Appellant

8TH K.R. RAMAMANI MEMORIAL NATIONAL TAXATION MOOT COURT COMPETITION- 2018 TEAM:

TN 09

IN THE HIGH COURT OF JUDICATURE AT MADRAS

Statutory Appeal Under Section 260A of the Income Tax Act, 1961 Tax Case No __/ 2018

(AGAINST THE IMPUGNED ORDER PASSED BY THE HONOURABLE INCOME TAX APPELLATE TRIBUNAL)

In the matter of:

Commissioner of Income Tax

…..(Appellant) Versus

Mr. V. Markiv

…..(Respondent)

UPON SUBMISSION TO THE HONOURABLE CHIEF JUSTICE AND HIS COMPANION JUSTCIES OF THE HONOURABLE HIGH COURT OF JUDICATURE AT MADRAS

MEMORANDUM ON BEHALF OF THE APPELLANT

8TH K.R. RAMAMANI MEMORIAL NATIONAL TAXATION TAXATION MOOT COURT COMPETITION2018

TABLE OF CONTENTS TITLE

PAGE NO

TABLE OF ABBREVIATIONS

…..

III

INDEX OF AUTHORITIES

…..

IV

Judicial Decisions

…..

IV

Articles

…..

V

Books

…..

V

Online Resources

…..

V

Statutes

…..

V

STATEMENT OF JURISDICTION

…..

VI

STATEMENT OF FACTS

…..

VII

ISSUES RAISED

…..

VIII

SUMMARY ARGUMENTS

…..

IX

ARGUMENTS ADVANCED

…..

1

1. Whether, on the facts and in the circumstances of the case, the Tribunal is right in law that the sale consideration was diverted to the Corporation by overriding title?

…..

1

1.1.What is overriding title?

…..

1

1.2.Assessee’s 1.2.Assessee’s case amounts to application applicati on of income

…..

2

1.2.1. It is Assessee’s income

…..

2

1.2.2. Consideration is received by the Asssessee

…..

3

1.2.3. Nature of obligation

…..

4

…..

5

1.3.Precedent relied upon by the Assessee not applicable

2. Whether the Tribunal was correct in allowing the deduction claimed by the Assessee u/s 48(i) of the Income-Tax Act, 1961?

…..

7

2.1. Facts pertaining to the issue

…..

7

2.2.Origin of liability

…..

7

2.3.Section 48(i) and the present factual matrix

…..

8

2.3.1. The nexus test

…..

8

2.3.2. Ambit of ‘expenditure ‘expenditure in connection with such transfer’

…..

9

2.4. R.M. Arunachalam’s judgementjudgement- applicable to the current case

…..

9

2.4.1. Judgements reiterating Arunachalam

…..

10

2.4.2. Other modes of voluntary payments- not deductible

…..

11

…..

12

2.5. Madras High Court judgments

Page | I

8TH K.R. RAMAMANI MEMORIAL NATIONAL TAXATION MOOT COURT COMPETITION2018

2.5.1. CIT v. N. Vajrapani Naidu

…..

12

2.5.2. Sri Kanniah Photo Studio v. ITO

…..

13

2.5.3. CIT v. Bradford Trading Company

…..

13

2.5.4. Lakshmi Reddy v. ITO

…..

14

…..

14

2.6. Lifting the Corporate veil PRAYER

…..

X

Page | II


TABLE OF ABBREVIATIONS

S.NO.

ABBREVIATION

EXPANSION

1.

¶

Paragraph

2.

u/s

Under Section

3.

AIR

All India Reporter

4.

CIT

Commissioner of Income Tax

5.

ITAT

Income-tax Appellate Tribunal

6.

Co.

Company

7.

Ed

Edition

8.

Ltd.

Limited

9.

Ors.

Others

10.

Pvt.

Private

11.

SC

Supreme Court

12.

SCC

Supreme Court Cases

13.

v.

Versus

14.

Hon’ble

Honourable

Page | III


INDEX OF AUTHORITIES Judicial Decisions 1.

CIT v. A. Tosh & Sons Pvt Ltd , (1987) 30 Taxman 516

2.

CIT .v. Abrar Alvi, (2001) 247 ITR 312,Bomaby

3.

CIT .v. Bradford Trading Company, (2003) 261 ITR 222

4.

CIT .v. N. Vajrapani Naidu, (2002) 241 ITR 560, Madras

5.

CIT .v. Poulose & Mathe Pvt. Ltd ., 1999 (236) ITR 416 (Ker)

6.

CIT .v. R. Ranga Shetty, (1985) 22 TAXMAN 192, Karnataka

7.

CIT .v. Roshanbabu Mohammed Hussein, (2005) 144 TAXMAN 720, Bombay

8.

CIT .v. Thressiamma Abraham, (1997) 227 ITR 802, Kerala

9.

CIT .v.Shakuntala Kantilal , (1991) 190 ITR 56, Bombay

10. CIT v. State Bank of India , (1987) 32 Taxman 619 (Bom) 11. CIT v. Attili N. Rao, AIR 2002 SC 388 12. CIT v. Nariman B. Barucha & sons , (1981) 130 ITR 863 (Bom) 13. CIT, Gujarat v. Shri Udayan Chinubhai & others , 309 1996 SCALE(6) 48. 14. Deputy Commissioner .v. Chetan Transport Corp. Ltd., (1992) 74 Comp.Cas 563 (Mad.)(DB) 15. Gopee Nath Paul and Sons v. Deputy Commissioner of Income Tax , (2005) 198 CTR Cal 116 16. Gresham Life Assurance Society v. Styles , (1892) A.C. 309 17. H.H. Lakshmi Bai .v. CIT (1994) 206 ITR 688, 691 (SC) 18. Indian Bank, Madras v. State of Tamil Nadu, AIR 2002 Mad. 134 19. Jit & Pal X-ray Pvt. Ltd. v. CIT, (2004)186 CTR All 542 20. L.M. Patel & B.M Patel (HUF) .v. CIT , (2013) 89 DTR 121, Gujarat 21. M.K. Bros (P) Ltd. v. CIT , (1972) 86 ITR 38 (SC) 22. McDowell & Co. Ltd. v. CTO, 1985 (3) SCC 230 23. Moti Lal Chaddami Lal Jain v. Commissioner of Income tax, Delhi , [1991] 190 ITR 1 (SC) 24. MSEB, Bombay v. Official Liquidator , AIR 1982 SC 1497 25. Pondicherry Railway Co. Ltd v. The Commissioner of Income-tax, Madras , 5 I.T.C 363 26. R.M. Aruunachalam Etc. v. CIT (1997) 141 CTR SC 361 27. Salay Mohammed Ibrahim Sait v. ITO 28. Sita Nanda (Smt.) .v. CIT , (2001) 251 ITR 575, Delhi 29. Sri Kanniah Photo Studio .v. ITO, (2016) 286 CTR 538, Madras 30. Srinivasan Chadira Kumar .v. The Additional CIT , 2014 SCC Online ITAT 6633(?) 31. Subhra Mukharjee .v. Bharat Coking coal Ltd. , 2000 (3) SCC 312 32. The Commissioner of Inland Revenue v. Paterson , 9 Tax Cases 163 33. Union of India v. Azadi Bachao Andolan & anr, (2004) 10 SCC 1 34. V. A. Vasumathi .v. CIT , (1980) 123 ITR 94, Kerala 35. V. Lakshmi Reddy .v. ITO, MANU/TN/2853/2010 36. V.S.M.R. Jagadishchandran .v. CIT (1997) 141 CTR SC 361

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37. Vodafone International Holdings B.V. v. Union of India & Ors, (2012) 1 S.C.R. 574

Articles TITLE and PUBLISHER

AUTHOR

Vasundhara Majithia

Lifting of Corporate veil

ACADEMIKE LAWCTOPUS

Anish Thacker

Diversion of income vs. Application of income

TAXSUTRA

Prashanth Thakur

Meaning of expenditure incurred wholly and exclusively in connection with such transfer

TAXWORRY Books TITLE and PUBLISHER

AUTHOR

The Law and Practice of Income Tax Lexis Nexis

Arvind P Datar

Supplement to Income Tax Law Lexis Nexis Butterworths Wadhwa Nagpur (5 th Ed.)

Chaturvedi Pithisaria

Landmark Judgments on Income Tax Lexis Nexis

M K Pithisaria Mukesh Pithisaria

The Transfer of Property Act Lexis Nexis Butterworths Wadhwa Nagpur (10 th Ed.)

GC Bharuka

Anson’s Contract of Law Oxford (28th Ed.)

J Beatson

Company Law and Practice Taxmann (15th ed.)

A K Majumdar Dr. G K Kapoor

Online Resources 

www.manupatra.com



www.scconline.com



www.taxman.com



www.taxsutra.com Statutes



Income-tax Act, 1861



Indian Contract Act, 1872



Transfer of Property Act, 1882 Page | V


STATEMENT OF JURISDICTION

The Appellant has approached this Hon’ble Court under section 260A of the Income -tax Act, 1961 on appeal against the order of the Income Tax Appellate Tribunal.

Page | VI


STATEMENT OF FACTS Historical background

Mr.V. Markiv (Assessee) was the main promoter (99% shareholding) of the company, Vulcan BPO Pvt. Ltd. (Principal Debtor). The assessee stood as surety for a loan taken by the Principal Debtor from the TN Financial Corporation (Creditor). The assessee also mortgaged his property in favour of the Creditor. In exercise of its rights under the document of mortgage, the Creditor sold the property and appropriated the entire proceeds towards discharge of the loan taken by the Principal Debtor. The property value and the debt amount were the same, that is, rupees two crores. Assessment and following litigation

The Income-tax Officer computed capital gains on the entire sale proceeds holding that the assessee is deemed to have received the entire sale proceeds. The Assessee contended that there was diversion of income by overriding title and alternatively, the expenditure incurred for the transfer was deductible u/s 48(i) of the Income-tax Act, 1961. The Assessee went on appeal and CIT(A) merely upheld the order of the ITO. The Assessee went on further appeal and the Tribunal, after recording the undisputed factual position, the Tribunal held that no amount was received by the assessee and that the entire sale consideration was paid directly to the Corporation by the purchasers and it was thereafter that the mortgaged property was released. Therefore, the sale consideration was diverted to the Corporation by overriding title. The Tribunal also upheld the alternate view that the amount settled is deductible u/s 48(i) of the Income-tax Act, 1961. Aggrieved by the order of the Tribunal, the department is on appeal before this Hon’ble Court.

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ISSUES RAISED 1. Whether, on the facts and in the circumstances of the case, the tribunal is right in law that the sale consideration was diverted to the corporation by overriding title?

2. Whether, on the facts and in the circumstances of the case, the tribunal is right in allowing the deduction claimed by the assessee under section 48(i) of the income-tax act, 1961?

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SUMMARY OF ARGUMENTS

1. Whether on facts and in the circumstance of the case, the Tribunal was right in holding that there is diversion of income by overriding title to the Corporation?

It is humbly submitted that the property which was transferred belonged to the Assessee. The mortgage was voluntarily created by the Assessee himself and not by any third party. Further, it is the Assessee who is benefitted out of the transfer as his obligation to the Creditor is discharged by the payment of the sale consideration. Therefore, the income is deemed to have been received by the Assessee and this amounts to application of income. Merely by making an arrangement such that the payment is made directly to the Creditor, the Assessee cannot claim that there is diversion of income by overriding title. 2. Whether on facts and in the circumstances of the case the Tribunal is right in allowing the deduction claimed by the assessee under Section 48 (I) of the Income Tax Act, 1961?

It is humbly submitted that the origin of liability for the assessee herein, arises from the guarantee contract signed with the creditor and not by the mortgage created in favour of the creditor. This clearly establishes the fact that payment of 2 crores to the creditor did not facilitate the transfer in any manner nor has an intrinsic link to the transfer of capital asset. Further, in light of a few Apex Court precedents, which laid down the principle of law regarding the ambit of the term ‘expenditure’ under Section 48 (i), so as to not cover payments made to remove the mortgage created by the assessee himself voluntarily, the claim of the assessee cannot be allowed. It is submitted that issue in the case at hand is a covered issue before the Madras High Court favouring the department, and therefore, it is persuaded that the bench in the case at hand follows the jurisdictional Court’s view.

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ARGUMENTS ADVANCED 1. Whether, on the facts and in the circumstances of the case, the tribunal is right in law that the sale consideration was diverted to the corporation by overriding title?

It is humbly submitted that in the present undisputed facts of the case, Mr. V.Markiv (herein after referred as “assessee”) had mortgaged a property belonging to him in favour of the TN Financial Corporation (herein after referred as “ creditor”).1 It is a voluntary and self-created mortgage by the assessee himself. Therefore, it is permissible t o conclude that the assessee had a perfect title over the property. Further, it is most respectfully submitted that the assessee cannot claim the transfer to be one, where there is diversion on income by overriding title since the nature of obligation is such that the income accrued to the assessee out of the sale is applied to discharge the liability. Merely because the payment was made to the creditor directly, there is no overriding title. 1.1. What is overriding title?

Diversion of income by overriding title takes place when there is an obligation at the source and the income never reaches the assessee, even if it does, the assessee should merely be a collector of the income on behalf of someone else. The critical test is that the assessee should be a mere conduit for a third party’s income. There should be no nexus between the assessee and the income. In other words, source of the income should not be traceable to assessee. However, in the present case it is the assessee’s property which was transferred. The Hon’ble Supreme Court in the case of Shri Sitaldas Tirathdas 2 had laid down the test for overriding title where it held that, “The true test is whether the amount sought to be deducted, in truth, never reaches the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee.” In the case of Moti Lal Chaddami Lal Jain 3, the Hon’ble Supreme Court while explaining the test laid down in Sitaldas Tiratdas(supra) held that, “it is clear, the expressions "reaches the assessee" and "has been received" have been used not in the sense of t he income being received

1

¶ 1, MOOT PROPOSITION The Commissioner of Income Tax, Bombay city-II v. Shri Sitaldas Tirathdas, AIR 1961 SC 728 3 Moti Lal Chaddami Lal Jain v. Commissioner of Income tax, Delhi , [1991] 190 ITR 1 (SC) 2

Page | 1


in cash by one person or another. What the passage emphasises is the nature of the obligation by reason of which the income becomes payable to a person other than the one entitled to it. Where the obligation flows out of an antecedent and independent title in the former (such as, for example, the rights of dependants to maintenance or of coparceners on partition, or rights under a statutory provision or an obligation imposed by a third party and the like), it effectively slices away a part of the corpus of the right of the latter to receive the entire income and so it

, where the obligation is self-imposed or would be a case of diversion. On the other hand gratuitous (as here) it is only a case of an application of income.” The principle which can be culled out from the above rulings is that where an assessee rec eived an amount of money but it is for the benefit of some other persons under some antecedent obligation then it is a case of diversion of income by superior title and not application of income.4 The same principle has been reiterated by various High Courts. 5Therefore, it is evident that in cases where the obligation is voluntary or self-created, it will not amount to overriding title. 1.2. Assessee’s case amounts to application of income

It is humbly submitted that any profits or gains arising from the transfer of a capital asset shall be chargeable to income tax.6 It is further submitted that when a capital asset is transferred to discharge an obligation, where the obligation is self-created, it amounts to application of income which is subject to the charge of income tax u/s 45 of the Income-tax Act, 1961 (herein after referred as “the Act ”). 1.2.1. It is assessee’s income

It is contended that the property which was mortgaged by the assessee belonged to him and despite the mortgage, it will continue to remain the assessee’s property. Though the Creditor sold the property under the mortgage deed, 7 the property being sold was a property belonging to the assessee. Therefore, the income out of the transfer will belong to the assessee.8

4

CIT v. State Bank of India , (1987) 32 Taxman 619 (Bom); CIT v. A. Tosh & Sons (P) Ltd ., (1987) 30 Taxman 516 (Cal) 5 Jit & Pal X-ray Pvt. Ltd. v. CIT, (2004)186 CTR All 542; CIT v. Nariman B. Barucha & sons, (1981) 130 ITR 863 (Bom) 6 Section 45, Income-tax Act, 1961. 7 ¶ 2, MOOT PROPOSITION 8 CIT v. Attili N. Rao, AIR 2002 SC 388

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In the present case, the Creditor merely acts as an agent of the assessee to make the sale and subsequently discharge the obligation of the assessee towards the debt. Reliance is also placed on the judgment of the Privy Council in the case of Paterson,9 where a debtor bought property with borrowed money and charged the proceeds of the property in favour of the creditors to repay the debt. It was observed by Lord Scrutton that, “ if they are not income of the debtor whose income are they? Whose income was it that paid those debts? It seems to me that in any ordinary sense it was the income of the debtor, the lady, which discharged the debts and which she was obliged to allow to be used to discharge the debts by the charge she had given on that income to the creditor. It appears to me, if it is not the debtor's income, it must be the creditor's income, and I am not sufficiently topsy-turvy to think of a creditor discharging debts due to him out of his own income.” Similar view was taken by the Hon’ble Supreme Court in the case of Shri Udhayan Chinubhai .10 Therefore, in the present factual matrix, a capital asset has been transferred and capital gains has accrued. So, the critical question to be answered is whose income is it? It cannot be said be said that the income has accrued to or received by the Creditor. This leaves us with only one answer, that the income belongs to the assessee. 1.2.2. Consideration is received by the assessee

The Department contends that the consideration out of the transfer is deemed to be received by the assessee. It is further contended that there is no actual difference between sale proceeds received by the Creditor directly from the buyer and the assessee paying the Creditor to discharge his liability. This contention is supported by the Madras High Court in the case of

Sri K anniah photo studio,11the Court held that, “When the mortgaged property is sold, if the consideration for the sale comprises the consideration for the sale of equity of redemption, and the amount required for the discharge of mortgage, it is the aggregate of both these sums that constitutes the consideration for the sale. The fact that the vendee makes the payment directly

to the mortgagee, instead of the vendor doing so, after receiving the money from the vendee, does not make any difference for the purpose of determining consideration for the sale and the extent of capital gain. ”

9

The Commissioner of Inland Revenue v. Paterson, 9 Tax Cases 163 CIT, Gujarat v. Shri Udayan Chinubhai & others, 309 1996 SCALE(6) 48. 11 Sri Kanniah Photo Studio v. ITO, ward-I (1), 2016 286 CTR 538 (Mad) 10

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It is also submitted that whether the mortgage is discharged by payment before the sale, or whether the amount is reserved with the vendee for payment to the mortgagee, the fact remains that it is the money of the vendor already paid or due, which is utilised for the purpose. And it is the vendor's liability that is discharged. The amount paid for discharging the mortgage is thus part of the consideration for the vendor parting with his rights in the property. 12 Therefore, it is argued that merely by making an arrangement such that the buyer pays the sale proceeds directly to the Creditor, the assessee cannot claim that he did not receive any consideration. The cases relied upon the department sternly state that the consideration is received by the assessee irrespective of the arrangement. It is this consideration which is applied by the assessee to discharge himself from the obligation and therefore this is a case of application of income. 1.2.3. Nature of obligation

The department staunchly contends that by virtue of section 128 of the Indian Contract Act, 1872, the liability of surety is co-extensive with that of the principal debtor. 13 When a debt incurred by a principal debtor under the contract of guarantee becomes due, both principal debtor and surety are on same stands of liability towards the creditor. The surety can at no point say that the creditor should first exhaust his rights against the principal debtor and then approach him.14 Therefore, it is the assessee who is actually getting benefitted out the transfer since his obligation to the Creditor is discharged and at no point can he claim that the only party benefitting out the transfer is the Principal Debtor. In fact, the Principal Debtor’s obligation still persists by virtue of section 140 of the Indian Contract Ac, 1872. The assessee cannot voluntarily mortgage his property and bind himself with an obligation for the repayment of a debt and later claim that it was for the benefit of a third party. Moreover, it is impossible to treat self-created arrangement of this kind on par with a case where an interest or encumbrance is created by a previous owner. There is a difference between obligation to

12

Salay Mohammed Ibrahim Sait v. ITO MSEB, Bombay v. Official Liquidator, AIR 1982 SC 1497 14 Indian Bank, Madras v. State of Tamil Nadu, AIR 2002 Mad. 134 13

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spend money in a particular manner attached to an income, and a similar obligation attaching to the source of the income. 15 It is further argued that the assessee was the main promoter of the Principal Debtor and holds ninety-nine percent shares.

16

Therefore, the corporate veil should be lifted and in such a case

it will be found that it is the assessee who is actually benefitted out of the transfer. If the veil if lifted it will be evident that the assessee is directl y benefitted or effected by act of the principal debtor. It is also submitted that if the veil is not lifted in the present matte r, it will lead to a case of tax evasion which is impermissible. 17 1.3. Precedent relied upon by the assessee not applicable

It is humbly submitted that the case of Smt. Thressiamma Abraham18 , which is strongly relied upon by the assessee has been overruled in the case of Attili N. Rao19 and in Roshanbabu

Mohammed H ussain20, where the Courts have discussed the nature of obligation in the case of a self-created mortgage in detail and declared that the judgment of the Kerala High Court in the case of in the case of Smt. Thressiamma Abraham is no longer good law. Therefore, it is strongly contended by the Department that the capital asset which was transferred belonged to the assessee and the income is deemed to have been received by the assessee. The act of discharging the mortgage was secondary and the revenue is not concerned with the subsequent events. Reliance is placed upon Pondicherry Railway Co. Ltd 21, where the Bombay High Court had held that for profits on their coming into existence attract tax at that point and the revenue is not concerned with the subsequent application of the profits. The Court reiterated the principle laid down in Greesham Life Assurance Society 22, where it was held that, “The thing to be taxed is the amount of profits or gains. The word "profits" I think is to be understood in its natural and proper sense-in a sense which no commercial man would misunderstand. But once an individual or a company has in that proper sense ascertained what

15

M.K. Bros (P) Ltd. v. CIT, (1972) 86 ITR 38 (SC) ¶ 1, MOOT PROPOSITION 17 McDowell & Co. Ltd. v. CTO, 1985 (3) SCC 230; see also Union of India v. Azadi Bachao Andolan & anr, (2004) 10 SCC 1; Vodafone International Holdings B.V. v. Union of India & Ors, (2012) 1 S.C.R. 574 17 Section 2(47), Income-tax Act, 1961 18 CIT v. Smt. Thressiamma Abraham, 1997 227 ITR 802 Ker 19 Supra at footnote no. 8 20 CIT v. Roshanbabu Mohammad Hussein, 2005 144 TAXMAN 720 Bom 21 Pondicherry Railway Co. Ltd v. The Commissioner of Income-tax, Madras, 5 I.T.C 363 22 Gresham Life Assurance Society v. Styles, (1892) A.C. 309 at p.315 16

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are the profits of his business or his trade, the destination of those profits or the charge which has been made on those profits by previous agreement or otherwise is perfectly immaterial.” Thus, it is a clear case of application of income and subject to chargeability of income tax u/s 45 of the Act. Allowing it as a diversion of income by overriding title will set a very bad precedent for any person who wishes to sell his capital asset will create an encumbrance as surety and later claim deduction which will in turn lead to tax evasion.

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2. Whether the tribunal was correct in allowing the deduction claimed by the assessee under Section 48 (i) of the Income Tax Act, 1961?

It is a settled law that a taxation statute in particular has to be strictly construed and there is no equity in a taxing provision 23. Capital gains is computed by deducting from the full value of consideration received on a transfer of capital asset, the cost of acquisition, the cost of improvement and the expenditure incurred in connection with such transfer. 24 The expression “expenditure incurred wholly and exclusively in connection with such transfer” means expenditure incurred which is necessary to effectuate the tr ansfer. It is humbly submitted that, the property was sold for discharging the guarantee liability of the assessee, and has no nexus to the transfer of property and hence, is not a deductible expenditure falling under Section 48 (i). Furthermore, it is implicitly held by the Apex Court that, the expenditure incurred by the assessee to remove the encumbrance created by the assessee himself on the property which was acquired by the assessee without any encumbrance is not an allowable deduction u/s 48 of the Act. 2.1 Facts Pertaining to the Issue

It is humbly submitted that, the assessee, stood guarantee for repayment of a loan taken by a private limited company, Vulcan BPO Pvt Ltd, of which the assessee was the main promoter (99% shareholding), from the TN Financial Corporation, the Creditor, and had also mortgaged certain property belonging to him in favor of the Creditor. Subsequently, the Creditor, by exercising its rights under the document of mortgage, sold the property and appropriated the entire sale proceeds towards the discharge of the loan taken by the company, which stood at two crores. On appeal to the Tribunal, the assessee claimed that the amount settle d by him was an expenditure incurred for the purpose of transferring the full ownership rights in the property and hence entitled to deduction under Section 48 (i), and the same was allowed by the Tribunal. 2.2 Origin of Liability

The facts of the present case reveal that, the assessee has voluntarily entered into a guarantee contract with the debtor-company. Section 126 of the Indian Contract Act, 1872 defines a contract of guarantee ‘as a contract to perform a promise or discharge the liability of a third person in case of his default ’. Therefore, when the company defaults, the assessee is under an obligation to repay the said amount. It is pertinent to note that the liabilit y of the assessee arises

23

H.H. Lakshmi Bai .v. CIT (1994) 206 ITR 688, 691 (SC) Section 48, Income Tax Act, 1961

24

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from the guarantee contract, and not from the mortgage cr eated in favor of the Creditor. Thus, it is submitted that the property was sold only to pay off the impending liability of the assessee and an obligation of that sort never falls under Secti on 48 (i) of the Act. 2.3 Section 48 (i) and the Present Factual Matrix

It is humbly submitted that, under Section 48 (i), only expenditure which is incurred wholly and exclusively in connection with the transfer of the capital asset, shall be deducted, from the full value of consideration resulting from the transfer. It is submitted that the assessee in the instant case is clearly not entitled to the deduction under Section 48 (i). 2.3.1 The Nexus Test

It is humbly submitted that, the payment of two crores to the Creditor was out of the transfer and not in connection with the transfer . Thus, the appropriation of the money obtained from the transfer is not intrinsically related to the transfer and hence there is no nexus between the transfer of the capital asset and the expenditure so claimed. It is argued that the facts and circumstances on record clearly indicate that the appropriation of sale proceeds was to discharge the guarantee liability of the assessee and has no connection with the transfer of capital asset. In order to establish that the expenditure incurred had no nexus to the transfer of capital asset, the series of events have to be taken into consideration. Firstly, in light of the rights vested with the creditor via the mortgage deed, the sale of the property was completed and the sale proceeds were utilized for discharging the loan. Secondly, the property was sold in the name of the assessee and a perfect title was conferred upon the purchaser. This implies that the entire sale consideration accrued in the hands of the assessee. Thirdly, by appropriating the sale proceeds towards the creditor, the assessee is releasing himself from the guarantee liability and not effecting the transfer in any manner. Therefore, discharging a primary obligation cannot be brought within the ambit of expenditure in connection with the transfer . It is strongly argued that the claim of the assessee, by far stretching the meaning of ‘in connection with such transfer ’ to transactions born out of the transfer towards other obligations, cannot be allowed as it was done with sole intention of reducing the tax liability.

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2.3.2 Ambit of ‘E xpenditure in connection with such transfer ’

It is humbly submitted that the crucial words in Section 48 (i) are “in connection with such transfer”. Further, the expression means intrinsically related to the transfer 25 and even if the expenditure has some nexus with the transfer it does not qualify for deduction unless it is wholly and exclusively in connection with such transfer 26. That being so, the amount appropriated herein cannot be treated as an expendit ure deductible under Section 48 (i). It is further submitted that, the word ‘exclusively ’ refers to the motive, objective and purpose of the expenditure. The deduction of expenditure is to be allowed if it satisfies the test of commercial expediency, and commercial expediency has to be judged from the point of view of a prudent and reasonable man, and free from an apparent taint of excessiveness, collusiveness and colourable discretion27. Therefore, it is an erroneous proposition to contend that as soon as an assessee has established two facts, i.e. the existence of an agreement and the fact of payment, no discretion is left to the Assessing Officer except to hold that the payment was made wholly and exclusively for the purposes of the sale transaction. Although the payment might have been made and although there might be an agreement in existence, it would still be open to the Assessing Officer to take into consideration all the relevant factors which will go to show whether the amount was paid wholly and exclusively in connection with the transfer as required by Section 48 (i) 28. It is therefore submitted that the expenditure made by the assessee herein will not satisfy the criteria to enter the ambit of Section 48 (i) as it was primarily for another obligation and not for the purpose of effecting the transfer. 2.4 R.M Arunachalam’s Judgment – Applicable to the current case

It is submitted that, in light of the Apex Court’s decision in the case of R.M.Arunachalam29 , it is not open to the assessee to contend that repayment of the mortgage debt is an expenditure incurred in connection with the transfer of the capital asset, and, therefore allowable under Section 48 (i) of the Act. The Apex court in this case, held that “where the mortgage is created

by the owner after he has acquired the property , the clearing off of the mortgage debt by him

25

V. A. Vasumathi .v. CIT (1980) 123 ITR 94, Kerala Sita Nanda (Smt.) .v. CIT (2001) 251 ITR 575, Delhi 27 L.M. Patel & B.M Patel (HUF) .v. CIT (2013) 89 DTR 121, Gujarat 28 Ibid 29 R.M. Aruunachalam Etc. .v. CIT (1997) 141 CTR SC 361 26

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prior to the transfer of the property would not entitle him to claim deduction under Section

48 of the Act.” It is humbly submitted that the court before arriving at the conclusion mentioned above, clearly drew a distinction between an obligation to discharge the mortgage debt cr eated by the previous owner and the obligation to discharge the mortgage debt cre ated by the assessee himself. While fortifying the view taken by the bench that the former is not entitled to be claimed as a deduction under Section 48, the court held that ‘ where the assessee acquires a property which

is unencumbered, then, the assessee gets absolute interest in that property on acquisition . The expenditure incur red by the assessee to remove the encumbrance created by the assessee himself on the property which was acquired by the assessee without any encumbrance is not allowable deduction under Section 48 of the I ncome Tax Act .’ It is humbly submitted that even though the question of law in Arunachalam pertained to Section 48 (ii) and the observations made therein were restricted to the same provision, the ratio will still bind a claim under Section 48 (i). The legislative desi gn of Section 48 is in such a way that there is an expenditure first and then, such an expenditure is classified under clause (i) or clause (ii) to analyze the deduction claimed. The ratio pronounced in Arunachalam lays down the principle of law that, an amount spent to remove the encumbrance created by the assessee himself does not fall within the ambit of an expenditure at all. Therefore, it is strongly argued that the binding nature of the ratio in Arunachalam is not influenced by the clause under which the claim is made and it applies to Section 48 in whole. It is submitted that in light of the above mentioned judgment and the observations made therein, the claim of the assessee cannot succeed and hence, has to be disallowed. 2.4.1 Judgments reiterating Arunachalam

It is humbly submitted that the Hon’ble Apex Court in the case of

V.S.M.R.

J agadishchandran30, while dealing with a claim under Section 48 for disch arging a mortgage liability created by the assessee himself, followed the judgment of Arunachalam and held that ‘ where the mortgage is created by the assessee himself, the expenditure incurred by the

assessee to repay the mortgage debt cannot be allowable under Section 48 of the I ncome Tax Act .’

30

V.S.M.R. Jagadishchandran .v. CIT, (1997) 141 CTR SC 361

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It is further submitted that in the case of Roshanbabu31 before the Bombay High Court, the question of law referred to the bench was ‘whether the repayment of the mortgage debt created by the assessee, is an expenditure incurred in connection with the transfer of the mortgaged asset allowable under Section 48 (i) of the Income Tax Act? ’ The Assessee in this case mortgaged her property in her capacity as surety in favour of a credit institution for a loan taken by a company in which her husband was a director. When the company defaulted, the Assessee with the permission of the credit institution, sold part of her property and appropriated the sale proceeds towards discharging the liability. While filing returns, she claimed a deduction under Section 48 (i) as an expenditure incurred wholly and exclusively in connection with the transfer. The Court interpreted the ratio of Arunachalam and disallowed the claim of the assessee as the mortgage was created by the assessee herself. It is submitted that in the above mentioned judgment the court interpreted the judgment of Arunachalam and held that ‘it is implicitly held by the Apex Court that the expenditure incurred to remove the encumbrance created by the assessee himself on a property on which assessee had absolute interest is not an expenditure incurred under Section 48 of the Income Tax Act .’ It is humbly submitted that the two other Bombay High Court judgments relied on by the assesse, Shakuntala32 and Abrar 33 were declared as bad law in the above mentioned judgment in light of the ratio in Arunachalam. A similar treatment was also extended to the Kerala High Court judgment in the case of Thressiamma34. Therefore, these three judgments cited by the assessee will not play any role in strengthening the claim of the assessee. 2.4.2 Other Modes of Voluntary Payments – Not Deductible

It is humbly submitted that in the case of Ranga Shetty 35 , wherein the assessee argued that the compensation paid to the tenants, for the purpose of making them surrender their rights in the property, should be an expenditure deductible under Section 48 (i) of the Act. The Court held that compensation paid to a tenant on transfer by compulsory acquisition of property is not expenditure incurred in connection with transfer and not allowable as a deduction. When the courts have treated involuntary transfers to be ineligible to knock the doors of Section 48 (i), it

31

Supra at footnote 20 CIT .v.Shakuntala Kantilal, (1991) 190 ITR 56, Bombay 33 CIT .v. Abrar Alvi, (2001) 247 ITR 312,Bomaby 34 Supra, at footnote 18 35 CIT .v. R. Ranga Shetty, (1985) 22 TAXMAN 192, Karnataka 32

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is not right to treat the meeting of an obligation created by the assessee himself, as an expenditure deductible under Section 48 (i). It is further submitted that the above decision has been followed in a case where the assessee claimed a deduction of certain sum he had to transfer from the sale consideration received, towards the benefit of employees as per the share purchase agreement. It was held that expenditure in question claimed by the assessee was a voluntary payment and therefore cannot be allowed as deduction under Section 48 (i)36. Applying these ratios to the instant case, it can be said that, the deduction claimed by the assessee in our case, cannot be allowed for the reason that, the assessee created the mortgage by himself, thereby creating a liability voluntarily. Therefore, it is argued that the amount paid by the assessee is not eligible for deduction under Section 48 (i). 2.5 Madras High Court Judgments

It is most humbly submitted that the question of law in the current case at hand and the jurisprudence revolving around it have come up before this Court previously in four petitions. It is further submitted that the issue at hand is a covered issue before this court, favoring the revenue and hence, the same has to be adopted. 2.5.1 Commissioner of I ncome Tax v. N. Vajrapani Naidu37

It is humbly submitted that, in this case, the assessee sold immovable property under 13 sale deeds and paid certain amounts to the creditors of the vendor-assessee, including mortgages on the property, which was the subject matter of sale. The court held that, “ the burden had been created by the vendor on the property sold by him. As the burden had been c reated for his own benefit by offering the property as security to his lenders, the amounts spent for discharging that burden of the vendor whether prior to sale, or at the time of sale, by payment to such creditors including the mortgagees, directly by the vendee cannot be regarded as expenditure wholly and exclusively in connection with the transfer”. While arriving at this conclusion, the Court referred to the ratio pronounced in Arunachalam by the Supreme Court. It is submitted that, in the instant case, the burden has been created by the assessee himself on the property, by voluntarily offering the same as security to the loan amount obtained from the Creditor, and therefore, the ratio of Vajrapani will have to be applied in favor of the revenue.

36 37

Srinivasan Chadira Kumar .v. The Additional CIT, 2014 SCC Online ITAT 6633(?) CIT .v. N. Vajrapani Naidu, (2002) 241 ITR 560, Madras

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2.5.2 Sri Kanniah Photo Studio v. I ncome Tax Officer 38

It is humbly submitted that, in this case, the assessee had taken a loan from City Union Bank by mortgaging his property. Subsequently, the assessee made a one-time settlement with the bank in respect of the loan amount, for the purpose of clearing the mortgage. While filing returns, the assessee claimed the same amount as expenses falling under Section 48 (i) of the Income Tax Act. The Assessing Officer, after considering the facts of the case, held that, “since the mortgage loan had been long time after the acquisition of the property, the same would not stand covered under Section 48 (i) of the Act ”. It is humbly submitted that the said finding was arrived at, by placing reliance on this jurisdictional court’s decision in Vajrapani Naidu’s case. The Court also reiterated the principle enunciated in Arunachalam that, only the discharge of a mortgage debt created by a previous owner to the property is eligible as an expenditure under Section 48. In light of these observations, the Court in this case held that, the payment of the outstanding amount in discharge of mortgage by the vendor-assessee, cannot partake the character of an expenditure falling under Section 48 (i). It is humbly submitted that the Court in Kanniah also took note of the observation made by the Calcutta High Court in the case of Gopee Nath39, where the court in explicit words held that ‘discharge of mortgage created by the assessee after he acquired the property would not be deductible.’ This judgment relied on by the assessee herein, squar ely supports the contentions of the revenue and therefore, cannot strengthen the assessee’s claim. 2.5.3 Commissioner of I ncome Tax v. Bradford Trading Company 40

It is humbly submitted that, in this case, the assessee was restrained by one Mr. Buhari from selling his undertaking to M/s. India Tobacco Company Ltd., by way of litigation. A payment of 2 lakhs was made to Mr. Buhari as a settlement to withdraw his claim against the transfe r of the undertaking. The assessee claimed the payment of 2 lakhs as a deduction under Section 48 (i) of the Income Tax Act as an expenditure wholly and exclusively in connection with the transfer. It is further submitted that the court held that “only by the payment of 2 lakhs, the assessee was in a position to transfer the property in favor of the Tobacco Company, and hence we hold that payment was made wholly and exclusively in connection with the transfer of the capital asset.”

38

Supra, at foot note 11 Gopee Nath Paul and Sons v. Deputy Commissioner of Income Tax , (2005) 198 CTR Cal 116 40 CIT .v. Bradford Trading Company, (2003) 261 ITR 222 39

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It is strongly argued that this case has no application to the current case at hand as the facts in both the scenarios are entirely different. The Court in Bradford while explaining the view adopted in the judgment of Vajrapani, held that ‘the mortgage was created by the assessee subsequent to the acquisition of the property and therefore there is no difficulty in holding that the payment made to discharge the mortgage was not an expenditure incurred wholly and exclusively in connection with the transfer .’ This clearly indicates that the court in Bradford agreed with the ratio in Vajrapani, but did not incorporate it as it was not applicable to the facts therein. It is well established by the revenue that the present factual matrix is directly covered by the judgment of Vajrapani and hence, the case of Bradford has no application in the current case at hand. 2.5.4 V. L akshmi Reddy v. I TO 41

The assessee in this case gave her property as collateral securit y for a loan taken by a company to the Jammu and Kashmir bank, and the assessee was caught up in litigation to get back the title deeds from the bank in order to effectively transfer the property. She claimed a deduction under Section 48 (i) of the Act for the expenditure incurred in improving her title to the property by getting back the title deeds. The court followed the judgment given in Bradford and upheld the claim of the assessee under Section 48 (i) of the Act. It is argued that, the judgment of Lakshmi Reddy will not govern the claim of the assessee in the current case at hand as Bradford will not apply to the present factual matrix. It is submitted that in view of two clear decisions of the Madras High Court in the cases of Vajrapani Naidu and Kanniah, about the interpretation of Section 48 (i) and the ambit of the word ‘expenditure’ under Section 48, so as to not cover the amounts paid to remove mortgages created by the assessee after acquiring the property, free from encumbrances, the bench in the current case at hand, should dismiss the claim of the assessee and rule in favor of the revenue. 2.6 Lifting the Corporate Veil

It is most humbly submitted that in order to benefit from the ratio pronounced in Arunachalam, the assessee has compared the debtor herein and the previous owner mentioned in the ratio on the same footing. Through this contention, a picture is painted in such a way that the assessee is clearing a mortgage debt created by a third party and not a debt created by himself, and the same act of the assessee has to be treated as discharging a mortgage debt of a previous owner. It is strongly contended that this contention of the as sessee does not hold good as he is merel y 41

V. Lakshmi Reddy .v. ITO, MANU/TN/2853/2010

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hiding behind the veil to benefit from the taxing provisions governing the transfe r. It is further contended that by lifting the corporate veil, it can be establis hed beyond reasonable doubt that the benefit arising from the loan, to the company assessee stood guarantee for, and the benefit arising to the assessee himself are not two different scenarios as the company and the assessee are the same. It is strongly argued that, for the purpose of taxation, the court would be justified in piercing the veil of incorporation to ascertain the nature of the transaction and whether it was genuine and bona fide. 42 It is respectfully submitted that, in the case at hand, the assessee who is the main promoter of the company with a 99% shareholding, has used the company to evade tax. It is emphasized that the substance of the transaction is to be seen and not merel y the form. It is only appropriate, indeed normal, that dealings involving transfer of funds to near and dear ones need to be looked into with care and caution, and necessary inferences drawn if there are abnormalities attached to such transactions.43

42

Subhra Mukharjee .v. Bharat Coking coal Ltd., 2000 (3) SCC 312; Deputy Commissioner .v. Chetan Transport Corp. Ltd., (1992) 74 Comp.Cas 563 (Mad.)(DB); CIT .v. Poulose & Mathe Pvt. Ltd., 1999 (236) ITR 416 (Ker) 43 Supra, at footnote 27

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PRAYER

In the light of arguments advanced and authorities cited, the Appellant humbly prays that this Hon’ble High Court may be pleased allow the present appeal on the following grounds: -

That there is no diversion of income by overriding title and the Income Tax Appellate Tribunal erred in its holding regarding the same.

-

That deduction under section 48(i) of the Act is not allowable to the Assessee and the Income Tax Appellate Tribunal erred in its holding regarding the same.



This Hon’ble Court may be pleased to set aside the impugned order of the Income Tax Appellate Tribunal



This Hon’ble Court may be pleased to grant such f urther and other relief as it may deem fit.

Sd/(Counsel for the Appellant)

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Appellant

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