TMI Blog1956 (12) TMI 44X X X X Extracts X X X X X X X X Extracts X X X X ..... who are willing to advance as loan to the extent of the paid-up value of the holdings by two instalments, i.e., 50 per cent. by the end of February, 1945, and 50 per cent. by the end of March, 1945, which will bear a minimum interest at 6 per cent. or at the same rate as the dividend the directors May recommend for the period during which such loans are used in the business of the company whichever is higher. Such loans will be returned as and in the manner the directors May think fit, provided that such loans shall be repayable within three years from the date of the loans. If any shareholder does not advance any portion of the money that he is entitled to advance within the prescribed time such moneys the managing agent May at this discretion receive from any other shareholders over and above the amounts they are entitled to advance and such loans shall bear interest at the same terms as above , and the same was unanimously passed. Out of the 21 shareholders only 17 availed themselves of the offer made by the company to borrow money from the shareholders. A sum of ₹ 75,000 was borrowed by 31st March, 1945, in the year of account of 1945. Under a resolution of the genera ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e deal with the cases cited before us, we shall set out our conclusions about the nature of the transaction, which was the basis of the assessee's claim. The sum of one lakh of rupees was the amount borrowed by the assessee to provide working capital for its expenses. What it paid annually was interest. Learned counsel for the Department could not dispute that the relationship between the shareholders of the company that lent money to the company on the one hand and the company on the other which borrowed those moneys was that of creditors and debtors. The genuineness of the loan and that of the payments made by the assessee were never in issue. It was only on that basis that the Tribunal could allow and did allow 6% towards interest charges. Once the factors mentioned above were established, there was no scope for limiting the deduction to what the tribunal considered was a reasonable rate of interest. Section 10(2)(iii) did not provide for such a limitation. All that section 10(2)(iii) requires is (i) that the money, the capital, must be borrowed by the assessee; (ii) the amount should have been borrowed for the purpose of the business of the assessee, and (iii) the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d declares by a named bank, that would not have made the transaction any the less a loan. The as the dividend declared by the company, subject to a minimum of 6 per cent. The rate of dividend only provided the basis for computation of interest. What was payable and what was paid was interest and not dividend. Was the contract the assessee entered into with 17 of its shareholders a device to screen the real nature of the transaction? The Tribunal recorded: The additional payments which are linked with the declaration of dividends and the profits earned is nothing but a mere device to distribute the profits made in this form amongst the shareholders of this private limited company. In our opinion, there was no basis for that finding. We have pointed our that not all the shareholders advanced moneys to the assessee-company. The right of each of the shareholders, who had lent money, to receive the interest depended on the money that he had advanced, and not on the number of shares he held. No dividend could be withheld from a shareholder who did not advance moneys. The dividend could not depend on anything other than the number of shares the shareholder held. Only the lender could ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ure capital an additional characteristics, a characteristic inconsistent with that of a simple external loan by a creditor looking only for security for his capital and a certain regular remuneration for its use...............The share in the profits appears to us to represent a right to the distribution of the fund finally earned by the business, the taxable fund. Earlier at pages 229-230 the learned Judges laid down: ....when money is borrowed for use in the business the reward of the lender in the form of interest is regarded as a necessary or proper deduction for the purpose of ascertaining the profits of the business, and the fact that the reward is made to a vary with the success of the business ought not to effect its character as an expenditure incurred for the purpose of earning profit. Yet capital May be invested in a business in order to obtain a share in the profits indistinguishable from that of the proprietor. The solution of the difficulty must in every case be found in determining the point at which the ascertainment of net profits is required, and this depends upon the purpose for which they are to be computed. Profits May be regarded as a fund composed of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0. The excess came to 300. The claim for 200 was allowed, and the claim for the additional 300 was negatived. Rowlatt, J., observed, with reference to the 300, that it was nothing but giving the lenders a share of the profits eo nomine. The learned Judge observed further: They both, of course, are in consideration of the loan; that is why they are paid, there is no doubt about that, but they are different things, and the people who have lent this money have got interest and they have got a share of the profits--that is the long and short of it. They have got interest which is payable to them as a debt, it matters not whether the concern prospers or languishes; they have got the other thing, which is a share of what the business earns, and that is not interest, that is simply a share of the profits. If there are profits they get a share, if there are no profits whey do not get anything. It is simply, as it says in the agreement, a share of the profits. But the contract between the lenders and the assessee, we have to consider in this case, is quite different. In this case, if the assessee company declared a dividend, whether or not there were profits that year, the lend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... allowable deductions. Lord Hanworth, M.R., pointed out at page 322; .....it is important to bear in mind that it is not alleged by the Crown that this indenture of lease in not a valid and effective document, a specious device or strategy to cloak the true facts; it is accepted as a food agreement, and that carries one a very long way; it is no use to say the lease must be accepted as a lease, but must be looked at with the eye of suspicion; you have got to take its terms, and I think Mr. Justice Rowlatt is right in saying that once the Crown has admitted that it is a real document, then the case has to be decided upon the tenor of the document as it stands, without an ingenious effort to get round it because one May hold that it has the effect of withdrawing some profits from tax. At page 324, the learned Master of the Rolls observed: I have already state that the Crown do not attack the lease; they only attack the effect of it. Wen one comes to measure the true effect of it in the light of the surrounding facts, it appears to me that Mr. Justice Rowlatt was quite right in holding that this payment was, according to the tenor of the document, a sum payable for the purpos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... yalty. Therefore the payment could in no sense be regarded as an allocation of profits to one of the coshares in the company. It is merely an unconnected fact that Government are at present shareholders in the company. To the extent to which the character in which the additional royalty was received was differentiated from that of a shareholders, the principle laid down in that case is, as we said, analogous to that laid down by the House of a Lords in a Lock and Trotman v. Queensland Investment and Land Mortgage Company Limited [1986] A.C. 461. But we must also point out that in Indian Turpentine and Rosin Co. Ltd. v. Commissioner of Income-tax, United Provinces [1929] 3 I.T.R. 219 it was not the scope of section 10(2)(iii) that arose for determination. In Devarajulu Chetty Co. v. Commissioner of Income-tax [1950] 18 I.T.R. 357 at page 367, the learned Judges pointed our, it is the quality of the payment that is the test and not its admeasurement. With that principle we are in entire agreement. Once the true nature of the transaction is realised, there is no scope afforded in section 10(2)(iii) to reduce the quantum paid as interest, to anything considered reasonable b ..... X X X X Extracts X X X X X X X X Extracts X X X X
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