DCIT, NEW DELHI vs. M/S. RANBAXY HOLDING CO., NEW DELHI

Date of Hearing 24.06.2020 Date of Pronouncement 07.09.2020 ORDER PER SUCHITRA KAMBLE, JM

These three appeals are filed by the assessee and the Revenue against the order dated 28/06/2010 and order dated 06.11.2012 passed by CIT(A)- XVIII, New Delhi for Assessment Year 2007-08.

1.1 That the Ld.CIT(A) has erred in upholding disallowance amounting to Rs.3,36,37,563 made by the Assessing Officer (AO) on account of Administrative, Personnel and Financial Expenses as per Rule 8D of the Income Tax Rules (calculated @ 0.5% of average value of investments) over and above the total disallowance of Rs.2,31,16,023 (Out of Financial Expenses - Rs.1,95,26,109 and Out of Administrative & Personnel Expenses - Rs.35,89,914) suo moto made by the appellant company in its return of income without considering the reasonability and basis of addition made by the appellant company. 1.2 That the Ld.CIT(A) has erred in not considering the contention of the appellant company that addition in terms of Rule 8D can be made only if the AO was not satisfied as regards the amount suo moto added by the appellant company on account of expenditure relatable to the exempt income. 1.3 That the Ld.CIT(A) has erred in upholding the aforesaid disallowance by not considering that some portion out of the total Administrative, Personnel and Financial Expenses would also have been incurred for other activities viz. financing on which the appellant has earned an interest income of Rs.53.09 Crs.

2. That on facts and in law the Ld.CIT(A) has erred in upholding the application of the provisions of Rule 8D(2) of the Income Tax Rules, 1962 by the Assessing Officer, inserted by IT (Fifth Amdt.) Rules 2008, w.e.f. 24.03.2008 in the case of the appellant for the Assessment Year 2007-08.

(Revenue’s appeal) (A.Y 2007-08) 1. That on the facts and circumstances of the case and in law, the Ld. CIT(A) has erred in deleting the additional disallowance of Rs.23,08,14,127/- made by the AO u/s 14A of the Act.

2. That on the facts and circumstances of the case and in law, the Ld. CIT(A) has failed to appreciate the fact that sub-section (2) & (3) of section 14A were inserted by the Finance Act, 2006, w.e.f. 1.4.2007 and provide for the determination of the amount of expenditure incurred by the assessee in relation to such income which does not form part of the total income, by the AO and he has further failed to appreciate the fact that the AO has rightly applied Rule 8D(2)(ii) as envisaged u/s 14A(2) of the Act for computing the amount of expenditure incurred by the assessee in relation to such income which does not form part of the total income instead of Rule 8D(2)(i) as applied by the assessee.

(Assessee’s Appeal) A.Y 2007-08 “1. That on taw, fads and in the circumstances of the case, the Ld. CIT{A) has erred in upholding the penalty of Rs,1,13,02,230 u/s 271{1)(c) of the income Tax Act, 1961 levied by the AO without appreciating that the appellant had neither concealed the particulars assessee particulars of its income nor had furnished inaccurate particulars of such income. 1.1 That on fads and in law, the Ld.CIT{A)erred in not properly considering the facts and the explanation submitted by the appellant during the course of hearing as well as detailed submissions furnished before her and· has upheld the penalty of Rs.1, 13,02,230 by making incorrect and irrelevant observations. The CIT(A) has also erred in ignoring the decision of the Hon'ble Supreme Court in the case of CIT vs. Reliance Petroproducts (P) Ltd. {2010) 322 ITR 158 {SC) which is directly applicable and therefore no penalty at all is leviable in the case of the appellant.

1.2 That on facts and in law, the Ld.CIT(A) erred in upholding the levy of penalty u/s 271(1)(c) of Rs.1, 13,02,230 without appreciating the fad that the appellant had duly made disallowance on the basis of reasonable estimate which stands accepted in the earlier years and there was no basis for the AO and the Ld.CIT(A) to disregard the said basis adopted by the appellant and uphold an ad hoc disallowance made by the AO on the basis of Clause {iii) of sub-rule (2) of Rule 80, which was notified on 24th March, 2008 and was not applicable to the Assessment Year under reference as per the holding of the Hon'ble High Court of Delhi in the case of Maxopp Investment Ltd. vs. CIT, New Delhi - {dated 18.11.11) and Godrej & Boyce Mfg. Co. Ltd. vs. DCIT & Anr (2010) 328 ITR 81. 1.3 That on facts and in law, the Ld.CIT{A) has erred in not appreciating that the appellant had suo moto made disallowance of expenses u/s 14A on the same basis which stood accepted in the earlier years assessments u/s 143(3) hence levy of penalty on this account is not justifiable. 1.4 That on facts and in law, the Ld.CIT(A) has erred in not appreciating that under similar set of facts and circumstances, in the Assessment Year 2006- 07, the Ld.AO did not even initiate the penalty proceedings u/s 271(1)(c) despite the fact that Rule 80 was applied for the purpose of determination of disallowance u/s 14A in the Assessment Order for the Assessment Year 2006-07. 1.5. That on facts and in .Jaw, the Ld.CIT(A) erred in holding assuming that the appellant has accepted the disallowance @ 0.5% of the average value of investments in the Assessment Year 2006-07, whereas the appellant has filed an appeal before the Hon’ble ITAT, Delhi which is subject··matter of record available with the department. Thus, the observat1on ct the Ld.CIT(A) that the appellant could easily have revised its return of income filed. before 31st October, 2007 and computed the disallowance as per provisions of rule 80 within the admissible time under section 139(5)" is on wrong understanding contrary to the factual-posit-ion. The order passed by the Ld.CIT(A) upholding the penalty levied by the AO, is thus, on wrong understanding and against the facts of the case of the appellant.”

3. During the year under consideration, the assessee company was mainly involved in the business of non banking finance. During the relevant previous year, the assessee has shown income from dividends and interest besides minor other income. The assessee had shown income from dividends of Rs.86,88,24,733/- and claimed it to be exempt u/s 10(34) of the Income Tax Act, 1961. Out of the dividend income of Rs.86,88,24,733/-, the assessee allocated expenses for earning this dividend income and suo moto disallowed Rs.67,48,50,222/- u/s 14A at the time of assessment proceeding. As per the working, the assessee allocated Rs.67,12,60,308/- on account of interest expenses and Rs.35,89,914/- on account of administrative expenses on estimated basis to earn the dividend income. The Assessing Officer after going through the working of interest expenses allocation, observed that the assessee has not allocated the expenses properly in its working for disallowance, (suo moto by the assessee) u/s 14A. The Assessing Officer by applying Rule 8D made disallowance of Rs.93,93,01,912/-. The Assessing Officer further made disallowance u/s 43A in respect of foreign exchange loss of Rs.4,80,25,006/-.

Assessee in its return of income suo moto made a disallowance u/s 14A as under: - Out of Interest Cost - Rs.65,17,34,199 - Out of Financial Expenses - Rs. 1,95,26,109 - Out of Personnel & Administrative Expenses - Rs. 35,89,914

Total - Rs.67,48,50,222 For explaining the basis and manner of computation of the above disallowance of interest before the Assessing Officer, the same was submitted by the assessee (along with relevant workings) that at the beginning of the previous year relevant to Asstt. Year 2005-06 i.e. on 01.04.2004, the assessee held shares of the aggregate value of Rs. 3,81,94,91,358/-. The corresponding position of share capital and reserves and surplus on the said date was as under:

- Share capital - Rs. 54,75,50,000

- Reserves and surplus - Rs. 2,93,52,91,325

Total - Rs. 3,48,28,41,325 The Ld. AR further submitted that investments in years earlier to A.Y. 2005-06 were initially financed out of share capital and reserves and surplus and the balance investments were taken to have been financed out of borrowed funds. The disallowance under Section 14A of the Act was, accordingly, calculated identifying the value of investments which were financed out of borrowed funds. Assessments for years prior to A.Y. 2005-06 were completed by the Assessing Officer accepting the basis of disallowance under Section 14A adopted by the assessee. The Ld. AR further stated that the reserves and surpluses of the assessee comprise mainly of profits on sale of investments and dividends earned by the assessee over the years, which were utilized by the assessee either to make fresh investments or to repay the loans taken earlier. The Assessing Officer erred in not appreciating that the nomenclature or name given to a particular reserve is not determinative of the source of creation of the reserve. Nomenclature or name is only an identification given to meet statutory compulsions/restrictions. As regards A.Y. 2004-05 the accepted position was that as on 31.03.2004 there were no borrowings attributable to investments considering that assessee’s own funds by way of capital, reserves and surplus on account of dividend/profit on sale of investments exceeded the amount of investments. In A.Y. 2005-06 assessee had made fresh investments in shares to the tune of Rs. 609.92 Crs., out of which Rs. 597.34 Crs. was investments in shares to the tune of Rs. 609.92 Crs., out of which Rs. 597.34 Crs. was invested in shares of Ranbaxy. Since almost the entire share capital and reserves had been exhausted in acquisition of investments appearing in the opening balance as on 1st April, 2004, fresh investments made during the course of previous year 2004-05 came out of borrowed funds and dividend income. The assessee computed the disallowance under Section 14A of the Act with respect to the interest paid on borrowed funds on product basis, taking into account the date on which the investment was made, the amount invested and the period for which borrowed funds were utilized. In A.Y. 2005-06, the method adopted by assessee for identifying interest cost attributable to investments, own funds viz. share capital, reserves and surplus and dividend/ profit on sale of investments earned from year after year, it was held that in respect of the investments made in shares as on 31.03.2004/01.04.2004 i.e., at the beginning of the previous year relevant to A.Y. 2005-06, virtually, no borrowed funds were used for investment in shares. The CIT(A) held that in respect of borrowings made during A.Y. 2005-06 for investments in shares, the assessee has correctly computed the disallowance on account of interest in relation to earning dividend income which does not form part of total income. In A.Y. 2006-07 adopting similar methodology, the disallowance u/s 14A for interest cost was computed by the assessee and was suo moto added back in the return of income. This was also accepted by the Assessing Officer, however it was alleged by him that the capital and reserves of assessee cannot be held attributable only to investments made in share. Attributing (on proportionate basis) part of capital and reserves to other business assets i.e. stock in trade, fixed assets, cash and bank, loans and advances, balance was held attributable to investments in shares. The Ld. AR pointed out that even after alleging as such the Assessing Officer computed disallowance of interest cost u/s 14A on product basis, taking into consideration the date on which investment was made, the amount invested and the period for which borrowed funds were utilized (i.e. by identifying the interest expenditure which is directly relatable/attributable to investment made in shares). The Ld. AR further submitted that in appeal, the CIT(A) held that clear nexus was demonstrated by the assessee between the interest free funds (i.e. Share Capital and Reserves) and the investments made by it in shares which was also accepted by the department in past. Similarly during the assessment year under consideration i.e. A.Y. 2007-08 interest cost of Rs. 65,17,34,199/- was computed by the assessee in consonance with past practice. However, completely ignoring the accepted position as mentioned above, this year disallowance u/s 14A was computed by the Assessing Officer blindly relying upon Rule 8D of Income Tax Rules, 1962. While computing the disallowance of Rs. 93,93,01,912/- u/s 14A by applying Rule 8D, under Sub Rule (2) clause (ii) a disallowance of interest cost for Rs. 88,25,48,326/- was computed by the Assessing Officer. This was done by completely disregarding the fact that in earlier years (i.e. A.Y. 2005-06 and A.Y. 2006-07) the disallowance of interest cost was made by identifying the interest expenditure which is directly relatable/attributable to investment made in shares. The Ld. AR submitted that for computing the said disallowance u/s 14A the Assessing Officer erred in relying upon the method prescribed by Rule 8D of Income Tax Rules, 1962. The Ld. AR submitted that disallowance as per Rule 8D is required to be made only if the conditions of Section 14A(2) of the Act are satisfied. A disallowance as per Rule 8D could have been made provided the Assessing Officer having regard to the accounts of the assessee, was not satisfied with the correctness of the claim made by the assessee. The Ld. AR further submitted that the correctness of assessee’s method or claim having regard to its accounts has been accepted by CIT under Section 263 in A.Y. 2005-06 and by the Assessing Officer himself in A.Y. 2006-07. The Ld. AR submitted that even disallowance under Rule 8D has been wrongly computed by the Assessing Officer. While computing disallowance under Rule 8D sub rule (2) clause (ii) the Assessing Officer did not exclude the interest cost amounting to Rs. 46,16,82,089/- attributable to the business of granting loans and advances, despite clear nexus being demonstrated to this effect before him vide submissions dated 29.12.2009 and 30.12.2009. These submissions were filed before the Assessing Officer against a specific query raised by him vide order sheet entry dated 24.12.2009 during the course of assessment. While computing disallowance under Rule 8D sub rule (2) clause (ii) the Assessing Officer incorrectly computed “Total Interest Cost”, “Average Value of Investments” and “Average Value of Total Assets”. A petition u/s 154 dated 05.01.2010 was also filed in this regard before Assessing Officer .

(i) Only that expenditure which is in relation to earning dividends can be disallowed u/Section 14A and Rule 8D.

(ii) The dominant purpose for which investment into shares is made by may not be relevant as Section 14A applies irrespective of whether shares are held to gain control or as stock-in-trade. However, where shares are held as stock-in-trade main purpose is to trade in those shares and earn profits there from and, in process, certain dividend is also earned which is tax exempt u/Sec 10(34); expenditure attributable to exempt dividend income will have to be apportioned to be disallowed u/s 14A.

(iii) Rule 8D is prospective in nature and could not have been made applicable in respect of Assessment Years prior to 2007 when this rule was inserted.

The Ld. DR further submitted that Section 14A(l)says that no deduction shall be allowed in respect of expenditure incurred in relation to income which does not form part of total income. The issue therefore is if Section 14A(1) would stand attracted even if such income, i.e., income not includible in the total income, is not actually earned, subject to expenditure relatable to such income having been incurred. The CBDT Circular 5/2014, after explaining the rationale of the provision of Section 14A (with reference to Circular 14 of 2001), i.e. to curb the practice of reducing the tax liability on taxable income (i.e., income forming part of the total income) by claiming expenditure incurred in earning tax-exempt income against taxable income, goes on to state that the legislative intent is that the expenditure relatable to earning income shall have to be considered for disallowance. In that event i.e. expenditure relating to earning tax-exempt income-having been incurred, it would become irrelevant if the exempt income has actually materialized or not, so that the disallowance of the said expenditure u/s 14A would follow. The same therefore is only a continuation of Circular 14 of 2001, taking the premise of Section 14A to its logical conclusion. The purpose of these Circulars and the legislative intent is to apply the basic principle of taxation, i.e. that it is only the net income- taxable or non-taxable, i.e. net of all expenditure incurred for earning the same, that could be subject to tax or, as the case may be, exempt from tax. The later Circular, which is in consonance with Memorandum explaining the provisions of Finance Bill, 2001 (introducing Section 14A) as well as the Notes to the clauses presented along with the said Bill, has been noted with approval by the Hon'ble Supreme Court in CIT(A) Vs. Walfort Share & Stock Brokers (P) Ltd.[2010] 192 Taxman 211/326 ITR (S.C). The issue considered in perspective, is not if the income not forming the part of the total income (the tax-exempt income) is earned or not but if expenditure relatable to such income has been incurred. If such expenditure stands incurred, Section 14 A (1) becomes applicable. The decision by the Apex Court in the case of CIT(A) Vs. Walfort Share 86 Stock Brokers (P) Ltd (supra) stands followed in Godrej 8& Boyce Mfg. Co. Ltd Vs. Dy. CIT(A) [2017] 81 taxmann. Com 111 (S.C) where the Hon'ble Supreme Court while considering whether deduction of expenditure incurred in earning dividend income which is not includible in the total income of the assessee by virtue of the provisions of Section 10(33) of Income Tax Act, 1961 as in force during A.Y 2002-03 was admissible or otherwise. The expenditure is incurred to produce or generate or in anticipation of, income, whether taxable or non- taxable. In fact, the classification as to tax status (i.e, taxable or non- taxable) has nothing to do with the income generating process; an income being, as a matter of fiscal incentive, being granted tax exempt status under the Act, for the time being. The fact of having incurred expenditure for earning income- tax-exempt (or non-exempt), which is largely a question of fact, would thus remain and not undergo any change, irrespective of whether it has resulted in any income (whether tax-exempt or non-exempt). The principle is well-settled, representing a fundamental concept of taxation, i.e. the allowability (or otherwise) of an expenditure would not depend upon whether it has in-fact resulted in an income, i.e. positive income, which is in any case a matter subsequent, and that the mere fact that expenditure stands incurred for the purpose is sufficient for its admissibility, as explained by the Apex Court in CIT(A) Vs. Rajendra Prasad Moody [1978] 115 ITR 519 (S.C) The Apex Court was in that case examining the true interpretation of Section 57(iii) which employed the words any expenditure (not being in the nature of capital expenditure)/laid out or expended for the purpose of making or earning such income.

“i) The reserves and surplus of the assessee have been on account of dividend income as well as profit on sale of shares held as investments. The position of Investments/Reserves/Capital etc. as on 1st April, 2004 was as under: Investments Capital as Reserves Dividend Profit on Total of as on on as on Recd from Sale of Dividend 1/4/2004 1/4/2004 1/4/2004 1/4/99 to Investments and Profit 31/3/2004 from on sale of 1/4/99 to Investments 31/3/2004 381.95 54.76 293.35 172.73 258.45 431.18

In view of the fact that Dividend Income and Profit on sale of Investments aggregating to Rs 431.18 Crs. were more than investments i.e. Rs. 381.95 Crs., the investments were not made out of borrowings and hence there was no borrowing cost. Year-wise detail of dividend and profit on sale of investments (Annexure-II) is enclosed.

However as per past practice, the assessee had considered disallowance by considering reserve / Capital as on 1st April 2004 instead of total of dividend and profit on sale of investments. ii) Investments amounting to Rs 609.92 C/s. were made in Assessment Year 2005-06 (mainly in Ranbaxy shares). Since, almost the entire capital and reserves etc. had been exhausted in acquisition of investments as on 1st April, 2004, the fresh investments were made out of borrowings and disallowance u/s 14A in Assessment Year 2005-06 and in subsequent years was made on product basis, taking into account We date on which investment was made out of borrowed funds. iii) In the year under reference also, the assessee has computed disallowance u/s 14A on We same basis by considering the following: Investments Capital Reserves/Int Net Total Profit on Total as on as on erest Free Investment Dividen sale of Dividend & 1/4/06 1/4/06 Funds as on s as on d Recd. Investment Profit on 1/4/06 1/4/06 Upto s upto sale of 31/3/0 31/3/06 Investments 6 (i) (ii) (iii) (i)-{(ii)+(iii)} (v) (vi) (vi)+(vii) =(iv) =(viii) Total as 12.2 390.40 704.60 334. 258.70 593.56 per 5 86 Balance sheet 1128.13 Less: Investme nts 20.88 (Income of which is taxable)_ Net Investme nts 1107.25

In view of the fact that dividend Income and Profit on Sale of Investments aggregating to Rs.59S.56 Crs upto 31st March., 2006 were more than that the reserves and capital reduced i.e. Rs.402.65 Crs from investments We assessee has already considered less reduction of capital and free reserves in its Computation of disallowance of Interest. Accordingly, We net investments as on f* April, 2006, amounting to Rs.704.60 Crs. along with investments (Net) made during We year were considered for disallowance u/s 14A on product basis taking into account We date on which investments were made /disposed-off (As per Annexure-III) Therefore, it is humbly requested that no further disallowance of interest is called for on this account.”

Thus, the disallowance was computed at Rs.67,48,50,222/-. The Assessing Officer has computed the disallowance as per Rule 8D of the Income Tax Rules which is not applicable for the year under consideration as the present Assessment Year is 2007-08. It is pertinent to note that the Assessing Officer has also not given the satisfaction as to how the working given by the assessee is not plausible. The assessee has made disallowance at 10% which was in support for the earlier Assessment Year 2006-07 which was confirmed by the Tribunal in assessee’s own case being order dated 3/4/2019. Therefore, the suo motu disallowance at 10% is reasonable and cannot be faulted with. We, therefore, set aside the findings of the CIT(A) and direct the Assessing Officer to accept the suo motu disallowance of Rs.

67,48,50,222/-. Hence, the appeal filed by the assessee is allowed.