Mutual benefit company – Principle of mutuality – Income from sale of shares and the occupancy rights – cannot be assessed in the hands of the assessee – Land continues to be owned by the assessee – No transfer of any FSI attached to the land – Tax under the head ‘capital gain’ in the hands of the shareholder not company:

[The ITO 6(2)(1) vs. M/s. Calico Dyeing and Printing Mills Pvt.Ltd . [ITA No. 4297/MUM/2009 ; Bench : C ; dated 05/06/2013 ; A Y: 2006- 2007. Mum. ITAT]

The assessee was engaged in the business of construction and started construction of 15 storied building consisting of 85 dwellings units in the year 2002-03. The assessee had finished major construction activity in early 2005 and had received the “Occupation Certificate” from BMC authorities upto the 13th floor on 31st May, 2005. As per the details, totally 67 flats weresold 67.

It was the claim of the assessee that it was a mutual benefit company therefore it had not made any profit from the construction activity as it had only collected the construction cost from the flat owner. The company has entered into a tripartite agreement with the flat owners. The parties to the sale agreement being the flat purchaser, the assessee company and a partnership firm Viz., M/s. Calico Associates who held 12,100 shares of the assessee company.

After considering these facts, the AO issued show cause asking the assessee why the activity of construction and sale of residential units should not be considered as a business of the assessee company and the profits arising out of the same not be taxed in its hands as business income. The assessee explained to the AO that the activity of construction and allotment of residential flat cannot be treated as business venture because it was a Non Trading Company doing activities of construction of residential buildings for the benefit of its members. Therefore, there was no motive of earning any profits or gains from the activity. It was explained that the assessee was working solely for the benefit of its members/share holders. The AO did not accept the contention of the assessee and was of the firm belief that the flat owners at the time of booking of the premises were not share holders of the company. The AO further observed that the flat owners had no right other than the flats occupied by them. The AO further observed that principle of mutuality did not apply on the facts of the case because there is no reciprocity or mutual dependence which are necessary conditions in the case of mutuality. The AO was of the view that the claim of the assessee is nothing but a sham and a colourable device used by it to divert and avoid taxable income in its own hands.

Being aggrieved by this finding of the AO, the assessee carried the matter before the Ld. CIT(A). Before the Ld. CIT(A), the assessee explained the entire nature of transaction and contended that only the share holders are liable to tax on the income arising from such transfer and the share holders have already offered the income to tax. If the income was taxed in the hands of the assessee, it would amount to double taxation. The Ld. CIT(A) was convinced that what was attached to the shares and subject matter of transfer were the occupancy rights of the constructed flats in the building Kamal Darshan and not the land. Such rights did not belong to the assessee since before rights came into existence, they were attached to the shares of the company.

CIT(A) held that in terms of Section 27(iii) of the Act, the shareholder was the owner of the flat. It found that in fact what had been sold were its shares held by its shareholder one M/s.Calico Associates. The sale of shares by its shareholder – M/s. Calico Associates was brought to tax under the head ‘capital gain’ in the hands of the shareholder for the subject Assessment Year. It also held that there was no sale of the land by the asseseee nor any sale of FSI available on the land which continued to be owned by the asseseee. In these circumstances, it allowed the asseseee’s appeal.

Aggrieved by the above finding of the Ld. CIT(A), Revenue carried the matter before ITAT . This ground of appeal was dismissed by the ITAT .

The Revenue filed an appeal before the High court challenging the order of ITAT . The High Court held that the question as raised was in respect of impairment of land (use of FSI) was not canvassed before the Tribunal. Therefore, the question raised does not arise out of the Tribunal’s order. In any case, the finding of fact rendered by the CIT(A) that land continued to be owned by the assessee and there was no transfer of any FSI attached to the land was not shown to be perverse and/or arbitrary. In the above view, the Appeal was dismissed.