1990 (7) TMI 145 - AT - Income Tax

A Partner, Business Expenditure, Capital Reserve, Deduction In Respect, Gold Bonds, Investment Company, Partnership Firm, Provident Fund

Summary

Issues Involved:
1. Nature of the company's transactions with Gold Bonds.
2. Characterization of the company as an Investment Holding Company or an Investment Trading Company.
3. Taxability of the profit realized from the sale of Gold Bonds.
4. Disallowance of the company's contribution to Provident Fund and other funds.
5. Substitution of sale price of Gold Bonds by the ITO.
6. Application of principles from Supreme Court decisions in McDowell & Co. Ltd. and Workmen of Associated Rubber Industry Ltd.

Issue-wise Detailed Analysis:

1. Nature of the Company's Transactions with Gold Bonds:
The company, a Private Limited Company, filed its returns for A.Y. 1979-80 and 1981-82. For A.Y. 1979-80, it declared a loss of Rs. 1,875, showing service charges and interest income. It claimed exemption from tax on Rs. 3,38,000 profit from the sale of National Defence Gold Bonds, arguing these were not capital assets under section 2(14)(iv) of the Income-tax Act, 1961. The ITO disagreed, treating the sale as an adventure in the nature of trade, adding Rs. 3,38,000 to the company's income.

For A.Y. 1981-82, the company declared an income of Rs. 75,000, showing interest income. The ITO assessed it at Rs. 88,757 and also noted a profit of Rs. 13,72,500 from the sale of Gold Bonds, which was credited to the Capital Reserve Account. The ITO considered the actual profit to be Rs. 22,72,500, treating the difference as a deemed gift and an adventure in the nature of trade, adding Rs. 22,75,500 to the company's income.

2. Characterization of the Company:
The IAC examined the company's character, noting its main objective as an Investment Holding Company, but also pointing out that clause 160(C) in the Articles of Association allowed distribution of profits on sale of capital assets. The IAC concluded the company could act as both an Investment Holding and an Investment Dealing Company. However, the Tribunal found that the company maintained its character as an Investment Holding Company, as profits from the sale of capital assets were transferred to the Capital Reserve Account and not distributed.

3. Taxability of Profit from Sale of Gold Bonds:
The Tribunal held that the sales of Gold Bonds were not adventures in the nature of trade. The company's conduct, treatment of profits, and the nature of Gold Bonds (not being capital assets under section 2(14)(iv)) supported this conclusion. The frequency of sales did not indicate trading activity, and the surplus was consistently transferred to the Capital Reserve Account.

4. Disallowance of Provident Fund Contributions:
The ITO disallowed Rs. 7,385 claimed as contributions to Provident Fund and other funds, stating these were not recognized by the department. The Tribunal set aside this disallowance, noting the company had applied for a Provident Fund Code and made contributions, which were later returned and paid to employees as additional salaries. The Tribunal allowed the deduction under section 37(1) of the Act.

5. Substitution of Sale Price by ITO:
For A.Y. 1981-82, the ITO substituted the sale price of Gold Bonds from Rs. 13,72,500 to Rs. 22,72,500. The Tribunal found this action unjustified, as Gold Bonds were not capital assets under section 2(14)(iv), and the ITO lacked jurisdiction under section 52(2) of the Act. The Tribunal also noted that treating the difference as a deemed gift contradicted treating it as income.

6. Application of Supreme Court Principles:
The CIT(A) applied principles from McDowell & Co. Ltd. and Workmen of Associated Rubber Industry Ltd., suggesting the transactions were non-genuine. The Tribunal rejected this, noting the company sold Gold Bonds for good consideration, and the proximity in relationships and timing did not prove non-genuineness without hearing the involved entities.

Conclusion:
The Tribunal allowed the appeals, deleting the additions of Rs. 3,38,000 for A.Y. 1979-80 and Rs. 22,75,500 for A.Y. 1981-82, and set aside the disallowance of Rs. 7,385 for A.Y. 1979-80. The Tribunal held the company maintained its character as an Investment Holding Company, and the sales of Gold Bonds did not constitute adventures in the nature of trade.