Income Tax Appellate Tribunal - Madras
Consolidated Investments Ltd. vs Deputy Commissioner Of Income-Tax on 4 December, 1995
Equivalent citations: [1996]57ITD286(MAD)
ORDER
G. Santhanam, Accountant Member
1. This is an appeal by the assessee. The appellant is a company in which public are substantially interested. The previous year of the appellant ended on 31-3-1992 relevant to the assessment year 1992-93. The assessment was completed under the provisions of Section 143(3) of the Income-tax Act. In arriving at the business income, the appellant had debited a sum of Rs. 1,59,75,409 as interest paid (which included a sum of Rs. 1,20,20,766 being interest paid to the holding company). The Assessing Officer noticed from the accounts that a sum of Rs. 1,99,78,000 was due from M/s. Unitel Communications Limited, a joing sector project promoted by U.B. Group companies, of which the appellant is one such company. But no interest was charged by the appellant on such advance. It was explained before the Assessing Officer that the financial position of Unitel Communication's Limited was in a precarious condition and as the assessee is one of the major shareholders, at the request of the borrower and on ground of commercial expediency interest was not charged on the advances made to the other party, namely, Unitel Communications Ltd. The learned Assessing Officer was of the view that the appellant-company was paying interest to the holding company on the amounts borrowed from it and as it did not choose to charge interest on the advances made by it to Unitel Communications Ltd., there was diversion of borrowed funds for non-business purposes and in this view of the matter he estimated the interest on such advances at 21% to make a disallowance of Rs. 41,95,3 80, from out of the interest charges claimed as deduction by the assessee-company.
2. For similar reasons the Assessing Officer disallowed interest on estimate basis at 21 per cent per annum in a sum of Rs. 40,07,010 in the case of advances made to Sapthagiri Traders (P.) Ltd.
3. The assessee appealed. The learned CIT (Appeals) held that the appellant-company had borrowed money at interest but had made advances to the two companies without charging interest. Though the balance-sheet of the holding company was not before him, still he ventured an inference that the holding company must be setting off the interest cost of its borrowings against the interest income received from the assessee-com-pany and thus must have paid lesser amount of tax by not charging interest on its advances. Thus the transactions of lending and borrowing with interest and without interest are of a colourable nature at the cost of the revenue. He further held that merely because the assessee-company had the object of promoting or aiding promotion of companies, it did not follow that it could lend its interest-bearing funds free of interest to other companies. Any company purporting to invest funds in deposits or loans would look for the return of its investment as a prudent business proposition and this element was totally absent in the case of the assessee. Further he held that though the Orissa Government (not the UB group of companies as stated by the Assessing Officer) is the major shareholder in the joint sector project, yet it is all well-known that except on rare occasions participating Government did not interfere in the working of the companies and hence the decision not to charge interest cannot be justified on ground of commercial expediency. In the case of Sapthagiri Traders (P.) Ltd., there was equally no countervailing circumstances to make the advances free of interest. In addition, the CIT (Appeals) on a scrutiny of the balance-sheet of the assessee-company held that the assessee did not have any non-interest bearing funds from out of which the advances could have been made. For all these reasons, he upheld the order of the Assessing Officer. The assessee is in second appeal.
4. Shri K.R. Ramamani, the learned Advocate for the assessee submitted that it is not in dispute that the assessee did not charge interest on the advances made by it to the two companies in question. It is also not in dispute that the appellant-company was paying interest on the funds borrowed by it. The disallowance has been made on a very narrow view of the whole issue for the simple reason that interest bearing funds were advanced to the two companies without charging interest on the advances made by it. Narrow view because it has been conveniently forgotten that the assessee is an investment company with the object of dealing in shares, stocks, debentures and making advances and also promoting companies in India, subsidise, organise, assist or aid in forming, promoting, subsidising, organising or aiding companies, syndicates, etc. One of the objects of the company is to subsidise or aid other companies. When the object itself is such a one, it is immaterial whether the company used its interest free funds or interest bearing funds for making interest-free advances. Prudent business considerations cannot be tested on short-term policies or short-term norms. Unitel Communications Ltd. is a joint sector-project with Orissa Government having 26.5 per cent shares in the company. Unit Trust of India is having 12.79 per cent. U.B. Group of companies to which the assessee belongs is having 24.93 per cent. 36.23 per cent is held by the public. The company was facing financial difficulties and had to go before BIFR. The BIFR in case No. 106/92 had in its hearing held on 21-12-1994 confirmed its prima facie opinion of winding up of the company and directed Canara Bank to say whether they are agreeable for disposal of the assets of the company under Section 20(4) of the Sick Industrial Companies (Special Provisions) Act, 1985. In its order dated 5-6-1994, the BIFR appointed Canara Bank to dispose of the assets of the company and gave guidelines for the same. Thus it is not in doubt that Unitel Communications Ltd. was found to be fit for being wound up by competent authorities. There cannot be overnight sickness of an industrial undertaking unlike in the case of human beings. The signs of sickness were evident over the years and it is in consideration of these facts that the assessee did not charge any interest. Charging of interest to a company tending to become sick would only result in unnecessarily inflating the profits of the assessee-company without any chance of recovery of such interest at a future date. At the same time, as a shareholder the assessee was interested in reviving the company or to ward off the sickness, and it was in this view the moneys were advanced but without interest. The assessee's very object is to promote and aid companies and in the circumstances of the case besides commercial expediency and business prudence, the action of the assessee could be justified in terms of its very object for which the company was formed. Therefore, the question of diversion of funds for non-business purposes cannot be raised in the case of advances made to Unitel Communications Limited. He relied on the following decisions :
(1) CIT v. Pudukottai Co. (P.) Ltd. [1972] 84 ITR 788 (Mad.) (2) CIT v. Premier Auto Finance (P.) Ltd. [1981] 128 ITR 540 (Delhi) (3) Patnaik & Co. Ltd. v. CIT[1986] 161 ITR 365 (SC) (4) Indian Commerce & Industries Co. (P.) Ltd. v. CIT[1995] 213 ITR 533 (Mad.) (5) N. Sundareswaran v. CIT[1969] 72 ITR 219 (Ker.) (6) Durametallic (India) Ltd. v. IAC[1991] 38 ITD 211 (Mad.).
5. Shri Sachan, the learned Departmental Representative submitted that for purposes of allowing interest on the capital borrowed under Section 36(1)(iii), what is relevant is that money should be borrowed for the purpose of business and utilised for the purpose of business. This test is not satisfied in the case of the assessee. The decisions cited by the learned Advocate are not germane to the issue on hand. Though the assessee pleaded for commercial expediency, such plea should not be allowed on mere statement. But there should be material to say that the advances were made free of interest solely on grounds of commercial expediency. He took us through the order of the CIT (Appeals) to show that it is only the borrowed funds that were utilised for making interest free advances and in this connection he drew our attention to the balance-sheets of the assessee-company filed before us. He submitted that the ultimate destination of the funds belong to the holding company and in this connection he referred to pages 31 and 77 of the paper book filed by the assessee to buttress the point that the advances had been made free of interest to the UBL (United Breweries Ltd.), the 100 per cent holding-company of the assessee. Thus the UBL is the ultimate beneficiary. He sought to distinguish the cases relied on by the assessee's counsel by stating that the iss ue in Palnaik & Co. Ltd.'s case (supra) was about purchase of Government security and the purpose of the advance in Indian Commerce & Indus tries Co. (P.) Ltd.'scase (supra) was to increase the investment and in Durametallic (India) Ltd.'s case (supra) the transaction was between the holding-company and the subsidiary company and thus submitted that these cases are not relevant to decide the issue. Next he submitted that the interest-free advances were not made for business purposes and at any rate there was no winding up of Sapthagiri Traders Pvt. Ltd. and, therefore, the advances made to the latter company, namely, Sapthagiri Trading Pvt. Ltd. is in a weaker wicket. For all these reasons he submitted that the disallowance should be upheld.
6. We have thus heard the rival submissions and perused the records. The assessee-company borrowed moneys at interest and advanced moneys to Unitel Communications Ltd. and Sapthagiri Traders Pvt. Ltd. but without interest. The case of the Revenue is that the borrowed funds have thus been diverted for non-business purposes and hence to thai-extent interest on the borrowings cannot be allowed. The case of the assessee is that the very obj ect of the appellant is to promote, aid and subsidise the formation and organisation of companies doing business in India and, therefore, the issue must be tested not in a narrow compas but on the larger canvas of the activities of the company. We have gone through the Memorandum and Articles of the company. Clause 2 of the Memorandum and Articles of Association of the company is as follows :
2. To advance, deposit or lend with or without security, moneys, securities, assets and property to or with such persons, firms, companies or corporations and on such terms as may seem expedient, to negotiate loans, to discount, buy, sell and deal in bills, notes, warrants, coupons and other negotiable or transferable securities or documents. The Company shall not, however, do Banking Business as defined in the Banking Regulations Act, 1949.
Thus the company can lend moneys with or without security and on such terms as it may seem expedient. Clause 7 of the Memorandum of Association is as follows :
7. To form, constitute, promote, subsidise, organise and assist or aid in forming, promoting, subsidising, organising, or aiding companies, syndicates or partnerships of all kinds for the purpose of acquiring and undertaking any property and liabilities of the Company or of advancing directly or indirectly the objects thereof, or for any other purpose which this Company may think expedient, and to acquire and hold shares, stocks or securities issued by or other obligations of any such Company, and to sell otherwise deal with the same.
Thus the company is empowered to subsidise, organise or aid companies or syndicates doing business in India. From the above objects as stated in the Memorandum of Association we have no hesitation in holding that one of the aspects of the business of the company is to help or subsidise other companies with or without security and on such conditions as it may deem fit. This is what has happened in the case of interest-free advances made to Unitel Communications Ltd.
7. In the cases reported in Pudukottai Co. (P.) Ltd. (supra), Premier Auto Finance (P.) Ltd. (supra) and N. Sundareswaran (supra), the ratio is that where the money is borrowed at interest for purposes of business, disallowance cannot be made under Section 36(1)(iii) merely for the reason that the borrowed funds had been lent to parties free of interest. The only point to be seen is whether the lending of moneys free of interest was in the course of the business and for the purpose of the business. In the case before us we have already indicated that one of the purposes of the assessee-company is to subsidise or aid other companies and such subsidising or aiding constituted one facet of its business.
8. We deal with the other question as to whether even if the appellant is authorised to subsidise or aid other companies as one of its planks of business activity, whether the interest-free advances made to the two companies was dictated by commercial expediency or considerations. Unitel Communications Ltd. is a joint sector project with Orissa Government having 26.5 percent shares in the company. UTI is having 12.79 per cent, U.B. Group of companies to which the assessee belongs is haying 24.93 percent.36.23 percent is held by the public. Thus the assessee along with its sister concerns is having substantial interest in Unitel Communications Ltd. Funds from the sister concerns have flowed through the assessee-company to the other company. The other company, namely, Unitel Communications was not financially viable and was facing resource crunch as seen from the balance-sheet produced before us. It had a loss of Rs. 509.79 lakhs for the year ending 31-3-1990 and an accumulated loss of Rs. 904 lakhs as against Rs. 491 lakhs for the year ending on 31 -3-1989. The accumulated losses increased to Rs. 1,253 lakhs in the year ending on 31-3-1991 and there is no respite from the same in the year ending on 31 -3-1992 even though there has been some improvement in the sales from Rs. 283 lakhs in the previous year ending on 31-3-1989 to Rs. 1,091 lakhs in the year ended on 31-3-1991. Cost of production has increased from Rs. 645 lakhs to Rs. 1430 lakhs in this period. As a result, the company has been suffering losses from year to year. It had come to grief with the financial institutions as a result of its dismal performance. Even as early as on 11-6-1987, the assessee-com-pany had given an undertaking to the Industrial Finance Corporation of India, New Delhi that it will not withdraw loans or deposits granted by it or that may be granted by it to Unitel Communications Ltd. in future without the prior written permission of the Industrial Finance Corporation of India. In the very same letter the assessee-company has given an undertaking to the Industrial Finance Corporation of India as follows :
We shall not receive or demand any interest on the said loans/deposits granted and/or to be granted by us to the Company if at the time of payment of the said interest, there is a default in the payment of instalment of principal sum(s) and/or interest or any other monies due and owing by the company to you.
We further hereby agree and undertake that any breach of the above undertaking shall be deemed to be a breach of the conditions and covenants contained in the said Loan Agreement referred to above and other documents of security executed/to be executed by the Company in your favour and you will be at liberty to take such action against us and/or the Company as may be deemed fit by you.
Such is the undertaking given by the assessee-company to the Financial Institution in respect of loans and advances granted to Unitel Communications Ltd. Considering the objects of the assessee-company and the substantial nature of the interest it held in the loanee company and the commitment it had given to the Financial Institution for purposes of obtaining facilities for the loanee company, we hold that the assessee-company was guided by the dictates of commercial expediency in not charging interest on its loans to Unitel Communications Limited. One more aspect in this easels that ultimately Unitel Communications Limited had been declared fit for winding up by the BIFR in its preliminary finding dated 21-4-1994 and its ultimate finding dated 7-6-1994. Shri Ramamani rightly contended before us that an industrial unit does not become sick overnight or all of a sudden unlike human beings. Their Lordships of the Supreme Court in CIT v. Mahindra & Mahindra Ltd. [1983] 144 ITR 225 held "that, broadly, the three aspects which constituted the substratum of viability were profitability, liquidity and solvency. If they showed positive figures the unit's financial viability would be sound; where one of the three aspects showed a negative figure the unit could be regarded as 'tending towards sickness'; when two of the three aspects showed negative figures, it would be a case of 'incipient sickness' and when all the three aspects showed negative figures the unit was 'sick'. This being the three concept of financial non-viability as understood by men of business and commerce and financial institutions it was by reference to the several tests or criteria adopted by them that the question whether a particular undertaking was financially non-viable at a given point of time, had to be decided.
9. Applying the above test we are satisfied that Unitel Communications Ltd. has been passing through the three stages of sickness over the years and any prudent businessman who had stake in the business by way of investment of capital would refrain from charging interest further on the advances made by him, as it would only just inflate its own profits without any reward in real terms at a future date. Another aspect of the matter is whether it would be prudent for the company to make further advances to another company facing financial difficulties with lack of profitability and solvency. Small investors can afford to ignore such a company. The assessee-company along with the sister concerns had substantial interest in the company. The assessee's objects are to subsidise or aid other companies. The assessee had entered into a commitment with Financial Institution not to charge interest. Even a fisherman with a fishing hook may not catch fish while standing on the river bank but may hope to get more catches by entering the stream knee-deep or neck-deep in water. He may nat_get catches even then but his attempts should not be pooh-poohed as an imprudent act. Profits are always associated with risk bearing and the act of financing even sick companies in the hope of its revival or survival should be viewed from the stand point of businessman and not from the angle of tax-gatherer. Judging from all these angles, we hold that non-charging of interest on the advances made available to Unitel Communications Ltd. cannot be considered as act of imprudence or an act not dictated by commercial expediency.
10. The authorities have not appreciated in the proper perspective the loan account of Unitel Communications as held in the books of the assessee-company in coming to the conclusion that the ultimate beneficiary in the transaction is United Breweries Ltd. We have got the account copies of United Breweries Ltd. in the books of the assessee-company at pages 31 and 32 of the paper book. From the copies of the accounts it is seen that UBL Ltd.'s account is credited by the payments made to Unitel Communications Ltd. This does not mean that the funds had been given to UBL. Therefore, the charge that UBL is the ultimate beneficiary cannot be held against the assessee. Considering the objects for which the assessee-company has been formed, the interest it had in the working of Unitel Communications Ltd. and the undertaking it had given to the Financial Institution for continuing the facility to Unitel Communications Ltd., it cannot be said that the assessee has entered into transactions of a colourable nature. Common is the tax rate in the case of holding company and subsidiary company. The materials before us do not point to any colourable device. We reject the finding of the CIT (Appeals) on this aspect.
11. In the light of the above discussion, we delete the disallowance of interest of Rs. 41,95,380 on the loans made to Unitel Communications Ltd.
12. The advances to Sapthagiri Traders Pvt. Ltd. are also interest-free. The assessee has not placed any material unlike in the case of Unitel Communications Limited to underline the fact that the advances were made in similar circumstances out of commercial expediency nor has it been shown that the assessee had substantial stake in Sapthagiri Trading Co. Ltd. which warranted its intervention with copious funds without interest. Therefore, the disallowance of interest of Rs. 40,07,010 on the advances made to Sapthagiri Traders Pvt. Ltd. is sustained.
13. The last point at issue before us is whether income by way of dividend and interest are assessable under 'Other sources'. Certainly the objects point to the fact that the assessee is formed for the purpose of lending moneys and making investments in other companies and dealing in shares. Only one of the activities, namely investment in other companies, has taken place. The other activity of dealing in shares, etc., either on a large scale or on a small scale has not taken place during the relevant previous year. In the circumstances, the CIT(Appeals) is justified in treating the dividend income under the head 'Other sources'. However, as far as income by way of interest is concerned, considering the objects of the company and the frequency of advances, we hold that the interest income is part of its business activity and should, therefore, be viewed as income from business only. To this extent the order of the CIT (Appeals) is modified.
14. In the result, the appeal is partly allowed.