DEPUTY COMMISSIONER OF INCOME TAX v. NATURAL GAS CO. LTD
[Citation -2005-LL-1124-6]

Citation 2005-LL-1124-6
Appellant Name DEPUTY COMMISSIONER OF INCOME TAX
Respondent Name NATURAL GAS CO. LTD.
Court ITAT
Relevant Act Income-tax
Date of Order 24/11/2005
Assessment Year 1997-98
Judgment View Judgment
Keyword Tags memorandum of association • disallowance of interest • solitary transaction • accumulated profit • single transaction • business activity • bank transaction • lending of money • outstanding loan • deemed dividend • interest earned • interest income • legal provision • speaking order • penal interest • additional tax • interest paid • money lending • voting power • capital gain • cash in hand • interest-tax
Bot Summary: In appeal, the CIT(A) deleted the disallowance so made by the AO by taking note of assessee s contention that there is no infraction of law involved and it is a case of additional tax levied by HDFC for some contractual delays and observing that since there is no infraction of law, the additional interest, though termed as penal interest, is clearly a normal incidence of business. The AO rejected this contention for various reasons, including, the receipts on account of interest are only 15.56 per cent of the gross receipts; out of 445 bank transactions that the assessee had in the whole year, only one bank transaction pertained to the money lending business; there is no mention about money lending business, as one of the businesses of the PDPL, in the assessment order for the preceding year; and PDPL was not assessed to interest-tax. The CIT(A) accordingly held that money lending business formed a substantial part of PDPL s business, taking the present case outside the ambit of s. 2(22)(e). In our considered view, in order to satisfy the conditions laid down by second exception to s. 2(22)(e), not only that the company lending money should have substantial business activity of money lending but also the loan or advance in question should be given in the ordinary course of business. On the given set of facts, it is not possible to hold that the assessee-company was engaged in the business of lending of money particularly as, even according to the assessee, the lending is within the group concerns. Even if we are to assume that it was a business, it does not help the case of the assessee because a solitary transaction in the year, irrespective of the size of the said transaction, cannot be said to constitute substantial business of PDPL. One of the argument of the assessee is that out of total assets of Rs. 4.15 crores, the sum employed in giving loans and advances to group concerns is Rs. 2.63 crores which constitutes 63 per cent of the total assets, and, for this reason, it should be considered as substantial business of PDPL. This plea is also devoid of any substance. At the cost of repetition, we may mention that for the purpose of deciding what is main business of an assessee, we have to see which are the major organized activities of the assessee for earning profits.


In this Revenue s appeal, which is directed against CIT(A) s order dt. 28th March, 2000 for asst. yr. 1997-98, following grievances have been raised: "On facts and in circumstances of case and in law, learned CIT(A) erred in deleting disallowance of interest paid to HDFC of Rs. 71,939 which was made by AO on ground that payment was made due to infraction of law. On facts and in circumstances of case and in law, learned CIT(A) erred in deleting addition of Rs. 76,74,436 being deemed dividend under s. 2(22)(e) of Act, on account of loans received from Phoenix Distributors (P) Ltd." As far as first grievance of Revenue is concerned, impugned disallowance was made by AO by making rather cryptic observation as follows: "The assessee has paid Rs. 45,32,422 as interest to HDFC. Out of this, Rs. 71,939 is penal interest. Penal interest is not allowable expenditure, and, hence, I disallow Rs. 71,939 out of interest paid and add back same to total income." In appeal, CIT(A) deleted disallowance so made by AO by taking note of assessee s contention that "there is no infraction of law involved and it is case of additional tax levied by HDFC for some contractual delays" and observing that "since there is no infraction of law, additional interest, though termed as penal interest, is clearly normal incidence of business". Revenue is aggrieved and in appeal before us. Having heard rival contentions and having perused material on record, we see no reasons to disturb well-reasoned stand of CIT(A). As there is nothing on record to suggest that interest paid as penal interest is on account of infraction of law, and as penal interest is on account of contractual delays, disallowance has rightly been deleted by CIT(A). We confirm and approve his action in doing so. grievance raised by Revenue is devoid of any merits. Ground No. 1 is thus dismissed. Coming to second grievance raised by Revenue, relevant material facts are like this. During course of assessment proceedings, AO noticed that assessee had taken loan of Rs. 1,40,00,000 from Phoenix Distributors (P) Ltd. (PDPL, in short). It was also noted that one Shri R.M. Goculdas is holding more than 10 per cent equity of PDPL and is also holding more than 20 per cent shares of assessee-company. assessee accepted factual position regarding shareholding pattern and applicability of s. 2(22)(e) of Act from that point of view, but it was contended by assessee that in view of fact that main business of assessee- company was money lending, provisions of s. 2(22)(e) are not applicable on facts of this case. AO rejected this contention for various reasons, including, (a) receipts on account of interest are only 15.56 per cent of gross receipts; (b) out of 445 bank transactions that assessee had in whole year, only one bank transaction pertained to money lending business; (c) there is no mention about money lending business, as one of businesses of PDPL, in assessment order for preceding year; and (d) PDPL was not assessed to interest-tax. It was thus held that provisions of s. 2(22)(e) are applicable on facts of this case and to extent loans received from PDPL are covered by accumulated profits same shall be taxable in hands of assessee-company as deemed dividend . next question then w s quantification of deemed dividend taxable in hands of assessee. It was contended by assessee that capital gain exempt under s . 54E was Rs. 1,19,13,657 and capitalization of profits by issuance of bonus shares was Rs. 1,19,00,000 which are to be excluded from accumulated profits. AO rejected this claim and held that both deductions cannot be made simultaneously. It was held that out of tax exempt receipt of Rs. 1,19,13,657, amount of Rs. 1,19,00,000 was already capitalized. remaining accumulated profit was Rs. 76,88,093, from which further amount of Rs. 13,657 being balance tax exempt gain, was reduced. accumulated profit was thus worked o u t to Rs. 76,74,436 which was added back to assessee s income under s. 2(22)(e) as deemed dividend . Aggrieved by addition so made by AO, assessee carried matter in appeal before CIT(A). CIT(A) was of view, that AO was not justified in comparing gross interest receipts with gross amount of other receipts; what is to be really seen is income from respective heads, and, if that is criterion, interest income of assessee is more than other profits of assessee. It was also observed that more than 60 per cent of assets of assessee are deployed in money lending. CIT(A) also held that even single transaction constitutes business, that this has to be viewed in context of outstanding loan position and organized manner in which this activity has been carried out over years, that non- disclosure of such business in IT return and default in payment of interest-tax cannot have any bearing on merits of this case and that it is sufficient, for coverage by exclusion clause in s. 2(22)(e), that money lending business of lender should be one of significant , sizeable or noteworthy businesses of lender. CIT(A) accordingly held that money lending business formed substantial part of PDPL s business, taking present case outside ambit of s. 2(22)(e). addition was thus deleted. Revenue is aggrieved and is in appeal before us. We have heard rival contentions, perused material on record and duly considered factual matrix of case as also applicable legal position. We deem it appropriate to reproduce relevant legal provision, contained in s. 2(22)(e) of IT Act, which is as follows: "2(22) Dividend includes.......... (e) any payment by company, not being company in which public are substantially interested, of any sum (whether as representing part of assets of company or otherwise) made after 31st day of May, 1987, by way of advance or loan to shareholder being person who is beneficial owner of shares (not being shares entitled to fixed rate of dividend whether with or without right to participate in profits) holding not less than ten per cent of voting power, or to any concern in which such shareholder is member or partner and in which he has substantial interest (hereafter in this clause referred to as said concern) or any payment by any such company on behalf, or for individual benefit, of any such shareholder, to extent to which company in either case possesses accumulated profits; but "dividend" does not include (ii) any advance or loan made to shareholder or said concern by company in ordinary course of its business, where lending of money is substantial part of business of company;" There is no dispute about fact that case of assessee meets conditions laid down under s. 2(22)(e) and assessee s only defence about non- taxability as deemed dividend is that case is covered by second exemption, i.e., cl. (ii), inasmuch as money lending activity constituted substantial business activity of PDPL. CIT(A) finally upheld this contention and it was on this basis that taxability of deemed dividend under s. 2(22)(e) was deleted. In our considered view, in order to satisfy conditions laid down by second exception to s. 2(22)(e), not only that company lending money should have substantial business activity of money lending but also loan or advance in question should be given in ordinary course of business . It is only when these twin conditions are satisfied that case can be said to be covered by aforesaid exception. In statement of facts before CIT(A), assessee has narrated relevant facts as follows: "During year ended 31st March, 1997, appellant company had received loan of Rs. 140 lakhs from Phoenix Distributors (P) Ltd. Phoenix Distributors (P) Ltd. is company carrying on trading and money lending business. This is evident from continuity, regularity and volume of money lending transactions. Interest earned forms sizeable portion of PDPL s taxable income. PDPL has given loans to various associate companies and is earning substantial interest on these loans and advances. It was therefore contended before learned AO that s. 2(22)(e) does not apply in respect of loans/advances given by said PDPL." It is thus clear that even by assessee s own admission, said business of PDPL extended only to giving loans to "various associate companies" and earning interest income therefrom. It is difficult for us to comprehend as to how giving loans and advances to associated concerns can be construed as independent business . This could be profitable way to employ surplus funds within group and to help group concerns or otherwise associated concerns but it cannot constitute business on given set of facts. There is nothing on record to show that it is organized business activity with view to make profits. quantum of income, in present context, is not of much significance either. question of quantum becomes relevant only when it is established that money lending is business in first place. Learned counsel s reliance on memorandum of association is not of much help either; just because clause is set out in memorandum of association of company, which are often as widely worded as possible, does not mean that business covered by that clause has actually been carried out. Learned CIT(A) s reliance on Hon ble Supreme Court s judgment in case of CIT vs. P.K.N. Co. Ltd. (1966) 60 ITR 65 (SC) is misplaced inasmuch as this judgment can in fact be authority for proposition that mere existence of enabling clause to do business does not mean that such business has actually been carried out, because, in this case, Their Lordships have observed that ".....the nature of transaction must be determined on consideration of all circumstances, and fact that this transaction is within powers (as given by memorandum of association) is relevant but has, standing alone, not much significance". On given set of facts, it is not possible to hold that assessee-company was engaged in business of lending of money particularly as, even according to assessee, lending is within group concerns. If profit was motive of making these loans and advances, which is sine qua non for any business activity, restricting transactions to transactions with associated concerns seems totally out of place. Even if we are to assume that it was business, it does not help case of assessee because solitary transaction in year, irrespective of size of said transaction, cannot be said to constitute substantial business of PDPL. One of argument of assessee is that out of total assets of Rs. 4.15 crores, sum employed in giving loans and advances to group concerns is Rs. 2.63 crores which constitutes 63 per cent of total assets, and, for this reason, it should be considered as substantial business of PDPL. This plea is also devoid of any substance. If that be any criterion, in case where cash and bank balances of business constitute say 50 per cent of assets-side total, main business of company can be claimed to be keeping cash in hand and bank. At cost of repetition, we may mention that for purpose of deciding what is main business of assessee, we have to see which are major organized activities of assessee for earning profits. It is also noteworthy that PDPL was not assessed to interest-tax and rightly so because, on facts of case, it could not have been said to have been engaged in business of money lending. assessment records of PDPL, which are essentially based on information supplied by PDPL, also do not show that PDPL was engaged in business of money lending. assessee s case fails on these tests. Learned counsel has referred to Benchmark of 20 per cent income, to decide whether or not it is covered by expression substantial , but these Benchmarks in ss. 2(22)(e) and 40A(2)(b) are in altogether different context of determining substantial interest . quantum of receipts from interest is also less than 16 per cent which can hardly be termed as substantial. Keeping all these factors in mind, we are of considered view that CIT(A) did err in coming to conclusion that assessee s case was covered by second exception to s. 2(22)(e). We, therefore, vacate relief given by CIT(A). Learned counsel contends that even if Revenue succeeds in appeal, it still makes no difference to assessee because accumulated profits are negative figures. In computation that he has filed, he has reduced figure of Rs. 1,22,95,000 on ground that this amount was added back as deemed dividend in earlier years and same could not be taxed again now. In response to our query, however, he admits that addition so made was subsequently deleted in appellate proceedings but then he is unable to file relevant orders. This plea is devoid of any substance. When addition made in preceding year has already been deleted, there cannot be relevance of same in determining deemed dividend for this year. In principle, we agree that in case accumulated profits of PDPL are already taxed as deemed dividend in hands of assessee to that extent, addition cannot be made again, but we do not think that situation exists here. addition made is perhaps already deleted and matter is settled at that. However, since complete facts in respect thereof are not available to us, we have to remit this matter to file of AO for quantification aspect. Learned counsel has also contended that capital gains considered in past as exempt are required to be reduced from accumulated profits, but then as we are remitting matter to file of AO for quantification of deemed dividend, we also consider it appropriate to direct assessee to place all relevant facts, with supporting evidences and authorities relied upon, before AO who will decide on all aspects related to quantification of dividend, including this aspect of matter, by way of speaking order in accordance with law and after giving due and fair opportunity of hearing to assessee. Ground No. 2 is thus allowed for statistical purposes in terms indicated above. In result, appeal is partly allowed for statistical purposes in terms indicated above. *** DEPUTY COMMISSIONER OF INCOME TAX v. NATURAL GAS CO. LTD.
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