S.B Sinha, C.J:— At the instance of the Revenue, the following questions have been referred to this court for its opinion by the Income-tax Appellate Tribunal, Delhi Bench “C”, New Delhi (hereinafter referred to as “the Tribunal”), in terms of section 256(1) of the Income-tax Act, 1961 (in short, “the said Act”):

“1. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the assessee was entitled to the deletion of addition of Rs. 3,67,619 out of its interest claim ?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in allowing the deduction of Rs. 1,48,500 to the assessee in respect of payments made to field organisers after the abolition of the sole selling agency ?”

Re: Question No. 1:

Facts:

2. The assessee is a public limited company. It filed a return of its income declaring the total taxable income for the assessment year 1977–78 at Rs. 3,53,28,960 while claiming various deductions under Chapter VI-A. The Income-tax Officer (in short “the ITO”) disallowed the claim of expenditure made by the assessee on account of payment of interest on loans raised, as according to him, the assessee had made interest-free advance to Utkal Investment Ltd. (a subsidiary of the assessee-company), Lions club, Rajgangpur, Lanjiberna Quarry Employees Consumers Co-operative Stores Ltd., and employees of Rs. 3,35,111, Rs. 7,699, Rs. 4,839 and Rs. 20,000, respectively.

3. The Income-tax Officer, while taking into consideration the contentions raised by the assessee before him and various replies given by it to the querries raised by the Income-tax Officer and relying on CIT v. United Breweries, [1973] 89 ITR 17(Mys); Milapchand R. Shah v. CIT, [1965] 58 ITR 525(Mad) and Roopchand Chabildass and Sons v. CIT, [1967] 63 ITR 166(Mad), took a view that it looked illogical that on the one hand the assessee should have raised heavy interest bearing loans and on the other should give interest-free loans to various societies/subsidiary companies.

4. The Income-tax Appellate Commissioner (in short “the IAC”), out of a large number of disallowances proposed in the draft assessment order, deleted some disallowances and confirmed the others.

5. In the aforesaid situation, the Income-tax Officer determined the total income of the assessee at Rs. 3,82,42,720 disallowing the claim of deduction amounting to Rs. 3,67,619 as against Rs. 3,85,111 on account of payment of interest on loans raised.

6. Thereafter, the assessee preferred an appeal before the Commissioner of Income-tax (Appeals) (in short “the CIT(A)”).

7. The Commissioner of Income-tax (Appeals) recording his finding as under:

“Ground No. 9(a) objects to the disallowance of Rs. 3,67,619 out of interest paid by the company, being amount equal to assumed interest on loans advances to:

(i) Utkal Investment Ltd. (subsidiary of the appellant company);

(ii) Lions club, Rajgangpur;

(iii) Lanjiberna Quarry Employees Consumers Co-operative Stores Ltd.; and

(iv) Employees”.

8. Considering the explanation given by the Income-tax Officer dated January 18, 1980, the Commissioner of Income-tax (Appeals) deleted the entire amount of disputed disallowance of Rs. 3,67,619 and held:

“On the basis of the aforesaid discussion, entire disputed disallowance of Rs. 3,67,619 is deleted. In this view of the matter, the contention regarding interest calculation in respect of loan given to the subsidiary company being wrong as raised by ground No. 9(b) requires no consideration.”

9. The Tribunal while upholding the findings recorded by the Commissioner of Income-tax (Appeals) observed:

“The next ground pertains to allowance of interest paid on borrowings. The interest amount is equal to the assumed interest on loans/advances to subsidiary of the assessee-company by name of Utkal Investment Ltd. and to Lions Club, Rajganpur, Lanjiberna Quarry Employees Consumers Co-operative Stores Ltd., and to its employees. This matter is also covered by the order of the Tribunal for the assessment year 1976–77, a copy of which is on page 402 onwards of the paper book. In para. 29 of this order, the disallowance of interest has been deleted on the ground that it had not been proved that the advances were out of borrowed funds on which interest had been paid by the assessee-company. In fact before interest can be disallowed in the hands of the assessee, it is necessary for the Revenue to establish that the interest bearing loans raised by the assessee were diverted for giving loans to the subsidiary company or to other concerns free of interest. In the absence of such proof, disallowance cannot be sustained. We agree with the order of the Commissioner (Appeals) and uphold the same.”

10. The short question, which arose for consideration was as to whether the following amount was to be allowed or not:

Name of debtor Interest disallowed (Rs.) Utkal Investment Ltd. (a subsidiary of the assessee-company) 3,35,111 Lions club, Rajgangpur 7,699 Lanjiberna Quarry Employees Consumers Co-operative Stores Ltd. 4,839 Employees 20,000 Total 3,67,619

11. We may notice that in CIT v. Motor General Finance Ltd., [2002] 254 ITR 449 (Delhi), this Bench held (page 460):

“From the conspectus of the decisions as noticed hereinbefore, there cannot be any doubt whatsoever that the nexus between the amount paid by way of advance to a sister concern and the fund available at the relevant time in the assessee's hands must be found out from the advances taken by the assessee. The onus to prove that it is entitled to (deduction) in this regard was on the assessee. It was to be proved that a bona fide loan had been granted in favour of a sister concern. It was, therefore, its duty to place requisite materials on record.”

12. This aspect of the matter has also been considered in CIT v. H.R Sugar Factory Pvt. Ltd., [1991] 187 ITR 363, wherein the Allahabad High Court held (page 370):

“The court cannot shut its eyes to realities. What has actually happened is visible to the naked eye. The assessee, a private limited company closely held by three family groups, is made to lend huge amounts (up to 23 lakhs of rupees as per the compromise arrived at between the assessee and the directors/shareholders in the civil suits referred to above) at a very low rate of interest and the entire difference of interest is being charged to the assessee. The assessee is not a finance company. It is engaged in the manufacture of sugar. No business purpose of the assessee-company is served by such lendings to its directors/shareholders. It cannot be said that it is expedient in the interest of business or is laid out for the purpose of the business of the assessee. May be that the company borrows large amounts for the purpose of its business every year, but that does not explain the huge advances to the directors/shareholders. Had this money been not advanced to the directors, it would have been available to the assessee for its business purposes and to that extent it may not have been necessary to borrow from the banks. We are, therefore, of the opinion that the Income-tax Officer was right in disallowing the difference of interest under section 36(1)(iii) of the Income-tax Act and that the Tribunal's approach is not only superficial but too naive.”

13. In Indian Metals and Ferro Alloys Ltd. v. CIT, [1992] 193 ITR 344, the Orissa High Court held (page 349):

“…it may be pointed out that, in a hypothetical case, an assessee can earn profits only after the date of investment and advance. It cannot be said that because, in the concerned assessment year, the profit was more than the investment and advance, those came only out of the profit. The actual financial liquidity position on the relevant date has to be established by the assessee.”

14. Yet again in CIT v. H.R Sugar Factory Pvt. Ltd., [1991] 190 ITR 643(All), B.P Jeevan Reddy C.J (as his Lordship then was) relying upon his earlier decision in H.R Sugar Factory Pvt. Ltd.'s case, [1991] 187 ITR 363(All), held that the assessee-company was not entitled to the allowance of interest.

15. In Hira Lall and Sons v. CIT, [1991] 190 ITR 408(Delhi), a Division Bench of this court held that the question whether the loan was taken for the purpose of business was a question of fact and that no question of law arose out of the order of the Tribunal.

16. It may be true that the question as to whether advance to the subsidiary company was given out of the sale proceeds or out of the funds from the depositors from the banks is essentially a question of fact, but such question of fact must be determined on the basis of the materials, which may be placed by the parties.

17. Section 106 of the Indian Evidence Act or the principles analogous thereto places the burden in respect thereof upon the assessee, as the facts are within its special knowledge. However, a presumption may be raised in a given case as to why an assessee who for the purpose of running its business is required to borrow money from banks and other financial institutions would be giving loan to its subsidiary companies and that too when it pays a heavy interest to its lenders, it would claim no or little interest from its subsidiaries.

18. We are not oblivious of the fact that while arriving at such a finding, a nexus between the borrowings from the banks and other financial institutions by the assessee and lending it to its subsidiary companies must be found out, but such nexus must also be found out from the materials on record only.

19. In United Breweries’ case, [1973] 89 ITR 17, whereupon the Income-tax Officer has placed reliance, the Mysore High Court held (headnote):

“There was no material for the Tribunal to come to the conclusion, that the assessee-company carried on its business through the agency of its subsidiaries and that the business carried on by the subsidiaries was not their own but that of the assessee-company. Hence, the part of the capital borrowed by the assessee and advanced by it to its subsidiaries free of interest was not borrowed for purposes of its own business and the interest on such borrowing was not an admissible deduction under section 36(1)(iii).”

20. In Roopchand Chabildass and Sons’ case, [1967] 63 ITR 166, whereupon also the Income-tax Officer has placed reliance, the Madras High Court held (head note):

“…as the amount borrowed was not utilised for purposes of business of the assessee, the interest paid on it was not allowable under section 10(2)(iii) either in the assessment of the firm or of the partners in their individual capacity.”

21. In this view of the matter, the first question must be answered in the negative, i.e, in favour of the Revenue and against the assessee.

Re: Question No. 2:

Facts:

22. The assessee claimed a deduction of Rs. 2,97,000 on account of commission paid to three parties for organising/supervising sales of its product, i.e, cement:

Rs. Cement Distributors Ltd. 1,35,000 Ganesh Trading Corporation 90,000 Vishnu Agencies 72,000 Total 2,97,000

23. The Income-tax Officer disallowed the above expenditure on the ground that these payments were made in violation of the Government policy under which the system of sole-selling agencies in cement industry was abolished and observed as under:

“The institution of sole-selling agency in cement has been abolished by the Government of India. Cement Distributors Ltd., who were the sole-selling agent of the assessee-company, ceased to be so with effect from April 1, 1976. This institution was abolished because in the eyes of Government, no service of sole-selling agent was considered necessary in cement sales. In this connection, it may be stated that cement is a controlled commodity, its sales are regulated by the Government and the assessee is not to run here and there in search of cement customers. It was precisely in view of this reason that system of sole-selling agency in cement has been abolished by the Government.

In order to circumvent and frustrate this policy of Government that the assessee has continued the institution of selling agency though in a different form and under different name with effect from April 1, 1976, i.e, immediately after the termination of sole-selling agency system, the assessee has appointed the above three parties as ‘market supervisors’.

The nature of services rendered by these parties is same as that of sole selling agent. The assessee in its reply dated January 11, 1980, has itself admitted that these parties were appointed to fill the void caused by the termination of the sole-selling agency system.

Since the payments earlier made to selling agents was disallowed, the payments now made to these market supervisors is also disallowed in computing the total income of the assessee.”

24. The Commissioner of Income-tax (Appeals) upon considering various documents brought on record by the Revenue as well as by the assessee deleted the disallowance of Rs. 2,97,000 holding:

“17. Having regard to the submissions made and evidence regarding services rendered by the three parties brought on record, I am of the view that it has to be held that the payments in question represented expenditure incurred wholly and exclusively for the purpose of the business within the meaning of section 37(1). It is no doubt correct that the system of sole selling agency was abolished by the Government. Yet it is quite evident that the new arrangements made with Cement Distributors Ltd. and the other two parties did not violate or run counter to the said Government decision. After all the actual running of the business has to be done by the businessman himself and in the case of the appellant company it had to make some sort of temporary marketing arrangements in order to exercise control over the stockists in the matter it was done when it had no marketing organisation of its own to take over such functions with immediate effect. In other words, the payments in question were fully justified on the grounds of actual needs of the company's business and practical considerations. Moreover by many appellate orders for the earlier years, assessment years 1974–75 to 1976–77, the disallowances of commission paid to Cement Distributors Ltd. were deleted. The amounts of commission paid in those years were quite substantial so that I find there is merit in the learned representative's contention that the new arrangement with effect from April 1, 1976, was as a matter of fact very economical to the appellant-company. In other words, there is and can be no question of the payments to the outside agencies as claimed being regarded as excessive or unreasonable. Lastly, the Income-tax Officer himself has not indicated any doubt as regards the genuineness of the payments in question and/or the actual rendering of the services by the three parties to the appellant-company. On the basis of all these reasons, I would allow the contention and delete the disputed disallowance of Rs. 2,97,000.”

25. Thereafter, the Revenue preferred an appeal before the Tribunal wherein the Tribunal having regard to the policy decision of the Central Government noticed:

“20. The last ground pertains to the allowance of commission paid to Cement Distributors Ltd. in a sum of Rs. 2,97,000. In fact, the whole amount has not been paid to Cement Distributors Ltd. only but to three parties as follows:

Rs. Cement Distributors Ltd. 1,35,000 Ganesh Trading Corporation 90,000 Vishnu Agencies 72,000

The Income-tax Officer disallowed the claim on the ground that the system of sole selling agency in cement having been abolished by the Government, Cement Distributors Ltd. ceased to be the sole selling agent of the company with effect from April 1, 1976. However, with immediate effect the assessee-company appointed the above three parties as market supervisors. The Income-tax Officer held that the Government had abolished the sole selling agency system since no services of sole selling agents were considered necessary in cement sales, which was a controlled commodity. The assessee had, however, appointed the market supervisors to render the same services as were alleged to have been rendered by the sole selling agents. Since the payments earlier made to the sole selling agents had been disallowed by the Income-tax Officer, he disallowed the payment made to the market supervisors also.…

23. The Department is aggrieved and is in appeal. We have heard the learned Departmental Representative and counsel for the assessee at length. We are unable to agree with the learned Commissioner (Appeals) that the new arrangement of payment to market supervisors does not really run counter to the abolition of the sole selling agency by the Government. In fact cement is a controlled commodity and has most of the time been a scarce commodity. The cement dealers function purely in a sellers market and not in a buyer's market. The buyers get in a bag of cement what the seller gives. The beggars, that is exactly the position of the buyer in respect of the cement and the supplier or the manufacturer is the real boss in the system. The list furnished of the job done by the market supervisors in para. 15 is really more in the nature of a cosmetic than in the nature of actual services required and rendered though the correspondence on record shows that some services were rendered. We are satisfied that the payment made to Cement Distributors Ltd., which is a sister-concern of the assessee at Rs. 15,000 per month and Vishnu Agencies P. Ltd. at Rs. 8,000 per month was ad hoc and not commensurate with the services rendered by them. It is clear that the assessee-company has tried to frustrate the Government policy and circumvented it by paying huge amounts under different names. It is immaterial that the payments to the Cement Distributors were allowed in earlier years by the Tribunal. The sole selling agencies were abolished as a matter of public policy, for cement, obviously for the reasons discussed that no services of sole selling agents were required for a scarce and controlled commodity. Looking to the facts stated above, we hold that the payment made to the three market supervisors should be allowed only to the extent of the half, i.e, Rs. 7,500,. Rs. 5,000 and Rs. 4,000 per month, respectively, which is reasonable and commensurate with the services rendered. The sum of Rs. 1,48,500 shall, therefore, stand disallowed.”

26. The question, which, in our opinion, should have been posed by the Tribunal, was as to whether having regard to the Cement Control Order made by the Central Government in exercise of its power conferred upon it under section 3 of the Essential Commodities Act, 1955, such an arrangement was permissible in law ?

27. The learned Tribunal, in our opinion, having regard to the aforementioned finding committed a serious error in directing payment to the extent of 50 per cent, of the claim. Once it is held that the arrangement entered into by the assessee with the firms in question was entered into with a view to defeating the policy decision of the Government of India as regards abolition of the sole selling agency, in our considered view, no amount whatsoever could have been allowed. If the arrangements entered into by the assessee with the alleged market supervisors were violative of the statutory provisions and against public policy, the same cannot be encouraged for any purpose whatsoever, far less for evasion of tax. In this view of the matter, the second question also must be answered in the negative, i.e, in favour of the Revenue and against the assessee.

28. This reference is answered and disposed of accordingly without any order as to costs.