By TIOL News Service

JAMMU, SEPT 20, 2017: THE issue before the Bench is - Whether no tax liability arises if there is diversion of income at source itself by overriding title. YES is the answer.

Facts of the case

The Assessee, a joint venture(JV) of M/s TRG Industries (P) Ltd and M/s Soma Enterprises Ltd, entered into two separate JV agreements with an objective of submission of two tenders for construction of two tunnels of Northern Railway on the Katra-Reasi Section of Udhampur-Srinagar-Baramullah rail link project. However, it was only M/s Soma Enterprises Ltd. which had the necessary experience under the Notice Inviting Tender floated by Northern Railways. The Assessee had filed its return with two TDS certificates showing that northern railways had deducted tax at source in respect of aggregate payments made.

The AO computed the income at Rs.12,09,55,137 as against the income which was declared to be NIL. It was also observed by the AO that the tax was deducted at source on the payments made by the railway authorities treating the Assessee as contractor, hence, the Assessee had sub-contracted the execution of the work in the ratio of 97:3 and thus provisions of Section 40(a)(ia) are attracted. Thereby, the AO disallowed an amount paid by the Assessee to the joint venturers as per the provisions of Section 40(a)(ia). It was further held that contention of the Assessee that it did not carry out any business during the relevant AY was factually incorrect.

Aggrieved Assessee filed an appeal before the CIT(A), where the same was dismissed by confirming the assessment order. Later, again another appeal was preferred by the Assessee before the Tribunal, wherein, it was held that income had accrued to the Assessee and it was not a case of diversion of income by overriding title because all payments were received and duly credited in the books. It was further held that the Assessee was liable for deduction of tax at source in respect of payments made to M/s TRG Industries (P) Ltd and M/s Soma Enterprises Ltd u/s 194 C and 194 J. It was also held that the payments made by the Assessee to M/s TRG Industries (P) Ltd and M/s Soma Enterprises Ltd were not eligible for deduction in view of Section 40(a)(ia). Thereupon, a miscellaneous application was filed u/s 254(2) by the Assessee and prayed for correction of the mistakes which had crept in the records, however, the same was not decided.

On appeal, the High Court held that,

Whether no tax liability arises if there is diversion of income at source itself by overriding title - YES: HC

++ from the relevant clauses of the agreement, it is evident that the Assessee was formed only for the purposes of submission of tender and it was agreed between the two companies namely M/S TRG Industries (P) Ltd and M/s Soma Enterprises Ltd that in case the JV is awarded the work by the employer, a more detailed joint venture based on the agreement shall be signed. Admittedly, M/s Soma Enterprises Ltd was the lead party of the JV and was supposed to execute the agreement. The Assessee has admittedly not executed the agreement. For the purpose of execution of the agreement, thereafter admittedly, the side agreements were executed;

++ it is pertinent to note that neither the existence nor the genuineness of side agreements have been disputed or even doubted by the Revenue. There is no finding by the AO that the members of the JV had authority to interfere with or comment on the work executed by the other member or that both the members have jointly executed the work. It is pertinent to note that neither amount would have been received by the Assessee from the northern railways for no work performed by it nor it could be stated that the Assessee has performed any activity but still the income has accrued. We are aware that the definition of income as provided u/s 2(24) is inclusive and wide, yet the fact remains that the income diverted at source before it accures to the Assessee cannot be regarded as an income;

++ admittedly, the Assessee had not incurred any expenditure and the work admittedly was executed by M/s Soma Enterprises Ltd. It was also held by the Apex Court that true test of diversion of income by overriding title is whether the amount sought to be deducted, in truth, never reached the Assessee as his income. To apply the doctrine of diversion of income by overriding title, the first and foremost condition to be satisfied is the nature of Assessee's obligation, whether by the obligation, the income is diverted before it reaches the Assessee, or whether the income is required to be applied to discharge an obligation after such income reaches the Assessee. In the instant case, there is diversion of income at the source itself. Therefore, the instant case is diversion of income by overriding title. The receipt of amount of Rs.12,09,55,137/- could not be treated as income of the Assessee and it was the case of diversion of income by overriding title. Accordingly, the first substantial question of law is answered in favour of the Assessee.

(See 2017-TIOL-1971-HC-J&K-IT)