TMI Blog1991 (4) TMI 64X X X X Extracts X X X X X X X X Extracts X X X X ..... rcumstances of the case, the addition of Rs. 4,40,000 to the total income in the assessment for the assessment year 1961-62 was justified?" Question of law referred at the instance of the Department: " 1. Whether, on the facts and in the circumstances of the case, the sums of Rs. 10,000 and Rs. 5,600 for the assessment years 1965-66 and 1966-67, respectively, could be allowed as deduction from the total income of the assessee ? " In so far as question No. 1 referred at the instance of the assessee is concerned, it relates to inflation of the cotton purchase price in the assessment years 1958-59, 1961-62 and 1962-63. The assessee is a limited company carrying on a business in manufacturing of yarn, etc. The assessee-company was managed by a managing agency firm called R. S. Guruswamy Naidu and Company consisting of Mr. G. Krishnan, his brothers and brother-in-law as partners. The assessee-company was managed by the above-said firm till March 6, 1961. Mr. G. Krishnan was controlling both the assessee-company as a director and the managing agency firm as a partner. The Income-tax Officer made additions of Rs. 34,692, Rs. 31,826 and Rs. 11,693 for the assessment years 1958-59, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he case of Ramdas Dossa and Co. v. CIT [1956] 29 ITR 1001 (Bom), in the case of CIT v. India United Mills Ltd. [1978] 112 ITR 129 (Bom) and in the case of CIT v. Vijayalakshmi Mills Ltd. [1974] 94 ITR 173 (Mad), held that there is inflation of cotton purchase price in the assessment years 1958-59, 1961-62 and 1962-63 and, accordingly, upheld the additions made by the Income-tax Officer for all these assessment years under consideration. Before us, learned counsel, Mr. S. A. Balasubramanian, appearing for the assessee, submitted as under : the assessee-company is not responsible for the mischief committed by the director in collusion with a broker. So far as the assessee-company is concerned, it had paid the full price quoted by the sellers as per the contract and hence the money went out of its coffers. There was no evidence to show that the money paid came back to the assessee-company, either directly or indirectly. It is a case where director of the company defrauded the company, whether this was known to the company or not. In working out the profit and loss account of a business, the assessee has to take into account the actual price paid for the purchase of the raw materials ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 34,692, Rs. 31,826 and Rs. 11,693, respectively, on account of inflation of the cotton purchase price. For the purpose of working out the profit and loss account of a business, it is necessary to take into account the actual expenses incurred. If such expenses are inflated deliberately to the knowledge of the assessee, then, the Income-tax Officer is entitled to disallow the inflated expenditure. If the account of the assessee-company reflect such irregularities committed by the directors, then the accounts of the assessee cannot be said to be a true account. In such a case, the Income-tax Officer is entitled to reject the entire books of account and work out the correct profit from the materials gathered by him. A company is a legal entity and it can act through its directors. The company can act only through the resolutions passed by the directors. The assessee has not controverted the facts mentioned in the assessment orders for all the three assessment years under consideration. The quantum of inflation is also not disputed. According to the assessee, in working out the profit and loss of the business, the assessee has to take into account the proper price paid for the raw mate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eference, since the books of the three purchasers were not examined, the matter was remitted to the Tribunal for reconsideration. In that decision, this court felt that it is not for the Revenue to fix the price and assess the assessee on that amount. But, according to the facts appearing in the instant case, higher prices were paid to the sellers than the market rate and the difference was pocketed by the director so as to reduce the profit of the assessee-company. Hence, the present case has got to be decided on the facts available on record. Thus, on the facts, the Tribunal came to the conclusion that expenditure on cotton purchase was inflated deliberately for the personal benefit of the managing director. The Calcutta High Court had occasion to consider a question of similar nature in the case of Asian Tool and Plastic Co. v. CIT reported in [1965] 55 ITR 392. In the said decision, the Calcutta High Court pointed out that the income-tax authorities can substitute their own standard of reasonableness of expenditure for that of the assessees when the following conditions prevail (headnote) : "Where (a) the transaction is not a genuine or a straightforward one or is either ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s the assessee-company was concerned, it could not be said that the alleged income either accrued to, or was received in fact by, the assessee-company. On a reference, the High Court agreed with the Tribunal. But the facts appearing in the present case are entirely different as pointed out earlier. In the present case, the Tribunal, on considering the facts appearing in this case, came to the conclusion that the inflated price was paid deliberately only for the purpose of siphoning off the income of the assessee-company in order to reduce the profit of the company. Further, the director who is responsible for this was controlling both the assessee-company and the managing agency firm. The partners of the managing agency firm and the directors of the assesseecompany are closely related. Therefore, in the present case, it cannot be said that the assessee-company did not benefit out of the inflation in the price paid to the sellers. Therefore, the above said decision will not be applicable to the facts of this case. Another decision relied upon by learned counsel for the assessee was that reported in the case of A. D. Jayaveerapandia Nadar and Co. v. ITO [1975] 101 ITR 390 (Mad). In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assesseecompany borrowed huge amounts. The Income-tax Officer doubted from the manner in which the amounts have been advanced to cotton suppliers that the cash balance was not really so high and the extra cash must have been used in some manner other than for the assessee's business. Two of the managing agents accepted the withdrawal of money to the extent of Rs. 4,50,000 for personal purposes. The entries in the account books showed that amounts were taken and brought back again. The Income-tax Officer pointed out that if the assessee had its own money and had not to resort to borrowings, a huge cash balance would have been justified. The assessee was borrowing large amounts from its bankers. The Income-tax Officer found that the assessee had advanced amounts to various parties allegedly for the purpose of cotton, but these amounts were not specifically utilised for that purpose. The borrowed amounts were actually diverted for the benefit of the managing director and his men. The assessee contended that there is no nexus between the diversion of the money and the borrowings from banks and outsiders. The Income-tax Officer pointed out that the director, after collecting the ou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (MP), CIT v. Coimbatore Salem Transport (P.) Ltd. [1966] 61 ITR 480 (Mad), upheld the disallowance made by the Incometax Officer in all the assessment years under consideration. Before this court, learned counsel for the assessee submitted as under : The cash balance in the books of the assessee-company was maintained to the extent reflected in the accounts and that there was nothing to show that there was any depletion. When amounts had to be taken out, they were taken out and promptly returned. The entries for the same can be seen from the account books. The amounts that were withdrawn were only for the purpose of business of the company. There was no evidence on the side of the Department to show that a huge cash balance was in existence on a particular day and the same was withdrawn for the personal benefit of the managing director or the partners of the managing agency firm. So far as the advances made to persons like Panna Lall Ramkumar, C. Jairam and Co., etc., are concerned, it cannot be said that these persons had no business transactions with the assessee. The raw materials had been purchased from them and utilised by the assessee for its business. It is well known in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in many cases. The amounts advanced were much more than the supplies made. In some cases, supplies were not made at all. There was also evidence on record to show that the amounts advanced were diverted by these supplies to the managing director and his partners. It is a deliberate attempt on the part of the assessee to divert the amounts from the business to personal benefits of the managing director and his partners. Therefore, the amounts borrowed were not utilised for the purpose of business in its entirety. The interest on the amounts diverted for non-business purposes should be disallowed. In the present case, it is not correct to state that the company and the managing agency firm are two different entities. The mere fact that the monies borrowed found their way into the account books of the company would not be sufficient to show that they were borrowed for business purposes. As regards interest on loans from multani bankers, the interest should be necessarily disallowed. In order to support his contention, learned standing counsel for the Department also relied upon the decision in the case of CIT v. Sujani Textiles (P.) Ltd. [1985] 151 ITR 653 (Mad). We have heard the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ings to remain without charging any interest thereon while it was paying interest on the amounts borrowed by it, and that the extent to which it would have been in a position to collect interest on the outstandings due to it from others, it could not be permitted to claim as an allowance interest paid by it, is not correct." Similarly, while considering the provisions of section 36(1)(iii) and section 57(iii) of the Income-tax Act, 1961, this court, in the case of CIT v. Sujani Textiles (P.) Ltd. [1985] 151 ITR 653, held as under (headnote) : "That in view of the finding of the Tribunal that the amounts borrowed by the company had been utilised for non-business purposes, viz., for investment in shares, the interest paid on the capital borrowed could not be allowed as a deduction under section 36(1)(iii). In view of the question of allowance under section 57(iii) not having been argued before the Tribunal, even though there was a passing observation that the interest may be allowed under the head 'Other sources', the question of considering the allowability of the interest under section 57(iii) could not be said to be comprehended in the question referred to the High Court. Even ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r the personal benefit of the managing director and his men. In view of the categorical findings given by the Tribunal that the amounts borrowed were utilised for non-business purposes, we consider that the above-cited decisions will not render any help to the assessee to succeed in this case. Another decision relied on by learned counsel for the assessee was that in the case of Amna Bai Hajee Issa v. CIT [1964] 51 ITR 835 (Mad). According to the facts appearing in this case, on April, 1956, the assessee had an overdraft of Rs. 96,625 in a firm which acted as her bankers. On March 31, 1957, she received a sum of Rs. 1,01,000 and paid it to this firm. She also borrowed Rs. 90,000 from this firm and invested it as capital in another firm and, after setting off this sum of Rs. 90,000 and other withdrawals made by her, the debit balance remained at Rs. 53,182 on March 31, 1957. In the accounting year ended March 31, 1959, she had to pay Rs. 2,965 as interest on this sum of Rs. 53,182 and claimed it as an allowance from her profits from the firm in which she had invested Rs. 90,000. This claim was disallowed by the Tribunal on the ground that the Rs. 90,000 could not be treated as bor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... est on borrowed capital, the assessee has got to satisfy that (1) the money was borrowed, (2) it must have been borrowed for the purpose of business ; and (3) the assessee must have paid the interest on the said amount. As already pointed out, in the present case, the Tribunal, after delving very deep into the facts in detail came to the conclusion that the account books did not reveal the reality, the managing director was diverting the funds belonging to the assessee-company for his own personal benefit, the extra amount was not brought into the accounts and there was nexus between the amounts diverted and the borrowings from banks and outsiders. Therefore, the Tribunal came to the conclusion that the borrowed fund was not utilised for business purposes of the assessee-company. Hence, the addition is sustainable not only on the ground of disallowance but also on the ground of extra income not brought in the account books in all the assessment years under consideration. In that view of the matter, we answer the second question referred to us at the instance of the assessee, in the affirmative and against the assessee. The third question referred to us at the instance of the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e's business show wastage at 29 per cent. and an invisible loss at 13 per cent. amounting to Rs. 4,61,580. There is no evidence to show that the waste produced was utilised as alleged. If, really, the waste produced was utilised as alleged, the invisible loss would have been reduced to a great extent. The wastage was found to have taken place at blow room stage. The irresistible conclusion was that in fact the assessee had not issued cotton for manufacture but only showed it as having been issued in several cases. It remains to be seen that the actual extent of cotton consumed was far less than what was entered in the books. Vijayakumar Cotton Press supplied the cotton. It supplied cotton bales each weighing 400 pounds but actually each bale weighed only 260 to 270 pounds. It was conceded that 40,000 pounds of cotton found deficient was not a wastage as claimed at the blow room stage but it represented shortage in the overall quantity of cotton put into manufacture. It was shown that the managing director, Mr. G. Krishnan, of the assessee-company is in fact running Vijayakumar Cotton Press also. It is with the connivance of Mr. G. Krishnan that the assessee-company was defrauded. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a third party to purchase foreign goods without a licence to lift the same. On the other hand, learned counsel for the assessee submitted that the assessee entered into a contract with a third party and the contract could not be honoured since the assessee has no licence to lift the goods. The third party filed a suit and the same was compromised by paying a lump sum amount of Rs. 10,000 in the assessment year 1965-66 and Rs. 5,600 in the assessment year 1966-67. Therefore, it was not a speculative transaction but the expenditure was incurred in the ordinary course of a continuing business in order to maintain good relationship with the customer. Therefore, it was submitted that the Tribunal was correct in allowing the claim. We have heard the rival submissions. In the assessment year 1965-66, there was an agreement for supply of cotton. The assessee could not obtain the necessary licence. The cotton, therefore, could not be lifted. The third party filed a suit O. S. No. 35 of 1963 and the suit was compromised on payment of a lump sum amount of Rs. 10,000 in the assessment year 1965-66 and a sum of Rs. 5,600 in the assessment year 1966-67. The assessee was interested in impor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enses with or remits, wholly or in part, the performance of the promise made to him or accepts instead of it any satisfaction which he thinks fit. We are concerned with the sense of law, and it is that sense which must prevail in sub-section (5) of section 43. Accordingly, we hold that a transaction cannot be described as a 'speculative transaction' within the meaning of sub-section (5) of section 43 of the Income-tax Act, 1961, where there is a breach of the contract and, on a dispute between the parties, damages are awarded as compensation by an arbitration award." However, learned standing counsel for the Department relied on decision of the Orissa High Court in the case of Raghunarayan Rice Mills v. CIT [1970] 75 ITR 682. According to the facts appearing in that case, there was no breach of contract. By frustration, the contract became unenforceable. It was open to the assessee to resile from the contract and take a stand that the residual contractual obligation was incapable of performance. Without doing so and without any pressure from the Calcutta constituents, the assessee, to save its business reputation, honoured the contract which amounts to settlement of the contract ..... X X X X Extracts X X X X X X X X Extracts X X X X
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