DCIT, CHENNAI vs. SPERO FOUNDATIONS PVT LTD., CHENNAI

The first issue arising in the assessee’s appeal is the maintainability of the claim qua advances written off, at �. 67.87 lacs. The same were given during the relevant year itself to two concerns, namely, VK Investments and Holdings Pvt. Ltd. (at �. 30.11 lacs) and Naughty Trading Pvt. Ltd (at �. 37.76 lacs), against fabric purchase orders, placed on them for �. 31.69 lacs and �. 39.78 lacs respectively (refer paras 2.1 and 5.5 of assessment and the impugned order respectively). However, no goods were supplied nor were the amounts forthcoming and, rather, the companies were subsequently dissolved. Accordingly, the assessee was constrained to write off the debts as irrecoverable, claiming the same as business loss. The advances, as found by the Assessing Officer (AO), are to related parties. The companies were dissolved on 11.04.2011 and 28.01.2011, i.e., soon after being advanced on 19.07.2010. How could it be that the assessee company, a group concern, was not aware of their financial status? The transaction was only a camouflage to derive a tax advantage. The claim was accordingly dismissed. In appeal, the same was confirmed in the absence of any improvement being effected in its’ case by the assessee. Aggrieved, the assessee is in second appeal.

Before us, the ld. Authorized Representative (AR) would, placing reliance on CIT v. Crescent Films (P.) Ltd. [2001] 248 ITR 670 (Mad), submit that the assessee had purchased from the lendee concerns in the past as well. The companies had been declared defunct, and not gone into dissolution. The genuineness of the claim of loss could not be doubted merely because the said date was close to the date of the advance/s. The ld. Departmental Representative 3 & 1572/Mds/2016 (AY 2011-12) Spero Foundations Pvt. Ltd. (DR) would, on the other hand, urge for the confirmation of the disallowance, stating that no material has been brought on record by the assessee at any stage to establish its’ case. The transaction/s is only a make believe.

We have heard the parties, and perused the material on record. The Revenue has not raised any objection, i.e., in principle, to the assessee’s claim. Without doubt, a trade advance which becomes bad, being sustained in the regular course of business, the concomitant loss is a business loss, liable for being allowed in the computation of business income u/s. 28. The assessee’s reliance on the decision in Crescent Films (P.) Ltd. (supra), clarifying the legal position, would therefore be of no moment. It is the genuineness of the impugned loss – a matter of fact, that has been doubted by the Revenue. This is as the two advancee-payee concerns are related parties, so that it could not be that the assessee was not aware of their financial health when the advances were given. This is particularly so as the date of their being declared defunct is only a few months after the date of the advance/s. Rather, the said (defunct) status would only follow an acute financial stress. And, perhaps, for a considerable time prior to their being so declared (as defunct) inasmuch as the same signifies a declaration to the effect that the concern is no longer a going concern, i.e., a complete inability to function as an economic entity/agent. Without doubt, these facts and incidents, which are not in dispute, are sufficient to raise a strong, bona fide doubt as to the advances being genuine trade advances. In our view, the matter, rather than resting on a doubt, howsoever strong, is to be determined on a clear and definite finding of fact as to the transactions being motivated by an improper or oblique purpose and did not represent a genuine loss, i.e., which stands incurred bona fide by the assessee in the normal course of its business. This is all the more so as the same has penal and other consequences under the Act as well. Further, in view of the payee-companies having been declared defunct, there is little doubt that the 4 & 1572/Mds/2016 (AY 2011-12) Spero Foundations Pvt. Ltd. amounts stand lost irrecoverably and, thus, of the assessee incurring loss of capital to that extent. However, in view of the purchase orders, the same assumes the nature of a business loss. The companies are not in the relevant business/trade. Why did, then, the assessee place the orders? We have already opined that there exist reasons to doubt the genuineness of the transaction/s. This becomes all the more relevant as but for the orders, the amount advanced would be a capital transaction and, it’s loss, consequently, a capital loss, inadmissible as a business deduction. Further, as aforesaid, the financial condition would only be deleterious for the said companies to have been declared defunct just a few months later. The group concerns would, in any case, be in the intimate know of their own affairs. Why, and under what circumstances, then, did they accept the order/s, implying them to be in business, i.e., as going concerns, which they are apparently not. Again, even if facing financial stress, the supplies could yet been affected. That is, by securing goods from the market using the assessee’s money, earning a neat margin in the bargain and, rather, mitigating their financial problems to some extent. No supplies were admittedly made, and there is also no clue as to where the money advanced by the assessee has disappeared. That is, the placement of the purchase orders and their acceptance is, under the circumstances, highly suspect. It therefore cannot be said that the apparent is to be presumed, as is generally the case, as real. Also, the onus to prove its return, and claims preferred thereby, is only on the assessee (CIT v. Calcutta Agency Ltd. [1951] 19 ITR 191 (SC); CIT v. R. Venakataswamy Naidu [1956] 29 ITR 529 (SC)). The Assessing Officer (AO), on his part, may make any verification he deems proper, including collection of material in rebuttal of the assessee’s claims, duly confronting the same to the assessee. A number of surrounding circumstances need to be explained. To begin with, who placed the order/s on the assessee company, which is in the business of property rentals and running service apartments? That is, is a company not in the business of manufacturing 5 & 1572/Mds/2016 (AY 2011-12) Spero Foundations Pvt. Ltd. of garments, or even in the garment trade, i.e., for supplying which (garments) fabric is stated to being purchased, or even a significant part or a regular segment of its business. The business environment is extremely competitive, so that it is only the firms with long standing and experience in the relevant trade which would stand to be awarded the business or, in any case, would have to be competed with. Does, then, the assessee has the wherewithal to prosecute the orders inasmuch as the garments have to be manufactured? That is, on what basis did the assessee consider itself competent to supply, given the technical details of each product; the facilities required to deliver; the business intricacies of each trade, etc.? Then, on what basis does the company consider it prudent to source the supply from rather than those in the trade, the payee-concerns, which, like itself, have, clearly, no name or proven competence therein. That is, what is the source of its business confidence or commercial decision for the said purchases and, two, for the trade advance, which appears to be inconsistent with the trade practice. There are no details of fabric in the purchase orders (PB pgs. 23-26, 27-30). How would the purchase price, which varies over a range, to be assessed. The fabrics could vary over a vast range, on the parameters of yarn quality/size, composition, spun, colour, weave, design, etc. Unless communicated, it is neither possible for the assessee to source the material, nor for its supplier/s to do so. Again, how would they quote of price, or agree to a price, which implies a communication and understanding in the matter, which is conspicuous by its absence. This is all the more significant as, as it appears, the assessee itself did not receive any advance for the purpose, so that payment in advance does not characterize the trade. Continuing further, the purchase orders reflect the terms of payments as 50% advance. How, then, has the assessee given nearly the entire amount, which, rather, in one case (VK Investment, at �.32.90 lacs) exceeds 100% (of the order), as advance? This is all the more significant as, as it appears, the assessee itself did not receive any advance for the purpose, so that payment in 6 & 1572/Mds/2016 (AY 2011-12) Spero Foundations Pvt. Ltd. advance does not characterize the trade. The ledger accounts of the advancees (PB pgs. 33, 34) reveal the assessee to have money transactions with them; in fact settling their account (by making payment (�. 6.53 lacs) in one case, and receiving (�. 13.52 lacs) in another) months before the placement of purchase order/extending advance. How has the money been utilized by the payee companies, being related concerns, is also very relevant. That is, it could be a case where they had accepted the orders bona fide and proceeded to the source the materials, of which, to any extent, they may even have inventory, giving further advances, for purchasing the balance, etc. On the other hand, it would also be that the money has been diverted to make some urgent payments, leaving no money to supply. In case of the latter, the same would give credence to the Revenue’s claim of the transaction/s being camouflaged as an advance against purchase, i.e., to secure a tax advantage and, besides, to siphon off its funds to related concerns, admittedly in financial distress. Toward this, their balance-sheet/s or the work undertaken in the recent past would be relevant. Further, the orders clearly mention that the supplies are to be made within 15 days. Is it that the entire money has been utilized (lost) within the said span of time in-as-much as no supply whatsoever stands made within that time. That is, instead of the complete supply, even a part supply has not been made in the 15 day period, after which the assessee would definitely inquire, if not earlier, about the execution of its order. After all, its’ own supplies would get impacted by the non-receipt of the goods. Normally, the supplies would start soon after, i.e., in part shipments, enabling the assessee to process the goods further. Rather, it would be in constant contact with the supplier/s about the progress/ status of its order. There appears to be no such communication even after lapse of the 15 days. These and such like details, would throw light on the genuineness of the transaction, which would stand to be determined only after proper answers to these facts, incident to the business transaction, are made available. In fact, a defunct company is required to file a nil balance sheet with 7 & 1572/Mds/2016 (AY 2011-12) Spero Foundations Pvt. Ltd. the Registrar of Companies, i.e., along with it’s application u/s. 560 of the Companies Act, 1956. When was this application made in the case of the payee concerns? Further, how has the liability to the assessee been accounted for or treated in their books of account? This is as in the absence of any supplies being made, the entire sum would ostensibly continue to outstand as a liability, and could not possibly be neutralized in their books, as required to yield a nil balance sheet. This aspect would also be required to be examined. All these explanations/details, among others, would be readily available with the assessee if the transactions have actually arisen in the normal course of its business, to which surprisingly no reference has at all been made, even in passing, by the assessee while pleading its’ case. The facts/incidents referred to are only to enable definite findings of fact in the conspectus of the case. We, accordingly, only consider it proper to restore the matter back to the file of the AO to allow the assessee, in the interest of justice, another opportunity to prove its claims, which could be so on various counts and per a number of supporting documents and corroborative circumstances. Needless to add, he shall decide per a speaking order. The burden to prove its claims being on the assessee, an inability on its part to do so shall entitle the AO to draw inference(s) as may be proper under the circumstances. Reference here may be made to the decision in Kapurchand Shrimal v. CIT [1981] 131 ITR 451 (SC). We decide accordingly.

The next ground relates to the disallowance of personnel and administration expenses in the sum of �. 48,15,744/-, worked out at 96% of the total such expenditure. The assessee disclosed a rental income of �. 1,74,27,736/-, claiming personnel and administrative expenditure at �. 25.02 lacs and �. 25.15 lacs respectively there-against. The same surely could not be allowed against income from house property, under which head of income the rental income was returned and assessed. The rental receipt working to 96% of

We have heard the parties, and perused the material on record. Without doubt, there is no question of personnel and administrative expenditure being allowed in computing the income assessable as income from house property (s. 22), which is to be per ss. 23 & 24 of the Act. The ld. AR was questioned in respect of receipt from service apartments, who explained it to be booked under the head ‘silver spring income’ (at �. 5.34 lacs), i.e., separate from the rental income (�. 174.28 lacs), and returned and assessed as business income. This is as the service apartment income is only in the nature of a business, and income there-from, accordingly, business income. The question therefore that needs to be answered is the extent of expenditure incurred for or attributable to the property income, which constitutes the principal receipt and, correspondingly, the principal activity during the year. It was upon the assessee to show that the expenditure incurred in relation thereto is lower in proportion to that obtaining on the basis of the proportionate receipt in the total turnover. However, both before the AO as well as the ld. CIT(A) no explanation, much- less materials, stand furnished by the assessee toward the same. The position continues to be the same before us. How, therefore, we wonder, can the AO’s estimate, who is entitled to make the same on the basis of the material and the information on record, be faulted with (refer Consolidate Coffee Ltd. v. State of Karnataka [2001] 248 ITR 432 (SC)). That the AO is entitled to make a reasonable estimate is well settled. The reasonability of the estimate apart, personnel and administrative expenditure is inadmissible u/ss. 23 & 24, so that the AO has in fact, in allowing proportionate expenditure thereon, been liberal. Under the circumstances, we find no infirmity in the impugned order and, accordingly, confirm the disallowance. We decide accordingly.

9 & 1572/Mds/2016 (AY 2011-12) Spero Foundations Pvt. Ltd. Revenue’s Appeal 7. The only issue in the Revenue’s appeal is the disallowance u/s. 14A in respect of dividend income of �. 1,12,122/-, which stands worked out u/r. 8D at a total of �. 58,29,423/-, comprising direct expenditure (on interest) (at �. 56.16 lacs), indirect interest expenditure (�. 49,555/-) and indirect administrative expenditure (�. 1.64 lacs). The basis of the relief by the ld. CIT(A), approving the disallowance in principle, is that the disallowance u/s. 14A cannot exceed the exempt income, as held in Joint Investments Pvt. Ltd. v. CIT [2015] 372 ITR 694 (Del).

We have heard the parties, and perused the material on record. Section 14A seeks to disallow, in computing the assessee’s total income, expenditure incurred in relation to income not forming part of the total income under the Act. This is as, as explained in Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT [2010] 328 ITR 81 (Bom), ‘income’ implies only net income, i.e., net of expenditure incurred for or toward earning the same, whether taxable or tax- exempt. Where, therefore, expenditure is incurred which is partly in relation to income forming part of the total income and the partly not so, the expenditure in relation to the latter is to be isolated and netted against the said, i.e., income not forming part of the total income. This is the rationale of s. 14A, as explained in CIT v. Walfort Share & Stock Brokers (P.) Ltd. [2010] 326 ITR 1 (SC), referred to in Godrej & Boyce Mfg. Co. Ltd. (supra). Further, the expenditure incurred in relation to exempt income is to be computed with reference to and having regard to the assessee’s accounts. However, where the same is not ascertainable with reference to the assessee’s accounts or the AO is not satisfied with the assessee’s appropriation, i.e., the correctness of the method employed by the assessee, he shall compute the same with reference to the method as may be prescribed, and which brings us to r. 8D (s. 14A(2)). The assessee’s appropriation would include a case where no expenditure is, in it’s view, 10 & 1572/Mds/2016 (AY 2011-12) Spero Foundations Pvt. Ltd. attributable to the exempt income (s. 14A(3)). Of course, the assessee’s method has to be, again, with reference to its accounts and not de hors the same, in which case it is not more than a bald claim (refer: AFL (P.) Ltd. v. Asst. CIT [2013] 28 ITR (Trib.) 263 (Bom)). The constitutionality of r. 8D stands upheld in Godrej & Boyce Mfg. Co. Ltd. (supra), and is not under challenge, so that it is, by necessary implication, reasonable and not arbitrary. In fact, the only component of r. 8D which seeks to estimate without reference to the accounts – except broadly, is qua indirect, administrative expenditure, pegging the same at an extremely low ratio of the investment that yields exempt income. This is as the nature of such expenditure may assume diverse forms and, further, has no correspondence with the income that may arise from the activity entailing the expenditure. The company may, for example, hold an investment for an entire year, to no avail, while in another case an investment at the fag-end of the year may be productive, yielding income, the quantum of which is again uncertain/ variable. That is, there could be no uniformity in the expenditure incurred on holding/managing the investments. While in one case it may be a case constant review as to buy, hold or sell, i.e., on a regular basis, in another there may be practically no expenditure, i.e., indirect, administrative expenditure, in relation thereto. The same, therefore, where not determinable with reference to the assessee’s accounts, has been provided for by law to be at a fraction (0.5%) of the average value of investment held during the relevant year. As regards interest, the same would without doubt depend upon the financing, direct or indirect, of the relevant investment, so that the same would again depend on the facts of the case. The Finance Act, 2017 further fine tunes the attribution method prescribed u/r. 8D by averaging the investment on a monthly basis, rather than the simple mean of the opening and closing balance for the year. Further, by way of abundant caution, it also provides that the disallowance (of expenditure) shall not exceed the total expenditure claimed by the assessee. This is in fact axiomatic as the same cannot possibly exceed the expenditure actually 11 & 1572/Mds/2016 (AY 2011-12) Spero Foundations Pvt. Ltd. incurred, which is/is to be attributed, i.e., in whole or in part, to the income not forming part of the total income. In other words, the disallowance of expenditure is essentially a matter of fact, and cannot be either prejudged or predetermined by law. Why, the amount of income, with reference to and at which the expenditure is said to be artificially pegged/limited to, is itself uncertain. Reference in this regard may also be made to the decision in CIT v. Rajendra Prasad Moody [1978] 115 ITR 519 (SC), as well as the decisions in Dy. CIT v. Damani Estates & Finance (P.) Ltd. [2013] 25 ITR (Trib) 683 (Mum) and Voltech Engineers (P.) Ltd. v. Dy. CIT [2017] 163 ITD 469 (Ch), to cite some, by the Tribunal. There is, in fact, no mandate in law for the proposition being advanced, attributed to the decision in Joint Investments Pvt. Ltd. (supra). All that this decision says is that the expenditure disallowed under section 14A could not exceed that actually incurred, the cache notes of the said decision reading as under: ‘Income – Computation – Disallowance of expenditure on earning non- taxable income – disallowance only to extent of expenditure incurred by assessee in relation to tax exempt income – no reason for disallowance of sum volunteered – no scrutiny of accounts – entire tax exempt income lower than disallowance – matter remanded – Income-Tax Rules, 1962, r. 8D – Income-Tax Act, 1961, s. 14A.’ We have in fact regarded this – the ratio of the decision, as a truism inasmuch as no more than the expenditure incurred could, at best, be attributed to the relevant income, further pointing that such a caveat has since been incorporated in the statute itself. There being no scrutiny of accounts, a pre-requisite, the Hon’ble Court wondered as to how could the disallowance ‘swallow’ the entire (exempt) income. In the present case, on the contrary, the assessee has furnished no basis for its nil disallowance. Almost, the entire disallowance u/s. 14A is qua direct interest expenditure, implying an examination of accounts, as well as of the extent to which the investment has been financed by interest bearing funds.

In the result, the assessee’s appeal is partly allowed for statistical purposes, while the Revenue’s appeal is allowed. Order pronounced on September 04, 2017 at Chennai.