THE COMMISSIONER OF INCOME TAX vs. M/S. STATE BANK OF MYSORE

1 IN THE HIGH COURT OF KARNATAKA AT BENGALURU DATED THIS THE 15TH DAY OF OCTOBER 2020 PRESENT THE HON’BLE MR. JUSTICE ALOK ARADHE AND THE HON’BLE MR. JUSTICE H.T.NARENDRA PRASAD I.T.A. NO.355 OF 2013 BETWEEN: 1. THE COMMISSIONER OF INCOME-TAX

LTU, JSS TOWERS

BSK III STAGE, BANGALORE. 2. THE ADDL. COMMISSIONER OF INCOME-TAX

LTU, JSS TOWERS

100 FEET RING ROAD

BSK III STAGE, BANGALORE-560085.

... APPELLANTS (BY SRI. K.V. ARAVIND, ADV.,) AND: M/S. STATE BANK OF MYSORE HEAD OFFICE, P.B. NO.9727 K.G. ROAD, BANGALORE-560254. ... RESPONDENT (BY SRI. ANKUR PAI, FOR SRI. K.R. VASUDEVAN, ADV.) - - - THIS ITA IS FILED UNDER SECTION 260-A OF I.T. ACT, 1961 ARISING OUT OF ORDER DATED 28.02.2013 PASSED IN ITA NO.1242/BANG/2011, PRAYING TO: (I) FORMULATE THE SUBSTANTIAL QUESTIONS OF LAW STATED THEREIN.

2 (II) ALLOW THE APPEAL AND SET ASIDE THE ORDERS PASSED BY THE ITAT, BANGALORE IN ITA NO.1242/BANG/2011 DATED 28.02.2013 CONFIRMING THE ORDER OF THE APPELLATE COMMISSIONER AND CONFIRM THE ORDER PASSED BY THE ADDITIONAL COMMISSIONER OF INCOME TAX, (LTU), BANGALORE. THIS ITA COMING ON FOR FINAL HEARING, THIS DAY, ALOK ARADHE J., DELIVERED THE FOLLOWING: JUDGMENT This appeal under Section 260A of the Income Tax Act, 1961 (hereinafter referred to as the Act for short) has been preferred by the revenue. The subject matter of the appeal pertains to the Assessment year 2003-04. The appeal was admitted by a bench of this Court vide order dated 12.08.2013 on the following substantial questions of law: (i) Whether the Appellate Authorities were correct in holding that the assessee has claimed the provision created under Section 36(1)(viia) of the Act and the bad debt written off is adjusted to the provision and no bad debt is written off under Section 36(1)(vii) of the Act and hence provisions of Section 41(1)/41(4) of the Act are not attracted on a subsequent recovery of the

3 written off debt, when the provision created under Section 36(1)(viia) of the Act is allowed as a deduction and recorded a perverse finding? (ii) Whether the Appellate Authorities were correct in holding that the employees contribution deducted by the assessee has been credited under the respective statue before filing return of income and hence allowable deduction without taking into consideration, the provisions of Section 2(24)(x) read with Section 36(va) of the Act? (iii) Whether the Appellate Authorities were correct in holding that the Assessing Officer has not discharged his burden of proving that the entire income under investment is from the investments made by utilizing borrowed funds, when 80% of the funds employed in the business are borrowed funds and recorded a perverse finding?

4 (iv) Whether the Appellate Authorities committed an error in not taking into consideration that the income earned is exempt and the expenditure incurred for earning the exempt income is not allowable under Section 14A of the Act and the burden of establishing non-incurring of expenditure was on the assessee? (v) Whether the Appellate Authorities committed an error in not taking consideration that 80% of the total funds employed are borrowed funds and the investment by the assessee is from the borrowed funds and the correspondent interest is liable to be disallowed under section 14A of the Act? (vi) Whether the Appellate Authorities committed an error in not taking into consideration that the assessee has earned income exempted under Section 80M of the Act and the corresponding expenditure is required to be disallowed under section 14A of the Act?

5 2. Facts leading to filing of this appeal briefly stated are that the assessee is subsidiary of state bank of India and is governed by State Bank of India (Subsidiary Banks) Act, 1959. The assessee filed the return of income for the Assessment Year 2003-04 on 24.11.2003 and declared a total income of Rs.109,80,14,986/-. The assessment under Section 143(3) of the Act was completed on 27.03.2006 by which taxable income of the assessee was determined at Rs.209,05,29,960/-. The Commissioner of Income Tax (Appeals) by an order dated 25.03.2008 passed under Section 263 of the Act held that order dated 27.03.2006 passed by the Assessing Officer was erroneous and prejudicial to the interest of revenue. Thereafter, the Assessing Officer passed an order dated 31.07.2008 under Section 143(3) of the Act making various addition / disallowances to the taxable income, in addition to the one's already made in the order dated 27.03.2006.

6 3. The assessee thereupon filed an appeal before the Commissioner of Income Tax (Appeals) who by an order dated 28.09.2011 inter alia held that as deduction is under Section 36(1)(viia) of the Act, the subsequent recoveries are not taxable under Section 41(1) or Section 41(4) of the Act. It was further held that disallowance under Section 14A of the Act towards borrowed fund on investment should be restricted to 2% of the interest on tax free bonds. The Commissioner of Income Tax (Appeals) deleted the disallowance of expenditure incurred on earning the income exempt under Section 80M of the Act. The appeal was partly allowed. Being aggrieved, the revenue approached the Income Tax Appellate Tribunal (hereinafter referred to as 'the tribunal' for short). The tribunal by an order dated 28.02.2013 inter alia held that assessee is entitled for deduction as the entire amount of employees contribution is credited under the restricted statute before filing the return. The tribunal also allowed the

7 deduction of expenditure under Section 14A of the Act on the ground that burden of proving the expenditure on the exempt income for disallowance of claim under Section 14A of the Act is on the Assessing Officer, which he has failed to discharge. The tribunal by following its earlier order held that expenditure disallowed for earning of income exempt under Section 80M of the Act is not sustainable and the entire expenditure was allowed. In the aforesaid factual background, the revenue has filed this appeal. 4. Learned counsel for the assessee submitted that the revenue had filed a miscellaneous petition before the Income Tax Appellate Tribunal which has been allowed by the Tribunal vide order dated 05.03.2016 and the matter has been remitted to the Assessing Officer. The aforesaid submission could not be disputed by the learned counsel for the revenue. In view of the order dated 05.03.2016 passed by the Income Tax Appellate Tribunal, the 1st substantial

8 question of law involved in this appeal has been rendered academic. However, all contentions with regard to the 1st substantial question of law are kept open for the time being. 5. Learned counsel for the assessee further submitted that the 2nd substantial question of law as well as 6th substantial question of law are answered against the revenue by a Bench of this Court in ‘COMMISSIONER OF INCOME-TAX Vs. SABARI ENTERPRISES’ (2008) 298 ITR 141 (KAR) and 'COMMISSIONER OF INCOME-TAX VS. KARNATAKA BANK LTD.', (2014) 49 TAXMANN.COM 246 (KARNATAKA). The aforesaid legal position could not be disputed by the learned counsel for the revenue. For the reasons assigned by a Bench of this Court in SABARI ENTERPRISES and KARNATAKA BANK LTD., supra, the 2nd as well as 6th substantial question of law are answered against the revenue and in favour of the assessee.

9 6. Now we may advert to substantial questions of law Nos.3, 4 and 5. learned counsel for the revenue submitted that the tribunal committed an error of law in shifting the burden on Assessing Officer to establish that the investment is out of the interest bearing funds. It is submitted that Section 37 of the Act imposes burden on the assessee to establish that expenditure is incurred for business purposes. It is also pointed out that profit and loss account establishes the fact that 80% of the borrowed funds were utilized for tax free investments, which has not been disputed by the assessee. However, the tribunal has failed to record any finding on this aspect. It is also urged that contention of the assessee that investment is out of surplus funds is not correct and the aforesaid contention does not find mention in the order of the tribunal. 7. On the other hand learned counsel for the assessee submitted that investment in securities earning exempt income have been made only out of surplus

10 funds of bank and no expenditure has been incurred in earning the exempt income. It is also pointed out that Assessing Officer has not demonstrated the proximate cause between the exempt income and the expenditure disallowed. It is also argued that Income Tax Appellate Tribunal and the Commissioner of Income Tax (Appeals) have noted the submissions of respondent that investment in the securities earning exempt income has been made only out of surplus funds of the bank and Commissioner of Income Tax (Appeals) has observed that disallowance made by the Assessing Officer was based on the presumption that entire investment is in tax free bonds / eligible investments would have invariably come from borrowed funds only without substantiating the claim anything with evidentiary value. It is further submitted that Commissioner of Income Tax (Appeals) and Income Tax Appellate Tribunal have followed the rule of consistency and have upheld the suo motu disallowance of 2% of exempt income. It is

11 contended that the tribunal has rightly held that the burden is on the revenue to demonstrate that the expenditure incurred for earning exempt income. It is also urged that Section 14A(2) of the Act is not applicable for Assessment Year 2003-04 and the Assessing Officer not having identified the expenditure and assuming the entire interest expenditure to the extent of exempt income without demonstrating the relatability / nexus with the exempt income, the disallowance under Section 14A is not sustainable. In support of aforesaid submissions, reliance has been placed on decisions in 'CIT VS. WALFORT SHARE & STOCK BROKERS (P) LTD', (2010) 326 ITR 1 (SC), 'CIT VS. ALOM EXTRUSIONS LTD', (2009) 319 ITR 306 (SC), 'CIT V. SYNDICATE BANK', (2020) 115 TAXMANN.COM 287 (KARNATAKA), 'CIT VS. KARNATAKA BANK LTD', (2014) 226 TAXMAN 187 (KARNATAKA) 'CANARA BANK VS. ASST CIT', (2014) 265 CTR 385 (KARNATAKA), CIT VS.

12 SABARI ENTERPRISES', (2008) 298 ITR 141 (KARNATAKA), MAHARASHTRA APEX CORPORATION LTD V. CIT (2006) 286 ITR 585 (KARNATAKA) . 8. We have considered the submissions made by learned counsel for the parties and have perused the record. Section 37(1) of the Act provides that any expenditure not being expenditure of the nature described in Sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee, laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession". Thus, it is evident that the burden is on the assessee to prove that the expenditure has been incurred for business purposes and investment is made out of surplus funds. In the instant case, from the perusal of the order of the Assessing Officer, it is evident

13 that Assessing Officer on perusal of the balance sheet filed by the assessee has recorded a finding that 80% of the funds employed in the business are borrowed funds, on which the assessee is paying interest and therefore, the investment has been made by the assessee on tax free bonds should have invariably come from borrowed funds only. It was further held that the assessee has not made any effort to discharge the onus of proving that such investment or any part was made out of its own fund and not out of borrowed capital. 9. During the course of hearing before the Commissioner of Income Tax (Appeals), the assessee along with written submissions dated 15.07.2011 produced documents to show that it had made investment in securities earning exempt income out of surplus funds of the bank and disclosed the particulars of the income earned by the bank by investing in surplus funds. However, the Commissioner of Income Tax (Appeals) has also not recorded any finding in this

14 regard. The tribunal in paragraph 9 of its order that it was the duty of the Assessing Officer to identify the expenditure which is relatable to earning of the exempt income and only such part of expenditure has to be disallowed under Section 14A of the Act. However, neither the Commissioner of Income Tax (Appeals) nor the tribunal has recorded any finding whether the bank had made investment in the securities earning exempt income out of surplus funds. Therefore, we are left with no option but to remit the matter to the Commissioner of Income Tax (Appeals). For the aforementioned reasons, we hold that the tribunal erred in holding that the burden was on the Assessing Officer to prove that entire income under investment is from the investment made by utilizing borrowed funds. Accordingly, the substantial questions of law Nos.3, 4 and 5 are answered. In the result, the order passed by the tribunal as well as Commissioner of Income Tax (Appeals) is hereby quashed. The Commissioner of Income Tax

15 (Appeals) shall examine the material produced by the assessee to show that the investment in securities earning exempt income was made from surplus funds of the Bank and thereafter, shall proceed to decide the matter in accordance with law. The issue with regard to applicability of Section 14A for the Assessment Year 2003-04 as well as all other contentions are kept open. In the result, the appeal is disposed of. Sd/- JUDGE Sd/- JUDGE ss