COMMISSIONER OF INCOME TAX vs. PANKTI POLYTEX PVT. LTD.

This appeal under section 260A of the Act is filed at the instance of the Revenue challenging the order dated 28th April, 2006 passed by the Income Tax Appellate Tribunal, Ahmedabad in ITA No. 175/Ahd/2001 for the assessment year 1997­1998. 2. This Court has passed the following order dated 9th August, 2007  while admitting the substantial questions of law : “Heard learned counsel for the appellant. The   appeal   is   admitted   in   terms   of   the   following questions: “(i) Whether on the facts and circumstances of the case,   the   Appellate   Tribunal   was   right   in   law   in allowing   the   interest   expenditure   on   the   borrowed funds from the group companies, which funds were in turn utilized in purchasing the shares of the group companies?” (ii) Whether on the facts and circumstances of the case,   the   Appellate   Tribunal   was   right   in   law   in holding that the modus of utilizing the borrowed fund from group companies in purchasing shares of group companies was not fraudulent, sham and thereby, not illegal?” Issue notice to the other side. Paper book be filed within 3 months. List the appeal for final hearing after 3 months.”

The   Assessing   Officer   noticed   during   the   assessment proceedings for assessment year 1997­1998 in case of the respondent assessee that the assessee was paying huge interest on the purported loans from group companies and such loans were utilized for purchasing shares of the said group companies. The Assessing Officer therefore, called for the explanation of the assessee to show cause why such interest expenditure should not be disallowed treating it to be dubious transaction with an ulterior motive to defraud the   revenue   and   evade   tax.   The   Assessing   Officer   after considering   the   explanation   tendered   by   the   assessee disallowed the interest payment of Rs.2,64,49,312/­ out of the interest expenses of Rs.3,49,92,157/­ as claimed in the Profit and Loss account of the assessee.

Being aggrieved and dissatisfied by the disallowance of the interest expenses by the Assessing Officer, the assessee preferred an appeal before the CIT(Appeals) who by order dated 4th October, 2000 allowed the appeal of the assessee holding that the borrowings made by the assessee were for the purpose of business and same were utilized for the purpose   of   business   and,   therefore,   the   assessee   was justified   in   claiming   interest   expenses.   CIT(Appeals)

The Revenue being aggrieved by the order of CIT(Appeals) preferred Second Appeal before the Tribunal. The Tribunal considered the fact that the interest expenses claimed by the assessee pertains to business of financing and trading in shares and securities carried on by the assessee as it had no capital of its own and assessee was procuring loan from various parties and had been investing in shares of the other companies which are found by the Revenue as group   companies.   The   Tribunal   after   considering   the findings arrived at by CIT(Appeals) held as under :

The Assessee, in addition to aforesaid submissions, had made further submissions as contained in paragraph No.3.11 to 3.15 of the order of the CIT(Appeals).

The CIT(Appeals) allowed the assessee's appeal by observing as under: “3.16 I have gone through the assessment order and I have considered the contentions raised by the appellant. I am of the considered opinion that the borrowings are for business of the  appellant, that on  perusal of the details of the funds are utilized for the purpose of business therefore the appellant is justified in claiming that the borrowings were   made   for   the   purpose   of   the   business   of   the appellant. Once those borrowings are held to be for the purpose of business in view of the ratio of the Supreme Court decision in Madhav Prasad Jatia (supra) and other decision cited by the appellant as reproduced above there is absolutely no justification in disallowing the claim either in full or in part. I also agree with the learned counsel of the appellant that the reliance placed by the Assessing Officer   on   the   Hon’ble   Supreme   Court   in   McDowell   is misplaced and does not support the action of the Assessing Officer.     I   also  find     that  on   the   facts  and   in  law  the Assessing   Officer   is   not   justified   in   holding   that   the appellant company has violated the provisions of section 77 of the Companies Act.  In fact appellant company has dealt   with   more   than   one   company’s   shares   and debentures.   So   the   Assessing   Officer’s   conclusion   of violation of section 77 is factually incorrect. Thus, having regard to the facts and circumstances of the case as well as   the   law   on   the   subject   the   Assessing   Officer   is   not justified in disallowing the sum of Rs.26,44,932. The same is deleted.

The Tribunal also considered the decision in case of Addl. CIT v. Pinnacle Project and Infrastructure Pvt. Ltd  in ITA No. 195/Ahd/2001 in similar facts and followed the same   to   uphold   the   order   of   the   CIT(Appeals)   and dismissed the appeal of the Revenue. The Tribunal in the impugned   order   has   considered   the   decision   in   case   of Pinnacle Project and Infrastructure Pvt. Ltd  (supra) as under :

We   have   carefully   considered   the   rival submissions in the light of material placed before us.   The   borrowing   of   funds   and   utilization thereof for the purpose of business activity of the assessee is not disputed even by A.O. The only objection of AO is that the borrowed funds were utilized   by   the   assessee   for   the   purpose   of purchasing   shares   of   group   companies,   and, therefore, the principle laid down by the decision of   Hon’ble   Supreme   Court   in   the   case   of McDowell & Co. Ltd.(supra) was applicable. It is, therefore,   the   A0   has   disallowed   the   interest being a device adopted by assessee for reducing its   income.   One   other   ground   on   which   the Assessing   Officer   proceeded   to   disallow   the claim of interest is the applicability of provisions of section 77 of Companies Act, 1956. 12. As per the decision of Hon. Supreme Court in the case of McDowell & Co. Ltd. (supra) that it is open to everyone to show arrange his affairs as to reduce the brunt of taxation to the minimum and such a process does not constitute tax evasion, nor does it carry any ignominy. Tax planning may be legitimate provided it is within 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 resorting to dubious methods. It is the obligation of every   citizen   to   pay   the   taxes   honestly   without resorting   to   subterfuges.   This   decision   of   Hon. Supreme Court was considered by their Lordships of Hon. Gujarat High Court in the case of Banyan & Berry (supra) and considering the said decision it was   observed   by   their   Lordships   that   the   said decision has not affected the freedom of an assessee to plan his business affairs within the framework of law unless the same fell in the category of colourable device which may properly be called a device or a dubious   method   or   a   subterfuge   clothed   with apparent   dignity   and   the   decision   in   the   case   of McDowell & Co. Ltd. (supra) does not lay down that tax payers must arrange his affairs so as to arrange maximum tax liability and every act resulting in tax reduction, exemption or not attracting tax should be treated  as  device  of  tax  avoidance. This  principle laid   down   by   Hon.   Gujarat   High   Court   has   been approved   by   Hon.   Supreme   Court   in   the   case   of Union of India & Anr. Vs. Azadi Bachao Andolan & Anr.   263   ITR   706   (SC).   It   will   be   relevant   to reproduce below the observations of Hon. Supreme Court in the case of Union of India & Anr. Vs. Azadi Bachao Andolan & Anr.(at page 759 of the report) (supra):­

Further   in   the   above   decision   in   the   case   of Banyan & Berry (supra) while defining the words ‘colourable   device’.   ‘dubious   methods’   or ‘subterfuge’,   their   Lordships   have   observed   that these words have special significance in legal world. The   definition   given   to   ‘colourable’   in   Brown’s Judicial   Dictionary   is   as   ‘reverse   of   bona   fide’. Referring to Black’s Dictionary the word ‘colourable’ to mean that which is in appearance only and not in reality,   what   it   purports   to   be   hence,   counterfeit, feigned having the appearance of truth. Seeing from that angle so as to find out that what is “colourable” in the present case, it is to be established that the transactions of payment of interest by the assessee were   “reverse   bona   fide”   or   which   were   in appearance   of   truth.   A   perusal   of   the   chart   will reveal   that   assessee   has   deducted   a   substantial amount of TDS out of all the payments of interest ad the funds have also been borrowed through banking channels.   Unless   It   is   shown   that   all   these   were ‘reverse bona fide’ or interest was paid for only for appearance and not reality the transactions entered into   by   the   assessee   could   not   be   held   to   be “colourable” so as to fall these transactions within the ambit of “colourable device” as defined by Hon. Jurisdictional High Court. A perusal of assessment order will reveal that no material has been brought on record by AO to show that the interest payment by the assessee and receipt of loan and transaction of purchases and sales of shares entered into by the assessee were ‘reverse bona fide’ or these were the transaction which were for appearance and not in reality   and   they   were   feigned   of   having   the appearance of truth. In absence of any material on record to establish such circumstances, mere saying will   not   make   the   transactions   of   the   assessee recorded   in   the   books   of   accounts   as   “colourable device.”

Examining   the   word   ‘device’,   their Lordships   found   that   as   per   Shorter   Oxford Dictionary it means inneuity, something device, arrangement, plan, contrivance, a plot or a trick and as per Black’s Dictionary ‘device’ is referred as   contrivance,   a  scheme,   trick.   Here   also   no material has been brought on record by AO to suggest that it was a device, arrangement, plan or contrivance there is no material on record to suggest that any of the sales or purchases of the shares made by the assessee was found by the revenue   authorities   to   be   the   transaction   in contrivance of any law, thus the same were in the   nature  of   device.   In  absence   of   any   such material it cannot be held that the transaction entered   into   by   the   assessee   for   sale   and purchase of shares for borrowing and lending of money   was   in   the   nature   of   "device”.

Similarly referring to the word ‘subterfuge’ reference was made to Shorter Oxford English Dictionary which define as to which one refers for   escape   or   concealment.   On   historical principles it means an article or device to which a person refers in order to escape the force of an argument, an excuse with which conceals a clue. As pointed out earlier there is no material on record   brought   by   the   AO   to   show   that   the transaction entered into by the assessee were In the nature of subterfuge. So also the expression “dubious”  refers to  a doubtful  or questionable character.   Here   also   there   is   no   material   on record   to   establish   that   there   was   anything doubtful   or   a   questionable   character.

As explained by Jurisdictional High Court in the   case   of   Banyan   &   Berry   (supra)   and approved   by   Hon.   Supreme   Court   in   Azadi Bachao Andolan & Anr. (supra) that even by the decision in the case of McDowell, the freedom of the citizen to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law has not   been   affected.   If   such   trade,   activity   or planning falls within the frame work of law, the same cannot be discarded unless that falls in the   category   of   colourable   device   which   may properly be called a device or a dubious method or   subterfuge   clothed   with   apparent   dignity. Thus the assessee is free to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his   affairs   with   circumspection   and   which   is within the framework of law. The assessee thus is entitled to do so and there is no prohibition put by the above mentioned decision of Hon. Supreme Court in the case of McDowell (supra). It has already been held that the transactions on the basis of which the AO has disallowed the interest have not been shown or established to be the colourable device or dubious method or subterfuge clothed with apparent dignity. No single instance has been brought on record to prove the existence of “colourable device”, “dubious method” or “subterfuge” as these are the ingredients to   bring   the   planning   of   the   assessee   within   the purview of falling the same in the ambit of situation described in the case  of  McDowell  & Co. (supra). Thus we hold that there is  absence of any material to   say   that   the   transactions   entered   into   by   the assessee   with   regard   to   which   interest   has   been paid by the assessee to fall within the category of “colourable   device”,   “dubious   method”   or “subterfuge” to bring the applicability of decision in the case of McDowell & Co. (supra). So by applying the ratio of McDowell and Co. (supra) the interest could not be disallowed.

Now as it relates to the applicability of section 77 of the Companies Act, 1956 to the transaction by the assessee on which the interest has been paid it is observed that the said contravention has not been proved   or   established   by   the   AO.   Section   of Companies   Act,   1956   is   interest   could   not   be disallowed. “S.   77   Restrictions   on   purchase   by company,   or   loans   by   company   for purchase,   of   its   own   or   is   holding company’s shares  ­ (1) No company limited by   shares   and   no   company   limited   by guarantee and having a share capital, shall have power to buy its own shares, unless the consequent reduction of capital is effected and sanctioned in pursuance of section 100 to 104 or of section 402. (2)   No   public   company,   and   no   private company   which   is   a   subsidiary   of   a   public company,   shall   give,   whether   directly   or indirectly; and whether by means of a loan, guarantee,   the   provision   of   security   or otherwise,   any   financial   assistance   for   the purpose of or in connection with a purchase of subscription   made   or   to   be   made   by   any person of or for any shares in the company or in its holding company: provided that nothing in this sub­section shall be taken to prohibit­ (a) the lending of money by a banking company in the ordinary course of its business; or (b) the   provision   by   a   company,   in accordance   with   any   scheme   for   the time   being   in   force,   of   money   for   the purchase   of,   or   subscription   for,   fully paid up shares in the company or its holding company, being a purchase or subscription by trustees of or for shares to   be   held   by   or   for   the   benefit   of employees holding a salaried office or employment in the company; (c) or the making by a company of loans, within the limit laid down in sub­ section   (3)   to   persons   (other   than directors, or managers) bona fide in the employment of the company with a view to enabling those persons to purchase or subscribe   for   fully   paid­shares   in   the company or its holding company to be held by themselves by way of beneficial ownership. (3) No ban made to any person in pursuance of clause (c) of the foregoing proviso shall exceed in amount his salary or wages at that time for a period of six months. (4) If   a   company   acts   in   contravention   of   sub­ section (1) to (3), the company, and every officer of the company who is in default, shall be punishable with fine which may extend to one thousand rupees. (5) Nothing in this section shall affect the right of a company to redeem any shares issued under section 80   or   under   any   corresponding   provision   in   any previous companies law.” Sub­section (1) is not applicable to the facts of the case as it is not a case where company has bought its own shares. Sub­section   (2)   prohibits   public   companies   and   private companies   which   are   their   subsidiaries   giving   financial assistance to persons for purchasing their shares. In the present case, the assessee company has not given any financial assistance to persons for purchase of its shares. Thus   there   is   no   contravention   of   section   77   of   the Companies Act, 1956. The contravention, if any, may be in the hands of companies who have advanced the money to the assessee company. Thus section 77 of Companies Act is   not   applicable   to   the   case   of   assessee   company, therefore, disallowance of interest based on contravention of section 77 holds no ground.

It is not disputed that sale and purchase of shares and to receive money on interest and lending thereof are the business activities of the assessee company. Therefore, the transactions   entered   into   by   the   assessee   were   the transactions entered into by it in the normal course of its business.   It  is not  the case  of  revenue  that  the  money obtained by assessee company on interest was utilized for any purpose other than its business. In other words, it is not the case of revenue that interest bearing funds were utilized   by   the  assessee   for  the  purpose  other  than  its business.   If   it   is   so,   interest   has   to   be   allowed   under section 36(1 )(iii) of the Act and has rightly been held to be allowable by CIT(A). We confirm his order and this ground of the department is dismissed.”

After having considered the totality of the facts and circumstances   of  the   case  and   the   fact   that  the  issues involved in the present case are same/similar to the issues as were involved in the case of M/s. Pinnacle Project and Infrastructure   Pvt.   Ltd.   and   also   the   fact   that   both   the parties, at the time of hearing of this appeal, had agreed that   this   appeal   be   decided   on   the   basis   of   Tribunal's decision   in   the   case   of   M/s.   Pinnacle   Project   and Infrastructure Pvt. Ltd., we respectfully following the said decision of Tribunal (in the case of M/s. Pinnacle Project and Infrastructure Pvt. Ltd.­ in ITA No.195/Ahd/2001, for Asst. Year 1997­98, order dated 24/03/2006), uphold the order   of   the   CIT(Appeals)   in   deleting   the   disallowance under appeal.”

Learned Standing Counsel Ms. Mauna Bhatt appearing for the Revenue submitted that the Tribunal has committed an error by overlooking the fact that modus adopted by the respondent assessee is nothing but a camouflage so as to evade   tax   inasmuch   as   amount   borrowed   from   group companies   was   again   reinvested   in   the   said   group companies by claiming huge interest amount paid on the said fund to decrease the tax burden. Ms. Bhatt further pointed   out   that   provisions   of   section   36(1)(iii)   of   the Income Tax Act, 1961 provides for allowance of expenditure genuinely incurred by respondent assessee but in the facts of the case, payment of expenditure incurred cannot be said to be genuinely incurred by the respondent assessee. It was further submitted that the interest payment made by the respondent assessee is also in contravention to the provisions of section 77 of the Companies Act, 1956 and

It   was   submitted   that   the   modus   adopted   by   the respondent   assessee   is   a   clourable   device   as   per   the principles   laid   down   by   the   Apex   Court   in   case   of McDowell & Co. Ltd. v. CTO reported in 154 ITR 148(SC). Learned Standing Counsel Ms. Bhatt invited the attention of   the   Court   to   the   fact   that   as   against   total   loss   of Rs.2,78,87,604/­ claimed by the respondent assessee, loss of Rs.2,64,49,312/­, pertains to interest paid to the group companies.

It was also submitted that the modus of the respondent assessee is to borrow the funds of the group companies and invest in share of the group companies and thereafter claiming the interest paid on the borrowed fund is only with a view to evade the tax and, therefore, the Assessing Officer has rightly disallowed the interest expenditure of the respondent assessee.

Though served, no one appears for the respondent assessee.

Having heard the learned Standing Counsel for the Revenue and having  considered the findings arrived at by the CIT(Appeals) as well as the Tribunal, it appears that the   funds   borrowed   by   the   respondent   assessee   were utilised for the purpose of its business. It is also found by both the authorities below that the transactions entered into by the assessee were the transactions entered by it in the normal course of business and it is not the case of the Revenue that the funds borrowed by the assessee company on  interest   was  utilised  for   any  purpose  other  than  its business. In other words, it is not the case of the Revenue that the assessee utilised interest bearing funds for the purpose other than its business. Therefore, in view of such concurrent findings of fact, interest   expenditure claimed by  the  assessee has  been  rightly  allowed under  section 36(1)(iii)   of the Act by the CIT(Appeals) as well as the Tribunal.

Insofar as contention raised on behalf of the Revenue that in   view   of   section   77   of   the   Companies   Act,   1956,   the assessee could not have invested in the shares of the group companies by utilising the borrowed funds, it would be necessary   to   refer   to   section   77   of   the   Companies   Act which provides for restrictions on purchase by company or loans by company for purchase   of its own or is holding company's   shares.   Sub­section(1)   of   section   77   is   not applicable to the facts of the case as the assessee has not bought its own shares and sub­section(2) prohibits public company or private company which are subsidiaries giving financial assistance for purchasing the shares. In the facts of   the   case,   the   assessee   has   not   given   any   financial assistance to any person for purchase of its shares. Hence, section 77 cannot be made applicable in facts of the case because   contravention,   if   any,   may   be   in   hands   of   the company who advanced money to the assessee company on interest.

In view of the above discussion, there is no infirmity in   the  impugned   orders   passed  by   both   the  authorities below as there is concurrent findings of fact so as to allow the   interest   expenditure   claimed   by   the   respondent assessee,   as   utilising   the   borrowed   funds   of   the   group companies   for   purchase   of   the   shares   of   the   groups companies   are   not   fraudulent,   sham   and   thereby   not illegal.

In the result, both the substantial questions of law are   answered   in   the   affirmative   i.e.   in   favour   of   the assessee and against the Revenue.

Appeal is accordingly dismissed. No order as to costs. (J. B. PARDIWALA, J) (BHARGAV D. KARIA, J) RAGHUNATH R NAIR