Adarsh Kumar Goel, J.:— The following question of law has been referred for opinion of this court at the instance of the Revenue by the Income-tax Appellate Tribunal, Chandigarh Bench, Chandigarh arising out of its order dated November 19, 1995, in cross-appeals in I.T.A Nos. 70 and 93 of 1990 relating to assessment year 1986-87:

“Whether on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was right in law in allowing interest claimed by the assessee at a higher rate on the borrowings though the investment had been made by the assessee in the shares of a sister concern which gave a fixed return of income?”

2. The assessee borrowed money from a sister concern and paid interest therein at 18 per cent, per annum and purchased shares from the sister concern which carried dividend at 4 per cent. The Assessing Officer (AO) held that there was no justification to borrow funds at the rate of 18 per cent, interest for making investment in shares, which would give a dividend of 4 per cent only. Having regard to the fact that the borrowing was made from a sister concern and the investment was also in another sister concern, the claim for interest was disallowed. It was held that the investment in shares was not for business purpose or business considerations. The observations of the Assessing Officer are as under:

“3. No prudent person will make such an investment. A man may invest in equity shares may get 10 per cent., may get dividend of 50 per cent, or more along with appreciation or may not get the dividend at all. In preference shares the return determines its market value. At the rate of 4 per cent., preference shares may fetch not more than Rs. 30 to 35 per share of the face value of Rs. 100. For the purpose of wealth-tax the value of these shares has been shown between Rs. 30 to 35 by the shareholders. In the assessee's case it knew before making the investment that the maximum yield expected could not be more than 4 per cent. The assessee belongs to one of the largest groups of M/s. Hero Cycles (P) Limited and is assisted by a number of senior counsel. The assessee's conduct of paying higher interest to the sister concern of the same group by taking a loan for the purchase of preference shares with a low fixed yield is a clear cut colourable dubious device to reduce the tax liability, such device is not permissible in view of the hon'ble Supreme Court's decision in the case of McDowell and Co. Ltd. v. CTO reported in [1985] 154 ITR 148.

Penalty proceedings under section 271(1)(c) are initiated for furnishing of in-accurate particulars of income.”

3. The Commissioner of Income-tax (Appeals) upheld the finding of the Assessing Officer with the following observations:

“7.3.1 do not find any reason to give relief to the appellant on this account. Another ground that the appellant is entitled to 4 per cent, dividend on these shares that in case of Highway Cycle Ind. Ltd., Ludhiana, for assessment year 1986-87 the Assistant Commissioner of Income-tax has added back the difference of 18 − 4 = 14 per cent, under similar circumstances on the amount borrowed for that company for purchase of similar shares. This plea of the appellant is also rejected as these are non-cumulative preference shares and no dividend has been declared by Hero Investments P. Limited for the year under consideration. It is held that the case of McDowell and Co. Ltd. v. CTO, [1985] 154 ITR 148 (SC) is applicable, as the appellant has adopted circuitous method, where it was observed:

‘… the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it’.”

4. The Tribunal upheld the plea of the assessee and held that the assessee could not be prevented from making investment only because the return from shares was low. The investment was incidental activity of the business and there was no effect on revenue as the assessee and the sister concern belonged to the same group. The transaction was bona fide and not sham. The relevant part of the order of the Tribunal is extracted below:

“10. We have considered the rival contentions and we have also perused the different rulings cited by the learned counsel and are of the view that the assessee did borrow certain funds at a higher rate of interest and utilized them for investments in certain preference shares. The assessee could not be prevented from making investment in certain shares only on the ground that the return from shares was very low. We do not agree with the Revenue that the benefit accruing at 4 per cent, from preference shares was not sufficient so as to justify the borrowings at 18 per cent. It is to be noted that the assessee was not dealing in shares and investments had been made as incidental activity of the business. The learned counsel has argued that there was ultimately no effect on the revenue because the assessee as well as the other two parties involved belonged to the same group. Borrowing was made from MAL and shares were purchased from M/s. Hero Inv. Pvt. Limited. Since the transactions were bona fide and not sham, the interest payable to the creditor is found to be incidental and wholly for the purposes of business. We are unable to agree with the Revenue that the interest paid at a higher rate could not be allowed. We have already seen that in the case of Pankaj Munjal Family Trust, the Tribunal on an identical question, took a view that the payment of interest at a higher rate could not be disallowed. Therefore, following the Tribunal's orders in the cases of Pankaj Munjal Family Trust as well as Yogesh Chander, as also in view of the various judicial pronouncements, discussed above, ground No. 2 is accepted and the disallowance is deleted.”

5. We have heard learned counsel for the parties. The submission on behalf of the Revenue is that when interest paid by the assessee was at a higher rate and investment made in a sister concern gave lower income, the claim for interest cannot be held to have nexus with business and would be only manipulation to avoid tax which may be attracted in normal course. The case of the assessee that investment in shares was made not from the amount borrowed from the sister concern but out of its own profits could not be enough to take out the effect of manipulation. The alternative submission that disallowance of interest should be after taking into account benefit at the rate of 4 per cent, earned by the assessee from investment in shares of the sister concern could at best be ground for partial relief to the assessee.

6. Learned counsel for the assessee at the outset submitted that the Tribunal followed its order in the case of Pankaj Munjal Family Trust and the question arising therefrom was referred for opinion of this court, which has been decided on July 9, 2008 in favour of the assessee and against the Revenue in I.T.R Nos. 87 to 91 of 1995 (CIT v. Pankaj Munjal Family Trust) [2010] 326 ITR 286).

7. Learned counsel for the Revenue, however, submitted that even though, in the case of Pankaj Munjal (supra), this court held that no substantial question of law arose and tax planning was the right of the assessee, the inference by this court that the transactions could not be held to be dubious, is not sound and cannot be treated as a precedent.

8. The question for consideration is whether in dealing with sister concerns, a transaction which does not appear to be prudent and normal should be accepted as genuine merely on the plea that it is for the assessee to take its decisions, even if not prudent.

9. In the famous case of CIT v. A. Raman and Co., [1968] 67 ITR 11 (SC) it was observed (headnote):

“Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited. A taxpayer may resort to a device to divert the income before it accrues or arises to him. Effectiveness of the device depends not upon considerations of morality, but on the operation of the Income tax Act. Legislative injunction in taxing statutes may not, except on peril of penalty, be violated, but it may lawfully be circumvented.”

10. In Commissioner Of Income Tax, Gujarat Ii v. B.M Kharwar, [1969] 72 ITR 603 (SC), it was observed (head-note):

“The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authorities to unravel the device and to determine the true character of relationship. But the legal effect of a transaction cannot be displaced by probing into the ‘substance of the transaction’.”

11. In McDowell and Co. Limited v. CTO, [1985] 154 ITR 148 (SC), the above observations were sought to be disapproved but in Union of India v. Azadi Bachao Andolan, [2003] 263 ITR 706 (SC), it was observed that the observations of Chinnapa Reddy J. were not supported by other members of the Bench and the principles in IRC v. Fishers Executors, [1926] AC 395 and in IRC v. Duke of Westminster, [1936] AC 1, on which the observations in A. Raman and Co., [1968] 67 ITR 11 (SC) and B.M Kharwar, [1969] 72 ITR 603 (SC) were based, still held the field.

12. We may proceed on the basis that tax planning is permissible even if it results in avoidance of tax as observed in Azad Bachao Andolan, [2003] 263 ITR 706 (SC). The legitimacy of claim for deduction has still to be made out on the principles of business expediency. In S.A Builders Limited v. CIT, [2007] 288 ITR 1 (SC), it was observed that amount paid as interest for business was a permissible deduction under section 36(1)(iii) of the Act and the test of commercial expediency applied for permitting deductions under section 37 applied to such claim for deduction. The said test itself is the test of a prudent businessman. This test has been laid down in Atherton v. British Insulated and Helsby Cables Limited, [1925] 10 TC 155 (HL), as approved in Eastern Investments Ltd v. Commissioner Of Income Tax, West Bengal, [1951] 20 ITR 1 (SC) and CIT v. Chan-dulal Keshavlal, [1960] 38 ITR 601 (SC). It was further observed in S.A Builders, [2007] 288 ITR 1 (SC) that in the absence of commercial expediency, the deduction could not be allowed. The matter was remanded to the Tribunal for fresh decision for applying the test of business expediency. In the present case, the Tribunal has not applied the said test and merely observed that it was in the wisdom of the assessee to have entered into transactions even if such transactions were not prudent. The hon'ble Division Bench in the earlier order in Pankaj Munjal Family Trust, [2010] 326 ITR 286 (P&H), affirmed the order of the Tribunal without applying the test of commercial expediency. We, thus, respectfully disagree with the view taken therein and refer the matter to a larger Bench. Moreover, since this question is frequently arising, it would be desirable to have an authoritative view of the larger Bench on the following question:

“Whether having regard to relationship between different concerns, where a transaction which is patently imprudent, takes place, the taxing authority should examine the question of business expediency and not go merely by the fact that the assessee had taken a decision in its wisdom which may be wrong or right?”

13. Accordingly, the papers may be placed before the hon'ble Chief Justice for further orders for constituting a Bench.