2001 (10) TMI 1167 - AT - Income Tax

Tribunal Disallows Interest Payments for Tax Avoidance Scheme

Kantilal Manilal & Co. Versus Deputy Commissioner of Income-Tax

The tribunal upheld the disallowance of interest payments to M/s. Emjey Enterprises and M/s. Kantilal Manilal & Co. Pvt. Ltd., ruling that the ... - Issues Involved:1. Disallowance of interest payment to M/s. Emjey Enterprises and M/s. Kantilal Manilal & Co. Pvt. Ltd.2. Consideration of credit balances obtained through journal entries for calculating interest payable.Detailed Analysis:1. Disallowance of Interest Payment to M/s. Emjey Enterprises and M/s. Kantilal Manilal & Co. Pvt. Ltd.:The assessee, a partnership firm, challenged the disallowance of interest payments amounting to Rs. 5,87,339 to M/s. Emjey Enterprises and Rs. 1,68,119 to M/s. Kantilal Manilal & Co. Pvt. Ltd. The assessee argued that the transactions were genuine business transactions and supported by relevant documentation. The partners had withdrawn money from their capital accounts and advanced it to the said firms, which in turn lent it back to the assessee-firm. The assessee contended that the transactions were legitimate and not intended to avoid tax, citing several judicial precedents to support their claim.The revenue, however, argued that the transactions were a colourable device intended solely to avoid the applicability of section 40(b) of the Income-tax Act, which disallows interest paid to partners. The money did not actually move and remained within the control of the assessee-firm, indicating that the transactions were pre-ordained with the sole purpose of reducing taxable profit.Upon review, the tribunal found that the transactions were indeed intended to avoid the provisions of section 40(b). The money remained with the assessee-firm, and the interest payments were merely routed through sister concerns to create an appearance of compliance with the law. The tribunal emphasized that the true nature of the transactions must be considered as a whole, rather than dissecting individual steps, citing the principle laid down in the case of McDowell & Co. Ltd. v. CTO. The tribunal concluded that the transactions were a colourable device for tax avoidance and upheld the disallowance of interest payments.2. Consideration of Credit Balances Obtained Through Journal Entries for Calculating Interest Payable:The assessee also contested the CIT(A)'s decision to ignore the credit balances obtained through journal entries for calculating interest payable to M/s. Emjey Enterprises and M/s. Kantilal Manilal & Co. Pvt. Ltd. The assessee argued that the partners had the right to withdraw money from their capital accounts and deal with it as they wished, and that the transactions were genuine and acted upon.The tribunal, however, found that the partners had not actually withdrawn the money. Instead, journal entries were passed to show credit in the accounts of the sister concerns without any actual movement of funds. The tribunal noted that the money remained with the assessee-firm throughout the transactions, and the interest payments to the sister concerns were effectively payments to the partners, disguised to avoid section 40(b).The tribunal dismissed the assessee's argument that the transactions were genuine and had been accepted in the income-tax assessments of the sister concerns. It emphasized that the assessment proceedings of the assessee and the sister concerns are independent, and the true intention and consequences of the transactions must be examined in the assessee's case. The tribunal concluded that the transactions were a colourable device for tax avoidance and upheld the CIT(A)'s decision to ignore the credit balances obtained through journal entries for calculating interest payable.Conclusion:The tribunal dismissed the appeal, holding that the transactions were a colourable device for avoidance of section 40(b) of the Income-tax Act. The interest payments to M/s. Emjey Enterprises and M/s. Kantilal Manilal & Co. Pvt. Ltd. were effectively payments to the partners and rightly disallowed by the Assessing Officer.