Paper loan arrangement and round-tripping of funds can be disregarded, with resulting interest taxed in the controller's hands.

A loan arrangement in favour of the assessee's children was found to be a paper device, not a genuine borrowing, because funds were round-tripped through the books on the same day without real loan substance. On that factual characterisation, the interest arising from the arrangement was assessable in the assessee's hands under anti-avoidance principles governing direct and indirect transfers. The Supreme Court also noted that, in the section 256 reference, the High Court did not exceed its jurisdiction by sustaining that legal characterisation on the facts found.

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Issues: Whether the so-called loan transaction in favour of the assessee's children was a genuine loan or merely a paper device attracting taxability of the resulting interest income in the assessee's hands, and whether the High Court exceeded its advisory jurisdiction in answering the reference accordingly.

Analysis: The relevant question arose in reference proceedings under section 256 of the Income-tax Act, 1961, where the Tribunal's factual characterisation of the transaction was examined in the light of the material on record. The arrangement showed a round-tripping of funds through the books of the assessee and the children's firm on the same date, without any real loan substance. The transaction was therefore treated as a devised paper adjustment intended to reduce tax liability and not as a genuine loan. On that footing, the income arising from the arrangement could be assessed in the assessee's hands under the anti-avoidance provisions concerning direct and indirect transfers, and the High Court was not shown to have reappreciated facts beyond its jurisdiction.

Conclusion: The transaction was not a bona fide loan, the interest income was rightly taxed in the assessee's hands, and the High Court's answer to the reference was upheld.

Ratio Decidendi: A paper arrangement lacking real loan substance, devised to avoid tax, may be disregarded for income-tax purposes and the resulting income taxed in the hands of the person who controlled the transaction; in a reference under section 256 of the Income-tax Act, 1961, the High Court does not exceed jurisdiction where it sustains such a legal characterisation on the facts found.

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