2025 (4) TMI 1227 - HC - Income Tax

Disallowing interest paid to the beneficiaries u/s 40(b) - status of the Appellant Trust was that of Association of Persons - HELD THAT - The Supreme Court in INDIRA BALKRISHNA ( 1960 (4) TMI 7 - SUPREME COURT has held that an association of persons must be one in which two or more persons jointly held common purpose or common action and as the word occurs in a section which imposes tax on income the association must be one which produces income profits or gains. The scope of Appeal u/s 260A of the Act is well settled. This Court in an Appeal under Section 260A can interfere with the finding of fact only if when the same is shown to be perverse. See SYEDA RAHIMUNNISA VS. MALAN BI BY L.RS. AND ORS. 2016 (10) TMI 1233 - SUPREME COURT and SOFTBRANDS INDIA P. LTD. 2018 (6) TMI 1327 - KARNATAKA HIGH COURT . AO by applying the aforesaid criteria to the facts of the case has held that the beneficiaries have come together voluntarily by pooling their money in the trust with clear knowledge that the funds will be utilized by the trust for the business of project work undertaken and would result in profits for the trust and consequently for the beneficiaries. AO has recorded a finding that the Trust is an Association of Persons. Accordingly the interest claim to the beneficiaries has been disallowed. The aforesaid findings recorded by the Income Tax Officer as AO has been upheld in Appeal. The Income Tax Appellate Tribunal has held that the assessee himself has declared the status as an association of persons and on that basis the Assessing Officer has passed the order. It has further held that declaration by assessee is not a mistake which has been erroneously made as no attempt has been made to rectify the aforesaid mistake. It is also pertinent to note that the assessee while filing the return had described itself as an Association of Persons for which neither any attempt has been made to correct the so called mistake nor any explanation has been offered for making such a mistake. The order passed by the Assessing Officer as well as the Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal is based on meticulous appreciation of evidence. The finding of fact recorded therein by no stretch of imagination can be said to be perverse. Tribunal was justified in law in holding that the status of the Appellant Trust was that of Association of Persons and thus the lower authorities were justified in disallowing interest paid to the beneficiaries under Section 40(b) of the Income Tax Act 1961.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Court are:

- Whether the Tribunal was justified in law in holding that the status of the appellant Trust was that of an Association of Persons (AOP) under the Income Tax Act, 1961, particularly for the Assessment Year 1995-1996.

- Whether the lower authorities were justified in disallowing the interest payment of Rs. 5,38,100/- made by the Trust to its beneficiaries under Section 40(b) of the Income Tax Act, 1961, on the basis of the Trust's status as an AOP.

- The legal validity of treating a Private Specific Trust, engaged in business and having multiple beneficiaries, as an Association of Persons for income tax purposes.

- Interpretation and application of Section 161 and Section 40(ba) of the Income Tax Act, 1961, in relation to the Trust's income and payments to beneficiaries.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Status of the Trust as an Association of Persons

Relevant legal framework and precedents: The Supreme Court's decision in CIT v. Indira Balkrishna (1960) 39 ITR 546 (SC) provides the foundational test for determining the status of an Association of Persons. The Court held that an AOP must consist of two or more persons who come together with a common purpose or common action aimed at producing income, profits, or gains. Section 161 of the Income Tax Act defines an AOP and its taxability.

Court's interpretation and reasoning: The Assessing Officer applied the Indira Balkrishna test and found that the beneficiaries voluntarily pooled their monies into the Trust with the clear knowledge that the funds would be used for business projects, thereby generating profits. The Trust was thus held to be an AOP under Section 161. This finding was upheld by the Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal.

Key evidence and findings: The Trust was a Private Specific Trust settled in 1986, with six trustees and 32 beneficiaries, including minors represented by legal guardians. The assessee had consistently filed returns declaring its status as an AOP and had declared nil income for the relevant year due to set-off of losses. The Tribunal noted that the assessee itself declared its status as an AOP and did not attempt to correct this classification.

Application of law to facts: The Court noted that the beneficiaries' pooling of funds with the objective of business profits satisfied the common purpose requirement for an AOP. The Trust's business activities and the beneficiaries' interest in the income generated established the Trust's status as an AOP for income tax purposes.

Treatment of competing arguments: The assessee argued that a Private Specific Trust, even if engaged in business, cannot be treated as an AOP, emphasizing the absence of a common purpose or common action among trustees and beneficiaries. Reliance was placed on the Indira Balkrishna decision and the Bombay High Court's decision in CIT v. Marsons Beneficiary Trust (1991) 188 ITR 253, which distinguished trusts from AOPs. The assessee also contended that Section 161(1A) and Section 164(1) of the Act, relating to discretionary trusts and indeterminate beneficiary shares, applied instead.

The Court rejected these submissions, emphasizing that the facts showed a voluntary coming together of beneficiaries with a common business purpose, aligning with the criteria for an AOP. The Court also noted that the assessee's own declaration of status as an AOP was not corrected or explained, undermining its argument.

Conclusions: The Court affirmed the finding that the Trust was an Association of Persons under Section 161 of the Income Tax Act.

Issue 2: Disallowance of Interest Payment under Section 40(ba)

Relevant legal framework and precedents: Section 40(ba) of the Income Tax Act disallows deductions for payments of interest, salary, bonus, commission, or remuneration made by an AOP or body of individuals (other than companies or registered societies) to its members. The rationale is to prevent such payments from being deducted when computing income chargeable under the head "Profits and gains of business or profession."

Court's interpretation and reasoning: Since the Trust was held to be an AOP, the interest payment of Rs. 5,38,100/- made to beneficiaries was disallowed under Section 40(ba). The Court observed that the Assessing Officer's disallowance was based on the Trust's status and was upheld on appeal by the Commissioner and the Tribunal.

Key evidence and findings: The payment constituted interest to members of the AOP, which Section 40(ba) explicitly excludes from deductible expenses. The assessee's failure to challenge or explain the classification of the Trust as an AOP reinforced the validity of disallowance.

Application of law to facts: The Court applied Section 40(ba) strictly, given the Trust's status as an AOP, and found no error in disallowing the interest payment as a deductible expense.

Treatment of competing arguments: The assessee contended that the Trust's status was not that of an AOP and thus Section 40(ba) should not apply. This argument was rejected based on the earlier finding of the Trust's status. The revenue emphasized the consistency and reasonableness of the findings across all authorities.

Conclusions: The disallowance of interest payment under Section 40(ba) was upheld as legally justified.

Issue 3: Scope of Appeal under Section 260A and Standard of Interference

Relevant legal framework and precedents: The scope of appellate interference under Section 260A of the Income Tax Act is limited to questions of law. Interference with findings of fact is permissible only if such findings are perverse or wholly unsupported by evidence. The Court referred to authoritative decisions emphasizing this principle.

Court's interpretation and reasoning: The Court noted that the Assessing Officer's finding that the Trust was an AOP was based on a meticulous appreciation of evidence and consistent application of legal tests. The Commissioner of Income Tax (Appeals) and the Tribunal concurred with this conclusion. The Court found no perversity or error warranting interference.

Key evidence and findings: The assessee's own declaration of status as an AOP and the absence of any corrective action or explanation were significant. The evidence showed pooling of funds with a business purpose among beneficiaries.

Application of law to facts: The Court applied the settled standard, concluding that the factual findings were not perverse and that the Appeal under Section 260A did not warrant interference with these findings.

Treatment of competing arguments: The assessee's arguments challenging the factual findings were rejected as insufficient to meet the high threshold for appellate interference under Section 260A.

Conclusions: The Court dismissed the Appeal on the ground that no legal error or perversity existed in the factual findings.

3. SIGNIFICANT HOLDINGS

- "An association of persons must be one in which two or more persons jointly hold common purpose or common action and as the word occurs in a section which imposes tax on income, the association must be one which produces income, profits or gains."

- The Trust, by pooling monies from beneficiaries with knowledge that the funds would be used for business projects resulting in profits, qualifies as an Association of Persons under Section 161 of the Income Tax Act.

- Section 40(ba) precludes deduction of interest payments made by an AOP to its members; thus, the disallowance of Rs. 5,38,100/- interest paid to beneficiaries was justified.

- The scope of appellate interference under Section 260A is limited to questions of law, and findings of fact can be interfered with only if perverse. The findings of the Assessing Officer, upheld by appellate authorities, were not perverse.

- The assessee's own declaration of status as an Association of Persons, without any attempt to rectify or explain, is a significant factor in upholding the classification and consequent tax treatment.

The Court answered the substantial question of law in the affirmative and dismissed the Appeal.