MALLO GEMS & JEWELLERY LTD., (PRESENTLY KNOWN AS LYPSA GEMS & JEWELLERY LIMITED),,AHMEDABAD vs. THE CIT-II,, AHMEDABAD

आदेश / O R D E R

PER SHRI MAHAVIR PRASAD, JUDICIAL MEMBER : This is an appeal by the assessee against the order of the Commissioner of Income Tax(Appeals)-II, Ahmedabad, dated 05/12/2014 for the Assessment Year (AY) 2010-11, on the following Grounds:

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 2 - i. The ld.CIT has grossly erred in law and on facts in assuming jurisdiction u/s.263 of the Act on the erroneous ground that the impugned assessment order is erroneous in so far as it is prejudicial to the interest of the revenue. ii. Ld. CIT grossly erred in not appreciating that in order to invoke S.263, two conditions must be fulfilled viz. the impugned assessment order must be erroneous and that error must be prejudicial to the interest of the revenue. In the present case, ld. AO has passed the reasoned assessment order after analyzing all details and therefore there was no error in the impugned assessment order so as to justify action u/s.263 of the Act. Under the circumstances, the very assumption of power u/s.263 of the Act is unjustified and bad in law and therefore, order u/s.263 of the Act deserved to be quashed. iii. Alternatively and without prejudice, ld. CIT erred in law and on facts in holding that the provisions of S.14A read with Rule 8D are applicable and mandatory disallowance of expenditure is required to be made. iv. In any case, ld.CIT further erred in invoking provisions of Explanation to S.73 that too without raising the same in the notice u/s 263 of the Act.

v. Alternatively and without prejudice, ld.CIT erred in law and on facts in holding that the valuation of closing stock is not proper and as per the accepted methods of accounting consistently followed by the assessee. vi. The ld.CIT has further erred in law in not coming to any concrete conclusion and without conducting any inquiry or investigating the issue, merely directed the AO to frame the assessment order afresh. Without there being any positive and exact finding about order being erroneous and prejudicial to the interest of the revenue, the action of ld. CIT is without jurisdiction and illegal and hence deserves to be deleted.

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 3 - vii. Ld. CIT has erred in not considering various facts, submissions, explanation and clarifications as given by the appellant and further erred in not appreciating the facts and law in their proper perspective. 2. The relevant facts as culled out from the materials on record are as under:- In this case, the assessee is engaged in the business of Manufacturing & Trading in diamonds and Allied products. The various issues arising out of the scrutiny of accounts of the assessee during the course of assessment proceedings are discussed in the subsequent paras.

2.2 Disallowance of Expenses u/s.14A On perusal of the return of income it was noticed that the assessee has earned dividend income of Rs.19,28,694/- during the year and claimed as exempt u/s.10(33) of the Income tax Act, 1961. During the course of assessment proceedings the assessee was requested to show- cause as to why the provisions of section 14A read with rule 8D of the Income Tax should not be applied in this regard. The assessee vide its reply dated 26/11/2012 has submitted as under: “D Disallowance u/s 14A 1. The company has made investments in shares and securities for some time of period i.e. till August 2009. 2. There was a change in the ownership and management of the company and the present promoters took over in AY 2009-10 and started the business activities in August 2009. 3. Until that period the entire amount of capital was invested in Kotak Bank Flexi Mutual Fund Plan. Dividend amounting to Rs.19,28,693 was received. The copy of the

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 4 - ledger accounts of Mutual Fund and Dividend are enclosed at page number 53-57. 4. It can be observed from the ledger accounts submitted that the entire amount invested in Mutual Funds was withdrawn on 27-08-2009, 5. Whereas the loans on which interest was paid were received only in March 2010. 6. Hence there is no direct nexus between the dividend income earned, the amount borrowed and the interest paid on the loans. 7. In absence of any direct nexus between exempt income and interest paid the provisions section 14A read with Rule 8D will not be applicable. 8. We are also enclosing the details expenditure incurred until 27-08-2009 i.e. till the time of withdrawing of the investments from mutual Funds at Page number 58. It can be observed from the same that no expenditure has been incurred to earn the dividend income. 9. In respect of the applicability of Section 14A read with Rule 8D reliance is placed on the following decisions:

M/s Auchtel Produts Ltd, vs. ACIT 22 taxman.99 (Mum) (ITA Nos.3189, 2649 & 3185/Mum/2010)

In A.Y.2008-09, the assessee claimed that it had not incurred any expenditure in earning dividend income and no disallowance u/s.14A could be made. However, the AO computed disallowance u/s.14A & Rule 8D of Rs.12.81 Lakhs. The Hon'ble Tribunal held that s.I4A(2) empowers the AO to determine the amount of expenditure incurred in relation to tax-free income if, "having regard to the accounts of the assessee, he is not satisfied with the correctness of the claim of the assessee". The satisfaction of the AO as to the incorrect claim made by the assessee is sine qua non for invoking the applicability of Rule 8D. The satisfaction can be reached only when the claim of the assessee is verified. If the assessee proves before the AO that it incurred a particular expenditure in respect of earning the exempt income and the AO is satisfied, then there is no requirement to proceed with the computation under Rule 8D. The

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 5 - AO wrongly proceeded on the premise that Rule 8D is automatic irrespective of the genuineness of the assessee's claim in respect of expenses incurred in relation to exempt income. The correct sequence for making any disallowance u/s.14A is to firstly, examine the assessee's claim of having incurred some expenditure or on expenditure in relation to exempt income. If the AO is satisfied with the same, then there is no need to compute disallowance as per Rule 8D. It is only when the AO is not satisfied with the correctness of the claim of the assessee in respect of such expenditure or no expenditure having been incurred in relation to exempt income, that that mandate of Rule 8D will operate. Justice Sam P Bharucha vs. ACIT (ITAT Mumbai) (ITA 3889/M/2011)

The assessee earned tax-free income from shares and units and claimed that he had not incurred any expenditure on earning the tax-free income and so no disallowance u/s.14A was permissible. The AO & CIT(A) rejected the claim and disallowed Rs.2.26 lakhs u/s.14A as expenditure incurred to earn the tax free income. the Hon’ble Tribunal held that S.14A has within it implicit notion of apportionment in cases where expenditure is incurred for composite/indivisible activities in which taxable and nontaxable income is received. But when it is possible to determine the actual expenditure in relation to exempt income or when no expenditure has been incurred in relation to exempt income, then the principle of apportionment embedded in s.14A has no application. For s.14A to apply, there should be a proximate relationship between the expenditure and the tax-free income. If the assessee claims that non expenditure and the tax- free income. If the assessee claims that no expenditure has been incurred for earning the exempt income, it is for the AO to determine as to whether the assessee had incurred any expenditure in relation to the tax-free income and, if so, to quantify the extent of disallowance. In order to disallow the expenditure u/s.14A, there must be a live nexus between the expenditure incurred and the income not forming part of total income. No notional expenditure can be apportioned for that

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 6 - purpose of earning exempt income unless there is an actual expenditure in relation to earning the tax-free income. If the expenditure is incurred with a view to earn taxable income and there is apparent dominant and immediate connection between the expenditure incurred and taxable income, then no disallowance can be made u/s.14A merely because some tax exempt income is received by the assessee. On facts, from the details of the expenditure, it is clear that the expenditure incurred by the assessee has direct nexus with the professional income of the assessee. It is not the case of the revenue that the assessee has used his official machinery and establishment for earning the exempt income. The AO has not given any finding that any of the expenditure incurred and claimed by the assessee is attributable for earning the exempt income. Consequently, s.14A disallowance is not permissible

2.3 The submissions of the assessee was pursued carefully and considered. As submitted by the assessee that the investments in shares and securities were made tell August 2009, the Profit and Loss A/c up to 27/08/2009 was perused. It was observed that the assessee has debited expenses to the tune of Rs.8,465/- under the head Commissioner of Brokerage and another expenses of Rs.39,708/- under the head CDSL fees. Since these expenses were incurred to earn the exempted dividend income, therefore the total amount of Rs.48,173/- was disallowed u/s.14A of the Act and added to total income of the assessee.

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 7 - 1. Although the assessee had earned tax exempt income in the nature of dividend to the tune of Rs.19,28,693/-, however, no disallowance u/s.14A r.w.s. 8D of the Act, was made. 2. It was also noticed from perusal of case records that, veracity of valuation of the closing stock was not made at the time of finalization of assessment. 3. In the light of the above, notice u/s.263 of the Act was issued to the assessee on 25th September, 2014 requiring assessee to show- cause as to why the assessment order finalized on 14/03/2013 should not be set aside and assessing officer directed to modify the same on the issues mentioned above. 4. In response to the notice assessee filed a writted submission dtd. 14/10/2014 on 17/10/2014 contending the following: “In this regard we have to state the notice with reference to both the issues are correct as neither the assessment order is prejudicial to interest of revenue, nor it erroneous for the following reasons: A. Disallowance under Section 14A.

i. The assessee company is assessed to tax since past many years. i. The assessee company was mainly having activities of investment in shares and securities till August 2009. ii. There was a change in the ownership and management of the company and the present promoters took over business and started activities in August 2009. iii. The company has made investments in shares and securities for some period of time i.e. till August 2009. iv. The company had invested the entire capital in Kotak Bank Flexi Mutual Fund Plan till August 2009. The company had not borrowed any interest bearing fund to make investment in mutual fund. v. The company had initially made investments in Kotak Monthly Plan Series II amounting to Rs. 96,22,405/- and in Kotak Flexi Debt of Rs.1,30,44,291/-. The Investment in Kotak Monthly Plan Series- II along with dividend was transferred to Kotak Flexi Debt on 08/04/2009. vi. During the period till August 2009 the assessee company has earned dividend income amounting to Rs.79,28,693/-

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 8 - vii. Once there was change in the management, the new management started the diamond business in August 2009. The investment in Mutual fund matured on 27/08/2009. The total amount of investment along with the dividend was received back. viii. To establish this fact, we have also furnished the Interim Profit & Loss Account and Balance Sheet as on 27/08/2009 as well as the ledger account of investments during the course of assessment proceedings. The same is enclosed for your reference at page no. 39-40 ix. Therefore, it was duly explained during the course of assessment proceedings that the investment in shares and securities has been made till August 2009 and dividend has also been received till August 2009. x. It is also further submitted that the assessee company had started business of diamonds w.e.f. August 2009 and the loans both secured and unsecured have been availed mainly for the purpose of diamond business and none of the amount borrowed has been invested in shares and securities. xi. The loan amount has been mainly availed in the month of March 2010. The copy of ledgers of all the loans were submitted before the learned AO during the course of assessment proceedings, the same is enclosed for your reference at page number 46-70. xii. Therefore, the exempt income has been earned upto August 2009, whereas the loan has been borrowed in March 2010 and therefore the interest has been paid only for the period March 2010. xiii. Therefore, from the above facts it is duly established that there is no nexus between investments made which have generated the exempt income and the borrowed funds on which interest has been paid. xiv. It was also further established during the course of assessment proceedings that the paid up Share Capital and the Reserves & Surplus as on 31/03/2009 was Rs.5,89,58,697/- and the investments which generated Dividend Income was Rs.2,26,66,696/-. Therefore, the Investments were made by the company out of its paid up capital and Reserves & Surplus. Therefore, none of the borrowed fund had been invested in shares and securities and therefore there was no question about the applicability of provisions of Section 14A.

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 9 - xv. In this regard, your kind attention is invited to section 14A(2), which states that the AO will determine the expenditure incurred to earn exempt income, and if the AO is satisfied with correctness of the claim then AO would not disturb the accounts and would not apply section 14A accordingly. xvi. During the course of assessment proceedings, the AO has considered all the relevant aspects and duly come to the conclusion that the interest expenses do not have any nexus with the dividend income and to that extent the interest has not been considered in determining disallowance u/s.14A. xvii. During the course of assessment proceeding, we have also placed reliance on the applicability of Section 14A read with Rule 8D on the following decisions:

M/s Auchtel Products Ltd, vs. ACIT 22 taxman.99(Mum) (ITA Nos. 3189,2649 &3185/Mum/2011)

In A.Y. 2008-09, the assessee claimed that it had not incurred any expenditure in earning dividend income and no disallowance u/s.14A could be made. However, the AO computed disallowance u/s.14A & Rule 8D Rs.12.81 lakhs. The Hon'ble Tribunal held that S.14A(2) empowers the AO to determine the amount of expenditure incurred in relation to tax-free income if, "having regard to the accounts of the assessee, he is not satisfied with the correctness of the claim of the assessee The satisfaction of the AO as to the incorrect claim made by the assessee is sine qua non for invoking the applicability of Rule 8D. The satisfaction can be reached only when the claim of the assessee is verified. If the assessee proves before the AO that it incurred a particular expenditure in respect of earning the exempt income and the AO is satisfied, then there is no requirement to proceed with the computation under Rule 8D. The AO wrongly proceeded on the premise that Rule 8D is automatic irrespective of the genuineness of the assessee's claim in respect of expenses incurred in relation to exempt income. The correct sequence for making any disallowance u/s.14A is to, firstly, examine the assessee's claim of having incurred some expenditure or no expenditure in relation to exempt income. If the AO is satisfied with the same, then there is no need to compute disallowance as per Rule 8D. It is only when the AO is not satisfied with the correctness of the claim of the assessee in respect

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 10 - of such expenditure or no expenditure having been incurred in relation to exempt income, that the mandate of Rule 8D will operate.

Justice Sam P Bharucha vs. ACIT (ITAT Mumbai) 53 SOT 192(Mumbai)(URO), 25 taxmann.com 38KITA 3889/M/2011)

The assessee earned tax-free income from shares and units and claimed that he had not incurred any expenditure on earning the tax-free income and so no disallowance u/s.14A was permissible. The AO & CIT(A) rejected the claim and disallowed Rs. 2.26 lakhs u/s.14A as expenditure incurred to earn the tax-free income. The Hon'ble Tribunal held that S. 14A has within it implicit notion of apportionment in cases where expenditure is incurred for composite/indivisible activities in which taxable and non-taxable income is received. But when it is possible to determine the actual expenditure in relation to exempt income or when no expenditure has been incurred in relation to exempt income, then the principle of apportionment embedded in s.14A has no application. For s.14A to apply, there should be a proximate relationship between the expenditure and the tax-free income. If the assessee claims that no expenditure has been incurred for earning the exempt income, it is for the AO to determine as to whether the assessee had incurred any expenditure in relation to the tax-free income and, if so, to quantify the extent of disallowance. In order to disallow the expenditure u/s.14A, there must be a live nexus between the expenditure incurred and the income not forming part of total income. No notional expenditure can be apportioned for the purpose of earning exempt income unless there is an actual expenditure in relation to earning the tax-free income. If the expenditure is incurred with a view to earn taxable income and there is apparent dominant and immediate connection between the expenditure incurred and taxable income, then no disallowance can be made u/s.14A merely because some tax exempt income is received by the assessee. On facts, from the details of the expenditure, it is clear that the expenditure incurred by the assessee has direct nexus with the profession income of the assessee. It is not the case of the revenue that the assessee has used his official machinery and establishment for earning the exempt income. The AO has not given any finding that any of the expenditure incurred and claimed by the assessee is attributable for earning the exempt income. Consequently, s.14A disallowance is not permissible

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 11 -

xviii. Therefore, from the above facts it is duly submitted that the assessee company has submitted all the relevant details to prove that the interest shall not form part of disallowance and which is also duly accepted by the learned AO after going through detailed submissions. xix. As per section 263 of the I.T. Act, the order should be erroneous and error has resulted into prejudice to the interest of the revenue then only such order can be revised as held in the case of Taradevi 88 ITR 323 (SC). xx. At the first instance the order of the learned AO is not erroneous so far as the facts are concerned and the view taken is duly supported by the legal principles and also under the provision of the law. xxi. Without prejudice to the above, we would like to state that during the course of assessment proceedings the learned AO has made detailed inquiries about the expenses incurred on earning the exempt income as well as the applicability of Section 14A. xxii. The assessee vide its submission dated 26/11/2012 had given a detailed explanation, citing relevant case laws and stating that the provisions of Section 14A r.w. Rule 8D are not applicable to the assesssee. xxiii. The assessee had also submitted various details to prove the contention during the course of assessment proceedings. The "A" had furnished following documents: - ledger accounts of all the investments in Mutual Fund - Ledger accounts of dividend income - ledger accounts of unsecured loans were also submitted to establish that the same were received after the exempt income was earned i.e. on 27/08/2009. - break up of expenditure incurred till 27/08/2009 - Profit and Loss Account as on 27/08/2009 - ledger accounts of all the secured loans and unsecured loans were also submitted and it was explained that all the loans were received in the month of March 2010 while the exempt income was earned till August 2009. - Further, the provisional balance sheet as on 27/8/2009 was called for and the same was submitted vide submission dated 18/12/2012.

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 12 - xxv. Further, the bifurcations of the various items of the provisional balance sheet as at 27/08/2009 was also given vide submission dated 25/01/2013. xxiv. Therefore, from the above it is clear that the learned AO during the course of the assessment proceedings has made detailed inquiries about the applicability of Section 14A. xxv. Section 14A(2) also states that the AO will disallow the expenses only if he is not satisfied with the explanation of the accounts submitted by the "A". xxvi. It is duly submitted that jurisdiction u/s.263 can be invoked only if the twin conditions are satisfied, being a) the order is erroneous and b) it is also prejudicial to the interest of the revenue. If any one of the conditions is absent then the CIT cannot invoke the provisions of Section 263. xxvii. It can be seen from the records that the assessee has made detailed submissions during the course of assessment proceedings, the assessee has submitted as many as 9 written submissions to prove the contentions and therefore while passing the order u/s.143(3), the learned AO has verified each and every aspects in detail and therefore such an order cannot be considered as erroneous and prejudicial to the interest of the revenue and therefore such order cannot be revised u/s.263 of the I.T. Act. xxviii. The learned AO has also relied on two direct decisions while considering the submission and therefore the view taken by AO is also judicially acceptable view. xxix. We may draw your kind attention to Para 4, Page 2 of the assessment order, the learned AO has issued specific show cause notice for disallowance of expenses u/s.14A, the Ld. AO has considered in detail, the submission of the assessee and has finally after going through the provisional Profit & Loss Account as on 27/08/2009 has disallowed the expenses in Para 4.1 Page 4 of the assessment order. xxx. The learned AO has determined the disallowance u/s 14A should be restricted to the extent of Rs.48,171/- being the commission and brokerage expenses and CDSL fees after thorough evaluation of facts, such an order cannot be regarded as erroneous.

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 13 - xxxi. It is also one of the legal principle that every loss of revenue as a consequence of an order cannot be considered as prejudicial to the interest of the revenue. xxxii. An order which has been passed after application of mind and detailed inquiries cannot be regarded as erroneous nor would it be prejudicial to the interest of the revenue. xxxiii. Thus, as the assessee has submitted all the requisite details at the time of assessment proceedings, the revision u/s.263 is not justified at all. xxxiv. In this regards reliance is placed in the case of Girdhrilal Lal 176 CTR 092 (Raj)

4.2 In support of its contention assessee cited a judgment of Hon’ble Supreme Court (243 ITR 0083) in the case of Malabar Industrial Co. Ltd. vs. CIT, it has been held by the Apex Court that as per Section 263 there must be two conditions to be satisfied for application of law of 263 that the order should be erroneous as well as prejudicial to the interest of the revenue, if the assessing officer has made proper enquiry and one of the possible step has

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 14 - been taken the same cannot be considered as erroneous and therefore, CIT is not justified in invoking section 263.

4.3 In the case of CIT vs. Max India Ltd.295 ITR 282 (SC), it has been held that the phrase “prejudicial to the interest of revenue” in section 263 has to be read in conjecture with the expression “erroneous”. When the AO takes one of the two views permissible in law and which the commissioner does not agree and which results into loss of revenue. Unless the view taken by the Assessing Officer completely untenable in law.

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Ahmedabad; Dated 27/10/2017 Priti Yadav, sr.PS

ITA No.316/Ahd/2015 Maloo Gems & Jewellery Ltd. (Presently known as Lypsa Gems & Jewellery Ltd.) Vs. CIT Asst.Year –2010-11. - 15 -

आदेश क� ��त�ल�प अ�े�षत/Copy of the Order forwarded to : 1. अपीलाथ� / The Appellant 2. ��यथ� / The Respondent. 3. संबं�धत आयकर आयु�त / Concerned CIT 4. आयकर आयु�त(अपील) / The CIT(A)-II Ahmedabad. �वभागीय ��त�न�ध, आयकर अपील�य अ�धकरण, अहमदाबाद / DR, ITAT, Ahmedabad 5. 6. गाड� फाईल / Guard file. आदेशानुसार/ BY ORDER, स�या�पत ��त //True Copy//

उप/सहायक पंजीकार (Dy./Asstt.Registrar) आयकर अपील�य अ�धकरण, अहमदाबाद / ITAT, Ahmedabad 1. Date of dictation 24/10/2017 (dictation-pad 8 pages attached at the end of this appeal-file) 2. Date on which the typed draft is placed before the Dictating Member 26/10/2017 3. Other Member… 4. Date on which the approved draft comes to the Sr.P.S./P.S…………….. 5. Date on which the fair order is placed before the Dictating Member for pronouncement…… 6. Date on which the fair order comes back to the Sr.P.S./P.S……. 7. Date on which the file goes to the Bench Clerk………………… 8. Date on which the file goes to the Head Clerk…………………………………... 9. The date on which the file goes to the Assistant Registrar for signature on the order…………………….. 10. Date of Despatch of the Order………………