NAGARAJAN SHANMUGAM ,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-2(1)(1), BANGALORE

The facts relating to the issue are discussed in brief. The assessee is a director in M/s 24/7 Customer P Ltd and is resident in India. He has also floated a company in USA named M/s 24/7 Customer Inc. The assessee filed his return of income for the year under consideration declaring taxable income of Rs.156.45 lakhs. Subsequently he revised his return of income twice. The return of the assessee was taken up for scrutiny. During the Course of assessment proceedings, the assessee filed a revised computation of total income (since the time limit for filing revised return of income had expired by that point of time), wherein the . Shri Nagarajan Shanmugam. assessee declared foreign dividend income of Rs.603.13 lakhs. It was submitted that the assessee is required to declare his entire global income in his return of income, since his status was “resident” and the foreign dividend income was omitted to be declared in the return of income.

The AO examined the details of foreign dividend income declared by the assessee. He noticed that the dividend was received from M/s 24/7 Customer Inc., USA. The shares of the above said company was held by following trusts:- (a) Shanmugam and Sucharitha Nagarajan 2009 Family Recoverable Trust. - 66.98% (b) Ashirtha Valli Nagarajan 2009 Irrevcoverable Trust - 16.51% (c) Bharath Vaidya Nagarajan 2009 Irrecoverable Trust – 16.51% --------- 100.00% ======= The AO noticed that the total dividend received from the above said company was US $ 16,50,457.40 equivalent to Rs.900.50 lakhs. However, the assessee had offered dividend income relating to 66.98% of the shares, i.e., the assessee had offered dividend income of Rs.603.13 lakhs only. The assessee explained that he and his wife are beneficiaries of M/s Shanmugam and Sucharitha Nagarajan 2009 Family Recoverable Trust and further this trust is revocable one. Hence the income pertaining to this trust was offered by the assessee in his return of income. The assessee explained that other two trusts are irrevocable trusts and the beneficiaries are minor daughter and minor son of the assessee. As per the trust deed, the income shall be accumulated and the minor children are entitled to receive it only after they attain majority. Accordingly, it was submitted that the foreign dividend income belonging to these two trusts are not liable to be included in the hands of the assessee and accordingly it was not offered to tax in India by the assessee.

The AO examined the submissions of the assessee, but did not accept the submissions of the assessee for the following reasons:- (a) The assessee has received entire dividend income, i.e., 100% of the dividend income (including that of the trusts created for the benefit of children) in the joint bank account of the assessee and his wife. (b) The assessee has not offered any explanation for receiving entire dividend income in his bank account. (c) The assessee has also declared entire dividend income (including that of trusts created for the benefit of children) in his tax return filed in USA. (d) The trusts created for children have not filed their tax returns in USA. No bank account was also opened in the name of trusts. Though it was claimed that the bank accounts have been opened in FY 2015-16, yet not proof was submitted. (e) The bank account of the assessee would show that the assessee has used entire dividend income for his own purposes. (f) The trusts have been formed in the year 2009. The assessee had claimed that 3,56,766 shares were assigned in favour of trusts on 14.10.2009. However, the share certificates of entire shares (8,22,572 shares) have been given to the trusts only on 08-08-2012.

Accordingly the AO took the view that the entire dividend income would belong to the assessee only. The AO further held that if the dividend income belonging to the trusts is paid to the trusts subsequently by the assessee, the same would amount application of income only.

Before the AO, the assessee submitted that the minor children, being the beneficiaries of the trust, is not entitled to receive income until they attain majority and hence the clubbing provisions will not apply. It was also submitted that the provisions of sec.61 of Income tax Act will not apply in case of transfer by way of trust which is not revocable during the life time of the beneficiary or a transfer which is not revocable

. Shri Nagarajan Shanmugam. during the life time of the transferee. In this regard, the assessee placed his reliance on the following case law:- (a) CIT vs. M.R Doshi (b) CIT vs. Abhayananda Rath Family Benefit Trust (c) CIT vs. Yogindra Prasad N Mafatlal (d) CIT vs. M D Veeranarasimhaiah (e) CIT vs. Brig. Kapil Mohan (No citation given in the assessment order for the above said case laws)

The AO, however, expressed the view that the above said case laws have been rendered in the context of sec. 64(1)(vii) of the Act. He held that the provisions of sec.64(1A) is applicable in the instant case, as per which all income arising or accruing to the minor child shall be included in computing the total income of any individual. Accordingly, the AO held as under:- “5.5 (d) Assessee’s minor children are stated to be beneficiaries of the two trusts. Thus the said dividend income accrued to the children even though there is no right to enjoy the said amounts till the two minor children attain age of majority. Hence whenever the dividends are received by the two trusts, the said dividends stand to the credit of the two minor children. Hence dividend accrue to the two children.”

The AO also took the view that the assessee has adopted colourable device in order to evade payment of tax by creating these two trusts. According to the AO, above said position is evident from the fact that the two trusts did not have bank account; entire dividend income was received in the bank account of the assessee and was also declared in the tax return of assessee; the shares were given to the trusts only in August 2012 and these trusts have not filed their return of income.

The Ld CIT(A) observed that the two trusts were formed as revocable trusts only in 2009, but they were converted into irrevocable

The Ld CIT(A) also noticed that the trusts did not have bank accounts till September, 2015; the dividend was received in the bank account of the assessee; the trusts have not filed return of income and the assessee has declared entire dividend income in his tax return filed in USA. Based on these facts, the Ld CIT(A) held that it cannot be said that an irrevocable trust has been executed in the year relevant to AY 2013-14. Accordingly, he agreed with the view of the AO that subsequent transfer of funds to the trusts, if any, is only application of income by the assessee. Accordingly, the Ld CIT(A) confirmed the addition made by the AO.

The Ld A.R submitted that these trusts were created as Grantor Retained Annuity Trusts, wherein the residual value of the assets transferred, being the appreciation in the value of stocks transferred, would vest with the trusts created for the benefit of minor children on the expiry of two years and the said assets would be available for the benefit of the beneficiaries only on their attaining majority and also upon fulfillment of other conditions. He submitted that these trusts are separate taxable entities as per tax laws of USA. Hence the assessee did not offer the dividend income belonging to these two trusts in his return of income filed in India. He submitted that all the flaws pointed out by the tax authorities are due to certain mistakes committed by the company, M/s 24/7 Customer Inc., USA while making payments of dividend. With regard to the various flaws pointed out by the tax authorities, the Ld A.R gave following clarifications: -

The Ld A.R further submitted that the above said mistakes have since been rectified. He submitted that the assessee has rectified all the errors by amending his tax returns in USA by excluding dividend income belonging to the trusts. Further the trusts created for the benefit of . Shri Nagarajan Shanmugam. children have also filed tax returns in USA declaring their dividend income. Accordingly, the Ld A.R submitted that all the reasons cited by the tax authorities for taxing the dividend income belonging to the trusts in the hands of the assessee would fail. In support of his submissions, the assessee furnished following documents in the form of additional evidences:- (a) Form No.1099 – DN containing details of dividend income of each of the trusts, which would also show that the Social Security number of the assessee is given against each shareholder. (b) Copy of letter issued by the Chief Financial Officer of the company, 24/7 Customer Inc., USA certifying shareholding pattern. (c) Copy of original tax return in Form 1040 and amended tax return of Shanmugam Nagarajan and Sucharitha Nagarajan in Form 1040X for Calendar year ending December, 2012 filed in USA. (d) Copy of tax return in Form 1041 of Bharath Vaidya Nagarajan 2009 trust for calendar year ending December, 2012 filed in USA along with amended Form -1099 DIV issued to the Trust. (e) Copy of tax return in form 1041 of Ashritha Valli Nagarajan 2009 Trust for Calendar year ending December, 2012 filed in USA along with amended Form-1099 DIV issued to the Trust. (f) Copy of bank account statements of both the trusts. The Ld A.R prayed for admission of above cited additional evidences and further submitted that these documents would clarify the points cited by the tax authorities for assessing the dividend income of trusts in the hands of the assessee. He further submitted that the trusts created for the benefit of minor children were irrevocable at the time of receipt of dividend. Accordingly he prayed that these additional evidences be admitted and the entire issue may be restored to the file of the AO for examining them and further he may be directed to delete the impugned addition.

On the contrary, the Ld D.R submitted that the tax authorities have given sound reasons for making addition of dividend income claimed to belong to the trusts created for the benefit of minor children of the assessee. He submitted that the AO has established that the assessee has created the trusts as colourable devices in order to evade payment of tax. The AO has brought out the fact that both the trusts did not have bank accounts; the entire dividend was received in the bank account of the assessee and the same has also been declared in the tax return of the assessee filed in USA. He submitted that various documents filed in the form of additional evidences are only after thought of the assessee and accordingly submitted that they should not be admitted.

We heard rival contentions and perused the record. We notice that the assessing officer has taken the view that the entire dividend income should have been offered by the assessee for the reason that (a) the entire dividend income has been received in the bank account of the assessee. (b) the entire dividend income has been offered as income of the assessee in the tax return filed in USA. (c) the trusts did not have bank accounts at the time of receipt of dividend and bank accounts have been opened by them in September, 2015. (d) the trusts have not filed return of income in USA as separate taxable entity for the year under consideration. (e) the assessee has used the dividend income of trusts for his own purposes and hence, even if it is paid back to the trusts, the same would amount to application of income only.

The Ld CIT(A) has agreed with the above said points cited by the assessing officer. He has further taken the view that irrevocable transfer has not been executed in the financial year relevant to assessment year 2013-14. Since the company, which paid the dividend, has recognized

It is pertinent to note that the AO has also taken the view that the provisions of sec.64(1A) is applicable to the facts of the case and accordingly held that various case laws relied upon by the assessee are not applicable. He has also expressed the view that the creation of trusts is a colourable device adopted by the assessee to evade payment of tax.

It is to be noted that the assessee has created both the trusts for the benefit of his minor children and has also transferred the shares to the trusts in accordance with the laws of USA. The Hon’ble Supreme Court has held in the case of Vodafone International Holdings B.V vs. Union of India (Civil appeal No.733 of 2012) has held that the tax planning may be legitimate provided it is within the frame work of law. Same view has been expressed by Hon’ble Karnataka High Court in the case of M/s Bhoruka Engineering Inds Ltd (ITA No.120 of 2011 dated 9.4.2013). It is not shown by the AO that the creation of trusts by the assessee for the benefit of his minor children was beyond the framework of law, in which case, the argument of the AO that the trusts were mere colourable device would fail.

We noticed that the AO has taken support of the provisions of sec.64(1A) of the Act. The said section provides for clubbing with the individual of all such income as arises or accrues to his minor child. In the instant case, the shares were held by the trusts and hence the dividend income cannot be said to accrue or arise in the hands of the minor children of the assessee. Hence this view of the AO would also . Shri Nagarajan Shanmugam. fail. Since there is no dispute that the trusts were irrevocable when the dividends were declared, the Ld CIT(A) was not justified in holding that the trusts are revocable.

Under the provisions of Income tax, the income belonging to minor is liable to be clubbed in the hands of his parents, whose income is higher. Since the tax status of the assessee is “resident and ordinarily resident” in India, he is liable to declare his global income, i.e., all income accruing or arising to the Individual or his minor children (if it is liable to be clubbed in his hands) globally shall be included in the total income of the assessee. Hence, before proceeding to club the dividend income accruing or received by the trusts created for the benefit of minor children, it is mandatory to show that the said income accrued or was received by the minor children. The tax authorities have taken the view that the dividend income relating to shares held by the trusts created for the benefit of children actually belongs to the assessee only and even if it is said to belong to his children, then the same is liable to be clubbed u/s 64(1A) of the Act. They were constrained to hold so for reasons that the entire dividend income was received in the bank account of the assessee, it has been declared in the tax returns of the assessee, the trusts have not filed returns of income, there is no bank account in the name of trusts at that point of time etc.

We are of the view that all these flaws/points have been addressed by the assessee by furnishing explanations before us in the form of additional evidences furnished before us. The Ld A.R has clarified the reasons for receiving and declaring entire income by the assessee, copies of amended tax return and copies of tax returns filed by trusts, bank account details of trusts, copies of letter issued by the company, amended dividend certificate etc. In our considered view, the assessee has clarified all the flaws pointed out by the tax authorities. However, since these documents are additional evidences and since there was no occasion for the AO to examine them, we are of the view that the issue

Accordingly, we set aside the order passed by Ld CIT(A) and restore the impugned issue to the file of the AO for examining it afresh in the light of discussions made supra by duly considering the additional evidences furnished by the assessee.