M/S PRANAVA ELECTRONICS PRIVATE LIMITED ,BANGALORE vs. INCOME TAX OFFICER WARD-5(1)(3), BANGALORE

O R D E R Per Shri Jason P Boaz, A.M. :

This appeal by the assessee is directed against the order of CIT(A)-5, Bangalore, dated 10.08.2017 for Assessment Year 2014-15.

2.1 The assessee, a company engaged in letting out of movable and immovable assets, filed its return of income for Assessment Year 2014-15 on 29.11.2014 declaring income of Rs.85,02,970/-. The case was taken up for scrutiny for this Assessment Year and the assessment was completed u/s 143(3) of the Income Tax Page 2 of 12 Act, 1961 (in short ‘the Act’) vide order dated 15.12.2016, wherein the assessee’s total income was determined at Rs.1,01,05,624/-, in view of disallowance u/s 14A r.w.r. 8D(2)(iii) amounting to Rs.16,02,670/-. Aggrieved, the assessee filed an appeal before the CIT(A)-4, Bangalore, who dismissed the assessee’s appeal on the aforesaid issue of disallowance u/s 14A r.w.r. 8D(2)(iii) vide order dated 27.03.2018.

3.1 Aggrieved by the order of CIT(A)-5, Bangalore, dated 10.08.2017 for Assessment Year 2014-15, the assessee has filed this appeal before the Tribunal; wherein it has raised the following grounds:

3.2 In these grounds (supra), it is seen the sole issue of dispute for consideration is the disallowance of Rs.16,02,670/- made by the Assessing Officer (AO) u/s 14A r.w.r. 8D(2)(iii) which was upheld by the CIT(A) in respect of exempt dividend income of Rs.82,76,385/- earned by the assessee in this year which was claimed as exempt u/s 10(34) of the Act. According to the learned AR of the assessee, the Page 3 of 12 aforesaid disallowance u/s 14A r.w.r. 80(2)(iii) was excessive and ought to have been restricted to only to the actual amount of expenditure incurred or only to those investments which yielded exempt income during the year. In support of this proposition, the assessee placed reliance on the decision of the Special Bench of ITAT Delhi Bench in the case of ACIT Vs. Vireet Investments (P) Ltd., (2017) 82 taxmann.com 415 (Delhi – Trib) (SB).

3.3 Per contra, the learned DR for Revenue supported the orders of the authorities below.

3.4.1 We have heard the rival contentions and perused and carefully considered the material on record; including the judicial pronouncements cited therein. Admittedly, the assessee has earned exempt dividend income of Rs. 82,76,385/- from one company; M/s. Embassy Services Pvt. Ltd., during the year under consideration and did not suo moto disallow in its accounts any amount on account of expenditure incurred in earning such exempt dividend income. The AO, after considering the explanations put forth by the assessee that no disallowance was warranted u/s 14A of the Act, proceeded to disallow an amount of Rs.16,02,670/- u/s 14A r.w.r. 8D(2)(iii). On appeal, the same was upheld by the CIT(A).

3.4.2 According to the averments in the grounds (supra), the assessee, inter alia, submits that the disallowance u/s 14A r.w.r. 8D(2)(iii), if at all called for, ought to be restricted to those investments which yielded the exempt income earned by the assessee in the year under consideration. Meaning thereby, that the said disallowance ought to be restricted to the investment in those instruments from which the assessee earned the entire exempt dividend income of Rs. 82,76,385/-. In the decision of the Special Bench of ITAT Delhi in the case of Vireet Investments (P) Ltd., (supra); which was also cited before the CIT(A); the issue for consideration before the special Bench was similar to the one before us; i.e., whether or not the investment, which did Page 4 of 12 not yield any exempt income, should OR not enter into the computation under Rule 8D(2)(iii) of Income Tax Rules, 1962 (in short ‘the Rule’). The Special Bench, after consideration of this issue, in para 11-16 of its order, held that for computing the disallowance u/R 8D(2)(iii) ‘only those investments are to be considered for computing average value of investment which yielded exempt income during the year.’ The operative part of this decision of the Special Bench at paras 11 to 11.18 are extracted hereunder:

“11. We have considered the submissions of both the parties and have perused the record of the case. The basic issue for consideration is that the investment, which did not yield any exempt income, should enter or not enter into the computation under Rule 8D, while arriving at the average value of investment, income from which does not or shall not form part of the total income. 11.1. In the present case, our decision is restricted only to the extent of interpretation of language employed in Rule 8(2)(iii). The submission of ld. counsel for the assessee is that this issue is now covered by the decision of the Hon’ble Delhi High Court in the case of CIT Vs. Holcin India (P) Ltd. (supra), wherein it has been held that if no dividend income was earned, section 14A couldnot be invoked.

The Hon’ble Delhi High Court has referred to the decisions, which we have noted earlier i.e.: - M/s Shivam Motors (P) Ltd. ITA 88 of 2014 (All.); - Winsome Textile Industries Ltd. 319 ITR 204 (P&H) - M/s Lakhani Marketing ITA 970 of 2008 (P&H) - Corrtech Energy Pvt. Ltd. 223 Taxman 130 (Guj.). - CIT Vs. Hero Cycles Ltd. 323 ITR 518.

11.2. The submission of ld. Principal CIT(DR) is that ITAT in the case of Delhi Special Bench in the case of Cheminvest Ltd. (supra) has specifically held that even if there is no exempt income, the provisions of section 14A are applicable in view of the decision of Hon’ble Supreme Court in the case of Rajednra Prasad Moody (supra). His submission is that the decision of Hon’ble Delhi Court reversing the decision of Special Bench in Cheminvest should not be followed because that is contrary to the principles laid down in Rajendra Prasad Modi(supra). 11.3. It is against these submissions, we first refer to the facts as were obtaining in these two decisions 11.4. In the case of Cheminvest Ltd. (supra), the assessee had borrowed funds of Rs. 8,51,65,000/- and during the previous year relevant to assessment year 2004- 05 paid interest of Rs. 1,21,02,367/- thereon. Out of this unsecured loan, the assessee invested a sum in purchase of shares, which was shown as investment for the purpose of long term capital gains. The AO disallowed interest proportionate to the investment in shares, though no exempt income was earned during the year. The CIT(A) affirmed this but held that the net interest debited to the P&L A/c was required to be apportioned and not the gross interest expenditure. The Tribunal held that interest expenditure incurred by the assessee was for borrowing used for the purposes of investment in shares, both held for trading as well as investment purposes. Irrespective of whether or not there was any yield of dividend on the shares purchased, the interest incurred was relatable to earning of dividend on the shares purchased. The dividend income being exempted from tax by virtue of section 10(34) of the Act, the interest paid on borrowed capital utilized in purchase of shares, being the expenditure incurred in relation to dividend income not forming part of the assessee’s total income, was held to be not an allowable deduction. In coming to the conclusion, the Special Bench primarily relied on the ratio laid down by the Hon’ble Supreme Court in the case of Rajendra Prasad Moody (supra). 11.5. In the case of Rajendra Prasad Moody (supra), the facts were that the assessees were brothers and each of them had borrowed moneys for the purposes of making investment in shares of certain companies. During the relevant assessment year they paid interest on the moneys borrowed but did not receive any dividend on the shares purchased with these moneys. Both of them made a claim for deduction of the amount of interest paid on borrowed moneys but this claim was negated by the ITO and on appeal by the AAC on the ground that during the relevant assessment year the shares did not yield any dividend and, therefore, interest paid on the borrowed moneys could not be regarded as expenditure laid out or expended wholly and exclusively for the purposes of making or earning income chargeable under the head ‘income from other sources’, so as to be allowable as a permissible deduction u/s 57(iii). The Tribunal, however, on further appeal, disagreed with the view taken by the taxing authorities and upheld the claim of each of the two assessees for deduction u/s 57(iii). 11.6. In the backdrop of these facts the Tribunal’s order was upheld by the Hon’ble High Court and Hon’ble Supreme Court. The Hon’ble Supreme Court, inter alia, held that it is the purpose of the expenditure that is relevant in determining the applicability of section 57(iii) and that purpose must be making or earning of income. It was further held that section 57(iii) does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction. It does not say that the expenditure shall be deductible only if any income is made or earned. There is in fact nothing in the language of section 57(iii) to suggest that the purpose, for which the expenditure is made, should fructify into any benefit by way of return in the shape of income.

Page 6 of 12 11.7. Thus, in both the decisions viz. in the case of Cheminvest Ltd. (supra), and in the case of Rajendra Prasad Moody (supra), the issue related to allowability of expenditure which had direct nexus with the earning of income. The borrowing in both the cases has not been disputed being for acquiring shares. Hon’ble Delhi High Court has specifically held in para 21 as under:- “21. There is merit in the contention of Mr. Vohra that the decision of the Supreme Court in Rajendra Prasad Moddy (supra) was rendered in the context of allowability of deduction under Section 57(iii) of the Act, where the expression used is ‘for the purpose of making or earning such income’. Section 14A of the Act on the other hand contains the expression ‘in relation to income which does not form part of the total income.’ The decision in Rajendra Prasad Moody (supra) cannot be used in the reverse to contend that even if no income has been received, the expenditure incurred can be disallowed under Section 14A of the Act.” 11.8. In the case of Holcin India (P) Ltd. (supra) the facts were that the respondent- assessee was a subsidiary of Holder ind Investments Ltd., Mauritius, which was formed as a holding company for making downstream investments in cement manufacturing ventures in India. In the return of income filed for the Assessment Year 2007-08, the respondent-assessee declared loss of Rs. 8.56 Crores approximately. The respondent-assessee had declared revenue receipts of Rs. 18,02,274/- which included interest of Rs. 726/- from Fixed Deposit Receipts and profit on sale of fixed assets of Rs. 16,52,225/-. As against this, the respondent assessee had claimed administrative and miscellaneous expenditure written off amounting to Rs. 8.75 Crores. For the Assessment Year 2008-09, the assessee had filed return declaring loss of Rs. 6.60 Crores approximately. The assessee had declared revenue receipts in the form of foreign currency fluctuation difference gain of Rs. 12,46,595/-. It had claimed expenses amounting to Rs. 7.02 Crores as personal expenses, operating and other expenses, depreciation and financial expenses. 11.9. In both the assessment orders, the Assessing Officer held that the respondent-assessee had not commenced business activities as they had not undertaken any manufacturing activity or made downstream investments. It was observed that the respondent-assessee, after receiving approval of Foreign Investment Promotion Soard (FIPS) dated 20.12.2000 acquired shares capital of Ambuja Cement India Ltd. This, the Assessing Officer felt, was not sufficient to indicate or hold that the respondent-assessee had started their business. He, accordingly, disallowed the entire expenditure of Rs. 8.75 Crores for the Assessment Year 2007-08 and Rs.7.02 Crores for the Assessment Year 2008-09 11.10. Ld. CIT(A) did not agree with the findings of Assessing Officer that the business of the respondent- assessee had not been set up or commenced. The CIT(A) observed that the respondent-assessee had been set up with the business objective of making investment in cement industry after due approval given by the Government of India, Ministry of Commerce and Industry vide letter dated18.12.2002 and 20.12.2012. It was observed that in fact, the respondent- Page 7 of 12 assessee was not to undertake any manufacturing activity themselves. After considering the FIPS approval and the purchase of shares in the said company of Rs. 1850.91 crores, ld. CIT(A), inter alia, observed that the assessee was engaged in the business of holding of investment and was entitled to claim expenditure provided. There was a direct connection between expenditure incurred and business of the assessee company. However, he pointed out that since the business of the respondent assessee was to act as a holding company for downstream investment and as it was an accepted fact that they had incurred expenses to protect their business and explore new avenues of investment, the provisions of section 14A were applicable. 11.11. The Hon’ble High Court observed that the reasoning given by the CIT(A) was ambiguous and unclear and on clarity being sought from the Revenue it was pointed out that “the stand of the assessee contained a contradiction to the extent that on the issue of setting up of business, it was stated that the assessee had incurred expenditure on acquiring the shares, therefore, the assessee could not now take different stand than the one taken in the first issue”. 11.12. The Hon’ble High Court, after considering in detail the decision of ld. CIT(A) finally observed in para 13 as under: 13. We are confused about the stand taken by the appellant-Revenue. Thus, we had asked Sr. Standing Counsel for the Revenue, to state in his own words,their stand before us. During the course of hearing, the submission raised was that the shares would have yielded dividend, which would be exempt income and therefore, the CIT(A) had invoked Section 14A to disallow the entire expenditure. The aforesaid submission does not find any specific and clear narration in the reasons or the grounds given by the CIT(A) to make the said addition. Possibly, the CIT(A), though it is not argued before us, had taken the stand that the respondent-assessee had made investment and expenditure was incurred to protect those investments and this expenditure cannot be allowed under Section 14A. 11.13. Thus, Hon’ble Delhi High Court primarily decided the issue regarding applicability of section 14A even if no dividend income was earned. The Hon’ble High court in paras 14 to 16 of its decision observed as under: 14. On the issue whether the respondent-assessee could have earned dividend income and even if no dividend income was earned, yet Section 14A can be invoked and disallowance of expenditure can be made, there are three decisions of the different High Courts directly on the issue and against the appellant-Revenue. No contrary decision of a High Court has been shown to us. The Punjab and Haryana High Court in Commissioner of Income Tax, Faridabad vs. MIs. Lakhani Marketing Incl., decided on 02.04.2014, made reference to two earlier decisions of the same Court in CIT vs. Hero Cycles Limited, [2010]323 ITR 518 and CIT vs. Winsome Textile Industries Limited, [2009] 319 ITR 204 to hold that Section 14A cannot be invoked Page 8 of 12 when no exempt income was earned. The second decision is of the Gujarat High Court in Commissioner of Income Tax-I vs. Corrtech Energy (P.) Ltd. [2014] 223 Taxmann 130 (Guj.). The third decision is Of the Allahabad High Court in Income Tax Appeal No. 88 of 2014, Commissioner of Income Tax (Ii) Kanpur, vs. MIs. Shivam Motors (P) Ltd. decided on 05.05.2014. In the said decision it has been held:- "As regards the second question, Section 14A of the Act provides that for the purposes of computing the total income under the Chapter, 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. Hence, what Section 14A provides is that if there is any income which does not form part of the income under the Act, the expenditure which is incurred for earning the income is not an allowable deduction. For the year in question, the finding of fact is that the assessee had not earned any tax free income. Hence, in the absence of any tax free income, the corresponding expenditure could not be worked out for disallowance. The view of the CIT(A), which has been affirmed by the Tribunal, hence does not give rise to any substantial question of law. Hence, the deletion of the disallowance of Rs.2,03,752/- made by the Assessing Officer was in order” "15. Income exempt under Section 10 in a particular assessment year, may not have been exempt earlier and can become taxable in future years. Further, whether Income earned in a subsequent year would or would not be taxable, may depend upon the nature of transaction entered into in the subsequent assessment year. For example, long term. capital gain on sale of shares is presently not taxable where security transaction tax has been paid, but a private sale of shares in an off market transaction attracts capital gains tax: It is an undisputed position that respondent assessee is an investment company and had invested by purchasing a substantial number of shares and thereby securing right to management. Possibility of sale of shares by private placement etc. cannot be ruled out and is not all improbability. Dividend may or may not be declared. Dividend is declared by the company and strictly in legal sense, a shareholder has no control and cannot insist on payment of dividend. When declared, it is subjected to dividend distribution tax. 16. what is also noticeable is that the entire or whole expenditure has been disallowed as if there was no expenditure incurred by the respondent-assessee for conducting business. The CIT(A) has positively held that the business was set up and had commenced. The said finding is accepted. The respondent-assessee, therefore, had to incur expenditure for the business in the form of investment in shares of cement companies and to further expand and consolidate their business. Expenditure had to be also incurred to protect the investment made. The genuineness of the said expenditure and the fact that it was incurred for business activities was not doubted by the Assessing Officer and has also not been doubted by the CIT(A).

Page 9 of 12 11.14. Now the position of law as stands is that the decision of Hon’ble Jurisdiction High Court is directly on the point in dispute whereas the decision of Hon’ble Supreme court in the case of Rajendra Prasad Moody (supra) has been rendered in the context of section 57(iii), the applicability of which has been ruled out by Hon’ble Delhi High Court in the case of Cheminvest (supra). 11.15. Under Article 227 of the Constitution of India, the courts function under the supervisory jurisdiction of Hon’ble High Court. The decisions rendered by Hon’ble High Court are binding on all subordinate courts working within its jurisdiction. In this regard we may refer to the following decisions: (i)CIT V. Thana Electricity Supply Ltd. (1994) 206 ITR727 (Bom.), wherein on the issue of “whose decision is binding on whom”, the Hon’ble Bombay Court considered in detail the hierarchy of the courts and has observed as under: “It is also well-settled that though there is no specific provision making the law declared by the High Court binding on subordinate courts, it is implicit in the power of supervision conferred on a superior Tribunal that the Tribunals subject to its supervision would conform to the law laid down by it. It is in that view of the matter that the Supreme Court in East India Commercial Co. Ltd. v. Collector of Customs, AIR 1962 SC 1893 (at page 1905) declared “We, therefore, hold that the law declared by the highest court in the State is binding on authorities or Tribunals under its superintendence, and they cannot ignore it. .. ." This position has been summed up by the Supreme Court in Mahadeolal Kanodia v. Administrator General of West Bengal, AIR 1960 SC 936 (at page 941) as follows : “Judicial decorum no less than legal propriety forms the basis of judicial procedure. If one thing is more necessary in law than any other thing, it is the quality of certainty. That quality would totally disappear if judges of co-ordinate jurisdiction in a High Court start overruling one another’s decisions. If one Division Bench of a High Court is unable to distinguish a previous decision of another Division Bench, and holding the view that the earlier decision is wrong, itself gives effect to that view, the result would be utter confusion. The position would be equally bad where a judge sitting singly in the High Court is of opinion that the previous decision of another single judge on a question of law is wrong and gives effect to that view instead of referring the matter to a larger Bench.” The above decision was followed by the Supreme Court in Baradakanta Mishra v. Bhimsen Dixit, AIR 1972 SC 2466, wherein the legal position was reiterated in the following words (at page 2469) : “It would be anomalous to suggest that a Tribunal over which the High Court has superintendence can ignore the law declared by that court and start proceedings in direct violation of it. If a Tribunal can do so, all the subordinate courts can equally do so, for there is no specific provision, just like in the case of Supreme Court, making the law declared by the High Court binding on subordinate courts. It is implicit in the power of supervision conferred on a superior Tribunal that all the Tribunals subject to its supervision should conform to the law laid down by it. Such obedience would also be conducive to their smooth working; otherwise there Page 10 of 12 would be confusion in the administration of law and respect for law would irretrievably suffer." (ii) CIT V. Sunil Kumar (1995) 212 ITR 238 (Raj.), it was observed as under: “The point which has been raised could have been considered to be debatable because other High Courts have taken a different view. But since the view taken by this court is binding on the Tribunal and other authorities under the Act in this State, it could not be considered to be a debatable point in view of the decision of this court in the case of CIT v. M.L. Sanghi (1988) 170 ITR 670.” (iii)Indian Tube Company Ltd. V. CIT & others (1993) 203 ITR 54 (Cal.) , it was observed as under: “In the impugned order, respondent No.1 has rejected the petitioner’s contention by stating that, although the Calcutta High Court had held that an assessee was entitled to interest on such refund calculated up to the date of the order passed consequent upon an appeal or revision of the original assessment, this view had not been accepted by the Bombay High Court, the Allahabad High Court and the Kerala High Court. Respondent No.1, accordingly, chose to accept the view of the Bombay, Allahabad and Kerala High Courts in preference to the view of the Calcutta High Court. In my view, the order of respondent No.1 cannot be sustained on the simple ground that respondent No. 1 is an authority operating within the State of West Bengal and is bound by the decisions of the High Court of this State ( see CIT v. Indian Press Exchange Ltd. [1989] 176 ITR 331 (Cal) ; East India Commercial Co. Ltd. v. Collector of Customs AIR 1962 SC 1993, paragraph 29). In that view of the matter, the impugned order must be set aside and the Commissioner is directed to consider the matter afresh in keeping with the decisions of this court after giving the petitioners an opportunity of being heard. At least 48 hours' clear notice must be given to the petitioners. The Commissioner will communicate the final order to the petitioner within eight weeks from the date of hearing.” (iv)CIT Vs. J.K. Jain (1998) 230 ITR 839 (P&H), observing as under: “We have carefully examined the records and have heard learned counsel representing the parties. We are in respectful agreement with the view expressed by the Allahabad High Court in Omega Sports and Radio Works’ case [1982] 134 ITR 28, as also the decision of this court in Mohan Lal Kansal’s case [1978] 114 ITR 583. Following the decision in the two cases referred to above, we hold that it was not a case of divergence of opinion inasmuch as the opinion expressed by this court was binding upon the Tribunal.” 11.16. Therefore, in our considered opinion, no contrary view can be taken under these circumstances. We, accordingly, hold that only those investments are to be considered for computing average value of investment which yielded exempt income during the year. 11.17. As far as argument relating to meaning to be ascribed to the phrase ‘shall not’ used in Rule 8D(2)(iii) is concerned, the Revenue’s contention is that it refers to those investments which did not yield any exempt income during the year but if Page 11 of 12 income would have been yielded it would have remain exempt. There is no dispute that if an investment has yielded exempt income in a particular year then it will enter the computation of average value of investments for the purposes of Rule 8D(2)(iii). The assessee’s contention that if there is no certainty that an income, which is exempt in current year, will continue to be so in future years and, therefore, that investment should also be excluded, is hypothetical and cannot be accepted. 11.18. In view of above discussion, the matter is restored back to the file of AO for recomputing the disallowance u/s 14A in terms of above observations.”

3.4.3 Respectfully following the decision of the Special Bench of ITAT, Delhi, in the case of ACIT Vs. Vireet Investments (P) Ltd., (2017) 82 taxmann.com 415 (Delhi-Trib) (SB), we also hold that only those investments are to be considered for computing average value of investment which yielded exempt income during the year under consideration for working out the disallowance u/s 14A r.w.r. 8D(2)(iii) in the case on hand. In our view, since this judicial pronouncement of the Special Bench of ITAT (supra) was passed subsequent to the passing of order of assessment for Assessment Year 2014-15, we deem it appropriate to restore this issue to the file of the AO only for the purpose of recomputing the disallowance u/s 14A r.w.r. 8D(2)(iii) of the Rules by restricting the disallowance thereunder i.e., for computing the average value of investments only to those investments which yielded the exempt income earned by the assessee during the year under consideration; as has been held and directed by the ITAT, Delhi Special Bench in the case of Vireet Investments (P) Ltd., (supra). We hold and direct accordingly. Consequently, the assessee’s appeal is partly allowed for statistical purposes.

Page 12 of 12 Order pronounced in the open court on this 2nd day of January, 2019.