2017 (9) TMI 2056 - AT - Income Tax

Denial of exemption under section 11 for alleged fund diversion to specified persons rejected; revenue appeal dismissed.

Whether transactions amounted to diversion of trust funds benefiting persons specified in section 13(3) was tested by their substantive nature; repayments ... Denial of exemption u/s 11 - assessee had violated the provisions of section 13(1)(c) &(d) - Assessee as diverted its funds to the persons as specified u/s 13(3) HELD THAT:- Act prohibits persons specified u/s 13(3) to get direct or indirect benefit from the trust or institution claims exemption u/s 11 of the Act. The specified persons cannot use funds or property of the trust for their personal purpose. To decide whether a particular transaction between the trust and trustees is hit by the provisions of section 13(1)( c) or not, have to be judged from the basic nature of transactions. In this case, the facts borne out from the records clearly indicate that there is no diversion of funds to the persons as specified u/s 13(3) of the Act. The amount outstanding in the name of M/s Moidu’s Medicare Pvt Ltd is a repayment of amount taken from Dr K Moidu, Managing Trustee. The Trust has repaid an amount of Rs. 10 lacs by cheque in the name of M/s Moidu’s Medicare Pvt Ltd as per the instructions of Dr K Moidu and debited to the account of the company instead of to the account of Dr K Moidu. The said mistake has been rectified by passing necessary journal entries in the books of account in the subsequent financial year. Therefore, there is reasonableness in the arguments of the ld AR of the assessee trust that this amount represents repayment of loan availed from the Managing Trustee and the amount was paid to M/s Moidu’s Medicare Pvt Ltd upon the instructions of the Managing Trustee. Debit balance in the books of National Hospital College of Nursing AO neither in the assessment order nor in the remand report has brought out any evidence to show that this advance was used by the trustee for their personal benefit. Therefore, we are of the considered view that there is no diversion of funds so as to get benefit to the trustees referred to in section 13(3) of the Act. Debit balance to Dr K M Mehaboob and two others, Trust has debited annual license fee payable to the advance account over a period of 20 years. This rent was fixed for the building works out to less than the prevailing market rate. Therefore, we are of the considered opinion that the said transaction cannot be considered as an isolated transaction to hold that the assessee has diverted its funds to the benefit of the persons as specified u/s 13(3) of the Act. Moreover, we find that there is an aggregate credit balance of Rs. 41,14,000/- as on 1.4.2004 in the name of the trustees which was in excess of aggregate of the amount treated by the Assessing Officer as diversion of funds for the benefit of trustees. Thus, there is no diversion of funds to persons as specified u/s u/s 13(3) of the Act. Appeal filed by the revenue is dismissed. Issues: (i) Whether the Trust diverted funds or applied property for the benefit of persons specified in section 13(3) of the Income-tax Act, 1961 so as to disentitle it from exemption under section 11; (ii) If such diversion is found, whether tax can be charged only on the relevant part of income at the maximum marginal rate under section 164(2) or on the entire income.Issue (i): Whether the transactions and advances identified by the Assessing Officer constituted diversion of trust funds to persons specified in section 13(3) of the Income-tax Act, 1961.Analysis: The Tribunal examined three specific instances relied on by the Assessing Officer: (a) amounts appearing as due to M/s Moidu's Medicare Pvt. Ltd. which the assessee explained as repayments to the Managing Trustee inadvertently debited to the company and later rectified by journal entries; (b) advance payment to the company for nursing training made under an existing agreement and adjusted against fees; and (c) advance towards construction on trustees' leasehold land adjusted as license fee over 20 years with substantial trustee contribution and a rent below market rate. The Tribunal assessed documentary evidence, contractual terms, subsequent account adjustments, aggregate credit balances in trustees' accounts and prior holdings distinguishing commercial transactions from impermissible diversion.Conclusion: The Tribunal held that on the facts and record there was no diversion of funds to persons specified in section 13(3) and therefore the Trust was not disentitled from exemption under section 11 on the basis alleged by the Assessing Officer. This conclusion is in favour of the assessee.Issue (ii): If diversion of relevant income is established, whether tax is to be charged on the whole income of the trust or only on the part so diverted at the maximum marginal rate under section 164(2).Analysis: The Tribunal analysed the statutory scheme and binding precedents addressing application of section 13(1)(c) together with section 164(2). It observed that clause (c) of section 13(1) limits exemption where income or property is used for benefit of specified persons, and section 164(2) prescribes charging tax at the maximum marginal rate on the relevant income or part thereof which is not exempt by virtue of clause (c) or (d) of section 13(1). The Tribunal referred to judicial authority distinguishing assessment of only diverted portions from charging tax on entire receipts.Conclusion: The Tribunal upheld that where any part of relevant income is hit by section 13(1)(c) or (d), tax can be charged only on that relevant part at the maximum marginal rate under section 164(2), and not on the whole income. This conclusion is in favour of the assessee as to the correct legal consequence.Final Conclusion: The Tribunal dismissed the revenue's appeal, upholding the CIT(A)'s findings that there was no diversion of funds on the facts and affirming the legal position that only diverted relevant income (if any) is taxable at the maximum marginal rate under section 164(2), thereby maintaining the assessee's entitlement to exemption under section 11 on the facts before it.Ratio Decidendi: Where transactions between a trust and persons specified in section 13(3) are supported by contractual arrangements, account adjustments and evidentiary records showing bona fide commercial dealings or repayments, they do not constitute diversion under section 13(1)(c); and if any part of relevant income is rendered non-exempt by clause (c) or (d) of section 13(1), tax is leviable only on that relevant part at the maximum marginal rate as provided by section 164(2) of the Income-tax Act, 1961.