PRINCIPAL COMMISSIONER OF INCOME TAX 2, VADODARA vs. SHRENO LTD

C/TAXAP/1065/2018 ORDER IN THE HIGH COURT OF GUJARAT AT AHMEDABAD R/TAX APPEAL NO. 1065 of 2018 With R/TAX APPEAL NO. 1066 of 2018 With R/TAX APPEAL NO. 1067 of 2018 With R/TAX APPEAL NO. 1068 of 2018 ========================================================== PRINCIPAL COMMISSIONER OF INCOME TAX 2, VADODARA Versus SHRENO LTD ========================================================== Appearance: MR.VARUN K.PATEL(3802) for the PETITIONER(s) No. 1 MR B S SOPARKAR(6851) for the RESPONDENT(s) No. 1 ========================================================== CORAM: HONOURABLE MR.JUSTICE AKIL KURESHI and HONOURABLE MR.JUSTICE B.N. KARIA

Date : 27/08/2018 ORAL ORDER (PER : HONOURABLE MR.JUSTICE AKIL KURESHI) 1.   These appeals filed by the Revenue involve the same assessee. Facts are similar. We may record them from Tax Appeal No.1065 of 2018.

Tribunal

dated

17.11.2017. Following   questions   are   presented   for   our consideration : “(a) Whether   on   the   facts   and   in circumstances   of   the   case,   the   learned ITAT has erred in law and on facts in not upholding the disallowance u/s.14A of the Page 1 of 15

C/TAXAP/1065/2018 ORDER Income   Tax   Act   made   by   the   Assessing Officer ?

(b)     Whether   on   the   facts   and   in   the  circumstances   of   the   case,   the   learned  ITAT has erred in law and on facts in not  upholding the disallowance u/s.14A of the  Income   Tax   Act   made   by   the   Assessing  Officer   and   in   deleting   the   disallowance  even   under   Rule   8D(2)(iii)   without  considering   that   in   any   case,   this  disallowance was not dependent on whether  investments were made out of interest free  funds ?

During

the

assessment proceedings   the   Assessing   Officer   noticed that the assessee had earned dividend income of   Rs.1.24   crores   (rounded   off)   which   was claimed as exempt income under Section 10(34) of   the   Income   Act,   1961   (for   short   'the Act'). The assessee had on its own added back an amount of Rs.1 lac as disallowance under Section 14A of the Act towards administrative expenses   incurred   for   earning   such   exempt income. 4.      The Assessing Officer was not satisfied Page 2 of 15

C/TAXAP/1065/2018 ORDER with   this   working   out   presented   by   the assessee.  He  therefore  issued  a notice  why disallowance should not be made under Section 14A   read   with   Rule   8D   of   the   Income   Tax Rules,   1961   (‘the   Rules’   for   short).   The assessee   replied   to   such   notice   contending that   it had  sufficient  interest  free   funds for   making   the   investments   from   which dividend was earned. The investment was thus made   out   of   its   own   funds.   The   principal borrowing of the assessee comprised of cash credit, corporate loans and term loans from banks.   Such   loans   were   opted   through hypothecation   of   assets,   investments   in securities   was   not   permissible   from   such borrowed funds. The assessee supplied details of   its   own   interest   free   funds   available contending that its reserves and surplus are sufficient to cover the investments made in shares. 5.     The   Assessing   Officer   rejected   such   a contention of the assessee observing that the assessee   has   not   adduced   any   evidence   in support   of   such   a   contention   except   for providing aggregate figures of share capital and   reserves   as   on   31.3.2010.   He   observed that the business funds and investment funds of the assessee are mixed up and it cannot be Page 3 of 15

C/TAXAP/1065/2018 ORDER assumed that the funds deployed for earning tax free income were entirely out of interest free   funds and   resultantly   the   entire interest   cost   is   to   be   loaded   on   to activities leading to taxable income. Merely because the assessee has positive net worth, it  does  not  mean   that  the  entire   tax  free income yielding activities were carried out by deploying own or surplus funds. He further observed   that  “the  tax  free  income  earning activities   and   taxable   income   earning activities   are   both   carried   out   using   the common kitty of funds, it would be reasonable to apportion the interest burden between the two activities”.

C/TAXAP/1065/2018 ORDER the   assessee   itself   and   borrowed   the discussion in such judgment, in which it was observed that, it is a settled position that Assessing  Officer  has  to  record  a  specific satisfaction before resorting to disallowance under Section 14A read with Rule 8D to the effect   that   disallowance   offered   by   the assessee is inadequate to cover the expenses incurred   in   earning   tax   exempt   income. Resorting

the

method

prescribed under Rule 8D is not automatic.

C/TAXAP/1065/2018 ORDER Commissioner   of   Income   Tax,   reported   in (2018) 402 ITR 640 has been rendered altering the situation materially. Our attention was drawn to para 42 of the said judgment. 9.      On the other hand, learned counsel Shri Soparkar for the Revenue opposed the appeal contending that application of Rule 8D is not automatic.   Unless   and   until   the   Assessing Officer   records   his   satisfaction   that accounts of the assessee of previous year do not   reflect   correctly   the   claim   of expenditure made by the assessee in relation to   income   not   forming   part   of   the   total income, formula provided in sub­rule of Rule 8D cannot be applied. In the present case the assessee   had   established   through   reliable evidence   that   the   assessee   had   sufficient interest free funds which were utilized for making investment yielding tax free income. He   submitted   that   the   decision   of   Supreme Court   in   case   of  Maxopp   Investment   Ltd., (Supra) does not alter the basic requirements of applicability of Rule 8D, understood and explained, by various decisions of the High Courts. 10. As is well known, Section 14A of the Act relates to expenditure incurred in relation Page 6 of 15

C/TAXAP/1065/2018 ORDER to   income   not   includable   in   total   income. Sub­section (1) of Section 14A provides that for  the  purposes   of computing  total  income under   Chapter­IV   no   deduction   shall   be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act. As per sub­section (2) of Section 14A the   Assessing   Officer   would   determine   the amount of expenditure incurred in relation to such income which does not form part of the total income in accordance with the method as may be prescribed, if having regard to the accounts of the assessee he is not satisfied with   the   correctness   of   the   claim   of   the assessee in respect of such expenditure. The method for such purpose has been prescribed under Rule 8D of the Rules. Sub­rule (1) of Rule   8D   substantially   reiterates   what   sub­ section   (2)   of   Section   14A   provides. Essentially under sub­rule (1), the Assessing Officer would be authorized to determine the expenditure to be disallowed in relation to earning tax free income in terms of sub­rule (2) where having regard to the accounts of the assessee of the previous year he is not satisfied with the correctness of the claim of expenditure made by the assessee or the claim   made   by   the   assessee   is   that   no Page 7 of 15

C/TAXAP/1065/2018 ORDER expenditure has been incurred in relation to income   which   does   not   form   part   of   total income. 11. In   case   of  S.   A.   Builders   Ltd.,   vs. Commissioner

of Income­Tax

(Appeals), reported in (2007) 288 ITR page­1 (SC)  the Supreme Court considered an issue where the Revenue   desired   to   disallow   an   assessee’s claim of expenditure of interest on borrowed capital which was lent to its sister concern without charging interest. The Supreme Court interpreted the term “for the purpose of the business” used in Section 36(1)(iii)  of the Act   in   such   context.   The   Supreme   Court approved the decision of the Delhi High Court in case of  CIT vs.  Dalmia Cement (B) Ltd., reported in (2002) 254 ITR 377  and observed that once it is established that there was nexus between the expenditure and the purpose of business which need not necessarily be the business of the assessee itself, the Revenue cannot justifiably claim to put itself in the armchair   of   the   businessman   or   in   the position of the Board of Directors and assume the   rule   to   decide   how   much   is   reasonable expenditure

having

regard

the circumstances of the case. No businessman can be   compelled   to   maximize   his   profit.   The Page 8 of 15

C/TAXAP/1065/2018 ORDER transfer   of   borrowed   funds   to   a   sister concern has to be seen from the point of view of   commercial   expediency   and   not   from   the point of view whether the amount was advanced for earning profits.

C/TAXAP/1065/2018 ORDER observations:­ “5.   Learned   counsel   for   the   Revenue   was unable to point out that these observations on facts by the Tribunal to the effect that the assessee had interest free funds far in excess   yield   tax   exempt   income   was   wrong. That being the position as held by this Court in number of occasions including judgments in case of Deputy Commissioner of Income Tax Vs. Vasco Sales & Marketing Corpn. reported in 66 taxmann.com 366 relying upon the judgment of the   Supreme   Court   in   case   of  S   A   Builders Limited   Vs.   Commissioner   of   Income   Tax (Appeals), Chandigarh reported in 288 ITR 1, disallowance under section 14A would not be permissible. We do not find that the Tribunal has committed any error.” 14.  As   pointed   out  by   the   counsel   for   the assessee Punjab & Haryana High Court in case of  M/s.  Max India Ltd.,  in a  judgment dated 8.3.2017   considered   a   similar   issue   as under : “6.   With   regard   to   the   second   issue regarding expenditure related to  exempt income,   the   same   is   covered   by   the decision   of  this   Court   in   the   case  of the   assessee   in  Commissioner   of   Income Tax, Jalandhar I, Jalandhar vs. M/s Max India   Limited,  ITA   No.186   of   2013, decided   on   6.9.2016, wherein   after considering the relevant case law on the point, the issue was decided in favour of   the   assessee   and   it   was   recorded thus:­ “9.   This   presumption   is   unfounded. Merely   because   the   interest   free funds   with   the   assessee   have decreased during any period, it does not follow that the funds borrowed on   interest   were   utilized   for   the Page 10 of 15

C/TAXAP/1065/2018 ORDER purpose   of   investing   in   assets yielding   exempt   income.   If   even after the decrease the assessee has interest   free   funds   sufficient   to make   the   investment   in   assets yielding   the   exempt   income,   the presumption that it was such funds that   were   utilized   for   the   said investment   remains.   There   is   no reason for it not to. The basis of the presumption as we will elaborate later   is   that   an   assessee   would invest its funds to its advantage. It   gains   nothing   by   investing interest   free   funds   towards   other assets   merely   on   account   of   the interest

free

funds

having decreased. In that event so long as even   after   the   decrease   thereof there   are   sufficient   interest   free funds   the   presumption   that   they would   be   first   used   to   invest   in assets   yielding   exempt   income applies with equal force.” Learned   counsel   for   the   appellant­ revenue has not been able to distinguish the   aforesaid   decision   taken   by   this Court.” 15.Division   Bench   of   this   Court   in   case   of Gujarat State Fertilizer and Chemicals Ltd., in  a  judgment  dated  31.7.2018  followed  the earlier judgment in case of the assessee and observed as under :­ “16. Considering the aforesaid findings and decision of the Division Bench of this Court   of   the   very   assessee   for   the Assessment Year : 2004­2005, the Division Page 11 of 15

C/TAXAP/1065/2018 ORDER Bench  of  this  Court  in  the  case  of  the very assessee has set aside /deleted the similar disallowance made by the Assessing Officer under Section 14A of the Act, the same has been been subsequently followed in the case of the very assessee that in the   proceeding   years,   i.e.   2005­2006   to 2007­2008.   The   Division   Bench   of   this Court   in   the   aforesaid   decision   has specifically observed that in a case where the assessee was having sufficient funds available   with   it,   more   than   amount invested   for   earning   the   dividend,   the disallowance   in   respect   of   interest expenditure under Section 14A of the Act read with Rule 8(d) of the Rules is not permissible. The decision of the Division Bench  of  this  Court  in  the  case  of  the very  assessee  for  the  Assessment  Year  : 2004­2005   has   attained   finality.   In   the present case, it is required to be noted that   in   the   earlier   years   also   more particularly,   even   in   the   Assessment Year  :  2004­2005,  the  assessee   was  also having mixed funds and still considering the   fact   that   the   assessee   was   already having   sufficient   surplus   interest   free funds,   the  Division  Bench  of  this  Court has   held   that   the   disallowance   under Section 14A of the Act is not permissible. At the cost of repetition, it is observed that   the   said   decision   has   attained finality   between   the   parties.   Not   only that, but the Department has followed the same   in   the   subsequent   assessment   years also. Considering the aforesaid facts and circumstances, it cannot be said that the Tribunal   has   committed   any   error   in deleting   the   disallowance   made   by   the Assessing Officer under Section 14A of the Act.   Therefore,   the   two   Tax   Appeals No.900/2018 and 901/2018 stands dismissed so far as the proposed question No.2 (a) Page 12 of 15

C/TAXAP/1065/2018 ORDER is concerned.” 16. The   primary   question   which   the   Supreme Court considered in case of Maxopp Investment Ltd.,   (Supra)  was   whether   disallowance   of expenditure   under   Section   14A   of   the   Act would be applicable in a case where shares or stocks of a company were purchased for the purpose   of   gaining   control   over   the   said company   and   incidentally   tax   free   dividend income   was   generated.   The   assessee   had contended   that   the   dominant   intention   for purchasing the shares was not for earning the dividend   but   to   gain   control   over   the business in the company in which the shares were purchased. The Supreme Court held that the   purpose   for   which   the   shares   were purchased   was   inconsequential.   As   long   as such   investment   generated   tax   free   income, disallowance of expenditure for making such investment   would   be   justified.   This   issue does not arise in the present case. However, it is true that while disposing of bunch of appeals   by   the   said   judgment   the   Supreme Court also considered the correctness of the view of the Punjab & Haryana High Court in case of Avon Cycles Ltd. It was the case in which   the   Assessing   Officer   had   invoked Section 14A read with Rule 8D and apportion Page 13 of 15

C/TAXAP/1065/2018 ORDER the expenditure between investments made for earning tax free income and the rest. The CIT (Appeals) had deleted the entire disallowance upon which in the appeal filed by the Revenue the   Tribunal   restored   portion   of   the disallowance   observing   that   the   funds utilized by the assessee being mixed funds, the disallowance is confirmed in view of the provisions   under   Rule   8D(2)   of   the   Rules. This decision of the Tribunal was challenged before the High Court. The Court held that the funds utilized by the assessee were mixed funds and the interest paid by the assessee is also an interest on the investments made, was   the   finding   of   fact   and   therefore,   no substantial   question   of   law   arises.   This judgment   was   carried   in   appeal   by   the assessee.   The   Supreme   Court   dismissed   the appeal  confirming  the  decision  of  the  High Court. 17. We do not find that this portion of the judgment   of   the   Supreme   Court   in   case   of Maxopp   Investment   Ltd.,  can   be   seen   as fundamentally changing the understanding and interpretation of Section 14A and Rule 8D of the Rules adopted by this Court and various Courts, noted above. This judgment does not lay down a proposition that the requirement Page 14 of 15

C/TAXAP/1065/2018 ORDER of   sub­rule   (1)   of Rule   8D of   the satisfaction to be arrived by the Assessing Officer before applying the formula given in sub­rule (2) of Rule 8D is done away with. In other words, the judgment in case of  Maxopp Investment   Ltd., does   not   lay   down   a proposition   that   the   moment   it   is demonstrated that the assessee had availed of mixed   funds   i.e.   interest   free   as   well   as interest bearing funds and utilized them for making   investments   into   securities   earning tax free income and the rest applicability of the Section 14A read with Rule 8D would be automatic. We are conscious that neither in M/s. Max India Ltd., Punjab & Haryana nor in Gujarat State Fertilizer and Chemicals case, this High Court had noticed the judgment of the   Supreme   Court   in   case   of Maxopp Investment Ltd.  Nevertheless in view of the discussion   above,   in   our   opinion   the situation would not change on account of the said judgment of the Supreme Court.