ORDER
Gopal Chowdhury, J.M.
1. This appeal is filed by the assessee against the order of Commissioner (Appeals) rejecting the claim of the appellant that it is not liable to be taxed on the rental income received for the assessment year 2002-03. Appellant is also aggrieved by the order of Commissioner (Appeals) upholding the liability of appellant to pay dividend distribution tax under Section 115-O of the Act and the computation of book profits. Though Commissioner (Appeals) did not deal with the ground regarding computation of book profits under Section 115JB as the tax on total income computed under the normal provisions exceeded the book profit tax under Section 115JB of the Act, the counsel for the appellant and the respondents submitted their arguments on this issue also. Hence, we propose to dispose off all the grounds raised by the appellant.
2. The facts of the case are as follows
“(i) A partnership firm was formed on 6-9-1995. The land belonging to the partners were contributed as capital by the partners.
(ii) This partnership firm was converted into a company by following the procedure laid down in Part IX of Companies Act, 1956.
(iii) article 51 of the Articles of Association states that company may by a resolution passed at General Meeting frame Rules for construction, allocation or allotment of constructed area to the members of the company. It also authorised the members to frame a scheme for allocation. Article 52 empowers the Board of the appellant to decide the number of shares a member shall acquire and the deposit to be maintained by such member with the company for enabling such member to be allotted such constructed area. Article 53 entities the members who have been allotted constructed area to possess, exploit and enjoy the usufruct therefrom. Article 54 permits him to lease, let-out, mortgage, hypothecate, create charge or lien over these deposits and also to dispose off in any manner right over the constructed area allotted to him. Article 55 states that the Board of Directors shall recognize all mortgage and charge. Article 59 prohibits a member from disposing off his rights in the constructed area without transfer or disposal of the shares and deposits held by him and vice versa.
(iv) A scheme of allotment of shares was approved by the company in an EGM held on 30-7-1998. The shareholders entered into an agreement on 7-8-1998 in accordance with the scheme. As per the scheme framed, each member was allotted specific units of constructed area. For instance, Mr. Dawood Mohammed was allotted units B 1, G2, G3, G9, etc. and Mr. Padmanabhan was allotted units G5, G10A, G11, M-4, etc. Similarly the other shareholders were allotted specific units.
(v) At the time of conversion into company, the land was made an asset of the company. The Land account was debited and the share capital account was credited.
(vi) The construction was entrusted to Silverline Resorts Pvt. Ltd. who were also desirous of acquiring units by owning the requisites shares. Silverline reached an understanding with the company and the shareholders regarding construction. The cost of construction was to be met by transferring the shares by individual members to the extent of 50 per cent of the agreed consideration and the balance 50 per cent of the consideration was agreed to be treated deposits due to Silverline. Accordingly, the company debited the cost of construction to building account and the shareholders deposit account was credited,
(vii) M/s. Samsung Electronics Co. Ltd., was interested in occupying the entire building Instead of entering into a separate agreement with each of the shareholders, it entered into an agreement with company itself. The Memorandum of Understanding dated 17-11-2000 recognizes the fact that the shareholders have framed a scheme as mentioned above.
(viii) The rent was paid by Samsung directly to the appellant and the appellant after deducting the municipal tax and small sundry expenses transferred the amounts to individual shareholders. The deposit paid by Samsung was also distributed to shareholders.
(ix) It may be mentioned here that the shareholders deposit credited towards cost of construction is Rs. 1,60,00,000. This amount is kept as it is in the balance sheet as is evident from balance sheet as on 31-3-2002. The balance in shareholder deposit account as on 31-3-2003 is Rs. 1,60,00,000 and the same amount is shown as outstanding on 31-3-2002 also. The rent deposit received from Samsung amounting to Rs. 2,40,00,000 was distributed to the shareholders.”
3. The assessing officer held that rental income is to be assessed in the hands of appellant. He did not agree with the contention of the appellant that Section 27(iii) of the Act applies to it. He laid great stress on the fact that the agreement was entered into with Samsung by the appellant and the investment was made by the company and not by the shareholders. He also held that the appellant company is not a party to the resolution passed in the EGM held on 7-8-1998. The ownership over the building continued to vest with the appellant and this ownership has not been transferred to individual shareholders. He therefore, held that the appellant is not only the legal owner but also the beneficial owner. The appellant is held liable to pay dividend distribution tax on the amount of rent distributed. He also held that the amount so distributed though debited to Profit and Loss Account cannot be deducted from the book profit.
4. The appellant carried the matter in appeal to Commissioner (Appeals). The Commissioner (Appeals) concurred with the view of the assessing officer. As stated elsewhere, he thought it fit not to deal with the grounds regarding Section 115JB of the Act as in his opinion it was academic. The Commissioner (Appeals) also referred to certain provisions of the Karnataka Stamp Act, 1957 wherein it is stated that transfer of an apartment as defined in clause (a) of Section 2 of the Karnataka Ownership Flats (Regulation of the Promotion of Construction, Sale Management and Transfer) Act, 1972 is treated as conveyance and stamp duty is to be paid. Since the stamp duty has not been paid and conveyance obtained in favour of shareholders, the appellant continues to be legal and beneficial owner.
5. The appellant is in appeal before us challenging the order of the lower authorities.
6. Sri S. Ramasubramanian, Chartered Accountant, learned Counsel for the appellant made the following submissions:
(a) The factual finding regarding the investment made by the company is incorrect. The appellant had not paid a single rupee to the contractor. Since appellant had the shell of the legal title, it is necessary to bring into books the cost of the building. A mere book entry was passed for this purpose,.
(b) He also assailed the finding of assessing officer that the deposits accounted in the books of appellant (Rs. 1,60,00,000) were returned. They are outstanding as on 31-3-2002 as is evident from the balance sheet. What was paid to the shareholders was the proportionate share of rental advance received from Samsung. He submitted that the finding of the lower authorities on this issue is completely erroneous and perverse.
(c) Section 27(iii) of the Act squarely applies to the facts of the case. The entire purpose right from the incorporation of the company till the building was let-out was to enable the shareholders to allot the constructed area as per the scheme. He strongly relied on the decision of the Tribunal in Inspecting Assistant Commissioner v. Ranka Construction (P.) Ltd. (1995) 52 ITD 122 (Coch.). He also placed reliance on the decision of the Hon’ble Supreme Court in CIT v. Podar Cements (P.) Ltd. . He referred to the relevant passages in the order of the Hon’ble Supreme Court wherein the Hon’ble court held that the owner for the purpose of Section 22 is a person entitled to receive the income of property in his own right. The facts of the case in Ranka Construction (P.) Ltd (supra) and the facts of the present case are similar.
(d) Articles 51 to 56 clearly recognize that the shareholder can deal with the property as they deem fit.
(e) The resolution passed in the EGM and the shareholders agreement clearly specify that the individual units of the building be allotted to shareholders. Para 23.2 of Board Circular No. 495 dated 22-9-1997 (168 ITR (St) 87) clearly applies to the facts of the present case.
(f) The company cannot be a party to the resolution passed by its members in EGM. Therefore, the fact that the company was not a party and hence resolution cannot be taken into account as held by lower authority is not material. The agreement and the EGM resolutions clearly effectuate the scheme. The agreement with Samsung was entered into by the appellant only as a matter of convenience and nothing more should be read into it. In any case, Memorandum of Understanding recognizes the right of shareholders to receive rentals.
(g) The reference to the Memorandum of Association by the lower authority to say that it is appellant who has to construct and let-out properties is not valid in law. He relies on the decision of Karnataka High Court in CIT v. Bangalore Stock Exchange Ltd. and the Calcutta High Court in Imperial Chemical Indus tries Ltd. v. Income Tax Officer the proposition that the objects clause in memorandum do not determine the character of income.
(h) There is a diversion of income by overriding title in favour of the shareholders. Reliance is placed on the decision of Rajasthan High Court in Smt. Savita Mohan Nagpal v. CIT . The individual shareholders have offered rental income in their hands and the assessments have been made by department accordingly. Once it is taxed in the hands of individual shareholder, same income cannot be taxed again in the hands of the company as held by Tribunal in Ranka Constructions (P.) Ltd’s case (supra) and by the Calcutta High Court in Madugal Udyog v. CIT .
(i) Regarding dividend distribution tax he stated that the amount distributed to shareholders is as per the overriding obligations on the company. No resolution was passed by the Board of Directors
(j) recommending dividend nor the shareholders approved payment of dividends by passing resolutions. Therefore, the rentals distributed to shareholders are not dividend. Section 115-O does not apply.
(1) On book profit tax, it was submitted that the amount credited to profit and loss account does not have the character of income at all as there is an overriding obligation on the part of the company to distribute the rentals in accordance with the scheme. He referred to the decision of the Hon’ble Supreme Court in Siddheshwar Sahakari Sakhar Karkhana Ltd. v. CIT (2004) 270 ITR 11 and the unreported decision of this Bench in Syndicate Bank v. Assistant Commissioner (ITA No. 326/ Bang/2002)2.
7. The learned Departmental Representative Mr. Mathew strongly supported the orders of the revenue authorities. He submitted as follows:
(a) The appellant has described itself as the sole and absolute owner of the property in the Memorandum of Understanding with Samsung. This goes to prove that the appellant itself has understood that appellant alone is entitled to receive the income.
(b) Reliance was placed on the decision of the Karnataka High Court in CIT v. Bhoopalam Commercial Complex &Industries (P) Ltd and S. Kartar Singh v. CIT (Delhi). He also relied on the Delhi High Court’s decision in D.C. Anand & Sons v. CIT to say that the principle of diversion of income by overriding title does not apply to Section 22.
(c) As regards the submissions of the appellant that individual shareholders have been assessed on the same rental income, it was submitted that assessment on income in the hands of a wrong person cannot be a bar in assessing the income in the hands of the person who is ought to be taxed.
(d) The company by passing the necessary entries in the books of account has invested in the construction. To apply Section 27(iii) it is necessary that the investments should be made by the shareholders and not by the company.
(e) The amounts paid to the shareholders are dividends and the assessing officer has rightly levied tax under scction 115-O of the Act.
(f) Since the amounts paid to shareholders are dividends, the same cannot be deducted from the book profits.
8. We have heard both sides and perused the materials on record. Before deciding the legal issue, it is necessary to give our finding on the factual disputes. The assessing officer states that the investment has been made by the company and therefore, Section 27(iii) does not apply. He states that the asset is brought into the books of the appellant and hence the investment is deemed to have been made by the appellant. The learned Counsel for the appellant submits that it is only a book entry to recognize the shell of the legal title. We have perused the balance sheet and we find that there is no actual case outflow from the company to meet the cost of construction. 50 per cent of the construction has been met by the shareholders by transferring their shares to Silverline Resorts Pvt. Ltd. and the balance 50 per cent is treated as share deposit due to Silverline. These facts have not been disputed. Under the circumstances, we do not agree with the factual finding of the lower authorities that the investment has been made by the appellant.
9. The finding regarding the deposit returned to the shareholders by the appellant is clearly contrary to what is stated in the balance sheet. We find that the shareholders deposit of Rs. 1.60 crores remains intact. What has been paid to them is their share of rental deposit received from Samsung. The factual finding of the lower authority in this regard is incorrect.
10. The major dispute in this appeal is with reference to applicability of Section 27(iii) of the Act. Section 27(iii) reads as under for the purposes of sections 22 to 26
“(iii) A member of a co-operative society, company or other association of persons to whom a building or a part thereof is allotted under a house building scheme of the society, company or association, as the case may be shall be deemed to be the owner of that building or part thereof.”
The CBDT in Circular No. 495 dated 22-9-1987 explains that where the building legally belongs to a company, the company is taxed under the head ‘Income from house property’ and at the same time since the shareholder actually enjoys the income, he is assessed under the head Income from other sources’. This has led to taxing the same income twice. The amending Act by incorporating Sub-clause (iii) in Section 27 determines the ownership of the property for the purpose of Section 22. We find that the circular brings out the intention to tax only the shareholders or members and not the company. The purpose is to avoid double taxation and fix with clarity the person who is to be assessed. Section 27(iii) stipulates that, among other things, a member of the company to whom a building or part thereof is allotted under the house building scheme is deemed to be the owner. Once he is deemed to be owner irrespective of the fact that the legal ownership continues to vest with the company, we fail to understand as to how the company can be assessed under Section 22 of the Act.
11. The entire scheme starting from the formation of the company, the relevant articles of association, the resolutions passed in EGM and shareholders agreement fall under the house building scheme referred to in Section 27(iii). We do not agree with the finding of the assessing officer that the shareholders are entitled only to usufruct of the building. As pointed out by the learned Counsel for the appellant, articles 53 and 54 confer an unfettered right over the constructed area to the shareholders.
In fact article 54 refers to leasing, letting-out, mortgage, hypothecate or create charge or lien over the constructed area or dispose off the right over constructed area. Article 53 grants the right of possession. These are the rights which are enjoyed by a beneficial owner. The Hon’ble Supreme Court in Podar Cements (P.) Ltd.’s case (supra) held that the owner for the purpose of Section 22 even prior to insertion of Section 27(iii) is a person who is entitled to receive income from the property in his own right and the requirement of registration of the sale deed in the context of Section 22 is not warranted. The decision of the Tribunal in Ranka Construction (P.) Ltd.’s case (supra) is squarely applicable to the facts of the present case and we have no reservation in following principles laid down in that case. In view of what is stated in Podar Cements (P.) Ltd.’s case (supra), the reference to Karnataka Stamp Act and Karnataka Apartment Ownership Act made by the Commissioner (Appeals) in deciding whether the appellant is an owner or not is ex facie unsustainable.
12. The learned Departmental Representative laid great emphasis on the fact that the appellant has described itself as the sole and absolute owner in the rental agreement. We do not find anything wrong in it. Qua the tenant, the appellant is the legal owner, qua Income Tax Act, it is the shareholders who are to be assessed under Section 22 read with Section 27(iii). This position is not something peculiar to income-tax. For instance, the Courts have held that qua the third parties, the Karta of HUF is a partner of the firm to whom they can look up to, qua Income Tax Act, he represents HUF. Therefore, the fact that the appellant is a legal owner is neither here nor there as for Section 27(iii) is concerned. If the argument of the department is to be accepted, Section 27(iii) becomes otiose.
13. The learned Departmental Representative relied on the decision of Karnataka High Court in Bhoopalam Commercial Complex & Industries (P.) Ltd.’s case (supra). As was rightly argued by the learned Counsel for the appellant, this case does not apply to the facts of the present case. In Bhoopalam Commercial Complex &Industries (P.) Ltd.’s case (supra), the question before the Hon’ble Karnataka High Court was whether the rental income was to be assessed under the head ‘Income from house property’ or ‘Income from business’. There was no issue in whose hands the income is to be assessed. We find that the Hon’ble court has referred to the observations of the Supreme Court in Podar Cement (P.) Ltd.’s case (supra) regarding the person to be taxed under Section 22. This supports the case of appellant rather than the department.
14. The learned Departmental Representative relied on the decision of Rajasthan High Court in S. Kartar Singh’s case (supra) to state that principle of diversion of income by overriding title does not apply to Section 22. We find that in S. Kartar Singh’s case (supra) there was a transfer of income by the legal and beneficial owner without transferring the assets. Obviously in such cases Section 16 of 1922 Act or Section 60 of 1961 Act would apply. We do not find anything in the judgment to say that the principles of overriding title are not applicable to Section 22. Similarly, in D.C. Anand & Sons’ case (supra), the Delhi High Court proceeded on an uncontroverted finding of fact that there was nothing to show that income from property was diverted by assessee by overriding title. The decision is also not applicable to-facts of the case.
15. The reliance on Memorandum of Association to buttress the stand of the department is clearly misplaced. It is well-settled that the objects clause of the Memorandum of Association do not determine the character of income. One has to apply the provisions of Income Tax Act and come to a clear finding that the income is taxable or not. The objects clause is not relevant in deciding the taxability.
16. Though we have held that the factual finding by assessing officer regarding investment by the company is not correct, for the sake of completeness, we would discuss the applicability of Section 27(iii) if the investment is routed through the company. In our opinion, Section 27(iii) would apply even if funds have been provided by the shareholders to the company for the specific purpose of construction and allotment of building or part thereof to shareholders under the house building scheme. Viewed from this angle, it is really not material as to whether the shareholders directly invested in the building or channelled it through the company. Only in those cases where the profits or income earned by the company are invested in construction of building, the company would be the owner and Section 27(iii) may not apply. Any how, that is not the case here. It is nobody’s case that income of the company is invested in construction of building.
17. For the reasons stated above, we hold that the rental income received from Samsung cannot be taxed in the hands of the appellant and we delete the sum of Rs. 81,33,657, being income charged under the head ‘Income from house property’ in the hands of the appellant,
18. The next ground is regarding the applicability of Section 115-O of the Act to the rentals distributed to shareholders in accordance with the scheme. It was strenuously contended that in order to constitute dividend, there should be a profit earned by the company and out of those profits dividends should be declared. We have already held that the rentals received by the company are not its income. It is an undisputed fact that apart from rentals, there is no other income earned by the appellant. If the company does not have any income, it is trite to say that it cannot have any profits. If there are no profits, dividends cannot be declared. Moreover, for a company to declare dividend, the Board of Directors must recommend dividend and the same should be approved by shareholders in meeting. The learned author in A. Ramaiya’s Companies Act refers to the decision of the Bombay High Court in Bacha S. Guzdar v. CIT 22 Comp. Cas. 198 and states that right to claim dividend will only arise after the dividend is declared by company in general meeting. Unless and until it is so declared, no shareholder has any claim against the company in respect of it. The usual practice is for the Board of Directors to recommend and the AGM to declare dividend. Therefore, the distribution of rentals is not declaration of dividend as understood under the Companies Act. In present case, no such steps have been taken.
19. We also feel that the same does not fall within the definition of Section 2(22) of Income Tax Act. On the facts of the case, clauses (b) to (e) of Section 2(22) do not apply. The only question is whether any distribution of accumulated profits entailing the release of assets of the company has taken place to fall under clause (a) of Section 2(22). In our opinion, in order to attract clause (a) first it must be proved that the company has earned profits. in order to apply Section 2(22)(a), first it must be proved that the company has earned profits. Such profits must be commercial profits. The amount received by a company with an overriding obligation to distribute it to shareholders as per scheme referred in Section 27(iii) of the Act gets diverted at source. It cannot be treated as income even under the commercial sense. If it is not income, obviously there will be no profits. We uphold the contention of the appellant that the rentals transferred by the appellant are in discharge of its overriding obligation to shareholders and it is not dividend within the meaning of Income Tax Act. Section 115-O of the Act does not apply.
20. The last ground is with regard to the computation of book profits under Section 115JB of the Act. We have already held that the rentals received by the appellant are received on behalf of the shareholders and distributed to them. Discharge of that obligation cannot be treated as income of the appellant even under commercial principles of accounting. As stated by this Bench in Syndicate bank v. Assit. CIT (ITA No. 326/ Bang./2002 dated 8-6-2005), an amount credited to Profit and Loss Account, if it is not income in accordance to Part II and Part III of Schedule VI to Companies Act, 1956, it cannot be included in book profits.
21. Relevant portion of the order is quoted below
We have carefully considered the relevant facts and arguments advanced. The CBDT by its Circular aforesaid opined that interest on zero coupon bonds is not an interest in strict sense as it encompasses over certain period of time. The Circular issued by CBDT are binding upon the authorities working under it. Similar view has been adopted by Hon’ble Supreme Court in the case of UCO Bank v. CIT 237 ITR 889, in the case of Collector of Central Excise v. Dhiren Chemical Industries (254 ITR 554) and in the case of Commissionerof Customs v. Indian Oil Corporation Ltd. 267 ITR 272. The entry by way of crediting the Profit & Loss Account in respect of interest on zero coupon bonds is of notional credit and not in respect of interest accruing during the year. The bonds are maturing over long period of time and the entire income by way of difference between acquisition price and redemption price do not accrue to the assessee during the financial year. Thus, though the assessee has credited the income, the same is not strictly in accordance with Part II and Part, III of Schedule VI to the Companies Act, 1956. Hon’ble Supreme Court in the case of Appollo Tyres Ltd. (255 ITR 272) held that the assessing officer has no power to rework the book profit if the profits are computed in accordance with Part II and Part III of Schedule VI to the Companies Act, 1956. Hon’ble Bombay High Court in the case of CIT v. Veekaylal Investment Co. P. Ltd (249 ITR 597) held that if the profit is not computed in accordance with Part II and Part III of Schedule VI to the Companies Act, 1956, the assessing officer has power to recompute such book profits. Thus, it can be held that if the assessing officer can amend the book profit if it is not in accordance with Part II and Part III of Schedule VI to the Companies Act, 1956, likewise, the assessee also can recomputed the book profit for the purpose of Section 115JA. Since in the present case, the entire income by way of interest on zero coupon bond has not accrued during the year, the same cannot be considered as “to disclose the result of working of the Cornpany during the financial year” as provided under Part II and Part III of Schedule VI to the Companies Act, 1956. We accordingly hold that the notional income by way of interest on zero coupon bonds has to be excluded while computing book prof its as per Section 115A of the Act.
22. Following the aforesaid decision, we hold that there are no book profits to be taxed under Section 11 5JB of the Act for the year in question.
23. In conclusion, we hold that:
(i) The rental income cannot be taxed in the hands of appellant in view of Section 27(iii) of the Act. Appellant is not the owner for the purpose, of Section 22 as the shareholders are treated as owners under section
(ii) The amount of rentals distributed to the shareholders of the appellant is in discharge of its overriding obligation and therefore, it is not a devidend. The tax under Section 115-O is not leviable on such distribution.
(iii) The amount received by appellant from Samsung is not income for the purpose of Parts II and III of Schedule VI to Companies Act, 1956. It is not an income that is to be reckoned for calculating book profits and therefore, minimum alternative tax is not payable for the year under appeal.
24. In the result, the appeal of the appellant is allowed.