1991 (10) TMI 99 - AT - Income Tax

Association Of Persons Assessable As Business Expenditure Allowability of Words And Phrases

Issues Involved:
1. Status of the assessee as 'Association of Persons' (AOP).
2. Application of Section 161(1A) of the Income-tax Act, 1961.
3. Disallowance of interest and salary payments to beneficiaries.
4. Validity of assessment under Section 166 of the Income-tax Act, 1961.

Detailed Analysis:

1. Status of the Assessee as 'Association of Persons' (AOP):
The primary issue was whether the assessee trust should be assessed in the status of an 'Association of Persons' (AOP). The assessee argued that the trust should not be assessed as an AOP because the income should be assessed in the hands of the beneficiaries or trustees individually, according to their shares specified in the trust deed. The Revenue contended that the trust should be assessed as an AOP, especially since the trustees were authorized to carry on business on behalf of the beneficiaries.

The Tribunal noted that the trust was created by a registered deed for the benefit of 59 beneficiaries, and the trustees were carrying on business in various names and styles. The Tribunal held that the assessment of the trust in the status of AOP was not justified. The Tribunal emphasized that the status of the trustee should be the same as that of the beneficiaries and that the trustee should be assessed in a representative capacity only. The Tribunal also referred to the Supreme Court's decision in the case of Trustees of H.E.H. Nizam's Family (Remainder Wealth) Trust, which held that the trustee's liability should be co-extensive with that of the beneficiaries.

2. Application of Section 161(1A) of the Income-tax Act, 1961:
Section 161(1A) was introduced to counteract tax avoidance by taxing the entire income of the trust at the maximum marginal rate if the trust's income includes profits and gains of business. The Tribunal examined the legislative intent behind the introduction of Section 161(1A) and concluded that the section was meant to impose a higher rate of tax on the income of a representative assessee if the income includes profits and gains of business.

The Tribunal clarified that Section 161(1A) did not authorize the aggregation of the income of all beneficiaries and taxing it in the hands of the trustee as an AOP. Instead, the section aimed to apply the maximum marginal rate to the income of each beneficiary individually. The Tribunal emphasized that the trustee's liability should be limited to the extent of the beneficiary's liability and that the income of each beneficiary should be taxed separately.

3. Disallowance of Interest and Salary Payments to Beneficiaries:
The assessee trust had paid interest to beneficiaries who had substantial credit balances and salaries to some beneficiaries who rendered services to the trust. The Assessing Officer disallowed these payments, considering them as a device to avoid tax under Section 161(1A).

The Tribunal held that interest payments to beneficiaries who deployed their own funds in the trust's business should be allowed to the extent of the actual deployment of funds. The Tribunal directed the Assessing Officer to determine the personal funds deployed by the beneficiaries and allow the corresponding interest payments.

Regarding the salary payments, the Tribunal noted that the services rendered by the beneficiaries were not disputed by the Assessing Officer. The Tribunal held that the salaries paid to beneficiaries for their services should be allowed as a deduction. The Tribunal emphasized that the payment of salary for services rendered to the business cannot be considered a device to avoid tax and should be treated as a legitimate business expenditure.

4. Validity of Assessment under Section 166 of the Income-tax Act, 1961:
The assessee argued that once the Income-tax Officer exercised the option under Section 166 to assess the beneficiaries, the same income could not be assessed again in the hands of the trust as an AOP. The Tribunal agreed with this contention, stating that once the choice is made to tax either the trustee or the beneficiary, it is not open to the department to assess the other at the same time. The Tribunal referred to the Central Board of Direct Taxes' instructions, which supported this view.

Separate Judgments:
The Tribunal noted a difference of opinion between the Judicial Member and the Accountant Member on certain issues. The Judicial Member upheld the assessment in the status of AOP and disallowed the salary payments, while the Accountant Member disagreed. The matter was referred to the President of the Tribunal, who constituted a larger Bench to resolve the differences.

The larger Bench, after considering the arguments and relevant precedents, concluded that:
- The assessment in the status of AOP was not justified.
- The maximum marginal rate should be applied to the income of each beneficiary individually, not on the aggregate income of all beneficiaries.
- The salaries paid to beneficiaries for their services should be allowed as a deduction.

Conclusion:
The appeals were partly allowed, with the Tribunal directing the Assessing Officer to allow interest payments to the extent of the personal funds deployed by the beneficiaries and to allow the salary payments as legitimate business expenditure. The Tribunal also clarified the application of Section 161(1A) and the status of the trustee for tax purposes.

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