2016 (10) TMI 594 - AT - Income Tax

Addition u/s 36(1)(iii) - investment in AOP - whether interest bearing funds were diverted as advances to the sister concern, friends and family members without any business expediency and that too without charging any interest? - Held that - The impugned amounts were invested in earlier years and not in the current year. It is also noted that no evidence has been produced by the Revenue evidencing that the funds were diverted without commercial exigencies. So far as, making investment is concerned, it is the businessman who is to make the investment protecting his business interest. The Assessing Officer cannot be expected to sit in the chare of the assessee and decide in which manner the investment has to be made. Action can only be taken or disallowance can be made only in a situation when it is found that the investment or granting loans is contrary to the provisions of the Act. Compensation received for cancellation of development agreement - contractual receipt or short term capital gain - Held that - CIT(A) has observed that, AO has developed a misplaced understanding of the nature of the transaction by treating it as capital receipt. It is clear that the assessee has carried out the expenditure towards the performance of the development agreement. - Therefore CIT(A) directed the AO to treat ₹ 50,00,000/- as contractual receipt. - order of CIT(A) is not erroneous. Decided against the revenue.

Issues Involved:
1. Allowance of relief under Section 36(1)(iii) of the Income Tax Act, 1961.
2. Treatment of compensation received for cancellation of a development agreement.

Issue-wise Detailed Analysis:

1. Allowance of Relief under Section 36(1)(iii) of the Income Tax Act, 1961:

The Revenue challenged the relief of ?3,61,356/- granted under Section 36(1)(iii) of the Income Tax Act, 1961. The primary contention was that the assessee had not provided evidence for investment in the Association of Persons (AOP) and had diverted interest-bearing funds as advances to related parties without any business expediency and without charging interest.

During the assessment, the Assessing Officer (AO) disallowed the interest payment of ?3,61,356/- on the grounds that the interest-bearing funds were diverted without charging any interest. The assessee had given loans and advances totaling ?23,68,000/- and invested ?1,52,00,427/- in Kings Empire Developers without charging interest. The AO issued a show-cause notice to the assessee, questioning why the interest should not be disallowed under Section 36(1)(iii) of the Act.

The assessee responded, stating that they were a member of AOP Kings Empire Developers and had introduced capital in earlier years, with no new investments in the current year. The closing balance of capital as on 31/03/2008 was ?1,52,00,428/-, reduced from ?2,46,80,000/- as on 31/03/2007. The assessee argued that the borrowed funds were used for business activities and that there was no question of earning income from the investment made in Kings Empire Developers.

The Commissioner of Income Tax (Appeal) found merit in the assessee's argument, concluding that the investments were made in earlier years and not in the current year. Therefore, the proportionate disallowance made by the AO was not upheld. The Tribunal affirmed this view, noting that no evidence was produced by the Revenue to show that the funds were diverted without commercial exigencies. The Tribunal emphasized that it is the businessman who decides on investments to protect business interests, and disallowance can only be made if the investment is contrary to the provisions of the Act.

2. Treatment of Compensation Received for Cancellation of Development Agreement:

The Revenue also contested the direction to the AO to treat ?50 lakh compensation received by the assessee for the cancellation of a development agreement as a contractual receipt instead of a short-term capital gain.

The AO had noticed that the assessee received ?50,00,000/- as compensation for the cancellation of a development agreement with Chandralok Fabrics. The AO treated ?40,00,000/- (after reducing a ?10,00,000/- security deposit) as short-term capital gain. The assessee argued that the compensation was for expenses incurred and time devoted to the development work, not for the transfer or sale of an asset, and hence should not be treated as capital gains.

The First Appellate Authority agreed with the assessee, concluding that the ?50,00,000/- was compensation for reimbursement of actual expenses incurred by the assessee as a developer. The Authority noted that the AO had misunderstood the nature of the transaction by treating it as a capital receipt. The Tribunal upheld this conclusion, noting that the AO was directed to verify the genuineness of the expenses and conduct a consolidated exercise considering the ?10,00,000/- deposit.

Final Judgment:

The Tribunal dismissed the Revenue's appeal, affirming the conclusions drawn by the Commissioner of Income Tax (Appeal) on both issues. The order was pronounced in the presence of the ld. DR at the conclusion of the hearing on 29/08/2015.

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