The Commissioner of Income Tax-II vs Audh Educational Society

Satish Chandra, J.—Present appeal u/s 260A of the Income Tax Act, 1961 has been filed by the department against the judgment and order dated 24.03.2006 passed by the Income Tax Appellate Tribunal, Lucknow in ITA No. 424/Luc/2005 for the assessment year 2001-02. This Court vide order dated 13.09.2006 has admitted the appeal on the following substantial question of law:

Whether, under the facts and circumstances of the case, the Hon''ble ITAT was correct in holding that the Assessee had not contravened the provisions of Section 13(1)(c) and 13(3) of the I.T. Act, 1961 even though it was conclusively proved by the A.O. that the loan was given without interest to the person referred to in Section 13(3), which is in contravention to the provisions of Section 13(2)(a) of the I.T. Act, 1961.

The brief facts of the case are that the Assessee is a society registered under the Societies Registration Act, U.P. w.e.f. 18.12.1990 and is running an educational institution. The Assessee is also registered u/s 12-A of the Income Tax Act, w.e.f. 01.04.1994. During the assessment year under consideration, the A.O. noticed that a loan of Rs. 2,37,500/-was outstanding against Sri Virendra Singh, Treasurer of the society and No. interest had been charged nor any provision for accrued interest was made. Originally, the loan of Rs. 2,50,000/-was taken by Sri Virendra Singh during the assessment year 1999-2000 and thereafter Rs. 12,500/-was paid towards the principal amount. The A.O. mentioned in its order that the Assessee is following the mercantile system of accounting but No. accrued interest on the loan had been accounted for the assessment year 1999-2000; 2000-2001. Thus, the A.O. concluded that the funds of society were diverted for personal benefits of the Treasurer and consequently exemption claimed u/s 11 was denied to the Assessee society in view of provisions contained in Section 13(1)(c) and 13(2)(a) of the Income Tax Act. The Assessee filed an appeal before the First Appellate Authority who has confirmed the order of the A.O. Being aggrieved, the Assessee has filed an appeal before the Tribunal who has allowed the claim of the Assessee. Not being satisfied, the department has filed the present appeal.

With this background, Sri D.D. Chopra learned Counsel for the Appellant submits that the Assessee society is following the mercantile system of accounting not only for the year under consideration but also for the past many years. The Assessee society charged interest @12% on loan/advance given to other employees. However, neither principal amount nor interest on the loan given to Sri Virendra Singh was reflected in the balance sheet and in this regard, the relevant coloumns of Annexure to Form 10B filed along with the return of income, were silent. He also submits that a resolution was passed by the Assessee but it was silent regarding repayment of principal amount. When No. schedule for the repayment of the principal amount has been decided in the resolution, how could the charging of interest be decided. He further submits that so-called resolution was only an afterthought and the Tribunal has wrongly relied upon it, while deciding the issue. Lastly, he justified the order and made a prayer to set aside the impugned order passed by the Tribunal.

On the other hand, Sri Neerav Chitravanshi, learned Counsel for the Assessee relied on the Tribunal''s order. He submits that accrued interest of loan given to Sri Virendra Singh was not shown in the audit account because of the fact that a resolution has been passed to the effect that first principal amount should be recovered and thereafter interest would be recovered. He also submits that vide letter dated 03.02.2004, the Assessee has submitted before the A.O. that in the instant case, interest @10% is to be charged after recovery of principal amount. It has also been provided that under No. circumstances, the liability of interest shall be waived. Accordingly, the loan of Rs. 2,50,000/-was sanctioned to Sri Virendra Singh. It is wrong to conclude that loan was given interest free. He relied on the ratio laid down in the case of Commissioner of Income Tax/wealth-tax Vs. Polisetty Somasundaram Charities, He further submits that the payment of loan cannot be held to be hit by Section 13 regarding the claim of exemption. The A.O. has wrongly made the addition of Rs. 29,250/-on account of accrued interest only on exemption basis and the same may be deleted.

On specific query from the Bench, he accepted that the Assessee has charged the interest @ 12% per annum from Smt. Kiran Verma, an employee of educational institution. The Assessee had duly accounted accrued interest on FDRs. He also submits that the Assessee has wrongly denied the exemption u/s 11 primarily on the ground that it had contravened the provision of Section 13(2) and 13(1)(c) of the Act. Sub-clause (ii) of Section 1(c) of the Act states that any part of income or property, which is applied directly or indirectly for the benefit of any person, referred to in Section 13(3), will form part of the income of the Trust. According to him, against the loan, a security in the form of surety was given.

We have heard both the parties at length and gone through the material available on record.

From the record, it appears that the Assessee is a society registered under the Societies Registration Act, w.e.f. 18.12.1990 with the Registrar of the Societies and Sri Virendra Singh is the Treasurer of the society. The Assessee is also registered u/s 12-A of the Income Tax Act w.e.f. 01.04.1994. The Assessee is running Primary, Junior and High School Unit separately and maintained the accounts for each unit. For the assessment year under consideration, the Assessee has filed return on 30.10.2001 showing nil income. The return was accompanied with Form No. 10-B and the accounts of the Assessee has been audited. In Part-II of Form 10B, application or use of income of property for the benefit of the person referred to in Section 13(3) were mentioned.

The relevant provision in the Income Tax Act are as under:

Section 13(1)(c): (c) In the case of a trust for charitable or religious purposes or a charitable or religious institution, any income there of (i) If such trust or institution has been created or established after the commencement of this Act and under the terms of the trust or the rules governing the institution, any part of such income ensures, or (ii) If any part of such income or any property of the trust or the institution (whenever created or established) is during the previous year used or applied.

Section 13(2):

(2) Without prejudiceto the generality of the provisions of Clause (c) [and Clause (d)] of Sub-section (1), the income or the property of the trust or institution or any part of such income or property shall for the purposes of that clause, be deemed to have been used or applied for the benefit of a person referred to in Sub-section (3).-

Section 13(2)(a):

(a) if any part of the income or property of the trust or institution is, or continues to be, lent to any person referred to in Sub-section (3) for any period during the previous year without either adequate security or adequate interest or both;

Section 13(3):

(3) The persons referred to in Clause (c) of Sub-section (1) of Sub-section (2) are the following namely: (a) the author of the trust or the founder of the institution; (b) any person who has made a substantial contribution to the trust or institution, [that is to say, any person whose total contribution up to the end of the relevant previous year exceeds [fifty] thousand rupees];

(c) where such author, founder or person is a Hindu undivided family, a member of the family;

(cc)any trustee of the trust or manager (by whatever name called) of the institution;

(d) anyrelative of any such author, founder, person, [member, trustee or manager, as aforesaid;

(e) any concern in which any of the persons referred to in Clauses (a), (b), (c) [(cc)] and (d) has a substantial interest.

Since in the instant case the interest was charged @10%, as alleged by the Assessee, it should have been reflected in the books of accounts of the Assessee as well as in the audit report but the same was not reflected in any document even subsequent document filed by the Assessee except the resolution, which cannot be relied and it can be considered an afterthought. In the instant case, the Assessee was liable to show this interest as income in the books of account as per mercantile system of accounting.

The Assessee has also claimed that a sale deed of the property in the name of Sri Ram Karan Verma was deposited as security. So, the provision of Section 13(1)(2)(a) is not attracted. However, the Assessee has failed to explain that why security, as claimed, was provided that of Sri Ram Karan Verma instead of Sri Virendra Singh himself when he was having assets/property in his name. Thus, the A.O. has rightly concluded that the Appellant has given interest free loan to Sri Virendra Singh in violation of the provisions of Section 13(1)(c) of the Income Tax Act and also giving loan without any adequate surety in violation of Section 13(2)(a) of the Act. The A.O. has rightly denied the exemption to the Assessee u/s 11 of the I.T. Act.

It may be mentioned that in view of Clause (c) of Section 13(1) rendering the entire income of Trust or charitable institution on liable to tax even if only part of income is directed to be applied for the benefit of the specified persons. The legislature, however, also creates a fiction and enumerates in Clauses (a) to (h) of Sub-section (2) a list of circumstances in which the income shall be deemed to have been used or applied for the benefit of the specified persons. These clauses comprehend various types of benefits such as by way of interest free loans, loans without security, permission or licence to use land or other property without charging adequate recompense, excessive payment for service, sale of property for inadequate consideration and investment of the trust funds in concern belonging to the specified person or in which he has substantial interest as observed in the case of Talaprolu Bapanaiah Vidya Dharma Nidhi Trust Vs. Commissioner of Income Tax, In the instant case, the beneficiary is not covered by the list of persons mentioned in Section 13(3) of the Act.

Hence, we set aside the impugned order passed by the Tribunal and restored the order passed by the A.O. The answer to the question is in negative i.e. in favour of the revenue and against the Assessee.

The appeal filed by the department is allowed.