PRINCIPAL COMMISSIONER OF INCOME TAX 2 vs. GUJARAT STATE FINANCIAL SERVICES LTD

C/TAXAP/1252/2018 ORDER IN THE HIGH COURT OF GUJARAT AT AHMEDABAD R/TAX APPEAL NO. 1252 of 2018 With R/TAX APPEAL NO. 1253 of 2018 With R/TAX APPEAL NO. 1255 of 2018 ========================================================== PRINCIPAL COMMISSIONER OF INCOME TAX-2 Versus GUJARAT STATE FINANCIAL SERVICES LTD ========================================================== Appearance: MRS MAUNA M BHATT(174) for the PETITIONER(s) No. 1 MR MANISH J SHAH(1320) for the RESPONDENT(s) No. 1 ========================================================== CORAM: HONOURABLE MR.JUSTICE AKIL KURESHI and HONOURABLE MR.JUSTICE B.N. KARIA

Date : 15/10/2018

COMMON ORAL ORDER (PER : HONOURABLE MR.JUSTICE AKIL KURESHI) 1. These   Tax   Appeals   are   filed   by   the   Revenue. Facts being identical, we may notice from Tax Appeal No.1252 of 2018.  Revenue has challenged the judgment of the Income Tax Appellate Tribunal dated 06.04.2018 raising following questions for our consideration: “[A] Whether the Appellate Tribunal had erred in law and on facts restricting the disallowance to Rs.15,44,972/­   instead   of   Rs.5,78,22,678/­ u/s.14A r.w.r 8D of the Act? [B] Whether the Appellate Tribunal had erred in law and on facts by not appreciating the ratio decided in Maxopp Investment Ltd. vs. CIT?” 2. In relation to the respondent­assessee, for the Page 1 of 10

C/TAXAP/1252/2018 ORDER assessment year 2008­09, the question of disallowance of expenditure in terms of section 14A of the Income Tax Act, 1961 ('the Act' for short) and rule 8D of the   Rules   came   up   for   consideration   before   the Assessing Officer.  The Assessing Officer noted that the assessee had invested its funds in investments earning   tax   free   income.     He   therefore   disallowed interest expenditure of Rs.5,78,22,678/­ in terms of section   14A   read   with   rule   8D   of   the   Rules.     The issue ultimately reached the Tribunal.  The Tribunal restricted the disallowance to Rs.15,44,972/­ which could be attributed to such activity.   It is this judgment of the Tribunal, the Revenue opposed in this appeal.  The main contention of the counsel for the Revenue revolves around the judgment of the Supreme Court   in   case   of Maxopp   Investment   Ltd.   v. Commissioner   of   Income   Tax  reported   in  [2018]  402 ITR   640   (SC).    Counsel   argued   that   whenever   the assessee has two sources of funds, interest bearing and non interest bearing and also made investments in funds yielding tax free income, disallowance in terms of section 14A of the Act would have to be made.  If the   assessment   is   in   relation   to   the   year   after Page 2 of 10

C/TAXAP/1252/2018 ORDER introduction of rule 8D, the formula provided therein would   also   apply.     According   to   him,   one   of   the issues   decided   by   the   Supreme   Court   in   case   of Maxopp Investment Ltd. (supra) was this one. 3. On   the  other   hand,   learned   advocate  Shri   Shah for the respondent opposed the appeal contending that the Tribunal has correctly assessed the materials on record and found that no interest bearing funds were diverted for making tax free income.  He pointed out that all the investments were of the past years and no   fresh   investments   during   the   current   year   were made.  We had an occasion to examine the judgment of the Supreme Court in case of Maxopp Investment Ltd. (supra)   in   context   of   similar   challenge   of   the Revenue.   The   Tax   Appeal   was   dismissed   making following observations: “10.  As is  well known,   Section  14A  of the Act relates   to   expenditure   incurred   in relation  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 Page 3 of 10

C/TAXAP/1252/2018 ORDER 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   sub­section (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 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 page 1 (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 Page 4 of 10

C/TAXAP/1252/2018 ORDER regard to the circumstances of the case. No businessman can be compelled to maximize his profit. The 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. 12. The   exposition   of   law   made   by   the Supreme Court in case of S. A. Builders and observation   made   therein   have   been   applied by   this   court   on   various   occasions, particularly   in   connection   with   the disallowance to be made under Section 14A of the   Act.   It   has   been   held   that   if   the assessee   can   demonstrate   availability   of surplus   interest   free   funds   for   making investment   generating   tax   free   income, disallowance   under   Section   14A   of   the   Act would not be justified. 13. In case of this very assessee  such an issue   came   up   for   consideration   for   the assessment   year   2008­09.   In   such   case   the Tribunal had held that Section 14A read with Rule   8D   could   be   applied   only   after   the Assessing Officer is not satisfied with the claim   of   the   assessee   regarding   the expenditure. The Revenue had approached the High   Court   against   the   judgment   of   the Tribunal. The Court dismissed the appeal by judgment   dated   6.9.2017   making   following 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 Page 5 of 10

C/TAXAP/1252/2018 ORDER 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   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 Page 6 of 10

C/TAXAP/1252/2018 ORDER 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 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, Page 7 of 10

C/TAXAP/1252/2018 ORDER 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) 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   the   expenditure between   investments   made   for   earning   tax Page 8 of 10

C/TAXAP/1252/2018 ORDER 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

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 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 Page 9 of 10

C/TAXAP/1252/2018 ORDER 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. 18. All tax appeals are dismissed.” 4. In   the   result,   these   Tax   Appeals   are   also dismissed. (AKIL KURESHI, J) (B.N. KARIA, J) ANKIT SHAH Page 10 of 10