COMMISSIONER OF INCOME TAX, KOLKATA v. MUKUNDRAY K. SHAH

Citation: [2007] 4 S.C.R. 1104

Court: Supreme Court of India

Bench: S.H. KAPADIA, B. SUDERSHAN REDDY

Case summary

COMMISSIONER OF INCOME TAX, KOLKATA v. MUKUNDRAY K. SHAH.pdf

Judgment text

COMMISSIONER OF INCOME TAX, KOLKATA v. MUKUNDRAY K. SHAH APRIL I0, 2007 [S. H. KAPADIA AND B. SUDERSHAN REDDY, JJ. ] } Income Tax Act, 1961 Section 2(22)(e)-Deemed dividend- - Diary belonging to assessee, seized by department during search of premises ofa company, MKSEPL, indicating investment by him in bonds- Assessing Officer finding that bonds were purchased from money received from two firms in which assessee was partner, and their books of accovnt showed repayment of loans and advances from three companies, including MKSEPL, which were closely related private limited companies, wherein assessee had controlling interest and considerable voting power-Assessing Officer concluding that MKSEPL had accumulated profits but deliberately refused .

to distribute them as dividends to its shareholders, and money paid by it to two firms wasfor purchase ofbonds by assessee which was assessable as deemed dividend in his hands under Section 2(22)(e)-Correctness of- - Held-Entries discovered during search had direct co-relation with payment by MKSEPL to two firms andpayments by said two firms to assessee who used it to buy bonds; saidfunds were not repayment ofloans. ;_Timing ofso-called repayments by company to those firms and immediate withdrawal offunds by assessee and timing of purchase of bonds was around same time-It was noteworthy that in MKSEPL assessee was not only a shareholder having more than 10% of total voting power, but was also its Director, and said company was partner in the two firms; also withdrawal ofmoney by assessee were debited in capital account offirm leading to a debit balance. Merger of companies-Effect of-Held-Reserves had to he taken on basis of merged account.

Chapter XIV-B dealing with block assessment-Invocation of- Undisc/osed income in nature of deemed dividend detected wholly and A. .. -. exclusively as a result ofa search by department and not from any scrutiny I COMMISSIONEROFINCOMETAX,KOLKATAv. MUKUNDRAYK. SHAH 1105 proceedings, tax evasion petitions, surveys, information receivedfrom ext. _rnal agency etc. -Case of circular trading wherein funds were routed through conduits and clear picture emerged only after seeing cash flow statements- Held-Department was right in invoking provisions of Chapter XIV-B. Section 260A-Appeal to High Court-Interference with fir.

ding of facts of Tribunal-Held-Question as to whether payment by company is for benefit ofassessee is a question offact-Conclusions of Tribunal that it was routed through other firms for benefit ofassessee, on date ofpayment there existed accumulated profits and all withdrawals were debited in cupital account offirm leading to debit balance, were findings offacts-These were not perverse and could not be interfered by High Court-Section 2(22)(e). Words and phrases-Circular trading-In the context ofChapter XIV- B ofIncome Tax Act, 1961. Appellant, the Income Tax Department, searched the premises of company, MKSEPL and seized a diary titled "ML-20" belonging to respondentassessee. The diary indicated investment ofRs. 26. 35 crores by the respondent in 9% RBI Relief Bonds between 17. 11. 99 and 11. 2. 2000 during the accountir. g year ending 31. 3. 2000.

The Assessing Officer found that the said Bonds were purchased from the money received from two firms, MKF and MKI, in which the respondent was partner. In the books ofaccount, the said two firms were shown to have received back the loans and advances from three E. companies viz. MKTPL, SCPL and MKSEPL, which were closely related private limited companies, wherein the respondent had controlling interest and considerable voting power. On the basis of the said diary and the cash flow chart, the Assessing Officer concluded that (i) MKSEPL had accumulated profits but deliberately refused to distribute them as dividends to its .. Shareholders; (ii) Rs. Y. 99 crores was paid by MKSEPL (including SCPL) in the Accounting Year 1999-2000 to MKF and MKI respectively for the purchase of9% RBI Relief Bonds by the respondent, and assessed the said sum as deemed dividend in the hands of the respondent under Section 2(22)(e) of the Income Tax Act, 1961.

It was more so as SCPL stood merged with MKSEPL with effectfrom 18. 5. 98 Aggrieved by the Assessment Order, the respondent filed an appeal before Commissioner of Income Tax (Appeals), which was allowed. Against this appellant appealed to the Tribunal. The Tribunal held that (i) Section 2(22)(e) was attracted to facts of the case since disbursement was made by MKSEPL; (ii) all payments should be taken to have originated from MKSEPL (iii) in January/February 2000 when payments were made by MKI and MKF to the respondent, SCPL had no independent existence in law having merged with MKSEPL with effect from 18. 5. 98; therefore shareholding of respondent in SCPL and its accumulated profits were liable to be taken into account; (iv) though the respondent had bought the Bonds for Rs. 26. 35 crores, restriction of deemed dividend amount to Rs. 5. 99 crores was correct since known company sources had to be eliminated.

Accordingly, the Tribunal allowed the appeal Aggrieved by the decision of the Tribunal, the respondent appealed to the High Court. The High Court held that (i) as the respondent had declared the primary facts in the returns, it was not a case of undisclosed income, but of regular assessment which did not fall under Chapter XIV-B ofthe Act; (ii) none ofthe Authorities below had held that the entries in the books ofaccounts were fictitious; (iii) all payments were made by cheque; (iv) moneys were lent and advanced by MKSEPL to MKF and MKI in normal course ofbusiness; (v) the Tribunal erred in holding that MKF and MKI were conduits for routing the money from MKSEPL to the respondent as there was no evidence in that regard; (vi) there was no evidence to show that payments were made by MKSEPL for the individual benefit of the respondent; (vii) when Rs. 26. 35 crores was invested in the above financial year, there was no reason to treat Rs. 5. 99 crores as deemed dividend.

For the above reasons the High Court set aside~the judgment of the Tribunal. Hence present appeal. Appellant contended that under Section 260A ofthe Act the High Court should not have interfered with the findings offacts recorded by the Tribunal as there was neither a substantial question of law nor any perversity in its findings. Respondent contended that the appellant was wrong in treating the accumulated profits of MKSEPL as accumulated profits of SCPL merely because the merger became effective retrospectively with effe~t from 18. 5. 98. It was more so as MKSEPL had not merged with SCPL but SCPL had merged withMKSEPL Allowing the appeal, the Court HELD 1. 1. The Tribunal was right in holding, on examination of the cash flow statement, that MKSEPL had made payments to MKF and MKI for the benefit of the assessee which enabled the assessee to buy 9% RBI Relief Bonds in the F. Y. 1999-2000. It is in this sense that the Tribunal was right in COMMISSIONEROFINCOMETAX,KOLKATAv. MUKUNDRAYK.

SHAH 1107 holding that the two firms were used as conduits by the assessee. It is not in dispute that the assessee had more than 10% ofvoting power in MKSEPL during the block period. It is not in dispute that the assessee had substantial interest ofabout 16% in MKF. It is not in dispute that the three companies were the controlled companies. (Para 12) (1118-A-C) Commissioner ofIncome-Tax, Madras-Iv. L. Alagusundaram Chettiar, (1977) I09 ITR 508, approved. 1. 2. The timing ofso-called repayments by the company to MKF and MKI and the immediate withdrawal of the funds by the a~um-Director cum-shareholder-cum-partner and the timing of investmer. t in purchase of Bonds were around the same time. Moreover, in MKSEPL the assessee is not only a shareholder having more than 10% of total voting power, he is also a Director of that company. The said company is also a partner in MKF and MKI which explains why the amount ofRs. 5.

99 crores was routed by splitting the said amount into two parts ofRs. 2. 79 crores and Rs. 3. 20 crores. (Para 12) (1118-C-D) 1. 3. The most important aspect, which has not been considered by the High Court, was that withdrawal of money by the assessee from his capital account, in the books ofMKI, during F. Y. 1999-2000 led to a debit balance of Rs. 8. 18 crores as on 31. 3. 2000. To this extent, the finding given by the A. O. and by the Tribunal remains unchallenged. [Para 12) (1118-D-E] 2. 1. On the maintainability of the block assessment, the Department was right in assessing the said amount as deemed dividend in the hands of the assessee under Section 2(22)(e) of the Act. The impugned Assessment Order was passed under Section 158BC. That assessment originated on account ofa search conducted under Section 132(1) ofthe Act. In that search the diary "ML-20" was identified.

That identification was the starting point of connected enquiries resulting in the detection of undisclosed income of Rs. 5. 99 crores. In other words, undisclosed income, in the nature ofdeemed dividend, did not arise from any scrutiny proceedings, tax evasion petitions, surveys, information received from external agency etc. The undisclosed income was detected by the A. O. wholly and exclusively as a result of a search and, therefore, the Department was right in invoking the provisions of Chapter XN-B. [Para 12) (1118-E-G) 2. 2. The Department has established a sort ofcircular trading in this case. One of the important features ofcircular trading is to route the funds through conduits. In such cases the picture emerges only after seeing the cash Dow statem~nts. In the present case, ML-20 made the A. O. to hold enquiries and in that enquiry the cash flow statement emerged, therefore, the Department was right in invoking the provisions ofChapter XIV-B in the present case.

The five payments had direct co-relation with Rs. 5. 99 crores paid by MKSEPL to MKF and MKI and payments by the said two firms to the assessee who used the said money to buy 9% RBI Relief Bonds. Therefore, the said payment by the company through the two firms was for the benefit of the assessee. Therefore, the said funds were not repayment ofloans, they were for purchase of 9% RBI Relief Bonds by the respondent. (Para 12) (1118-G-H; 1119-A-B) 3. The A. O. was correct ·in expressing the view )hat on merger the accounts ofthe two companies had merged and, therefore, the reserves had to be taken on the basis of merged account. Moreover, the assessee had substantial interest in MKSEPL right from the inception. (Para 13) (1119-C) 4. 1. The question as to whether payment made by the company is for the benefit of the assessee is a question of fact. In this case, the Tribunal has concluded that the payment routed through MKF and MKI was for the benefit ofthe assessee.

This was a finding of fact. It was not perverse. Therefore, the High Court should not have interfered with the said finding. [Para 16) (1121-D) Nandlal Kanoria v. Commissioner of Income-Tax, Central, Calcutta, (1980) 122 ITR 405 and Commissioner ofIncome-Tax (Central), Bombay v. P. K Badiani, (1970) 76 ITR 361, approved. 4. 2. The concept·ofdeemed dividend under Section 2(22)(e) of the Act postulates two factors, namely, whether payment is a loan and whether on the date of payment there existed "accumulated profits". These two factors have . to be correlated. This correlation has been done by the Tribunal coupled with the fact that all withdrawals were debited in the capital account of the firm leading to the debit balance of Rs. 8. 18 crores. The High Court has e. rred in disturbing the findings offact. (Para 16) (1121-E] 5.

The companies having accumulated profits and the companies in which substantial voting power lies in the hands of the person other than the public (controlled companies) are required to distribute accumulated profits as dividends to the shareholders. In such companies, tht controlling group can do what it likes with the management of the company, its affairs and its profits. It is for this group to decide whether the profits should be distributed as dividends or not. The declaration ofdividend is entirely within the discretion of this group. Therefore, the legislature realized that though funds were available with the company in the form of profits, the controlling group refused to distribute accumulated profits as dividends to the shareholders but adopted the device ofadvancing the said profits by way ofloan to one ofits shareholders so as to avoid payment oftax on accumulated profits. This was the main reason for enacting Section 2(22)(e) of the Act.

[Para 11) (1117-D-F] CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1873 of2007. From the Judgment and Order dated 12. 05. 2005 of the High Court of Calcutta in G. A. No. 321 of2005 and ITA No. 21 of2005. Mohan Parasaran, A. S. G. , Chidananda, Gaurav Dhingra, K. K. Senthilvelan and B. V. Balaram Das for the Appellant. N. K. Poddar and Rakha Rangaswamy for the Respondent. The Judgment of the Court was delivered by KAPADIA, J. 1. Leave granted. 2. A short question which arises for determination in this civil appeal filed by the Department: whether payments made by M. K. Shah Exports Pvt. Ltd. (for short, 'MKSEPL') during the Accounting Year ending 3l. 3. 2000 (Assessment Year 2000-01) amounting to Rs. 5. 99 crores was made to the two finns M/s. M. K. Foundation (for short, 'MKF') and Mis. M. K. Industries (for short, 'MKJ') for the benefit of respondent-assessee herein, Mukundrai K. Shah. 3. Department sought to tax the said amount of Rs. 5.

99 crores as undisclosed income in the hands ofthe assessee. On 24. 8. 2000, the Department searched the premises of the assessee under Section 132 of Income Tax Act, 196l(for short, 'the Act'). During the search apart from cash and jewellery a diary titled "ML-20" was seized. On 16. 11. 2000, during the search the statement of Kalpesh Shah, son of the assessee, was also recorded under Section 132(4) of the said Act. Statement of the assessee was also recorded on that date. The diary indicated investment of Rs. 26. 35 crores by the assessee in 9% RBI Relief Bonds during the accounting year ending 31. 3. 2000. By the Assessment Order dated 29. 11. 2002, the said amount of Rs. 5. 99 crores was assessed as deemed dividend under Section 2(22)(e) of the said Act. The A. O. took into consideration the income of the assessee for the block period, under Chapter XIV-Bat Rs. 65. 77 crores. This was for the block period 1. 4. 90 to 24. 8. 2000 (for short, "block period").

The diary was seized from the premises of MKSEPL. It belonged to the assessee. The assessee was asked to explain the sources of investment ofRs. 26. 35 crores in purchase of9% RBI ReliefBonds during Financial Year 1999-2000. The said Bonds were purchased between' 17. 11. 99 and 11. 2. 2000. The A. O. found that the said Bonds were purchased from the money received from MKF and MKI (for short, 'two finns') in which the assessee was the partner. In the books of account the said two finns were shown to have received back the loans and advances from three companies M. K. Tea (P) Ltd. (for short, 'MKTPL'), Safari Capital (P) Ltd. (for short, 'SCPL') and MKSEPL, which three companies were closely related companies, in which the assessee had controlling interest. All three companies were private limited companies in which the assessee had considerable voting power. However on the basis of the said diary and the cash flow chart, the A. O. concluded that Rs. 5.

99 crores was paid by MKSEPL (including SCPL) and Rs. 94 lakhs by MKTPL in the Accounting Year 1999-2000 toMKF and MKI respectively for the purchase of 9% RBI Relief Bonds by the assessee. In the circumstances, by the Assessment Order, the Department assessed the said sum as deemed dividend in the hands of the assessee under Section 2(22)(e) of the Act. It was held that MKSEPL, SCPL and MKTPL (for short, 'three companies') we~e the companies in which the public was not substantially interested; that the assessee was one of the shareholders having morj:: than l0% total voting rights of MKSEPL and SCPL; that in MKTPL the total shareholding ofthe assessee was 9. 3% and, therefore, he was not the beneficial owner of the shares of the said companies. It was further held by the A. O. that SCPL stood merged with MKSEPL with effect from 18. 5. 98. This was by the Order of the Calcutta High Court dated 5. 7. 2001.

Therefore, according to the Order of Assessment, the alleged repayments by MKSEPL including SCPL were not repayments but they were payments made by MKSEPL (including SCPL) to MKF and MKl for the individual benefit of the assessee amounting to Rs. 5. 99 crores which was held to be a deemed dividend under Section 2(22)(e) of the Act. Before the A. O. the assessee contended that during the financial year 1999-2000, his shareholding in MKTPL was only 9. 3% and, therefore, he was not having substantial interest in the said company; that similarly he was not having substantial interest in SCPL in which his shareholding in the F. Y 1999-2000 was only 0. 2%; that the assessee was one of the partners in MKF and MKI and that the said two finns did not have substantial interest in MKSEPL, SCPL and MKTPL; that reserves and surplus of MKSEPL cannot be taken as reserves and surplus of SCPL which was merged with the company with effect from 18. 5.

98; that MKl had advanced COMMISSIONEROFINCOMETAX, KOLKATAv. MUKUNDRAYK. SHAH(KAPADIA,J. ) J111 loan to SCPL which was repaid; that payment made by MKSEPL to MKF was through the current account and that the withdrawal made by the assessee from the two firms were debited to his capital account in the books of MKF and MKI and, therefore, the assessee contended that the said payments were not made to the said two firms for his individual benefit. These arguments were rejected by the A. O. It was held that the assessee had substantial interest in MKSEPL in which SCPL stood merged with effect from 18. 5. 98; that there was no merit in the contention of the assessec that the two firms, in which he was the partner, were not beneficial owner of shares of MKSEPL and SCPL; that the only relevant criteria was whether payments made to the said two firms was for the individual benefit of the assessee, who was the shareholder in MKSEPL. This point, according to the A. O.

, became relevant since the only issue which arose for det jlncome:.. Tax (Central), Bombay v. PX Badiani, reported in{l970) 76 ITR 361: "19. Now, the assessee's account for 1st April, 1957, to 31st March, 1958, shows that there are credits as well as debits. What has to be ascertained is whether the debits are "loans", so that they can be deemed as dividends. The account is a mutual,. open, and current account. Every debit, i. e. , every payment by the company to the assessee, may not be a loan. To be treated as a loan, every amount paid must make the company a creditor of the assessee for that amount. If, however, at the time when the payment is made by the company is already a debtor of the assessee, the payment would be merely a repayment by the company towards its already exisiting debt. . It would be a loan by the company only ifthe payment exceeds the amount ofits already existing debt and that too only to the extent of the excess.

Therefore, the position as regards each debit will have to be individually considered, because it may or may not be a loan. The two basic principles are, that only a loan; which would include the other payments mentioned in section 2(6A)(e),'. can· be deemed to be dividend and that foo only to the extent that the company has at the date of the payment "accumulated profits" after deducting therefrom all items legitimately deductible therefrom. xxx xxx xxx 21. As regards questions Nos. 3 and 4, Mr. Rajgopal conte4ded that the debit balance, if any, at the last date of the assessee' s accounting year lst April, 1957 to 31st March, 1958, should be taken as the amount to be treated as dividend and as the assessee;s··accoimt is on ; the last dayto his credit, no amount can be deemed to be dividend. As already pointed out, the position has to be ascertained at'the date of each payment by the company to the assessee and this contention must, therefore, be rejected. If Mr.

Rajgdpal's contentiOn was to be accepted, the' result would be that if a shareholder borrows alarge amount during the year, but repays it on the last day of the year, it would not be considered to be a loan_, though·the facts show that he did borrow a loan. Such a contradiction ofth. e·real factwould result · ifMr. Rajgopal's contention were to be accepted. Mr,:Rajgopal further contended that in any event the highest amount to the assessee's debit on any day of the year should be the amount to be deemed to be dividend. This argument, again, ignores the principle laid down by us, that the position at the date of each payment must be considered. Moreover, there is another reason and that is that if it were to be so done, it would not enable the position of the balance of th-:: "accumulated profits" being taken into account, as more than one shareholder may have borrowed loans from the company in an account similar to that of the assessee. All these contentions of Mr.

Rajgopal ignore the basic fact that section 2(6A)(e) uses the words "any payment" which means, every payment, and section 2(6A)(e) requires the determination oftwo factors, viz. , whether the payment is a loan and whether at the date when the payment is made there were "accumulatedprofits" and that these two factors are to be correlated and the result must be ascertained at the date of each such payment. " (emphasis supplied) 16. The above two judgments indicate that the question as to whether payment made by the company is for the benefit of the assessee is a question of fact. In this case, the Tribunal has concluded that the payment routed through MKF and MKI was for the benefit of the assessee. This was a finding of fact. It was not perverse. Therefore, the High Court should not have interfered with the said finding.

Further, the above two judgments lay down that the concept of deemed dividend under Section 2(22)(e) of the Act postulates two factors, namely, whether payment is a loan and whether on the date of payment there existed "accumulated profits". These two factors have to be correlated. This correlation has been done by the Tribunal coupled with the fact that all withdrawals were debited in the capital account of the firm leading to the debit balance of Rs. 8. 18 crores. The High Court has erred in disturbing the findings of fact. p 17. For the above reasons, we set aside the impugned judgment of the High Court. Accordingly, the appeal stands allowed with no order as to costs. vs Appeal allowed.