2011 (8) TMI 461 - HC - Income Tax

Section 13(1)(2)(a) of the Income-tax Act 1961 - assessee is a society registered under the Societies Registration Act U.P and is running an educational institution - loan outstanding against Treasurer of the society and no interest had been charged nor any provision for accrued interest was made - AO contended that concluded that the funds of society were diverted for personal benefits of the Treasurer - Thus exemption claimed under section 11 was denied to the assessee-society in view of the provisions contained in section 13(1)(c) and 13 (2) (a) - clause (c) of section 13(1) renders the entire income of trust or charitable institution liable to tax even if only part of income is directed to be applied for the benefit of the specified persons. The Legislature however also creates a fiction and enumerates in clauses (a) to (h) of sub-section (2) a list of circumstances in which the income shall be deemed to have been used or applied for the benefit of the specified persons - in this case beneficiary is not covered by the list of persons mentioned in section 13 (3) of the Act - Decided in favour of Revenue.

Summary

Issues:
- Interpretation of provisions of section 13(1)(c) and 13(2)(a) of the Income-tax Act, 1961 regarding loan given without interest to a specified person.
- Application of mercantile system of accounting in reflecting accrued interest on loans.
- Compliance with the provisions of section 11 for exemption under the Income-tax Act.
- Validity of security provided for the loan.

Analysis:

Interpretation of Provisions of Section 13(1)(c) and 13(2)(a):
The case involved a society providing an interest-free loan to its Treasurer, which raised concerns under section 13(1)(c) and 13(2)(a) of the Income-tax Act. The society argued that interest would be charged after recovering the principal amount, supported by a resolution. However, the court found that the interest should have been reflected in the accounts as per the mercantile system of accounting. The absence of proper documentation except for the resolution led the court to conclude that the loan was interest-free, violating the provisions of section 13(1)(c) and 13(2)(a).

Application of Mercantile System of Accounting:
The court emphasized the importance of reflecting accrued interest on loans in the books of accounts as per the mercantile system of accounting. The failure to do so, except for a resolution, was considered insufficient evidence to support the claim that interest would be charged after recovering the principal amount.

Compliance with Section 11 for Exemption:
The Assessing Officer (A.O.) denied exemption under section 11 of the Income-tax Act to the society due to the diversion of funds for personal benefits, leading to a violation of section 13(1)(c) and 13(2)(a). The court upheld the A.O.'s decision, emphasizing the need for compliance with the provisions to claim exemptions under the Act.

Validity of Security Provided for the Loan:
The society claimed to have provided a sale deed as security for the loan, arguing against the violation of section 13(1)(2)(a). However, the court questioned why the security was in the name of a third party instead of the borrower himself, raising doubts about the adequacy of the security provided.

Conclusion:
The High Court set aside the Tribunal's decision and reinstated the A.O.'s order, ruling in favor of the revenue department and against the society. The court highlighted the importance of adhering to accounting principles, complying with statutory provisions, and ensuring proper documentation to support financial transactions to avoid violations under the Income-tax Act.