2025 (4) TMI 1272 - HC - Income Tax

Denial of benefit of the exemptions u/s 11/12 - payment of salary to a related party - HELD THAT - There is no cavil that the salary paid to Ms Rai was not excessive or unreasonable considering her educational qualifications and the functions performed by her. ITAT had examined the evidence as to her qualifications as well as her contribution. Revenue also did not contest the said findings. As noted above he had advanced submissions on the sole ground that if any part of the income of the trust is diverted for benefit of any of the prohibited person referred to in sub-section (3) of Section 13 of the Act the entire income of the trust would be chargeable to tax. If a person specified under sub-section (3) has rendered any service and the amount or allowance paid to such person is such that is reasonably paid for such services the same cannot be deemed to have been applied for the benefit of the said person for the purposes of clauses (c) or (d) of Section 13(1) of the Act. This is apparent from the plain language of clause (c) of sub-section (2) of Section 13 of the Act. The opening words of the said clause must be read in conjunction with the last words of the said clause If any amount is paid by way of salary allowance or otherwise in excess of what may be reasonably paid for such services . Thus if the amount paid for services is such as is reasonably payable for such service the same cannot be construed as applied for the benefit of a prohibited person notwithstanding that it is paid to such a person. Consequently such payment would not fall within the exception of clause (c) of sub-section (1) of Section 13 of the Act. The observations made by this Court in Director of Income Tax (Exemption) v. Charanjiv Charitable Trust 2014 (3) TMI 760 - DELHI HIGH COURT must be read in the context of the facts of that case. Decided in favour of the Assessee and against the Revenue.

Summary

1. ISSUES PRESENTED and CONSIDERED

The Court framed the following core legal questions for consideration:

(i) Whether the Income Tax Appellate Tribunal (ITAT) erred in law and on facts by holding that the Assessee did not violate the provisions of Section 13(1)(c) of the Income Tax Act, 1961, in remunerating Ms. Malvika Rai for services rendered;

(ii) Whether the impugned order of the ITAT is perverse both on facts and in law.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Violation of Section 13(1)(c) in payment of remuneration to a related party

Relevant Legal Framework and Precedents:

Section 13(1)(c) of the Income Tax Act excludes from exemption under Sections 11 and 12 any income of a trust or institution that is directly or indirectly used or applied for the benefit of any person referred to in Section 13(3), which includes certain related persons or "prohibited persons." Clause (c) of sub-section (2) of Section 13 further deems income to have been applied for the benefit of such persons if any amount is paid by way of salary or allowance to them out of the trust's resources in excess of what may be reasonably paid for services rendered.

A key precedent cited by the Revenue was the decision in Director of Income Tax (Exemption) v. Charanjiv Charitable Trust, which held that even one instance of application or use of trust income for the benefit of a prohibited person results in loss of exemption for the entire income.

Court's Interpretation and Reasoning:

The Court emphasized a plain reading of Section 13(1)(c) and 13(2)(c). It noted that exemption under Sections 11/12 is denied only to the extent income is applied for the benefit of prohibited persons. However, where salary or allowance is paid to such persons for services rendered and the amount is reasonable, it is not deemed to be applied for their benefit within the meaning of Section 13(1)(c). The Court stated:

"If any amount is paid by way of salary, allowance or otherwise during the previous year to any person referred to in sub-section (3) out of the resources of the trust or institution for services rendered by that person to such trust or institution and the amount so paid is in excess of what may be reasonably paid for such services," then it is deemed to be applied for benefit of that person. Conversely, reasonable payment for services rendered does not attract this deeming provision.

The Court found that the Revenue's reliance on the Charanjiv Charitable Trust decision was misplaced as that decision must be read in the factual context of that case and does not establish a blanket prohibition on payment to prohibited persons.

Key Evidence and Findings:

The Assessee paid an annual salary of Rs. 16,20,000 to Ms. Malvika Rai, Chairperson of the trust. The Assessing Officer (AO) initially disallowed 30% of this payment as excessive under Section 40A(2)(a). However, the Commissioner of Income Tax (Appeals) (CIT(A)) accepted the reasonableness of the salary, relying on evidence of Ms. Rai's qualifications, over two decades of experience in education, and active involvement in the trust's functioning and events. The Assessee produced extensive documentary evidence including brochures, journals, and records of events chaired or guided by Ms. Rai, demonstrating her active role and contribution.

The ITAT, after recalling its earlier order and considering additional evidence, upheld the CIT(A)'s findings that the salary was reasonable and commensurate with services rendered.

Application of Law to Facts:

The Court applied the legal framework to the facts and concluded that since the salary paid was reasonable and for actual services rendered, it did not amount to income applied for the benefit of a prohibited person under Section 13(1)(c). Therefore, the exemption under Sections 11/12 was not lost.

Treatment of Competing Arguments:

The Revenue's contention that any payment to a prohibited person, regardless of reasonableness, results in loss of exemption was rejected. The Court noted the absence of any evidence from the Revenue to show the salary was excessive or unreasonable. The Revenue also failed to rebut the extensive evidence of Ms. Rai's active role and qualifications. The Court found the CIT(A) and ITAT's approach consistent with the statutory language and principles of reasonableness.

Conclusions:

The Court held that the Assessee did not violate Section 13(1)(c) in remunerating Ms. Rai and was entitled to exemption under Sections 11/12 for the relevant assessment years.

Issue 2: Whether the impugned order is perverse on facts and law

Relevant Legal Framework and Precedents:

An order is perverse if it is based on no evidence or is so unreasonable that no reasonable authority could have arrived at the same conclusion.

Court's Interpretation and Reasoning:

The Court found that the ITAT's order was based on a detailed examination of evidence, including additional documentary proof of Ms. Rai's services. The Tribunal correctly applied the legal provisions regarding reasonable remuneration and exemption. The Revenue did not demonstrate any error in the Tribunal's appreciation of facts or law that would render the order perverse.

Key Evidence and Findings:

The Tribunal considered the Assessee's detailed submissions, documentary evidence, and the CIT(A)'s consistent findings over multiple years. The AO's ad-hoc disallowances were found unjustified in light of the material on record.

Application of Law to Facts:

The Tribunal's order was a reasoned decision based on the statutory framework and evidence, not arbitrary or capricious.

Treatment of Competing Arguments:

The Revenue's argument of perversity was rejected as it was grounded only on disagreement with the Tribunal's factual findings and legal interpretation, without any substantive basis.

Conclusions:

The impugned order was not perverse either on facts or in law.

3. SIGNIFICANT HOLDINGS

The Court's key legal reasoning and principles established include the following verbatim excerpts and determinations:

"A plain reading of sub-section (1) of Section 13 of the Act indicates that exemptions under Section 11/12 of the Act would not operate so as to exclude from the total income of the previous year any income, which is directly or indirectly, for the benefit of the person referred to in sub-section (3) of Section 13 of the Act. It is, thus, clear that if any part of the income of a trust for charitable or religious purposes is diverted for the direct or indirect benefit of a person referred to in sub-section (3) of that Act, that part of the income would not be excluded from the total income of the Assessee by virtue of Section 11/12 of the Act."

"By virtue of clause (c) of sub-section 2 of the Act if any amount is paid by way of a salary or allowance to a person, which is specified under sub-section (3) of Section 13 of the Act, it would be deemed that the income of the property or trust has been applied for the benefit of that person for the purposes of Clause (c) and (d) of sub-section (1) of Section 13. However, if a person specified under sub-section (3) has rendered any service and the amount or allowance paid to such person is such, that is, reasonably paid for such services, the same cannot be deemed to have been applied for the benefit of the said person notwithstanding that it is paid to such a person."

"The observations made by this Court in Director of Income Tax (Exemption) v. Charanjiv Charitable Trust must be read in the context of the facts of that case."

"In view of the above the questions of laws as noted in paragraph no.3 of the order is answered in favour of the Assessee and against the Revenue."

Final determinations:

• The ITAT correctly held that the Assessee did not violate Section 13(1)(c) by paying reasonable remuneration to Ms. Malvika Rai for services rendered.
• The exemption under Sections 11/12 of the Income Tax Act was rightly allowed to the Assessee.
• The impugned order was not perverse on facts or law.
• The appeals filed by the Revenue were dismissed accordingly.