Commissioner of Income Tax vs Jagath Enterprises (P) Ltd.

Chitra Venkataraman, J.—Tax Case No. 14 of 2004 relates to the asst. yr. 1995-96. Tax Case Nos. 1094 to 1096 of 2004 relate to the

asst. yrs. 1998-99, 1999-2000 and 2000-01. All these appeals are at the instance of the Revenue. The facts are common in all the cases. The

question of law raised is also the same, which is as follows:

Whether, in the facts and circumstances of the case, the Tribunal was right in allowing interest neither contracted to be paid to the trust, nor

claimed in the return, as a deduction from income from house property ?

For convenience, the facts in Tax Case No. 848 of 2005 are referred to here.

The assessee is a private company. The promoters of the company are the trustees of Shri Lakshmi Ammal Educational Trust. The trust owns

shares in the company. It is seen that the said trust advanced a sum of Rs. 72,46,000 to the assessee company. With this money the company

purchased two properties and let them out. The company filed its return for the first time for the asst. yrs. 1991-92 and 1992-93. However, they

did not show the rental income from properties. During the assessment proceedings, it was explained by the assessee that it had not disclosed the

rental income but the same should be treated as the income of the educational trust, as the assessee had diverted the rental income by overriding

title to the trust. It is stated that the assessee did not file its returns for the asst. yrs. 1993-94 and 1994-95. The trust had not paid any tax on this

income.

The assessing authority initiated action to finalise the assessment u/s 144 by treating the rental income credited to the account of the trust by the

principle of diversion of overriding title as the taxable income of the company The assessee defended its conduct by stating that the entire rental

income belonged to the trust by overriding title In support of this, it filed a memorandum dt 28th March, 1994 In response to a notice u/s 143(2)

the assessee responded that as per the memorandum of understanding with the trust, the assessee had transferred the rental income arising from the

properties to the trust directly by reason of overriding title, since the company desired to provide for interest/compensation for the money provided

by the trust Accordingly, the rental income relating to the company is appropriated directly by the trust from the asst yr 1993-94 onwards It further

stated for all practical purposes, the trust owned the company Hence the assessee stated that there was no taxable income in the hands of the

assessee for the year 1995-96 and hence it filed a ml return Consequently it pleaded that the inclusion was unsustainable

Noting the memorandum of understanding and the contentions raised, the assessing authority noted that it was strange that the understanding

arrived at on 1st April, 1992 was reduced into writing in the form of memorandum of understanding only on 28th March, 1994 He stated that

there were inconsistencies in the memorandum of understanding He pointed out that the trust invested money for the purpose of acquiring the

property for the use of the trust with the company availing banking loan The applications made by the company to the bank for the purpose of

availing loans also indicated this He also pointed out that the returns of income filed by the trust for asst yrs 1993-94, 1994-95 and 1995-96 did

not show that it held the shares of Jagath Enterprises (P) Ltd. the assessee herein, as assets in its balance sheet. The assessing authority noted that

memorandum of understanding orally agreed on 1st April, 1992 and reduced to writing on 28th March, 1994 was a self-serving document on

which no reliance could be placed He also held that the shares of the company were not beneficially held by the trust Hence, the assessing

authority concluded that the company was legal owner of the property and the rental income was to be assessed at the hands of the assessee only

In short, it rejected the contention of the assessee that the trust had overriding title over the rental income.

Aggrieved by this order, the assessee preferred an appeal before the CIT(A) In the course of the proceedings the assessee made an alternative

plea that if the rental income was to be assessed at the hands of the company, it should be permitted to claim deduction in terms of proviso to

Section 24(1)(iv) Hence, as an alternative plea, the assessee claimed that an interest payment at 18 per cent should be considered for deduction.

The CIT(A) noted that in the initial assessment years the assessee company admitted income from house property The appellate authority held that

the question of diversion of income by overriding title was not there at all at the time the advance was made to the company, that the obligations

arose due to the directors of the company being managing trustees of the trust In the circumstances, the appellate authority agreed with the AO that

the assessee company was not obliged to divert its income to the trust as compensation for its loss on investment It held that the income was

received by the company first and then as a consideration for nonpayment of interest was diverted to the trust Consequently, the income was liable

to be assessed at the hands of the assessee company only

On the question of claim of interest, the appellate authority held as a measure of compensating the financial loss that the trust would suffer on the

huge investments and as a fair return, interest at 18 per cent or the net property income, whichever was less, deserved to be given The order of the

CIT(A) was subjected to appeal both at the hands of the Revenue as well as at the hands of the assessee.

The Tribunal noted that the properties were purchased only in the name of the assessee company The substantial portion of the purchase cost

was advanced by the trust Yet, that did not create any interest or title in the properties in favour of the trust It also noted that there was no intention

to the parties to hold the properties jointly with the trust In the circumstances, there could not be any diversion in the monthly income by overriding

title In the course of the judgment, the Tribunal referred to a decision rendered in Smt. Savita Mohan Nagpal Vs. Commissioner of Income Tax,

relied on by the assessee and factually found that both stood on different degrees, that the investment of funds would not justify the diversion of

income by overriding title since there was no overriding interest for the trust in those properties However, the Tribunal held that since no interest

was created in favour of the educational trust, the assessee was liable to pay interest for the sum advanced by the trust Consequently, it held that

the first appellate authority had rightly allowed the alternative plea of the assessee by granting interest at 18 per cent on the advance made by the

educational trust The Tribunal held that it was not the case of anybody that the amount was advanced free of obligations or by way of gift and

hence, if the rental income could not be allowed as claimed by the assessee, then the trust would be entitled to an interest Hence, accepting the

claim for payment of interest at 18 per cent, it confirmed the order of first appellate authority Consequently, the Tribunal rejected the appeal of the

assessee as well as that of the Revenue

Aggrieved by this, the Revenue has come on appeal contending that the Tribunal was not justified in allowing the interest at 18 per cent, which

was not contracted for or claimed in the return

We agree with the submissions made by the learned senior standing counsel appearing for the Revenue From a perusal of the memorandum of

understanding dt 28th March, 1994, it is clear that the same was prompted by the reason that there was no stipulation as regards interest on the

money advanced by the trust However, to compensate the loss, it was agreed that the rental income would be treated as return on the investment

by the trust Taking note of the fact that the property did not belong to the trust, rightly the authorities below have come to the conclusion that the

question of treating rental income as going to the account of the trust directly by the overriding title would not arise

As rightly contended by the Revenue, it is no doubt true that the parties did not originally contract to pay interest Yet, the memorandum of

understanding contemplating the rental income as a return of investment could not be denied There is no allegation as to the genuineness of the

document.

The learned senior standing counsel for the Revenue submitted that even the memorandum of understanding did not specify any interest return

She submitted that the authorities below erred in noting the fact that the claim for payment of interest at 18 per cent itself was made only in the

proceedings before the first appellate authority The payment of interest was never in contemplation when the trust advanced money In the

circumstances, the authorities below overstepped in granting the relief to the assessee

It is no doubt true that the assessee made its alternative plea for the payment of interest at 18 per cent first time before the appellate authority

However, taking note of the memorandum of understanding and considering the fact that the question of diversion of income by overriding title was

rejected, this plea was made by the assessee While considering the same, the CIT(A) at para 8 held that

the interest to be allowed in the hands of the company would be interest at the rate of 18 per cent of the deposits made by the trust and the net

property income whichever is less

Learned Counsel for the respondent submitted that the Revenue would not be justified in saying that the trust advanced money to the detriment

of its very existence The parties always contemplated return on the investment Hence, the record of memorandum of understanding to give a return

on the investment was reached by taking the rental income as the fair return He also submitted that considering the fact that the authorities have

taken the view that the rental income was liable to be assessed at the hands of the assessee, it made a alternative plea for application of Section

24(1)(iv) for deducting the interest and the advance made by the first charitable trust The learned Counsel for the respondent submitted that

considering the nature of the transactions, that the investment was solely for the purpose of construction of the properties, the claim u/s 24(1)(iv)

has to be accepted

As already stated in the preceding para, the memorandum of understanding is a matter binding on both the parties The clear contemplation is

that parties intended that the trust (be) compensated on the investment made in the company Thus the return was worked out on the basis of the

rental income In the circumstances, the grant of interest at 18 per cent or restricting it at 18 per cent by the Tribunal, is an act not contemplated

either in the time when the trust advanced the money or even when the assessee made an alternative plea before the first appellate authority In the

above circumstances, a unilateral offer by the assessee to have a return at 18 per cent is totally uncalled for and not supported by any consensus

between the trust and the assessee. But at the same time, the memorandum of understanding stands as regards the contemplation on the return of

the investment made. However, the order of the Tribunal confirming the CIT(A)''s order as regards the return on investment made is sustained to

this extent. However, the order of the Tribunal restricting the return at 18 per cent interest cannot be sustained even as an alternative plea since it is

a one-sided offer and there is no consent to receive the same at 18 per cent. The restriction is totally not borne out by any record. To this extent,

we agree with the submission made by the learned standing counsel for the Revenue that the Tribunal''s order merits to be rejected.

In the above circumstances, we confirm the order of the Tribunal in its view as regards the granting of return in terms of the memorandum of

understanding dt. 28th March, 1994, and that the Tribunal should not have restricted it to interest at 18 per cent.

The learned Counsel appearing for the assessee however pleaded that in the event, the assessee should be given the benefit of deduction in

terms of Section 24(1)(iv). We do not agree with the assessee. Considering the provisions u/s 24(1)(iv) and having regard to the return on

investment made, it is open to the assessee to make such claims as are permissible under law with reference to the said payment of rent as a return

from the investment. The authorities below shall consider the amount payable by the assessee in accordance with law.

With this observation, the Tax Case No. 14 of 2004 is allowed. In view of the order passed in Tax Case No. 14 of 2004 allowing the case,

other connected Tax Case Nos. 1094 to 1096 of 2004 are also allowed. No order as to costs.