2017 (5) TMI 1839 - AT - Income Tax

Denial of exemption u/s 11 - addition on account of surplus of the trust in view of the provisions of sec 13(2) - AO noted that the assessee has paid interest @18% on unsecured loans from specified persons u/s 13(3) - HELD THAT - The copies of bank account computation of total income and copy of intimation u/s 143(1) of the Act. AO did not confront any of the evidences submitted by the assessee and merely rejected the details furnished. CIT(A) has examined each of the loan in detail after obtaining the remand report as well as admitted the additional evidence with respect to the other creditors and hence deleted the addition. DR could not show us any infirmity in the order of the CIT(A) in deleting the above addition. Assessee has submitted the complete details of unsecured loan proving identity creditworthiness and genuineness of the above transaction. No infirmity in the order of ld CIT(A) in deleting the above disallowance. Therefore ground No. 4 and 5 of the appeal of the revenue is dismissed. Interest paid by the assessee @18% results into violation of the provisions of section 13(3) - Except for AY 2010-11 we note that this issue has not been examined. For AY 2010-11 the AO has stated that assessee trust has paid interest on unsecured loan ranging from 12% to 18 % and the query raised was with respect to allowability of interest and not applicability of section 13 of the act - we reject the argument of the assessee that in pas and subsequent years the revenue has accepted the above stand of the assessee that no benefit has resulted to the specified persons. Further in that year rate of interest is also varying. In view of this we are of the opinion that provisions of section 13(1)(c) read with section 13(2) has triggered in the case of the assessee. In the result the ground No. 3 of the appeal of the revenue is allowed. Granting of advance to the contractor for the construction of the institute building was considered by AO as application of the funds in violation of section 11(5) - main reason given by AO is that above advance is not a permissible investment - HELD THAT - For the reasons given by the CIT(A) in para No. 11.5 are exhaustive and same were not contraverted by the ld DR. before us it could not be pointed out by the revenue that assessee has not got contraction none from these contracts and further these contractors are any way persons covered u/s 13(3) of the Act. Section 11(5) applies only in case of investment and deposit and revenue could not bring any thing on record to say that the above sum given as an advance to the contractor are not part of regular terms of the contract of the construction activity or contractors have not done any work on behalf of the trust but merely enjoyed the advances. Therefore we are of the opinion that by giving advances to those contractors the trust has violated provisions of section 11(5) of the Act. In view of this ground No. 2 of the appeal of the revenue is dismissed. Whenever there is violation of provisions of section 11 12 and 13 whether the trust losses the full exemption or only to the extent impugned income or benefit on investment? - Hon ble Supreme Court has admitted Special Leave Petition of the assessee 2014 (8) TMI 1130 - SC ORDER however above decision has not be stayed therefore following the binding precedent of the jurisdiction high Court wherein para No. 22 it has been held that even if there is one instance of application or use of the income or property of the trust directly or indirectly for the benefit of any prohibited persons the trust will lose exemption in respect of its entire income and resultantly the assessment of its income will be made according to the provisions of the Act. We are of the opinion that whole surplus of the trust shall be chargeable to tax under the normal provisions of the Income Tax Act and not u/s 11 12 and 13 of the Act specifically applicable to the trust. In view of this by allowing ground of the appeal of the revenue we have held that provisions of section 13 of the act are violated and hence trust losses exemption u/s 11 12 and 13 of the Act.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal are:

(a) Whether the deletion by the Commissioner of Income Tax (Appeals) of the addition on account of surplus of the trust amounting to Rs. 6,54,58,599/- was erroneous, particularly in light of the provisions of section 13(2) of the Income Tax Act, 1961, which could render section 11 inapplicable.

(b) Whether the advance payment of Rs. 2,65,70,000/- to contractors for construction of the institute building qualifies as an application of funds under section 11(5) of the Income Tax Act and whether such advances violate the provisions of section 13(2) of the Act.

(c) Whether the deletion of disallowance of Rs. 20,50,491/- on account of interest paid at an exorbitant rate (18%) to persons specified under section 13(3) of the Act was justified, or whether such payment constitutes diversion of trust funds in violation of section 13(3).

(d) Whether the addition of Rs. 28,60,000/- on account of cash credits under section 68 was justified, given the alleged lack of creditworthiness and genuineness of the lenders, who purportedly had no regular source of income except interest from the trust.

(e) Whether the Commissioner of Income Tax (Appeals) erred in admitting additional evidence under Rule 46A of the Income Tax Rules, 1962, while deleting the addition made under section 68, without complying with the procedural safeguards prescribed in the Rule.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (d) and (e): Addition of Rs. 28,60,000/- under section 68 and admission of additional evidence under Rule 46A

Legal Framework and Precedents: Section 68 requires an assessee to prove the identity, genuineness, and creditworthiness of persons from whom unexplained cash credits or loans are received. Rule 46A prescribes conditions for admission of additional evidence during appeal proceedings.

Court's Interpretation and Reasoning: The Assessing Officer (AO) disallowed Rs. 28.60 lakhs received as unsecured loans from eight persons, treating them as name lenders due to the alleged absence of regular income sources and suspicious bank transactions. The AO relied on the lack of creditworthiness and the suspicious nature of deposits to disallow the loans under section 68.

The assessee submitted detailed documentary evidence including confirmatory letters, bank statements, income tax returns, and computation of income of the lenders, asserting their creditworthiness and genuineness. The assessee also filed an application under Rule 46A for admission of additional evidence that could not be produced before the AO due to reasons beyond their control.

The Commissioner of Income Tax (Appeals) (CIT(A)) admitted the additional evidence under Rule 46A, finding that the assessee was prevented by sufficient cause from producing the evidence earlier and that the AO was given an opportunity to respond but did not controvert the evidence effectively. The CIT(A) examined each lender's documents in detail, noting that the AO had not disproved the evidence and had made additions based on mere suspicion and surmises.

Key Evidence and Findings: Confirmatory letters, bank statements, income tax returns, and audit reports were submitted for each lender. The CIT(A) found that most lenders were assessed to tax and had declared interest income from the trust loans. The AO's observations about contradictory replies and lack of cash accruals were found to be unsubstantiated.

Application of Law to Facts: The CIT(A) applied the principle that suspicion cannot substitute evidence and that the onus to prove that the loans were sham lay on the revenue. Since the assessee had satisfactorily discharged this onus, the additions under section 68 were deleted.

Treatment of Competing Arguments: The revenue's argument that the lenders were name lenders and that the assessee was attempting to mislead the department was rejected due to lack of evidence. The revenue's reliance on the AO's observations was found insufficient to sustain the additions.

Conclusion: The CIT(A)'s deletion of the addition of Rs. 28.60 lakhs under section 68 and admission of additional evidence under Rule 46A was upheld. The Tribunal found no infirmity in this approach and dismissed the relevant grounds of appeal.

Issue (c): Disallowance of interest paid at 18% to persons specified under section 13(3)

Legal Framework and Precedents: Section 13(3) prohibits diversion of income or property of a trust in favor of specified persons such as founders, trustees, or their relatives, including payment of excessive remuneration or interest beyond reasonable limits. Violation leads to denial of exemption under sections 11 and 12.

Court's Interpretation and Reasoning: The AO disallowed interest of Rs. 20,50,491/- paid at 18% on unsecured loans from specified persons, holding that the trust had surplus funds and no need to raise such loans at exorbitant rates, thus constituting diversion under section 13(3).

The assessee contended that the loans were necessary due to bank conditions requiring maintenance of unsecured loans from promoters and relatives, and that the interest rate reflected market conditions. The assessee also highlighted that the loans were secured by personal guarantees and that bank overdraft limits were underutilized at times.

The CIT(A) examined the sanction letter from the bank, which imposed restrictions on withdrawal of unsecured loans without bank permission and required promoters to maintain margin contributions. The CIT(A) found that the AO had not disproved the documentary evidence submitted by the assessee and had disallowed interest on mere suspicion.

Key Evidence and Findings: The bank sanction letter, audit reports, and income tax returns of the lenders were considered. The CIT(A) noted that the interest payments were consistent with previous years and that the AO had not provided valid reasons to disallow the interest.

Application of Law to Facts: The CIT(A) applied the principle that the burden to prove diversion rests on the revenue and that apparent transactions are presumed genuine unless disproved. Since the assessee had substantiated the necessity and genuineness of the loans and interest payments, no contravention of section 13(3) was established.

Treatment of Competing Arguments: The revenue's argument regarding surplus funds and underutilized bank limits was rejected as the trust's decision to raise loans was not subject to AO's interference. The revenue's suspicion about the lenders' income was also dismissed.

Conclusion: The CIT(A)'s deletion of the disallowance of interest paid at 18% was upheld by the Tribunal, dismissing the relevant ground of appeal.

Issue (a) and (b): Deletion of addition of surplus and treatment of advances to contractors under section 11(5)

Legal Framework and Precedents: Section 11 provides exemption for income applied to charitable or religious purposes. Section 11(5) restricts application of income by trusts to specified modes, and advances to contractors may not qualify as application of income if not properly accounted. Section 13(2) provides that exemption under section 11 is lost if income or property is applied for benefit of specified persons.

Court's Interpretation and Reasoning: The AO treated advances of Rs. 2,60,51,000/- to contractors as not qualifying as application of income under section 11(5), and treated the surplus of Rs. 6,54,58,599/- as taxable income due to violation of section 13(2). The AO also noted that contractors failed to comply with summons and that the cost per square foot was unreasonably high.

The assessee submitted detailed contracts, estimates, bills, and land purchase deeds, arguing that advances were part of regular construction activity and not diversion of funds. The CIT(A) found the advances to contractors did not violate section 11(5) and that the AO failed to prove any diversion or misuse.

Key Evidence and Findings: Contracts with contractors, ledger accounts, bills for steel, cement, and other materials, and land purchase deeds were considered. The AO's summons to contractors were not complied with, but the CIT(A) noted the revenue failed to establish that advances were diverted or misused.

Application of Law to Facts: The CIT(A) applied the principle that advances made in the ordinary course of construction and supported by documentation qualify as application of income. The AO's suspicion and non-compliance by contractors were insufficient to disallow the advances.

Treatment of Competing Arguments: The revenue's argument of unreasonable cost and lack of details was rejected as the assessee provided sufficient supporting documents. The AO's inference of siphoning off funds was not substantiated.

Conclusion: The CIT(A)'s deletion of addition relating to advances to contractors and the surplus was upheld, and the ground of appeal challenging this was dismissed.

Issue (a) and (c) combined: Applicability of section 13 and loss of exemption

Legal Framework and Precedents: Section 13(1)(c) and section 13(2) provide that if income or property of a trust is applied for the benefit of specified persons, the exemption under sections 11 and 12 is lost for the entire income. The Hon'ble Delhi High Court decision cited states that even one instance of such application leads to loss of exemption.

Court's Interpretation and Reasoning: The Tribunal noted that the persons receiving interest on unsecured loans are specified under section 13(3). The AO found that the trust had surplus funds and no need to raise unsecured loans at 18%, indicating diversion of income. The CIT(A) rejected this, but the Tribunal found that the interest payments at 18% constituted direct or indirect benefit to specified persons.

The Tribunal examined the trust's corpus, secured loans, and unsecured loans, concluding that the provisions of section 13(1)(c) and 13(2) were triggered. It held that the trust lost exemption under sections 11, 12, and 13, and the entire surplus was taxable under normal provisions.

Key Evidence and Findings: The trust's financial statements, loan schedules, bank sanction letters, and income tax returns of lenders were considered. The Tribunal noted that the trust had a corpus of Rs. 15.20 crores and secured loans of Rs. 10 crores, yet raised unsecured loans at high interest rates benefiting specified persons.

Application of Law to Facts: The Tribunal applied the binding precedent that any application of income or property for benefit of specified persons causes loss of exemption for the entire income. The high interest payments were deemed to confer benefit, triggering section 13.

Treatment of Competing Arguments: The assessee's reliance on past and subsequent years' acceptance was rejected as the issue was not examined in those years. The Tribunal rejected the argument that the trust's decision to raise loans was discretionary without consequence.

Conclusion: The Tribunal allowed the revenue's ground that the trust violated section 13, resulting in loss of exemption and taxation of the entire surplus under normal provisions.

3. SIGNIFICANT HOLDINGS

"Even if there is one instance of application or use of the income or property of the trust directly or indirectly for the benefit of any prohibited persons, the trust will lose exemption in respect of its entire income and resultantly the assessment of its income will be made according to the provisions of the Act."

"The burden to prove that such creditors were merely name lenders rests on the Revenue. Mere suspicion cannot substitute evidence, and the assessee having furnished detailed documentary evidence proving identity, creditworthiness and genuineness, the additions under section 68 cannot be sustained."

"Interest paid on unsecured loans at a higher rate, without valid and sustainable reasons, constitutes diversion of income or property in favor of persons specified under section 13(3), thereby invoking provisions of section 13(1)(c) and causing loss of exemption under sections 11 and 12."

"Advances given to contractors for construction of building, supported by contracts, bills, and ledger accounts, do not violate section 11(5) if they represent bona fide application of funds for charitable purposes."

"Admission of additional evidence under Rule 46A is justified if the assessee is prevented by sufficient cause from producing the evidence earlier, and the AO is given an opportunity to respond but fails to controvert the evidence."

Final determinations:

- The addition of Rs. 28.60 lakhs under section 68 was deleted as the assessee proved genuineness and creditworthiness of lenders.

- The disallowance of Rs. 20,50,491/- on account of interest paid at 18% was deleted as no contravention of section 13(3) was established by the AO or CIT(A).

- Advances to contractors amounting to Rs. 2,60,51,000/- were held to be application of income under section 11(5) and not disallowed.

- The trust was held to have violated section 13(1)(c) and 13(2) due to payment of interest benefiting specified persons, resulting in loss of exemption and taxation of the entire surplus of Rs. 6,54,58,599/- under normal provisions.

- Grounds of appeal challenging deletion of additions under section 68 and interest disallowance were dismissed; grounds relating to violation of section 13 and consequent loss of exemption were allowed.