Court’s decision
The Karnataka High Court dismissed the appeal filed by the Appellant and upheld the findings of the Income Tax Appellate Tribunal that the amount of ₹66,00,000 received from a private company must be treated as salary and not as professional income. The Court concluded that the Appellant had completely failed to produce any documentary evidence showing that he rendered professional or technical services to the company. The Court held that tax deduction under professional-fee provisions or treatment in the company’s accounts is not determinative of the true nature of the income in the hands of the recipient.
The Court emphasised that an individual who claims professional income cannot merely rely on service-tax treatment or internal company records; instead, he must substantiate the nature of services with independent proof. The Court also affirmed the view that interest expenditure of ₹45,26,956 claimed against the alleged professional income could not be deducted, as the Appellant had failed to establish any nexus between the borrowed funds and the earning of the income. The principle of “commercial expediency,” the Court held, was not attracted.
Relying on the Tribunal’s reasoning and analysing the precedents cited, the Court rejected all substantial questions of law and held that the Appellant’s appeal lacked merit. It also held that the Appellant failed to contradict the factual findings recorded by the lower authorities. Consequently, the appeal was dismissed in its entirety.
Facts
The Appellant, an individual, filed returns of income for three assessment years. These returns were selected for scrutiny, during which he declared receipt of ₹66,00,000 from a company of which he was a director. The Appellant claimed that this amount constituted professional or technical services income and not salary. The Assessing Officer issued repeated notices seeking details of the nature of services rendered, but no documents were produced. He also claimed deduction of interest expenditure exceeding ₹45 lakh on borrowed funds allegedly raised to support the company’s operations.
The Assessing Officer held that the Appellant had failed to prove both the nature of services rendered and any nexus between the borrowed funds and business income, and therefore treated the receipt as salary and disallowed the interest deduction. The first appellate authority upheld this finding. The Tribunal also affirmed the same, noting lack of evidence and relying on legal principles regarding remuneration paid to directors. Aggrieved, the Appellant approached the High Court.
Issues
The Court considered multiple substantial questions of law, primarily concerning:
- Whether the Tribunal erred in holding that the Appellant had not demonstrated rendering of professional services despite TDS being deducted as professional fees.
- Whether the Tribunal ignored additional evidence relating to service-tax proceedings treating the income as professional charges.
- Whether the Tribunal erred in rejecting the Appellant’s claim of commercial expediency for borrowing funds and advancing them to the company.
- Whether interest expenditure could be allowed as business loss even if income was ultimately assessed as salary.
Petitioner’s arguments
The Petitioner argued that proceedings under Section 206 treating the amount as professional charges precluded the department from subsequently classifying the income as salary. It was submitted that the company had discharged service tax on the payment under the reverse-charge mechanism, which showed that the income was professional in nature. The Petitioner contended that he was never treated as an employee and the department failed to establish the existence of an employer–employee relationship.
The Petitioner submitted that he borrowed funds and advanced them to the company purely out of commercial expediency as a director and shareholder, and therefore interest must be allowed as a business expenditure. Alternatively, the Petitioner argued that even if the income was treated as salary, interest should be allowed as a separate source of income and set off against income determined by the department.
Respondent’s arguments
The Respondent maintained that the Appellant repeatedly failed to provide any documentary evidence showing professional or technical services rendered to the company. It was submitted that deduction of tax under provisions relating to professional fees could not determine the true nature of the transaction. The Respondent contended that the Appellant had also failed to demonstrate any nexus between borrowed funds and business activities, making interest deduction wholly inadmissible.
The Respondent argued that mere status as a director does not automatically establish business income, as a director may also be an employee. It was further argued that the reliance on service-tax orders and decisions concerning commercial expediency was misplaced because factual foundations were absent. Thus, the Tribunal’s findings required no interference.
Analysis of the law
The Court analysed the principle that classification of income depends on the real nature of the relationship between parties and not on nomenclature used in accounting entries or tax sheets. Citing established jurisprudence, the Court reiterated that a director may have a dual capacity—he may act as an agent but may also simultaneously be an employee, depending on contractual terms. The Court noted that the Appellant produced neither the Articles of Association nor any agreement establishing the nature of his engagement with the company.
The Court also examined the requirements for claiming business expenditure under the Income Tax Act. It held that only such expenditure incurred wholly and exclusively for the purpose of business can be allowed as deduction. Since the Appellant failed to prove that the loan was taken for business or that advancing funds to the company was integral to his own professional activity, the expenditure lacked requisite nexus. Thus, the Tribunal’s view aligned with statutory principles.
Precedent analysis
The Tribunal relied on the Supreme Court’s ruling recognising dual capacity of directors and explaining that remuneration paid to a director may constitute salary depending on terms of engagement. The Court endorsed this position, stating that directors must substantiate claims of independent professional engagement through contractual documents.
The Court rejected reliance on the decision concerning commercial expediency, noting that the assessee in that case had proved lending to a subsidiary as part of business activity, whereas in the present case no such proof existed. The Court also distinguished the Calcutta High Court ruling relating to share investment business on similar factual grounds. The Court held that the Orissa High Court decision cited by the Appellant was irrelevant because the Appellant here failed to produce essential documents or evidence supporting his claim.
Court’s reasoning
The Court concluded that the Appellant failed at the most fundamental threshold—producing evidence. It held that despite repeated opportunities, the Appellant neither produced documentation of services rendered nor any contractual terms showing he was engaged as a consultant. The Court emphasised that treatment in the company’s accounts or TDS deduction patterns cannot override substantive legal tests. It reiterated that the burden of proof lies on the assessee claiming professional income.
Regarding interest deduction, the Court held that the Appellant failed to prove nexus between borrowed funds and business activities. The Tribunal had also correctly held that advancing interest-free loans to a company does not establish business purpose. The Court affirmed these findings as reasonable and consistent with the Income Tax Act.
Conclusion
The High Court dismissed the appeal in full, answering all substantial questions of law against the Appellant. It upheld the Tribunal’s conclusions that the ₹66,00,000 receipt constituted salary income and that the interest expenditure lacked nexus with any business income. The Court held that the Appellant provided no basis to disturb the factual findings of the lower authorities and therefore the Tribunal’s order required no interference.
Implications
The ruling reinforces that TDS classification, internal bookkeeping, or service-tax treatment cannot substitute for substantive proof when determining the true nature of income. Taxpayers claiming professional income must ensure documentary evidence of contractual arrangements and actual services rendered. The judgment also tightens the test for interest deductibility, making it clear that commercial expediency claims must be supported by concrete evidence. It underscores the Court’s expectation that taxpayers must strictly meet statutory requirements before claiming specialised deductions or income characterisations.