Application Vs. Diversion of Income – CA Final DT Question Bank

Application Vs. Diversion of Income – CA Final DT Question Bank is designed strictly as per the latest syllabus and exam pattern.

Application Vs. Diversion of Income – CA Final DT Question Bank

Question 1.
SR Ltd., a Company operating Chain of Hotels charges a Nominal Amount of ₹ 50 in each bill of the Resident Guests which is specifically earmarked only for the purpose of ‘Local Charities’. This amount of ₹ 50 so collected in each Bill is credited to separate account named “Charity Account”. The Assessing Officer doing the assessment has issued a Show Cause Notice to tax this amount of Charity as Income of the Company for the relevant assessment year. The Company for objecting the stand of the Assessing Officer consults you and seeks your opinion. [CA Final Nov. 2013] [5 Marks]
Answer:
The given question deals with the issue that whether the amount specifically earmarked in bills for the purpose of “local charities” can be included in the total income of the assessee.

The facts of the given case are similar to the facts in CIT v. Bijli Cotton f Mills (P) Ltd. (1979)(SC), where the Supreme Court held that since right from the inception, the amounts were impressed with an obligation to be spent for charitable purposes only, these amounts were not in the form of trading receipts.

In the given question, the guests are paying ₹ 50 in each bill to the hotel separately which is specifically earmarked only for the purpose of ‘Local Charities’. Further the amount so collected is credited to a separate “Charity Account”.

Applying the rationale of the Supreme Court’s judgment in the Bijli Cotton Mills case, the levy by the hotel was clearly a case of collecting payment for specific purpose and validly earmarked for charities.

Application Vs. Diversion of Income – CA Final DT Question Bank

Therefore, such amount credited to a separate “Charity” account would not form part of the price/cost of the hotel room. Accordingly, the action of the Assessing Officer in issuing show cause notice to tax the amount of charity as income of company is not correct.

Alternate view:
A Rule framed by an assessee for its internal management cannot be elevated to the level of Statutory Rule and the decision on the part of the assessee to apply a portion of what is received for benevolent purposes cannot be regarded as diversion of income by overriding title. Such amounts should be added to Income of the Assessee.
CIT v. Madras Race Club (2003) (Mad.)

Thus, where by a legal obligation, income is diverted before it reaches to the assessee, it is not taxable in the hands of the assessee, as he is not actually entitled to it. However, an essential condition for the concept of “diversion of income by overriding title” is the existence of a legal compulsion or contractual obligation to do so.

In this case, there appears to be no legal compulsion or contractual obligation, requiring the assessee to earmark the amount of ₹ 50 collected on each bill to a separate account called “Charity account”.

Application Vs. Diversion of Income – CA Final DT Question Bank

Therefore, in the absence of any such legal compulsion or contractual obligation, the crediting of the amount of ₹ 50 in each bill to a separate account is not diversion of income by overriding title, but application of income by SR Ltd. Consequently, the action of the Assessing Officer in bringing to tax the amount of charity as income of the company would be proper.

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