ADDL.CIT., RANGE-5(2), MUMBAI vs. KARP IMPEX LTD., MUMBAI

Order u/s.254(1)of the Income-tax Act,1961(Act) लेखा सद� राजे� के अनुसार PER RAJENDRA, AM- Challenging the order dated 01.06.2011of CIT(A)-,Mumbai,the Assessing Officer(AO)and the Assessee have filed cross appeals,raising following grounds of appeal

6346/M/11 Karp Impex The appellant craves leave to amend or alter any ground or add any other grounds which may be necessary. Assessee-company,engaged in the business of import of rough and polished diamonds,filed its return of income on 26.10.2007,declaring total income of Rs.16.70Crores.The AO completed the assessment u/s.143(3) of the Act on 30.11.2010,determining the income of the assessee at Rs. 19,46,67,820/-. 2.First ground of appeal is about restricting the disallowance,made by the AO u/s.14A of the Act r.w.Rule 8D of the Rules,to Rs.1,72,09,410/-.During the assessment proceedings the AO found that the assessee had received exempt share of profit from registered firm M/s. Karp Manufacturing Co. (KMC) amounting to Rs.6.93 crores, that it had invested in the firm Rs.44.87 crores, that it had paid interest of Rs.33.23 crores on the loans taken by it during the year, that it had not shown any direct expenditure against the exempt income.However, by its letter dt.30.8.2010 the assessee stated that return of income was submitted without considering the applicability of section 14A in respect of exempt income from the firm.The AO observed that the assessee had composite books of account and common pool of funds wherefrom it was not possible to identify expenses incurred for earning income under various heads.He directed the AO to explain as to why the disallowance u/s. 14A of the Act should not be made.After considering the submission of the assessee, the AO held that the argument of the assessee that it had enough interest free fund to invest in firm was not acceptable. Invoking the provisions of section 14A r.w.Rule 8D(2) of the Income tax Rules, 1962(Rules) he made a disallowance of Rs.2.54 crores. 3.Aggrieved by the order of the AO,the assessee preferred an appeal before the First Appellate Authority (FAA).Before him it was contented that provisions of sub-section 2 and 3 of section 14A were prospective in nature and were not applicable during the year under consideration, that the AO had not considered the contention of the assessee, that it had submitted the working of disallowance on the basis of funds invested in partnership firm on daily basis.Vide its letter dt.2.5.2011, assessee raised additional ground before the FAA stating that in view of large network of company, the interest should not be disallowed for investment in a partnership firm for earning exempt income u/s. 10.It referred to the decision of the Hon’ble Bombay High Court in the case of Reliance Utilities and Power Ltd., that no disallowance was to be made either under Rule 8D or section 14A of the Act.After considering the submissions of the assessee and the assessment order,he held that disallowance u/s. 14A had to be made but not with reference to Rule 8D, that the working of the disallowance made by the AO indicated that it was on the same line as for earlier years, that his predecessor had worked out the disallowance on that line.He restricted the disallowance u/s. 14A to Rs.1,72,09,413/- and partly allowed the appeal filed by the assessee. 4.Before us,Authorised Representative (AR) stated that the assessee had capital plus free reserves and surplus aggregating to Rs.233.38 crores and Rs.217.63 Crores as on 31.03.2007 and 31.02.2016 respectively,that it had made investment of Rs.44.87 and 41.97 Crores respectively on 31.03.2007 and 31.03.2006,that that the interest free funds available to it were five times larger than the investments made in the partnership firm,that in the year ended 31.03.2007 the profit of the assessee was 18.59 Crores,that it had not invested borrowed funds for making 2 6346/M/11 Karp Impex investments,that loans were taken were Packing Credit in Foreign Currency(PCFC)and Export Bill Rediscounting (EBRD),that same could be used only for business purposes,that PCFC and EBRD could be used only for the specific purpose,that no portion of interest paid on such secured loans could be disallowed.He referred to page no.1,5,6 and 34 of the paper book.He relied upon the cases of HDFC Bank Ltd. (366ITR505)and Gujarat Narmada Valley Fertilizers Co. Ltd. (42taxmann.com 270)delivered by the Hon’ble Bombay High Court and Gujarat High Courts respectively.Departmental Representative(DR)supported the order of the FAA . 5.We have heard the rival submissions and perused the material before us.We find that the assessee had received exempt income,from KMC,amounting to Rs.6.63Crores,that it had an opening balance in the partnership firm at Rs.41.94 Crores,that the amount of capital introduced during the year was 10.95 Crores,that it had taken loan of Rs. 476.88 Crores,that it had paid interest of Rs.33.23 Crores,that it had claimed that no direct expenses were incurred for earning exempt income,that it had suo motu disallowance u/s.14A of the Act,that later on it stated that the return of income was submitted without considering the applicability of section 14A of the Act,that the AO made inquiry in that regard,that invoking the provisions of section 14A r.w.r.8D of the Rules,he made an addition of Rs.2.54 Crores,that the assessee had raised additional ground of appeal before the FAA and stated that no disallowance should be made u/s.14A,that following the judgment of Godrej Boyce & Co. (supra),the FAA held that Rule 8D was not applicable,that he reduced the disallowance to Rs. 1.72 Crores(Rs.1.50 Crores under the head interest expenses+ Rs.21.70 lakhs administrative Expenses),that the FAA while deciding the additional ground held that there was no merit in the arguments of the assessee,that it had earned exempt income,that disallowance u/s.14A was mandatory. He referred to the judgment of his predecessor and held that the assessee had not used loans for investment in the firm,that the share of profit from the firm started coming to the firm only from 31.03.2006,that the investment in the firm were out of the funds that were lying elsewhere,that same were deemed to be investment in firm.Finally,he dismissed the additional ground raised by the assessee,that in the earlier year,in the appeal before the Tribunal,the ground raised by the assessee with regard to disallowance of 14A was with - drawn,that the assessee had filed details of availability of capital plus free reserves and surplus, that it claimed that borrowed funds were not invested in firm,that it further made a claim that PCFC and EBRD could be used only for those specific purposes.It is found that the assessee had not claimed any administrative expenditure in the P &L account that could be linked to exempt income,that the FAA had not considered the availability of capital plus free reserves and surplus,that he had not considered the fact that the PCFC and EBRD loans could be used only for specific purposes. Therefore,following the judgment of the Hon’ble jurisdictional High Court delivered in the case of HDFC Bank Ltd. (supra),we decide the first ground of appeal in favour of the assessee,as no nexus between the exempted income and interest paid on borrowings for such investment was established. 6.Next ground of appeal is about disallowance of interest at Rs.21,86,897/- u/s. 36(1)(iii) of the Act.During the assessment proceedings,the AO found that the assessee had made investments in the office premises in Bharat Diamond Bourses Ltd.(BDB)situated at BKC,that the assessee had put to use the office premises during the year under appeal.Relying upon the order of the FAA for the earlier year,he disallowed interest amounting to Rs.21.86 lakhs.The FAA,in the appellate proceedings,confirmed the addition.