2019 (5) TMI 2031 - AT - Income Tax

Addition as interest income under the head income from other sources on share application money given - HELD THAT - A perusal of the assessment orders show that the A.O made the addition as a transfer pricing adjustment being transactions entered into between associated enterprises. It seems that the A.O has re-characterized the transaction of share application money as loan. Though this issue was not agitated before the CIT (A) as ultimately the additions were made on the assumption that no unrelated party would advance money without charging interest and since in the present case the money was advanced to a related party the notional interest was estimated at 12% per annum. Addition only in respect of the addition on account of notional interest - T he transaction has to be looked as it is. The facts on record show that the transaction is of share application money given by the assessee to M/s Sweet Home Estate Pvt. Ltd. It is also not in dispute that the shares have been subsequently allotted. It is not the case of the Revenue that the assessee has used borrowed funds in making such investment and it is also not the case of the Revenue that the assessee has paid substantial interest on borrowings. No merit in the addition sustained by the CIT (A). The A.O is accordingly directed to delete the addition. Assessee appeal allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal question considered by the Tribunal was whether the addition of Rs. 36,55,900/- as interest income on share application money given to a related company was justified. Specifically, the issue was whether the share application money advanced by the assessee should be treated as a loan attracting interest income under the head "income from other sources," or whether it should be recognized as genuine share application money, which does not attract interest. A subsidiary issue was whether the reassessment proceedings initiated under section 148 were valid, but this was not pressed by the assessee.

2. ISSUE-WISE DETAILED ANALYSIS

Issue: Whether the addition of Rs. 36,55,900/- as interest income on share application money given to a related party is justified.

Relevant legal framework and precedents: The assessment and reassessment proceedings were governed by the provisions of the Income Tax Act. The question involved classification of the transaction-whether it was a loan or share application money. Interest income is taxable under "income from other sources" if a loan is advanced. However, share application money, being capital contribution, does not attract interest unless there is a specific agreement or commercial reality indicating otherwise. Transfer pricing principles and arm's length considerations are relevant when transactions occur between associated enterprises.

Court's interpretation and reasoning: The Tribunal noted that the Assessing Officer (A.O.) re-characterized the share application money as a loan based on the assumption that no unrelated party would advance such a large sum without charging interest. The A.O. computed notional interest at 12% per annum and added it to the assessee's income. The Commissioner of Income Tax (Appeals) [CIT (A)] confirmed this addition, agreeing that interest should have been charged.

The Tribunal observed that the transaction must be looked at in its true nature. The facts showed that the amount was given as share application money, supported by a Board Resolution and that shares were allotted in the subsequent year. There was no dispute regarding the genuineness of the share application money or allotment of shares. Importantly, the Revenue did not contend that the assessee had borrowed funds to make the investment or had paid substantial interest on borrowings. Thus, the Tribunal found no basis to treat the share application money as a loan or to impose notional interest.

Key evidence and findings: The assessee submitted a Board Resolution dated 21/11/2003 authorizing the share application money. The shares were allotted subsequently, confirming the transaction's genuineness. The Revenue's reliance on the assumption that interest should be charged was not supported by any direct evidence or agreement indicating that the amount was a loan.

Application of law to facts: The Tribunal applied the principle that share application money, when bona fide and followed by allotment of shares, cannot be treated as a loan for the purpose of charging interest income. The absence of any borrowing or interest payment by the assessee further negated the Revenue's claim. The notional interest addition was thus unwarranted.

Treatment of competing arguments: The Revenue relied on the principle that associated enterprises must transact at arm's length and that no party would advance large sums without charging interest. The Tribunal rejected this assumption as insufficient to re-characterize the transaction. The assessee's argument that the amount was genuine share capital was accepted, as it was substantiated by documentary evidence and subsequent allotment of shares.

Conclusions: The Tribunal concluded that the addition of Rs. 36,55,900/- as interest income was not justified and directed the deletion of this addition. The reassessment on this ground was thus set aside.

Issue: Validity of reassessment proceedings initiated under section 148

The assessee did not press the ground challenging the reopening of the assessment under section 148. Therefore, the Tribunal dismissed this ground as not pressed and did not examine the validity of the reassessment notice.

3. SIGNIFICANT HOLDINGS

The Tribunal held: "In our considered view, the transaction has to be looked as it is. The facts on record show that the transaction is of share application money given by the assessee to M/s Sweet Home Estate Pvt. Ltd. It is also not in dispute that the shares have been subsequently allotted. It is not the case of the Revenue that the assessee has used borrowed funds in making such investment and it is also not the case of the Revenue that the assessee has paid substantial interest on borrowings."

The Tribunal further stated: "Considering the facts of the case in totality, we do not find any merit in the addition sustained by the CIT (A). The A.O is accordingly directed to delete the addition of Rs. 36,55,900/-."

Core principles established include:

• Genuine share application money followed by share allotment cannot be re-characterized as a loan for the purpose of charging notional interest income.
• Assumptions about commercial improbability of interest-free advances do not suffice to reclassify transactions between associated enterprises.
• Absence of evidence regarding borrowed funds or interest payments by the assessee negates the Revenue's claim for interest income on share application money.
• Reopening of assessment under section 148, if not challenged by the assessee, is deemed accepted.

Final determination was to allow the appeal partly by deleting the addition of Rs. 36,55,900/- as interest income and dismissing the ground challenging reassessment as not pressed.