Calcutta High Court
M.D. Jindal vs Commissioner Of Income-Tax on 25 April, 1986
Equivalent citations: [1987]164ITR28(CAL)
JUDGMENT Ajit Kumar Sengupta, J.
1. In this reference under Section 256(1) of the Income-tax Act, 1961, the following question of law has been referred to this court :
"Whether, on the facts and in the circumstances of the case, the sum of Rs. 1,80,446, being the value of iron rods supplied by M/s. Machine Techno Sales (Private) Limited, during the previous year ended on March 31, 1965, amounted to dividend within the meaning of Section 2(22)(e) of the Income-tax Act, 1961, and 50% thereof, as reduced by the balance at his credit in the current account maintained with the company, was assessable in the hands of the assessee as such dividend for the assessment year 1966-67?"
2. The facts leading to this reference are stated hereafter.
3. The assessee is an individual. He is the managing director of M/s. Machine Techno Sales (Pvt.) Ltd. (hereinafter referred to as "the company"). The other director of the said company is the assessee's wife. The assessment year involved is 1966-67 and the relevant accounting year is the financial year ending on March 31, 1966. On June 20, 1964, the assessee purchased two adjacent plots of land at Alipore Road, Calcutta, one in the joint name of himself and his wife and the other in the names of his two minor sons. Thereafter, in the accounting year relevant to the assessment year under reference, the assessee started constructing a multi-storied building known as "Jindal House". Several self-contained flats were planned to be constructed in this building. The construction of the building was completed some time in early 1968. The entire "Jindal House" belonged to the assessee, his wife and his two minor sons, in equal proportion. As the assessee was contemplating selling of some of the flats in future, on April 21, 1965, he and his wife entered into an agreement with the company to sell six flats for Rs. 3,95,000 to it, which was wholly controlled by the assessee and his wife. As per Clause 4 of the said agreement, the company agreed to pay Rs. 3,50,000 to the assessee and his wife by way of earnest money and further agreed to pay the balance amount of Rs. 45,000 on the completion of the sale of the said six flats. During the accounting year relevant to the assessment year under reference, the company gave iron rods worth Rs. 1,80,446 to the assessee and his wife in order to facilitate them to construct the said building. It may be noted that the company was carrying on business in iron materials. During the course of the assessment proceedings, the Income-tax Officer asked the assessee as to why the iron rods worth Rs. 1,80,446 given by the company should not be treated as dividend within the meaning of Section 2(22)(e) of the 1961 Act. The assessee's reply to this was given in his two letters dated January 21, 1971, and February 17, 1971, which are as under:
"Letter dated January 21, 1971 :
The materials worth Rs. 90,223.23 sold to me cannot be considered as deemed dividend within the meaning of Sub-clause (e) of Clause (22) Section 2 of the Income-tax Act, 1961, for the following reasons :
(i) The value of materials sold to me cannot be considered as payment by the company of any sum by way of advance or loan to me as no cash has gone out of the company.
(ii) The cost of materials sold to me was adjusted against the consideration money due to me from the company. The company was under contractual obligation to pay me the consideration money in instalments against the sale of flats. It acquired right, title and interest in the six flats sold to it."
" Letter dated February 17, 1971 :
'This provision (meaning of Section 2(22)(e) of the Income-tax Act, 1961) legislates in respect of any payment by way of advance or loan to a shareholder. The original transaction should be a loan or advance so that the company is a creditor and the shareholder is a debtor and the assessee is under obligation to pay it along with the interest, if any, payable thereon.
In my case, M/s. Machine Techno Sales (P.) Ltd. sold to me materials worth Rs. 90,223 which was adjusted against the consideration money due to me for the flats sold to it. The company was under contractual obligation to pay me the consideration money in instalments against the sale of flats. I was under no obligation to repay Rs. 90,223 to the company with or without interest. I was under obligation to deliver the possession of the flats sold to the company. In fact, I delivered the possession of the flats to the company on May 27, 1968. It is, therefore, submitted that the sum of Rs. 90,223 cannot be considered as loan or advance within the meaning of Sub-clause (e) of Clause (22) of Section 2 of the Income-tax Act, 1961.
If, however, I was unable to deliver the possession of the flats to the company as agreed upon, then I would have been under obligation to refund Rs. 90,223. On the happening of such a contingency, the company would have become creditor and I debtor and I would have been under obligation to repay Rs. 90,223. This has not happened."
4. The Income-tax Officer, however, in his order dated April 26, 1971, held that the agreement dated April 21, 1965, was an "arranged affair" on the grounds that (i) the agreement was signed by the assessee in dual capacity, viz., as a seller as well as the managing director, on behalf of the company ; (ii) the agreement was entered into in April, 1965, while the building was ready only in May, 1968; (iii) there was no provision in the agreement as to what will happen to the earnest money, if the assessee did not build or abandoned the construction of the flats. He, therefore, concluded that the advance received by the assessee by way of iron rods would fall within the mischief of Section 2(22)(e) of the 1961 Act. However, he added one half of Rs. 1,80,446, i.e., Rs. 90,223, as deemed dividend within the meaning of Section 2(22)(e) of the 1961 Act, in the hands of the assessee as the iron rods were supplied to the assessee and his wife jointly.
5. The assessee preferred an appeal before the Appellate Assistant Commissioner. The Appellate Assistant Commissioner, in his order dated December 20, 1971, arrived at the following findings :
" (a) The company had sufficient accumulated profits;
(b) Jindal House, the property under consideration, actually belonged to the appellant and his wife ;
(c) Though the so called agreement was entered into on April 51, 1965, the flats were delivered as late as May 27, 1968. The amount received in the form of iron rods stated to be worth Rs. 1,80,446 was, therefore, nothing but advance since the actual sale took place much later as per the conveyance dated May 27, 1968 ;
(d) As the advance was adjusted towards the cost of the flats, the appellant's contention that cash was not received, and so, Section 2(22)(e) did not apply, does not hold water. It is nowhere indicated that the payments should be only in cash as such ;
(e) The theory of contractual obligation cannot be accepted, particularly when the same person acted at both ends. He held substantial and controlling interest as shareholder and the agreement was not registered ;
(f) The series of events arranged leave no doubt that a shareholder took advance from a company whose business was not that of money lending. This conclusion is reinforced by the fact that the flats were delivered much later. In case of non-delivery, the amount would certainly have had to be refunded and with interest, if real business principles were intended to be followed. This is also as per Clause 12 of the agreement ;
(g) The rate for these flats was much lower than that charged for others."
6. He concluded that the Income-tax Officer was justified in treating one-half of the value of the iron rods as deemed dividend under Section 2(22)(e) of the 1961 Act, in the hands of the assessee.
7. The assessee went in appeal before the Tribunal. Before the Tribunal, it was not disputed by the assessee that the expression "any sum" would not necessarily be money transaction only but could include money value of articles or things advanced by a company. It was contended before the Tribunal that by the agreement for sale entered into between the assessee and his wife with the company, the company became a debtor of the assessee and his wife to the extent of Rs. 3,95,000. He further pointed out that in the company's books of account, the earnest money (iron rods) paid by the company had been debited to "Purchase of Flats Account", It was further submitted that each and every payment made by a company to its shareholder cannot be treated as a loan but one has to establish that there was a relation of a creditor and debtor between the company and its shareholder. It was further submitted that in view of the terms contained in the agreement for sale, the value of the iron rods given by the company to the assessee and his wife was not a loan but was a sort of part payment made by the company towards its indebtedness of Rs. 3,95,000. As regards the agreement for sale, it was submitted on behalf of the assessee that the Income-tax Officer was not justified in treating the agreement as an "arranged affair" in view of the fact that the assessee and the company are two separate entities. It was further submitted that the fact that the assessee had substantial interest in the company should not influence the Tribunal's mind in considering the agreement for sale of the six flats. The representative for the assessee also referred the Tribunal to various clauses of the agreement dated April 21, 1965.
8. The Tribunal, in its order dated January 7, 1974, after considering the contentions as well as the provisions of Section 2(22)(e) of the 1961 Act, held that it is no doubt true that the company had not given any advance or loan to the assessee in cash. However, the iron rods supplied by the company to the assessee and his wife, definitely benefited the assessee who was contemplating constructing a house known as "Jindal House". As the iron rods were scarce material, the company, which was carrying on business in iron materials, came forward and gave iron rods to the assessee and his wife. If the assessee had got these iron rods before entering into an agreement for sale of flats to the company, there would not have been any dispute that provisions of Section 2(22)(e) of the 1961 Act would have been clearly applicable. But, instead of doing that, the assessee and his wife, controlling the company, thought of a device to circumvent the provisions of Section 2(22)(e) of the 1961 Act and made an agreement with the company by which the company was made a debtor to the assessee and his wife to the extent of Rs. 3,95,000. The Tribunal, however, did not agree with certain observations of the Income-tax Officer regarding the provisions for repayment of earnest money, etc., in the event of default on either side. But the Tribunal was in agreement with the submissions made on behalf of the Department that the assessee's case is one in which the income-tax authorities would be fully justified in going behind the agreement for sale of the flats as well as the sale agreement which was subsequently entered into on May 29, 1968. As regards the quantum of dividend to be included in the assessee's hands, the Tribunal accepted the assessee's contention that he should be given credit to the extent of the amount standing to his credit in the company's books. The Income-tax Officer was, therefore, directed to give necessary relief to the assessee.
9. Aggrieved by the said order of the Tribunal, the assessee raised three questions in the reference application under Section 256(1) of the Act. The first question which has been referred to this court has been reproduced earlier. The second and third questions were rejected by the Tribunal. The said questions are as follows:
"(ii) Whether the iron rods supplied by the company to the assessee and his wife jointly or the money value thereof represented a payment by the company for the individual benefit of the assessee as envisaged in Section 2(22)(e) of the Act ?
(iii) Whether there was any material before the Tribunal in support of its finding that instead of getting the iron rods from the company before entering into an agreement with it for sale of flats, the assessee and his wife thought of a device for circumventing the provisions of Section 2(22)(e) of the Act by making an agreement with the company whereby it was made the debtor of the assessee and his wife ?"
10. In rejecting question No. (ii), the Tribunal observed that the assessee did not dispute before the Tribunal that the expression "any sum" would not necessarily be money transaction only but could include money value of articles or things advanced by a company, although before the income-tax authorities, the assessee's contention was that the expression "any sum" would not include the value of the material. Question No. (iii) was rejected on the ground that it was an inference drawn by the Tribunal on the facts found. The assessee did not take the matter further by way of reference under Section 256(2) of the Act.
11. At the hearing before us, Dr. Pal, learned counsel for the assessee, has submitted that although questions Nos. (ii) and (iii) had been rejected by the Tribunal and no application under Section 256(2) of the Act was made, the question as framed and referred to this court would cover the controversy whether any payment within the meaning of Section 2(22)(e) would cover value of goods supplied by the company to its director. The main contention of Dr. Pal is that there must be an advance or loan to a shareholder by the company. Unless there is payment by way of advance or loan, it will not come within the mischief of Section 2(22)(e). He has further submitted that by Section 2(22)(e), the Legislature has created a fiction and the fiction cannot be extended further or so interpreted as to go beyond the legislative intention in creating the fiction. He has also submitted that since the Legislature has deemed loan or advance as dividend under Section 2(22)(e), this action must necessarily receive strict construction. He has relied on several decisions in support of his contentions. The first decision relied onby Dr. Pal is in the case of Bombay Steam Navigation Co. (1953) Pvt. Ltd. v. CIT [1965] 56 ITR 52 (SC). He has referred to the following passage at page 57 :
"The parties had agreed that assets of the value of Rs. 81,55,000 be taken over by the assessee company from the Scindias. Out of that consideration, Rs. 29,99,000 were paid by the assessee company and the balance remained unpaid. For agreeing to deferred payment of a part of the consideration, the Scindias were to be paid interest. An agreement to pay the balance of consideration due by the purchaser does not in truth give rise to a loan. A loan of money undoubtedly results in a debt, but every debt does not involve a loan. Liability to pay a debt may arise from diverse sources and a loan is only one of such sources. Every creditor who is entitled to receive a debt cannot be regarded as a lender. If the requisite amount of consideration had been borrowed from a stranger, interest paid thereon for the purpose of carrying on the business would have been regarded as a permissible allowance ; but that is wholly irrelevant in considering the applicability of Clause (iii) of Sub-section (2) to the problem arising in this case."
12. The next decision cited by Dr. Pal is in the case of CIT v. C. P. Sarathy Mudaliar . There, the Supreme Court held (at p. 173): "Section 2(6A)(e) gives an artificial definition of 'dividend'. It does not take in dividend actually declared or received. The dividend taken note of by that provision is a deemed dividend and not a real dividend. The loan granted to a shareholder has to be returned to the company. It does not become the income of the shareholder. For certain purposes, the Legislature has deemed such a loan as 'dividend'. Hence, Section 2(6A)(e) must necessarily receive a strict construction."
13. The Supreme Court further held in that case that only the loan advanced to a shareholder would be deemed to be dividend under the provisions of Section 2(6A)(e) of the old Act corresponding to Section 2(22)(e) of the 1961 Act.
14. Dr. Pal has also relied on the judgment of the Madras High Court in the case of G. R. Govindarajulu Naidu v. CIT [1973] 90 ITR 13.
15. In that case, a sum of Rs. 1,65,000 was debited in the account of the assessee in the books of the company towards first and second call monies. The question which fell for determination of the Madras High Court was whether the said sum of Rs. 1,65,000 can be treated as cash advances within the meaning of Section 2(6A)(e). The Madras High Court observed that there has been no cash payment of the sum of Rs. 1,65,000 by the company to the assessee but it is only a book adjustment in the company's account under which the assessee had become the debtor and the company had become a creditor in the said sum. The Madras High Court observed thus (at page 22):
"Having regard to the words 'payment by way of loan or advance' employed in Section 2(6A)(e), we are of the view that there should be an outgoing or flow of money from the company to the shareholder so as to attract the said provision. Some light is thrown by the provision in Section 205(5) of the Companies Act, 1956, which provides that no dividend shall be payable except in cash, the only exception being the issue of fully paid up bonus shares or the payment towards unpaid call monies on any shares held by the members. In this case, there cannot be any dispute that the sum of Rs. 1,65,000 cannot be treated as an advance, for it is not an amount paid towards any other amount due by the company to the assessee-family. The only question then is whether the said sum represents a payment by way of loan by the company to the assessee family. Having regard to the setting in which the said Clause (e) of Section 2(6A) occurs, it is not possible to say that the payment contemplated will include a notional payment by way of book entries."
16. In the case of Smt. Tarulata Shyam v. CIT [1977] 108 ITR 345, the Supreme Court held that the fiction created by Section 2(6A)(e) read with Section 12(1B) of the old Act is inexorably attracted as soon as all the conditions necessary for its application exist in a case.
17. In the light of the aforesaid decisions, learned counsel for the assessee has urged that no advance or loan was given to the assessee by the company and accordingly there is no deemed dividend in this case.
18. Section 2(22)(e) of the 1961 Act provides that dividend would include any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) by way of advance or loan to a shareholder, being a person who has a substantial interest in the company, or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits.
19. It is no doubt true that the company had not given any advance or loan to the assessee in cash. The question is whether, in view of the arrangement made by the company and its director, it can be said that a payment has been made by the company on behalf of or for the individual benefit of the assessee. We are only confined to the facts of this case which are not in dispute. The findings of the Tribunal have not been challenged. The Tribunal found that the company in question is one in which the public are not substantially interested within the meaning of Section 2(18) of the Act. Secondly, the assessee is a person having substantial interest in the company. Thirdly, the company had accumulated profits on the relevant date. The only dispute was whether there was any payment made to the assessee for his individual benefit. The Tribunal held as follows :
"The only point disputed on behalf of the assessee is that since the company had become a debtor to the extent of Rs. 3,95,000 by virtue of the terms of the agreement for sale dated April 21, 1965, the value of iron rods amounting to Rs. 1,80,446 (Rs. 90,223 in the assessee's case) supplied to the assessee and his wife for the construction of the 'Jindal House' cannot be termed as dividend within the meaning of Section 2(22)(e) of 1961 Act. On the other hand, it is the submission of the Department that since the agreement dated April 21, 1965, was an 'arranged affair', the income-tax authorities were fully justified in going behind the agreement to find out the true nature of the transaction.
The iron rods supplied by the company to the assessee and his wife, definitely benefited the assessee who was contemplating of constructing a house known as 'Jindal House'. As the iron rods were scarce material, the company, which was carrying on business in iron materials, came forward and gave iron rods to the assessee and his wife. If the assessee had got these iron rods before entering into an agreement for sale of flats to the company, there would not have been any dispute that the provisions of Section 2(22)(e) of the 1961 Act would have been clearly applicable. But, instead of doing that, the assessee and his wife, controlling the company, thought of a device to circumvent the provisions of Section 2(22)(e) of the 1961 Act and made an agreement with the company by which the company was made a debtor to the assessee and his wife to the extent of Rs. 3,95,000."
20. It is no doubt true that legal fictions are created only for a definite purpose and they are limited to the purpose for which they are created and should not be extended beyond their legitimate field. But the legal fiction has to be carried to its logical conclusion within the framework of the purpose for which it is created.
21. The Supreme Court in the case of Navnit Lal C. Javeri v. K. K. Sen, AAC [1965] 56 ITR 198, dealing with the interpretation of the corresponding section of the old Act, held (at pages 207, 208):
"The companies to which the impugned section applies are companies in which at least 75 per cent. of the voting power lies in the hands of persons other than the public, and that means that the companies are controlled by a group of persons allied together and having the same interest. In the case of such companies, the controlling group can do what it likes with the management of the company, its affairs and its profits within the limits of the Companies Act. It is for this group to determine whether the profits made by the company should be distributed as dividends or not. The declaration of dividend is entirely within the discretion of this group. When the Legislature realised that though money was reasonably available with the company in the form of profits, those in charge of the company deliberately refused to distribute it as dividends to the shareholders, but adopted the device of advancing the said accumulated profits by way of loan or advance to one of its shareholders, it was plain that the object of such a loan or advance was to evade the payment of tax on accumulated profits under Section 23A. It will be remembered that an advance or loan which falls within the mischief of the impugned section is advance or loan made by a company which does not normally deal in money-lending, and it is made with the full knowledge of the provisions contained in the impugned section. The object of keeping accumulated profits without distributing them obviously is to take the benefit of the lower rate of super-tax prescribed for companies. This object was defeated by Section 23A which provides that in the case of undistributed profits, tax would be levied on the shareholders on the basis that the accumulated profits will be deemed to have been distributed amongst them. Similarly, Section 12(1B) provides that if a controlled company adopts the device of making a loan or advance to one of its shareholders, such shareholder will be deemed to have received the said amount out of the accumulated profits and would be liable to pay tax on the basis that he has received the said loan by way of dividend. It is clear that when such a device is adopted by a controlled company, the controlling group consisting of shareholders have deliberately decided to adopt the device of making a loan or advance. Such an arrangement is intended to evade the application of Section 23A. The loan may carry interest and the said interest may be received by the company ; but the main object underlying the loan is to avoid payment of tax. It may ultimately be repaid to the company and when it is so repaid, it may or may not be treated as part of accumulated profits. It is this kind of a well-planned device which Section 12(1B) intends to reach for the purpose of taxation."
22. In the instant case, the assessee and his wife controlled the company. It is with a view to circumvent the provision of Section 2(22)(e) that by an agreement with the company, the company was made a debtor to the assessee and his wife to the extent of Rs. 3,95,000. What is apparent is not real and in a case like this, the Tribunal was justified in going behind the agreement for the sale of the flats as well as the sale agreement which was subsequently entered into on May 29, 1968. The agreement for sale was signed by the assessee as a seller and as the managing director on behalf of the company. In Juggilal Kamlapat v. CIT [1969] 73 ITR 702, the Supreme Court observed (at page 710) :
"In a matter of this description it is well-established that the income-tax authorities are entitled to pierce the veil of corporate entity and look at the reality of the transaction. It is true that from the juristic point of view, the company is a legal personality entirely distinct from its members and the company is capable of enjoying rights and being subject to duties which are not the same as those enjoyed or borne by its members. But in certain exceptional cases, the court is entitled to lift the veil of corporate entity and to pay regard to the economic realities behind the legal facade. For example, the court has power to disregard the corporate entity if it is used for tax evasion or to circumvent tax obligation or to perpetrate fraud."
23. In the instant case, iron rods were supplied to the assessee and his wife valued at Rs. 1,80,446 (Rs. 90,223 in the assessee's case). The company was carrying on business in iron materials. The iron rods were given to the assessee and his wife, who controlled the company, for the construction of Jindal House which again belonged to the assessee and his wife and their minor children. The iron rods were supplied. The assessee received the value of the materials. Such value expressed in terms of money is the price of the materials. The sum of Rs. 1,80,446 was thus paid by the company as advance. Section 2(22)(e) makes it clear that any payment by any company of any sum representing a part of the assets by way of advance would come within the mischief of the said section. By debiting the said sum in an account styled "Purchase of Flats Account" and not on any account for the assessee or his wife, the real intention behind the transaction could not be concealed. The finding of the Tribunal is that the assessee was benefited by this transaction. In the "Dictionary for Accountants" by Eric L. Kohler (5th edition), "Advance" has been defined as payment of cash or the transfer of goods for which accounting must be rendered by the recipient at some later date. Thus, in this case, there was an advance made by the company to the assessee by the transfer of goods. The conclusion of the Tribunal is that by such transfer of goods, a benefit accrued to the assessee. This conclusion is based on the facts found by the Tribunal, namely, the device adopted by the assessee and the motive or intention of the company in making an advance and in entering into an agreement for sale of flats, namely, a benefit accruing to the assessee. These are essentially findings of fact and have not been challenged by the assessee by an appropriate question.
24. For the reasons aforesaid, the contention of the assessee must fail and the question referred to us is answered in the affirmative and in favour of the Revenue.
25. There will be no order as to costs.
Dipak Kumar Sen, J.
26. I agree.