Commissioner of Income Tax vs D.P. Kanodia

Heard Sri R.K. Upadhyaya, learned counsel for the Revenue and Sri R.S. Agarwal, learned counsel appearing for the assessee. This reference has been made by the income tax Appellate Tribunal, Allahabad, u/s 256 of the income tax Act, 1961, referring the following question for consideration of this court:

Whether, on the facts and in the circumstances of the case, the income tax Appellate Tribunal was legally correct in holding that the building in question belonged to M/s. Hotel Ganges Ltd. and, therefore, it was also responsible to explain the source of investment in its construction?

For noticing the facts, it shall suffice to refer to paragraphs 3 to 7 of the statement of facts which are as under:

The assessee is an individual. He is a member of the Hindu undivided family called M/s. Sadi Ram Ganga Pd. He entered into an agreement with the said Hindu undivided family on April 2, 1974. The Hindu undivided family owned a property situated at 51/50 Nayaganj, Kanpur. This was a tenanted property. The tenants were got vacated and the structure was demolished leaving the plot measuring 353 sq. yds. In the aforesaid agreement, it was stated that the assessee would be floating a company with the object of carrying on the business of hotelling and catering, etc., for which the assessee would be developing the land and constructing a building on the aforesaid plot. The first party of the agreement was the Hindu undivided family of M/s. Sadiram Ganga Prasad and the second party to the agreement was the assessee. The following clauses of this agreement are relevant for our purpose:

And, whereas, the second party proposes to float a company limited by shares under the Companies Act, 1956, with the subject, inter alia, of carrying on the business of hotelling and catering, etc.

And, whereas, the second party represented the first party to allow the proposed company intended to be floated by the second party to develop the said premises by constructing a building thereon for the purpose of running a hotel on the said premises in partnership with the first party to which the first party has agreed.

Now, it is nearly agreed and declared by and between the parties here is as follows:

The first party, until the proposed company to be floated by the second party is duly incorporated, has in the meantime allowed with effect from February 15, 1974, the second party to develop the said premises by constructing a building and appurtenances thereon for the purposes of ultimately running a hotel on the said premises and for this purpose the second party shall employ his own resources available with the second party.

The second party undertakes that it will take all reasonable steps to ensure that all formalities legal or otherwise are complied with in developing the said premises and any liability on this account whatsoever shall be on the account of the second party. . .

The second party undertakes that as soon as the proposed company is duly incorporated and certificate of commencement of business is obtained this agreement would be ratified by the said company provided, however, that in case the second party is unable to float the said company or the said company is unable to ratify this agreement, the second party shall be at liberty to nominate any other person or body corporate in this behalf.

As soon as possible after this agreement is ratified by the company to be floated by the second party the said company and the first party shall enter into a partnership agreement to carry on the business, inter alia, of hotelling, restaurants, caterers, etc., and the contribution of the first party in the said partnership shall be the said vacant plot of land measuring 353 sq. yds. situate at 51/50 Nayaganj, Kanpur, and the contribution of the said company in the said partnership shall be the cost of constructing the building on the said premises and developing and furnishing the same and/or any other expenses made for the purpose of hotel.

A copy of the agreement dated April 7, 1974, is made as annexure ''A'' forming part of the statement of the case.

In the meantime, the company called ''Hotel Ganges Ltd.'' was incorporated on July 4, 1974. On July 27, 1974, a meeting of the board of directors of the company was held. A copy of the agreement dated April 2, 1974, entered into between the assessee as promoter/director of the company and M/s. Sadiram Ganga Prasad, Hindu undivided family was placed before this meeting. The following resolution was passed.

''Resolved that the agreement dated April 2, 1974, entered into between Sri D.P. Kanodia, promoter/director of the company and M/s. Sadiram Ganga Pd., Hindu undivided family, and terms and conditions thereof shall be and are hereby adopted and approved.''

The company was granted certificate of commencement of business on April 13, 1976. On July 27, 1976, an agreement of partnership was executed between Sri B.N. Kanodia on behalf of the Hindu undivided family of M/s. Sadiram Ganga Prasad and Hotel Ganges Ltd. It was decided as per this agreement that the Hindu undivided family would be contributing the plot in question as its capital while the company was to contribute the development and construction as its capital.

A copy of the partnership deed dated July 27, 1974, is made as annexure ''B'' of the statement of the case.

The assessee engaged himself in the construction of a property on the abovementioned plot in the accounting years 1974-75 to 1976-77 relevant for the assessment years 1975-76 to 1977-78. A total expenditure of Rs. 10,04,292 was incurred in the construction. This amount was borrowed by the assessee from the Hindu undivided family of M/s. Sadiram Ganga Pd. which was debited with various expenses relating to the construction of the hotel building. A meeting of the board of directors of the company was also held on June 30, 1976. In this meeting the assessee as a promoter of the company placed before the board statement of expenses incurred by him on behalf of the company up to date in connection with the construction of the hotel building and other incidental expenses. The board, after careful examination of the statement, approved the total expenditure incurred by the assessee and directed that the case be incorporated in the books of the company for the year ended June 30, 1976, by credit to the account of Sri D.P. Kanodia, the assessee. The expenditure also included interest payable by the assessee on the borrowings.

The question before the income tax Officer was regarding the cost of construction of the hotel building. He referred the matter of valuation to the valuation officer. The valuation officer estimated the cost of construction of the building in the above three assessment years at Rs. 14,11,425. On this basis, the income tax Officer held that there was excess investment of Rs. 1,33,941 in the assessment year 1976-77 and Rs. 2,10,935 in the assessment year 1977-78. It was contended before him that the property was constructed on behalf of the limited company, Hotel Ganges Ltd. and ultimately the cost of building was brought into the books of the limited company as an asset and, hence, if any addition was called for, it could be only in the hands of the limited company and not in the hands of the assessee as an individual. The income tax Officer rejected these contentions on the ground that the funds for the construction had been arranged by the assessee, that they had come from his account in the books of M/s. Sadiram Ganga Pd. and that in the relevant account years M/s. Hotel Ganges Ltd. had no other source of income. He, thus, held that whatever was the unexplained amount it had to be considered in the hands of the assessee. He, therefore, made an addition of Rs. 1,33,941 in the assessment year 1976-77 and Rs. 2,10,936 in the assessment year 1977-78 to the total income of the assessee. Copies of the assessment orders for the assessment years 1976-77 and 1977-78 are made as annexures C and D, respectively, being part of the statement of the case.

The assessee appealed to the Commissioner of income tax (Appeals). The first contention of the counsel for the assessee before the latter was that the building belonged to M/s. Hotel Ganges Ltd. and, therefore, the assessee could not be called upon to explain the source of investment and if there was any excess investment that has to be considered in the assessment of the limited company. It was next contended that reference to the valuation officer was uncalled for. It was finally contended that the expenditure as shown in the books of account was correct and required to be accepted.

The Commissioner of income tax (Appeals) dismissed the appeal against which the assessee appealed to the Tribunal. The Tribunal vide its order dated March 15, 1983, allowed the appeals of the assessee. The question, as noted above, was referred in view of the facts of the case.

The relevant findings by the Commissioner of income tax (Appeals) have been recorded while rejecting the submission of the assessee in the following words:

So far as the first question is concerned, I have no doubt in my mind that if any such addition is called for then it has to be in the hands of Sri D.P. Kanodia in his individual status for the assessment year 1977-78. I have arrived at this conclusion on the basis of certain facts, the most important of which is the agreement dated April 2, 1974, between M/s. Sadiram Ganga Prasad (HUF) and the appellant and especially clause (1) of the said agreement which has been reproduced earlier in this order. According to this clause, the construction of this building has to be started by Sri D.P. Kanodia, individual and for this purpose he was to employ his own resources available to him. This makes it amply clear that the funds for constructing the building of the hotel in the initial stages have to be arranged by Sri Kanodia which could be either by borrowing or from his own resources. In the instant case, Sri Kanodia has taken money from the books of M/s. Sadiram Ganga Prasad (Hindu undivided family) where account has been opened in the name of Sri D.P. Kanodia (building fund account) and the amounts advanced to Shri Kanodia debited thereof from time to time. This would show that Sri D.P. Kanodia was arranging for the funds for the construction and if ultimately it is found that some unaccounted investment was made in this building, then he will have to be responsible for such an unaccounted investment and it can be rightly taxed in his hands. The other two entities in whose hands such income could be considered for taxation could be the Hindu undivided family of M/s. Sadiram Ganga Prasad but it has to be treated as not responsible in view of clause (1) of the agreement referred to above. So far as the company or the Hotel Ganges Ltd. is concerned, this was completely out of the picture because up to January 2, 1976, (correct date is April 13, 1976) the company has not obtained even the certificate for commencement of business and it has no source of income till then. Even after that up to March 31, 1976, the company had absolutely no sources of income and the expenditure incurred has been transferred to the building account. The only funds available to the company was share capital of Rs. 700 and funds received from Shri D.P. Kanodia (individual) which was taken by him from the Hindu undivided family and these facts would show that as far as the Hotel Ganges Ltd. is concerned up to March 31, 1976, it could not have had any unexplained income. Under these circumstances, there was no question that the company, M/s. Hotel Ganges Ltd. was investing any unaccounted fund and considering all these circumstances, the full responsibility of unaccounted investment, if any, has to be borne by Shri D.P. Kanodia (individual). This question is, therefore, to be answered against the appellant and has been answered in this manner for the assessment year 1975-76 also in the case of the appellant, vide my appellate order dated January 30, 1980.

Sri R.K. Upadhyaya, learned counsel appearing for the Revenue, has submitted that the certificate of commencement of business was granted to the company on April 13, 1976, and the expenses for construction was made by the assessee who is an individual, although after borrowing from the Hindu undivided family. He submits that the company had neither any capital nor any amount which was utilised in the construction was paid by the company, hence it could not have been asked to explain the sources of income and the Tribunal has wrongly relied on the judgment of this court in Commr. of Income Tax, U.P. and Ajmer-Merwara, Lucknow Vs. Bijli Cotton Mills Ltd., Agra, . Even though expenses incurred by D.P. Kanodia were approved and adopted by the company, the unaccounted investment had to be assessed at the hands of the assessee who had undertaken to bear all the expenses for the construction of the hotel.

Sri R.S. Agarwal, learned counsel for the assessee, refuting the submissions of the learned counsel for the Revenue, submitted that the Tribunal rightly took the view that unexplained amount which was found incurred in the construction ought to have been assessed at the hands of company, i.e., Hotel Ganges Ltd. He submits that the Tribunal has rightly relied on the judgment of this court in the case of CIT v. Bijli Cotton Mills Ltd. (supra). He further submits that the board of directors of the company, vide resolution dated July 27, 1974, has already ratified the agreement dated April 2, 1974, and adopted the same, hence it is the company who has to be asked to disclose the source of unexplained amount. Sri R.S. Agarwal has further relied on two other judgments of this court in the cases of Security Printers of India (P.) Ltd. Vs. Commissioner of Income Tax, and Additional Commissioner of Income Tax Vs. Syntex Fabrics Ltd., .

We have considered the submissions of learned counsel for the parties and perused the record.

The facts of the case as have been stated in the statement of case clearly indicate that under the agreement dated April 2, 1974, it was the second party who was to employ his own resources available with the second party for purposes of construction of a building. The second party is the assessee. The facts further reveal that it was the second party who borrowed the amount from the Hindu undivided family, M/s. Sadiram Ganga Prasad for carrying out the construction of the hotel and a separate account, namely, D.P. Kanodia building fund account was opened and the amounts advanced to the assessee were debited thereof from time to time. The Commissioner of income tax (Appeals) has found that since it was D.P. Kanodia who was arranging for the fund for construction and when it was found that some unaccounted investments were made in the building, it is the assessee who has to be held responsible for such unaccounted investment and the said investment has rightly been taxed in the hands of the assessee. The above findings of the Commissioner of income tax (Appeals) in this regard have already been quoted above.

The Tribunal took the view that since the company has ratified the agreement and further in the meeting dated July 27, 1974, the statement of expenses placed before the company by the assessee was approved and it was directed to incorporate the same in the books of the company, it is the company who has to explain the undisclosed amount. The Tribunal in paragraph 8 of the judgment made the following observations:

We are of the opinion that the hotel building in question actually belonged to M/s. Hotel Ganges Ltd. and it was this company which was responsible to explain the sources of investment. Our this conclusion is based on the decisions of the Allahabad High Court itself. The issue had first come up for consideration of the hon''ble court in the case of Commr. of Income Tax, U.P. and Ajmer-Merwara, Lucknow Vs. Bijli Cotton Mills Ltd., Agra, ...

The judgment of this court in CIT v. Bijli Cotton Mills Ltd. (supra) relied upon by the Tribunal needs to be noted in detail. In the said case, one M/s. Shyamlal Chimanlal, a partnership firm, thought to acquire the Bijli Cotton Mills on behalf of the company which was going to be incorporated. The firm paid the stipulated price to the previous owner and obtained possession on December 10, 1942. On December 11, 1943, the company was duly incorporated. The Bijli Cotton Mills was assessed on the income from December 11, 1942 to December 31, 1943. The Bijli Cotton Mills filed an appeal. When the appeal was pending, the income tax Officer drew attention of the Appellate Commissioner that actually the firm ought to have been assessed during the relevant period. The Appellate Commissioner held that Bijli Cotton Mills Ltd. was assessable only from the period of its incorporation, i.e., December 11, 1943, and cancelled the assessment. The company filed an appeal before the Tribunal. The Appellate Tribunal held that the assessee was liable to tax for the period December 11, 1942 to December 10, 1943. It was further held that the Commissioner could not have cancelled the assessment. The assessee and the Commissioner both made application to make a reference to the High Court.

One of the questions referred before the High Court was whether, in the circumstances of the case, the income of the period from December 11, 1942, to December 10, 1943, could be legally assessed in the hands of the assessee-company which was incorporated on December 11, 1943. The question (second question), as noted above, was answered in favour of the assessee. Recording its conclusion, this court held as under (page 287):

We have already held that in the case before us though the assessee-company came into existence almost a year afterwards, the assessment proceedings were started at a time when the assessee-company had already decided to accept what had been done on its behalf by the promoters and take over the property and business and the income made therefrom from December 11, 1942, and it was in the same position as a beneficiary for whom the income was earmarked as payable to it. The case is, therefore, to our minds governed by the principle laid down in 1934 (36) BOMLR 557 (Privy Council) and the income from December 11, 1942, to December 10, 1943, could be legally assessed in the hands of the assessee.

The case of CIT v. Bijli Cotton Mills Ltd. (supra) was a case where the assessee-company had decided to accept the income made from the business at the time when the business was being looked into by the promoters. The Division Bench had further held as follows (page 283):

It is, however, well settled that if the promoters of a company buy a property or carry on a business on behalf of a company which they intend to float, on the incorporation of the company, the company has a right to either accept what has been done on its behalf by the promoters or repudiate the same. If the company accepts what the promoters have done on its behalf it has a right to claim from the promoters the entire income of the properly since its purchase or the entire income for the period during which the business was carried on for the benefit of the company.

In the present case, the ratio laid down by this court in CIT v. Bijli Cotton Mills Ltd. (supra) is not applicable. In the present case, the expenses for construction were being managed by the assessee by borrowing the funds from the Hindu undivided family. The expenses made by the assessee has been adopted by the company to which there can be no dispute. The Commissioner has found that the company has not even obtained the certificate of commencement of business up to January 2, 1976, and up to March 31, 1976, the company had no source of income which is a finding of fact.

The present is a case of assessment of unaccounted investment. The investment was done by the assessee. In the relevant assessment years, i.e., 1976-77 and 1977-78, the total investment was disclosed as Rs. 10,04,292. The income tax Officer found that there was excess investment of Rs. 1,33,941 in the assessment year 1976-77 and Rs. 2,10,935 in the assessment year 1977-78. The money for carrying out construction was being arranged by the assessee as per the terms of the agreement, hence the unaccounted investment has to be assessed in his hands. The company had no income at the time when the expenditure towards construction was undertaken, hence there is no occasion to assess the unaccounted investment at the hands of the company. The case of CIT v. Bijli Cotton Mills Ltd. (supra) was not a case of assessment towards unaccounted investment by the firm. The adoption of expenses by the company and showing it to its own account is another thing which cannot explain the unaccounted investment. The Tribunal thus fell in error in applying the judgment of this court in CIT v. Bijli Cotton Mills Ltd. (supra) in the facts of the present case. The said case was clearly distinguishable and had no application.

Now, coming to the case of Security Printers of India (supra), the said case was a case of expenditure incurred before the incorporation of the company. This court held that the expenditure having been incurred wholly for the purposes of business, they should be allowed as deduction against the receipts of the same period. The following was laid down by this court in the said case (page 772):

It is no doubt true that the above expenditure was incurred before the incorporation of the assessee-company, but, as pointed out above, the corresponding receipts were entered in the accounts for the relevant previous year and included in the assessment for the year 1958-59. The principle laid down by this court in CIT v. Bijli Cotton Mills Ltd. is that the profits of a business commenced by the promoters which is taken over by the company on its incorporation is assessable in the hands of the latter. If the pre-incorporation profits are assessable in the hands of the company the expenditure incurred to earn such profits must also be allowed in the assessment. In the present case, it is common ground that the business of the assessee-company was commenced by the promoters, namely, Mr. Harffey and the Khunnahs, and they secured orders of considerable value and also procured the necessary import licence for indent of fugitive papers for the purpose of execution of jobs in security printing. These expenditures were, evidently, incurred wholly for the purpose of the business commenced by the promoters before incorporation and they should be allowed as deduction against receipts of the same period.

The last case relied upon by the learned counsel for the assessee is Addl. CIT v. Syntex Fabrics Ltd. (supra). The said case was also a case of incurring of the expenditure prior to incorporation of company. Following CIT v. Bijli Cotton Mills Ltd. (supra), the Division Bench of this court held that the expenses should have been allowed. There cannot be any dispute to the said proposition but the said case is not applicable in the facts of the present case.

The Commissioner of income tax (Appeals) has rightly appreciated the facts and recorded a finding that there being no income of the company at the relevant period when unaccounted investment was made, the same has to be assessed in the hands of the assessee. He has rightly affirmed the order of the income tax Officer assessing the unaccounted investment at the hands of the assessee. The Tribunal, fell in error in applying the judgment of this court in CIT v. Bijli Cotton Mills Ltd. (supra) in the facts of the present case.

1In view of the foregoing discussions, we answer the question in favour of the Revenue and against the assessee. The application is allowed accordingly.

As corrected by order of the court dated February 10, 2014.