Interest claims by an AOP/BOI to its members are disallowed if the entity is assessable as an AOP

By | May 29, 2025
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Interest claims by an AOP/BOI to its members are disallowed if the entity is assessable as an AOP and the members voluntarily pooled funds for a joint venture.

Issue:

Whether interest paid by a private specific trust, which has declared itself as an Association of Persons (AOP) in its income tax return and whose beneficiaries have pooled funds for a joint business project, can be disallowed under Section 40(ba) of the Income-tax Act, 1961.

Facts:

  • The assessee was constituted as a private specific trust.
  • Six trustees were appointed to execute the trust’s object for the benefit of 32 beneficiaries.
  • The assessee filed its return of income as an “Association of Persons” (AOP) and declared its income as “Nil” due to set-off against forwarded losses.
  • The Assessing Officer (AO) determined that the beneficiaries had voluntarily come together by pooling their monies into the trust with a clear understanding that the funds would be utilized by the trust for the business project undertaken by them.
  • The AO further held that the trust, through its trustees, was assessable as an Association of Persons under Section 161 of the Income-tax Act, 1961.
  • Consequently, the AO disallowed a certain amount claimed as interest paid to beneficiaries, presumably under Section 40(ba).
  • Crucially, the assessee, when filing its return, had described itself as an AOP, and no attempt was made to correct this “mistake” or offer any explanation for it.

Decision:

The court upheld the order passed by the Assessing Officer, thereby ruling in favor of the revenue. The disallowance of interest paid to beneficiaries was sustained.

Key Takeaways:

  • Assessment of Trusts vs. AOPs: Trusts can be assessed in various capacities depending on their nature (e.g., specific trust, discretionary trust). However, if the beneficiaries are found to have voluntarily come together with a common objective to carry on a business or venture, and have pooled resources, the entity may be assessed as an Association of Persons (AOP).
  • Voluntary Association and Common Objective: The finding that beneficiaries voluntarily pooled their monies with the explicit knowledge that funds would be used for a business project undertaken by them is key to classifying the entity as an AOP. This implies a joint venture or common undertaking.
  • Self-Declaration as AOP: The assessee’s own declaration in the return of income as an “Association of Persons,” without subsequent rectification or explanation, significantly weakens its position to argue against such classification. This acts as an admission.
  • Section 40(ba) Disallowance: Section 40(ba) of the Income-tax Act, 1961, specifically disallows any payment of interest, salary, bonus, commission, or remuneration by an Association of Persons (AOP) or Body of Individuals (BOI) to its members. The rationale is to prevent tax avoidance by treating income as deductible expenses within the same group.
  • Interplay of Sections 161 and 40(ba): If a trust is assessed as an AOP under Section 161 (which deals with representative assessees but can also be applied to tax a trust as an AOP if conditions are met), then the provisions of Section 40(ba) automatically apply, leading to the disallowance of payments like interest to its members/beneficiaries.
  • Consequences of AOP Classification: Once an entity is determined to be an AOP, any payments of interest or remuneration to its members become non-deductible expenses in computing the AOP’s income.
HIGH COURT OF BOMBAY
Mehta Jaising Combine
v.
Income-tax Officer Ward-27(8) Mumbai
ALOK ARADHE, CJ.
and M.S. Karnik, J.
INCOME TAX APPEAL (IT) NO. 364 OF 2003
APRIL  3, 2025
Vipul B. Joshi, D.H. Hariya and Prashant Ghumare, Advs. for the Appellant. Ms. Mamta Omle, for the Respondent.
ORDER
Alok Aradhe, CJ. – This Appeal under Section 260A of the Income Tax Act, 1961 (the Act) has been filed by the Assessee. The subject matter of the Appeal pertains to the Assessment Year 1995-1996. The Appeal was admitted on the following substantial question of law:
“Whether on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the status of the Appellant Trust was that of Association of Persons and thus the lower authorities were justified in disallowing interest of Rs.5,38,100/- paid to the beneficiaries under Section 40(b) of the Income Tax Act, 1961 ?
2. The facts giving rise to filing of this Appeal, in nutshell, are that during the material time Mehta Jaising Combine was constituted as a Private Specific Trust which was settled on 27/3/1986 by Ms. Indira B. Jaising. Six trustees were entrusted to execute the object of the Trust for the benefit of 32 beneficiaries, which included minor beneficiaries, whose legal guardians were not the trustees. The assessee has been filing the return of income regularly in the status of an Association of Persons. The assessee, for the Assessment Year 1995-1996, filed the income as an Association of Persons and declared the income of the assessee as “Nil”, as the current year’s income was set off against the forwarded losses.
3. The Assessing Officer, by an order dated 27/3/1998, inter alia by applying the test laid down by the Supreme Court judgment in CIT v INDIRA BALKRISHNA, [1960] 39 ITR 546 (SC) held that the beneficiaries have come together voluntarily by pooling their monies in the trust with clear knowledge that the funds shall be utilized by the trust for the business of the project undertaken by them. The Assessing Officer further held that the trust, through the trustees, is assessable as an Association of Persons under Section 161 of the Act.
4. Being aggrieved by the aforesaid order, the assessee preferred an Appeal. The Commissioner of Income Tax (Appeal), by an order dated 15/7/1999, dismissed the Appeal preferred by the assessee. Thereupon the assessee filed an Appeal before the Income Tax Appellate Tribunal. The Appellate Tribunal, by an order dated 3/1/2003, has dismissed the Appeal preferred by the assessee. Hence this Appeal.
5. Learned counsel for the assessee has submitted that fundamental requirement of the concept of Association of Persons is that there has to be a common purpose of common action with the object of producing income, profits or gains. It is further submitted that mere fact that there exists a common source of income in which two or more persons are interested as members or otherwise is neither conclusive nor determinative of the status of a person. It is also submitted that a Private Specific Trust, even if doing business, cannot be treated as an Association of Persons. It is further submitted that neither the trustees nor beneficiaries have come together with a common purpose or common action with the object of producing income, profits or gains. In support of the aforesaid submissions, reliance has been placed on the decision of the Supreme Court in the case of CIT v. Indira balkrishna (supra) and on a division bench decision of this Court in CIT v MARSONS BENEFICIARY TRUST
6. It is urged that the expression “individual” includes a group of individuals and provisions of Section 161(1A) of the Act do not have the effect of changing the status of assessee, as it pertains to the rate of taxation. It is submitted that in the facts and circumstances of the case, the provisions of Section 164(1) are applicable, as in case of a discretionary trust where the shares of beneficiaries are indeterminate or unknown. In support of the aforesaid submissions, reliance has been placed on a division bench decision of this court in L. R. PATEL FAMILY TRUST v. ITO
7. On the other hand learned counsel for the revenue submits that the findings that the trust is an Association of Persons has been recorded by the Income Tax Officer on the touchstone of law laid down by the Supreme Court in CIT v. INDIRA BALKRISHNA (supra). It is further submitted that the order passed by the Income Tax Officer has been upheld in Appeal by the Commissioner of Income Tax (Appeals) as well as the Income Tax Appellate Tribunal. It is further submitted that the findings recorded by the Authorities by no stretch of imagination can be termed as perverse. It is, therefore, contended that no case for interference, with finding of fact which is based on meticulous appreciation is called for, in this Appeal under Section 268 of the Act.
8. Heard rival submissions made on behalf of both sides and have perused the record.
9. Before proceeding further, it is necessary to take note of Section 40 (ba) of the Act which is extracted below for the facility of reference:
“40. Notwithstanding anything to the contrary to section 40 to 48 the following amounts shall not be deducted in computing the income chargeable under head “the Profits and gains of business or profession.
(ba) in the case of an association of persons or body of individuals [other than a company or a co-operative society or a society registered under the Societies Registration Act, 1860 (21 of 1860), or under any law corresponding to that Act in force in any part of India], any payment of interest, salary, bonus, commission or remuneration, by whatever name called, made by such association or body to a member of such association or body.”
10. The Supreme Court in INDIRA BALKRISHNA (supra) has held that an association of persons must be one in which two or more persons jointly held common purpose or common action and as the word occurs in a section which imposes tax on income, the association must be one which produces income, profits or gains.
11. The scope of Appeal under Section 260A of the Act is well settled. This Court, in an Appeal under Section 260A, can interfere with the finding of fact only if when the same is shown to be perverse. [See : SYEDA RAHIMUNNISA v. MALAN BI BY L.RS. AND ORS. (2016) 10 SCC 315 and PRINCIPAL COMMISSIONER OF INCOME TAX, BANGALORE & ORS. v. SOFTBRANDS INDIA P LTD. (Karnataka) The Assessing Officer, by applying the aforesaid criteria to the facts of the case, has held that the beneficiaries have come together voluntarily by pooling their money in the trust with clear knowledge that the funds will be utilized by the trust for the business of project work undertaken and would result in profits for the trust and consequently for the beneficiaries. Thus, the Assessing Officer has recorded a finding that the Trust is an Association of Persons. Accordingly, the interest claim of Rs.5,38,100/- to the beneficiaries has been disallowed. The aforesaid findings recorded by the Income Tax Officer as Assessing Officer, has been upheld in Appeal. The Income Tax Appellate Tribunal has held that the assessee himself has declared the status as an association of persons and on that basis, the Assessing Officer has passed the order. It has further held that declaration by assessee is not a mistake which has been erroneously made, as no attempt has been made to rectify the aforesaid mistake. It is also pertinent to note that the assessee, while filing the return, had described itself as an Association of Persons for which neither any attempt has been made to correct the so called mistake nor any explanation has been offered for making such a mistake.
12. The order passed by the Assessing Officer as well as the Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal is based on meticulous appreciation of evidence. The finding of fact recorded therein by no stretch of imagination can be said to be perverse.
13. For the aforementioned reasons, the substantial question of law is answered in the affirmative. In the result, the Appeal fails and is hereby dismissed.