By TIOL News Service

ALLAHABAD, SEPT 20, 2017: THE issue before the Bench is - Whether when basic objective of the Mutual Benefit Company is to take deposit and lend loans to its members, mere fact that some members were also holding certain position in the Company and loans were given to sister company, it calls for invoking doctrine of ‘piercing of veil’. And the HC verdict is NO.

Facts of the case

The assessee is a Mutual Benefit Company. As per MoA, main objectives of Assessee were, (i) to receive deposits from shareholders and (ii) to lend money to shareholders. A Mutual Benefit Company takes deposits/ give advances only to its members or shareholders. During the A.Y. 1993-94, Rs. 1,12,14,665.30 was paid as interest on deposits. Interest on deposit scheme was calculated on product basis. Further interest was calculated on quarterly compounding basis in F.D.R. Schemes and half yearly basis in other schemes. Further a sum of Rs. 38,13,119.10 was debited in profit and loss account towards commission to agents, for procuring these deposits. Against this, total receipt from interest was Rs. 1,27,50,047.20 and Rs. 7,87,014.36 from Banks. Assessing Officer calculated commission on interest paid/payable on deposits as 34%. Administrative and establishment expenses were claimed as Rs. 27,84,389/-. Besides, Assessee Company also paid Interest Tax as Rs. 3,08,544/-. By this system, Assessee had received funds from public in the form of various types of deposits, by paying a high rate of interest, and commission to agents, and advanced these funds in the form of unsecured loans mainly to sister concerns at a very low rate of interest. In cases of loans, other than to sister concerns, Assessee has charged interest upto 28% p.a. also.

The assessee had been accumulating losses in several past years. As on 01.04.1992 losses were reflected at Rs. 44,53,045/-. Borrowed funds were utilized in advancing loans. Interest rates earlier being 20% in A.Y. 1992-93 was reduced to 16% in A.Y. 1993-94. Assessing Officer found that Assessee has paid compound interest including commission charges on various deposit schemes at higher rate. Interest had been charged on unsecured loans to its Directors at simple interest at 16% per annum, thus resulting in interest received/ receivable of Rs. 1,24,41,611.51 as against Rs. 1,51,91,943.03 paid by Assessee as interest and commission to obtain these deposits under various schemes. There was thus a difference of loss, which varied from Rs. 27 lacs and odd.

The AO took the view that expenditure in regard to payment of interest on borrowings had not been incurred wholly and exclusively for business purposes by resorting to colourable device for siphoning the profit to its sister concerns and a few selected share holders amongst total share holders numbering 30,000. A.O. thus held that Assessee has not used funds for its own business but had merely advanced in the form of unsecured loans, at a low rate of interest of 16% per annum, in majority of cases to sister concerns. In this way it has incurred loss, year after year, and has shown a loss of Rs. 41,76,919/-. during the year itself as per profit and loss account. A.O., therefore, disallowed interest charged less from sister concerns and said that it could not be allowed as "deduction". It held that instead of 16% interest, amount chargeable should have been 24.50%. In the result, it disallowed interest and commission of Rs. 29,20,123/-.

On appeal, the CIT(A) examined statutory character of a "Mutual Benefit Company" and found that in terms of Government of India's notification dated 31.07.1987, issued by Ministry of Industry (Department of Company Affairs), New Delhi, under G.S.R. 597, Assessee had been declared 'Nidhi' under Section 620A of Companies Act, 1956. The nature of "Mutual Benefit Company" was explained by observing that their objects were to enable members to save money or invest their savings and secure loans at favourable rates. They inculcated idea of thrift and compulsory savings in the minds of poor and middle class people. It was pointed out that A.O. wrongly held that "Mutual Benefit Company" could not admit, as member, any body corporate or trust, since this amendment came into force by notification dated 04.12.1995 and not applicable in A.Y. 1993-94, in question in this appeal. With regard to advancement of loan to certain individuals, CIT(A) held that A.O. forgot that Assessee was a Company which was authorized to advance loans and accept deposits. The CIT(A) held that Assessee was a "Nidhi Company" and transaction of raising funds and lending were confined amongst its members only. There were no borrowings as such from banks or any other Institutions, therefore, question of diversion of such borrowings did not arise. The huge sum of Rs. 29,20,123/- as had been added, neither accrued from income nor became legally due or payable. The CIT(A) found that there was virtually no difference in interest charged and paid. The CIT(A) further observed that there was a difference of only Rs. 2,40,000/. whereas cost of general administration and infrastructure, as was required to maintain corporate status, would be much more. Hence on this fact also there was no under recovery of interest. The Tribunal rejected the Revenue's appeal.

Having heard the parties, the HC held that,

++ whenever doctrine of "lifting of veil" has been applied, there have been compelling reasons therefor and many a times even statutory provision permits. In the present case it is not disputed that basic objective of Company was to take deposit and lend loans to its members and further that loans were actually advanced to members. The mere fact that some members were also holding certain position or status in Company, would make no difference. So long as there is no material evidence or otherwise findings recorded by A.O. that advancement of loan to members of particular category was for reasons other than bona fide, we do not find anything therein to justify application of doctrine of "piercing of veil";

++ some Authorities cited by the counsel for Revenue basically deals with cases of Companies of different nature and not Mutual Benefit Companies which is a different category, recognized in that category by Government of India under Section 620A of Act, 1956;

++ therefore, submission that here is a case where this Court must pierce veil and find out sophisticated device of tax evasion on the part of Assessee, in our view, is a misconceived proposition inasmuch as without appreciating nature of Assessee Company, and its business etc., actual transactions cannot be doubted. Only a part of rate of interest was questioned, hence this broad proposition of invoking doctrine of lifting of veil is not justified to be raised in this case and we have no hesitation in rejecting the same;

(See 2017-TIOL-1966-HC-ALL-IT)