2018 (10) TMI 65 - HC - Income Tax

Allowable expenditure u/s 37 - Distributable Surplus payment - application of income OR allowable expenditure - diversion of income by overriding title at source - taxable income of the assessee from the business under section 10(1) - Held that - In the present case, the entire income from manufacture and sale of Liquor in the present case by CHAMUNDI was taxable in the hands of the Assessee CHAMUNDI and the application of income in the form of distribution of surplus from CHAMUNDI to DIAGEO was neither an allowable expenditure under Section 37 of the Act nor as a trade loss under Section 28/29 of the Act, and only after payment of income tax by CHAMUNDI on the entire profits earned from such business, such distribution of surplus could be made by CHAMUNDI to DIAGEO by way of application of income under the Agreement dated 30/10/2007. Thus upon the overall reading of the Agreement dated 30/10/2007 in para 17 defining DIAGEO INDIA s entitlements before deducting entitlements of CHAMUNDI under Clause 16, the said Agreement in the correct perspective of applicability of Indian Tax laws on the income and profits of CHAMUNDI, ought to have provided for deduction of Income-tax payable on its profits and gains taxable in the hands of CHAMUNDI and thereafter from the net balance after deducting entitlements of CHAMUNDI under Clause 16, the balance surplus could only be taken as entitlement of DIAGEO INDIA Pvt.Ltd. Book entries and Method of Accounting is not determinative and conclusive for deciding the computation of taxable income in the hands of the Assessee though they may be relevant to be considered. This is where we feel the tax avoidance effort has been made by the parties and we cannot uphold the same in the overall analysis of the facts and legal position applicable to the facts of the present case. The diversion of income by transfer of overriding title at source should normally have the support of the statutory requirements or some decretal binding character of Courts of law and even though the private contractual obligations can also bring about such diversion of income at source but in this last sphere of private contractual obligations, the Courts and the Income Tax Authorities have to examine such aspects carefully in comparison to the above two other categories of statutory requirements and the Court decrees and then examine the real purport and object of such private arrangements and Contracts. Besides the issues of the legality of the Agreement, the real intention of the parties should be ascertained as to see whether such arrangements and contracts have been entered into to deflect and divert the applicability of Income-Tax laws on the Assessee who has really earned the real income , profits and gains under such Contract or whether such diversion is only an arrangement to suit the purposes of tax avoidance in such cases. Therefore, we reiterate that it will depend upon the facts and circumstances of each and individual case whether in those circumstances, it would amount to a diversion of income by overriding title at source or an arrangement to serve the purposes of tax avoidance, as is the case before us. - Decided in favour of revenue

Summary

Issues Involved:
1. Whether the Distributable Surplus paid by the Respondent Assessee to DIAGEO INDIA PRIVATE LIMITED was an allowable expenditure under Section 37 of the Income Tax Act.
2. Whether the terms and conditions of the Agreement between CHAMUNDI WINERY AND DISTILLERY and DIAGEO INDIA PRIVATE LIMITED amounted to Diversion of Income at source by overriding title.
3. Whether the method of Accounting or entries in the Books of Accounts determined the taxability of business income in the hands of DIAGEO INDIA PRIVATE LIMITED or the Respondent Assessee CHAMUNDI WINERY AND DISTILLERY.

Analysis:

1. Allowable Expenditure under Section 37 of the Act:
The Tribunal and the first Appellate Authority decided in favor of the Respondent Assessee, allowing the "Distributable Surplus" paid to DIAGEO INDIA PRIVATE LIMITED as an allowable expenditure under Section 37 of the Income Tax Act. However, the High Court held that this "Distributable Surplus" was not an allowable expenditure but an application of income. The Court emphasized that the entire business profits earned from the manufacture and sale of liquor under the Excise Licence held by CHAMUNDI WINERY AND DISTILLERY were taxable in its hands. The payment to DIAGEO was seen as a distribution of surplus and not a business expenditure incurred to earn income.

2. Diversion of Income at Source by Overriding Title:
The High Court held that the terms and conditions of the Agreement did not amount to "Diversion of Income at source by overriding title" in favor of DIAGEO INDIA PRIVATE LIMITED. The Court noted that the Excise Licence was in the name of CHAMUNDI WINERY AND DISTILLERY, and the entire business was conducted under this licence. Therefore, the profits and gains from the business were assessable in the hands of CHAMUNDI WINERY AND DISTILLERY. The Agreement's terms were crafted to give an impression of an overriding title but were ultimately deemed a devious diversion.

3. Method of Accounting and Taxability of Business Income:
The Court held that the method of accounting or entries in the Books of Accounts did not determine the taxability of business income. The income arising from the business of manufacture and sale of liquor was taxable in the hands of CHAMUNDI WINERY AND DISTILLERY, irrespective of the accounting method adopted. The Court emphasized that the substance of the transaction and the real income earned were the determining factors for taxability, not the accounting entries or methods.

Conclusion:
The High Court allowed the Revenue's appeals, holding that:
1. The "Distributable Surplus" paid to DIAGEO INDIA PRIVATE LIMITED was an application of income and not an allowable expenditure under Section 37 of the Income Tax Act.
2. The terms and conditions of the Agreement did not amount to a diversion of income at source by overriding title.
3. The method of accounting or entries in the Books of Accounts did not determine the taxability of business income, which was taxable in the hands of CHAMUNDI WINERY AND DISTILLERY.

The Court emphasized that the real income from the business of manufacture and sale of liquor under the Excise Licence was taxable in the hands of CHAMUNDI WINERY AND DISTILLERY, and the distribution of surplus to DIAGEO INDIA PRIVATE LIMITED was an application of income post-taxation.