BRIJLAL GUPTA J. - These are two income-tax references under section 66(1) of the Income-tax Act. They arise out of a consolidated appellate order of the Income-tax Appellate Tribunal and may be conveniently disposed of by a common judgment.
The question referred to us for opinion in the first reference is :
'Whether on the facts and circumstances of the case, the sum of Rs. 64,239 paid as interest to H. H. the Nawab of Rampur and others is a permissible deduction in computing the business income of the assessee ?'
The question referred in the other reference is :
'Whether the sum of Rs. 3,000 paid to Dalmia Cement Company Ltd. out of the office allowance received by the assessee from its managed companies was an admissible deduction in computing the business income of the assessee under the Indian Income-tax Act ?'
The facts giving rise to the two references are : The assessee is a private limited company. During the relevant accounting year the assessee was acting as the managing agent of two sugar companies, (1) The Raza Sugar Company Ltd., and (2) The Buland Sugar Company Ltd., under two different managing agency agreements, one executed on March 24, 1934, and the other on February 12, 1934. The relevant terms of the two agreements were the same. The managing agency in each case was to continue for a period of twenty years certain, and thereafter until the managing agents were removed by an extraordinary resolution of the managed company passed at an extraordinary general meeting specially convened for that purpose and of which not less than six calendar months notice was given and at which shareholders owning not less than 3/4 ths of the issued capital of the company were present. The managing agents were to receive an office allowance of Rs. 1,000 per month and a commission of 10%. In the event of the managed company being wound up during the period of the managing agency agreement with the object of transferring its business to another company, one of the terms and conditions of the agreement for transfer of the property and business of the vendor company to the vendee company was to be that the managing agents were to continue to be the managing agents of the transferred company on similar terms and conditions.
The fixed terms of twenty years of the managing agency was to continue for four years from the end of the accounting year in question. In both the managed companies the Nawab of Rampur was a major shareholder. On April 25, 1950, the assessee purchased from the Nawab 43,000 shares of the Raza Sugar Company and 66,478 shares of Buland Sugar Company for a sum of Rs. 19,04,126. The assessee alleged that the purchase was with a view to acquire a controlling interest in the two companies in order to make certain of the continuance of the managing agency. The assessee had very little funds of its own to pay the purchase price. Accordingly, it took loans at 6% from (1) Vyapari Ltd., New Delhi, and (2) Govan Agencies Ltd., New Delhi. Even then the full purchase price of the shares could not be paid to the Nawab and the assessee remained indebted to him for part of the purchase price. Interest was accordingly paid by the assessee as under on the loans and the amount still due to the Nawab.
Vyapari Ltd., New Delhi .
Govan Agencies Ltd., New Delhi .
H. H. Nawab of Rampur .
After about eight months from the date of the purchase of the shares, the assessee sold all the shares of the two companies to Messrs. Dalmia Cement Company Ltd., practically at the same price at which it had acquired them. Under the agreement of sale dated January 15, 1951, it was stipulated that Messrs. Dalmia Cement Company Ltd. will receive 25% of the managing agency commission and the office allowance which the assessee was receiving from the managed companies. This was receivable by Messrs. Dalmia Cement Company Ltd, only so long as the vendee company continued to hold all the shares purchased by it in the two companies. If the shareholding became reduced there would be a proportionate reduction in the percentage of the commission and office allowance payable by the assessee to Messrs. Dalmia Cement Company Ltd. There was a stipulation in the agreement of sale that in all meetings of the shareholders of the two managing companies, the vendees 'will vote in accordance with the desire of the vendors and in furtherance of the interest of the vendors in the office of the managing agents of the principal companies, so long as they enjoyed the benefits of any shares in the managing agency.' Lastly it was declared that nothing in the agreement of sale was to be deemed to constitute a partnership as between the vendors and the vendees.
Subsequently, on December 24, 1961, a further agreement between the parties was incorporated in this agreement of sale. This further agreement was to the effect that the provision for reduction in the percentage of commission and office allowance on reduction of the shareholding by the vendee company was to cease to be operative. The effect of this further agreement was that however much the shareholding of the vendee company in the shares of the managed company might become reduced, they will still be entitled to receive 25% of the commission and office allowance of the vendor company and there shall be no reduction in this percentage. It may be noted that the date of this further agreement, namely, December 24, 1951, fell outside the accounting year relevant to the assessment year inquestion.
There was yet another agreement incorporated in the original agreement of sale on January 2, 1952, with effect from January 1, 1952. This was to the effect that the percentage of commission and the office allowance shall be payable to Messrs. Dalmia Jain Trust instead of Messrs. Dalmia Cement Company Ltd.
In the assessment for the year 1951-52, the assessee claimed the sum of Rs. 64,239 paid by it as interest on the loan for purchase of the shares of the two managed companies as an admissible deduction in the computation of its business income. The Income-tax Officer disallowed the claim. He found that the shareholders of the Dalmia Cement Company and the beneficiary of Dalmia Jain Trust were mostly members of the family of the managing director of the assessees or his close relations and friends. The loan was incurred not for the purpose of the assessees business but for the benefit of the shareholders and beneficiaries of Dalmia Cement Company Ltd. and Dalmia Jain Trust, who ultimately became entitled to the dividend income of the shares purchased out of the loan incurred and to a percentage of the managing agency commission and the office allowance of the assessee. He further held, that the purchase of the shares by taking the loan and transfer of the shares was a device adopted to reduce tax liability of the assessee. An alternative argument also appears to have been addressed to the Income-tax Officer to the effect that the assessee carried on business on share dealings also and the interest paid was an allowable expense of its business of share dealing. This argument was repelled by the Income-tax Officer on the ground that the assessee did not carry on business in shares. Indeed, according to its articles of association it was not authorised to carry on such business.
Against the orders of the Income-tax Officer, the assessee went up in appeal to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner dealt with the subject at considerable length in connection with the disallowance of the sum of Rs. 3,000 representing 25% of the office allowance paid by the assessee to Dalmia Cement Company Ltd. under the terms of the agreement dated January 15, 1951, and subsequent agreements. In particular he considered the effect of the deletion of the provision in the original agreement by the subsequent agreement dated December 24, 1951, that the percentage of commission and office allowance payable by the assessee to the vendee will not be affected by the reduction in the shareholding by the assessee. He observed, 'Messrs. Dalmia Cement Co. Ltd. could not in the absence of shares vote in accordance with the desire of the appellant.' He went on to conclude, 'All this leads me to share the suspicion of the Income-tax Officer, who has held the agreement to be a manipulated affair, that these manipulations were possible, because all the persons concerned were close relatives who belonged to the Dalmia family, who in one way or the other controlled all the above mentioned companies.' But curiously enough when he came to consider the allowability or otherwise of the sum of Rs. 64,239, he lost sight of his earlier observation and held that the purchase of shares from H. H. the Nawab of Rampur '...was ostensibly made for the purposes of safeguarding the managing agency' and held the sum of Rs. 64,239 to be allowable as revenue expenditure.
The Commissioner of Income-tax directed the Income-tax Officer to file an appeal to the Income-tax Appellate Tribunal against the deduction of Rs. 64,239 allowed by the Appellate Assistant Commissioner. The Tribunal allowed the appeal on the finding that the debt incurred for purchase of the shares and interest paid thereon had no connection with the business carried on by the assessee. On the date of taking the loan the managing agency was still to run for a period of four years. Only eight months after the purchase of the shares with the money borrowed, the shares were sold away. The shares were not used as a business asset. Even if the acquisition of the shares had something to do with the renewal of the managing agency business for a further period in a very remote way, it had no connection with the business carried on by the assessee during the accounting year. In this view, the interest paid could not be allowed as a deduction under section 10(2)(iii) or 10(2)(xv).
Thereafter the assessee asked for the statement of case to this court and the case has been stated as mentioned above.
So far as the allowability of the sum of Rs. 64,239 under section 10(2)(xv) is concerned that is easily disposed of. The argument of the assessee both before the Appellate Assistant Commissioner as well as before the Tribunal was that 'the main purpose' of the acquisition of the shares was to retain the assessees business in the managing agency. On this argument itself, the amount could not be allowed under that section. If an amount is to be allowed as a deduction under section 10(2)(xv) it should be an expenditure made exclusively for the purposes of business. The assessee himself did not allege that the amount was 'wholly and exclusively' expended for the purpose of business. It merely alleged that it was done so 'mainly' for that purpose. Another answer to the assessees claim under section 10(2)(xv) is that even if it is accepted that the purpose of the borrowing and the purchase of shares was the retention of the managing agency business, the expenditure incurred by payment of interest on the loan was to bring into existence a capital asset or an asset of an enduring nature or an apparatus for enabling profits to be earned. Such expenditure is not a revenue expenditure which alone is allowable under section 10(2)(xv); hence the deduction of interest cannot be allowed to the assessee under section 10(2)(xv).
Coming now to its allowability under section 10(2)(iii) one has to remember that the managing agency was still to run for a period of four years on the date of borrowing and purchase. Only eight months later the shares were transferred to Dalmia Cement Company as according to the assessee it had no funds to pay the amount borrowed. Clearly, the assessee must have taken its financial position even on the date of the borrowing and the purchase. It could not have suddenly dawned on the assessee only after the expiry of eight months that it could not hold on to the shares and must part with them. It follows that the borrowing and the purchase and the subsequent transfer of the shares to Dalmia Cement Company were all parts of a pre-determined scheme. There is the further fact that the assessee and the Dalmia Cement Company were closely linked as the shareholders of the latter company were relations and close friends of the managing director of the assessee. The pretext for the borrowing and the purchase and sale was that the arrangement would help the assessee to retain the managing agency for a further period as under the agreement of sale, the vendee would exercise its vote according to the desire and in the interest of the assessee. This pretext stands completely exposed when we find that by further agreement between the parties incorporated on December 24, 1951, the benefit of the receipt of 25% commission and office allowance was in no way to stand reduced even if the vendee parted with all but a negligible portion of its shareholding. As the Appellate Assistant Commissioner observed if the vendee did not own a sufficient number of shares how was it possible to influence the voting in the interest of the assessee. It is true that this further agreement came into existence after the end of the accounting year but it is relevant for the purposes of determining the real nature of the transaction. It might also be noted that there is nothing on the record to show what proportion the shares purchased by the assessee and sold to Dalmia Cement Company formed of the total issued share capital of the two companies and whether in any case the acquisition of the shareholding would have achieved the object which is said to constitute the purpose of the purchase. If the purpose of retention of the managing agency could not be achieved, then it is clear that the purchase could not have even a remote connection with the business carried on by the assessee. If, as is clear, the purchase had no connection with the assessees business, the interest paid on the money borrowed cannot be claimed as a deduction under section 10(2)(iii).
The device is further exposed by the further agreement dated January 2, 1952, by which the benefit of the agreement was transferred to Messrs. Dalmia Jain Trust. Presumably this was done with a view to completely evade payment of tax on 25% of the managing agency commission and office allowance, the amount of which it appears was quite considerable. It is significant that the assessee himself probable felt that the arrangement for parting with 25% of the managing agency commission and the office allowance was in the nature of a partnership arrangement for depleting the profits of the business of the managing agency and not a bona fide arrangement for acquiring assets necessary for its business. It, therefore, incorporated a paragraph in the agreement of the sale that the agreement did not amount to a partnership between the parties. It is true that an assessee is entitled to arrange its affairs in such a way as to reduce its tax liability by all legal ways but the arrangement must be genuine and not a sham. Here it appears that the object of borrowing was illusory and colourable and not genuine or bona fide. It follows that the sum of Rs. 64,239 was not allowable as deduction under section 10(2)(iii) also. The deduction was not claimed under any other provision. The question referred to us should, therefore, be answered in the negative.
So far as the amount of Rs. 3,000 in the succeeding assessment year is concerned that was disallowed by the Income-tax Officer.
It is not possible to give the reasons on which the Income-tax Officer disallowed the amount as the assessment orders which have been included in our paper book relate to the assessment year 1951-52. In this year the Income-tax Officer has stated that he disallows the amount for the reasons given by him in the assessment order for the year 1952-53 in which also all the relevant facts are stated to have been stated by him. The assessment order for 1952-53 has not been included in our paper book. The Tribunal has also not given those reasons in the statement of the case drawn up by it.
The assessee went up in appeal to the Appellate Assistant Commissioner against disallowance by the Income-tax Officer. Before the Appellate Assistant Commissioner one of the grounds on which deduction was claimed was that it was allowable under section 12A. That provision relates to division of managing agency commission. As the claim related to the office allowance and not to the managing agency commission it was held by the Appellate Assistant Commissioner that it could not be allowed under that section. Other reasons given by the Appellate Assistant Commissioner were that all the conditions laid down in section 12A were not fulfilled, and that having regard to the modification made in the original agreement by a further agreement dated December 24, 1951, it was clear that there was no adequate consideration for payment of 25 per cent. of the office allowance to Dalmia Cement Co. Ltd. It may be recalled that this further agreement removed the bar to transfer by Dalmia Cement Co. Ltd. of any number of shares purchased by it. It would follow that the transfer could be of such number of shares as to make it impossible for Dalmia Cement Co. Ltd. to exercise the voting right effectively in the interest of the assessee company, and yet it would still be entitled to receive 25 per cent. of the managing agency commission and the office allowance. Extracts from the order of the Appellate Assistant Commissioner have already been quoted in an earlier portion of this judgment.
The assessee went up in appeal to the Income-tax Appellate Tribunal against the disallowance of this sum of Rs. 3,000 also. The Tribunal affirmed the view of the Appellate Assistant Commissioner that the amount could not be allowed under section 12A and as such they held that it was not necessary for them to consider whether the conditions laid down in that section were satisfied or not. It is clear that on the plain language of section 12A the conclusion of the Tribunal that the deduction of Rs. 3,000 could not be claimed under section 12A was perfectly correct. The Tribunal went on to hold that the amount represented by the payment of Rs. 3,000 was merely a diversion of part of the office allowance to which the assessee was entitled. Presumably the view of the Tribunal was on the basis that there was no consideration for the payment of this amount. It is, therefore, clear that it could not be said that the payment of this sum of money was an admissible deduction under any part of section 10 of the Income-tax Act under which alone it could be allowed. Clearly, the payment was not influenced by business considerations. It appears to have been influenced by considerations of relationship and other extraneous considerations such as the desire to evade liability for payment of the proper amount of tax. It follows that the question relating to the amount of Rs. 3,000 should also be answered in the negative.
Both the references should, therefore, be returned to the Tribunal with the above answer. The department should get the costs of both these references assessed at Rs. 100 each.
Questions answered in the negative.