DELHI E BENCH SUBHASHCHAND v. INCOME TAX OFFICER SANJAY KUMAR November 28, 1986 JUDGMENT NARAYANAN, A.M. assessee firm paid interest of Rs. 17,900 to M/s Subhash Chand Jain Financiers Corp. of Shamli (for short "M/s SPC Corpn.") It claimed interest payment as deduction from its business profits this year. ITO looked into this account. He noted that M/s. SPC Corpn. had advanced sum of Rs. 1,00,000 to assessee firm and its account was accordingly credited with said amount in books of assessee firm on 17th Oct., 1979. It transpired that M/s SPC Corp. was AOP and members of this AOP and their respective capital contribution in AOP were as under: Name Capital (i) Mam Chand Rs. 25,000 (ii) Subhash Chand Rs. 25,000 (iii) Sanjay Kumar Rs. 50,000 Out of above, Mam Chand and Subhash Chand were partners of assessee firm. Sanjay Kumar was minor admitted to benefits of partnership of assessee firm. further fact noticed by ITO was that above sums had been withdrawn by three parties above from their respective capital accounts in books of assessee firm and transferred to credit of AOP. ITO wanted to satisfy himself about genuineness of AOP. He required members of AOP to be produced but, in spite of opportunity given, this requirement was not complied with. Instead assessee s counsel stated in writing that there was no need to produce members as they were regular taxpayers. According to ITO, AOP was not genuine at all. It was just paper arrangement. interest credited in AOP s account was nothing but interest paid to partners concerned. Keeping in view decision of Allahabad High Court in CIT vs. London Machinery Co. (1979) 10 CTR (All) 301: (1979) 117 ITR 111 (All) ITO disallowed following interest in terms of s. 40(b) of IT Act, 1961: Name Interest payment disallowance (1) Mam Chand Rs. 4,475 (2) Subhash Chand Rs. 4,475 (3) Sanjay Kumar Rs. 8,950 Rs. 17,900 assessee appealed. AAC confirmed disallowance. In doing so, he recorded following: (i) claim for assessee was that AOP was genuine entity evidenced by Memorandum i.e., agreement to come together as AOP was put into writing and witnessed by competent persons, that capital had been contributed by members of AOP out of their disclosed capital as accepted by Department, that hence there could be no reason for disallowing interest paid to it, that in similar factual context, Tribunal held that s. 40(b) was not attracted (M/s Jagdish Medical Hall vs. ITO ITA Nos. 1895 & 1896/Del/83 dt, 7th April, 1984. But decision of Tribunal in that case was apparently given without noting earlier decision of Tribunal in case of Shamlal Bros. vs. ITO ITA No. 2942/Del/1980 dt. 9th Oct., 1980. In that case, contrary view was taken. (ii) only source of income of AOP was interest credited to it in books of assessee firm on sum of Rs. 1,00,000 transferred to its credit from capital of three parties mentioned above. It is not necessary in this context to consider, whether AOP was genuine or otherwise. No doubt, AOP was formed and as evidenced by Memorandum in writing. But where only purpose of formation of such AOP was tax avoidance such AOP cannot be taken at its face value. reality behind such facade has to be uncovered. (iii) obvious intention of three parties, who claimed to have formed AOP here were reduction of tax liability of assessee firm and themselves as partners of said firm. No doubt, reduction of tax liability by resort to legal device is not forbidden, but when it takes such extreme form as in this case, ITO is not expected to swallow whole arrangement as being in order without looking into motivations behind such arrangement. (iv) That three parties here had done was merely to adopt dubious method to divert their funds lying with assessee firm. It was clear that AOP did not render any service to assessee firm except that it lent its name to be utilised in books of firm for making debit and credit entries. In present case, interest payment to AOP was nothing but interest paid to three partners under veil of aforesaid arrangement. Once this veil is lifted, it is clearly seen to be payment to partners. Sec. 40(b) is, therefore, attracted and this was view taken by Tribunal in Shamlal & Bros. supra. disallowance made by ITO was, therefore in order. assessee is in further appeal. We have heard both Shri V.K. Chadha, ld. counsel for assessee as well as Smt. Manjri Kakkar, Departmental Representative. For assessee, submissions before authorities below were reiterated. For Department, reliance was placed on order of AAC. Smt. Kakkar referred in particular to new judicial response to tax avoidance as stated in McDdowell & Co. Ltd. vs. CTO (1985) 47 CTR (SC) 126: (1985) 154 ITR 148 (SC). In our view, there is no room for interference. It is true that it was held in CIT vs. A. Raman & Co. (1968) 67 ITR 11 (SC) that avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed, is not prohibited. But this view no longer holds field. There has been sea-change in judicial attitude to tax avoidance since then. observations on tax avoidance in A. Raman & Co. (supra) were specifically disapproved by Supreme Court in McDowell (supra) In McDowell Court observed that proper way to construe taxing statute, while considering device to avoid tax is not to ask whether provisions should be construed literally or liberally. Nor whether transaction is not unreal and not prohibited by statute but whether transaction is device to avoid tax and whether transaction is such that judicial process may accord its approval to it that it is neither fair nor desirable to expect legislature to intervene and take care of every device and scheme to avoid taxation that it is upto Court to take stock to determine nature of new and sophisticated legal devices so avoid tax and expose devices for what they really are and to refuse to give them judicial benediction. It would appear that these observations invest judicial bodies with powers of amplitude that were hitherto unrecognised. traditional role of our Courts has been to interpret and not to legislate. Apparently, there has been some shift in emphasis in this regard. new philosophy has received seal of approval of highest Court. It is now possible, in fact obligatory for judicial body to see whether factual context before it shows up device to avoid tax and that further whether transaction that has resulted should be accorded approval of judicial process. No doubt in McDowell, no parameters were laid down for such intrinsically subjective exercise. This may perhaps lead to certain amount of lopsideness in transaction of this philosphy into actual practice by judicial bodies. Perhaps, more definite form and content will come to be given to this new doctrine so that this area of uncertainty is either removed or greatly reduced. However, proceeding in light of McDowell, we have little doubt in recognising that transaction before us had no genuine family necessity or genuine business arrangement behind it and only motivation was avoidance of tax. We do not think that such device cannot be given judicial benediction . We would, therefore, maintain order of AAC as correct. In result, appeal is dismissed. *** SUBHASHCHAND SANJAY KUMAR v. INCOME TAX OFFICER