2007 (4) TMI 201 - SC - Income Tax

Appeal allowed: payments routed through firms deemed dividends under section 2(22)(e); circular funding and merged-account profits upheld

Commissioner of Income-Tax Versus Mukundray K. Shah

SC allowed the appeal, set aside the High Court's judgment, and upheld the Assessing Officer and Tribunal's finding that payments routed through two firms ... Payment made by a company to two firms i.e. MKF and MKI - accumulated profits of MKSEPL - undisclosed income under section 2(22)(e) - whether payment made by the company is for the benefit of the assessee - HELD THAT:- It is for this group to decide whether the profits should be distributed as dividends or not. The declaration of dividend is entirely within the discretion of this group. Therefore, the Legislature realised that though funds were available with the company in the form of profits, the controlling group refused to distribute accumulated profits as dividends to the shareholders but adopted the device of advancing the said profits by way of loan to one of its shareholders so as to avoid payment of tax on accumulated profits. This was the main reason for enacting section 2(22)(e) of the Act. From the facts, indicated above, the Department has established a sort of circular trading in this case. One of the important features of circular trading is to route the funds through conduits. In such cases the picture emerges only after seeing the cash flow statements. In the present case, ML-20 made the Assessing Officer to hold enquiries and in that enquiry the cash flow statement emerged, therefore, the Department was right in invoking the provisions of Chapter XIV-B in the present case. The five payments had direct co-relation with Rs. 5.99 crores paid by MKSEPL to MKF and MKI and payments by the said two firms to the assessee who used the said money to buy 9 per cent. RBI Relief Bonds. Therefore, the said payment by the company through the two firms was for the benefit of the assessee. Therefore, the said funds were not repayment of loans, they were for purchase of 9 per cent. RBI Relief Bonds by the respondent. As regards the contention advanced on behalf of the assessee that the accumulated profits of MKSEPL could not be treated as the accumulated profits of SCPL in spite of the order of merger with effect from May 18, 1998, we agree with the view expressed by the Assessing Officer that on merger the accounts of the two companies had merged and, therefore, the reserves had to be taken on the basis of the merged account. Moreover, the assessee had substantial interest in MKSEPL right from the inception. Lastly, in the present case, we are concerned with the block assessment which covers the period April 1, 1990, to August 24, 2000. In this case, the Tribunal has concluded that the payment routed through MKF and MKI was for the benefit of the assessee. This was a finding of fact. It was not perverse. Therefore, the High Court should not have interfered with the said finding. Further, the above two judgments lay down that the concept of deemed dividend under section 2(22)(e) of the Act postulates two factors, namely, whether payment is a loan and whether on the date of payment there existed 'accumulated profits'. These two factors have to be correlated. This correlation has been done by the Tribunal coupled with the fact that all withdrawals were debited in the capital account of the firm leading to the debit balance of Rs. 8.18 crores. The High Court has erred in disturbing the findings of fact. Thus, we set aside the impugned judgment of the High Court. Accordingly, the appeal stands allowed with no order as to costs. Issues Involved:1. Whether the payments made by MKSEPL during the accounting year ending March 31, 2000, amounting to Rs. 5.99 crores to MKF and MKI for the benefit of the respondent-assessee, Mukundrai K. Shah, should be taxed as undisclosed income under section 2(22)(e) of the Income-tax Act, 1961.2. The applicability of Chapter XIV-B of the Income-tax Act for block assessment in this case.3. Whether the High Court was correct in interfering with the findings of fact recorded by the Tribunal.Detailed Analysis:1. Taxation of Payments as Undisclosed Income:The Department sought to tax Rs. 5.99 crores as undisclosed income in the hands of the assessee. During a search on August 24, 2000, a diary titled 'ML-20' was seized, indicating investments of Rs. 26.35 crores in RBI Relief Bonds. The Assessing Officer assessed Rs. 5.99 crores as deemed dividend under section 2(22)(e) of the Act, concluding that the payments were made by MKSEPL and related companies to MKF and MKI for the individual benefit of the assessee. The Tribunal upheld this view, stating that MKSEPL made payments through MKF and MKI to benefit the assessee, who used the funds to purchase RBI Relief Bonds, thus these payments were not repayments of loans but for the purchase of bonds.2. Applicability of Chapter XIV-B for Block Assessment:The High Court held that the case did not fall under Chapter XIV-B, stating it was a matter of regular assessment and not undisclosed income. The High Court noted that the transactions were disclosed in the returns and books of account, and no fictitious entries were found. However, the Supreme Court disagreed, stating that the block assessment under Chapter XIV-B was appropriate as the undisclosed income was detected during the search, and the entries in the diary 'ML-20' led to further enquiries revealing the undisclosed income.3. High Court's Interference with Tribunal's Findings:The High Court set aside the Tribunal's judgment, stating there was no evidence that MKF and MKI were conduits for routing money from MKSEPL to the assessee. The Supreme Court found merit in the Department's appeal, emphasizing that the Tribunal's findings were based on the cash flow statement, which showed that MKSEPL made payments to MKF and MKI for the benefit of the assessee. The Supreme Court held that the High Court should not have interfered with the Tribunal's findings of fact, as they were not perverse.Conclusion:The Supreme Court set aside the High Court's judgment and upheld the Tribunal's decision, confirming that the payments made by MKSEPL to MKF and MKI were for the benefit of the assessee and were rightly assessed as deemed dividend under section 2(22)(e) of the Income-tax Act. The block assessment under Chapter XIV-B was deemed appropriate as the undisclosed income was detected during the search.