ITAT CHENNAI BENCH ‘B’
Income-tax Officer (OSD) Exemptions, Chennai
V/s.
KAS Foundation
IT APPEAL NOS. 1892 & 1893 (MDS.) OF 2010
C.O. NoS. 83 & 84 (MDS.) of 2011
[ASSESSMENT YEAR 2007-08]
MAY 10, 2012
ORDER
V. Durga Rao, Judicial Member
These are appeals filed by the Revenue and cross objections filed by different assessees against the order of the ld. CIT(A)- XII Chennai dated 31.08.2010 for Assessment Year 2007-08. Facts being identical, we are disposing off these appeals and cross objections through this consolidated order for the sake of brevity and convenience.
2. Facts, in brief, pertaining to the case of KAS Foundation are that the assessee-foundation is a company, registered u/s 25 of the Companies Act, 1956. The assessee had also applied for registration u/s 12AA of the Income-tax Act, 1961 [the Act, in short] which was granted by the CIT(Exemptions) on 31.5.2004. The assessee had filed return of income admitting income at Rs. 3,39,03,877/- and claimed exemption u/ss 11 and 12 of the Act. The return filed by the assessee was processed initially u/s 143(1) of the Act and subsequently, a notice u/s 143(2) was issued to the assessee and in response to the notice issued by the Assessing Officer, the a representative appeared before the Assessing Officer and filed details from time to time.
3. During the course of assessment proceedings, the Assessing Officer has observed that the assessee, a foundation, invested 2 lakh shares at face value of Rs. 10/- per share in the company ‘Jagannatha Financial Services Limited’ [JFSL]’. The shares of JFSL are not listed in any recognized Stock Exchange. During the financial year2006-07, the company had not commenced its business. The company was issued certificate of registration to commence its business as a non-banking financial company [NBFC] on 2.4.2007. The Assessing Officer further observed that the assessee M/s KAS Foundation invested in shares of a company which is not a public company and hence it is not covered by section 11(5) of the Act and the same was pointed out to the representative who appeared on behalf of the assessee on 24.8.2009 and pointed out that the assessee foundation has violated the provisions of section 13(1)(d) of the Act and not eligible for exemption u/s 11 of the Act. Thereafter, the assessee’s representative, vide letter dated 22.10.2009 submitted his reply which is as under:
“In this respect we hereby bring to your kind notice that there is a decision of Delhi High Court in CIT v. Narinder Mohan Foundation [2009] 311 ITR and the Bombay High Court DIT(E) v. Seth Mafatlal Gagalbhai Foundation [2001] 249 ITR 533 (Bom.), where it is clearly decided that only the income from impermissible investments, could be taxed and not any other income following the Board Circular No.387 dated 06.07.1984 (1985) 152 ITR (St.) 1 at page 19. Since this the accepted position of the department itself and the decision of the court on which no special leave has been asked for, there could be no denial of total exemption and hence we hereby request your goodself to consider the above decision and Board Circular no.387.
Further we hereby inform your goodself that investment in shares of Jagannatha Financial Services Ltd. was due inadvertence and lack of awareness of the law on the subject on the part of the company management and it is on account of bona fide error. We hereby inform your goodself that we have already taken fruitful steps in realizing the investment in shares without any loss to the trust. We have entered into agreement for sale of shares. We also bring to your kind notice the Delhi High Court in the DIT(E) v. Agrim Charan Foundation [2002] 253 ITR 593 (Del.), where it was held that a bona fide error could not be treated as violation, so as to justify withdrawal of total exemption. A similar view was also taken by Karnataka High Court in M/s. Society of Bridgettine Sisters, ITA No.105/2004 dated 21st July 2008, where the decision in Agrim Charan Foundation case supra was followed in a case where the assessee has invested in as many as 3 different companies without realizing that such investments were barred. Hence we hereby kindly request your goodself to kindly consider the above decisions.
Further we hereby bring to your kind notice that KAS foundation, a Micro finance institution is primarily and predominantly engaged in rural development in remote village areas, tribal areas for the upliftment of rural poor people in under developed states like Orissa, Chattisgarh.
Hence, we hereby request your goodself to consider the above explanation and decisions and not to withdraw the exemption granted to us.”
4. The Assessing Officer, after considering the above reply of the assessee, has observed that the assessee was also director of JFSL and had substantial interest in the company. Hence the investment was not only a violation u/s 13(1)(d) but also u/s 13(2)(h) r.w.s 13(4) of the Act. The Assessing Officer had asked the assessee to clarify in this aspect. In response to the above, the assessee, vide letter dated 10.12.2009 submitted a reply which is as under:
“In this respect we hereby bring to your kind notice that investment in shares of Jagannath Financial Services Ltd. was due inadvertence and lack of awareness of the law on the subject on the part of the company management and it is on account of bona fide error. We hereby inform your goodself that we have already taken fruitful steps in realizing the investment in shares without any loss to the trust. We have entered into agreement for sale of shares on knowing that it is not a permissible investment.
We also bring to your kind notice the Delhi High Court in the DIT(E) v. Agrim Charan Foundation [2002] 253 ITR 593 (Del.), where it was held that a bona fide error could not be treated as violation, so as to justify withdrawal of total exemption. A similar view was also taken by Karnataka High Court in M/s. Society of Bridgettine Sisters, ITA No.105/2004 dated 21st July 2008, where the decision in Agrim Charan Foundation case supra was followed in a case where the assessee has invested in as many as 3 different companies without realizing that such investments were barred. Hence we hereby kindly request your goodself to kindly consider the above decisions and not to withdraw the exemption.
We further bring to your kind notice that that decision of Delhi High Court in CIT v. Narinder Mohan Foundation [2009] 311 ITR and the Bombay High Court DIT(E) v. Seth Mafatlal Gagalbhai Foundation [2001] 249 ITR 533(Bom.), where it is clearly decided that only the income from impermissible investments, could be taxed and not any other income following the Board Circular No.387 dated 06.07.1984 (1985) 152 ITR (St.) 1 at page 19.
We hereby request your goodself to kindly consider the above decisions and our explanations and we request your goodself not to withdraw the exemption.”
5. The Assessing Officer considered the above explanation of the assessee and case laws cited by the representative who appeared on behalf of the assessee observed that in the case of DIT(E) v. Agrim Charan Foundation [2002] 253 ITR 593/[2001] 119 Taxman 569 (Delhi), the trust was misleaded by the company into investing in their deposits and therefore, the above decision relied upon by the ld. Counsel has not application to the facts of the present case. In the case of CIT v. Narindra Mohan Foundation [2009] 311 ITR 425/[2008] 167 Taxman 73 (Delhi). The Assessing Officer observed that the issue involved in this appeal related to bonus shares and therefore, has no application to the facts of the assessee’s case. In the case of DIT (Exemption) v. Sheth Mafatlal Gagalbhai Foundation Trust [2001] 249 ITR 533/114 Taxman 19 (Bom.), the Assessing Officer has observed that as per section 13(4) clearly states that when investment in the interested concern exceeds 5% of the capital, the entire income has to be brought to tax. With the above observation, the Assessing Officer came to the conclusion that the case laws relied upon by the ld. A.R. of the assessee has no application to the facts of the present case in hand.
6. The Assessing Officer further observed that the assessee has borrowed loan from ICICI Bank @ 14% p.a. No dividend was received from the company on which the assessee made investment of Rs. 20 lakhs whereas JFSL has received a capital of Rs. 20 lakhs without any interest or dividend payment. The assessee-foundation has paid interest @ 12% p.a. on the funds borrowed from the founders. The Assessing Officer further examined the above facts in the light of section 13(1)(d)(iii) of the Act and held that the investments of M/s KAS Foundation in the shares of JFSL, a non-banking financial company whose shares are unlisted and are not covered by the provisions of Rule 17C and accordingly applied section 13(1)(d) of the Act and also further observed that the assessee has violated section 11(5)of the Act.
7. The Assessing Officer further observed at page 7 of the assessment order that the trustees of M/s KAS Foundation, M/s Saratha Kathiresan and K.T. Alamelu Abirami held 500 shares each out of a total of 1000 shares. Smt. Saratha Kathiresan and her family members own 7,23,870 shares out of the total 20,21,620/- shares in M/s JFSL. Dr. V. Prasanna Bhatt, Director, KAS Foundation also held 20,000 shares of JFSL. Hence the total investments in JFSL by the trustees and the management of KAS Foundation is 7,43,870/- shares out of total shares of 20,21,620/-. Thus the trustees, their relatives and the management hold 37% [aprox] of JFSL shares, thereby exceeding 20% of the share-holding and are deemed to have substantial interest in the company. The foundation has invested Rs. 20 lakhs in JFSL whose total paid up capital was Rs. 2,02,16,200/-. Hence the investment in the trust amounts to 10% [aprox] of the subscribed and paid up share capital. With the above observation, the Assessing Officer held that the assessee has violated the provisions of section 13(1)(d)(iii) and 13(2)(h) and section 13(4) of the Act and accordingly, the exemption claim made by the assessee was rejected. On being aggrieved, the assessee carried the matter in appeal before the ld. CIT(A).
8. Before the ld. CIT(A), the ld. A.R. reiterated the submissions which he has made before the Assessing Officer and also filed written submissions. The same were reproduced by the ld. CIT(A) at pages 5 to 7 of his order. The ld. CIT(A), after considering the submissions of the assessee has held as under:
“The crux of the issue is that the appellant is not disputing that the appellant had invested an amount of Rs. 20 lakhs in M/s JFSL buying 2 lakh shares at Rs. 10/- per share in the name of different trustees. For the reasons stated by the Assessing Officer, it is true that there has been a violation of section 11 and section 13 of the Act wherein detailed reasons have been given by the Assessing Officer.
However, two main issues to be decided before me are whether because of these violations as mentioned by the Assessing Officer (a) whether the appellant forfeits the entire exemption available to it or (b) whether the denial of exemption should only be proportionate to the diversion of the funds made by the appellant.
During the course of appellate hearing, the AR of the appellant quoted CBDT’s Circular No.387 dt. 06.07.19841 The relevant portion of the circular i.e. para 28.6 is reproduced as under:
28.6 : It may be noted that new sub-sec. (1.A) inserted in Sec. 161 of the IT Act, which provides for taxation of the entire income received by trust at the maximum marginal rates is applicable only In the case of private trust having profits and gains of business. So far as public charitable and religious trust are concerned, their business profits are not exempt from tax, except In the cases failing under Cl. (a) or Cl. (b) of Sec. 11(4A) of the IT Act. As the maximum marginal rate of tax under the new proviso to Sec. 164(2) applies to the whole or a part of the relevant Income of a charitable or religious trust which forfeits exemption by virtue of the provisions of the IT Act in regard to Investment pattern or use of the trust! property for the benefit of the settlor etc., contained in Sec. 13(1)(c) and (d) of that Act, the said rate V will not apply to the business profits of such trusts which are otherwise chargeable to tax. In other words, where such a trust contravenes the provisions of Sec. 13(1)(C) or (d) of the Act, the maximum marginal rate of income tax will apply only to that part of the income which has forfeited exemption under the said provisions”.
In other words, where such a trust contravenes the provisions of Sec. 13(1)(c) or (d) of the Act, the maximum marginal rate of income tax will apply only to that part of the income which has forfeited exemption under the said provisions.
A similar view is taken by the Hon’ble Bombay High Court in the light of the above. referred Circular in the case of Director of Income Tax (Exemptions) v. Sheth Mafatlal Gagalbhai Foubdation Trust [2001] 249 ITR 533 (Bom). In this decision, it was held that where it has been held that in the case of contravention of section 13(1)(d), maximum marginal rate of tax under the proviso to section 164(2) is applicable only to that part of income of the trust which has forfeited exemption and not to the entire income. Thus, the acquisition of shares amounts only to investment. Hence, the sale falls within the ambit of Sec. 13(1)(d) and not u/s 13(1)(c) of the Act. Reliance placed by the appellant on the decisions in the following case laws are well founded CIT v. Polisetty Somasundaram Charities [1990] 183 ITR 377 (AP) and Nawn Estates (P.) Ltd. v. CIT 1977 CTR (SC) 19: [1977] 106 ITR 4 (SC).
Further I find that Sec. 13(2)(h) can only apply in the instant case in the context of sec 13(1)(d) and not to See 13(1)(c) as 13(1)(c) is not invocable given the decisions cited supra where it has been held that the acquisition of shares only amounts to investment. Moreover, section 13(4) of the At is not applicable where section 13(4) by the Assessing Officer is not in order.
The CBDT’s Circular, thus clarifies the above two issues raised by me i.e. (a) whether the appellant forfeits the entire exemption available to it or (b) whether the denial of exemption should only be proportionate to the diversion of the funds made by the appellant.
Hence, for the above cited reasons, the violation which the appellant has committed u/s 13 of the Act, i.e. the amount of Rs. 20 lakhs, invested in JFSL needs to be brought to tax in the case of the appellant. The remaining part of the total income will enjoy exemptions u/s 11 of the Act. “
9. Aggrieved by this order of the ld. CIT(A), the Revenue has come in appeal before us.
10. The ld. Counsel for the department has submitted that the assessee has violated section 13(1)(d)(iii) of the Act and also invested the funds borrowed from ICICI Bank contrary to section 11(5) of the Act. Therefore, the assessee is not eligible for exemption u/ss 11 and 12 of the Act. The ld. D.R. further submitted that the assessee has also violated the provisions of section 13(2)(h) of the Act and therefore, is not eligible for exemption u/ss 11 and 12 of the Act. The ld. D.R. further argued that the ld. CIT(A), without considering the facts of the case, simply followed the CBDTs Circular No. 387 dated 6.7.1984 issued by the Board which is not at all relevant to the present case and therefore, the order passes by the ld. CIT(A) has to be reversed.
11. On the other hand, the ld. Counsel for the assessee has submitted that section 13(2)(h) has no application once the assessee borrowed money and invested it. Alternatively, he relied on the decision of the Hon’ble Mumbai High Court in the case of Sheth Mafatlal Gagalbhai Foundation Trust (supra) wherein it has been held that maximum marginal rate of tax under the proviso to section 164(2) is applicable only to that part of income of the trust which has forfeited exemption and not to the entire income.
12. We have heard the rival submissions and perused the orders of the lower authorities and the material available on record. The assessee-foundation is a company registered under the Companies Act and accordingly registration u/s 12AA of the Act was granted on 31.5.2004. The main activity of the foundation of the assessee is micro financing to the people residing in rural areas. During the year under consideration, the assessee foundation has borrowed Rs. 20 lakhs from ICICI Bank, interest payable @ 14% and the same was invested in JFSL. It is an undisputed fact that the founders of the assessee foundation are having substantial share in JFSL which is not recognized by any stock exchange. It is seen from the facts available on record that the assessee is a foundation and applied for registration u/s 12AA of the Act with an object to finance in rural areas and accordingly, exemption was granted u/s 12AA of the Act. The assessee borrowed money and invested the same in a company where the founder of the assessee foundation were having substantial interest which is contrary to the object for which the registration was granted to the foundation u/s 12AA of the Act. The assessee foundation, instead of financing in rural areas, financed money to the company where the founders were having substantial interest. Apart from the above, the assessee is paying 14% interest on money borrowed without receiving any benefit from the JFSL. Therefore, it appears to us that the assessee foundation borrowed money for the benefit of JFSL where the founders are having substantial interest not for the purpose of carrying on the object of the assessee foundation. In the light of the above facts itself, the assessee is not eligible for the claim of exemption u/ss 11 and 12 of the Act because the assessee carried on the activity of investment which is contrary to the object of the assessee foundation, where there is no public utility involved. We would like to further examine the provisions of law which prohibits exemption. The assessee is a foundation and started with an intention to promote some definite purpose i.e. financing in rural areas. With the above object, the assessee got registration u/s 12AA of the Act.
13. The assessee, contrary to the above object of the assessee foundation, invested the borrowed funds in a company where the founders are having substantial interest. Therefore, the assessee has violated the provisions of section 13(1)(d)(iii) of the Act. For the sake of convenience, section 13(1)(d)(iii) of the Act is extracted as under:
“Nothing contained in section 11 [or section 12] shall operate so as to exclude from the total income of the previous year of the person in receipt thereof:
