COMMISSIONER OF INCOME-TAX VS INDIAN EXPRESS NEWESEPAPERS(MESUARI) (P) LTD., 2000 PTD-MADRAS-HIGH-COURT-INDIA 3537 (1998)

(a) Income-tax---

----Interest on borrowed capital--Condition precedent for deduction-- Borrowed capital must be used for purposes of business---Amount borrowed by assessee-company transferred to investment company floated by it which in turn transferred it to an associate of assessee---Amount utilised by associate-company for construction of a building---Corporate veil could be, lifted and the true character of the transaction ascertained---Amount borrowed was not used for purposes of business of assessee---Interest on borrowed amount was not deductible---Indian Income Tax Act, 1961, S.36.

(b) Income-tax---

----General principles---Company---Corporate veil can be lifted to determine true nature of a transaction.

The Income-tax Officer disallowed a sum of Rs.86,300 claimed by the assessee as interest on borrowed capital for the assessment year 1971-72. The Income-tax Officer found that in order to enable its associate company at Bombay to receive a sum of Rs.10 lakhs, instead of making payment directly to that company, the assessee had floated the subsidiary A towards whose share capital, it invested a sum of Rs.10 lakhs and on the same day on which that sum was made available to its subsidiary, that sum was paid by A to the associate company at Bombay. The Assessing Officer also noticed the fact that the assessee-company did not have any surplus funds during that year and the "investment" made in A was out of borrowed funds, "admittedly". It was also noticed that the subsidiary company had no separate office of its own. The subsidiary company did not have any transactions other than the lending of the sum of Rs.10 lakhs made available to it by the assessee to the company at Bombay to which the assessee had been systematically diverting its borrowed funds to enable the associate company at Bombay to meet the' cost of construction of a building owned by it. It was also found by the Assessing Officer that though the subsidiary had charged interest to the Bombay company in the year ended March 31, 1970, there was no income whatsoever in the subsequent years as no interest was charged on the amounts advanced to the Bombay company, in spite of the fact that the extent of advances was the same. The Assessing Officer, therefore, held that. the subsidiary company was a conduit pipe to channel the borrowed monies from the assessee to its associate company at Bombay. However, the Commissioner of Income-tax (Appeals) accepted the assessee's contention that A was a separate legal entity and the investment made therein by the assessee. could not be regarded as a diversion of funds. The Tribunal agreed with that view of the Commissioner of Income-tax (Appeals). On a reference:

Held, that the corporate veil of a company can be lifted for the purpose of ascertaining the real character of a transaction, and to find out if that transaction was a fraudulent one or was intended to evade payment of tax. While legitimate tax avoidance is always permissible, devices adopted to evade payment of tax, are not permissible, though the dividing line is not always easy to draw. The true character of the transaction here clearly was one of an advance of Rs.10 lakhs by the assessee to the Bombay company for whose benefit that sum was obviously intended and had only been channelled through A. The amount invested in A being in substance and reality an amount advanced to the Bombay company for use of financing the construction undertaken by it at Bombay could not be said to be an amount which formed part of the capital borrowed for the purpose of the assessee's business. The disallowance was justified.

C.V. Rajan for the Commissioner.

R. Kumar for T.N. Seetharaman and Hema Sampath for the Assessee.

JUDGMENT

R. JAYASIMHA BABU, J---The question referred to us at the instance of the Revenue is, as to whether, on the facts and in the circumstances of the case, the Tribunal was right in deleting the disallowance of interest attributable to borrowals diverted to Indian Express Newspaper (Bombay) (Private) Limited, through Ace Investments Limited. The assessment year with which we are concerned is 1971-72. The assessee, the Indian Express Newspapers (Madurai) (P.) Limited, is a sister concern of In4ian Express Newspaper (Bombay) (Private) Limited.

While making the assessment for the year 1971-72, the Income-tax- Officer disallowed a sum of Rs.86,300 claimed as a deduction by the assessee under section 36(1)(iii) of the Act under the head "Amount of interest paid in respect of capital borrowed for the purpose of the business or profession". The reasons given for the disallowance are set out separately by the Assessing Officer Annexure B to the draft assessment orders. It must be mentioned here that the original assessment for the year was initially completed on February 28, 1974, but that assessment was set aside by the Appellate Assistant Commissioner on February '9, 1978, and thereafter, a fresh assessment was made on June 24, 1978.

The reasons which were set out in Annexure- "B" to the draft assessment order for the disallowance were that the assessee had been systematically diverting the monies borrowed by it ostensibly for its business, to its associate company at Bombay which was utilising the monies for the purpose of putting up a building, in which, the assessee-company had no interest either as partner, owner or an investor. Annexure B to the draft assessment referred to Annexure A, the draft assessment order, in which the Assessing Officer had set out in a table the steep increase in the amount of interest paid by the assessee from the accounting year commencing from April 30, 1965, and the fact that even in the immediately preceding year, a sum of Rs.15 lakhs had been disallowed as representing interest payments on borrowals not used for the purpose of the assessee's business. Annexure B thereafter proceeded to state that in order to enable its associate company at Bombay to receive a sum of Rs.10 lakhs instead of making payment directly to that company, the assessee had floated the subsidiary Ace Investments Limited towards whose share capital, it invested a sum of Rs.10 lakhs and on the same day, on which that sum was made available to its subsidiary, that sum was paid by Ace Investments Limited to Indian Express Newspapers (Pvt.) Ltd. The Assessing Officer also noticed the fact that the assessee company did not have any surplus funds during that year and the "investment" made in Ace Investments Limited was out of borrowed funds, "admittedly." It was also noticed that the subsidiary company had no separate office of its own, as its address is the same as that of the assessee, that the subsidiary did not employ any staff, and its books of account were written by the staff of the assessee. The subsidiary company did not have any transactions other than the lending of the sum of Rs. 10 lakhs made available to it by the assessee, to the company at Bombay to which the assessee had been systematically diverting its borrowed funds to enable the associate company at Bombay to meet the cost of construction of a building owned by it. It was also found by the Assessing Officer that though the subsidiary had charged interest to the Bombay company in the year ended on March 3, 1970, there was no income whatsoever in the subsequent years as no interest was charged on the amounts advanced to the Bombay company, in spite of the fact that the extent of advance was the same. The Assessing Officer, therefore, held that the subsidiary company was a conduit pipe to' channel the borrowed monies from the assessee, to its associate company at Bombay.

In the appeal filed by the assessee against the order of assessment which was made in accordance with what had been set out in the draft assessment order, the Commissioner of Income-tax (Appeals) accepted the assessee's contention that Ace Investments Limited is a separate legal entity and the investment made therein by the assessee 'could not be regarded as a diversion of funds, and that the amount disallowed as interest was not in accordance with the provisions of section 36(l)(iii) of the Act, as that investment was required to be regarded as part of the business of the company. The Tribunal has agreed with that view of the Commissioner, and held that it could not ignore the reality of two independent entities, viz., the assessee and the subsidiary, without anything to suggest that they were either fictitious or that the transaction itself was a sham one. It is also held that it did not have even tax particulars of the two other entities to verify the claim whether there has been tax advantage by this scheme. It further observed that the arrangement could not be ignored, even assuming that it was intended to secure tax advantage, unless there was fraud or that the transaction was only a paper transaction not intended to be carried out. The Tribunal was of the view that there was no material to hold that it was a paper transaction or was a fraud. The Tribunal did not advert to what had been noticed by the Income-tax Officer in the draft assessment order, the contents of which has already been adverted to in the earlier paragraphs of our order.

Learned counsel for the Revenue contended before us that the amount of Rs.10 lakhs made available to the Indian Express Newspapers (Bombay) (Private) Limited through the newly created subsidiary Ace Investments Limited was in reality and in substance of diversion of borrowed funds, as the object of that alleged investment in the subsidiary was only to make that amount immediately available to the Bombay company and in fact, the money was paid over by the subsidiary to the Bombay company on the very day on which the alleged investments was made. Though the subsidiary purported to charge interest to the Bombay company in the first year, in the subsequent years, no interest was charged at all on that sum. It was the assessee's staff who had written the books of account of the subsidiary. The subsidiary has no office of its own and it had no other transactions in the assessment year or in the immediately succeeding years, until the year of the order of reference, which was made on October 25, 1983, with any other borrowers, though the subsidiary purported to be a financing company; and that the assessee which was in the best position to place any material, if there was in fact any material, to show that the subsidiary had carried on business as financier, subsequent to the assessment year until the date of the order of the Tribunal, the assessee had not placed any such material before the Tribunal.

Learned counsel for the assessee submitted that the Tribunal has held that the two legal entities were separate and distinct and, therefore, the question of any diversion of funds cannot arise, as it was permissible for the assessee to invest in the subsidiary company and, the assesssee-company had income during the year, even though the Income-tax Officer had stated that "admittedly" the assessee had no surplus from which to make this investment. Counsel referred to the fact that the assessee had property income of Rs.1,17,629 during that year and had business income of Rs.22,67,729 although after the adjustment of its share of the loss in a firm, in which it was a partner, the year had ended with a net loss of Rs.7,21,542. The draft assessment order, however, shows that the business income reported by the assessee was only Rs.8,51,131, that income having been derived from the printing and publication of newspapers and share trading. It was only on account of various disallowances that the income for the purpose of computation of tax was taken at Rs.22,67,729.

The assessee had paid during the years 1968-69, 1369-70, 1970-71 and 1971-72 the sums of Rs.9,50,268, Rs.14,90,279, Rs.30,24,700 and Rs.38,53,589, respectively, as interest. During the assessment year, it had received Rs.5,97,382 as interest and its net claim for deduction by way of interest was Rs.24,27,317. In the immediate, preceding year, a sum of RS-15 lakhs had been disallowed as representing interest payment on borrowals not utilised for the purpose of the business. The amount so disallowed was the amount which had been paid by the assessee to Indian Express Newspapers (Bombay) Private Limited which was at that time engaged in constructing a building in Bombay, and which building was owned by that company. The sum of Rs.10 lakhs interest on, which was disallowed by the Income-tax Officer in the assessment year, was a sum which was shown as having been invested in the subsidiary Ace Investment (Private) Limited, which sum was immediately on payment to Ace Investments Ltd., transferred by that company to Indian Express Newspapers (Bombay) (Pvt.) Ltd. The true character of that sum paid over to that company at Bombay by Ace Investments Ltd., was no different from the sum of Rs.15 lakhs, which had been paid by the assessee directly to the Bombay company, which had been disallowed during the previous year as "monies not utilised for the purpose of the business of the assessee".

The fact that the money was not paid directly, but was shown as having been invested in the subsidiary company is not decisive of the true, character of the transaction. The mere fact that Ace Investments Ltd., is a distinct legal entity does not by itself establish that the purported investment was a genuine investment, which the company had made for securing benefits to itself by way of trading or carrying on business through that subsidiary. We are concerned with the sum of Rs.10 lakhs, interest on which had been disallowed by the Income-tax Officer. That sum of Rs. 10 lakhs, as noticed earlier was paid to the Bombay company on the same day on which it was paid to Ace Investments Ltd. Though Ace Investments is purported to charge interest in the first year, subsequently, no interest at all was charged to the Bombay Company on that sum. It is not the assessee's case that money was returned to Ace Investments subsequently with interest or that the assessee received dividends from out of the investments made by it in Ace Investments Ltd.

It is well-settled that the corporate veil of a company can be lifted for the purpose of ascertaining the real character of a transaction, if that transaction was a fraudulent one or was intended to evade payment of tax. While legitimate tax avoidance is always permissible, devices adopted to evade payment of tax, however, are not permissible though the dividing line is not always easy to draw, such a line does exist. The true character of the transaction here clearly was one of an advance of Rs. 10 lakhs by the assessee to the Bombay company for whose benefit that sum was obviously intended and had only been channelled through Ace Investments (Private) Limited. The Tribunal has failed to notice the facts, which had been set out in the draft assessment order in Annexure B, and has also erred in adopting the wrong approach for the purpose of deciding as to whether the amount disallowed was a sum, which could properly fall within the ambit of section 36(1)(iii) of the Act. The amount disallowed was the amount paid on amounts borrowed, but not used for the purpose of business or profession of the assessee. Rupees 10 lakhs "invested" in Ace Investments Limited being in substance and reality an amount advanced to the Bombay company for financing the construction undertaken by it at Bombay, cannot be said to be an amount which formed part of the capital borrowed for the purpose of the assessee's business.

We, therefore, answer the question referred to us in the negative, in favour of the Revenue and against the assessee. The Revenue shall be entitled to costs of Rs.750.

M.B.A./69/FCReference answered.