M/S HEMAVATHY POWER & LIGHT PVT LTD ,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-3(1)(2), BANGALORE

The common issue arising out of various grounds raised in these appeals is the disallowance of interest (finance cost) u/s. 36(1)(iii) of the Income-tax Act, 1961 [the Act]. For assessment year 2011-12 alone the assessee raised grounds for one more issue pertaining to disallowance of depreciation on goodwill.

The assessee is engaged in the business of generation of power from Hydel resources. The brief facts pertaining to the AY 2011-12 are that the assessee filed return of income on 30.10.2011 declaring a total income of Rs.80,07,662. The case was selected for scrutiny and assessee was called for to produce various documents including the financials. The AO completed the assessment by making the following disallowances/ additions:

During the AY 2011-12, the assessee claimed a sum of Rs.61,42,542 as depreciation on goodwill. Before the AO, the assessee submitted that the assessee has recognized the difference between the value paid for purchase of Sandur Manganese & Iron Ores Ltd. [SMIORE] and the value of assets acquired and accounted the same in the books as goodwill on which depreciation is charged. The AO disallowed the depreciation stating that u/s. 32(1)(ii) of the Act goodwill is not explicitly eligible for depreciation.

Before the CIT(Appeals), the assessee submitted that M/s. K. B. Power International Inc., by virtue of an agreement styled as Power Purchase Acquisition Agreement dated 22.02.2001, purchased all the assets of the Power plant belonging to SMIORE. The agreement was later on assigned in favour of the assessee vide the approval from Karnataka Government. SMIORE was a Sick Industrial Company which had approached BIFR which passed an order wherein the sale of the assets of the power plant was approved. The sale consideration for the asset acquired was initially fixed at Rs.70,00,00,000/- which was later on reduced to Rs.63,00,00,000. Since the consideration paid was lump sum and there was no bifurcation available in the agreement assigning value to each asset, the assessee requested M/s. A. F. Ferguson& Co. expert valuer to value the assets. Since the valuer arrived at a value of Rs.57,40,00,060/- for all the assets, the assessee treated the differential amount in the books of accounts as Goodwill. to 2719/Bang/2018 & 1820/Bang/2019 Page 4 of 13 This treatment is in line with Accounting standard-14 of the ICAI. The assessee subsequently claimed depreciation on straight line method available for power generation units u/s. 32 of the Act. The assessee relied on the decision of Hon’ble Supreme Court in the case of CIT v. Smiff Securities Ltd., 24 taxmann.com 222 (SC) in support of its contentions.

The CIT(Appeals), however, upheld the disallowance of depreciation on goodwill on the ground that :-

Before us, the ld. AR submitted that the assessee had acquired the complete power project from SMIORE in the year 2003-04 with the permission obtained from Energy Dept., Govt. of Karnataka, by which all its rights on projects including rights under the Power Purchase and Land Lease Agreements are obtained by the assessee. The ld. AR submitted that the difference between the amount paid and the assets value by the Valuation Officer was recorded in the books in the year in which the acquisition took place i.e., 2003-04. He further submitted that goodwill has been part of the fixed assets Schedule of assessee’s financials from 2003-04 and depreciation is being claimed since then. Hence he contended that the earlier year Written Down Value (WDV) cannot be questioned now. The ld AR drew our

We have considered the rival submissions and perused the material on record. We notice that this Tribunal in the assessee’s own case for AY 2009-10 (supra) while dealing with an issue pertaining to section 115JB(2) of the Act has given a finding pertaining to the goodwill which is the issue under dispute in the current appeal. The relevant findings of the Tribunal are as under:-

Aggrieved by the order of the CIT(Appeals), the revenue has preferred the present appeal before the Tribunal.

We have considered the rival submissions. It is clear from the provisions of the Act, referred to earlier, that depreciation which is to be added to the net profit as per the profit & loss account prepared in accordance with the Part II of Schedule VI to The Companies Act, 1956 in terms of Explanation 1 (g) to section 115JB(2) has to be reduced as per clause (iia) below clause (a) to (j) of Explanation (1) to sub-section (2) of section 115JB of the Act. Such reduction need not be made if depreciation debited in the profit & loss account is on account of revaluation of assets. As rightly contended on behalf of the assessee, this was never the case made out by the AO or before the CIT(A). As rightly contended on behalf of assessee, there is no factual basis for the revenue to raise ground No.4 in the form in which it has been raised before the Tribunal. In the circumstances, we are of the view that depreciation in question to 2719/Bang/2018 & 1820/Bang/2019 Page 7 of 13 has to be reduced from the book profits as per the provisions referred to earlier.”

During the course of assessment proceedings, the AO noticed that the assessee has advanced a sum of Rs.30,68,69,478 to the sister concerns as per Schedule 10 to the financials for the year ended to 2719/Bang/2018 & 1820/Bang/2019 Page 8 of 13 31.3.2011. The assessee submitted before the AO that the said loans had been advanced to the companies under the same management (sister concerns) to meet the purpose of business exigencies given out of assessee’s own funds and there is no diversion of interest-bearing funds to the business of sister concerns. The AO rejected the claim of the assessee and proceeded to make a disallowance of Rs.1,58,80,495 applying 10.35% on the average of the advances given. The CIT(Appeals) upheld the disallowance observing as follows:-

The ld. DR relied on the orders of the CIT(Appeals). She drew our attention to the earlier year’s Balance Sheet and submitted that the assessee’s own funds are deployed for purchase of fixed assets in those years. She submitted that there significant movement in the term loan in the current year and the corresponding movement in the advances to sister concerns demonstrates that borrowed funds are utilized for giving interest free loans to sister concerns.

We have considered the rival submissions and perused the material on record. As on 31.3.2011, the assessee had given interest free advances to the companies under the same management to the tune of Rs.30,68,69,478. As per the Balance Sheet, the Share Capital and Reserves & Surplus, i.e., own funds is at Rs.40,00,00,000 and Rs.31,37,24,375 respectively. Hence there is merit in the claim that to 2719/Bang/2018 & 1820/Bang/2019 Page 10 of 13 the assessee has used own funds for giving interest free advances to sister concerns. We notice that the similar issue was considered by Hon’ble Karnataka High Court in the case of CIT Vs. Micro Labs Ltd. (2016) 383 ITR 490, where it was held that no disallowance out of interest expenditure is called for. The relevant extract of the observations made by Hon’ble Karnataka High Court in the above said case is as below “40. We have heard the rival submissions. A copy of the availability of funds and investments made was filed before us which is at pages 38 to 42 of the assessee's paper book and the same is enclosed as ANNEXURE-III to this order. It is clear from the said statement that the availability of profit, share capital and reserves & surplus was much more than investments made by the assessee which could yield tax free income.

The Hon'ble Bombay High Court in Reliance Utilities & Power Ltd. 313 ITR 340 (Bom) has held that where the interest free funds far exceed the value of investments, it should be considered that investments have been made out of interest free funds and no disallowance u/s. 14A towards any interest expenditure can be made. This view was again confirmed by the Hon'ble Bombay High Court in CIT v. HDFC Bank Ltd., of 2012, judgment dated 23.7.14, wherein it was held that when investments are made out of common pool of funds and non-interest bearing funds were more than the investments in tax free securities, no disallowance of interest expenditure u/s. 14A can be made.

In the light of above said decisions, we are of the view that disallowance of interest expenses in the present case of Rs.49,42,473 made under Rule 8D(2)(ii) of the I.T. Rules should be deleted. We order accordingly." Thereafter, it was held by Hon’ble Karnataka High Court as under:-

The contention of the ld. DR that based on earlier years financials, the share capital & reserves are used for purchase of fixed assets is not relevant as the Balance Sheet of the year under consideration is what needs to be examined for deciding the issue contended here. Further there cannot be matching done based on review of financials to state that the term loan borrowed by the assessee is used for giving interest free advances merely based on the movement in these account lines.

Following the ratio laid down by the jurisdictional High Court in Micro Labs Ltd. (supra) and considering the fact that the assessee’s own funds are more than the advances given to sister concerns, we hold that no disallowance is warranted u/s. 36(1)(iii) of the Act. We therefore delete the disallowance on this count.

The only issue arising out of the appeals filed for the AYs 2012- 13 (ITA No.1820/Bang/2018), 2013-14 ( 2014-15 (ITA No.2719/Bang/2018) is the similar disallowance of finance cost by the AO. The availability of own funds and the advances to sister concerns for the said years are as follows:- to 2719/Bang/2018 & 1820/Bang/2019 Page 12 of 13 Amount in Rs. Particulars AY 2012-13 AY 2013-14 AY 2014-15 Share Capital 31,37,24,375 41,37,24,375 41,37,24,375 Reserves & Surplus 18,17,39,138 19,61,51,109 20,64,75,071 Total Own Funds 49,54,63,513 60,98,75,484 62,01,99,446 Advance to sister concerns 4,82,02,376 7,68,42,874 8,23,10,541

From the above table, it is clear that in all these years the own funds of the assessee is more than amount advanced interest free to sister concerns. For reasons given in assessment year 2011-12, we hold that no disallowance is warranted for these assessment years also and the same is deleted.

In the result, the appeals of the assessee for assessment year 2011-12 is partly allowed, and allowed for assessment years 2012-13 to 2014-15.