpose of creation of lien in favour of the BSE is to see that public confidence in the stock exchange is not lost, particularly because the stock exchange working is very much based on the confidence which public reposes qua the capital market. That the capital market performs a very important function in the economy. That, if income-tax dues are to be given priority, then the working of the stock exchange would be disrupted. It was argued that the investors' protection fund and the brokers' contingency fund have been created under the rules and bye-laws of the BSE to protect genuine investors and if income-tax dues are given priority then there would be total disruption in the function of various funds which, in turn, would have an adverse effect on the working of the stock exchange. In support of this argument numerous authorities were relied upon. However, at the outset, we may point out that none of those authorities deal with the priority given to the Crown debts vis-a-vis liability of the broker under rules and bye-laws of the BSE. In this matter, we are not concerned with the validity of the rules/bye-laws of the BSE. In the case of Vinay Bubna v. Mumbai Stock Exchange [1999] 97 Comp Cas 874 (SC), the facts were as follows. On May 10, 1995, a sum of Rs. 21,81,635.50 was due and payable by the share broker. However, the payment was not made. Therefore, Vinay Bubna filed an arbitration petition against the share broker before the Bombay High Court. In the said proceedings an application was filed for appointment of court receiver. The court did not grant to the appellant any relief in respect of the membership card of the share broker on the ground that the membership card was not a property of the broker. The broker was declared a defaulter under the rules/ bye-laws of the stock exchange on December 10, 1996, and thereafter, he ceased to be its member. Finally, Vinay Bubna challenged the validity of rule 16 and rule 43 of the BSE. The main reason for impugning the rules was that the membership of the stock exchange was an asset of the broker and on its sale, from the proceeds thereof, payment should be first made to creditors and the proceeds should not be distributed in the manner indicated under rule 16 and bye-law No. 400. The entire controversy in that matter related to the membership card. It was held by the Supreme Court that the order of priority laid down by rule 16 ensures that the dues to the exchange or to the clearing house have first to be met before the balance amount can be utilised for payment of debts, liabilities, obligations, etc., arising out of the contracts made by the former member and if the amount available was insufficient then the payment was to be made pro rata. That, if, however, any surplus remained, the same was to be disposed of in such manner as the exchange may decide. This judgment is entirely concerning issue No. 1 in this case. This judgment does not cover the point which arises under Issue No. 2 in this case, viz., application of defaulter's other assets as per the order of priority under bye-law No. 400. The judgment does not deal with rule 36 to rule 44 of the BSE, which refer to membership security. None of the judgments cited on behalf of the BSE, therefore, apply to the facts of this case. Reliance is also placed on the judgment of the Gujarat High Court in the case of P. I. Shukla v. Tribhovandas Hargovandas [1988] 173 ITR 624. In that matter, the facts were as follows. The judgment-creditors were trustees of a trust. They filed a suit for recovery of an amount and for enforcing an equitable mortgage. According to the final decree in the suit, the decretal amount had to be paid by the judgment-debtor by half-yearly instalments and in case of default in the payment of any two instalments the judgment-creditor was entitled to execute the decree. The judgment-debtor committed default. The judgment-creditor filed an execution application for executing the decree by selling the suit property belonging to the judgment-debtor. One of the tenants in the suit property received notice, calling upon him to pay rent to the decree-holder. Prior to such notice, the tenant was paying rent to the Tax Recovery Officer, who had issued prohibitory orders under the Income-tax Act. Therefore, the tenant filed an application before the court seeking a direction as to whom the rent should be paid to. The learned single judge held that the effect of the order of the court in the final decree amounted to creating a charge in favour of the judgment-creditor and, therefore, he negatived the claim of the Income-tax Department for priority on the ground that the Crown debt had priority over other debts. The matter came before the High Court, which took the view that under the decree, a charge had been created over the rent and mesne profits to be realised from the mortgaged property in favour of the judgment-creditor and the judgment-creditors could not be said to be creditors of equal degree and, therefore, the State dues could not have priority over the rights of the judgment-creditor. In our view the judgment of the Gujarat High Court has no application. In that matter, the High Court found creation of a charge over rent and mesne profits in favour of the judgment-creditor and, therefore, the High Court found that the judgment-creditor could not be said to be creditors of equal degree vis-a-vis the State. It was a case where the property stood charged. It was a case where the applicants were secured creditors. In the present case, the lien under rule 43 does not make the BSE or the clearing house a secured creditor. In the circumstances, the judgment of the Gujarat High Court in the case of P. I. Shukla v. Tribhovandas Hargovandas [1988] 173 ITR 624 has no application to the facts of the present case. All other judgments cited on behalf of the BSE relate to sale of the membership card with which we are not concerned under issue No. 2.

In this case, we are confining our judgment specifically to other assets of the defaulter. For example, securities under the membership security deposit account which has been valued at Rs. 1,11,220 as on February 7, 2003 ; credit balance with the clearing house on May 10, 1996, when the prohibitory order was issued ; cash in members security deposit and others which fall in the category of other assets. These have got to be appropriated and applied to liquidate the Crown debts first in priority and the balance, if any, can be applied to meet the defaulter's liability to the BSE, the clearing house and other creditor-members in the manner indicated under bye-law No. 400.

Conclusion :

To sum up, we hereby declare :

(a) That, the other assets (as described hereinabove) are attachable and recoverable under the 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 the rules and bye-laws of the stock exchange are creditors of equal degree and under section 73(3) of the Civil Procedure Code, the Government dues shall have priority over other such creditors.

(c) That, in the matter of application of the defaulter's assets under byelaw No. 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 byelaw No. 342 along with bye-law No. 400 of the BSE.

(d) That, a sum of Rs. 34,06,680 representing the balance surplus lying with the exchange out of the 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 Tax Recovery Officer under the impugned prohibitory order.

(e) We hereby direct the BSE also to hand over the securities lying in the members security deposit account to the Tax Recovery Officer, 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 Tax Recovery Officer so directs, those securities could also be sold by the BSE and the realised value, on the date of the sale, could be handed over to the Tax Recovery Officer. It is for the Tax Recovery Officer to decide this point. We further direct the credit balance with the clearing house of Rs. 1,53,538 to be paid over to the Tax Recovery Officer and that the Tax Recovery Officer would be entitled to appropriate the said amount towards the dues of the Department. In short, we are directing the BSE to pay a sum of Rs. 35,60,218 to the Tax Recovery Officer and in addition thereto, the Tax Recovery Officer would be entitled to the realised value of the securities as on the date of sales. 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 the BSE and the Tax Recovery Officer would be entitled to attach such other assets and appropriate the amounts towards its claim under the Income-tax Act.

Subject to above, the writ petition stands disposed of. No order as to costs.

C. C. expedited.

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