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Income Tax Appellate Tribunal, DELHI BENCH: ‘E’, NEW DELHI
Before: SHRI BHAVNESH SAINI & SHRI O.P. KANT
This appeal by the Revenue and the cross objection by the assessee are directed against order dated 24/05/2011, passed by the Ld. CIT (Appeals)-VIII, New Delhi [in short ‘the Ld. CIT(A)’] for assessment year 2008-09. 2. The grounds of appeal raised by the Revenue are reproduced as under:
The order of the ld. CIT(Appeals) is erroneous and contrary to facts and law.
2. On the facts and in the circumstances of the case and in law, the ld. CIT(A) has erred in deleting the addition of Rs.14,19,57,154/- made on account of difference between the value of shares and the cost shares taken by assessee on conversion of shares from stock in trade to investment. 2.1 The Ld. CIT(A) ignored the finding recorded by the AO and the act that the value of the shares was calculated by AO at the prevailing rates of the shares in the share market on the day of conversion. 3. On the facts and in the circumstances of the case and in law, the ld. CIT(A) has erred in restricting the disallowance u/s 14A of the Act to Rs.7,04,000/- as against Rs.3,56,96,487/- made by the AO. 3.1 The Ld. CIT(A) ignored the finding recorded by the AO and the act that the disallowance was correctly calculated by the AO in accordance with the provisions of Rule 8D of the IT Rules, 1962. 4. The appellant craves leave to add, to alter, or amend any grounds of the appeal raised above at the time of hearing.
2.1 Grounds of cross objection by the assessee are reproduced as under:
1. That on facts and in law, the Learned Commissioner of Income Tax (Appeals)-VIII [Ld.CIT(A)], New Delhi has erred in upholding the addition of Rs.7,04,411 without appreciating the contention of the appellant company that disallowance of expenditure in terms of section 14A read with clause (iii) of sub-rule (2) of Rule 8D can not exceed the amount of expenditure 'incurred' by the appellant company at Rs.8,43,942 as it is against the spirit / intention of section 14A which clearly envisages the words "expenditure incurred" therein.
2. That on facts and in law, the Ld.CIT(A) has erred in not considering the contention of the appellant company that it was holding the shares of three companies (converted from stock-in- trade to investments as on 1st April, 2007) for long term purposes and not for trading purposes as there was no trading since its acquisition in the last 6-7 years. 3. Without prejudice to the above, the Ld.CIT(A) has erred in not giving the holding that, even if the difference between the market price and cost is to be treated as business income, the same would be chargeable to tax only in the year of sale / transfer and not in the year under appeal. 4. That on facts and in law, the appellant craves leave to add, alter or amend any ground at or before the time of hearing.
Briefly stated facts of the case are that the assessee carried out business of accepting and granting loans as well as business of trading and investment in shares/debentures etc. For the year under consideration, the assessee filed return of income on 28/09/2008, declaring total income of ₹ 23,80,990/-, which was subsequently revised, though the total income remained the same. The case was selected for a scrutiny assessment and statutory notices under the Income-tax Act, 1961 (in short ‘the Act’) were issued and complied with. The scrutiny assessment under section 143(3) of the Act was completed on 03/11/2010 after making certain additions/disallowance to the returned income. On further appeal by the assessee, the Ld. CIT(A) allowed the appeal partly. 3.1 Aggrieved with the finding of the Ld. CIT(A), both the Revenue and assessee are before the Tribunal by way of appeal and cross objection respectively.
The ground Nos. 1 of appeal being general in nature, we are not required to adjudicate upon. The ground No. 2 and 2.1 are related to addition of ₹ 5. 14,19,57,154/- deleted by Ld. CIT(A), which was made by the Assessing Officer on account of the difference between the value of the shares and cost of acquisition on conversion of shares from stock-in-trade into investment. The Grounds No. 2 & 3 of the cross objection of the assessee are related to the issue of addition related to conversion of stock in trade into investment. 5.1 The facts qua the issue in dispute are that the assessee company was holding shares of M/s Oscar Investment Ltd.; M/s Ranbaxy Laboratories Ltd. and M/s Fortis Financial Services Ltd. During the year under consideration on 04/01/2007, by way of a book entry the assessee changed the classification of shares of three companies (quoted) held by it from “stock in trade” (i.e. current assets) to the “investments”. The book entry had been passed at the amount equal to the cost of the shares, at which those shares were acquired by the assessee in earlier years as a stock in trade. According to the Assessing Officer, those shares were treated by the assessee as its trading stock (current assets) and reflected as such in the accounts, which implied that sale of the shares would result in normal business profit, but upon being converted to investments, the profit on sale of such shares would amount to long-term capital gains, which is free from the chargeability of the Income-tax. In view of the Assessing Officer, merely by change of classification of the shares, the assessee converted its taxable business profit to tax-free long-term capital gains. On being confronted by the Assessing Officer as why the difference of market value of those shares on the date of the transfer and the cost of the shares should not be taken as business income of the assessee, it was submitted that: - there is no provision in the Act for taxing such income; - the shares of the companies were erroneously classified under stock in trade in earlier years instead of investment and now rectified.
5.2 The explanation given by the assessee was rejected by the assessing officer on the ground that separate account in respect of “stock in trade” as well as” investment” were maintained and reflected in the audited account. He also rejected the claim of the assessee that shares of the aforementioned companies were held as investment only but were inadvertently shown in stock-in- trade in the books of accounts. According to the Assessing Officer, the conversion of shares held in stock-in-trade into investment was conscious and deliberate attempt on the part of the assessee so as to ensure that no taxes would be paid at the time of sale of the shares claiming the profit as long-term capital gain, which is exempted from the tax. The Assessing Officer also rejected the contention that there are no provisions in the Act to tax the income on conversion of shares from stock in trade to investment.
5.3 The Assessing Officer treated the difference of market value of the shares on the date of book entry of converting the stock into investment and cost of the shares as business income of the assessee. The detailed computation of the profit by the Assessing Officer is reproduced as under:
Name of Company No. of Cost of shares Market Rate Market Value on Difference Shares on 01.04.07 date of transfer (01.04.07)
Fortis Fin. Services Ltd. 16,13,099 1,04,86,807. (*) 91.50 14,75,98,558 13,71,11,751 Oscar Investments Ltd. 86,280 50,51,511 (**) 238.75 2,05,99,350 1,55,47,839 Ranbaxy Ltd. 1,21,160 4,78,54,146 (**) 349.00 4,22,84,840 - 55,69,306 TOTAL 6,33,92,464 21,04,82,748 14,70,90,284 5.4 The Assessing Officer reduced a sum of Rs.51,33,130/-, which was included by the assessee in its income by way of taking value of 1,21,160 shares of Ranbaxy Ltd at cost price of Rs.4,78,54,146/- on the date of conversion of stock-in-trade to investment as against declared value of ₹ 4,27,21,016/- on the basis of market price as on 30 01/03/2007, and this balance amount of ₹ 14,19,57,154/- was added to the business income of the assessee. 5.5 On further appeal, the Ld. CIT(A) rejected the contention of the assessee of intention behind holding the shares in dispute as long-term investment. On the issue of treatment of difference in market price as on the date of conversion of his stock in trade into investment and the cost price, the Ld. CIT(A) discussed the ratio of following judgments:
(i) Westminister Bank Ltd. Vs. Osler (Inspector of Taxes) [1993] 1 ITR 65 (HL); (ii) Royal Insurance Co. Ltd. Vs. Stephen [1928] 14 TC22(kb) (iii) Californian Copper Syndicate Vs. Harris [1904] 5 TC 159(C. Exchq.) (iv) Raja Mohan Raja Bahadur Vs. CIT [1967] 66 ITR 378; (v) British South Africa Co. Vs. Varty (Inspector of Taxes) [1966] AC 381; (vi) Sir Kikabhai Premchand Vs. CIT, (1953) 24 ITR 506 (SC) (vii) CIT Vs. Dhanuka & Sons, (1980), 124 ITR 24(Cal.) (viii) ACIT Vs. Bright Star Investment (P) Ltd. (ITAT-Mum.) (ix) CIT Vs. Bai Shirinbai K. Kooka 5.6 In view of the ratio of the judgments, the Ld. CIT(A) deleted the addition of ₹ 14,19,57,154 observing as under:
“5.9 Thus, it may be seen that the view taken by the Hon’ble courts in the aforementioned cases is that to bring to tax any business income there has to be a sale/transfer in commercial sense. Mere conversion of trading assets into investment is not sufficient to entitle the revenue to fasten tax liability on the tax payers. The Hon’ble courts have dealt with different fact situations before coming to this conclusion. It may be seen that in a situation where shares of a particular company are surrendered/exchanged for shares of another company for a higher amount, the difference has been held to be taxable as business income. However, when the facts of the present case are analyzed in light of the basic parameters laid down by the courts for deciding the issue of change in character of holding of trading assets, it may be seen that after converting shares of the aforementioned three companies, no real transfer/sale had taken place in real business sense during the FY under consideration resulting into any income to the appellant company. It has to be appreciated that the legislature has provided for taxation o.f capital gains in the event of conversion of investment into stock-in-trade in terms of section 45 (2) of the IT Act, 1961 in the year'of actual sale/transfer of the shares/investment in question. However, there is no such provision in so far as the conversion of trading assets into investment is concerned. In view of the above facts and the legal position as elaborated by the Hon’ble courts, I have no hesitation in holding that the AO was not justified in bringing to tax the amount of Rs. 141957154/- on account of mere conversion of shares of M/s Oscar Investments Ltd., M/s Ranbaxy Laboratories Ltd. and M/s Fortis Financial Services Ltd. as there is no transaction between the appellant company and any third party which is a prerequisite for determining the business income. Accordingly, the addition of Rs. 141957154/- is being deleted. This disposes of the ground no. 1 and 1.3 of the appeal.”
Before us, the ld. Departmental Representative relied on the order of the Assessing Officer and submitted that the Ld. CIT(A) is not justified in deleting the business income arising on conversion of shares held at the stock in trade into investment in the year under consideration.
7. On the contrary, the Ld. counsel of the assessee filed a paper-book in two volumes from pages 1 to 21 and from 22 to 108. It was submitted by the ld counsel that during the year shares were converted from stock-in trade to investment in its books of account and there was no transfer or sale of shares to third parties, thus there was no real income in the hands of the assessee. The Ld. counsel relied on the order of the Ld. CIT(A) and submitted that during relevant period, there was no provision in the Act to treat the notional income arising on account of conversion of stock-in-trade into investment. The Ld. Counsel referred to amendment introduced by way of insertion of sub- section (via) to section 28 of the Act with effect from 01/04/2019, where income on conversion of stock-in-trade has been brought to tax. Thus, according to the learned counsel, there was no provision in the Act prior to the amendment introduced with effect from 01/04/2019, as the relevant period in the case of the assessee is previous years corresponding to assessment year 2008-09. The learned counsel also referred to explanatory notes to the Finance Act, available on page 28 of the paper-book. The counsel submitted that in the case of Bright Star Investment Private Limited, reported in 122 TTJ 498 (Mumbai), the Tribunal was of the opinion that to deal with the situation of conversion of stock-in-trade into investment, there can be two formulas for computing the income. First formula, which was adopted by the Assessing Officer i.e. difference between the book value of the shares and the market value of the shares as on the date of the conversion should be taken as business income and difference between the sale price of the shares and the market value of the shares on the date of conversion, be taken as capital gain. The second formula, which was adopted by the assessee, i.e., the difference between the sale price of the shares and cost of acquisition of the shares, which is the book value as on date of the conversion with indexation from the date of conversion should be computed as capital gain. The Tribunal held that in the absence of a specific provision, out of these two formulas, the formula which was favourable to the assessee should be accepted. He further submitted that the Hon’ble Bombay High Court rejected the appeal of the Revenue in the case of CIT Vs Synchem Chemicals (I) Limited reported in 384 ITR 498 (Bombay) on identical ground in view of decision of the Tribunal accepted by the Revenue in the case of Bright Star Investment (supra). 7.1 The learned counsel submitted that shares were not sold or transferred to 3rd parties during the year under consideration and no long-term capital gain has been claimed during the year under consideration. He submitted that gain on sales of shares declared in the subsequent year has been accepted by the Department and therefore, no income is taxable in the year under consideration. In support of his contention that no income arises on mere conversion of stock-in-trade into investment, he relied on the decision of the Hon’ble Supreme Court in the case of KikabhaiPremchand Vs CIT (1953) 24 ITR 506 (SC).
We have heard the rival submissions of the parties and perused the relevant material on record. As far as facts of conversion of shares of three companies from stock-in-trade into investment are concerned, same have not been disputed before us. The only dispute is regarding whether such conversion in the year under consideration would result into income in the hands of the assessee. We find that the Ld. CIT(A) has relied on the ratio laid down in various judgments discussed in the impugned order. We find that Hon’ble Supreme Court in the case of Kikabhai Premchand (supra) concluded that withdrawal of the stock-in- trade for non-business purpose does not result in income and it can be valued at cost price, where assessee normally valued its stock at cost price. The paragraph of the decision of the Hon’ble Supreme Court (majority) is reproduced as under:
We are of opinion that the learned Attorney-General's second contention is unsound because, for income-tax purposes, each year is a self-contained accounting period and we can only take into consideration income, profits and gains made in that year and are not concerned with potential profits which may be made in another year any more than we are with losses which may occur in the future.
8. As regards the first contention, we are of opinion that the appellant was right in entering the cost value of the silver and shares at the date of the withdrawal, because it was not a business transaction and by that act the business made no profit or gain, nor
did it sustain a loss, and the appellant derived no income from it. He may have stored up a future advantage for himself but as the transactions were not business ones and as he derived no immediate pecuniary gain the State cannot tax them, for under the IT Act the State has no power to tax a potential future advantage. All it can tax is income, profits and gains made in the relevant accounting year.
It was conceded that if these assets had been sold at cost price the State could have claimed nothing, for a man cannot be compelled to make a profit out of any particular transaction. It was also conceded that if the silver and stocks had lain where they were, then again there would have been no advantage to the State because the appellant would have been entitled to enter their closing values at cost at the end of the year. The learned Attorney-General even conceded that if they had been sold at a loss the appellant would have been entitled to set that off against his other gains, but he said that that is because all those are business transactions and that is the way the law deals with such matters when they occur in the ordinary course of business. But, he argued, when there is a withdrawal and no sale or its equivalent, the matter is different. As this is a business, any withdrawal of the assets is a business matter and the only feasible way of regarding it in a business light is to enter the market price at the date of the withdrawal and whether that happens to favour the assessee or the State is immaterial. We do not agree.
It is well recognised that in revenue cases regard must be had to the substance of the transaction rather than to its mere form. In the present case disregarding technicalities it is impossible to get away from the fact that the business is owned and run by the assessee himself. In such circumstances we are of opinion that it is wholly unreal and artificial to separate the business from its owner and treat them as if they were separate entities trading with each other and then by means of a fictional sale introduce a fictional profit which in truth and in fact is non-existent. Cut away the fictions and you reach the position that the man is supposed to be selling to himself and thereby making a profit out of himself which on the face of it is not only absurd but against all canons of mercantile and IT law. And worse. He may keep it and not show a profit. He may sell it to another at a loss and cannot be taxed because he cannot be compelled to sell at a profit. But in this purely fictional sale to himself he is compelled to sell at a fictional profit when the market rises in order that he may be compelled to pay to Government a tax which is anything but fictional.
Consider this simple illustration. A man trades in rice and also uses rice for his family consumption. The bags are all stored in one
godown and he draws upon his stock as and when he finds it necessary to do so, now for his business, now for his own use. What he keeps for his own personal use cannot be taxed however much the market rises; nor can he be taxed on what he gives away from his own personal stock, nor, so far as his shop is concerned, can he be compelled to sell at a profit. If he keeps two sets of books and enters in one all the bags which go into his personal godown and in the other the rice which is withdrawn from the godown into his shop, rice just sufficient to meet the day-to-day demands of his customers so that only a negligible quantity is left over in the shop after each day's sales, his private and personal dealings with the bags in his personal godown could not be taxed unless he sells them at profit. What he chooses to do with the rice in his godown is no concern of the IT Department provided always that he does not sell it or otherwise make a profit out of it. He can consume it, or give it away, or just let it rot. Why should it make a difference if instead of keeping two sets of books he keeps only one ? How can he be said to have made an income personally or his business a profit, because he uses ten bags out of his godown for a feast for the marriage of his daughter ? How can it make any difference whether the bags are shifted directly from the godown to the kitchen or from the godown to the shop and from the shop to the kitchen, or from the shop back to the godown and from there to the kitchen ? And yet, when the reasoning of the learned Attorney-General is pushed to its logical conclusion, the form of the transaction is of its essence and it is taxable or not according to the route the rice takes from the godown to the wedding feast. In our opinion, it would make no difference if the man instead of giving the feast himself hands over the rice to his daughter as a gift for the marriage festivities of her son.
The appellant's method of book-keeping reflects the true position. As he makes his purchases he enters his stock at the cost price on one side of the accounts. At the close of the year he enters the value of any unsold stock at cost on the other side of the accounts thus cancelling out the entries relating to the same unsold stock earlier in the accounts; and then that is carried forward as the opening balance in the next year's accounts. This cancelling out of the unsold stock from both sides of the accounts leaves only the transactions on which there have been actual sales and gives the true and actual profit or loss on his year's dealings. In the same way, the appellant has reflected the true state of his finances and given a truthful picture of the profit and loss in his business by entering the bullion and silver at cost when he withdrew them for a purely non-business purpose and utilised them in a transaction which brought him neither income nor profit nor gain.
There is no case quite in point. The learned Attorney-General relied on Gold Coast Selection Trust Limited vs. Humphrey (H.M.
Inspector of Taxes) (1949) 30 Tax Cases 209 (HL) : (1949) 17 ITR Suppl 19 (HL), but there the assessee received a new and valuable asset in exchange for another in the ordinary course of his trade. It was held that he was bound to account for the receipt at a fair market valuation, for though the receipt was not money it was capable of being valued in terms of money. In the present case, the assessee's business received nothing in exchange for the withdrawal of the assets, neither money nor money's worth, therefore the only fair way of treating the matter was to do just what the appellant did, namely to enter the price at which the assets were valued at the beginning of the year so that the entries would cancel each other out and leave the business with neither a gain nor a loss on those transactions.
The learned Attorney-General contended that if that was allowed great loss would ensue to the State because all a man need do at the end of the year would be to withdraw all assets which had risen in value and leave only those which had depreciated and thus either show a loss or reduce his taxable profits.
This argument can only prevail on the assumption that the State can tax potential profits because, except for that, the State would neither gain nor lose in a case of this kind. Had the assets been left where they were, they would have been valued at the end of the year as they were at the beginning, at the cost price and we would still be where we are now. But the assumption that there would be a gain at some future indefinite date is mere guess work, for equally there might be loss. Apart, however, from that the learned Attorney- General's rule is equally capable of abuse. A man could as easily withdraw from the business assets which had depreciated and enter in his books the depreciated market value and leave at cost price the assets which had risen.
There are two cases which bear a superficial resemblance to this case. They are Inre, ChouthmalGolapchand (1938) 6 ITR 733 (Cal) : TC14R.495 and In re Spanish Prospecting Co. Ltd. (1911) 1 Ch 92.
We refrain from expressing any opinion about them especially as they appear to reach different conclusions, because the facts are not the same and the questions which arose on the facts there were not argued here. They raise matters of wider import which will require consideration in a suitable case. These cases were not cases of a business owned and run by a single owner and so the fiction of treating the business as a separate entity from its owner actually trading with him, which we are asked to apply here, does not arise. In the next place, the businesses there were not continuing as here.
In the Calcutta Case, a partnership was wound up and the question related to the valuation of assets consisting of stocks and shares, on the dissolution. In the English case, a company with no fixed capital was under liquidation and the question was whether the market value of certain debentures which the company had purchased ought to be brought into the profit and loss account so as to augment the profits actually shown in the balance-sheet. The company wished to treat those debentures as of no value and thus show a much smaller profit than would otherwise have been the case. On the answer to that question hung the fate of two servants of the company who under the terms of their agreement with the company, could only be paid their salaries out of the profits of the company. Neither case is, in our opinion, apposite here.
The questions referred were : "(1) Whether, in the circumstances of the case, any income arose to the assessee as a result of the transfer of shares and silver bars to the trustee ? (2) If the answer to question (1) is in the affirmative, whether the method employed by the AAC and upheld by the Tribunal in computing the assessee's income from the transfer is the proper method for computing the income ?"
Our answer to the first question is that in the circumstances of this case no income arose to the appellant as a result of the transfer of the shares and silver bars to the trustees. In view of that, the second question does not arise.
8.1 In the instant case, there is no real income in the hands of the assessee as the shares in reference have not either sold or transferred by the assessee in the year under consideration. There is no express or specific provision during relevant period in the Act to deal with the event of conversion of stock-in-trade into investment. In absence of specific provision, notional income if any, cannot be taxed in the year under consideration. We find that The Ld. CIT(A) has followed the ratio of the above decision of the Hon’ble Supreme Court along with other decisions. In view of the binding precedents followed by the Ld. CIT(A), we do not find any error in the order of the Ld. CIT(A) on the issue in dispute, and thus, we uphold the same. Accordingly, Grounds No. 2 & 2.1 of the appeal of the Revenue are dismissed.
9. As far as Ground No. 2 of the cross objection of the assessee is concerned, we find that the Ld. CIT(A) has given detailed reasoning for not considering the contention of the assessee that it was holding three shares as investment from very beginning. The relevant finding of the Ld. CIT(A) is reproduced as under:
“5.7 In view of the above factual position, I do not find myself in agreement with the .appellant company that the shares of M/s Oscar Investments Ltd., M/s Ranbaxy Laboratories Ltd. and M/s Fortis Financial Services Ltd. were being held by the appellant company as investment prior to the date of conversion as on 1.04.2007. I also do not agree with the claim of the appellant company that the intention behind holding of the shares was to keep them as long term investments as the appellant company has not furnished any credible evidence/ material to substantiate its claim. It has to be appreciated that the shares in question were being held by the appellant company as trading assets to be exploited commercially and the fact that the appellant company had to pass a resolution on 02.04.2007 itself suggests that the shares were not held as investments. As stated earlier, as per the incidental and ancillary objects of the appellant company, shares could be acquired as investment as well as stock-in-trade. In view of the aforesaid, ground nos. 1.1 and 1.2 are being rejected.”
9.1 Before us, the learned counsel failed to adduce any evidence other then submitted before the Ld. CIT(A) to establish that the shares were inadvertently characterized as a stock-in-trade. In view of the reasoning given by the Ld. CIT(A), we do not find any error in the order of the Ld. CIT(A) on the issue in dispute and accordingly, we uphold the same. The cross objection No. 2 of the assessee is dismissed.
10. The Ground No. 3 of the cross objection is in relation to not giving any finding by the Ld. CIT(A) for the year in which business income should be considered. In our opinion, the ground is infructuous when the Ld. CIT(A) has already allowed the ground in favour of the assessee. Accordingly, the cross objection No. 3 of the assessee is dismissed.
11. The ground No. 3 and 3.1 of the appeal relates to disallowance of ₹ 3,56,96,487/-under section 14A of the Act made by Assessing Officer, which has been restricted by the Ld. CIT(A) to ₹ 7,04,000/-. The Ground No. 1 of the cross objection of the assessee is also related to the disallowance under section 14A of the Act, wherein according to the assessee the disallowance under rule 8D(2)(iii) of Rules, cannot exceed the amount expenditure actually incurred by the assessee. 11.1 The brief facts qua the issue in dispute are that the assessee made disallowance under section 14A read with rule 8D of Income-tax Rules, 1962 at ₹ 1,77,79,925/-. The assessee followed direct nexus method in accordance with rule 8D(2)(i) of Income Tax Rules, 1962 and made entire disallowance under rule 8D(2)(i) only. This disallowance made by the assessee was not found to be correct by the Assessing Officer. According to the Assessing Officer, the assessee company was managing its business with the help of borrowed funds and made investment in shares of ₹ 33.80 Crores, the income from which would not form part of the taxable income, and he accordingly not being satisfied with the claim of the assessee, invoked provisions of Rule 8D of Income Tax Rules and computed the disallowance at ₹ 5,34,76,412/- and after reducing the sumo disallowance by the assessee, he made addition for ₹ 3,56,96,487/-. The disallowance computed by the Assessing Officer is reproduced as under:
Total Rs.5,34,76,412/- Less: Disallwoance U/s 14A added by Assessee himself In computation of Income Rs.1,77,79,925/- Further Addition on account of disallowance U/s 14A Rs.3,56,96,487/- 11.2 Before the Ld. CIT(A) the assessee submitted that disallowance for expenses of ₹ 1,77,79,925 /- including interest expenses directly related to investment was already made by the assessee, thus no disallowance could be made towards interest expenditure indirectly related to investment in shares yielding exempt income. The Ld. CIT(A), after considering submission of the assessee, was of the view that no disallowance under rule 8D(2)(ii)b related to indirect interest expenditure was not required but he justified disallowance under rule 8D(2)(iii) amounting to ₹15,48,353/- in the case of the assessee. It was contested by the assessee that total expenditure of ₹ 8,43,942 /- was only claimed by the assessee, therefore disallowance cannot be made more than that. However, according to the Ld. CIT(A), once the rule 8D has been invoked, the disallowance has to made according to the rules and therefore towards the disallowance under 80d(2)(iii), he computed the disallowance of ₹15,48,353/- and sustained the disallowance to the extent of the 7.04 lakhs out of the disallowance of ₹ 3,56,96,487 made by the Assessing Officer. 11.3 The learned DR relied on the order of the Assessing Officer and submitted a list of the decisions in support of the order of the Assessing Officer. The list of the decisions is reproduced as under:
1 Maxopp Investment Ltd. Vs CIT [2018] 91 taxmann.com 154 (SC) 2. Indiabulls Financial Services Ltd. Vs DCIT [2016] 76 taxmann.com 268 (Delhi) 3. Godrej & Boyce Manufacturing Company Ltd. Vs DCIT [2017] 81 taxmann.com 111 (SC)/[2017] 247 Taxman 361(SC)/[2017] 394 ITR 449 (SC)/[2017] 295 CTR 121 (SC) (Copy Enclosed) 4. Punjab Tractors Ltd Vs CIT [2017-TIQL-353-HC-P&H-IT] 5. Avon Cycles Ltd Vs CIT f20151 53 taxmann.com 297 (Punjab & Harvana)/[2015] 228 Taxman 368 (Punjab & Haryana)(MAG.) 6. Nahar Spinning Mills Ltd. Vs CIT [2017] 82 taxmann.com 154 (Punjab & Haryana) 7. Dy. CIT v. Virai Profiles Ltd. 156 ITD 721 46/ ITR 626/177 TTJ 466 8. NYK Line India Ltd. v. ACIT [175 TTJ 180/132 DTR 7] 9. Super Auto Forge (P.) Ltd. Vs. ACIT (157 JTD 467) 10. Vipin Malik Vs.ACIT (45 ITR 589)
11.4 The learned counsel of the assessee, on the other hand, relied on the submission made before the Ld. CIT(A) and submitted that disallowance under rule 8D(2)(iii) of the Income Tax Rules, 1962, for administrative expenses cannot exceed the total expenses claimed in the profit and loss account. The Ld. counsel referred to page 1 of the paper-book and submitted that during the year the assessee has shown exempted income from dividends of ₹ 10, 35, 890 under section 10(34) of the Act .He relied on the decision of the Hon’ble Delhi High Court in the case of Joint investment Private Limited reported in 372 ITR 694 (Del) and submitted that disallowance of expenses under section 14A should be limited to the exempted income only.
12. We have heard the rival submission of the parties and perused the relevant material on record. We find that the assessee has disputed the disallowance of ₹ 7.04 lakhs sustained by the Ld. CIT(A) for the administrative expenses under rule 8D(2)(iii) of the Income-tax Rules, 1962. The Revenue, on the other hand, has disputed the relief allowed by the Ld. CIT(A) towards disallowance under rule 8D(2)(ii) of the rules and relief allowed for disallowance under rule 8D(2)(iii) of the Income-tax Rules, 1962. As far as deletion of disallowance under rule 8D(2)(ii) is concerned, the Ld. CIT(A) has made detailed analysis of the money borrowed and utilisation towards the investment, which is reproduced as under:
6.5 I have carefully considered the submissions made on behalf of the appellant company and the findings recorded by the Ld. AO. On consideration I find that out of total disallowance of Rs. 53476412/- worked out by the Ld .AO in terms of clauses (i), (ii) and (iii) of sub-rule (2) of Rule 8D, a disallowance of Rs. 45593493/- has been calculated in terms of clause (ii) of sub-rule (2) of Rule 8D on the ground that the appellant company has not been able to explain the source of opening investment of Rs. 281351500/- brought forward as on 01.04.2007. Therefore, in order to find out the immediate source of investment of opening investment of Rs. 281351500/- , the Ld. Counsel was asked to submit the breakup of the aforesaid investment along with immediate sources thereof. In response to the aforesaid, a written reply has been filed by the Ld. Counsel for the appellant, vide his letter dated 29.04.2011 as under:- Kindly refer to our discussions held on 27th April, 2011 in connection with the captioned appeal. As desired during the course of proceedings, we wish to submit as under: 1. The investments in the case of appellant as on 1st April, 2007 (i.e. at the beginning of the year under reference) were to the tune of Rs. 28.14 Crs. (Please see Page 78 of Paper Book). The same were mainly acquired in the years ended 31st March, 2007 and 31st March, 2006. The details of acquisition and source thereof is given as under: i) Investments made in Y.E.31.03.2007 (A.Y. 2007-08) - Optionally Convertible Debentures of - 5.00 Crs. M/s. Delta Aromatics Pvt. Ltd. - Optionally Convertible Debentures of - 10.00 Crs. M/s. Oscar Pharmaceuticals Pvt. Ltd. --------- 15.00 Crs. [The aforesaid investments were acquired directly out of 0% OCD’s amounting to Rs. 40Crs. Raised from M/s. Shimal Research Laboratories Ltd. - as duly explained during the course of assessment proceedings for the Asstt. Year 2007-08 -Please refer Pages 56 to 66 (relevant Page - 66) of Paper Book.]
(ii) Investments made in Y.E.31.03.2006 (A.Y.2006-07) - Optionally Convertible Debentures of - 9.90 Crs. M/s. Orlando Trading Company [The aforesaid investments were made directly put of loan taken from M/s.Oscar Pharmaceuticals Pvt. Ltd. Copy of Bank Statement attached at Page 68 of Paper Book. The same was duly explained during the course of assessment proceedings for the Asstt. Year 2006- 07. The said loan was repaid to M/s. Oscar Pharmaceuticals Pvt. Ltd. on 2nd March, 2007 out of 0% OCD’s amounting to Rs.40 Crs. raised from M/s. Shimal Research Laboratories Ltd.- Please refer Page 65 of Paper Book] (iii) Remaining Investments made in earlier years 3.24 Crs. [The said investments were made in earlier years out of borrowed funds/loans and the said loan of Rs. 3.24 Crs. Was repaid out of 0% OCD’s amounting to Rs. 40 Crs. Raised from M/s. Shimal Research Laboratories Ltd. in March, 2007] Total - 28.14 Crs.
On perusal of the year-wise details as above, your honors would kindly observe that the opening investments (i.e. on 1st April, 2007) were ostensibly without the burden of interest cost as the appellant had either acquired them directly out of 0% OCD’s of Rs. 40 Crs. raised in February/March, 2007 or had utilized the 0% OCD’s amount of Rs. 40 Crs. For repayment of loans taken earlier for making such investments. However, as discussed, the disallowance of direct interest cost on investments made during the year under consideration out of borrowings made, was duly made in the Statement of Taxable Income in terms of clause (i) of sub-rule (2) of Rule 8D (Please refer Page 42 of Paper Book).
3. In view of the above, it is respectfully submitted that since the appellant had suo moto worked out the disallowance of interest cost as per direct nexus method, as consistently followed in the past and as duly accepted by the department in the scrutiny assessments (copies of Orders enclosed at Page 30 & 31 of Paper Book), the question of applicability of clause (ii) of sub-rule (2) of Rule 8D should not arise. We thus humbly submit that the Ld. AO be directed to kindly accept the appellant’s direct nexus method of disallowance of interest cost in terms of clause (i) of sub-rule (2) of Rule 8D and the additionaldisallowance of interest cost amounting to Rs. 3,49,92,076/- made by the Ld. AO be deleted.
6.6 Along with the aforesaid reply, the Ld. Counsel has also filed copy of bank statement maintained with standard chartered bank evidencing the receipt of 0% OCDs raised from M/s Shimal Research Laboratory Ltd. utilized for investment in OCDs of M/s Delta Aromatics (P) Ltd. -Rs. 5 Crs. and OCDs of M/s Oscar Pharmaceuticals (P) Ltd. - Rs. 10 Crs. as also repayment of loan of Rs. 99000000/- raised for purchase of OCDs of M/s Orlando Trading Company worth Rs. 9.90 Crs. and other loan of Rs. 3.24 Crs. raised for investments in earlier years. Confirmation of M/s Shimal Research Laboratory Ltd. and copy of account of M/s Religare Securities Ltd. have also been find.
6.7 In view of the aforesaid, it may be seen that the opening investment of Rs. 281351500/- has been duly explained by the Ld. Counsel. The cash flow statement filed by the Ld .Counsel clearly establishes that out of opening investments of Rs. 28.14 Crs., investment of Rs. 15 Crs. in OCDs of M/s Delta Aromatics (P) Ltd. and M/s Oscar Pharmaceuticals (P) Ltd. was directly linked with the OCDs of Rs. 40 Crs. raised from M/s Shimal Research Laboratory Ltd. Further, investment of Rs. 9.90 Crs. in OCDs of M/s Orlando Trading Company, though was made out of loans of identical amount raised from M/s Oscar Pharmaceuticals (P) Ltd., the same was repaid on 2nd March, 2007 out of 0% OCDs of M/s Shimal Research Laboratory Ltd. Similarly, balance loans of Rs. 3.24 Crs. raised in earlier years for investment were also repaid out of 0% OCDs M/s Shimal Research Laboratory Ltd. Therefore, I do not find any merit in the findings recorded by the AO that the appellant company failed to establish nexus" between the 0% OCDs of Rs. 40 Crs. raised from M/s Shimal Research Laboratory Ltd. and investment of Rs. 281351500/- brought forward as on 01.04.2007. Accordingly, I hold that no disallowance in terms of clause (ii) of sub-rule (2) of Rule 8D was called for in the case of the appellant company.”
12.1 In view of the detailed analysis, we agree with the finding of the Ld. CIT(A), that no disallowance is required for indirect expenses for earning exempt income, when the assessee has followed direct nexus method and already made disallowance of ₹1,77,79,925/- under Rule 8D(2)(i) of the Income-tax Rules, 1962. 12.2 As regard to the disallowance under rule 8D(2)(iii) of the Income Tax Rules, 1962 is concerned, we find that in view of the decision of the Hon’ble Jurisdictional High Court in the case of joint investment Private Limited (supra), disallowance towards administrative expenses cannot be exceeded the exempted income. The relevant paragraph of the decision is reproduced as under:
“9. In the present case, the AO has not firstly disclosed why the appellant/assessee's claim for attributing `2,97,440/- as a disallowance under Section 14A had to be rejected. Taikisha says that the jurisdiction to proceed further and determine amounts is derived after examination of the accounts and rejection if any of the assessee's claim or explanation. The second aspect is there appears to have been no scrutiny of the accounts by the AO - an aspect which is completely unnoticed by the CIT (A) and the ITAT. The third, and in the opinion of this court, important anomaly which we cannot be unmindful is that whereas the entire tax exempt income is `48,90,000/-, the disallowance ultimately directed works out to nearly 110% of that sum, i.e., `52,56,197/-. By no stretch of imagination can Section 14A or Rule 8D be interpreted so as to mean that the entire tax exempt income is to be disallowed. The window for disallowance is indicated in Section 14A, and is only to the extent of disallowing expenditure "incurred by the assessee in relation to the tax exempt income". This proportion or portion of the tax exempt income surely cannot swallow the entire amount as has happened in this case.”
12.3 In the case, the disallowance under Rule 8D(2)(iii) has been computed by the AO at Rs. 15,48,353/-. The Ld. CIT(A), however, restricted the disallowance to Rs.7.04 lakhs observing as under: “6.8 As regards, disallowance as per clause (iii) of sub-rule (2) of Rule 8D amount into Rs. 1548353/- made on account of other expenses, the grievance of the appellant is that after taking into account the disallowance of Rs. 25.72 lacs, only expenditure of Rs. 8.44 was left to be considered in terms of section 14A of the IT Act, 1961. Therefore, it is argued that the disallowance as per clause (iii) of sub-rule (2) of Rule 8D should have been restricted to the actual expenditure claimed by the appellant company. 6.9 However, on a careful consideration, I find that the provisions of Rule 8D are applicable to the facts of the present AY and the AO was under obligation to work out the disallowance strictly as per the mechanism provided it under the aforesaid rule. I am in agreement with the appellant, company that the disallowance of an amount which is greater than the actual expenditure may cause genuine hardship to the tax payers. However, in matters of taxation statutes, the revenue authorities are obliged to execute the provisions of law strictly and should not employee any interpretation of their own. Therefore, the disallowance of Rs.1548353/- made by the AO is in order and the same is being sustained. In view of the aforesaid, out of total disallowance of Rs.25696487/-, disallowance to the extent of Rs. 7.04 lacs is only being sustained. The AO is directed to grant consequential relief to the appellant company.”
12.4 Since in the case of the assessee the dividend income earned is of Rs.10,35,890/-, following the decision of the Hon’ble Delhi High Court in Joint Investment Private Ltd. (supra), we restrict the disallowance of administrative expenses to Rs.10,35,890/-. 13. In the result, the Ground Nos. 3 and 3.1 of the appeal of Revenue is partly allowed, whereas the Ground No. 1 of the Cross Objection of assessee is dismissed.
14. To sum up, the appeal of the Revenue and the Cross Objection of the assessee both are partly allowed. Order is pronounced in the open court on 28th January, 2020.