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 to a company were held to be reimbursement of a loan to the managing trustee after rectifying accounting entries, and advances to an associated college and discounted long term licence payments did not show use for trustees' personal benefit. The tribunal found aggregate trustee credits exceeded amounts treated as diversion and concluded no prohibited benefit under section 13(1)(c)/(d), so exemption under section 11 was not vitiated and the revenue appeal was dismissed.

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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.

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