2018 (10) TMI 65 - KARNATAKA HIGH COURT

Allowable expenditure u/s 37 - Distributable Surplus payment - ‘application of income’ OR ‘allowable expenditure’ - diversion of income by overriding title at source - taxable income of the assessee from the business under section 10(1) - Held that:- In the present case, the entire income from manufacture and sale of Liquor in the present case by CHAMUNDI was taxable in the hands of the Assessee CHAMUNDI and the application of income in the form of “distribution of surplus” from CHAMUNDI to DIAGEO was neither an “allowable expenditure” under Section 37 of the Act nor as a “trade loss” under Section 28/29 of the Act, and only after payment of income tax by CHAMUNDI on the entire profits earned from such business, such “distribution of surplus” could be made by CHAMUNDI to DIAGEO by way of application of income under the Agreement dated 30/10/2007.

Thus upon the overall reading of the Agreement dated 30/10/2007 in para 17 defining DIAGEO INDIA’s entitlements before deducting entitlements of CHAMUNDI under Clause 16, the said Agreement in the correct perspective of applicability of Indian Tax laws on the income and profits of CHAMUNDI, ought to have provided for deduction of Income-tax payable on its profits and gains taxable in the hands of CHAMUNDI and thereafter from the net balance after deducting entitlements of CHAMUNDI under Clause 16, the balance surplus could only be taken as entitlement of DIAGEO INDIA Pvt.Ltd.

Book entries and Method of Accounting is not determinative and conclusive for deciding the computation of ‘taxable income’ in the hands of the Assessee though they may be relevant to be considered.

This is where we feel the tax avoidance effort has been made by the parties and we cannot uphold the same in the overall analysis of the facts and legal position applicable to the facts of the present case.

The “diversion of income by transfer of overriding title at source” should normally have the support of the statutory requirements or some decretal binding character of Courts of law and even though the private contractual obligations can also bring about such “diversion of income at source” but in this last sphere of private contractual obligations, the Courts and the Income Tax Authorities have to examine such aspects carefully in comparison to the above two other categories of statutory requirements and the Court decrees and then examine the real purport and object of such private arrangements and Contracts.

Besides the issues of the legality of the Agreement, the real intention of the parties should be ascertained as to see whether such arrangements and contracts have been entered into to deflect and divert the applicability of Income-Tax laws on the Assessee who has really earned the “real income”, profits and gains under such Contract or whether such diversion is only an arrangement to suit the purposes of tax avoidance in such cases.

Therefore, we reiterate that it will depend upon the facts and circumstances of each and individual case whether in those circumstances, it would amount to a “diversion of income by overriding title at source” or an arrangement to serve the purposes of tax avoidance, as is the case before us. - Decided in favour of revenue