2022 (2) TMI 532 - HC - Income Tax

Exemptions u/s 11 - assessee is a trust registered under Section 12AA - Purchases made by the assessee from one Pawansut Trading Company Pvt. Ltd. which was a specified person under Section 13(3) - As per AO substantial purchases made from a related party had to be at arm s length - ITAT allowed deduction - HELD THAT - We do not see any error in the view of the Commissioner of Appeals and the Tribunal. As is well known Section 11 of the Act pertains to income from property held for charitable and religious purposes. Section 13 on the other hand pertains to cases where Section 11 would have no application. Sub-section (1) of Section 13 provides that nothing contained in section 11 or section 12 shall operate so as to exclude from the total income of the previous year of the person in receipt thereof under specified circumstances. Sub-section (2) of Section 13 provides that without prejudice to the generality of the provisions of clause (c) and clause (d) of sub-section (1) the income or the property of the trust or institution or any part thereof shall for the purposes of that clause would be deemed to have been used or applied for the benefit of a person referred to in sub-section (3) as provided in clauses (a) to (h) of sub-section (2). It is not in dispute that the assessee and the M/s Pawansut Trading Company Pvt. Ltd. are entities covered under sub-section (3) of Section 13. However the question is merely because such sale and purchase transaction took place between two such persons clause (g) of sub-section (2) of Section 13 would automatically kick in? The answer has to be in the negative. Clause (g) would apply where any income or property of the trust or institution is diverted during the previous year in favour of any person referred to in sub-section (3). The crux of this provision is diversion of income. Mere transaction of sale and purchase between two related persons would not be covered under the expression diversion of income. Diversion of income would arise when transaction is not at arm s length and the sale or purchase price is artificially inflated so as to cause undue advantage to other person and divert the income. In the present case the assessing officer never examined whether the transactions between the assessee and the said company were at arm s length. He merely referred to statutory provisions and without further discussion came to the conclusion that disallowance had to be made. CIT (Appeals) not only criticised this approach of the assessing officer but also independently examined whether the transaction was at arm s length. It was found that the rate paid to the related person was same as paid to the unrelated party. - Decided against revenue.

Summary

Issues:
1. Exemption u/s 11 of the Income Tax Act, 1961 for charitable activities.
2. Interpretation of provisions related to transactions with related parties under Section 13 of the Act.
3. Assessment of purchases made from a specified person under Section 13(3) of the Act.
4. Consideration of arm's length principle in related party transactions.
5. Application of Section 13(2)(g) regarding diversion of income to related parties.

Analysis:

1. The primary issue in this case revolved around the Tribunal's decision regarding purchases of ?9 crores made by the assessee from a specified person under Section 13(3) of the Income Tax Act, 1961. The revenue contended that these transactions fell under Section 13(2)(g) of the Act, questioning the eligibility of the assessee for exemption u/s 11. Other questions raised were deemed factual and did not require detailed consideration.

2. The core concern was the purchases made by the assessee from a related party, which led to scrutiny by the assessing officer. The officer concluded that such substantial purchases from a related party should be at arm's length, invoking Section 13 of the Act to disallow the exemption u/s 11 and 12 for the assessee.

3. The assessee appealed this decision, and the Commissioner, after reviewing the facts, deleted the disallowance, noting that the purchase rates from the related party were the same as those from unrelated parties. The Tribunal upheld this view, emphasizing that as long as transactions with related parties were conducted at normal terms and conditions without undue benefit, they should not be disallowed.

4. The Court concurred with the Tribunal, emphasizing the distinction between Section 11 related to charitable purposes and Section 13 dealing with cases where Section 11 does not apply. It clarified that mere transactions between related parties do not automatically trigger Section 13(2)(g), which requires a diversion of income, not just related transactions.

5. The assessing officer's failure to assess whether the transactions were at arm's length was criticized, with the Court supporting the Tribunal's decision that the rates paid to the related party were similar to those paid to unrelated parties. As there was no evidence of undue advantage or diversion of income, the appeal was dismissed, concluding that no legal question arose in this matter.