IN THE HIGH COURT OF GUJARAT AT AHMEDABAD INCOME TAX REFERENCE No 56 of 1986 WITH INCOME TAX REFERENCE NO. 75 OF 1987 AND INCOME TAX REFERENCE NO. 58 OF 1993 AND INCOME TAX REFERENCE NO. 220 OF 1995 For Approval and Signature: Hon'ble MR.JUSTICE R.K.ABICHANDANI and Hon'ble MR.JUSTICE K.A.PUJ ============================================================ 1. Whether Reporters of Local Papers may be allowed : YES to see the judgements? 2. To be referred to the Reporter or not? : YES 3. Whether Their Lordships wish to see the fair copy : NO of the judgement? 4. Whether this case involves a substantial question : NO of law as to the interpretation of the Constitution of India, 1950 of any Order made thereunder? 5. Whether it is to be circulated to the Civil Judge? : NO -------------------------------------------------------------- SARABHAI CHEMICALS PVT. LTD. (now known as Sarabhai Holdings Pvt. Ltd.) Versus THE COMMISSIONR OF INCOME-TAX -------------------------------------------------------------- Appearance: 1. INCOME TAX REFERENCE No. 56 of 1986, 58 of 1993 220 of 1995 and 75 of 1987 : MR KC PATEL with MR. R.K.PATEL, MR. M.K.PATEL and MR B.D.KARIA, Advocates for the Assessee in all References MR BB NAIK for the Revenue in all References -------------------------------------------------------------- CORAM : MR.JUSTICE R.K.ABICHANDANI and MR.JUSTICE K.A.PUJ Date of decision: 06/02/2002 ORAL COMMON JUDGEMENT Per : MR.JUSTICE R.K.ABICHANDANI (for the Court) :- 1. All these four references have been argued at length together and they concern the same assessee and therefore, they are disposed of by this common judgement. 2. In Income Tax Reference No. 56 of 1986 (which emanates from the quantum proceedings in respect of the Assessment Years 1979-80 and 1980-81), the Income Tax Appellate Tribunal, Ahmedabad Bench, Ahmedabad has referred the following questions of for the opinion of this Court : "For the A.Y. 1979-80 - at the instance of the assessee : [1] Whether, on facts and in the circumstances of the case, the Tribunal was right in law in holding that the interest of Rs.66,29,236/- being the amount of interest as determined by the Income Tax Officer on a notional basis from 1-7-1977 to 30-6-1978 was liable to tax on accrual basis for A.Y. 1979-80? [2] Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the interest accrued from day-to-day as a result of supplementary agreement and as such, the same was exigible to tax as income for Assessment Year 1979-80? [3] Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that giving up of interest on the ground of commercial expediency was not justified as no direct or indirect benefit had accrued to the assessee? For the A.Y. 1980-81 - at the instance of the Revenue : [1] Whether, the Appellate Tribunal has not erred in law and on facts in holding that no income could be said to be accrued to the assessee as the interest would start accruing from 1-7-1979 i.e. after the end of the accounting year? [2] Whether, the finding of the Tribunal that the interest could not be said to be accrued to the assessee during the accounting period in question and hence, question of relinquishment of any right does not arise is correct in law?" 2.1 In Income Tax Reference No. 75 of 1987 (which also relates to the Assessment Year 1979-80 pertaining to levy of interest under section 215 of the Act), the Tribunal has referred the following question : "Whether the Appellate Tribunal has not erred in law and on facts in holding that charging of interest under section 215 of the I.T. Act, 1961 in the instant case was not justified?" 2.2 In Income Tax Reference No. 220 of 1995 filed at the instance of the assessee, the Tribunal has, in respect of the Assessment Year 1979-80, referred the following question of law in respect of the penalty levied under section 273(2)(a) of the Act : "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in confirming the penalty of Rs.4 lakhs levied under section 273(2)(a) of the Act?" 2.3 In Income Tax Reference No. 58 of 1993 (which also relates to the Assessment Year 1979-80 and is in respect of the penalty imposed under section 271(1)(C) of the Act), the Tribunal has referred the following question of law : "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in confirming the penalty of Rs.55,00,000/- levied under section 271(1)(c) of the Act?" 3. Income Tax References Nos. 56 of 1986 (at the instance of the Assessee as well as the Revenue) and 75 of 1987 (at the instance of the Revenue) arise out of the same judgement of the Tribunal rendered on 15th February 1985 in I.T.A. Nos. 1137 and 1138 / AHD/ 84, by which the Tribunal had partly allowed the assessee's appeal and held in respect of the Assessment Year 1979-80 that levy of interest under section 215 of the said Act was not justified, while upholding the decision of the lower authorities in regard to the Assessment Year 1979-80 to the effect that there was accrual of interest income which was rightly brought to tax on accrual basis by them. As regards the Assessment Year 1980-81, the Tribunal held that, under the revised agreement reflected from the resolution dated 30th June 1979, no interest was payable on the outstanding amount, because, as a result of the resolution dated 30th June 1979, no income could be said to have accrued to the assessee as the interest was to start accruing from 1-7-1979 i.e. after the accounting year relevant to the Assessment Year 1980-81 and the assessee's appeal was, therefore, allowed in respect of the Assessment Year 1980-81. 3.1 The assessee - Sarabhai Chemicals Pvt. Ltd. (now known as Sarabhai Holdings Pvt. Ltd.) had filed its return on 26th June 1979 declaring a total income of Rs.772=00 under the head of business income for the Assessment Year 1979-80, and for the Assessment Year 1980-81, it had filed return on 27-9-1980 declaring a loss of Rs.17,345=00. The assessee was following mercantile system of accounting at the relevant time. In response to the notice under section 143(2) of the Act, the assessee had submitted that, w.e.f. 28th February 1977, the industrial undertaking of Sarabhai Chemicals and business activity of Sarabhai Common Services Division which was a unit of Sarabhai Chemicals were transferred by it to its subsidiary Elscope Pvt. Ltd., which in turn, after four months, transferred them to Ambalal Sarabhai Enterprises Ltd., which was the subsidiary of Elscope Pvt. Ltd. The said agreement was made on 28th February 1977, which was amended by the supplemental agreement dated 4th March 1977 and a deed of assignment came to be executed on 28th June 1977. The assessee effected the transfer of the industrial undertaking and business of Sarabhai Chemicals Division and Sarabhai Common Services Division to Elscope Pvt. Ltd. as a going concern. On inquiry, the assessee informed the I.T.O., as recorded in the draft order, that during the year, the assessee had not received any interest from Elscope Pvt. Ltd., to whom its undertaking was transferred on 28th February 1977. From the agreement of transfer, the I.T.O. noticed the terms of payment of purchase consideration to the assessee and the fact that, as per those terms, a sum of Rs.2 crore was to be paid as and when demanded by the Company, and it was to carry simple interest at the rate equal to the rate of interest which the Company paid to its bankers in the ordinary course of business, and that the sum of Rs.4,54,18,760=89 ps. which was also a part of deferred purchase consideration, payable in eight equal annual installments on 1st October of every year beginning from 1st October 1979 and was to carry interest at 11% per annum on the said sum or the amount remaining outstanding from time to time. The I.T.O. noted that the assessee was accordingly entitled to interest at the rate stipulated in the said agreement in respect of these amounts. On noticing that, in respect of none of these amounts, the assessee had shown interest as received or receivable, the assessee was, inter alia, asked to show cause as to why interest on accrual basis be not taxed on amounts due from Elscope Pvt. Ltd. as outstanding purchase consideration. Against the suggestion to tax the income from interest on accrual basis, the assessee sent its objections as per letter dated 16-9-1981, pointing out that no interest was in fact charged or chargeable in these accounting years in view of the revised mode of payment agreed to between the parties as it was to be now charged only with effect from 1-7-1979. The assessee filed exerpts from the minutes of the meeting of the Board of Directors, which was held on 30th June 1978 in support of his explanation. Thereafter, the assessee filed a further letter on 21-1-1982 explaining as to why the interest should not be taxed on accrual basis in the hands of the assessee, and contending that there were exceptions to the general rule. It was urged that the interest cannot be taxed on a hypothetical basis, because, the assessee did not actually receive any interest. 3.2 The I.T.O. was of the view that, in assessee's case, there was a written contract which was sought to be modified by the resolution dated 30th June 1978 by which date the interest for the whole year had already accrued to the assessee. It was observed that it was not the case of the assessee that the vendee company had gone into liquidation or had no assets from which the recovery could be effected. The I.T.O. further held that the assessee had relinquished the interest without any commercial consideration and since the two companies were closely related, it was a case of collusion to evade tax liabilities and therefore, interest on accrual basis was taxable in the hands of the assessee. The I.T.O. accordingly made a draft order computing the total income of the assessee at Rs.66,29,236=00 on the count of accrual of interest on the deferred consideration and also ordered to charge interest under section 217 of the Act as well as issued notices for default under section 273 and section 271(1)(c) of the Act. 3.3 The Inspecting Assistant Commissioner of Income Tax, to whom this draft order was forwarded, issued directions under section 144(B)(4) of the Act, after taking into consideration the objections raised by the assessee against the draft order, holding that the Income tax Officer was justified in coming to the conclusion that interest would be chargeable on accrual basis, and that the resolution dated 30th June 1978 passed by the Board of Directors on the last day of the previous year not to charge such interest from a retrospective date was nothing but a device to deprive the revenue of its dues which legitimately accrued to it. 3.4 The final assessment order in respect of the Assessment Year 1979-80 was thereafter made and the interest income as discussed in the draft assessment order as well as in the I.A.C.'s direction under section 144-B (4) was added to the tune of Rs.66,29,236=00 and it was ordered to charge interest under section 215 of the said Act and notices were ordered to be issued for the default under section 273(2)(a) and 271(1)(c) of the Act. 4. The assessee preferred an appeal before the Commissioner of Income Tax (Appeals-I), Baroda, who, by his order dated 29th February 1984, upheld the said addition of interest income, holding that interest was receivable by the assessee under the agreement dated 4th March 1977 and the deed of assignment dated 28th June 1977 and was, therefore, rightly brought to tax in the assessee's hands. The CIT (Appeals) elaborately considered the terms of the supplemental agreement as well as the deed of assignment and held that, for more than fifteen months from 4th march 1977 to 15th June 1978, the stipulations for payment of interest incorporated in the said documents held the field unchallenged and undiluted, and that, it was on 15th June 1978 that the buyer company made a proposal for amendment (in the stipulations) and the assessee ungrudgingly agreed to forgo the interest which exceeded Rs.120 lakhs for two years. The CIT (Appeals) considered the contentions raised by the assessee to the effect that it had agreed to this concession, firstly due to the business expediency and secondly, since the vendee company had offered to furnish security and found that there was nothing said on behalf of the company as to what was the so-called business expediency, and that original agreements were silent on the aspect of security and did not envisage that security would not be furnished. The appellate authority found that the vendee Elscope Pvt. Ltd. was a wholly owned subsidiary of the assessee and that the facts, figures and circumstances, mentioned in paragraph 13 of the order, highlighted the fact that the transaction could not be regarded as entered into any normal course and at arms length. It was observed that the business consideration put forth by the assessee was not actually specified beyond saying that the unsecured loans were offered to be secured. The appellate authority held that the talk regarding purchase price was merely an eye-wash and that it was obvious from the assessee's letter dated 6-1-1984 that the vendee far from offering securities for paying money in cash to the assessee merely furnished secured bonds of Ambalal Sarabhai Enterprises Ltd. to whom it had transferred the undertaking purchased from the assessee. These bonds carried interest of 11% and were redeemable in 1991 or subject to some conditions in 1987. It was observed that they were mortgageable but since they carried interest at 11% only and were not redeemable before 1987, the market price quoted was about two-third of the face value. Thus, in the process, the assessee company had accepted the assets worth two-third of the market price. As per the original agreement, the installments would have started in October 1979 and ended in October 1986, against which, as per the revised terms of the resolution dated 30th June 1978, the installmets would have started falling due from 1987 only. It was observed that, apart from postponement by about eight years, it is obvious that there was no security worth the name actually given by Elscope Pvt. Ltd. for making payments in cash and what was actually given was bonds whose market price was two-third of the face value. All these concessions were given to Elscope Pvt. Ltd. just like that and for no real consideration. In this background, the CIT (Appeals) applying doctrine of lifting the veil of corporate personality, found that the assessee was the sole shareholder of the vendee Elscope Pvt. Ltd., and that the transaction should be viewed in that perspective. The CIT (Appeals) observed that, taking totality of the connected transactions together, it could not be said that there was no loss caused to the revenue. He however held that the real relevant consideration was of accrual of interest to the assessee. 4.1 As regards the levy of interest under section 215 of the Act, the CIT (Appeals) held that the assessee company had neither filed any estimate, nor paid any advance tax. As per the assessee's letter dated 26-3-1983, it was an admitted fact that the I.T.O. had issued a notice under section 210 of the Act calling upon the assessee to pay advance tax on the basis of regular assessment completed for Assessment Year 1976-77 and thereafter, the notice was revised under section 210, but the assessee filed the estimate of advance tax in form No. 29 showing income of advance tax payable as `Nil'. Rejecting the contention that provision of section 215 of the Act did not apply since the assessee had not paid any advance tax, the CIT (Appeals) held that, in pursuance of the `Nil' estimate, the advance tax paid by the assessee was also `Nil' and that situation was obviously different from a case in which estimate is not filed at all, which would be covered by section 217 of the Act for levy of corresponding interest. It was observed that, to say that the assessee would have been covered by section 215, if it had paid Re.1 advance tax on the basis of estimate, but is not covered by that section, because, the advance tax paid is `Nil' in pursuance of the `Nil' estimate filed would lead to absurdity. He relied on the decision of the Bombay High Court in Bombay Burma Trading Corporation Ltd. v. CIT, reported in (1984) 145 ITR 793 (Bom), in which it was held that the case having `Nil' income from salary chargeable under the Act would be covered by dictate of the law that salary income chargeable was less than Rs.7,500=00. Reliance was also placed on the decision of the Madras High Court in ACE CIT v. Brakes India Ltd., reported in (1979) 118 ITR 820 in this regard and the contention of the assessee that `Nil' estimate of advance tax rules out applicability of section 215, was rejected. It was observed that levy of interest under section 215 of the Act was almost automatic unless and until the assessee was able to show that his `Nil' estimate at the time of filing was the correct estimate. The CIT (Appeals) also observed that the element of consciousness for wrong estimate is needed for levy of penalty under section 273 and not for levy of interest under section 215. It was also observed that the element of reasonable belief for quantum of income does not come into play in section 215 with that much force as it does in section 217(1A). It was, therefore, held that the decision of the Gujarat High Court in C.I.T. v. Bharat Machinery & Hardware Mart, reported in (1982) 136 ITR 875 could not assist the assessee on the question of interest chargeable under section 215 of the Act. The appellate authority observed that the interest income exceeding Rs.60 lakhs was attempted to be taken out of the taxation net, and that, this was a fit case for levy of interest under section 215 of the Act. It was further observed that, in regard to quantum, no calculation mistake was brought to the notice by applicability of Rule 40 of the Rules made under the Act. 5. The assessee preferred an appeal against the decision of the C.I.T. (Appeals) before the Tribunal. The Tribunal rejected the contention that no interest accrued for the Accounting Year 1-7-1977 to 30-6-1978 on the basis of the resolution dated 30th June 1978, by which the mode of payment incorporated in the original agreement stood revised. It also rejected the contention that, in view of the modification in the original agreement as amended by the supplemental agreement dated 4-3-1977, the interest which was recoverable stood waived. Construing the provisions of the agreement and deed of assignment which has a bearing on the obligation on the part of the vendee Elscope Pvt. Ltd. to pay interest on the deferred consideration, the Tribunal in paragraph 17 of its order held : "In the instant case, the income from interest on unpaid purchase price was a vested right created under the supplemental agreement, as a consequence the income from interest could be said to be accrued or arisen to the assessee during the relevant accounting year. In this connection, it is pertinent to note that while the supplemental agreement forms part of the original agreement, there is no indication in the resolution to suggest that the revised mode of payment was effective from any date prior to 30-6-1978. Therefore, this is not a case where the income though given up during the year could not be said to accrue as was the case in managing agency commission, the determination of which was based on accrual of profits. The accrual of interest commenced from the beginning of the accounting year as the interest accrues from day to day." 5.1 Considering the alternative contention of the assessee that if the interest had accrued, that income should be excluded from chargeability on the ground of commercial expediency, the Tribunal held that there was no material for reaching to a conclusion that the income from interest was given up on the ground of commercial expediency. The only ground that was placed before the Tribunal was that the unpaid purchase price which was unsecured had become secured under the revised mode of payment. The Tribunal held that this aspect did not carry the matter anywhere. The vendee Elscope Pvt. Ltd. was a subsidiary of the assessee and its entire share-holding was owned and controlled by the assessee. The security which was offered in terms of secured debentures of Ambalal Sarabhai Enterprises Ltd. to whom the undertaking was transferred by Elscope Pvt. Ltd. was again a subsidiary of Elscope Pvt. Ltd. Therefore, the offering of secured debentures to cover the unpaid purchase price would not give some added commercial benefit to the assessee which otherwise was secured in view of its position as the sole shareholder of its fully owned subsidiary and also vis-a-vis Ambalal Sarabhai Enterprises Ltd., which was a fully owned subsidiary of Elscope Pvt. Ltd. The Tribunal observed that when substantial portion of its income which had accrued was sought to be given up by the assessee, there ought to be some corresponding benefit matching giving up of such income, but there was nothing to indicate in this matter that the benefit accruing to the assessee was such as would outweigh the right which it was giving up. It was finally held that the inevitable conclusion which can be reached so far as the Assessment Year 1979-80 was concerned, was that there was accrual of interest as a result of the supplement agreement and that the interest amount was rightly brought to tax on accrual basis. 5.2 As regards the ground on which the interest charged under section 215 was challenged, the Tribunal in paragraph 23 of its judgement observing that, though it had rejected the assessee's claim that on the basis of resolution dated 30th June 1978 it had modified its original arrangement and therefore, there was no accrual of income and hence, no liability to advance tax was rejected by it, "it cannot be said that the assessee could predicate the said assessment based on estimate of notional income from interest. The question of determining accrual of income is a highly complex issue and the fact that a decision is reached against the assessee cannot be determinative of its liability to pay advance tax which arises in accordance with the statutory date fixed in the Act." Relying upon the decision of this Court in C.I.T. v. Bharat Machinery & Hardware Mart, reported in (1982) 136 ITR 875, the Tribunal held that levy of interest under section 215 of the Act, on the facts of the case, was not justified for the Assessment Year 1979-80. The assessee's appeal was accordingly partly allowed on the question of interest under section 215 of the Act. 6. Income Tax Reference No. 75 of 1987 arises from that part of the order of the Tribunal passed in respect of the Assessment Year 1979-80 by which the assessee's appeal was partly allowed and interest added under section 215 of the Act deleted. 6.1 For the reasons which were given by the C.I.T. (Appeals) in the appellate order dated 29-2-1984 for confirming the addition of Rs.66,29,236=00 as interest accrued for the Assessment Year 1979-80, the C.I.T. (Appeals) confirmed the addition of Rs.55,67,750=00 on the same count for the Assessment Year 1980-81 by his order dated 29th February 1984. The levy of interest under section 215 was also confirmed in respect of the said Assessment Year. 7. In appeal, the Tribunal held