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Income Tax Appellate Tribunal, COCHIN BENCH, COCHIN
Per CHANDRA POOJARI, AM:
These appeals filed by the Revenue in the case of two assessees are
directed against separate orders of the CIT(A), Kottayam and pertain to the
assessment years 2002-03 to 2007-08.
Since the issue involved in these appeals are common in nature, they
were clubbed together, heard together and are being disposed of by this
common order.
Since the grounds raised in all these appeals are similar, we take the
grounds raised in ITA No.69/Coch/2018 as follows:
The Ld. Commissioner of Income Tax (Appeals) has erred in deleting the disallowance of interest expenditure of Rs. 75,97,389/- under explanation to section 37(1) of the Income Tax Act, 1961 was contrary to the provisions of Act and ratio laid down by the Hon'ble Jurisdictional High Court of Kerala in the cases on the basis of which relief has been allowed by CIT(A), was actually in favour of revenue.
In the facts and circumstances of the case, the Ld. Commissioner of Income tax (Appeals), Kottayam has erred in relying on the Jurisdictional Tribunal's order in the case of Shri. K.T. Thomas in ITA No. 259,260 &402/Coch/2015 followed its decision in the case of Arun Thomas ITA No. 248/Coch/2012 to test the eligibility of S. 37(1) without appreciating that the said decision has been overruled in favour of revenue as per ITA No. 235 of 2013 dated 03-10-2017 & ITA No.23 of 2016 dated 06-10-2017.
The Ld. CTT(A) has erred in not following the judgment of the Jurisdictional Kerala High Court in the case of Shri Arun Thomas vide ITA No. 235 of 2013 dated 03-10-2017 and the ratio followed in the case of
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 Shri K.T. Thomas vide ITA No. 23 of 2016 dated 06-10-2017 thereby not following the judicial discipline while allowing appeal of the assessee.
Further the Ld. CIT(A) has failed to appreciate that as per section 45 S of the RBI Act and also per the provisions of the Partnership Act, 1932, the expense by way of interest incurred by the assessee-firm happened to be for a purpose "prohibited by law" and hence, not allowable in view of Explanation to section 37(1) of the Act.
In the facts and circumstances of the case, the Ld. CIT(A) ought to have considered the fact that the withdrawals were mere book entries and the assessee clearly camouflaged the real activities by diverting funds enrouted to its sister concerns those are well established in money lending business by using its brand name 'MUTHOOT ' and not for the purposes connected with the running the hospital and its development. The sole purpose of bringing in the partners in between has been to impart a legitimacy to this arrangement,
The Ld. Commissioner of Income tax (Appeals) erred in deciding that proportionate interest expenditure incurred on public deposits relatable to the withdrawals made by the partners are allowable u/s 57(iii) of the Income tax Act which ground also did not appear in the assessee's grounds of appeal.
Since the facts in all these appeals are identical in nature, we consider
the facts as narrated in ITA No.69/Coch/2018. The original assessment in
this case was completed u/s 143(3) r.ws. 147 of the Act vide order dated
28.12.2009, assessing the total income at Rs. 12,77,28,920./-. The appeal
filed by the Assessee against this order was partly allowed by the ClT(A)-
1,Trivandrum vide order dated 19.10.2010. The order of the CIT(A) was
challenged before the Tribunal by Department as well as the Assessee. The
Tribunal vide order dated 06.01.2012 set aside the order of CIT(A) to the file
of the assessing officer with directions to examine the issues afresh in
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 accordance with the law. Accordingly, the assessing officer passed an order
u/s 143(3) r.w.s. 147 r.w.s. 254 on 19/07/2013 and disallowed interest paid
on public deposits amounting to Rs. 7,45,07,387/-.
4.1 Therefore, the appeal under consideration is against the order under
section 143(3) r.w.s 147 r.w.s. 254 dated 19.07.2013. The relevant
paragraphs of the assessment order are as under:
"6. From the reply furnished by the assessee and related details available in the file, it would emerge that the deposits was raised from the public at large. The activity of raising deposits from the public does not have any connection with the stated objective of the firm -namely, operating a hospital at Kozhencherry. Perusal of the financial statements of the assessee firm for subsequent years also reveal that the deposits collected from the public was never used for the stated business activity of the assessee firm. There is not even a single instance where assessee could prove that these deposits were indeed used for purposes connected with the running of the hospital.........................................................
At this point, it would be pertinent to make a reference to section 45 S of the RBI Act, 1935 wherein it is clearly stated that "no person, being an individual or a Firm or an unincorporated Association of individuals shall, at any time, have deposits from more than the number of depositors specified". It is seen that the maximum number of depositors permissible for a firm is 250 only. In verification of the records it is seen that the number of depositors in this case is much more than the permitted limit, thereby openly fluting the provisions of RBl Act, 1934.
Therefore, the expenses incurred on accepting public deposits is nothing but an expense incurred for a purpose which is prohibited by law. Explanation to section 37(1) states "for the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 10. In view of these considerations, claim on account of interest paid on deposits is hereby disallowed. This would entail an addition of Rs. 7,45,07,387/- to the total income.”
4.2 Aggrieved by this order of the Assessing Officer, the assessee filed
appeal before CIT(A), Kottayam on 20.08.2013 and the said appeal was
allowed by the CIT(A), Kottayam vide order dated 29.07.2015. Against this
order, the Department filed appeal before ITAT, Cochin and vide order dated
06.01.2016 in ITA 480 to 483/C/2015, the Tribunal remanded the matter
back to CIT(A) for fresh adjudication. The relevant paragraph of the order of
ITAT is as under:
"8. The CIT(A) has stated that the AO has deviated from the specific directions given by the Tribunal while remanding the case. On perusal of the order of the Tribunal dated 6.1.2012, we notice that the directions of the Tribunal are to re-do the assessment afresh considering the facts and circumstances of the case and apply the principle laid down by the Hon'ble Apex Court in the case of McDowell reported in 159 1TR 148 , The AO, while re-doing the assessment, pursuant to the directions of the Tribunal has not deviated or expanded the scope of examination of the issues. The Tribunal order dated 6.1.2012 is a open remand and the AO was free to examine all aspect of the case. On contrary, the CIT(A)'s order is devoid of any reasoning and is a nonspeaking order while granting relief to the assessee. The issue needs fresh adjudication at the level of CIT(A), since the impugned order is non-speaking order. Therefore, the matter is remanded to the CIT(A). The CIT(A) shall dispose of the matter after taking into consideration all the relevant material and shall take a decision in accordance with law after affording reasonable opportunities of hearing to the assesses. It is ordered accordingly."
On remand by the Tribunal, the CIT(A), after considering the facts as
well as the legal principles, observed that the disallowance of interest
expenditure made by the Assessing Officer on public deposits amounting to
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 Rs. 7,45,07,387/- under explanation to section 37(1) of the I.T. Act,1961
was contrary to the provisions of the Act. The CIT(A) has elaborately
observed as follows:
“4. Appreciation of facts and Application of taw with reference to Grounds of Appeal:
4.1. The facts of the case, the grounds of appeal and the arguments of the assessee and Department have been considered. It would be appropriate to summarize the facts of the case before going into the discussion about the correctness or otherwise of the action initiated by the assessing officer. The facts apropos to the dispute are as under: a) The assessee borrowed funds from the public as deposits in earlier years and the outstanding balance of public deposits as on 31.03.2002 stands at Rs. 64,09,29,371.
b) The major portion of such funds received were withdrawn by the partners of the assessee firm and the outstanding amount as on 31.03.2002 stands at Rs. 61,25,90,000.
c) The assessee received an amount of Rs. 7,96,40,925 as interest from partners against the outstanding debit balance and credited the same to P&L account.
d) The assessee paid an amount of Rs. 7,46,95,598 as interest on public deposits and debited the same to the P&L account.
e) The assessing officer in the assessment order has held, at para No. 6, that the funds borrowed were not used for the purpose of business of the assessee.
f) The assessing officer disallowed the interest payment of Rs. 7,45,07,387 being the amount paid on public deposits on the ground that the acceptance of public deposits by the assessee was prohibited by the law.
4.2. In the light of the facts given above, appropriate conclusion can be drawn on the action taken by the assessing officer by finding answers to the following questions:
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 a) What would be the income assessable if the transactions carried, with the funds borrowed from public, are treated as illegal business?
b) Whether interest expenditure incurred on public deposits is covered by the provisions of explanation to Section 37(1) of the Income Tax Act?
c) If not covered by section 37(1) of the IT. Act, whether the interest expenditure disallowable either in total or in part under section 36(1 )(iii) of the Income Tax Act?
d) In the facts and circumstances of the case, whether the Assessing Officer correctly assessed the interest income received from partners under the head “income from Profits and Gains of Profession or Business?
4.3. What would be the income assessable if the transactions carried, with funds borrowed from public, are treated as illegal business?
4.3.1. From the facts as discussed above at para 4.1, it is evident that the assessing officer classified the fund borrowed by the assessee from public as illegal in nature since it is in violation of law. In such a case, subsequent activities carried on by the Assessee using such fund have to be construed as an extension of such illegality. Therefore, the assessment of income or disallowance of an expenditure out of this illegal activity has to be done by treating all transaction carried in extension of such illegality as a single unit. However, the assessing officer, on the one hand, treated the interest income received from the partners, on the funds withdrawn by them out of the public deposits, as an assessable legal business income and on the other hand, treated the expenditure incurred on the interest payments, for the public deposits, as illegal and disallowed.
4.3.2. Similar issue was before Hon'ble ITAT, Mumbai in the case of Credit Suisse First Boston (India) Securities Ltd. in ITA No.7354/Mum/2004 and the Tribunal held vide its order dated 06/03/2013 as under:
"9. .............The main contention of the department in denying the claim of the interest expenditure is that the SEBI has passed an order giving adverse report against the assessee. We have seen the report of the Special Auditor and in the note the Special
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 Auditor has noted that the activity of the assessee indulging in financing activity may construe that the assessee is indulged in illegal activity. For a moment if it is accepted that the assessee is indulged in unauthorized activity of financing in respect to purchase and sell of shares on behalf of others, in that case, we are of the view that the interest expenditure has to be set off against brokerage earned by the assessee because the interest expenditure is incurred by the assessee on borrowed money for the purpose of buying shares or making purchases of shares on behalf of others. Huge brokerage is charged, which is much more as compared to interest expenditure. This is not expenditure, which is prohibited under Explanation of Section 37(1) as this expenditure does not belong to bribery nor on account of fine or penalty or hafta paid to someone as these expenditures are on account of borrowed money used for the purpose of business transaction. Even the Courts have held that if for a moment it is accepted that some activities are on account of unauthorized activity, then also unauthorized income has to be set off against unauthorized
In case of Bank of America (nt &sa), reported in 124 TTJ 40, the Murnbai Bench of the Tribunal has held that loss incurred by the assessee in security transaction in violation of Section 15 of the Securities Contract Regulation Act, 1956, undisputedly borne out that it was set off against profit from comparable transaction. In this case, it was argued on behalf of the department that losses incurred by the assessee are not allowable on account of expenses as they are relating to illegal activities. Thereafter it was held by the Tribunal that if the expenses are on account of illegal transaction, then income part of the same transaction has to be treated on account of illegal transaction and both i.e. income as well as expenditure is to be set off against each other.
In the present case also facts are similar. If the department treats the activities of the assessee are illegal, then income earned by the assessee as well as expenditure incurred by the assessee has to be treated on the same transaction and they have to be netted against each other." [Emphasis Supplied]
4.3.3. In the case of Piara Singh, [1980] 3 Taxman 67, Hon'ble Supreme Court has considered the issue of assessment of income related to illegal business and held as under:
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 "The carriage of currency notes across the border was an essential part of the smuggling operation. If the activity of smuggling can be regarded as a business, those who are carrying on that business must be deemed to be aware that a necessary incident, involved in the business, is detection by the customs authorities and the consequent confiscation of the currency notes. It is an incident as predictable in the course of carrying on the activity as any other feature of it. Having regard to the nature of the activity, possible detection by the customs authorities constitutes a normal feature integrated into all that is implied and involved in it.
The confiscation of the currency notes is a loss occasioned in pursuing the business; it is a loss in much the same way as if the currency notes had been stolen or dropped on the way while carrying on the business. It is a loss which springs directly from the carrying on of the business and is incidental to it. Applying the principle laid down by this Court in Badridas Daga v. CIT [1958] 34 ITR 10 the deduction must be allowed.”
In CIT v. SC. Kothari (1971) 82 ITR 794. this Court held that for the purpose of section 10(1) of the Act, a loss incurred in carrying on an illegal business must be deducted before the true figure of profits brought to tax can be computed. Grover, J., speaking for the Court, observed:
"If a business is illegal, neither the profits earned nor the losses incurred would be enforceable in law: but that does not take the profits out of the taxing statute. Similarly, the taint of illegality of the business cannot detract from the losses being taken into account for computation of the amounts which can subjected to tax under section 10(1). The tax collector cannot be heard to say that he will bring the gross receipts to tax, he can only tax profits of a trade or business. That cannot be done without deducting losses and the legitimate expenses of the business."
Reliance was placed by the revenue on Haji Aziz & Abdul Shakoor Bros. v. CIT (1961) 41 ITR 350(SC). In that case, however, the assesses carried on the Lawful business of importing dates from abroad and selling them in India. The import of dates by steamer was prohibited. Nonetheless, he imported dates from Iraq by steamer, and the consignments were confiscated by the customs authorities. But the dates were released subsequently on
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 payment of fine. The assessee's claim to deduction, under section 10(2)(xv) of the Act, was rejected on the ground that the amount was paid by way of penalty for a breach of the law. An infraction of the law was not a normal incident of business carried on by the assessee and the penalty was rightly held to fall on the assessee in some character other than that of a trader. Reference was made by the revenue to Soni Hinduji Kusalji & Co. v. CIT [1973] 89 1TR 112 (AP). The assessee's claim to the deduction of the value of gold confiscated by the customs authorities was found unsustainable by the Court. The decision in that case can be explained on the ground that the assessee was carrying on a lawful business in gold, silver and jewellery and committed an infraction of the law in smuggling gold into the country. Our attention has also been invited to J.S. Parkar vs. V.B. Palekar [1974] 94 ITR 616, where, on a difference of opinion between two learned judges of the Bombay High Court, a third learned Judge agreed with the view that the value of gold confiscated by the customs authorities in smuggling operations was not entitled to deduction against the estimated and assessed income from an undisclosed source. It was observed that the loss arose by reason of an infraction of the law and as it had not fallen on the assessee as a trader or businessman a deduction could not be allowed. Apparently, the true significance of the distinction between an infraction of the law committed in the carrying on of a lawful business and an infraction of the law committed in a business inherently unlawful and constituting a normal incident of it was not pointedly placed before the High Court in that case." [Emphasis Supplied]
4.3.4. Therefore, as explained in the above judicial decisions, if the assessing officer considers borrowal of Fund as illegal then the consequent lending of such Fund should be treated as illegal, impliedly, the entire business activity surrounding the funds borrowed from public has to be treated as illegal and only the net income generated can be taxed. Further, the provisions of explanation to Section 37(1) of the Income Tax Act cannot be applied to illegal business.
4.4. Whether interest expenditure incurred on public deposits is covered by the provisions of explanation to Section 37(1) of the Income Tax Act?
4.4.1. Alternatively, let us consider the case of the assessing officer who treated the funds borrowed from public as borrowal for the purpose of business but invoked the explanation to Section 37(1) of the I.T. Act to disallow the expenditure incurred on public deposits. At this point, it
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 would be relevant to examine the provisions of Section 37(1) of the I.T. Act and the same is as under:-
"General. 37 (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession".
Explanation -For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.
(2) [****]
(2B) Notwithstanding anything contained in sub-section (1), no allowance shall be made in respect of expenditure incurred by an assessee on advertisement in any souvenir, brochure, tract, pamphlet or the like published by a political party." [Emphasis Supplied]
4.4.2. As per the provisions of Section 37 (placed above), it is evident that in order to invoke the provisions of section 37 in respect of any expenditure debited to P&L account, it should be first qualified that such expenditure is not of the nature described under Sections 30 to 36 of the I.T. Act provides specifically for reduction of interest paid in respect of capital borrowed for the purpose of business under sub section (iii). This would imply that the expenditure incurred by the assessee on the interest payments, on the public on deposits which were borrowed for the purpose of business but may not have been applied for the purpose of business, is outside the purview of the provisions of section 37 of the I.T. Act.
4.4.3. In the appeal proceedings, on the issue of applicability of section 37 the Assessee relied on the decision of Jurisdictional Tribunal in the case of Shri K.T. Thomas in ITA No. 259, 260 & 402/Coch/2015. On perusal of this decision, it is observed that Hon'ble ITAT followed its own decision in the case of Arun Thomas, I.T.A No. 248/Coch/2012, dated 22-03-2013. The relevant part of the decision is as under:
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018
"A bare reading of section 37(1) clearly shows that any expenditure which is not in the nature described u/s 30 to 36 and not being capital expenditure or personal expenditure laid out wholly and exclusively for the purpose of business has to be allowed in computing the total income. Therefore, it is obvious that the expenditure which falls under section 30 to 36 and capital expenditure and personal expenditure are excluded from section 37 of the Act. For removal of doubts, Explanation 1 to section 37(1) introduced by Finance (No.2) Act of 1998 with retrospective effect from 01-04-1962 clarifies that any expenditure incurred for any purpose, which is an offence or which is prohibited by law shall not be treated as incurred for business and no deduction shall be allowed in respect of such expenditure. While clarifying Explanation to section 37(1) the CBDT clarified in circular No.772 dated 23-12-1998 as under:
"20.1 Section 37 of the Income-tax Act is amended to provide that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purposes of business or profession and no deduction or allowance shall be made in respect of such expenditure. This amendment will result in disallowance of the claims made by certain assessees in respect of payments on account of protection money, extortion, hafta, bribes, etc. as business expenditure. It is well decided that unlawful expenditure is not an allowable deduction in computation of income."
From the above explanation, the legislature intended to disallow the payment like protection money, extortion, haftar bribe, etc. when it was claimed as business expenditure. The contention of the ld. senior counsel for the taxpayer is that the payment of interest by the taxpayer comes within the ambits of sections 30 to 36. No doubt, section 37(1) is not applicable in respect of expenditure which falls within sections 30 to 36 of the Act. In this case, the taxpayer admittedly borrowed funds for enhancing the working capital or the purpose of money lending business. Interest on capital borrowed for the purpose of business falls within the provisions of section 36(1)(iii) of the Act. Therefore, any interest paid on the capital borrowed for the purpose of business or profession has to be allowed as deduction u/s 36(1)(iii) of the Act. In view of the above, provisions of section 37(1) may not be applicable in respect of interest on the capital borrowed for
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 business purpose. Apart from this, the taxpayer claims that the funds were borrowed in the personal capacity and not in the name of business concern. The payment of interest on the borrowed capital falls within section 36(1)(iii) of the Act and hence the provisions of section 37(1) may not be applicable."
4.4.4. Therefore, as explained by the jurisdictional tribunal, provisions of section 37 of the I.T. Act cannot be applied to disallow the interest expenditure on capital borrowed for the purpose of business.
4.5. If not covered by section 37(1) of the I.T. Act, whether the interest expenditure disallowable either in total or in part under section 36(1)(iii) of the Income Tax Act? 4,5.1. From the facts brought on record by the assessing officer it is evident that the funds borrowed from the public by the assessee, may be for the purpose of business, have not been utilized for the purpose of business and have been diverted to the partners to a large extent. In this background, the question to be decided is whether the interest expenditure incurred on the public deposits is an allowable expenditure under section 36(1)(iii) of the I.T. Act, 1961?
4.5.2. Similar issue has been considered and decided in the case of V.I. Baby & Co. [2002] 123 TAXMAN 894, by Hon'ble High Court of Kerala and held as under:
"4. We are inclined to accept the argument raised by the counsel for the revenue, because the advances to the partners, their relatives and the sister concerns are not for business purposes and the assessee has not derived any benefit out of the same. Admittedly, no interest was charged on these advances. The Tribunal appears to have placed reliance on the fact that the partners and their relatives have utilised the amounts for business purposes, such as construction of a shop, building, etc. So long as the assessee-firm is 'not the beneficiary of such investments, the nature of investment or the utilisation of such advances has no relevance. So far as the assessee is concerned, it is only an interest-free advance. The claim of the assessee's counsel that cash balances were available with the firm for advances to the partners, their relatives and the sister concerns does not advance the assessee's case. If cash balances are available, the borrowing itself is not for the purpose of the business. An assessee with liquidity cannot claim that it can give interest-free advances to the partners and others and then borrow funds from the bank on interest for business purposes. Such borrowings will not be for
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 business purposes, but for supplementing the cash diverted by the assessee without any benefit to it. Therefore, so long as the assessee is not the beneficiary of the investments made by the partners, their relatives and the sister concerns and so long as the advances are interest free, the Assessing Officer is perfectly justified in disallowing the interest in proportion to the advances made. There is no dispute with regard to working out of the proportionate disallowance of interest." [Emphasis Supplied]
4.5.3. Therefore, as per the law laid down by the jurisdictional High Court so long as the advances are interest free, the Assessing Officer is perfectly justified in disallowing the interest in proportion to the advances made. But in the assessee's case the interest was received on withdrawals made by the partners and therefore, the question to be decided is what portion of the interest expenditure can be disallowed?
4.5.4. This issue has come up for consideration in the case of Rajesh J. Desai, [2013] 37 taxmann.com 78, before the Hon'ble High Court of Gujarat and the Court held as under:
"2. We have heard the learned counsel Shri Sudhir Mehta for the Revenue who has fervently made submissions. He urged that the Assessing Officer has given extensive finding that the loans were not used for the purpose of business and both the CIT (Appeals) and the Tribunal committed serious error in not appreciating the cogent finding given by the Assessing Officer. He urged this Court to quash and set aside both the orders on the ground of perversity.
On due consideration of the orders of all the Revenue Authorities and carefully considering the submissions made by the learned counsel appearing for the Revenue, we are of the opinion that this appeal deserves no consideration in absence of any substantial question of law having been posed before this Court. We say so for the following reasons :
3.1 There is a categorical finding on the part of the CIT (Appeals) that the respondent was engaging himself in multiple activities of finance, land dealing, hotel business, etc. For his own convenience, two balance sheets have been prepared, one in his personal name "Shri Rajesh J. Desai" and another in the name of proprietary firm "Rajiv Enterprises", which is engaged in the business of financing. The consolidated balance sheet as on March 31, 2007 had shown negative balance in the capital
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 account. However, this balance sheet had negatived the advance loan to the extent of Rs. 13,88,28,243/-. The categorical finding of the CIT (Appeals) has not been controverted by the Revenue that on every transaction entered into by the respondent-Assessee, he has charged the interest. The interest-free funds to the tune of Rs.6.5 crore were in the nature of advance receipt for the land and for all the borrowings, he has paid interest at the rate of 12%. It is only in the case of sister concern M/s. RJD Impex Pvt. Ltd. that the interest is received at the rate of 6%. Wherever he is partner, he is paying interest as well.
3.2 As can be noted from the discussion of the Tribunal that the rate of interest for advancing the loan to the sister concern was 6% and borrowing in the majority cases was at 12%. As the Tribunal found the possibility of factual error, it had remitted the matter to the Assessing Officer to assess as to whether the interest charged to M/s. RJD Impex Pvt. Ltd. was at 6% or 12% and if the interest is charged at 12%, in that case there would not be a case of passing of undue advantage in the case of sister concern and then, the disallowance would be required to be deleted. So after offering opportunities to both the sides, on considering the factual matrix, the aforesaid decision has been rendered. No error much less any substantial error can be said to have been committed by such directions. As far as M/s. RJD Impex Pvt. Ltd., a proprietary concern, is concerned, on having noted that it being in the business of financing, not only advances money and charges interest at the rate of 12%, but, it also passes 12% interest on the borrowings made by it. When both the CIT (Appeals) and the Tribunal appropriately dealt with the issue, we see no reason to interfere with the deletion made by the CIT (Appeals) and confirmed by the Tribunal. The Assessing Officer is required to cover the issue from the angle indicated in the order itself and after verification, the said direction is required to be flowed.
3.3 We are of the opinion that no error could be noticed in the approach of either of the authorities, much less any perversity which would warrant any interference at our end." [Emphasis Supplied]
4.5.5. In the above decision, Hon'ble High Court has upheld decision of lower authorities who have held that in cases where advances were
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 made at the same rate of interest as it is for borrowal then no disallowance can be made under section 36(1 )(iii) of the I.T. Act, 1961.
4.5.6. In the light of the decisions of Hon'ble High Court of Kerala and Gujarat, it is evident that in case of diversion of funds borrowed for the purpose of business what is disallowable is only net interest expenditure not the gross interest expenditure. Where there is no net interest expenditure incurred on the diversion of the funds borrowed, no disallowance of interest expenditure is called for under section 36(1)(iii) of the I.T. Act, 1961.
4.6 In the facts and circumstances of the case, whether the Assessing Officer correctly assessed the interest income received from partners under the head "Income from Profits and Gains of Profession or Business"?
4.6.1. In para 6 of the assessment order the Assessing Officer held that the activity of raising deposits from the public does not have any connection with the stated objective of the firm - namely, operating a hospital at Kozhencherry. Against these observations of the Assessing Officer, the Assessee submitted in the statement of facts as under:
"3. The appellant is engaged in the business of running of hospital for the medical need of public at large. In the object clause of the partnership deed, there was also a provision to carry on any business/ businesses as the partner may decide from time to time. This has been also reiterated by the assessing officer in para 3 of the proceedings." [Emphasis Supplied]
4.6.2. Therefore, from the facts brought on record, it is observed that the claim of the assessee to treat the Funds borrowed from the Public as Funds borrowed for the purpose of business is based only on the residuary object clause in the partnership deed. Now, the question is whether the assessee can take shelter under this residuary clause for all the activities specifically not provided in the object clause of the partnership deed to prove his claim for considering the activity as business?. This question has come up for consideration in the case of Raj Dadarkar & Associates, [2017] 81 taxmann.com 193, before the Hon'ble Supreme Court and the Court has held as under:
“15. What is the test which has to be applied to determine whether the income would be chargeable under the head “income from the house property” or it would be chargeable under the head “Profits and gains from business or profession", is the question. It may be
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 mentioned, in the first instance, that merely because there is an entry in the object clause of the business showing a particular object, would not be the determinative factor to arrive at a conclusion that the income is to be treated as income from business. Such a question would depend upon the circumstances of each case. It is so held by the Constitution Bench of this Court in Sultan Bros. (P) Ltd. v. CIT [1964] 51 ITR 353 (SC) and we reproduce the relevant portion thereof:
"7.... We think each case has to be looked at from a businessman's point of view to find out whether the letting was the doing of a business or the exploitation of his property by an owner. We do not further think that a thing can by its very nature be a commercial asset. A commercial asset is only an asset used in a business and nothing else, and business may be carried on with practically all things. Therefore, it is not possible to say that a particular activity is business because it is concerned with an asset with which trade is commonly carried on. We find nothing in the cases referred, to support the proposition that certain assets are commercial assets in their very nature."
In view thereof, the object clause, as contained in the partnership deed, would not be the conclusive factor. Matter has to be examined on the facts of each case as held in Sultan Bros. (P) Ltd. case (supra) Even otherwise, the object clause which is contained in the partnership firm is to take the premises on rent and to sub-let. In the present case, reading of the object clause would bring out two discernible facts, which are as follows:
The appellant which is a partnership firm is to take the premises on rent and to sub-let those premises. Thus, the business activity is of taking the premises on rent and sub- letting them.
In the instant case, by legal fiction contained in Section 27(iiib) of the Act, the appellant is treated as "deemed owner".
The aforesaid clause also mentions that partnership firm may take any other business as may be mutually agreed upon by the partners.
In the instant case, therefore, it is to be seen as to whether the activity in question was in the nature of business by which it could
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 be said that income received by the appellant was to be treated as income from the business. Before us, apart from relying upon the aforesaid clause in the partnership deed to show its objective, the aforesaid clause in the partnership deed to show its objective, the learned counsel for the appellant has not produced or referred to any material. On the other hand, we find that ITAT had specifically adverted to this issue and recorded the findings on this aspect in the following manner:
"26. ...On this issue facts available on record are that the assessee let out shops/stalls to various occupants on a monthly rent. The assessee collected charges for minor repairs, maintenance, water and electricity. As per the terms of allotment by the BMC, the assessee was bound to incur all these expenses, The assessee, in turn, collected extra money from the allottees. The assessee collected 20% of monthly rent as service charges. Such service charges were also used for providing services like watch and ward, electricity, water etc. This in our opinion was inseparable from basic charges of rent. The assessee has made bifurcation of the receipt from the, occupiers of the shops/stalls as rent and service charges. As rightly held by the Assessing Officer, decision of Hon'ble Supreme Court in the case of Shambu Investment Pvt. Ltd., 263 ITR 143 will apply. The assessee has not established that he was engaged in any systematic or organized activity of providing service to the occupiers of the shops/stalls so as to constitute the receipts from them as business income. In our opinion, the assessee received income by letting out shops/stalls; and therefore, the same has to be held as income from house property."
The ITAT being the last forum insofar as factual determination is concerned, these findings have attained finality. In any case, as mentioned above, the learned counsel for the appellant did not argue on this aspect and did not make any efforts to show as to how the aforesaid findings were perverse. It was for the appellant to produce sufficient material on record to show that its entire income or substantial income was from letting out of the property which was the principal business activity of the appellant. No such effort was made." [Emphasis Supplied]
4.6.3. Therefore, as laid down by Hon'ble Supreme Court in the above decision, it is not enough for the assessee to rely on the residuary clause
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 to claim that assessee is carrying a particular business activity. The assessee has to establish that it was engaged in any systematic or organized business activity. Further, the assessee advancing his case for a systematic business activity in borrowal and lending of funds, it has submitted in the statement of facts as under:
“4. Apart from the objects for which the firm was constituted, the appellant firm has also accepted deposits from the public and well- wishers and wherever surplus funds were available, such amounts were withdrawn by the partners of the firm. The appellant firm collected interest from the partners, out of which interest was paid to the public and thereby the appellant firm earned surplus on this transaction, i.e., to say the entire interest payment on the deposits were made out of the interest collected from the partners. At this juncture, it is submitted that there is no prohibition under the Indian Partnership Act or any other Act in carrying on the business between the firm and its partners. It is for the partners, who carry on the business activities of the firm, to decide the best possible manner to maximize their profit and Income Tax Department cannot sit on such judgment of the partners." [Emphasis Supplied]
4.6.4. Therefore, in para 4 of the statement of facts, the assessee submits that there is a systematic business activity with partners for advancing funds and receipt of interest. Further, it was also stated that there is no prohibition in Partnership Act for carrying on business with partners.
4.6.5. It is true that Partnership Act does not prohibit contractual business transactions with partners but such claim should be supported by the clauses in the partnership deed. From the facts available on record, it is observed that the partners of the assessee firm have entered into a partnership vide partnership deed dated 01.04.2002. This partnership deed does not provide for any contractual business obligations between firm and partners. Further, clause 7 of the partnership deed provides for remuneration/interest to the partners. But the deed does not provide any clause for the rate of interest to be charged on the advances taken by the partners.
4.6.6. Further, with regard to funds withdrawn by the partners, the assessee submitted in the statement of facts that even though the assessee firm has accepted deposit, it has not lent the funds to outsiders and only partners have withdrawn as a part of their capital, so much so the provisions of Money Lenders Act also does not apply and the relevant part of the submission is as under:
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018
"5. According to the Officer, the main business of the appellant is carrying on of hospital, where as the financial statement filed along with the return presents totally different picture of business carried, by way of earning interest from the partners and paying interest to outsiders. According to the Officer, this is in violation of section 45S of the R.B.I. Act, 1935. Basically the Officer has misconstrued the provisions of the RBI Act which concern in respect of Non Banking Finance Company and not the appellant firm. The appellant firm if at all carrying on any money lending business would be governed by the Kerala Money Lenders Act and not by the Central Act. In this case though the appellant firm has accepted deposit, it has not lend the funds to outsiders and only partners have withdrawn as a part of their capital, so much so the provisions of Money Lenders Act also does not apply." [Emphasis Supplied]
4.6.7. Therefore, in view of the legal principles and the facts discussed at para 4.6.1 to 4.6.5, it is evident that the activity of borrowing funds from public and withdrawal by partners cannot be classified as business activity. Consequently, the income generated or the expenditure incurred by the assessee in the course of these transactions cannot be assessed under the head "Income from Profits and Gains of Profession or Business". The question is whether the same are assessable under the head "Income from Other Sources". The provisions of section 56 of the I.T. Act, 1961 read as under:
"Income from other sources”
(1) Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head "Income from other sources", if it is not chargeable to income-tax under any of the heads specified in section 14, items A to E.
(2) In particular, and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income-tax under the head "Income from other sources", namely :-
(i) dividends;
(ia) income referred to in sub-clause (viii) of clause (24) of section 2;
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 (ib) income referred to in sub-clause (ix) of clause (24) of section 2;
(ic) income referred to in sub-clause (x) of clause (24) of section 2, if such income is not chargeable to income-tax under the head "Profits and gains of business or profession";
(id) income by way of interest on securities, if the income is not chargeable to income-tax under the head "Profits and gains of business or profession";
..................." [Emphasis Supplied]
4.6.8. From the above clauses, it is evident that the interest income earned by the assessee on account of withdrawal by the partners is assessable under section 56. Now the question is whether expenditure incurred by the assessee in generation of interest income is allowable as deduction?. Section 57 of the l.T, Act, 1961 provides for the deductions against the income shown und§^ section 56 and the same is as under:
"Deductions.
The income chargeable under the head "Income from other sources" shall be computed after making the following deductions, namely:—
(i) in the case of dividends, other than dividends referred to in section 115-O or interest on securities, any reasonable sum paid by way of commission or remuneration to a banker or any other person for the purpose of realising such dividend or interest on behalf of the assessee;
(ia) in the case of income of the nature referred to in sub-clause (x) of clause (24) of section 2 which is chargeable to income-tax under the head "Income from other sources", deductions, so far as may be, in accordance with the provisions of clause (va) of sub- section (1) of section 36 ;
(ii) in the case of income of the nature referred to in clauses (ii) and (iii) of sub-section (2) of sectjon_56, deductions, so far as may be, in accordance with the provisions of sub-clause (ii) of clause (a) and clause (c) of section 30, section 31 and sub-sections (1) and (2) of section 32 and subject to the provisions of section 38;
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 (iia) in the case of income in the nature of family pension, a deduction of a sum equal to thirty-three and one-third per cent of such income or fifteen thousand rupees, whichever is less,
Explanation.-For the purposes of this clause, "family pension" means a regular monthly amount payable by the employer to a person belonging to the family of an employee in the event of his death ;
(iii) any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income; (iv) in the case of income of the nature referred to in clause (viii) of sub-section (2) of section 56. a deduction of a sum equal to fifty per cent of such income and no deduction shall, be allowed under any other clause of this section." [Emphasis Supplied]
4.6.9. Therefore, under section 57, only the expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income under section 56 is deductible. Now important question is whether the expenditure incurred by the assessee on public deposits can be qualified as expenditure incurred exclusively for earning the interest income?
4,6.10. Similar issue has come up for consideration in the case of Smt. Santosh Agarwal, [2003] 1 SOT 431, before Hon'ble ITAT Cuttack and the Tribunal held as under:
"2. The assessee earned considerable income by way of capital gains, dividend and interest during the year under consideration. The first ground in this appeal relates to the addition of Rs. 10,506 in the matter of claim of interest payment, as deleted in the first appeal.
The Assessing Officer discusses in this connection that although the assessee claimed interest payment of Rs. 10,506 against her Overdraft A/c. with Punjab National Bank, Sambalpur, it may be found that the said overdraft facilities had been allowed to the assessee to enable her towards carrying on activities in the line of purchasing and selling of shares. The Assessing Officer discusses in this connection that the assessee, however, diverted the overdrafts taken from the Bank, on several occasions, for various other purposes like loans given to M/s. Sree Durga Automobiles,
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 M/s. Kalinga Batteries, etc. On this ground, the claim of interest payment has been disallowed by the Assessing Officer.
It is found that the major portion of the income of the assessee has arisen out of interests received from M/s. Kalinga Batteries, M/s. Sree Durga Automobiles, etc. as well as from dividend income if the contention of the Assessing Officer that the loan taken from the Bank was diverted by way of loans advanced to M/s. Kalinga Batteries and M/s. Sree Durga Automobiles be correct, in such case, the interest payment to the Bank will have to be allowed against the interest income taxed under the head "other sources" and under section 57(iii)." [Emphasis Supplied] 4.6.11. Further, similar issue was also considered by Hon'ble High Court of Delhi in the case of Taj International Jewellers, [2012] 20 taxmann.com 1, and the Court held as under:
"2. In order to deal with this issue one will have to go into the peculiar nature of the transaction entered into by the assessee. The assessee had given its detailed explanation to the Assessing Officer, inter alia, stating that it had borrowed a sum of Rs. 35.34 crores directly from the banks to make the FDRs, that is to say, on the one hand, the bank advanced loan to the assessee and on the other hand, the same amount was converted into FDRs. The assessee had further explained that it did not invest fresh capital in the years in question. More so, the activity of import of gold on 360 days credit against the letter of credit was permitted by the Government of India as per the Import and Export Policy for the benefit of exporters. The exporters were benefitted by the scheme purely on the facts that there was a difference of rate of interest in India as against the interest rate outside India which was payable, i.e., LIBOR rate (London Interbank Offered Rate). It was because of this peculiar nature of the transaction and the scheme of the Government of India for the benefit of exporters that the assessee earned more interest on the FDRs than the interest payable to the bank on the borrowed funds. It is not in dispute that the assessee intends to pay the tax on the extra interest earned on the said FDRs, what the assessee wanted to adjust therefrom the interest paid by it to the bank against the borrowed funds. Section 57(iij) of the Act reads as under :
"any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income."
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 3. The Commissioner of Income-tax (Appeals) as well as the Income- tax Appellate Tribunal have recorded a finding of fact that there was a clear nexus between the interest earned on the FDRs and the interest paid on loans utilized for purchase of FDRs and the intimate connection between the receipt and payment of interest stand established. It is not in dispute that the entire money was borrowed with the sole purpose of converting the same into FDRs and that was actually done as well. In these circumstances, we agree with the opinion of the authorities below. The interest paid had to be allowed under the provisions of section 57(iii) of the Act as the amount was borrowed for making and earning income, taking advantage of the EXIM policy of the Government of India as well as lower LIBOR interest rate." [Emphasis Supplied] 4.6.12. Therefore, in the light of above decision of Hon'ble High Court, it is evident that the proportionate interest expenditure on public deposits related to the withdrawals made by partners of the assessee is an allowable deduction. Similarly, under section 57 of the I.T. Act, all the expenditure incurred wholly and exclusively for the purpose of making or earning interest income is deductible.
Conclusion:
5.1. In view of the facts as well as the legal principles discussed in para 4 above, the disallowance of interest expenditure made by the Assessing Officer on public deposits amounting to Rs. 7,45,07,387 under explanation to section 37(1)of the I.T. Act,1961 is contrary to the provisions of the Act. Hence, the disallowance of Rs. 7,45,07,387 is deleted.
5.1. The action of the Assessing Officer in assessing the interest income received from partners under the head "Income from profits and gains of business or profession" is also contrary to the provisions of the Act, in view of the fact and circumstances of the case as well as the legal principles discussed in para 4.6, , the interest income received from partners from withdrawal of funds is assessable under the head "Income from Other Sources". Further, the proportionate interest expenditure incurred on public deposits relatable to the withdrawals made by the partners is an allowable expenditure under section 57(iii) of the I.T. Act,1961.
5.3. As per facts discussed by the Assessing Officer at para 5 of the assessment order, the asessee is having an exclusive resource division for acceptance of deposits from public. However, the details of
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 expenditure incurred by the assessee with respect to funds borrowed and withdrawals made by the partners are not on record. In view of this, the Assessing Officer is directed to assess the interest received from partners, in respect of the funds diverted from the Public deposits, under the head "Income from Other Sources". The Assessing Officer is directed to allow the interest expenditure on Public deposits as per para 5.2 above. Further, the other expenditure allowable under section 57 of the I.T. Act, 1961 in respect of the resource division should also be allowed and income should be assessed accordingly.
Against this finding of the CIT(A), the Revenue is in appeal before us.
The contention of the Ld. DR is that similar issue came up before the
Jurisdictional High Court in the case of CIT vs. Arun Thomas in ITA No.
100/2016 dated 03/10/2017 which was decided as follows:
“19. The adjudication before us concerns six assessment years: 2007 to 2013. As the questions of law are identical in all the cases, we will refer to the facts to the extent necessary only to contextualise those questions of law. .
The assessee is a licensed money lender; he obtained registration under the Kerala Money Lenders Act, 1958. He runs a proprietary concern, money lending being his principal business activity. The assessee is bound, among other enactments, by the Kerala Money Lenders Act and the RBI Act
In one particular year, the Revenue picked the assessee's case for scrutiny and issued notice u/s 143(2) of the IT Act. Later, the Assessing Authority found that the assessee accepted deposits in a 'personal book' and paid interest on those deposits. He has concluded that interest paid on deposits not reflected in the books of account cannot be allowed as "expense" under the IT Act. After disallowing the deduction, the Assessing Authority issued a revised demand notice to the assessee. This process was repeated for the other five assessment years, too.
In all the appeals, the Appellate Authority treated the payments as allowable expenses and allowed the appeals. In the second appeals filed by the Revenue, the Tribunal rejected the Revenue’s contentions; it affirmed the Appellate Authority’s findings.
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018
To contextualize, we may tabulate all the appeals:
Appeal No. Asst. year Assessed Amount Demand Income Disallowed 87/2016 2007-08 3,10,14,290 3,50,43,680 1,78,39,070 235/2013 2008-09 2,72,58,163 3,80,46,570 1,22,63,460 271/2013 2009-10 4,11,26,710 3,90,28,180 1,83,88,380 265/2015 2010-11 4,41,01,970 4,20,02,029 1,82,48,140 268/2015 2011-12 5,24,13,940 5,21,77,883 2,14,50,030 100/2016 2012-13 5,35,08,520 4,70,00,020 2,16,45,310 Total 24,94,23,593 25,32,98,362 10,98,34,390
Statutory Position:
Kerala Money Lenders Act, 1958:
Every application for a money-lender’s licence must be in writing and must be made to the licensing authority in the manner prescribed under the Act. Upon the applicant’s meeting, the prescribed parameters, the authority will grant licence to the applicant. Section 4(iii) mandates that deposits “shall be accepted only in accordance with the provisions of the Reserve Bank of India Act, 1934.” The interest chargeable, too, must be at the rates not exceeding the rates fixed by the Reserve bank of India under the Nonbanking Financial Companies (Reserve Bank) Directions, 1977.
Section 14 of the Money Lenders Act deals with the licencing authority's power to cancel a licence. The licence can be cancelled under these circumstances: (a) if the licensee contravenes any provision of the Act or the rules, or licence condition: (b) if the licencee had initially suppressed any material fact that would have disentitled him to have the licence; (c) if the licensee is convicted for an offence under sections 9, 11, or 13 of the Act; (cc) if the licensee carries on business without furnishing the security or additional security as provided in this Act; or (d) if the licensee maintains false accounts.
Section 17 of the Kerala Money Lenders Act deals with the penalties "for carrying on business without licence or in violation of the conditions of licence." If the licencee carries on business otherwise than in conformity with the terms of the licence, he will be punished with "imprisonment for a term which, in the absence of special reasons
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 to be recorded in the judgment of the court, shall not be less than three months but which may extend to three years and with fine which may extend to fifty thousand rupees."
A residuary provision. Section 18 of the Money Lenders Act, on the other hand, concerns itself with penalties. Whoever contravenes any provision of the Act, or any rule made under the Act, or any term or condition of a licence granted or deemed to be granted, or makes a claim or a statement which is false or which he does not believe to be true shall, if no other penalty is elsewhere provided for in this Act for such contravention, he will be punished with fine which may extend to one thousand rupees.
The salutary statutory mandate, as we can see, is that the licencee can accept the deposits "only in accordance with the provisions of the Reserve Bank of India Act, 1934."
RBI Act: 29. Section 45-1 is a lexical provision; among other terms, it defines "deposit" in clause (bb) (yi) to include any amount received from an individual or a firm or an association of individuals not being a body corporate, registered under any enactment relating to money lending which is for the time being in force in any State.
Section 45-S prohibits the money lender from accepting deposits in certain cases. It pays to quote the provision:
45-S. Deposits not to be accepted in certain cases.—(1) No person, being an individual or a firm or an unincorporated association of individuals shall, accept any deposit—
(i) if his or its business wholly or partly includes any of the activities specified in clause (c) of Section 45-1; or
(ii) if his or its principal business is that of receiving of deposits under any scheme or arrangement or in any other manner, or lending in any manner:
Provided that nothing contained in this sub-section shall apply to the receipt of money by an individual by way of loan from any of his relatives or to the receipt of money by a firm by way of loan from the relative or relatives of any of the partners.
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 (2) ……...
(3) .......
Explanation--For the purposes of this section, a person shall be deemed to be a relative of another if, and only if,— (i) they are members of a Hindu undivided family; or (ii) they are husband and wife; or (iii)the one is related to the other in the rnanner indicated in the List of Relatives below:-
List of Relatives 1. Father, 2. Mother (including stepmother), 3. Son. (including step-son), 4. Son's wife, 5. Daughter (including stepdaughter), 6, Father's father, 7. Father's mother, 8. Mother's mother, 9. Mother's father, 10. Son's son, 11. Son's son's wife, 12. Son's daughter, 13. Son's daughter's husband. 14. Daughter's husband, 15. Daughter's son, 16. Daughter's son's wife, 17. Daughter's daughter, 18. Daughter's daughter's husband, 19. Brother (including stepbrother), 20. Brother's wife, 21. Sister (including stepsister), 22. Sister's husband.
Here, the assessee falls within the mischief of section 45-S of the RBI Act. He cannot accept deposits save from his relatives enumerated in the provision. Income Tax Act
Indisputably, section 36 (i) (iii) allows the assessee to deduct the interest paid on the capital borrowed for the business or profession. Section 37 deals with the deductible expenditures. The provision reads: 37. General- (1) Any expenditure (not being expenditure of the nature described in Sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession".
[Explanation.—For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited. by law shall not be deemed to have incurred for the purpose of business or profession and no deduction or allowance shall be made m respect of such expenditure.
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 33. As seen from the explanation, Section 37 prohibits deduction from profits and gains of business any expenditure incurred by him for any purpose "which is an offence or which is prohibited by law." By way of legal fiction, the provision mandates that such an illegal expenditure is deemed to have never been incurred.
Applying Law to the Facts:
The assessee is a licensed money lender. His contravening, if at all, the Kerala Money Lenders Act, here, assumes no importance. As rightly contended by the assessee’s counsel, there has been an effective, elaborate mechanism in that act to deal with any statutory infraction. Does that mean the money lender can act with impunity until he is called upon to account for under that Act? Our answer is no.
Section 45-S of the RBI Act prohibits a money lender from accepting deposits from persons other than his relatives enumerated in that very provision. The explanation to section 37 of the IT Act further prohibits the assessee’s deducting, for tax, money spent on an activity which is an offence; equally prohibited is the assessee’s deducting amount spent on an activity prohibited by law; the first spending focuses on a penal activity and the second, on a statutorily impermissible activity – not necessarily penal.
Here, undeniably the assessee borrowed money or accepted deposits from persons other than those mentioned in section 45-S of the RBI Act. Leaving aside the consequences that may flow from the other statutes on the assessee’s borrowing from outside, we will solely focus on the adverse consequences that may flow from the IT Act. If an assessee spends money on an activity which is an offence per se, or if he spends on an activity prohibited by law, pure and simple, the assessee cannot deduct that expenditure from what can be termed as his profit.
As seen from record, both the Appellate Authority and the Tribunal have focused only on whether the assessee has spent the money on an offending activity, both the for a ignored the second statutory proscriptions; spending money on an activity prohibited by law. Here, assessee’s accepting deposits is prohibited by law – section 54-S of the RBI Act. His paying interest on those deposits is that expenditure on an activity prohibited by law.
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 38. Sri Menon, the learned Senior Counsel for the Revenue, has called our attenetion to McDowell and Co. Ltd., a decision rendered by a Constitution Bench of the Supreme Court, to underline his assertion that an assessee can adopt no subterfuge to avoid his solemn statutory obligation; paying taxes. Indeed, the Constitution Bench has held that tax planning may be legitimate provided it is within the framework of the law. “Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuge.
In this case even without conflating the moral obligation with the statutory compulsion we reckon that the assessee has been, in plain terms, prohibited from deducting the expenditure that fell foul of section 37 of the IT Act.
Though the assessee has relied on T.Velayudhan, we fail to see how its holding affects this case. In T. Velayudhan the writ petitioners challenged the constitutional validity of Chapter-IIIC read with Section 58B(5A) of the RBI Act, introduced by the Banking Laws (Amendment) Act, 1983. RBI issued directions under Chapter III-B of RBI Act prohibiting among others, non-banking financial companies from holding deposits over 25 per cent of its paid-up capital and the reserves. The Supreme Court has acknowledged that the impugned legislation placed restrictions on the rights of writ petitioners to carry on business. But to safeguard the rights of various depositors and to see that depositors are not preyed upon, the private rights must yield to public need, observed the Supreme Court. And any form of legislation is unconstitutional only if it is arbitrary, discriminatory, or demonstratively irrelevant to policy. So held the Supreme Court, rejecting the legislative curbs on the lending activities.
We therefore, answer the question of law in the Revenue’s favour and allow the appeals, thereby, restoring the assessments orders for the years 2007 to 2013
No order to costs”.
On the other hand, the Ld. AR submitted that there was no surviving
judgment of the Jurisdictional High Court in the case of Arun Thomas, cited
supra. The operative part of the said judgment of the Jurisdictional High
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 Court was stayed by the Supreme Court in W.P. Nos.31432-31437/2017
dated 24/11/2017. According to the Ld. AR, the income of the assessee is to
be assessed under the head income from other sources as the assessee
herein was not at all engaged in money lending.
7.1 According to him, by any stretch of imagination, the income of the
assessee cannot be assessed as business income. On the other hand, it
should be assessed as income from other sources only.
7.2 Without prejudice to the above argument, the Ld. AR placed reliance on
the surviving order of the Tribunal in the case of DCIT vs. Arun Thomas (143
ITD 237) wherein it was held as under:
“5. We have heard the rival contentions and perused the facts of the case. The circumstances and the facts of the case in the present case are that the assessee has raised loans in the individual capacity and interest has been paid on the capital so borrowed for the purpose of business or profession. The Assessing officer made the disallowance by following Explanation to section 37(1) of the Act. As regards section 37(1) of the Act, the CBDT has clarified vide Circular No.772 dated 23/12/1998 that where the disallowance has to be made with regard to the claims made by the assessees in respect of payments on account of protection money, extortion, hafta, bribes etc. as business expenses. Whereas in the present case, there is no payment on account of protection money, extortion, hafta, bribes etc. and therefore, Explanation to section 37(1) cannot be made applicable to the present facts and circumstances of the case.
As regards applicability of section 37(1), it excludes expenditure which falls under sections 30 to 36, capital expenditure or personal expenditure. Obviously, the present case falls u/s. 36(l)(iii) of the Act wherein deduction is allowed for the amount of interest paid in respect of capital
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 borrowed for the purpose of business. Accordingly, expenditure is allowed u/s. 36(1)(iii). Therefore, section 37(1) is not applicable to the present facts and circumstances of the case. An identical issue has been decided by the ITAT, Cochin Bench in the assessee's own case for the assessment year 2009-10 and it is pertinent to reproduce the order of the Bench dated 22/03/2013 herein"
We have considered the rival submissions on either side and also perused the material available on record. We have also carefully gone through the provisions o( section 37(1) of the Income-tax Act which reads as follows:
"37(1) Any expenditure not being expenditure of the nature described in sections 30 to 36 and (not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession".
Explanation.- For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure."
A bare reading of section 37(1) clearly shows that any expenditure which is not in the nature described u/ss 30 to 36 and not being capital expenditure or personal expenditure laid out wholly and exclusively for the purpose of business has to be allowed in computing the total income. Therefore, it is obvious that the expenditure which falls under sections 30 to 36 and capital expenditure and personal expenditure are excluded from section 37 of the Act. For removal of doubts, Explanation 1 to section 37(1) introduced by Finance (No.2) Act of 1998 with retrospective effect from 01-04-1962 clarifies that any expenditure incurred for any purpose, which is an offence or which is prohibited by law shall not be treated as incurred for business and no deduction shall be allowed in respect of such expenditure. While clarifying Explanation to section 37(1) the CBDT clarified in Circular No.772 dated 23-12-1998 as under:
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 "20.1 Section 37 of the Income-tax Act is amended to provide that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purposes of business or profession and no deduction or allowance shall be made in respect of such expenditure. This amendment will result in disallowance of the claims made by certain assessees in respect of payments on account of protection money, extortion, hafta, bribes, etc. as business expenditure. It is well decided that unlawful expenditure is not an allowable deduction in computation of income."
From the above explanation, the legislature intended to disallow the payment like protection money, extortion, hafta, bribe, etc. when it was claimed as business expenditure. The contention of the ld. senior counsel for the taxpayer is that the payment of interest by the taxpayer comes within the ambits of sections 30 to 36. No doubt, section 37(1) is not applicable in respect of expenditure which falls within sections 30 to 36 of the Act. In this case, the taxpayer admittedly borrowed funds for enhancing the working capital for the purpose of money lending business. Interest on capital borrowed for the purpose of business falls within the provisions of section 36(1)(iii) of the Act. Therefore, any interest paid on the capital borrowed for the purpose of business or profession has to be allowed as deduction u/s 36(1)(iii) of the Act. In view of the above, provisions of section 37(1) may not be applicable in respect of interest on the capital borrowed for business purpose. Apart from this, the taxpayer claims that the funds were borrowed in the personal capacity and not in the name of business concern. The payment of interest on the borrowed capital falls within section 36(1)(iii) of the Act and hence the provisions of section 37(1) may not be applicable. Therefore, it may be immaterial whether the money was borrowed in personal capacity or not? We have also carefully gone through the judgments of the Karnataka High Court and Bombay High Court. In Amarjeet Kaur (supra) and in Taraporewala Sons Co (P) Ltd (supra) the payment of interest was not on the money borrowed for capital. In Taraporewala Sons Co (P) Ltd (supra), the payment was made as secret commission. In Amarjeet Kaur (supra), deposit linked incentive scheme was found to be money circulation scheme. The relevant expenditure in both cases were allowable u/s 37(1) of the Act. Therefore, the High Court found that expenditure would fall under Explanation to section 37(1) of the Act. In this case, the expenditure / interest is allowable under section 36(1)(iii), therefore, the
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 Explanation to section 37(1) is not applicable. Accordingly, the order of CIT(A) is confirmed.
The cross objection filed by the taxpayer is only to support the order of the CIT(A), therefore, it is not maintainable. Accordingly, both the appeal of the revenue and the cross objection of the taxpayer are dismissed."
In the facts and circumstances of the case and our findings hereinabove and the decision of the ITAT, Cochin Bench for the assessment year 2009-10 reproduced hereinabove, we find no infirmity in the order of the Ld. CIT(A) who has rightly allowed the appeal of the assessee and therefore, all the grounds of the Revenue are dismissed.”
We have heard the rival submissions and perused the record.
Admittedly, in this case the assessees received deposits from public and lend
the same to the partners and received interest on it. In the case of the
assessee, Mar Gregorious Memorial Muthoot Medical Centre, the object
clause reads as follows:
“4. BUSINESS:- the object of the partnership business shall be: (a) Running of Hospital to care to the medical need of the public at large and in this connection to construct hospital building, install sophisticated medical equipment, maintenance and running of the said hospital by employing experts in the field of medical profession, consultation and dispensing in this line which includes purchase and sale of medicines, establishment of laboratories, scanning centre and the like to carry on such ancillary and incidental objects conducive to the main objects which in the opinion of the partners can be conveniently or advantageously combined with the main object as aforesaid.
(b) Such other objects which the partners may desire from time to time to time as could be carried out effectively by the partnership business.”
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 The object clause of the assessee, Muthoot Properties and Investments
reads as follows:
“4. BUSINESS:- The principal business of the firm shall be (a) purchase and sale of immovable property, (b) to undertake the works in connection with property development and building constructions, including purchase and development of land, construction of residential and/or commercial buildings and the sale of land/buildings in part or in full (c) construction and running of holiday resorts, (d) purchase and maintenance of plantations and sale thereof. The firm shall also engage itself in other allied activities related to the above business or any other business or businesses as the partners may decide from time to time.”
8.1 As seen from the object clause of the partnership deed, these activities
carried on by the assessee are not prohibited by the partnership deed. In
other words, these activities are allied activities relating to the business of
the assessee. Further, looking into the transactions carried on by the
assessee with its partners by advancing funds, it can be inferred that these
transactions have been entered into by the assessee with a profit motive.
The assessee had intention thereby to carry on business with its partners. It
can be said that these transactions were entered into only for the purpose of
carrying on business which is ancillary activities carried on by the assessee
to earn profit from these transactions from its partners. The word “business”
has not been defined in the taxing statute, yet it postulates the existence of
certain elements in the activity of an assessee which would invest it with the
character of business. According to well established interpretation of word
‘business’ as found in taxing statutes, it is the sense of an occupation or
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 profession which occupies the time, attention and labour of a person
normally with the object of making profit. To record an activity as business,
there must be of course dealing either actually continued or contemplated to
be continued with a profit motive and not for support.
8.2 In our opinion, whether or not a person carried on business in a
particular way must depend upon volume, frequency, continuity and
regularity of transactions and the transactions must ordinarily be entered
into with a profit motive. Such motive must pervade the whole series of
transactions effected by the person in the course of his activity. To infer
from a course of transaction that is intended thereby to carry on business
ordinarily the characteristic of volume, frequency and regularity of
transaction indicating the intention to continue the activity of carrying on the
transactions must exist. Looking into the facts of the present case, it can
easily be said that the assessee entered into the transactions with its
partners with a profit motive. Therefore, the only inference which can be
drawn from this case is that the income earned by the assessee by
advancing funds to its partners falls under the head ‘income from business’
and not under the head ‘income from other sources’. In our considered
opinion, after considering the cumulative effect of the facts and
circumstances of the case, the CIT(A) is not justified in treating the income
arising out of these transactions by the assessee as ‘income from other
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 sources’. Accordingly, we reverse the order of the CIT(A) for all the
assessment years and it is to be assessed as income from business.
Consequently, the claim of deduction of payment of interest is squarely
covered against the assessee by the judgment of the Jurisdictional High
Court in the case of Arun Thomas cited supra wherein it was held that
accepting deposits is prohibited by law and paying interest on deposits is
that of expenditure on an activity prohibited by law. Therefore, any interest
paid on deposits is not to be allowed as deduction u/s. 36(1)(iii) of the Act.
8.3 Without prejudice to the above, even agreeing with the argument of
the Ld. DR that the income earned by the assessee from lending funds to its
partners is to be assessed as business income of the assessee, interest
payment is not allowable in view of the judgment of the Jurisdictional High
Court in the case of Arun Thomas, cited supra and in our opinion, that
judgment was stayed by the Supreme Court in Writ Petition No. 33432-
31437/2017 dated 24/11/2017 and the said judgment of the Jurisdictional
High Court is not in operation as of now.
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018 8.4 In view of the above order of the Supreme Court in Writ Petition No.
33432-31437/2017 dated 24/11/2017, we are inclined to remit the issue to
the file of the CIT(A) to decide afresh after the final judgment of the
Supreme Court in the case of Arun Thomas cited supra.
In the result, the appeals of the Revenue are partly allowed for statistical
purposes. Order pronounced in the open Court on 21st February, 2019
sd/- sd/- (GEORGE GEORGE K.) (CHANDRA POOJARI) JUDICIAL MEMBER ACCOUNTANT MEMBER Place : Kochi Dated: 21st February, 2019 GJ Copy to: 1. M/s. Mar Gregorious Memorial Muthoot Medical Centre, Kozhencherry, Pathanamthitta. 2. Muthoot Properties & Investments, Muthoot Building, Kozhencherry, Pathanamthitta. 3. The Assistant Commissioner of Income-tax, Circle-1, Thiruvalla. 4. The Commissioner of Income-tax(Appeals), Kottayam. 5. The Pr. Commissioner of Income-tax, Kottayam.. 6. DR, I.T.A.T., Cochin Bench, Cochin. 7. Guard File. By Order
(ASSISTANT REGISTRAR) I.T.A.T., Cochin
I.T.A. Nos. 69-72/Coch/2018 & 73-75/Coch/2018