2002 (12) TMI 8 - SC - Income Tax

Final decision finds oral account acceptance perverse; founder received Rs70 lakh interest-free advance, attracting s13(3)(a)/13(1)(c)(ii) and denial of s11 exemption

Director of Income-Tax Versus Bharat Diamond Bourse

SC held the Tribunal's acceptance of the assessee's oral account was perverse and affirmed the Assessing Officer and appellate authority. The court found ... Entitlement of the assessee to the benefit of section 11- non-profit service organization incorporated as a company limited by guarantee - 'charitable purposes' within the meaning of section 2(15) - expenses incurred by the MMTC - Status of Bharat Shah as Founder - term 'founder of the institution' used in section 13(3)(a) - adequate security or interest and without a written agreement - HELD THAT:- The Tribunal seems to have accepted the facile explanation given by the assessee, perhaps manufactured post facto the assessment order, without critical appraisal. We are surprised that the entire agreement between Bharat Shah and the assessee was supposed to be an oral agreement, which was supposed to have been terminated orally with Bharat Shah being orally called upon to return the money with interest of 12 per cent., which he is said to have refused. In our view, this story does not ring true and could not have been accepted by any reasonable person, instructed in law. It is wholly unnatural, because one does not expect hard-nosed businessmen to part with an amount of Rs. 70 lakhs without even recording an agreement under which it is paid, nor without agreeing upon the precise terms of the lease. The story rings false from beginning to end, and yet, the Tribunal accepted it by saying, 'as regards the bona fides of the transaction, in our opinion, there is nothing to suspect the same.' The Tribunal says, 'there is a transparency about the entire transaction which nullifies any attempt to make out the transaction as something unusual and out of the ordinary.' That diamonds are not transparent, that they dazzle with a brilliance that blinds the eye, seems to have escaped the notice of the Tribunal, It undiscerningly accepted the glib explanation of the assessee, though teeming with improbabilities and strenuous on credulity. We, therefore, are of the view that the Tribunal's conclusions on this issue are perverse and need to be interfered with. We affirm the conclusions arrived at by the Assessing Officer and the appellate authority to the effect that Rs. 70 lakhs were lent to Bharat S. Shah for substantial periods during the previous years pertaining to the relevant assessment years, without interest and without adequate security. In our view, the term 'founder of the institution' used in section 13(3)(a) means no more nor less than what it says. The expression 'founder' means what is understood in ordinary parlance -the originator or the person responsible for the establishment of the institution. The Concise Oxford Dictionary, new seventh edition, page 388, defines the expression 'founder' as 'one who founds an institution' and the verb 'found' to mean 'lay base of; be original builder, begin building of, set up, establish, orginate, initiate, construct, base.' The Collins Cobuild English Dictionary, new edition, page 670, gives the meaning of the term 'founder' as 'The founder of the institution, organisation, or building is the person who got it started or caused it to be built Often by providing necessary money' and the verb 'found' means 'when an institution, company, or organisation is founded by someone or by a group of people, they get it started, Often by providing the necessary money.' In the case of the assessee, we are of the view that Bharat Shah, along with several others, founded the company as all of them were subscribers to its memorandum of association. It is by their acts that the company got incorporated under the provisions of the Companies Act and was thus born. May be that Bharat Shah did not contribute any money, apart from the guarantee given as the company is one limited by guarantee. That hardly makes any difference to the situation and Bharat Shah would very much answer the description 'founder of an institution' used in section 13(3)(a) of the Act. That there may be others also is irrelevant and immaterial for the purpose of this appeal. In fact, a reading of section 13(3) and the contrast between clauses (a) and (b) brings home the distinction made by the Act between the founder of the institution and the person who has made substantial contribution to the institution. We are, therefore, unable to accept the contention of learned counsel for the assessee that Bharat Shah was not a founder of the institution. In the result, we disagree with the view taken by the High Court and the Tribunal and affirm the view taken by the Assessing Officer and the Appellate Commissioner of Income-tax (Appeals). We hold that Bharat Shah was a founder of the assessee institution; that during the previous years relevant to the assessment years 1989-90 and 1990-91, a substantial amount of money to the extent of Rs. 70 lakhs was lent to Bharat Shah without adequate security or interest. Consequently, the assessee would lose the benefit under section 11 of the Act by falling within the mischief of section 13(3)(a) read with section 13(1)(c)(ii) of the Income-tax Act, 1961. Issues Involved:1. Entitlement of the assessee to the benefit of section 11 of the Income-tax Act, 1961.2. Loss of exemption under section 11 due to lending Rs. 70 lakhs to Bharat Shah, the founder of the institution, under section 13(2)(a) read with section 13(3)(a) of the Act.Issue-wise Detailed Analysis:Issue 1: Entitlement to the Benefit of Section 11 of the ActThe primary question was whether the assessee, a non-profit service organization incorporated as a company limited by guarantee, was entitled to the benefit of section 11 of the Income-tax Act, 1961. The Assessing Officer (AO) denied this benefit on two grounds:1. The objects of the assessee, being a diamond bourse, were not considered 'charitable purposes' within the meaning of section 2(15) of the Act.2. The assessee had breached conditions under section 13, thereby losing the benefit of section 11.The Tribunal concluded that the objects of the assessee were indeed for 'charitable purposes' as defined in section 2(15) and that there was no breach of section 13. The High Court upheld this view.The Supreme Court analyzed the circumstances under which the assessee came into existence. The diamond exporters in India formed the Diamond Exporters Association to facilitate diamond export. The Central Government accepted their proposal to set up a diamond bourse in Bombay, named Bharat Diamond Bourse, to enhance the diamond trade and increase foreign exchange earnings. The assessee was registered under section 11 as an institution established for charitable purposes, with its dominant object being of general public utility.The Court referred to the judgment of the Constitutional Bench in Addl. CIT v. Surat Art Silk Cloth Manufacturers Association [1980] 121 ITR 1, which established that if the primary object of an institution is charitable and any non-charitable object is merely ancillary, the institution remains charitable. Applying this test, the Court concluded that the assessee's predominant objectives were to promote diamond exports, establish trading facilities, and develop India as a modern diamond market. Therefore, the assessee was rightly registered under section 11 as an institution established for charitable purposes.Issue 2: Loss of Exemption under Section 11The second issue was whether the assessee lost the exemption under section 11 by lending Rs. 70 lakhs to Bharat Shah, a founder of the institution, without adequate security or interest, thereby invoking section 13(2)(a) read with section 13(3)(a).Issue (A): Adequacy of Interest or SecurityThe AO found that the amount was lent without adequate security or interest and without a written agreement. The Tribunal reversed this finding, accepting the assessee's explanation that the amount was a deposit for procuring premises. The Supreme Court found the Tribunal's reasoning perverse, noting that no proper documentation existed, and the terms of the lease were indefinite. The Court concluded that the transaction was a colorable one, intended to enable Bharat Shah to purchase property for his own purposes, thus affirming the AO's view that the amount was lent without adequate security or interest.Issue (B): Status of Bharat Shah as FounderThe Court examined whether Bharat Shah fell within the prohibited category under section 13(3)(a) or 13(3)(cc). The term 'founder' was interpreted as the originator or person responsible for establishing the institution. Bharat Shah, being a signatory to the memorandum of association and instrumental in the company's incorporation, was deemed a founder. The Court rejected the argument that Bharat Shah was not a founder due to lack of substantial financial contribution.The Supreme Court held that Bharat Shah was a founder of the institution and that the assessee lost the benefit under section 11 due to lending Rs. 70 lakhs without adequate security or interest, falling within the mischief of section 13(3)(a) read with section 13(1)(c)(ii).ConclusionThe Supreme Court set aside the judgments of the High Court and the Tribunal, affirming the AO's view that the assessee lost the benefit of section 11 due to the transaction with Bharat Shah. The appeals were allowed, and the orders of the AO and the Commissioner of Income-tax (Appeals) were reinstated.