2011 (2) TMI 62 - HC - Income Tax

Business expediency Interest on borrowed capital Borrowing from sister concern paying higher rate of interest Investment in shares of another sister concern carrying dividend at lower rate - Tribunal had committed illegality by deleting addition with regard to interest on loan taken from company of the assessee up and investing it in a sister concern was not expended exclusively for the purpose of earning income. Assessing Officer or the appellate authorities and even the courts can determine the true legal relation resulting from a transaction. If some device has been used by the assessee to conceal true nature of the transaction, it is the duty of the taxing authority to unravel the device and determine its true character. However, the legal effect of the transaction cannot be displaced by probing into the substance of the transaction . The taxing authority must not look at the matter from their own view point but that of a prudent businessman. Each case will depend on its own facts. The exercise of jurisdiction cannot be stretched to hold a roving enquiry or deep probe.

Issues Involved:
1. Justification of borrowing funds at a high interest rate for low-yield investments.
2. Determination of the true nature of transactions between sister concerns.
3. Application of the principle of business expediency.
4. Jurisdiction of the Assessing Officer to examine the prudence of business decisions.

Issue-wise Detailed Analysis:

1. Justification of Borrowing Funds at a High Interest Rate for Low-Yield Investments:
The primary issue was whether it was justified for the assessee to borrow funds at an 18% interest rate to invest in shares yielding only a 4% dividend. The Assessing Officer (AO) disallowed the interest expense beyond the 4% yield, reasoning that no prudent person would make such an investment, especially when the borrowing and investment were within sister concerns. The AO viewed this as a colorable device to reduce tax liability, referencing the Supreme Court decision in McDowell and Co. Ltd. [1985] 154 ITR 148.

2. Determination of the True Nature of Transactions Between Sister Concerns:
The Tribunal, however, upheld the assessee's plea, stating that the investment was a bona fide business activity and not a sham transaction. The Tribunal emphasized that the investment was incidental to the business and that there was no adverse effect on revenue since the entities involved belonged to the same group. The Tribunal referenced its earlier decisions in similar cases, such as Pankaj Munjal Family Trust, and ruled that the interest paid was incidental and wholly for business purposes.

3. Application of the Principle of Business Expediency:
The Division Bench referred the matter to a larger Bench due to differing opinions on the application of business expediency. The larger Bench considered the principles laid out in various Supreme Court judgments, including S.A. Builders Ltd. v. CIT [2007] 288 ITR 1, which emphasized that the test of commercial expediency should be applied from the viewpoint of a prudent businessman. The Bench noted that tax planning is permissible, but the legitimacy of claims for deductions must be based on business expediency.

4. Jurisdiction of the Assessing Officer to Examine the Prudence of Business Decisions:
The larger Bench concluded that the AO and appellate authorities have the jurisdiction to determine the true legal relationship resulting from a transaction. They can unravel any device used to conceal the true nature of the transaction but must not displace the legal effect by probing into the substance of the transaction. The AO's role is to assess the transaction from the viewpoint of a prudent businessman, and each case must be judged on its own facts without conducting a roving inquiry.

Conclusion:
The larger Bench answered the referred questions by affirming that the AO and appellate authorities can examine the true nature of transactions and assess them based on the principle of business expediency. The matter will now return to the Division Bench for a decision on the merits, considering the guidelines provided by the larger Bench.

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