2016 (9) TMI 18 - HC - Income Tax

Benefit of exemption u/s 11 denied - education institution - profit motive - commercial activity - transaction with the specified persons - Held that - Insofar as the lease rent is concerned, the revenue had not brought on record any evidence to suggest that such lease rent was either excessive or even higher than the normal market rate prevailing in the region at the relevant time. In fact, the assessee produced material to show that a part of the land belonging to the trustees was leased to one Max New York Life Insurance Co. Ltd. at the rate of ₹ 5/- per sq. ft. as against the rate of ₹ 1/- per sq. ft. being paid by the assessee. The CIT (Appeals) discarded such comparison on the ground that the area occupied by the Max New York Life Insurance Co. Ltd. was much smaller, as compared to the area leased to the assessee. The size of the land under occupation may have some bearing on the lease rent which the land may fetch, nevertheless, in the present case, the difference of rate between two cases was nearly five times. Without there being any further material on record, the Commissioner could not have come to the conclusion that the rent paid by the assessee to the trustees for the leased land, was excessive. Similarly, the assessee pointed out to the authorities that it needed to raise a fund of ₹ 2 crores by taking loan from the financial institutions for which permission was also granted by the Charity Commissioner. The Bank had offered loan at the interest rate of ₹ 12.50% per annum which would also require giving securities and executing documents. As against this the trustees offered unsecured loan at the interest rate of ₹ 9% per annum. Here again, the CIT (Appeals) discarded such comparison by contending that the trustees themselves would have fetched lower fixed deposit rate from the Bank. For multiple reasons, this was not a correct approach. First, we are trying to ascertain whether the trust was paying the interest at the rate higher than the market rate. What the trustees could have got from the Bank was not correct comparison. Secondly, the trustees were offering unsecured loan, which with inherent risks, invites higher interest than the bank loans. Last but not the least, if the trustees had parked their money in the Bank fixed deposits, the liquidities and security of such investment would be much higher than lending substantial amount to the trust without a collateral security. Section 13(1)(c) of the Act does not prohibit normal transactions between the trust and the persons referred to in sub-section (3) of the Act. What is relevant is the use or application of any part of the income of the trust directly or indirectly for the benefits of any such person referred to in subsection (3). Mere payment of lease rent or interest on borrowed funds, without there being any element of such payments being excessive or unreasonable compared to the normal rates prevailing, would not fall within the mischief of section 13(1)(c). - Decided in favour of the assessee

Summary

Issues Involved:
1. Whether the Income Tax Appellate Tribunal was right in law in denying benefit under Section 11 of the Income Tax Act, 1961 to the appellant-assessee?

Issue-wise Detailed Analysis:

1. Denial of Benefit under Section 11 of the Income Tax Act, 1961:

The primary question was whether the Income Tax Appellate Tribunal was correct in denying the benefit under Section 11 of the Income Tax Act, 1961 to the appellant-assessee, an educational trust.

Facts and Background:
- The assessee, a trust registered under the Bombay Public Trusts Act, runs a school named Delhi Public School in Rajkot.
- For the assessment year 2003-04, the assessee declared a total loss of ?8,47,901/-. The Assessing Officer scrutinized this return and issued a notice focusing on the assessee’s claim of exemption under Section 11.
- The Assessing Officer pointed out substantial payments made by the trust to the settler, trustees, and their relatives, allegedly violating Section 13(1)(c) of the Act. These payments included interest on deposits and lease rent for land taken on lease from them.
- The Officer compared the school's fee structure with another school, St. Marry School, concluding that the trust was not engaged in charitable activities and proposed to deny the exemption.

Assessee’s Defense:
- The assessee argued that the lease rent of ?1 per sq.ft. was below the prevailing market rate of ?5 per sq.ft., evidenced by a lease deed with M/s. Max New York Life Insurance Co. Ltd.
- Regarding the interest on borrowed funds, the trust needed ?2 crores, and the trustees offered a loan at 9% interest per annum, lower than the bank's rate, without requiring security.

Revenue’s Argument:
- The Revenue contended that the trust was run for profit, with profits diverted to trustees and their relatives through rent and interest payments.

Court’s Analysis:
- The court noted that mere creation of surplus in running an educational institution does not deprive the trust of its charitable status, referencing Supreme Court decisions in Queen’s Educational Society vs. Commissioner of Income-tax and Vivesvaraya Technological University vs. Assistant Commissioner of Income Tax.
- The court found no evidence of surplus creation over seven years, with the trust showing a total deficit of ?11.78 lakhs.
- The court emphasized that Section 13(1)(c) does not prohibit normal transactions with trustees or relatives if payments are not excessive or unreasonable.

Lease Rent:
- The Revenue failed to prove the lease rent was excessive. The assessee demonstrated that the rent was significantly lower than the market rate, with the CIT(Appeals) incorrectly dismissing the comparison with Max New York Life Insurance Co. Ltd.

Interest on Borrowed Funds:
- The court found the interest rate of 9% per annum for unsecured loans reasonable compared to the bank’s 12.50% with security requirements. The CIT(Appeals) wrongly compared it to the fixed deposit rate trustees might receive from a bank.

Conclusion:
- The Tribunal and Revenue Authorities incorrectly analyzed the situation. The court reversed their judgments, answering the question in favor of the assessee, allowing the tax appeal, and restoring the benefit under Section 11 of the Income Tax Act, 1961.