2015 (2) TMI 996 - HC - Income Tax

Disallowance of interest u/s 57(iii) - AO observed the transaction as colourable device / tax planning - Held that - It is an admitted fact that the Revenue has not disbelieved the loan transaction of ₹ 3 crores with the company, namely, Arvind Mills Ltd. at the rate of 18.5% p.a. and payment of interest at the rate of 12% to the said four companies where, the appellant - Assessee made investment. It is not in dispute that the appellant - Assessee invested the amount equally in the above four companies so as to get interest at the rate of 12% p.a. It is not a case of the Revenue that the estimated book value of the shares of the said company, as reproduced hereinabove, is not true or correct. Thus, the transaction of borrowing of ₹ 3 crores and payment of interest at the rate of 18.5% made by the appellant - Assessee to Arvind Mills Ltd. and, in turn, receipt of 12% interest by the appellant - Assessee from the investment made by it in the above four companies are believed and, therefore, the said transactions are genuine in nature. To disallow the deduction under Section 57(iii) of the Act, the assessing authority considered the transactions as loan and not as OCDs. The investment made by the appellant - Assessee in the said four companies were not loss making concern at the relevant time and, therefore, the decision of the appellant - Assessee to borrow the money at a higher rate of interest and to invest the same in the said four companies at the rate of 12% with a hope to get shares in future was made to earn income. So, it appears that the Revenue splitted the transactions in such a manner that it upheld the genuineness of borrowing, payment and receipt of interest but when question of considering payment of additional interest of 6.5% came into consideration, it termed the said part of transaction as colourable device/tax planning. So, the question is whether the Revenue can split the transaction in the manner it did so. It is true that the Court cannot re-examine/re-appreciate the findings of fact recorded by the Tribunal but as a matter of fact, after splitting transaction, as done in the case on hand, the Tribunal was required to term/treat the entire transaction as a whole colourable device. Had it been so, the matter would stand on different footing. In our opinion, the Tribunal cannot split the transaction into two parts or more. For that purpose, we made searching inquiry from learned advocate Mr.Bhatt to show any provision of law under the Act or precedent which empowers the Revenue to split transaction into two or more parts and then to hold any one particular part of said transaction as legal/permissible/admissible and other part of the same transaction being colourable device. Learned advocate Mr.Bhatt could not lay his finger on any provision/ precedent which empowers the Revenue to do so. So, once the primary transaction of lending, borrowing and passing of payment of interest is found to be genuine, merely because it resulted into equal amount of income, it would not become a colourable device and consequently earning any disqualification. - Decided in favour of Assessee.

Issues Involved:
1. Disallowance of interest under Section 57(iii) of the Income Tax Act, 1961.
2. Determination of whether the transaction was a genuine investment or a tax avoidance scheme.
3. Examination of whether the expenditure was wholly and exclusively for earning income.

Detailed Analysis:

1. Disallowance of Interest under Section 57(iii):
The primary issue was whether the Tribunal was correct in disallowing the interest of Rs. 19.50 lacs claimed under Section 57(iii) of the Income Tax Act, 1961. The appellant borrowed Rs. 3 crores at 18.5% p.a. and invested in Optionally Convertible Debentures (OCDs) at 12% p.a., claiming the excess interest paid as a deduction. The Tribunal upheld the disallowance, citing that the expenditure was not wholly and exclusively for earning income, as required by Section 57(iii). The Tribunal relied on precedents like Padmavati Jai Krishna vs. CIT and Virmati Jai Krishna vs. CIT, which were affirmed by the Supreme Court.

2. Determination of Whether the Transaction was a Genuine Investment or a Tax Avoidance Scheme:
The Tribunal and lower authorities examined the nature of the transaction, noting that the appellant borrowed funds at a higher interest rate and invested in companies of the same group at a lower rate. The Tribunal found that the option to convert debentures into shares was illusory, as the companies retained the right to redeem the debentures. The Tribunal concluded that the transaction was a tax planning device, not a genuine investment, citing the Supreme Court's judgment in McDowell & Co. Ltd. vs. Commercial Tax Officer.

3. Examination of Whether the Expenditure was Wholly and Exclusively for Earning Income:
The Tribunal examined whether the expenditure was incurred solely for earning income. It found that the appellant incurred a loss by borrowing at a higher rate and investing at a lower rate, which did not meet the criteria of Section 57(iii). The Tribunal distinguished the case from the Supreme Court's judgment in CIT vs. Rajendra Prasad Moody, stating that the appellant's investment in debentures did not qualify for deduction as the primary purpose was not to earn income.

Judgment Analysis:
The High Court examined the Tribunal's findings and the legal principles involved. It noted that the Tribunal's decision to disallow the deduction was based on a dissected view of the transaction rather than considering it as a whole. The Court emphasized that the transaction must be viewed in its entirety, as per the Supreme Court's judgment in Vodafone International Holdings B.V. vs. Union of India. The Court found that the Revenue had accepted the genuineness of the borrowing and investment transactions but disallowed the excess interest deduction by splitting the transaction, which was not permissible.

The High Court referred to the principles laid down in various judgments, including CIT vs. Rajendra Prasad Moody and SA Builders Ltd. vs. CIT, which emphasized that the purpose of expenditure should be to earn income, and the transaction should be viewed from the perspective of a prudent businessman. The Court concluded that the Revenue's approach of splitting the transaction and disallowing the deduction was incorrect. It held that the entire transaction was genuine and aimed at earning income, thus qualifying for deduction under Section 57(iii).

Conclusion:
The High Court allowed the appeals, setting aside the Tribunal's orders to the extent of disallowing the interest deduction. It held that the appellant was entitled to the deduction under Section 57(iii) as the transaction was genuine and aimed at earning income. The Court emphasized that the transaction should be viewed as a whole, and the Revenue's approach of splitting it was not supported by any legal provision or precedent.

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