2002 (12) TMI 8 - SC - Income Tax

Assessee is incorporated as a company limited by guarantee under the Companies Act, 1956 - assessee s claim for the benefit of section 11 was denied by AO on two grounds - firstly, assessee was a diamond bourse and as such its objects were not charitable purpose - secondly, the assessee had breached the conditions under section 13 and as such was liable to be denied the benefit of section 11 - Contention of AO is justified - revenue s appeal allowed

Issues Involved:
1. Entitlement of the assessee to the benefit of section 11 of the Income-tax Act, 1961.
2. Loss of exemption under section 11 due to lending Rs. 70 lakhs to Bharat Shah, the founder of the institution, under section 13(2)(a) read with section 13(3)(a) of the Act.

Issue-wise Detailed Analysis:

Issue 1: Entitlement to the Benefit of Section 11 of the Act
The primary question was whether the assessee, a non-profit service organization incorporated as a company limited by guarantee, was entitled to the benefit of section 11 of the Income-tax Act, 1961. The Assessing Officer (AO) denied this benefit on two grounds:
1. The objects of the assessee, being a diamond bourse, were not considered "charitable purposes" within the meaning of section 2(15) of the Act.
2. The assessee had breached conditions under section 13, thereby losing the benefit of section 11.

The Tribunal concluded that the objects of the assessee were indeed for "charitable purposes" as defined in section 2(15) and that there was no breach of section 13. The High Court upheld this view.

The Supreme Court analyzed the circumstances under which the assessee came into existence. The diamond exporters in India formed the Diamond Exporters Association to facilitate diamond export. The Central Government accepted their proposal to set up a diamond bourse in Bombay, named Bharat Diamond Bourse, to enhance the diamond trade and increase foreign exchange earnings. The assessee was registered under section 11 as an institution established for charitable purposes, with its dominant object being of general public utility.

The Court referred to the judgment of the Constitutional Bench in Addl. CIT v. Surat Art Silk Cloth Manufacturers Association [1980] 121 ITR 1, which established that if the primary object of an institution is charitable and any non-charitable object is merely ancillary, the institution remains charitable. Applying this test, the Court concluded that the assessee's predominant objectives were to promote diamond exports, establish trading facilities, and develop India as a modern diamond market. Therefore, the assessee was rightly registered under section 11 as an institution established for charitable purposes.

Issue 2: Loss of Exemption under Section 11
The second issue was whether the assessee lost the exemption under section 11 by lending Rs. 70 lakhs to Bharat Shah, a founder of the institution, without adequate security or interest, thereby invoking section 13(2)(a) read with section 13(3)(a).

Issue (A): Adequacy of Interest or Security
The AO found that the amount was lent without adequate security or interest and without a written agreement. The Tribunal reversed this finding, accepting the assessee's explanation that the amount was a deposit for procuring premises. The Supreme Court found the Tribunal's reasoning perverse, noting that no proper documentation existed, and the terms of the lease were indefinite. The Court concluded that the transaction was a colorable one, intended to enable Bharat Shah to purchase property for his own purposes, thus affirming the AO's view that the amount was lent without adequate security or interest.

Issue (B): Status of Bharat Shah as Founder
The Court examined whether Bharat Shah fell within the prohibited category under section 13(3)(a) or 13(3)(cc). The term "founder" was interpreted as the originator or person responsible for establishing the institution. Bharat Shah, being a signatory to the memorandum of association and instrumental in the company's incorporation, was deemed a founder. The Court rejected the argument that Bharat Shah was not a founder due to lack of substantial financial contribution.

The Supreme Court held that Bharat Shah was a founder of the institution and that the assessee lost the benefit under section 11 due to lending Rs. 70 lakhs without adequate security or interest, falling within the mischief of section 13(3)(a) read with section 13(1)(c)(ii).

Conclusion
The Supreme Court set aside the judgments of the High Court and the Tribunal, affirming the AO's view that the assessee lost the benefit of section 11 due to the transaction with Bharat Shah. The appeals were allowed, and the orders of the AO and the Commissioner of Income-tax (Appeals) were reinstated.

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