1995 (8) TMI 80 - AT - Income Tax

Summary

Issues Involved:
1. Justification of CIT(A) in deleting the additions of Rs. 2,01,178 and Rs. 61,053 being interest received by the assessee-company from M/s. V.H. Mehta.

Detailed Analysis:

1. Justification of CIT(A) in Deleting the Additions of Interest Income:

Background:
The assessee-company, incorporated on 24-10-1981, had its Chairman-cum-Managing Director as Shri V.H. Mehta, with his wife and daughter as Directors. The company had an issued share capital of Rs. 200, owned by Shri V.H. Mehta and his wife. A non-trading association named M/s. Strong Foundation Association (SFA) was also registered on 17-10-1981, with Shri V.H. Mehta as President. The assessee-company assisted SFA in enrolling members and collecting funds, which were used for land acquisition and development activities. Surplus funds were invested with M/s. V.H. Mehta, earning interest of Rs. 2,01,178 and Rs. 61,053 for the assessment years 1984-85 and 1985-86, respectively.

ITO's Findings:
The ITO noted that the interest income was initially recorded in the assessee-company's books but later reversed, crediting SFA. The ITO concluded that SFA was a smoke screen created by Shri V.H. Mehta to evade tax. The letter dated 11-11-1981, relied upon by the assessee, was not a valid agreement as per clause 10, which required a formal agreement. The ITO applied the Supreme Court's decision in McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 (SC), treating the interest amounts as the assessee-company's income.

CIT(A)'s Decision:
On appeal, the CIT(A) held that the relationship between the assessee-company and SFA was that of an agent and a principal. The letter dated 11-11-1981 was considered a valid agreement, consistently acted upon by both parties. CIT(A) rejected the ITO's view that SFA was a smoke screen, thus deleting the additions.

Revenue's Arguments:
The Revenue argued that SFA was a creation of Shri V.H. Mehta with no independent existence, serving as a smoke screen to evade tax. The letter dated 11-11-1981 was not a binding agreement, and the interest income should be taxed in the hands of the assessee-company. The Revenue relied on the Supreme Court's judgment in Workmen of Associated Rubber Industry Ltd. v. Associated Rubber Industry Ltd. [1986] 157 ITR 77 (SC).

Assessee's Arguments:
The assessee contended that the funds and interest income belonged to SFA, a legal entity in its own right. The initial erroneous entries in the books were corrected, and the relationship between the assessee-company and SFA was that of an agent and a principal.

Tribunal's Findings:
The Tribunal concluded that SFA was a creation of Shri V.H. Mehta, serving as a smoke screen to evade tax. The initial and reversed entries in the books indicated an attempt to avoid tax. The letter dated 11-11-1981 was not a valid agreement but a piece of enabling/self-serving correspondence. The Tribunal applied the Supreme Court's decision in Workmen of Associated Rubber Industry Ltd., holding that SFA had no independent existence and was created to evade tax. The Tribunal reversed CIT(A)'s findings, treating the interest amounts as the assessee-company's income.

Conclusion:
The Tribunal held that the amounts of Rs. 2,01,178 and Rs. 61,053 being interest income are assessable in the hands of the assessee-company, reversing the CIT(A)'s decision. The creation of SFA was deemed a colourable device to evade tax, and the ratio laid down by the Supreme Court in McDowell & Co. Ltd. was applicable.