DCIT 10(3), MUMBAI vs. AARTI INDUSTRIES LTD, MUMBAI

Date of hearing : 07-12-2016 Date of order : 21 -12-2016

O R D E R Per ASHWANI TANEJA, AM: These cross appeals have been filed against the order of Commissioner of Income-tax (Appeals)-22, Mumbai [in short CIT(A)] dated

2. First, we shall take up appeal filed by the assessee on the following grounds:- “

The Appellant submits the following grounds, which are without prejudice to one another:

1. Re: Disallowance u/s. 14A of Rs. 1,24,28,099/- 1.1 On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in upholding disallowing expenses attributable to earning the dividend income u/ s. 14A by invoking Rule 8D without satisfying or establishing as to why the disallowance carried out by the Appellant amounting to Rs.4,67 ,021/ - was not satisfactory. 1.2 The learned CIT(A) ought to have considered that the Appellant had sufficient own / interest free funds and an investment made ought to have been considered as made out of own interest free funds in absence of direct nexus between funds employed and investments made. 1.3 Without prejudice to the above, the Assessing Officer grossly erred in computing disallowance under rule 8D. 1.4 Without prejudice to the above, the disallowance u/s. 14A ought to be substantially reduced.

2. Re: Reducing disallowance made u/s. 14A while computing 115JB: 2.1 On the facts and in the circumstances of the case and in law, the learned CTT(A) ought to have considered that no disallowance u/s 14A is warranted while computing book profit u/s 115.JB.

2.2 Without prejudice to the above, the learned CIT(A) erred in upholding disallowing expenses attributable to earning the dividend income u/s. 14A by invoking Rule SD without satisfying or establishing as to why the disallowance carried out by the Appellant amounting to Rs.4,67 ,021/- was not satisfactory. 2.3 Without prejudice to the above, the learned CIT(A) ought to have considered that the Appellant had sufficient own / interest 3 & 2633/Mum/2014 free funds and an investment made ought to have been considered as made out of own interest free funds in absence of direct nexus between funds employed and investments made. 2.4 Without prejudice to the above, the Assessing Officer grossly erred in computing disallowance under rule 8D. 2.5 Without prejudice to the above, the disallowance u/s. 14A ought to be substantially reduced.

4. Re: Disallowance u/ s.40A(2) in case of goods purchased from M/ s. Ganesh Polychem Limited of Rs.4,75,200/-: 4.1 The learned CIT(A) erred in upholding the disallowance made by Assessing Officer in respect of goods purchased from M/ s. Ganesh Polychem by stating that the said expenditure is excessive or unreasonable having regard to the fair market value of the goods. 4.2 The learned CIT(A) relied on the preliminary analyses done by Assessing Officer of comparison of rates of other vendors for same goods and held that the said purchases were not at arms length. The learned CIT(A) failed to consider that the facts and circumstances of the case were different and thus the expenditure incurred was fair and reasonable.

3. Ground 1: This ground is against the disallowance u/s 14A. The brief background is that during the course of assessment proceedings it was noted by the AO that assessee had received dividend income of Rs.96,70,037 and claimed it as exempt. He invoked provisions of section 4 & 2633/Mum/2014 14A and made disallowance aggregating to Rs.1,28,95,120/- (i.e. Rs.1,16,01,605/- on account of interest and Rs.12,93,515/- on account of administrative expenses @ 0.5% of average investment). It was also noted by the AO that voluntary disallowance was made by the assessee of Rs.4,67,021/- therefore, no disallowance of Rs.1,24,28,099/- was made by him. In the appeal before the Ld. CIT(A), detailed submissions were made. It was inter-alia submitted by the assessee that assessee has got interest free sufficient funds. Therefore, no disallowance was called for on account of interest. Further, with regard to the expenses incurred it was submitted that assessee had already made voluntary disallowances of Rs.4,67,021/- therefore, no further disallowance was required to be made. But, the Ld. CIT(A) did not accept the submissions of the assessee and confirmed the disallowance made by the AO with following observations:-

“6.3 I have carefully considered the finding of the AO in the impugned assessment order and the above submission of the appellant. It is the claim of the appellant that interest bearing funds were not utilized for the, purpose of investments in shares. Since funds are mixed and both interest bearing as well as non- interest bearing funds goes to the common kitty and as the appellant did not furnish any evidence to show that the investment in shares which earned exempt income was exclusively out of non interest bearing funds. I do not agree with the claim of the appellant. Rule 8(2) is squarely applicable to the facts and once it is applied there is no discretion left to the AO, he had to follow the formula. Hence, I find the disallowance made by the AO is in order. This ground of appeal is dismissed.”

4. During the course of hearing before us, it was submitted by the Ld. Counsel that no disallowance is required to be made on account of interest since own funds of the assessee are far more than the amount of No interest disallowance can be made u/s 14A of the Act since own funds are sufficient to cover up the value of investments - CIT v. Reliance Utilities Ltd [313 ITR 340 (Bom)] - CIT vs. HDFC Bank Ltd [366 ITR 505 (Bom)] - Alchemic Financial Services v Addl.CIT (ITA No. 6349/Mum/2011) - Paresh K Shah v. Dy.CIT (ITA No. 8214/Mum/2011)

5. With regard to the expenses disallowed @0.5% u/r 8D(2)(iii), it was submitted that no satisfaction was recorded by the AO, therefore, AO wrongly applied the said rule to make the impugned disallowance. It was also submitted that investments made in subsidiary / group companies were made for the purpose of strategic reasons and acquiring control and not for the purposes of earning exempt income, therefore, this should be excluded while computing disallowance u/s 14A in view of the following judgments:- 1. Cheminvest Ltd vs CIT 378 ITR 33 (Del) 2. Garware Wall Ropes Ltd vs Addl CIT (ITA No. 5408/Mum/2012 3. M/s JM Financial Ltd vs Addl. CIT (ITA No.4521/Mum/2012) 4. CIT vs. Oriental Structural Engineers Pvt Ltd (Delhi High Court)

6. Per contra, the Ld. DR relied upon the order of the AO as well as the order of the CIT(A) and requested for upholding the disallowance.

7. We have gone through the orders passed by the lower authorities. It is noted from the perusal of the table reproduced by the Ld. CIT(A) in his order on page 12 that net worth of the assessee company comprising of share capital and reserves aggregated to Rs.284.27 crores, whereas the aggregate amount of investments was merely to the tune of Rs.26.19 crores. Thus, ‘own funds’ of the assessee were apparently far more than the amount of investments in tax free securities. Under these

6 & 2633/Mum/2014 circumstances, no disallowance can be made on account of interest in view of judgements of Hon'ble Bombay High Court in the case of CIT vs Reliance Utilities Ltd vs CIT (supra) and HDFC Bank Ltd (supra). Therefore, disallowance on account of interest of Rs.1,16,01,605 is hereby directed to be deleted.

“11.2 The above submissions are considered carefully. With the introduction of section 14A of the Act, no expenditure incurred in relation to earning of income not forming part of total income, is allowable as deduction. The administrative and other expenses incurred by the Assessee Company facilitate earning of all incomes including the exempt income. The funds of business are a mix of own as well as borrowed funds. Hence, the incurring of interest income in relation to earning of exempt income cannot be ruled out. These are valid inferences based on the facts of the case. In this connection, reliance is placed on the following decisions/ judgments.

11. Magganlal Chagganlal Pvt. Ltd. (236 ITR 456) (Born)

11.3 The submission of the assessee company that no effort was required for maintaining the investment is not born out of the records. The investments made by the assessee have gone up during the year. The assessee had debited huge expenditure in the Profit & Loss account like interest expenditure, administrative expenditure etc. Moreover, no separate books of accounts are maintained for the purpose of earning exempt 7 & 2633/Mum/2014 income and taxable income. The accounts are mixed. The common fund is employed for earning exempted income as well as taxable income. Therefore, I am not satisfied with the claim of the assessee that no expenditure has been incurred for earning exempt income.”

9 & 2633/Mum/2014 Fertilizers & Petrochemicals. The AO found the same to be excessive and, therefore, he disallowed 50% of the total purchases for Rs.7,20,000/- was disallowed. In the appeal before the Ld. CIT(A), it was submitted by the assessee that rates of methanol have fluctuated all around the year. The purchases from Ganesh Polychem Ltd were made in April, 2007 whereas the purchases from the other concerns were made in June, 2007. Therefore, the purchases of two different parties should not be compared. It was also submitted that the credit terms and lead time for delivery taken by Ganesh Polychem Ltd was better in comparison to other concerns and that is why higher rate was paid. The Ld. CIT(A) was not fully satisfied with the submissions of the assessee and, therefore, he upheld the disallowance in principle, but re-computed the amount of disallowance in view of correct facts. The following are the findings of the Ld. CIT(A):-

“9.3 I have carefully considered the finding of the AO in the impugned assessment order and the above submission of the appellant. The contention of the appellant that there were material differences in the both the purchases on account of the factors like different dates of purchase, favourable credit terms, etc. cannot be accepted. The purchase from M/s.Ganesh Polychem Ltd. was made in the month of March,2007 and the rate per kg. is Rs.25.50. In support of this, two invoices raised by M/s.Ganesh Polychem Ltd. were furnished along with the submission. I have perused both the invoices and found that after inclusion of excise duty and other cess and CST, the rate works out to Rs.30.89. The copy of the invoice for purchases from M/s.Urmi Chemicals and M/s. Deepak Fertilizers and Petrochemicals was also filed along with the submission which shows that the rate per kg. was Rs.15.37 and 15.69 exclusive of excise duty and other levies. Hence, to this extent, I find the contention of the appellant that the AO has erred in adopting the rate inclusive of taxes in the case of sister concern is acceptable. However, with regard to the different dates of 10 & 2633/Mum/2014 purchases as contended by the appellant, I find the purchase from M/s.Ganesh Polychem Ltd. was in March, 2007 and with other two concerns it was in July, 2007.1_ feel there cannot be a great variation in rate within 3 months and purchase at different dates should not have a great impact on the rate of purchase. Further, the appellant did not bring any evidence to show that a favourable credit terms have been extended by the sister concern because of which, a higher rate was charged. In view of this, I am satisfied that the rate per kg. from M/s.Ganesh Polychem Ltd. should be adopted at Rs.25.50 as against Rs.30.89 adopted by the AO which has resulted in a difference of RS.5.39 per kg. which works out to 17%. To this extent, the which has resulted in a difference of RS.5.39 per kg. which works out to 17%. To this extent, the AO had made an excess disallowance of 17%. In view of this, I direct the AO to adopt disallowance at 33% (50-17) as against 50% adopted. The appellant gets relief of the balance. This ground of appeal is partly allowed.”

16. During the course of hearing before us, the Ld. Counsel vehemently argued that since purchases were made from different parties at two different points of time, the purchases cannot be compared.

11 & 2633/Mum/2014 to half in the open market. In any case, no such evidence was brought on record by the assessee. It is also noted that the Ld. CIT(A) has already given appropriate relief by re-working the amount of disallowance at correct rates. We do not find any need for making any further interference in the order of the Ld. CIT(A) on this issue and, therefore, the same is hereby upheld. This ground is dismissed.

12 & 2633/Mum/2014 circumstances, we find it appropriate to send this issue back to the file of the AO where the assessee shall get adequate opportunity of hearing to submit the reconciliation statement and other required details and evidences. The AO shall also consider all the arguments of the assessee including the arguments that the impugned difference is not leading to suppression of income, and therefore, no addition could be made on account of impugned difference. With these directions, this ground is send back to the file of the AO for deciding it afresh after giving adequate opportunity of hearing to the assessee. As a result, this ground may be treated as allowed, for statistical purposes.

“1. On the facts and in the circumstances of the case and in law, the Ld.CIT{A) erred in allowing the depreciation Rs. 32,82,7.26/- claimed by the assessee on the basis of letter of approval dated 10/10/2010 received much later than the date of filing of Return of Income without considering Rule 5(2)(ii) for claim of such depreciation.

2. On the facts and in the circumstances of the case and in law, the Ld.ClT(A) erred in allowing the appeal and deleting the disallowance of Rs.64,22,951/- without analysing the provisions of section 35(2AB)(3) of the Act. "2. On the facts and in the circumstances of the case and in law, the Ld.ClT(A) erred in allowing the interest u/s 36(1)(iii) of Rs. 2,37,16,415/- on loans advanced to the subsidiary companies viz M/s Aarti Healthcare Ltd and M/s Avinash Drugs Ltd. without appreciating the fact that the assessee failed to establish that it served the business Interest of the assessee.

13 & 2633/Mum/2014 3. "On the facts and in the circumstances of the case and in law, the Ld.CIT(A) erred in allowing the interest u/s 36(1)(iii) of Rs.2,37,16,415/- on loans advanced to the subsidiary companies viz. M/s Aarti Healthcare Ltd and M/s Avinash Drugs Ltd without appreciating the fact that the assessee failed to establish that it served the business interest of the assessee.

1. The Appellant in A. Y. 2005-06 and A. Y. 2006-07 had claimed depreciation @ 40% under rule 5(2) on plant / machinery put to use for commercializing the technology developed in-house. The said claim was disallowed in the respective assessment years as the DSIR had not accorded the approval to claim under rule 5(2). (We enclose herewith depreciation schedule for A. Y. 2005-06 at page no. 33 and A. Y. 2006-07 at page no. 36 to page no. 37 of the paper book, and the relevant extract of the Assessment Order u/s. 143 (3) for A. Y. 2005-06 at page no. 34 to page no. 35 and A. Y. 2006-07 at page no. 38 to page no. 39 of the paper book) .

15 & 2633/Mum/2014 completing the assessments. Since the approval is now granted, I find the claim of the appellant needs to be allowed. However, I direct the AO to allow the depreciation on the corrected W.D.V. after giving effect to the claim of depreciation for A.Y.2005-06 to A.Y.2007-08. Subject to this direction, this ground is partly allowed.”

16 & 2633/Mum/2014 No.3CL and hence, the report is incomplete. The AO had allowed Rs.1,28,45,902/- which is the actual cost incurred (includes both revenue expenditure u/s 35(1)(i) and capital expenditure u/s 35(21)(iv) as against the claim of Rs.1,92,68,853/- by the assessee and added Rs.64,22,951/-. In the appeal before Ld.CIT(A), it was brought to the notice of the Ld.CIT(A) that assessee had subsequently received approval in Form 3CM and the same was shown, and therefore, there was no reason to continue with the disallowance. After examining the evidence, Ld. CIT(A) allowed the relief with following observations :- “4.3 I have carefully considered the finding of the AO in the impugned assessment order and the above submission of the appellant. As brought out by the appellant in the submission, a prescribed agreement duly signed by the Managing Director of the company is filed alongwith form NO.3CK before the DSIR. Once the DSIR gives an approval, it automatically means that the agreement is given effect to. The AO had never doubted the genuineness of this claim. He was convinced that all conditions lay down in section 35(2AB) was satisfied except clause (iv). There cannot be a doubt that the appellant is having in-house R&D facility and as discussed in par 3.3 above in ground of appeal No.2, the DSIR has given due approval for the in-house research facility set up. Further, as a standard procedure, the agreement signed by the Managing Director is filed along with Form NO.3CM which was very much produced before the AO and it was also produced before me. The appellant had complied with all the conditions laid down in Section 35(2AB). Signing of the agreement by DSIR is only a technical formality. As mentioned above the appellant had complied with the formality by submitting the same before the authority. Hence the appellant cannot be blamed. 4.4 Before me, the appellant had strongly relied on the decision of the ITAT in its own case for A.Y.2003-04. A clear finding to the effect that once the appellant gets the formal approval from DSIR in Form No.3CM, the appellant is entitled for deduction u/s.35(2AB) was given by the ITAT.

17 & 2633/Mum/2014 4.5 Further a finding was also given to the effect that even if the agreement is not signed by DSIR, it will not make a difference and the deduction has to be allowed. Since there is no change in the facts and circumstances during the year, respectfully following the decision of the Hon'ble ITAT, I direct the AO to allow the weighted deduction of 150%. The decisions relied on by the appellant also supports its case. This ground of appeal is allowed.”

18 & 2633/Mum/2014 32. The brief background is that during the course of assessment proceedings it was noted by the AO that the interest bearing funds were not utilized for advancing loan to the sister concern, the AO disallowed the claim u/s 36(1)(iii). The claim of the assessee that there is business expediency relying on the decision of SA Builders, was also not accepted by the AO. Further, since the assessee failed to discharge the onus and did not satisfactorily demonstrate that only interest free funds were advanced as loans to sister concern, the AO disallowed proportionate interest @12% on the interest free loans advanced amounting to Rs.2,37,16,415/-. In the appeal before Ld. CIT(A), detailed submissions were made by the assessee wherein it was inter-alia submitted that the assessee had sufficient funds to give these loans and in any case, these amounts were given for the purpose of business of the assessee.

19 & 2633/Mum/2014 "The appellant has mentioned before the AO that loan was advanced to the subsidiary company for purpose of strengthening financial condition and thereby improving business since it was holding 51% of shares of Aarti Healthcare Ltd. and 86% shares of Avinash Drugs Ltd. Relying upon several judgements, the appellant further stated before AO that since interest free advances to subsidiary company have been given for the purpose of business of commercial expediency, disallowance cannot be made. It was also stated that the assessee has huge interest free funds and accumulated reserves. Detailed submissions have also been made wherein the commercial expediency has been explained. Identical issue had come up before my Ld. Predecessor in A.Y.2003-04 & 2004-05 and also undersigned for A.Y.2005-06 and 2006-07 wherein this ground of appeal was allowed relying on several judgements including that of SA Builders Ltd. 288 ITR

1. The facts of the case are identical and hence following these judgements, the AO is directed to allow claim of appellant of interest u/d.36(1 )(iii) of the I.T.Act." 5.5 Since there is no change in the facts and circumstances, following my predecessor's decision, I direct the AO to delete the addition made in this regard. This ground of appeal is Allowed.

Sr.No. Particulars Total 1 Interest paid on Unsecured Loans 3,60,32,974 2 Interest paid on Working Capital Loans 25,61,18,560 3 Interest on Term Loans 7,05,53,202 Total interest 36,27,04,736 Further, with regard to break-up of assets employed, following particulars were submitted by the assessee:- Particulars Total 10B Non 10B % of % of 10B Non unit to 10B total unit to total Gross block 5,18,27,73,230 29,03,02,610 4,89,24,70,620 5.60% 94.40% (A) (including capital (WIP) Current 5,68,58,64,106 41,99,16,440 5,26,59,47,666 - - Assets Current 1,58,79,97,787 18,19,68,151 1,40,60,29,636 Liabilities Net 4,09,78,66,319 23,79,48,289 3,856,99,18,030 5.81% 94.19% current assets (B) Capital 9,28,06,39,549 52,82,50,899 8,75,23,88,650 5.69% 94.31% employed (A+B)

In view of the above particulars, it was alternatively submitted by the Ld. Counsel that apportionment can be done in the ratio of net current assets which would be more logical than the apportionment made on the basis of turnover, since turnover is not the sole criteria.

23 & 2633/Mum/2014 42. The brief background is that during the course of assessment proceedings, it was noted by the AO that assessee had made payment through credit card using American Express Bank Card aggregating to Rs.16,77,803 but the assessee could explain the details for an expense upto Rs.15,66,104. Thus, the remaining amount of Rs.1,14,700 remained unexplained, and therefore the same was treated as expenses incurred for non-business purposes and was disallowed by the AO.

24 & 2633/Mum/2014 45. We have gone through the orders passed by the lower authorities and submissions made before us. Since the impugned amount was not debited by the assessee in the P&L Account, the disallowance made by the AO has been rightly deleted by Ld. CIT(A). No interference is called for in his order. Ground 5 of the Revenue is dismissed.

Order was pronounced in the open court at the conclusion of the hearing.