The Assessee borrowed money from a sister concern at 18 per cent interest and purchased shares from another sister concern carrying a dividend at 4 per cent. The Revenue thought the device was colourable and disallowed the interest. Investment in shares was considered not for business purposes.
High Court applied the test of commercial expediency.
The question whether having regard to the relationship between different concerns, where a transaction which was patently imprudent takes place, the taxing authority should examine the question of business expediency and not go merely by the fact that the assessee had taken a decision in its wisdom, which may be wrong or right, and should be referred to a larger bench.
Punjab High Court chose respectfully to disagree with the views of the very same High Court in the Pankaj Munjal Family Trust Case and referred the matter to a larger Bench. The High Court felt that the question is frequently arising and it would be desirable to have an authoritative view of the larger Bench on the question whether having regard to the relationship between different concerns, where a transaction which is patently imprudent takes place, the taxing authority should examine the question of business expediency and not go merely by the fact that the assessee had taken a decision in its wisdom which may be wrong or right. The Larger bench held as below:-
Assessing Officer or the appellate authorities and even the courts can determine the true legal relation resulting from a transaction. If some device has been used by the assessee to conceal true nature of the transaction, it is the duty of the taxing authority to unravel the device and determine its true character. However, the legal effect of the transaction cannot be displaced by probing into the “substance of the transaction”. The taxing authority must not look at the matter from their own view point but that of a prudent businessman. Each case will depend on its own facts. The exercise of jurisdiction cannot be stretched to hold a roving inquiry or deep probe.
IN THE HIGH COURT OF PUNJAB AND HARYANA AT CHANDIGARH
ITR Nos. 169 and 170 of 1996
Date of decision: February 01, 2011
The Commissioner of Income Tax (Central) Vs. M/s Rock man Cycle Industries Private Limited
1. The following question of law was referred by a Division Bench of this court vide order dated 7.8.2009 for consideration by a larger Bench:
“Whether having regard to relationship between different concerns, where a transaction which is patently imprudent, takes place, the taxing authority should examine the question of business expediency and not go merely by the fact that the assessee had taken a decision in its wisdom which may be wrong or right?”
2. Briefly, the facts are that the Income-tax Appellate Tribunal, Chandigarh Bench, Chandigarh (for short, `the Tribunal’), at the instance of the revenue, referred the following question of law arising out of order dated 19.11.1995, passed in ITA Nos. 70 and 93 of 1990 relating to assessment year 1986-87 for determination by this court:
“Whether on the facts and in the circumstances of the case, the ITAT was right in law in allowing interest claimed by the assessee at a higher rate on the borrowings though the investment had been made by the assessee in the shares of a sister concern which gave a fixed return of income?”
3. The facts, which were taken note of by the Division Bench of this court, while referring the question of law to the larger Bench are extracted below:
“2. The assessee borrowed money from sister concern and paid interest therein @ 18% per annum and purchased shares from sister concern which carried dividend @ 4%. The Assessing Officer (AO) held that there was no justification to borrow funds at the rate of 18% interest for making investment in shares, which would give a dividend of 4% only. Having regard to the fact that the borrowing was made from sister concern and investment was also in another sister concern, the claim for interest was disallowed. It was held that investment of shares was not for business purpose or business consideration. Observations of the AO are as under:
“3 No prudent person will make such an investment. A man may invest in equity share may get 10%, may get dividend of 50% of more along with appreciation or may not get the dividend at all. In preference shares the return determines its market value. At the rate of 4%, preference share may fetch not more than Rs. 30/- to 35/- per share of the face value of Rs. 100/-. For the purpose of wealth tax the value of these shares has been shown between Rs 30/- to 35/- by the share holders. In the assessee’s case it knew before making the investment that the maximum yield expected could not be more than 4%. The assessee belongs to one of the largest group of M/s Hero Cycles (P) Limited and is assisted by a number of senior counsels. The assessee’s conduct of paying higher interest to the sister concern of the same group by taking a loan for the purchase of preference shares with a low fixed yield is a clear cut colourable dubious device to reduce the tax liability, such device is not permissible in view of the Hon’ble Supreme Court’s decision in the case of Mc. Dowell & Co. Limited, reported in 154 ITR 148. Penalty proceedings under Section 271(1)(c) are initiated for furnishing of in accurate particulars of income.”
3. The CIT (A) upheld the finding of the Assessing Officer with following observations:
“7.3. I do not find any reason to give relief to the appellant on this account. The another ground that the appellant is entitled to 4% dividend on these shares that
in case of Highway Cycle Ind. Ltd. Ludhiana for assessment year 1986-87 the ACIT has added back the difference of 18-4= 14% under similar circumstances on the amount borrowed for that company for purchase of similar shares. This plea of the appellant is also rejected as these are non-cumulative preference shares and no dividend has been declared by Hero Investments P. Limited for the year under consideration. It is held that the case of Mc. Dowell & Co. Limited (154 ITR 148) is applicable, as the appellant has adopted circuitous method, where it was observed:
“the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it.”
4. The Tribunal upheld the plea of the assessee and held that the assessee could not be prevented from making investment only because the return from shares was low. The investment was incidental activity of the business and there was no effect on revenue as the assessee and sister concern belonged to the same group. The transaction was bonafide and not sham. Relevant part of the order of the Tribunal is extracted below:
“10. We have considered the rival contention and we have also perused the different rulings cited by the ld. Counsel and are of the view that the assessee did borrow certain funds at a higher rate of interest and utilized them for investments in certain preference shares. The assessee could not be prevented from making investment in certain shares only on the ground that the return from shares was very low. We do not agree with the revenue that the benefit accruing @ 4% from preference shares was not sufficient so as to justify the borrowings @ 18%. It is to be noted that the assessee was not dealing in shares and investments had been made as incidental activity of the business. The ld. Counsel has argued that there was ultimately no effect on the revenue because the assessee as well as the other two parties involved belonged to the same group. Borrowing was made from MAL and shares was purchased from M/s Hero Inv. Pvt. Limited. Since the transactions were bonafide and not sham, the interest payable to the creditor is found to be incidental and wholly for the purpose of business. We are unable to agree with the revenue that the interest paid at a higher rate could not be allowed. We have already seen that in the case of M/s Pankaj Munjal Family Trust, the Tribunal on identical question, took a view that the payment of interest at a higher rate could not be disallowed. Therefore, following the Tribunal’s orders in the case of M/s Pankaj Munjal Family Trust as well as Yogesh Chander, as also in view of the various judicial pronouncements, discussed above, ground No. 2 is accepted and dis allowance is deleted.”
4. The Division Bench of this Court considered it appropriate to refer the question for consideration by a larger Bench of this court on account of the fact that the Tribunal while deciding the appeal in favour of the assessee in the present case had followed its earlier order in the case of M/s Pankaj Munjal Family Trust. A similar question of law arising therefrom was referred for opinion of this court vide ITR Nos. 87 to 91 of 1995 –The CIT (Central) Ludhiana v. M/s Pankaj Munjal Family Trust, Ludhiana) and vide order dated 9.7.2008, the same was answered in favour of the assessee therein. While proposing to differ with the view taken by this court in M/s Pankaj Munjal Family Trust’s case (supra) and with the following observations, the matter was referred for consideration by the larger Bench:
“10. In famous case of CIT v. A. Raman & Co. (1968) 67 ITR 11, it was observed:
“Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited. A taxpayer may resort to a device to divert the income before it accrues to arise to him. Effectiveness of the device depends not upon considerations of morality, but on the operation of the Income tax Act. Legislative injunction in taxing statutes may not, except on pain of penalty, be violated, but it may lawfully be circumvented.”
11. In CIT v. B. M. Kharwar, 1969(72) ITR 603, it was observed:
“The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authorities to unravel the device and to determine the true character of relationship. But the legal effect of a transaction cannot be displaced by probing into the “substance of the transaction.”
12. In M/s McDowell and Company Limited v. Commercial Tax Officer, (1985) 154 ITR 148, the above observations were sought to be disapproved but in Union of India v.Azadi Bachao Andolan, (2003) 263 ITR 706, it was observed that observations of Chinnapa Reddy, J. were not supported by other members of the Bench and principles in IRC v. Fishers Executors, 1926 AC 395 and in IRC v. Duke of Westminster, 1936 AC 1, on which observations in A. Raman & Co. and B. M. Kanwar (supra) were based, still held the field.
13. We may proceed on the basis that tax planning is permissible even if it results in avoidance of tax as observe in Azadi Bachao Andolan (supra). Legitimacy of claim for deduction has still to be made out on the principles of business expediency. In SA Builders Limited v. CIT, (2007) 288 ITR 1, it was observed that amount paid as interest for business was a permissible deduction under Section 36(1)(iii) of the Act and test of commercial expediency applied for permitting deductions under Section 37 applied to such claim for deduction. The said test itself is test of prudent businessman. This test has been laid down in Atherton v. British Insulated & Helsby Cables Limited (1925) 10 TC 155, as approved in Eastern Investments Limited v. CIT, (1951) 201 ITR (SC) and CIT v. Chandulal Keshavlal, (1960) 38 ITR 601 (SC). It was further observed in SA Builders (supra) that in absence of commercial expediency, deduction could not be followed. The matter was remanded to the Tribunal for fresh decision for applying the test of business expediency.
14. In the present case, the Tribunal has not applied the said test and merely observed that it was in the wisdom of assessee to have entered into transactions even if such transactions were not prudent. The Hon’ble Division Bench in earlier order in M/s Pankaj Munjal Family Trust (supra) affirmed the order of the Tribunal without applying the test of commercial expediency. We, thus, respectfully disagree with the view taken therein and refer the matter to larger Bench.”
5. In view of the aforesaid factual matrix the matter is before this Bench.
6. Mr. K. K. Mehta, Senior Standing Counsel addressed arguments for the revenue, whereas Mr. Akshay Bhan, Advocate made submissions for the assessee.
7. Learned counsel for the revenue submitted that in the present case, during the financial year 1986-87, the assessee claimed deduction on account of payment of interest amounting to Rs. 26,66,408/- to the bank and other creditors. During the course of assessment proceedings, the Assessing Officer noticed that the assessee had borrowed a sum of Rs. 45,00,000/- from M/s Majestic Auto Limited, another sister concern, on 28.11.1984 carrying interest @ 18% per annum. The assessing officer also noticed that the assessee had purchased 50,500 (4%) preference shares of Rs. 100/- each of M/s Hero Investments (P) Ltd., a sister concern, for Rs. 50,00,000/- on 30.11.1984. The Assessing Officer was of the view that there was no justification to borrow funds carrying interest @ 18% per annum for the purpose of making investment in shares which would have given dividend of only 4% p.a. In the aforesaid facts, the Assessing Officer opined that the expenditure incurred by the assessee in raising loans for the purpose of investment in shares was not for the purpose of business and accordingly, expenditure to that extent was disallowed. It was submitted that in terms of the provisions of Section 57(iii) of the Income-tax Act, 1961 (for short, `the Act’), only that expenditure can be allowed, which was made to earn income. In the present case, expenditure on interest made by the assessee was not for the purpose of earning income because from the very beginning it was known to the assessee that the investment would result in income less than the expenditure being made to earn that. The companies between whom the transactions have taken place, may be group companies, otherwise they are separate legal entities.
8. Referring to the definition of “prudent” in Black Dictionary of Law, it was submitted that it is a “reasonable person”. In the present case, the action of the assessee cannot be said to be of a reasonable person.
9. Relying upon a judgment of Hon’ble the Supreme Court in SA Builders Limited v. Commissioner of Income-tax (Appeals) and another, (2007) 288 ITR 1, it was submitted that the issue under consideration therein was advance of interest-free loan to a sister concern where the assessee himself was raising loans and paying interest. On these facts, Hon’ble the Supreme Court inter alia, opined that the income-tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman could act.
10. On the other hand, learned counsel for the assessee submitted that the question of law, as has been referred for consideration by the Full Bench, needs a little modification. His submission was that instead of word “patently” used in the question with reference to the transaction, the word “apparently” would be more appropriate. He further referred to the finding recorded by the Tribunal in paragraph 10 of the order regarding the transactions entered into by the assessee with Hero Investment Private Limited to be bonafide and not sham. The aforesaid finding recorded by the Tribunal has not been challenged by the Revenue being perverse claiming any question of law thereon, hence, the issue of business expediency is not required to be gone into. Investment by an assessee in a venture today may or may not result in profit immediately, but the steps may have been taken as long term investment. Merely because in a particular assessment year when the expense was incurred, there was no profit earned by the assessee, the cost so incurred or the expenses so made could not be disallowed. The Revenue has no authority to go into the prudence of a businessman as he is the best judge for running his business, which may be in the form of a single establishment or a group of establishments.
11. Learned counsel further submitted that the opinion of different persons with regard to the fact as to whether a particular transaction is to be entered into or not would be subjective and differs from each other. The Assessing Officer may look at the facts from a conservative point of view whereas the assessee may have to look for a broader aspect keeping in view long term planning. Many a times, to keep the flag flying, the group companies have to be supported with funds from financially healthy companies. The manner in which the transaction has been entered into by the assessee can at the best be termed as tax planning, but in no way it can be opined as tax evasion. Tax planning is permissible. Reliance for the purpose was placed upon M/s McDowell and Company Limited v. Commercial Tax Officer, (1985) 154 ITR 148 and Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706.
12. Learned counsel further submitted that even in SA Builders Limited’s case (supra), Hon’ble the Supreme Court has opined that the expression “commercial expediency” is an expression of wide import and includes such expenditure which a prudent businessman incurs for the purpose of business. It may not have been incurred under any legal obligation, but still allowable if incurred on the ground of commercial expediency. Each case depends on its own facts. In the present case, there being a definite finding of fact recorded by the Tribunal in favour of the assessee, the same having been accepted by the Revenue, in fact, no question of law arises in the appeal. Not only this, even in the case of sister concern of the assessee, namely, M/s Pankaj Munjal Family Trust’s case (supra), an identical question has already been answered in favor of the assessee.
13. Heard learned counsel for the parties and perused the paper book.
14. This court is required to go into the question of jurisdiction to be exercised by an Assessing Officer with reference to some transactions entered into by an assessee with another group company on the issue of prudence, namely, whether a prudent person would enter into such a transaction during the course of his business and would incur that expenditure, on account of which deduction is claimed as a business expense or otherwise. As to whether the Assessing Officer can lift the veil to see the real face ?
15. The undisputed facts are that the assessee borrowed money from its sister concern carrying interest @ 18% per annum and purchased preference shares of another company carrying divided @ 4%. The issue before the Assessing Officer was as to whether there was any justification to borrow funds @ 18% per annum for making investment in shares carrying divided of only 4%. The Assessing Officer dis-allowed the interest as expense to the extent beyond 4%. The Commissioner of Income-tax (Appeals) [for short, `the CIT (A)’) upheld the order of the Assessing Officer. However, the Tribunal relying upon its earlier decision accepted the plea of the assessee and the entire interest paid by it was allowed as expense.
16. A perusal of the orders passed by the Assessing Officer as well as CIT (A) shows that the claim of the assessee for deduction on account of payment of interest has been considered under Section 57(iii) of the Act. 17. Section 57 of the Act deals with the income chargeable under the head “income from other sources”. It provides for various permissible deductions from such income. Chapter-IV of the Act deals with computation of total income. The same has been divided into six parts, which deal with different heads under which the income is to be assessed. Part-D thereof provides for computation of income in the form of profits and gains of business or profession. The same is dealt with in Sections 28 to 44 of the Act. It provide for various permissible rebates and deductions for the purpose of computation of such income. Section 36 of the Act deals with other permissible deductions while computing the income from business or profession. Section 36(1)(iii) provides for deduction on account of amount of interest paid in respect of capital borrowed for the purpose of business or profession.
18. Section 37 of the Act is a residuary section which provides for deduction on account of expenditure not being capital in nature, which are not as such specified in Sections 30 to 36 of the Act, but laid out or expended wholly and exclusively for the purpose of business or profession, while computing the income under the head “profits and gains of business or profession”. The import of Sections 37(1)(iii) and 57(iii) of the Act was considered by Hon’ble the Supreme Court in Commissioner of Income Tax v. Rajendra Prasad Moody, (1978) 115 ITR 519. It was a case where difference of opinion on the subject between various judgments of the High Courts was considered as the Tribunal had directly referred the matter for opinion of Hon’ble the Supreme Court. The issue under consideration therein was whether interest on money borrowed for investment in shares which had not yielded any dividend is permissible under Section 57(iii) of the Act. It was opined that even though the language of Section 37(1) is a little wider than that of Section 57(iii) of the Act, but that was of no effect, as the language of Section 57(iii) being clear and unambiguous has to be considered according to its plain natural meaning. It should not be given narrow and constricted meaning. It does not provide that expenditure shall be deductible only if any income is made or earned. The relevant paragraphs therefrom are extracted below:
“4. What S. 57(iii) requires is that the expenditure must be laid out or expended wholly or exclusively for the purpose of making or earning income. It is the purpose of the expenditure that is relevant in determining the applicability of s. 57(iii) and that purpose must be making or earning of income. S. 57(iii) does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction. It does not say that the expenditure shall be deductible only if any income is made or earned. There is in fact nothing in the language of S. 57(iii) to suggest that the purpose for which the expenditure is made should fructify into any benefit by way of return in the shape of income. The plain natural construction of the language of s. 57 (iii) irresistibly leads to the conclusion that to bring a case within the section, it is not necessary that any income should in fact have been earned as a result of the expenditure. It may be pointed out that an identical view was taken by this court in Eastern Investments Ltd. vs. CIT (1951) 20 ITR 14 (SC), where interpreting the corresponding provision in s. 12(2) of the Indian I.T. Act, 1922, which was ipsissima verba in the same terms as s. 57(iii), Bose J., speaking on behalf of the court observed:
“It is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned.”
It is indeed difficult to see how, after this observation of the Court there can be any scope for controversy in regard to the interpretation of s. 57(iii).
5. It is also interesting to note that, according to the Revenue, the expenditure would disqualify for deduction only if no income results from such expenditure in a particular assessment year, but if there is some income, howsoever small or meagre, the expenditure would be eligible for deduction. This means that in a case where the expenditure is Rs. 1,000, if there is income of even Re. 1, the expenditure would be deductible and there would be resulting loss of Rs. 999 under the head “Income from other sources”. But if there is no income, then, on the argument of the Revenue, the expenditure would have to be ignored as it would not be liable to be deducted. This would indeed be a strange and highly anomalous result and it is difficult to believe that the legislature could have ever intended to produce such illogicality.
Moreover, it must be remembered that when a profit and loss account is cast in respect of any source of income, what is allowed by the statute as proper expenditure would be debited as an outgoing and income would be credited as a receipt and the resulting income or loss would be determined. It would make no difference to this process whether the expenditure is X or Y or nil; whatever is the proper expenditure allowed by the statute would be debited. Equally, it would make no difference whether there is any income and if so, what, since whatever it be, X or Y or nil, would be credited. And the ultimate income or loss would be found. We fail to appreciate how expenditure which is otherwise a proper expenditure can cease to be such merely because there is no receipt of income. Whatever is a proper outgoing by way of expenditure must be debited irrespective of whether there is receipt of income or not. That is the plain requirement of proper accounting and the interpretation of s. 57(iii) cannot be different. The deduction of the expenditure cannot, in the circumstances, be held to be conditional upon the making or earning of the income.
6. It is true that the language of s. 37(1) is a little wider than that of s.57(iii), but we do not see how that can make any difference in the true interpretation of s. 57(iii). The language of s. 57(iii) is clear and unambiguous and it has to be construed according to its plain natural meaning and merely because a slightly wider phraseology is employed in another section which may take in something more, it does not mean that s. 57 (iii) should be given a narrow and constricted meaning not warranted by the language of the section and, in fact, contrary to such language.
This view which we are taking is clearly supported by the observations of Lord Thankerton in Huges vs. Bank of New Zealand (1938) 6 ITR 636, 644 (HL), where the learned Law Lord said:
“Expenditure in course of the trade which is unremunerative is none the less a proper deduction, if wholly and exclusively made for the purposes of the trade. It does not require the presence of a receipt on the credit side to justify the deduction of an expense.”
19. The issue regarding jurisdiction of the taxing authorities was considered by Hon’ble the Supreme Court in Commissioner of Income Tax v. B. M. Kharwar, (1969) 72 ITR 603 (SC), wherein it was opined that a taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. The relevant paragraph is extracted below:
“The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authorities to unravel the device and to determine the true character of the relationship. But the legal effect of a transaction cannot be displaced by probing into the “substance of the transaction”. This principle applies alike to cases in which the legal relation is recorded in a formal document, and to cases where it has to be gathered from evidence- oral and documentary- and conduct of the parties to the transaction. The observation made by Bose J. in Sir Kikabhai Premchand vs. CIT (1953) 24 ITR 506 (SC): TC13R.271, “It is well recognised that in revenue cases regard must be had to the substance of the transaction rather than to its mere form. In the present case disregarding technicalities it is impossible to get away from the fact that the business is owned and run by the assessee himself. In such circumstances we are of the opinion that it is wholly unreal and artificial to separate the business from its owner and treat them as if they were separate entities trading with each other and then by means of a fictional sale introduce a fictional profit which in truth and in fact is non-existent”, cannot be read as throwing any doubt on the principle that the true legal relation arising from a transaction alone determines the taxability of a receipt arising from the transaction.”
20. The issue as to whether an assessee, who had borrowed funds carrying interest and advanced part thereof to its sister concern on interest free basis, can claim deduction to that extent was considered by Hon’ble the Supreme Court in SA Builders Limited’s case (supra). In the aforesaid case, Hon’ble the Supreme Court opined that the tax authorities must not look at the matter from their own view point but that of a prudent businessman. In case, it is found that transfer of borrowed funds to a sister concern was on account of commercial expediency even if the same is interest free, the deduction claimed by the assessee cannot be disallowed. However, it was not laid down as a rule rather it was opined that each case will depend on its own facts and aspect of commercial expediency is to be examined by the Assessing Officer. Paragraphs 31 and 32 thereof are extracted below:
“31. We agree with the view taken by the Delhi High Court in CIT vs. Dalmia Cement (Bharat) Ltd. (2002) 174 CTR (Del) 188: (2002) 254 ITR 337 (Del) that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the armchair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize its profit. The IT authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman. As already stated above, we have to see the transfer of the borrowed funds to a sister concern from the point of view of commercial expediency and not from the point of view whether the amount was advanced for earning profits.
32. We wish to make it clear that it is not our opinion that in every case interest on borrowed loan has to be allowed if the assessee advances it to a sister concern. It all depends on the facts and circumstances of the respective case. For instance, if the directors of the sister concern utilize the amount advanced to it by the assessee for their personal benefit, obviously it cannot be said that such money was advanced as a measure of commercial expediency. However, money can be said to be advanced to a sister concern for commercial expediency in many other circumstances (which need not be enumerated here). However, where it is obvious that a holding company has a deep interest in its subsidiary, and hence if the holding company advances borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the assessee would, in our opinion, ordinarily be entitled to deduction of interest on its borrowed loans.” [Emphasis supplied]
21. A Division Bench of Delhi High Court in Punjab Stainless Steel Inds. v. Commissioner of Income Tax and another, (2010) 324 ITR 396, while considering the issue regarding advance of interest free loan to sister concern opined that to claim deduction under Section 36(1)(iii) of the Act, an assessee is required to prove that there is nexus between the advancing of funds and the business interest of the assessee firm. The appropriate test in such a case would be as to whether a reasonable person stepping into the shoes of the directors/partners of the assessee firm and working solely in the interest of the assessee firm/company, would have extended such interest free advances.
22. The issue regarding jurisdiction of the Assessing Officer to go into the transaction and consider whether pre- requisites for claiming deduction under Section 57(iii) of the Act have been complied with or not, was considered by a Division Bench of Allahabad High Court in Commissioner of Income Tax v. Smt. Swapna Roy, (2010) 233 CTR 10 (All) and it was opined that though it is not unfair to borrow money or take loan from one concern and invest the same in another concern for the purpose of profit or income, but in the process the assessee must act bonafide. The words “wholly and exclusively for the purpose of making or earning such income” have to be given its true meaning. In case, the dominant purpose for making such investment was not to earn income, the deduction under Section 57 of the Act may not be available. To ascertain the purpose, the courts may lift the veil. Even the Assessing Officer has the jurisdiction to find out the dominant purpose with regard to investment of borrowed money in the sister concern. Relevant paragraphs therefrom are extracted below:
“92. Accordingly, while considering a case to extend the benefit under Section 57(iii) of the Act, the effect of words “wholly and exclusively for the purpose” may not be diluted. By using three words, i.e., “wholly”, “exclusively” and “purpose”, the legislature had made it mandatory to find out the reason behind investment. In case, the dominant purpose is not for making or earning such income, then deduction under Section 57(iii) shall not be available and to ascertain the purpose, the courts may lift the veil.
93. In corporate law, the courts have ample power to lift the veil. It is the liability of the companies to be fair in dealing with tax matter. Being a separate juristic personality, it is expected that the companies shall not conceal their income or to escape the liability with regard to payment of tax. Lifting the corporate veil is to find out who is real person, beneficiary or in controlling the position of the company. The doctrine of “lifting the veil” has marked a change and it is adopted whenever and wherever a situation warranted.
94. Lord Denning M. R. in Littlewoods Stores v. I.R.C. (1969) 1 WLR 1241 said:
“The doctrine laid down in Salomon’s case has to be watched very carefully. It has often been supposed to cast a veil over the personality of a limited company through which the courts cannot see. But that is not true. The courts can, and often do, draw aside the veil. They can, and often do, pull off the mask. They look to see what really lies behind. The legislature has shown the way with group accounts and the rest. And the courts should follow suit
95. One of the most important circumstance in which the veil has been lifted is the cases of fraud or improper conduct of the promoters. Where dummy companies were incorporated by a promoter and his family members to conceal profits and avoid tax liability, the separate entity of the company has been ignored by looking through the veil and identifying those individuals who have deviced such method for their own benefits.
96. In Juggilal Kamlpat v. Commissioner of Income Tax, AIR 1969 SC 932: 1969(1) SCR 988 it was found that three brothers who were partners in the assessee firm were carrying on the managing agency in a dominant capacity in the guise of a limited company. The court held that the corporate entity has to be disregarded if it is used for tax evasion or to circumvent tax obligation or to perpetrate fraud.
97. In C. I.T. v. Associates Clothiers Ltd., AIR 1963 Cal. 629 there was a sale by a company to another having some shareholders and the former company owning all shares in the latter. It was held that it would not escape the liability of tax under the Income Tax Act by taking recourse to the concept of separate legal entity.
In view of above, the assessing authority has rightly tried to find out the dominant purpose with regard to investment of borrowed money in the sister concern possessing fractured financial body and rightly held that the investment in the firm running in deficit since several years cannot be held exclusively for the purpose to earn income.”
23. In view of our aforesaid discussion and pronunciation of law, as referred to above, the question referred for consideration by the larger Bench can very well be answered by opining that the Assessing Officer or the appellate authorities and even the courts can determine the true legal relation resulting from a transaction. If some device has been used by the assessee to conceal true nature of the transaction, it is the duty of the taxing authority to unravel the device and determine its true character. However, the legal effect of the transaction cannot be displaced by probing into the “substance of the transaction”. The taxing authority must not look at the matter from their own view point but that of a prudent businessman. Each case will depend on its own facts. The exercise of jurisdiction cannot be stretched to hold a roving inquiry or deep probe.
The questions referred to the larger Bench having been answered, the matter will now go back to the Division Bench for decision on merits.
( Rajesh Bindal )
( M. M. Kumar )
( A. N. Jindal )
February 01, 2011