Income Tax Appellate Tribunal - Delhi
Moral Trading & Investment Ltd, New ... vs Assessee
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH 'E' DELHI
BEFORE SHRI RAJPAL YADAV AND SHRI K.G. BANSAL
I.T.A. No. 4753(Del)/2009
Assessment year: 2006-07
M/s Moral Trading & Investment Deputy Commissioner of Income
Ltd.,C/o Vinod Kumar Bindal & Vs. tax, Circle 5(1), New
Co.,C.As, Shiv Sushil Bhavan
D-219, Vivek Vihar, Ph-I, New Delhi.
PAN-AAACM1076B
(Appellant) (Respondent)
Appellant by : Shri Vinod Kumar Bindal &
Ms. Sweety Kothari
Respondent by: Shri M.K. Gautam, DR
ORDER
PER K.G. BANSAL : AM This appeal of the assessee emanates from the order of CIT(Appeals)-VIII, New Delhi, passed on 3.11.2009 in Appeal No. 89/08- 09, and it pertains to assessment year 2006-07. The corresponding order of assessment was passed by the Deputy Commissioner of Income-tax, Circle 5(1), New Delhi, on 26.12.2008 under the provisions of section 143(3) of the Income-tax Act, 1961. The assessee has taken following three substantive grounds in the appeal:-
"(1) The CIT(A) erred in law and facts in confirming the action of the AO in substituting the full value of consideration of the shares transferred by the assessee with 2 ITA No. 4753(Del)/2009 some presumed fair market value ignoring the judgment of the Hon'ble Supreme Court in the case of CIT Vs. Gillanders Arbhutnot & Co. (1973) 87 ITR 407 and CIT Vs. Nilofar I.Singh (2009) 309 ITR 233 (Del) and Dev Kumar Jain Vs. ITO (2009) 309 ITR 240(Del). Thus, the action of the Assessing Officer should be reversed and the capital gain should be computed on the basis of full value of consideration.
(2) The CIT(A) erred in law and on facts in confirming an addition of Rs. 37,60,41,886/- as short-term capital gain on sale of 23,90,000/- shares transferred on 10.05.05 by considering their date of acquisition as 27.7.04 whereas the same was 4.4.2004 following the Circular No. 704 dated 28.4.95 reported at 213 ITR(St.) 7. Thus, the said loss should be assessed as long term capital loss as claimed by the assessee.
(3) The CIT(A) erred in law and on facts in confirming the disallowance of Rs. 22,03,822/- under section 57(iii) of the Act on interest paid to others ignoring the facts and evidences placed on record. Thus, the action of the assessing officer should be reversed."
1.1 The facts culled out from the assessment order are that the assessee sold 32,88,181/- shares of Hotel Queen Road Pvt. Ltd. ("the HQR" for short) on 10.5.2005 to Shri R.P. Mittal @ Rs. 20/- per share, at a total consideration of Rs. 6,57,63,620/-. The cost of acquisition was shown at Rs. 15,21,79,158/-. In the return of income, short-term capital loss of Rs. 8,64,15,538/- was declared on sale of these shares. Out of the aforesaid, 8,98,181/- shares were acquired on or about 8.10.2002 on account of disinvestment in Hotel Ashok Yatri Niwas by the ITDC. The 3 ITA No. 4753(Del)/2009 details of acquisition, sale, balance shares etc. held by the assessee on 31.03.2006 are as under:-
Date Particulars No. of Rate Amount in
shares (Rs.)
08.10.2002 Shares purchased from 808342 183.63 148438576
ITDC
Shares purchased from 89819 183.63 16493711
Indian Hotels
Shares purchased from other 20 183.63 3673
share holders
898181 164935960
Other Expenses incurred
Bank guarantees given/ 1019631
processing fees etc.
Stamp Duty paid for transfer 825000
Amount of claim lodged 38501433
against ITDC as receivable
from them
Cost of 898181 shares 128279158
27/07/04 Allotment of shares of Hotel 2390000 10 23900000
Queen Road
07/01/05 Allotment of shares of Hotel 4151648 10 41516480
Queen Road
Sale of shares
10/05/05 3288181 shares sold at Rs. 898181 20 17963620
20/- each
10/05/05 2390000 47800000
3288181 657633620
Closing balance of 4151648 10 41516480
investments as on
31.03.2006
4 ITA No. 4753(Del)/2009
1.2 The AO examined the transaction of sale. He came to the
conclusion that sale to Shri R.P. Mittal was a colourable transaction as Shri R.P. Mittal and Smt. Sarla Mittal, the husband and wife duo, controlled the assessee company. Since the HQR was wholly owned subsidiary company of the assessee company, it was also controlled by the husband and wife duo. In order to arrive at this conclusion, he relied on the decision of Hon'ble Calcutta High Court in the case of CIT Vs. L.N. Dalmia (1994) 207 ITR 89, in which it was held that sale of shares to other company formed by the assessee at a lower rate was a devise to avoid tax and, thus, the resulting loss cannot be allowed. Thereafter, he proceeded to work out the fair market value of the shares of HQR on the date of transfer to Shri R.P. Mittal. In this connection, it was mentioned that the bid value of Hotel Ashok Yatri Niwas was about Rs. 45.03 crore. However, the assessee took over only the land and building and sundry creditors and debtors were to be dealt with by the ITDC. On this basis, the asset took over by the assessee from the ITDC, representing by 8,98,166 shares, was about Rs. 16.49 crore. This constituted 99.97% of the equity. The rest of the shares were also acquired from other shareholders at about Rs. 1.65 crore. Therefore, the cost of acquisition per share at the time of taking over Hotel Ashok 5 ITA No. 4753(Del)/2009 Yatri Niwas was about Rs. 183.63. The assessee had also incurred cost on bank guarantee, processing fees and stamp duty, which was added to the cost of acquisition, leading to valuation of the shares at the time of acquisition at Rs. 185.68 per share. The AO adopted this value for working out the capital gains, which worked out to about Rs. 37.60 crore against the loss of about Rs. 8.64 crore claimed by the assessee. The detailed working of the capital gains, computed by the AO, is described as under:-
Date of No. of shares Rate Total Value Indexed
Purchase value
(Rs) (Rs) (Rs.)
8.10.2002 898181 183.63 164932977 183381856
27.07.2004 2390000 10 23900000 24746458
Total 3288181 188832977
Date of sale No. of shares Rate Total Value Difference
(Rs) (Rs) (Rs.)
10.05.2005 898181 185.68 166774248 -16607608
10.05.2005 2390000 185.68 443775200 376041886
Total 3288181 610549448
Total capital gain (Short-term) 376041886
1.3 The assessee had also claimed deduction of Rs. 22,03,822/-, u/s 57(iii), while computing income under the head "income from other sources". In this connection, it was mentioned that share capital and reserve and surplus amounted to Rs. 9.60 crore on 31.3.2006. Therefore, 6 ITA No. 4753(Del)/2009 advances of Rs. 9.20 crore, on which interest was earned, were made out of own funds. The borrowed funds of Rs. 5.50 crore were, thus, deployed for making investments. Therefore, it was held that there is no nexus between borrowing and lending. Therefore, the aforesaid claim was disallowed.
1.4 In the result, the total income of the assessee was computed at Rs. 38,50,75,970/- against the returned income of Rs. 58,43,540/-.
2. Aggrieved by this order, the assessee moved appeal before the CIT(Appeals)-VIII, New Delhi. One of the ground taken before him was that all the shares held by the assessee ought to have been treated as long-term capital asset. It was mentioned that the assessee had shown the asset as short-term capital asset and consequently declared short- term capital loss of about Rs. 8.64 crore. In this connection, the claim of the assessee is that 23,90,000/- shares of the HQR were allotted to it on 4.4.2004 even though the delivery of the shares was taken on or after 27.7.2004. In order to support this contention, the assessee was required to file copies of letter of allotment and the Board resolution. The assessee expressed its inability to file the aforesaid evidence. As against 7 ITA No. 4753(Del)/2009 the aforesaid, evidence by way of copies of letter purportedly written in connection with allotment of shares were filed. According to letter dated 11.11.2003, the shares were to be allotted on the condition that the assessee paid Rs. 2.00 to Rs. 2.50 crore by 31.3.2004. The assessee responded to this letter on the same date. These letters were signed by the assessee and his wife respectively, who corresponded in the capacity of Managing Director and Director of the respective companies. Subsequently, the HQR, vide letter dated 4.4.2004, communicated to the assessee company regarding creating a right in its favour in 23,90,000/- equity shares on 4.4.2004. This letter has also been signed by Shri R.P. Mittal. The necessary formalities with regard to transfer of shares were completed on 27.7.2004. In these circumstances, the ld. CIT(Appeals) came to the conclusion that the aforesaid shares constituted short-term capital asset.
2.1 The ld. CIT(Appeals) also considered the matter regarding adoption of fair market value in place of the sale consideration at the time of transfer of the shares to Shri R.P. Mittal. It was inter-alia mentioned that Shri R.P. Mittal and Smt. Sarla Mittal were in effective control of the assessee company and the HQR. The assessee company managed the 8 ITA No. 4753(Del)/2009 affairs of the HQR in such a manner that other shareholders were kept in dark not only in respect of management of affairs but also about the transfer of shares. In view thereof, the action of the AO to bring a sum of about Rs. 37.60 crore to tax as short-term capital gain was upheld.
2.2 In regard to computation of income under the residuary head, it was submitted that the interest paid to others was on account of substitution of funds deployed earlier to earn interest income. The money was borrowed to discharge the loan due to Shri R.P. Mittal, which was deposited with the HQR. Interest of about Rs. 90.00 lakh was earned on such deposit from the HQR. On making the borrowings, the loan payable to Shri Mittal was reduced from Rs. 9.65 crore on 31.3.2005 to Rs. 3.29 crore on 31.3.2006. The amount was deposited with the HQR and the amount outstanding from this company on 31.3.2006 amounted to Rs. 8.8 crore. The ld. CIT(A) mentioned that for deduction of interest, it is incumbent upon the assessee company to show that the borrowings were actually utilized for earning interest income. The borrowings from Shri R.P. Mittal have been substantially utilized for acquisition of the shares of the HQR. Therefore, there 9 ITA No. 4753(Del)/2009 was no nexus between borrowings and lendings as contemplated u/s 57(iii). Apart from that, the account of Shri Mittal was debited by a sum of about Rs. 6.58 crore towards the shares transferred to him. This makes the absence of the nexus more clear. Therefore, the action of the AO in this regard was upheld.
3. Before us, the ld. counsel for the assessee furnished a brief background in regard to issues in dispute. We think it fit to paraphrase the background as it clarifies the contentious issues. The assessee filed a bid to take over Hotel Ashok Yatri Niwas as a going concern for a sum of about Rs. 45.33 crore. In case the bid became successful, the hotel was to be taken over from the ITDC by acquiring the shares of HQR, a subsidiary of the ITDC. The bid was successful. In terms of the bid, the ITDC was to deal with the debtors and the creditors and only the fixed assets were to be taken over by the assessee. The cost to be paid in respect of the assets, after making adjustment for creditors and debtors, was about Rs. 16.00 crore. Some shares of the HQR were held by the others. Such shares were also acquired by the assessee. There is no dispute about the cost of acquisition of the shares of the HQR acquired from ITDC and others, and the cost of 10 ITA No. 4753(Del)/2009 acquisition worked out by the AO at Rs 185.68 per share has become final.
3.1 Hotel Ashok Yatri Niwas required extensive repairs and renovation. Therefore, fresh capital was required for undertaking such repairs and renovation. Such capital was infused by the assessee company by way of fresh capital subscription at par. The assessee was allotted 23,90,000/- shares on 27.7.2004 at Rs. 2.39 crore. The assessee was further allotted 41,51,648/- shares on 7.1.2005 at Rs. 4,15,16,480/-. Out of original holdings acquired from ITDC and others and fresh allotment of equity, the assessee sold 32,88,181/- shares to Shri R.P. Mittal at Rs. 20/- per share. These shares comprised of 8,98,181/- shares originally acquired and 23,90,000/- shares allotted by the HQR to the assessee on 27.7.2004.
3.2 Coming to the arguments, it is submitted that there is no dispute about the cost of acquisition of these shares. However, there is a dispute when the sale price was substituted by the A.O with the fair market value. The assessee was required to substantiate the sale price as the assessee company as well as the HQR were controlled by Shri R.P. 11 ITA No. 4753(Del)/2009 Mittal and his wife. In this connection, a valuation report was filed showing the fair market value of the shares at Rs. 3.19 per share on the basis of last available balance sheet of 31.03.2005. The valuation was made on asset backing method as the company was not carrying out any business. The value was low because no business was conducted by the HQR between June, 2003 to October, 2008. In this period, the hotel was closed for extensive repairs and renovation. However, the AO did not accept the sale consideration and substituted it with the cost of acquisition and cost of improvement worked out on the basis of payment made at the time of acquisition of the shares from ITDC and others. This could not have been done in the light of various decided cases in the matter.
3.3 Further, there is a dispute whether the shares allotted to the assessee by the HQR constituted long-term or short-term capital asset. According to the evidence filed on record, the HQR, through Shri R.P. Mittal, intimated to the assessee company on 11.11.2003 that there is a need of funds for completing the work of renovation within the stipulated period. The fresh loans are not forth coming, which necessitates further infusion of capital between Rs. 2.00 to Rs. 2.50 crore. In lieu thereof, 12 ITA No. 4753(Del)/2009 equity shares of the company are to be allotted at par on confirmed basis (P.B. 21). This letter was responded to by the assessee company through Smt. Sarla Mittal on 11.11.2003 that the necessary subscription will be made in cash in installments so as to make-up Rs. 2.25 crore by 15.3.2004 for which fresh equity must be allotted by 31.3.2004. A cheque of Rs. 50.00 lakh was enclosed with this letter (PB 22). The HQR wrote a letter to the assessee company through Shri R.P. Mittal on 4.4.2004 acknowledging receipt of Rs. 2.39 crore by cheques up to 4.3.2004, being capital contribution towards 23,90,000/- equity shares and confirming that a right in the shares was created in favour of the assessee company. The share certificate numbers to be delivered to the assessee shortly were also mentioned in this letter (page 23 of the paper book). A copy of share application money account was also filed, which shows various payments between 12.11.2003 to 4.3.2004. On the basis of the Board circular no. 704 dated 28.4.1995 and other cases, it was contended that the assessee acquired the shares on 4.4.2004 when the HQR intimated to it the factum of allotment and the distinctive numbers.
3.4 There is also a dispute regarding deduction of interest paid to others. The facts in this regard are that the assessee company deposited 13 ITA No. 4753(Del)/2009 a sum of about Rs. 8.80 crore with the HQR on which interest of about Rs. 90.00 lakh was received. Borrowings to the extent of about Rs. 9.65 crore were made from Shri R.P. Mittal, to whom no interest was paid. Monies were borrowed from the third parties to discharge the liability towards Shri R.P. Mittal and interest of about Rs. 22.00 lakh was paid on such borrowings. Therefore, it is argued that there was a nexus between borrowings from others and lending to the HQR. Thus, interest paid to others is deductible in computing the income under the residuary head.
4. Coming to the issue of the period of holding the asset, the ld. DR submitted that the assessee had itself shown the date of acquisition as 27.7.2004 (PB 25) while working out short-term capital gains. The assessee company was controlled by Shri R.P. Mittal and Smt. Sarla Mittal, who are the directors of the company. The sales are effected to Shri R.P. Mittal. The assessee has not placed on record the resolution of the board or the minutes of the board meeting in which it was decided to allot shares to the assessee. Thus, the claim of the assessee is based solely on correspondence between the HQR and the assessee company. The three letters have been signed either by Shri R.P. Mittal or Smt. Sarla Mittal and they are in control of the affairs of the HQR also. This 14 ITA No. 4753(Del)/2009 correspondence is not shown to have been placed on the record of any other person or authority. Therefore, no evidentiary value can be placed on this correspondence. Relying on various case law, it was argued that the date of payment is irrelevant as date of acquisition of shares has to be ascertained on the basis of issue of the share certificates. The Board circular does not deal with the situation at hand but it deals with the trading of shares on the stock exchange through brokers. Since the shares were handed over to the assessee on 27.7.2004, the date of acquisition will also be 27.7.2004.
4.1 In regard to substitution of the fair market value in place of sale consideration, the contention is that the transaction was colourable in nature, being between the assessee company and its substantial shareholder. The assessee has not shown any basis for charging sale consideration at Rs. 20/- per share. These shares rank pari-passu with the shares acquired at the time of taking over Hotel Ashok Yatri Niwas. The cost of acquisition and the cost of improvement of the shares at that point was computed by the AO at Rs. 185.68 per share. Therefore, there is no reason to sell the shares at a price below the aforesaid amount. The cases relied upon by the ld. counsel are not applicable 15 ITA No. 4753(Del)/2009 while the cases relied upon by the AO and the ld. CIT(Appeals) are relevant for deciding the controversy. Therefore, it was argued that the computation of capital gain made by the lower authorities may be upheld. 4.2 In the alternative, it is argued that since originally acquired shares were sold at a loss, such loss may be disallowed as it was not a transaction in the nature of business, being a colourable transaction. 4.3 It is also argued that the money received from Shri R.P. Mittal was lent to the HQR on which interest was earned. There was no stipulation of payment of interest to Shri R.P. Mittal. This money was substantially used for allotment of shares to him at par. Therefore, there is no nexus between interest earned from the HQR and interest paid to the third parties.
5. In the rejoinder, the ld. counsel submits that the correspondence between the HQR and the assessee company was not required to be file before any other authority or third party. Therefore, it is not available with any one except the assessee and the HQR. The payments had been made by the assessee on the basis of the letter of the HQR. The 16 ITA No. 4753(Del)/2009 assessee is not in a position to produce the board resolution as it had been excluded from the management of the HQR as evidenced by the order of the ld. CIT(A) and page 84 of the paper book, being the letter dated 15.10.2009 addressed to the ld. CIT(Appeals). In paragraph 2, it is mentioned that at present the management of the company is with the opposite group and minutes book of the hotel company is in their custody. In view thereof, no copy of the resolution can be filed. The primary case of the AO is that fair market value should be substituted in place of the sale consideration. Therefore, it is not a case of disallowance of non-business loss but computation of capital gains by enhancing the sale consideration.
6. We have considered the facts of the case and submissions made before us.
6.1 Ground no. 1 is that the ld. CIT(A) erred on facts and in law in confirming the action of the AO regarding substitution of full value of consideration of shares transferred by the assessee with fair market value of the shares. Briefly, the facts are that the assessee acquired 8,98,181/- shares of the HQR on or about 8.10.2002 for the consideration 17 ITA No. 4753(Del)/2009 of Rs. 16,67,80,591/-. Further, the assessee was allotted 23,90,000/- shares of this company on or about 27.7.2004 for a consideration of Rs. 2.39 crore. These shares were sold to Shri R.P. Mittal @ Rs. 20/- per share for aggregate consideration of Rs. 6,57,63,620/-. The AO worked out the fair market value of the shares, on the basis of acquisition of 8,98,181/- shares, at Rs. 185.68 per share. The long-term and the short- term capital gains were worked out accordingly by substituting the aforesaid fair market value in place of the sale consideration actually received by the assessee.
6.2 Section 48 of the Act prescribes the mode of computation of the capital gains. It reads as under:-
"48. The income chargeable under the head "capital gains" shall be computed by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely:-
(i) expenditure incurred wholly and exclusively in connection with such transfer.
(ii) The cost of acquisition of the asset and the cost of any improvement thereto;"
[The remaining portion of the section is not relevant for our purpose]. 18 ITA No. 4753(Del)/2009 6.3 The issue as to whether fair market value can be substituted in place of the sale consideration was examined by the Hon'ble Supreme Court in the case of CIT Vs. Gillanders Arbuthnot & Co., (1973) 87 ITR 407 under section 12B(2) of the 1922 Act, which reads as under:-
"The amount of capital gain shall be computed after making the following deductions from the full value of the consideration for which the sale, exchange, relinquishment or transfer of the capital asset is made, namely:
(i) expenditure incurred solely in connection with such sale, exchange, relinquishment or transfer;
(ii) the actual cost to the assessee of the capital asset, including any expenditure of a capital nature incurred and borne by him in making any addition or alterations thereto, but excluding any expenditure in respect of which any allowance is admissible under any provision of sections 8, 9,10 and 12:"
[The remaining portion of section 12B is not relevant for our present purpose] 6.4 While deciding this case, the Hon'ble Court followed its own decision in the case of CIT Vs. George Henderson & Co. Ltd. (1967) 66 ITR 622. It was mentioned that the legislature has made a distinction between the expression "the full value of the consideration" and "fair market value of the capital asset". The 1922 Act provides for two 19 ITA No. 4753(Del)/2009 exceptions, which are not applicable to the facts of our case. It was held that if these two conditions are not applicable, the main provision will become applicable in computing the capital gains by taking into account the full value of consideration for the transfer. The relevant portion quoted from the case of George Henderson & Co. Ltd. (supra) by the Hon'ble Court, which was followed by it, is reproduced below:-
"In case of a sale, the full value of the consideration is the full sale price actually paid. The legislature had to use the words 'full value of the consideration' because it was dealing not merely with sale but with other types of transfer, such as exchange, where the consideration would be other than money. If it is therefore held in the present case that the actual price received by the respondent was at the rate of Rs. 136/- per share, the full value of the consideration must be taken at the rate of Rs. 136/- per share. The view that we have expressed as to the interpretation of the main part of section 12B(2) is borne out by the fact that in the first proviso to section 12B(2), the expression 'full value of the consideration' is used in contradistinction with 'fair market value of the capital asset' and there is an express power granted to the Income-tax Officer to 'take the fair market value of the capital asset transferred' as 'the full value of the consideration' in specified circumstances. It is evident that the legislature itself has made a distinction between the two expression 'full value of the consideration' and 'fair market value of the capital asset transferred' and it is provided that if certain conditions are satisfied as mentioned in the first proviso to section 12B(2), the market value of the asset transferred, though not equivalent to the full value of the consideration for the transfer, may be deemed to be the full value of the consideration. To give rise to this fiction the two 20 ITA No. 4753(Del)/2009 conditions of the first proviso are: (1) that the transferor was directly or indirectly connected with the transferee, and (2) that the transfer was effected with the object of avoidance or reduction of the liability of the assessee under section 12B. If the conditions of this proviso are not satisfied the main part of section 12B(2) applies and the Income-tax Officer must take into account the full value of the consideration for the transfer."
6.5 The ld. counsel had also relied on the decision of Hon'ble Delhi High Court in the case of CIT Vs. Smt. Nilofer I.Singh, (2009) 309 ITR
233. The Hon'ble Court applied the decision in the case of George Henderson & Co. Ltd. and Gillanders Arbuthnot &Co. (supra). It was held that for the purpose of computing capital gains in such a case as the one before us, there is no necessity for computing the fair market value and, therefore, the AO could not have referred the matter to the Valuation Officer. This decision was followed by the Hon'ble Court in the case of Dev Kumar Jain Vs. ITO & Another (2009) 309 ITR 240. 6.6 Coming to the cases relied upon by the ld. DR, the facts of the case of CIT Vs. L.N. Dalmia, (1994) 207 ITR 89 are that the assessee floated a private limited company called LNE. The assessee and his nephew became subscribers to the Memorandum and Articles of Association. The certificate of incorporation was issued by the 21 ITA No. 4753(Del)/2009 Registrar on 6.6.1969. The assessee sold 27,162 shares of Punalur Paper Mills Ltd. to LNE at Rs. 25/- per share in May, 1969. The LNE had not been incorporated till that date. The LNE duly ratified the purchase of shares on 7.6.1969, i.e., after its incorporation. Thereafter, another lot of 12,000 shares of the same company were sold by the assessee to LNE @ Rs. 25/- per share. The assessee suffered a loss of Rs. 7/- per share on the sale of 39,162 shares. The loss was disallowed by the AO by treating it to be unreal and sham. The AAC and the Tribunal allowed the loss. The Tribunal was of the view that the transaction took place between the individual, being the holder of the shares, and a company, being a separate legal entity. On the face of it, the transaction does not appear to be influenced by doubtful factors and the transaction took place as if it was a normal transaction. Reversing the order of the Tribunal, the Court observed as under:-
"As discussed, the assessee effected a transaction of sale of shares held by him to companies formed by himself holding the major part of shares of such companies along with his nephew and wife, who held only the smaller part therein and are shown to have suffered a loss by the sale which would be a cushion against future tax liability for gain either under the revenue head or under the capital head. We have observed that as for the exercise of control over the shares, more particularly over the control of the company (Punalur Paper Mills Ltd.), there has been no change whatsoever. He continued to exercise the same control over Punalur Paper Mills Ltd. as before. This 22 ITA No. 4753(Del)/2009 special aspect cannot be overlooked by any appellate authority dealing with tax matters. When there was no real change whatsoever, the apparent change being the transfer on the surface of shares from the individual to the company, a handmaid of the transferring individual, cannot be overlooked and we are in complete agreement with the view of the taxing authority that there was no real change or transfer and the transfer claimed was a sham transfer. Relying upon the decision of the Supreme Court in the case of Workmen of Associated Rubber Industry Ltd. (1986) 157 ITR 77, we hold that it was the duty of the Tribunal to get behind the smoke-screen and discover the true state of affairs in a case like the one before us. This duty the Tribunal pre-eminently failed to do. Accordingly, the issue set out earlier at No. (ii) involving question No. 2 is answered in the affirmative and in favour of the Revenue."
6.7 Thus, the ratio of the case is that the appellate authorities can go behind the transaction and examine whether the transaction was required to be undertaken because of valid consideration or not. If not, the loss incurred in the transaction can be ignored. However, we shall deal with this matter later.
6.8 The ld. DR had also relied on the decision of Hon'ble Delhi High Court in the case of A.S. Bhargava Vs. CIT, (1973) 88 ITR 14. The questions before the Court were as under:-
"1. Whether, on the facts and circumstances of the case, the Tribunal could hold that a sum of Rs. 30,000/- being the face value of three hundred fully paid up shares of 23 ITA No. 4753(Del)/2009 Messers. Delhi Gate Services (P) Ltd., was not capital but revenue receipt in the hands of the petitioner liable to tax?
2. Even if it be held that the aforesaid amount represented revenue receipt, could the Tribunal in law hold that the entire face value of the shares constituted revenue receipt which was assessable to tax?"
6.8.1 In that case, question no. 1 was decided against the revenue and in favour of the assessee. In regard to question no. 2, the Hon'ble Court held that the Tribunal was right in its observation that where income was not received in money but in money's worth, its value had to be determined with reference to the market conditions prevailing at the time of receipt of the money's worth. Therefore, the Tribunal ought to have determined the market value of shares at that point as face value of the shares would not constitute the income. Thus, the ratio of the case is that if income is earned in money's worth, the fair market value will be the quantum of income. Such is not the question before us. The assessee had not received the consideration in money. Further, there is no allegation that anything more over and above Rs. 20/- per share was received on sale to Shri R.P. Mittal. Therefore, the ratio of this case is not applicable.
6.9 The ld. DR had also relied on the decision of Hon'ble Supreme Court in the case of Orient Trading Co. Ltd. Vs. CIT, (1997) 224 24 ITA No. 4753(Del)/2009 ITR 371. The question before the court was whether, the Tribunal was right in holding that on the facts and in the circumstances of the case, the exchange of one security for another could be described as realization of the security resulting in profit? The Hon'ble Court held that having taken shares in the second company in exchange for the shares of the first company, the assessee had made realization of the value of shares of the first company and the difference between price of the shares of the first company and the second company on the date of such exchange has to be treated as profit of the assessee. It may be mentioned that the assessee had valued the shares of the second company at Rs. 1.45 lakh, being the cost of shares of the first company. The AO valued the shares of the second company on the basis of quotation at Rs. 5.51 lakh. The ratio of this case is that where money's worth is received in consideration for transfer of an asset, the fair market value will be the realization made for the purpose of computing the profit. The ratio of this case is also not applicable because the assessee realized the consideration in money and not in money's worth.
6.10 On consideration of the facts and the case laws relied upon by the rival parties, we are of the view that the ratio of the decision in the case 25 ITA No. 4753(Del)/2009 of Gillanders Arbuthnot & Co., Nilofer I. Singh and Dev Kumar Jain are applicable to the facts of the case. Section 52, containing provisions regarding substitution of fair market value in place of sale consideration, in the case of related parties transactions and understatement of consideration, stand omitted by Finance Act, 1987 w.e.f. 1.4.1998. Thus, no ground survives for such a substitution. Therefore, it is also held that the ld. CIT(A) could not have substituted fair market value of the shares transferred in place of consideration received or accruing.
7. The ld. DR also raised an alternative argument that the transactions were between the related parties. The assessee was a holding company of the HQR. Shri R.P. Mittal and his wife were controlling the affairs of both the companies. In such a scenario, it was argued that the transaction of sale was not in the normal course of business and, therefore, the loss could not have been allowed. In this connection, we have already considered the decision in the case of L.N. Dalmia (supra), in which it was held that the real question to be seen is whether there is any material change in position after transfer vis-à-vis the position before transfer. The facts of the case of L.N. Dalmia 26 ITA No. 4753(Del)/2009 (supra) were distinguished by the assessee before the ld. CIT(A) in letter dated 17.8.2009. Relevant paragraph nos. 2.15 to 2.17 are reproduced below:-
"2.15 Thus, Mr. Mittal pressurized for such transfer and it was decided by the appellant to transfer a part of the equity shares held by the appellant in HQR to Mr. Mittal @ Rs. 20/- per share though technically at that time the net worth of the said share was much lower. The said company is a private limited company and its shares are not quoted or freely transferable. Since by purchase of the said shares no other buyer could get controlling interest in HQR, no other person was willing to buy the same even at part value. Thus, the said shares were to transferred. In fact, out of the total 32,88,181 equity shares of Rs. 10/- each so transferred, more than 72% being 23,90,000 equity shares were transferred at a gain of Rs. 10/- share i.e., at 100% gain as those were allotted to the appellant just a little more than a year ago at Rs. 10/- per share but sold at Rs. 20/- per share. It is only the balance 8,98,181 equity shares the appellant incurred loss as due to passage of time the value eroded and the property got sterlised. It could not be used for any other purpose and in absence of the funds the same could also not be commissioned. All the licenses having been expired it could not be operated even as the old budget hotel as all the permissions were required afresh. It was an extremely adverse situation with a bleak prospect then. Thus, under several compulsions including as above, the said impugned shares were transferred to save the investments made by the appellant in the hotel company by letting Mr. Mittal arrange funds for the said company and then to enable it to commence commercial operations of the hotel. Admittedly, the appellant could not have arranged more funds and in absence of which the entire investment would have sunk. Thus, by the said transfer of shares, the appellant not only saved its investment and reduced the 27 ITA No. 4753(Del)/2009 liability but also ensured that in due course its remaining investment also gains with returns on investments in the hotel. It was a prudent businessman decision taken under the then prevalent circumstances and commercial expediency. It must be appreciated that it might be that Mr. Mittal was controlling both the companies but as far as the ownership of equity in HQR was concerned, it was the appellant who was the owner and not Mr. Mittal till the shares were transferred to him so that he actually becomes the owner of the said shares.
2.16 The Assessing Officer did not appreciate the ground reality of the appellant and the then prevalent circumstances that as to why the 23,90,000 and 41,51,648 equity shares were allotted against cash contribution by HQR to the appellant in 2004/2005 at par value if the said shares could be offered in the market at higher value by the said company. Admittedly, the only business being the hotel of the said company was closed for completion of renovation for want of funds. It was in dire need of money in any manner from any source. The assessing authority has not alleged that the said shares were purchased by the appellant by making underhand payments or not at the fair market value then. Even the appellant could have sold the shares in the market to some body else at a huge premium amount as computed by the assessing officer, if those were so saleable and would have used the said liquid funds by financing the hotel company to enable it to commence commercial operations of the hotel. Since, these shares did not have any market at all at that time, those could not fetch what to say higher but any price at all and, therefore, those were so sold to Mr. Mittal because it was only he who could be interested in those shares in terms of the prevalent circumstances.
2.17 The Assessing Officer has relied on a judgment of the Hon'ble Calcutta High Court in the case of CIT Vs. L.M. Dalmia, 207 ITR 89 to hold that the impugned loss was a colourable transaction. However, while adjudicating so, the Assessing Officer ignored that the facts of that case 28 ITA No. 4753(Del)/2009 were altogether different than the facts in the case of the appellant. In the said case, no payment was made for transfer of shares and the transaction was on credit. However, here the sale consideration had already been received in cash in advance from the buyer earlier. Further, there the Assessing Officer never determined the value under any permitted method but adopted a value as declared by the assessee. However, here the ld. assessing officer substituted the sale price by the value at which the appellant company acquired the said shares in 2002 while the hotel was running and the circumstances were different. In the said case, after appreciating various facts, the loss was disallowed but no addition was made. However, in this case an addition has been made on presumption presuming receipt of a higher sale consideration, which is not permitted. Thus, the ratio of the said judgment is not applicable to this case."
7.1 The facts of this case are that 8,98,181 shares were originally acquired in the year 2002 for a consideration of about Rs. 12.82 crore in order to acquire control over the HQR. Since the Hotel required extensive repairs etc. and money was not forthcoming from third parties, subscription was made in the year 2004 @ Rs. 10/- per share for additional capital of Rs. 2.39 crore. Further subscription was made in the year 2005 @ Rs. 10/- per share at about Rs. 4.15 crore. The original shares and 23,90,000 shares acquired in the years 2002 and 2004 were sold to Shri R.P. Mittal in this year. The hotel was not functional as it was under repairs. The funds for subscription were raised from Shri R.P. Mittal. The further facts are that the shares were valued @ Rs. 3.19 29 ITA No. 4753(Del)/2009 per share by the authorized valuer. The revenue, though challenged the valuation, has not placed any other valuation report to rebut the value of Rs. 3.19. We have accepted the value of Rs. 20/-, of course on legal grounds, which has resulted in profit to the assessee on transfer of 23,90,000 shares. There is also dispute about control and management of the company between two rival groups. The assessee was indebted to Shri R.P. Mittal, who had advanced money without stipulation of charging interest. Thus, there is a qualitative difference in the facts of this case and the facts of the case of L.N. Dalmia. In that case, there was no dispute between the shareholders in regard to management of the company. However, as we shall see later while dealing with ground no. 2 that there were two groups of shareholders in this case, one may be termed as R.P. Mittal group and the other as Ashok Mittal group, these persons being brothers. Litigation was going on in regard to management of this company and the HQR. Further, there were reasons to transfer the shares to Shri R.P. Mittal as the assessee was indebted to him. The other difference is that the sale price of Rs. 20/- per share in respect of 23,90,000 shares was more than the purchase price of Rs. 10/-. Thus, no loss but profit occurred in respect of sale of these shares. Having accepted this sale consideration, it would be difficult 30 ITA No. 4753(Del)/2009 to countenance the argument that original shares should be valued at a much higher value. Further, initial 8,98,181 shares were purchased to get complete control over the HQR, which finally vested in Shri R.P. Mittal. Shares were subsequently purchased to enhance the capital of the HQR, required for extensive repairs and renovation. In such circumstances, we do not find it feasible to record a finding that the sale was a colourable devise. Therefore, we do not think it necessary to lift the corporate veil as it cannot be said that the transactions were bogus or non-genuine.
8. Thus, ground no. 1 is allowed.
9. Ground No. 2 is that the ld. CIT(A) erred on facts and in law in confirming the addition of about Rs. 37.60 crore as short-term capital gain on sale of 23,90,000/- shares of the HQR transferred on 10.05.2005 by taking the date of acquisition as 27.7.2004 in place of 04.04.2004. 9.1 The facts in this connection are that the HQR wrote a letter dated 11.11.2003 through Shri R.P. Mittal, Managing Director, to the assessee bringing to his notice the matter regarding lack of funds necessary 31 ITA No. 4753(Del)/2009 to meet various requirements and requested to make necessary arrangements by 31.3.2004 for fresh contribution between Rs. 2.00 crore to Rs. 2.50 crore by way of equity to be allotted at par. This letter was responded by the assessee vide letter dated 11.11.2003 i.e., on the same date through Smt. Sarla Mittal, director, in which a firm commitment of subscribing Rs. 2.25 crore was made and promising to make effort for the balance contribution. It was also mentioned that the fresh equity must be allotted before 31.3.2004. A cheque of Rs. 50.00 lakh was enclosed with this letter. We may treat these letters as prospectus and offer to make contribution subject to the condition. The HQR responded by letter dated 4.4.2004 through Shri R.P. Mittal, acknowledging receipt of Rs. 2.39 crore by way of various cheques and allotment of 23,90,000/- shares at par. It was also mentioned that a right was created in his favour and requisite distinctive numbers of the shares were also mentioned. The share application account shows receipt of the aforesaid amount on various dates between 12.11.2003 and 4.3.2004. The share certificates were handed over to Shri R.P. Mittal on 27.7.2004. The assessee treated these shares as a short-term asset and computed short-term capital gain on transfer of these shares at Rs. 2.39 crore. However, this position was sought to be altered in the course 32 ITA No. 4753(Del)/2009 of assessment. In the proceedings, the assessee failed to produce minutes book to support whether any resolution was passed by the Board of Directors at any point of time for allotment of these shares. We may also add that the assessee has not furnished at any time any communication made to the Registrar of Companies in this matter or the copy of shareholders' register showing the date on which these shares were entered against his name.
9.2 The case of the assessee is built entire on paragraph 2 of Board circular no. 704 dated 28.4.1995. It is contended that in consonance with this circular, the period of holding should be counted from 4.4.2004. The Board circular deals with securities transaction undertaken through stock exchanges and it has been mentioned that the period of holding shall be reckoned from the date of the broker's note for purchase on behalf of the investors. For the sake of completeness, this paragraph is reproduced below:-
"2. When the securities are transacted through stock exchanges, it is the established procedure that the brokers first enter into contracts for purchase/sale of securities and thereafter, follow it up with delivery of shares, accompanied by transfer deeds duly signed by the registered holders. The seller is entitled to receive the consideration agreed 33 ITA No. 4753(Del)/2009 to as on the date of contract. The Board are of the opinion that it is the date of broker's note that should be treated as the date of transfer in cases of sale transactions of securities provided such transactions are followed up by delivery of shares and also the transfer deeds. Similarly, in respect of the purchasers of the securities, the holding period shall be reckoned from the date of the broker's note for purchase on behalf of the investors. In case the transactions take place directly between the parties and not through stock exchanges, the date of contract of sale as declared by the parties shall be treated as the date of transfer provided it is followed up by actual delivery of shares and the transfer deeds."
9.3 Therefore, the case of the ld. counsel is that the period of holding should be reckoned from 04.04.2004 when confirmation letter was received by the HQR.
9.4 Against the aforesaid, the case of the ld. DR is that the husband and the wife duo are controlling both the companies. These letters have not been filed before any authority. Therefore, the authenticity of the letters cannot be relied upon in the face of the fact that the assessee itself had taken the shares to be a short-term capital asset in the return of income by counting the period of holding from 27.7.2004. The assessee was required to produce the minutes book, which was not done by stating that there were disputes with the other group of Shri Ashok Mittal because of which the assessee is unable to produce the minutes book. 34 ITA No. 4753(Del)/2009 9.5 We have considered the facts of the case and submissions made before us. Section 2(42A) defines the term "short-term capital asset" to mean a capital asset held by an assessee for not more than 36 months immediately preceding the date of its transfer. The proviso to this section reduces the period from 36 months to 12 months in case of a share held in a company. The question is whether the assessee held these shares for not more than 12 months from the date of transfer? 9.6 None of the contending parties referred to the provisions of the Companies Act in this matter. We have done a bit of research to understand the situation on clearer footing. Under that Act, a contract for allotment of shares stands at par with an executory contract under the Contract Act. An agreement to allot shares or take and pay for shares is specifically enforceable, as held in the case of Sri Lanka Omnibus Co. Ltd. Vs. Perera, (1952) AC 76. The legal possibility of a valid executory contract for allotment of shares is recognized, provided there is an offer to take up shares which was communicated to and was accepted by or on behalf of the company. An executory contract to take up shares may be brought into existence in the same manner and subject to the 35 ITA No. 4753(Del)/2009 same principles as under the Contract Act. The communication of acceptance need not be in writing. It may be verbal or may be inferred from conduct as held in Transport Company Ltd. Vs. Tirunelveli Motor Bus Co. Ltd., (1955) 2 Mad LJ 141 at 147. The Court mentioned at page 147 that a Court has jurisdiction to decree specific performance of a contract either to take shares or to allot shares subject to the same principles which govern suits for specific performance, as laid down in the Specific Reliefs Act. It has, therefore, to be seen, whether the evidence in the case establishes an executory contract of exchange of shares for the buses" accepted by the directors. The court cited with approval the observation of FRY LJ in Portuguese Consolidated Copper Mines Ltd., Re, LR (1889) 42 Ch D 160 to the effect that the company is entitled to the combined wisdom of directors but that the exercise of combined wisdom does not necessarily require directors' meeting. Though no proof was available to show that the directors actually met to approve the transaction but there was the endorsement by five our of seven directors which shows that they consulted each other and the majority of them was of one mind and this was sufficient to signify their agreement on behalf of the company. The court relied upon Bonellis Telegraph Co. (Collie's claim), (1871) LR 12 Eq 246, 258. Also 36 ITA No. 4753(Del)/2009 Bai Mangu Vs Bharatkhand Cotton Mills Co., AIR 1930 PC 134 and In re, Universal Banking Corporation (Gunn's case), LR (1867) 3 Ch App 40. 9.7 Further, the Act uses the term "holding of shares" in section 81(1)(a). The general understanding under that Act is that this term is synonymous with the term "member". Although the term "holders of the equity shares" is used in sub-section (1)(a) and members in sub-section (1-A)(b), the two terms are synonymous and mean persons whose names are entered in the register of members as held in Balkrishan Gupta Vs. Swadeshi Polytex Ltd., (1985) 58 Com Cases 563: AIR 1985 SC520; Howrah Trading Co. Vs. CIT (1959) 29 Com cases 282: AIR 1959 SC 775; Killick Nixon Ltd. Vs. Bank of India, (1985) 57 Com Cases 831 (Bom-DB).
9.8 The assessee relies on Board circular (supra), which deals with the transaction carried on recognized stock exchanges. The broker's note is a third party evidence, which also get registered with the stock exchange. Thus, these are reliable evidences. However, the whole evidence here is internal and it is not in respect of transaction on a recognized stock exchange. Consequently, the circular or the ratio of the case of Max 37 ITA No. 4753(Del)/2009 Telecom Ventures Ltd. Vs. ACIT, (2008) 114 ITD 46 (Asr.), based on it, cannot be applied to the facts of this case.
9.9 On perusal of evidence on record, it can be said that there was an offer made by the assessee company to the HQR for subscribing to about 22,50,000 shares. However, it was a conditional offer that the allotment must be made before 31.3.2004. This condition has not been satisfied by the HQR. It is also a matter of fact on record that the assessee had paid Rs. 2.39 crore to the HQR by 04.03.2004 as share application money. However, it is not clear whether any board meeting took place or the directors by majority consensus decided to allot 23,90,000/- shares to the assessee company. As per the provisions of Companies Act, the shares could be allotted only if a meeting had taken place to consider the conditional officer and a decision taken to allot the aforesaid shares to the assessee. In the case of Portuguese Consolidated Copper Mines Ltd. (supra), there was no proof available to show that the directors actually met to approve the transaction, but there was endorsement of five out of seven directors, which shows that they consulted one another and majority of them was of one mind and this was sufficient to signify their agreement on behalf of the company. In the 38 ITA No. 4753(Del)/2009 instant case, letter dated 04.04.2004 does not indicate whether any meeting took place or not and if not, whether majority of the directors of the HQR was of one mind for allotting 23,90,000/- shares to the assessee on 4.4.2004. The delay in allotment probably required the assent of the assessee, which is also not proved by any evidence on record. Therefore, even in a situation where the requisite amount was paid by the assessee company, it cannot be said that any legally binding agreement came into existence between the assessee and the HQR on the basis of letter dated 04.04.2004. In other words this letter loses evidentiary value, more so because it has been written by the HQR without narrating the background details regarding meeting etc. and allotment. In the case of S.N. Zubin George Vs. CIT, (2004) 265 ITR 683, relied upon by the ld. DR, the Tribunal had recorded the finding that there was no evidence to show that the shares were in existence prior to 31.5.1988. Even if the money belonging to the assessee was appropriated to share deposit account of the company that by itself will not amount to allotment of shares. The reason being that the shares can be issued only after company passes a resolution deciding to allot shares. The assessee could not establish that the shares were allotted to him earlier than 31.5.1988. Therefore, its finding that the date of issue of share certificates was the date of 39 ITA No. 4753(Del)/2009 allotment was upheld by the Hon'ble Court. As in that case, in this also there is no evidence regarding the holding of board meeting to consider allotment of shares to the assessee in terms of its conditional offer dated 11.11.2003. The computation of gain as short-term capital gains by the assessee in the return of income by assessee itself negates the content of letter dated 04.04.2004. We are of the view that such a computation was in accordance with the judgment in the case of S.N. Zubin George (supra). We may add that the assessee has not produced copies of record from the office of Registrar regarding allotment of shares and shareholders' register showing the dates on which these shares were added against its name. The absence of these documents, the onus of production of which for substantiating its claim was on the assessee, further weakens the case of the assessee. It may also be added that under the Company Law "holder of equity shares" is a term synonymous with the "member of the company". Mere allotment of shares in the meeting of the board does not make an investor to be member of the company. He becomes the member only when his name is entered in the shareholders' register after completing necessary requirements under the Companies Act. However, we may not take this factor into account as the case is covered by the decision in the case of 40 ITA No. 4753(Del)/2009 S.N. Zubin George (supra). In such circumstances, we are of the view that the ld. CIT(Appeals) was right in holding that the assessee held the shares with effect from 27.07.2004 and, thus, the capital gain was to be treated as "short-term capital gains".
10. Thus, ground no. 2 is dismissed.
11. Ground no. 3 is that the ld. CIT(A) erred in confirming the disallowance of Rs. 22,03,822/- made u/s 57(iii) on interest paid to others. The facts on record in regard to this ground, mentioned in the assessment order, are that the assessee did not furnish any evidence to prove that the interest paid was for the purpose of earning interest income. Before the ld. CIT(Appeals), it was submitted that the money was borrowed from Shri R.P. Mittal and deposited with the HQR on which interest of Rs. 90.00 lakh was earned. This loan was reduced from Rs. 9.65 crore to Rs. 3.29 crore at the end of the year. For this purpose interest-bearing loans were raised from others. Therefore, there was a nexus between interest paid and the interest earned. The ld. CIT(Appeals) mentioned that necessary records for verification of the fact whether borrowings were made to partly discharge the debt in 41 ITA No. 4753(Del)/2009 respect of Shri R.P. Mittal, were not produced. Substantial part of the money raised from Shri R.P. Mittal has been utilized for acquisition of shares of the HQR. Thus, no specific case was made out regarding the nexus. It was further mentioned that on perusal of account of Shri R.P. Mittal it is found that the same has been debited by a sum of Rs. 6,57,63,620/- for transfer of shares to him. Therefore, the claim of the assessee is factually incorrect.
11.1 Before us, it has been submitted that no question was asked by the AO regarding disallowance of interest. The facts are that the assessee had raised loans of about Rs. 9.65 crore from Shri R.P. Mittal on which interest was not charged. A sum of about Rs. 8.80 crore was deposited with the HQR, on which interest of about Rs. 90.00 lakh was earned. As Shri Mittal was demanding the return of money, borrowings had to be made from outsiders on which interest of about Rs. 22.00 lakh was paid. Therefore, there is a nexus between interest paid and interest received. In reply, the ld. DR relied on the order of the ld. CIT(Appeals).
42 ITA No. 4753(Del)/200911.2 We have considered the facts of the case and submissions made before us. Section 57(iii) is in the nature of a residuary provision, permitting the deduction of any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income. This section is analogous to section 37(1) albeit with a narrower ambit, as that provision contains the words "laid out or expended wholly and exclusively for the purpose of making or earning such income" as against the words "laid out or expended wholly and exclusively for the purpose of business". The provision under consideration requires proof of nexus between earning of income and the expenditure. In the case of T.S. Krishna Vs. CIT, (1973) 87 ITR 429, it was held that payment of wealth- tax did bear any direct or incidental relationship with earning of dividend income and, therefore, it is not deductible in computing income under the residuary head. In the case of Seth R. Dalmia Vs. CIT, (1977) 110 ITR 644 (S.C.), one of the questions before the Court was whether, on the facts and in the circumstances of the case, the Tribunal rightly rejected assessee's claim for deduction of interest payment of Rs. 2,04,744? It was mentioned that the dividends, rights, bonuses etc. were held by the bank for the benefit of the assessee after they were 43 ITA No. 4753(Del)/2009 declared. If the assessee would not have paid the interest on the loan raised by him, he would not have been able to get the dividend income. Thus, there was a direct nexus between earning of dividend income and expenditure of Rs. 2,04,744/-. In this view, the expenditure was deductible in computing the income. In the case of Smt. Padmavati Jaikrishna (1987) 166 ITR 176 (S.C), it was held that interest paid on loan taken for discharge of income-tax and wealth-tax liability and to pay annuity deposit was not deductible u/s 57(iii). The Hon'ble Court referred to its own decision in the case of CIT Vs. Rajender Prasad Moody (1978) 115 ITR 519, in which it was held that the purpose of the expenditure is a relevant factor in determining the deductibility of expenditure u/s 57(iii) and that purpose must be making or earning of income. In this connection, it was also mentioned that so far as annuity deposit is concerned, the Tribunal and the High Court have come to the right conclusion that the dominant purpose was not to earn income by way of interest but to meet statutory liability of making the deposit. The test to apply is that the expenditure should be incurred wholly and exclusively for the purpose of earning the income. The fact finding authorities have come to the conclusion that no part of the expenditure came within the purview of section 57(iii). Relying on this 44 ITA No. 4753(Del)/2009 decision, it was held that the assessee's appeal has to fail. In the case of Jaswantrai P.Mehta Vs. CIT (1991) 192 ITR 577, it was held that interest paid on loan taken for the purpose of earning income was deductible, but interest on interest paid was not deductible. In this connection, it was mentioned that whether interest payable on interest is part of the same transaction and whether it becomes part of principal amount borrowed under the principles of accountancy is of no consequence.
11.3 The facts canvassed by the ld. counsel in our case are that the assessee had raised interest-free loans from Shri R.P. Mittal. The money was advanced to HQR and interest income was earned on the advances. The loans taken from Shri R.P. Mittal were discharged by repaying the loan from borrowed funds from others raised subsequently. The reason is stated to be that Shri Mittal was demanding return of his loan. Seen in this context, the dominant purpose of borrowings from others was to return the loan taken from Shri R.P. Mittal. This was done to discharge a pre-existing contractual liability. The funds were not borrowed from others to invest them for the purpose of earning the income. Thus, although the borrowings from others may have a remote 45 ITA No. 4753(Del)/2009 connection with the lending to the HQR, though repudiated by the revenue, the dominant purpose of the borrowings was not to earn interest income. Therefore, it cannot be said that moneys were borrowed from others wholly and exclusively for the purpose of earning interest income from the HQR. Thus, the provision contained in section 57(iii) is not applicable to the facts of the case as submitted to us and before the lower authorities. Therefore, it is held that the ld. CIT(Appeals) was right in disallowing the expenditure in computing interest income taxable under the residuary head.
12. In the result, the appeal is partly allowed.
This order was pronounced in the open court on 30 April, 2010.
Sd/- sd/- (Rajpal Yadav) (K.G.Bansal) Judicial Member Accountant Member Date of order: 30.04.2010. SP Satia Copy of the order forwarded to:- 1. Moral Trading & Investment Ltd., New Delhi. 2. DCIT, Circle 5(1), New Delhi. 3. CIT(A) 4. CIT, New Delhi. 5. DR, ITAT, New Delhi. Assistant Registrar.