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2025 (5) TMI 348 - AT - Income TaxDenial of benefit of exemption u/s 11 12 - assessee had paid interest at comparatively higher rate than from the rates paid to bank to the persons specified u/s 13(3) - HELD THAT - It is settled proposition of law that the income which has been applied in violation to section 13(1) of the Act could only be brought to tax and not the entire income. As in the case of Agrim Charan Foundation 2001 (8) TMI 78 - DELHI HIGH COURT has held that the legislature has clearly contemplated that in a case where the whole or part of the relevant income is not exempted u/s 11 by virtue of violation of Section 13(1)(d) of the Act tax shall be levied on the relevant income or a part of the relevant income at the maximum marginal rate. Thus the entire income of the assessee society cannot be assessed for tax even for violation of Section 13(1)(c) of the Act. As in the case of Krupanidhi Education Trust 2021 (11) TMI 382 - KARNATAKA HIGH COURT has held in para 9 that the alleged breach of Section 13(1)(c) of the Act based on these factors was baseless wholly untenable on the ground that the revenue cannot sit in the armchair of the assessee and decide the pattern of working / methodology to be adopted for the administration of the educational body. That the revenue cannot manage or control the managerial affairs of the educational body. These aspects would not come within the purview of the authorities to decide the income tax liability merely on suspicion that the assessee is claiming huge expenditures to get the corresponding benefits of allowable deductions. Thus considering the fact that assessee under the circumstances beyond its control had obtained loans at a higher rate solely for the benefit of society thus it cannot be held that it had violated the provisions of section 13(1)(c) and 13(2) read with Section 13(3) of the Act with the sole intention to transfer any direct or indirect benefit to them. Accordingly we set aside the orders of the AO and CIT(A) withdrawing the exemption available to the assessee u/s 11 12 which is hereby restored. Assessee appeal allowed.
1. ISSUES PRESENTED and CONSIDERED
The core legal questions considered by the Tribunal in these appeals are:
2. ISSUE-WISE DETAILED ANALYSIS Issue 1: Violation of Sections 13(1)(c), 13(2), and 13(3) due to payment of higher interest rates to specified persons and consequent withdrawal of exemption under Sections 11 and 12 Relevant legal framework and precedents: Sections 11 and 12 provide exemption for income applied for charitable or educational purposes. Section 13(1)(c) prohibits any direct or indirect benefit to specified persons, and section 13(2) restricts payment of excessive interest to such persons. Section 13(3) defines specified persons. The Supreme Court in Director of Income Tax vs. Bharat Diamond Bourse established that violation of these provisions can lead to withdrawal of exemption under section 11. Various High Court and Tribunal decisions, including those of Delhi and Karnataka High Courts, have clarified that only the income attributable to violation should be taxed at the maximum marginal rate, not the entire income. Court's interpretation and reasoning: The Tribunal acknowledged that the assessee paid interest at higher rates to specified persons compared to bank rates. However, it emphasized the financial difficulties faced by the assessee society, which was running educational institutions and incurring losses. The society needed to construct additional infrastructure urgently to comply with UGC guidelines and accommodate increased student strength. Due to lack of sufficient security and poor financial health, the society could not obtain adequate bank loans at reasonable rates and had to rely on unsecured loans from specified persons at higher interest rates. The Tribunal noted that loans from banks were fully secured and had structured repayment terms with penalties for defaults, effectively increasing the cost of borrowing. In contrast, loans from specified persons were unsecured and more flexible, justifying the higher interest rates. The Tribunal also observed that the interest rates paid to specified persons were comparable to those paid to non-specified persons and other non-banking financial companies, further supporting the reasonableness of the rates. Key evidence and findings: The assessee submitted detailed charts of interest paid, sanction letters from non-banking finance companies showing higher interest rates than those paid to specified persons, and the earlier assessment order for AY 2015-16 where similar interest payments were accepted without objection. The Tribunal found no cogent evidence from the Department contradicting the assessee's submissions or indicating any intention to divert income to specified persons. Application of law to facts: Applying the legal principles, the Tribunal held that mere payment of higher interest rates to specified persons does not ipso facto amount to violation of section 13(1)(c) or 13(2) if the payments are made under compelling circumstances and for the benefit of the society's objectives. The Tribunal relied on precedents holding that the Revenue cannot interfere with the managerial decisions of educational institutions or charitable trusts unless there is clear evidence of diversion of income or benefit. Treatment of competing arguments: The Department relied heavily on the Supreme Court judgment in Bharat Diamond Bourse and other decisions to argue for withdrawal of exemption. The Tribunal distinguished the facts, noting that in the present case, the assessee had demonstrated the necessity and reasonableness of higher interest payments due to financial constraints and urgency of construction. The Department failed to produce evidence disproving the assessee's bona fide claim. Conclusions: The Tribunal concluded that the assessee did not violate the provisions of sections 13(1)(c), 13(2), and 13(3) with the intention of conferring benefit on specified persons. Therefore, the exemption under sections 11 and 12 could not be denied. Issue 2: Whether the entire income can be taxed at maximum marginal rate due to violation of Section 13(1)(c) Relevant legal framework and precedents: The proviso to section 164(2) and judicial pronouncements clarify that only the income attributable to violation of section 13(1)(c) or 13(1)(d) should be taxed at the maximum marginal rate, not the entire income. The Delhi High Court in DIT (Exemption) vs. Agrim Charan Foundation and Karnataka High Court in CIT (Exemption) vs. Krupanidhi Education Trust held that the Revenue cannot deny exemption on the entire income for partial violations. Court's interpretation and reasoning: The Tribunal reiterated that the legislature intended to tax only the relevant portion of income that violates section 13(1)(c), not the entire income. It emphasized that the Revenue's approach of taxing the entire income at maximum marginal rate was arbitrary and contrary to settled law. Application of law to facts: Since the Tribunal found no violation warranting withdrawal of exemption, the question of taxation at maximum marginal rate on any part of the income did not arise. However, the Tribunal clarified that even if violation existed, only the relevant income portion would be liable to such tax. Conclusions: The Tribunal rejected the Department's contention of taxing the entire income at maximum marginal rate. Issue 3: Application of principle of consistency based on earlier assessment year Relevant legal framework: The principle of consistency in tax assessments requires that similar facts and circumstances should be treated alike unless there is a change in law or material facts. Court's interpretation and reasoning: The Tribunal noted that in AY 2015-16, the assessee had taken similar loans at higher interest rates from specified persons, and the Assessing Officer had not raised any objections or denied exemption. The Tribunal held that this prior acceptance reinforced the reasonableness of the assessee's claim and supported granting exemption in the subsequent years. Application of law to facts: The Tribunal applied the principle of consistency to hold that the exemption should not be withdrawn in the present years merely because of higher interest payments, as the circumstances and facts were substantially similar. Conclusions: The principle of consistency favored the assessee, and exemption was restored accordingly. Issue 4: Allowance of depreciation on assets acquired during the year Court's reasoning: The Tribunal observed that once exemption under sections 11 and 12 was restored, the question of allowance of depreciation became academic and did not require detailed discussion. However, it implied that depreciation on assets acquired during the year should be allowed. 3. SIGNIFICANT HOLDINGS "The Assessing Officer in the instant case has denied the exemption u/s 11 & 12 for the sole reason that assessee has paid interest to specified person more than bank rates. It is settled proposition of law that the income which has been applied in violation to section 13(1) of the Act could only be brought to tax and not the entire income." "The legislature has clearly contemplated that in a case, where the whole or part of the relevant income is not exempted under Section 11 by virtue of violation of Section 13(1)(d) of the Act, tax shall be levied on the relevant income or a part of the relevant income at the maximum marginal rate." "The Revenue cannot sit in the armchair of the assessee and decide the pattern of working / methodology to be adopted for the administration of the educational body." "The assessee under the circumstances beyond its control had obtained loans at a higher rate solely for the benefit of society thus it cannot be held that it had violated the provisions of section 13(1)(c) and 13(2) read with Section 13(3) of the Act with the sole intention to transfer any direct or indirect benefit to them." "Following the principle of consistency also the claim of the assessee should be allowed and exemption granted u/s 11 & 12 could not be withdrawn." Final determinations:
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