2022 (6) TMI 1428 - HC - Income Tax

Court Upholds Tax Deduction Disallowances; Allows Deductions for Bad Debts, Royalties, ESOPs, Investment, and Hedging Losses.

The court affirmed the decisions of the lower authorities on most issues, emphasizing adherence to statutory requirements under the Income Tax Act. It ... Diversion of income by overriding charge - amount transferred to Statutory Reserve Fund in compliance with the mandatory provisions of Section 45 IC read with Section 45Q of the RBI Act - HELD THAT:- We are of the firm view that when the income by way of profit, as in the present case, is received and then reflected as part of the total income, deduction is not permissible. Therefore, the authorities below were justified in disallowing the deduction claimed by the assessees for the amount transferred to reserve fund in compliance with the mandatory provisions of the RBI Act, which do not call for any interference by this court. Accordingly, the main issue stands answered against the assessees. MAT Computation - AO added the fund transferred to the statutory reserve to the total income of the assessees, while computing the taxable income under section 115JB, which was also affirmed by the appellate authorities - HELD THAT :- Section 115JB states that for computing the book profit, the amount meeting out the liabilities other than ascertained liabilities, has to be added. The statutory reserve fund based on the RBI guidelines, is not based on any ascertained liabilities and hence, it has to be added for arriving at the book profit under section 115 JB. At this juncture, it would be relevant to refer to the decision of the Delhi High Court in SREI Infrastructure Finance Ltd [2015 (2) TMI 545 - DELHI HIGH COURT] wherein, an identical question of law as raised herein it was clearly stated that the reserve is the amount of profit which is retained for use in business, when difficulty arises and on the basis of our earlier findings and from the very language of section 45 IC, this court comes to a conclusion that the amount transferred by the assessees herein, to the statutory reserve as mandated under the provisions of the RBI Act, is not an allowable deduction in computing the assessable income under the provisions of the Act under the regular computation and computation of book profits under section 115JB, as the case may be and therefore, the orders of the authorities below, do not call for any interference. Accordingly, the consequential issue is also decided against the assessees. Bad debts written off as deduction u/s 36(1)(vii) - Once the bad debts are written off by debiting the same in the profit and loss account and by giving a corresponding credit in the loans and advances/debtors on the asset side of the balance sheet, the requirement under law is satisfied. It is not necessary to make corresponding entry towards each individual account separately to qualify as a valid write off. The department has not disputed the entries in the profit and loss account and balance sheet. Tribunal failed to see that once the sums written off in the books maintained for the purpose of Income Tax Act and debited in the profit and loss account and satisfied the other requirement as held in Vijaya Bank [2010 (4) TMI 46 - SUPREME COURT], it is suffice to hold that the assessees are entitled to the allowance. In such view of the matter, we are of the opinion that the Tribunal rightly deleted the disallowances made by the assessing officer - Decided in favour of the assessees. Nature of expenses - royalty paid to the holding company - whether to be treated as revenue expenses? - AO disallowed the royalty amount and allowed depreciation at 25% by holding that the expenditure incurred is for acquiring intangible asset and would thus amount to capital expenditure - HELD THAT:- Every expenditure incurred to acquire some right over intangible asset, cannot be ipso facto termed as capital expenditure. The nature of the assets, right, information or technical know-how that is transferred, must be such that without which the transferee could never commence the business. As rightly contented by assessees, the benefit granted by the licensor is not enduring in nature in the present cases. The assessing officer without appreciating the terms of the licence agreement and ascertaining the nature of the expenditure incurred by the assessee companies, disallowed the deduction of royalty payment and allowed the depreciation at 25% treating it as capital expenditure. However, the appellate authorities, while deleting the disallowances made by the assessing officer, have rightly treated the royalty payment as revenue expenditure. Once the payment of royalty is treated as revenue expenditure, automatically, it goes without saying that the assessees would be entitled to 100% deduction. Therefore, we need not interfere with the orders passed by appellate authorities. Accordingly, the substantial questions of law relating to royalty, are answered in favour of the assessees. Employees Stock Option Plan ( ESOP) expenditure - AO disallowed the said claim and added the same back to the total income of the assessee companies - HELD THAT:- This court comes to a conclusion that the Tribunal was correct in holding that the ESOP expenditure is revenue in nature and the assessee is entitled for deduction. Accordingly, the orders passed by the Tribunal in deleting the disallowances of ESOP expenses by the assessing officer, do not require any interference in these appeals. Resultantly, this issue stands answered in favour of the assessees. Loss on sale of investments / Diminution in value of investments - assessees claimed deduction for the value of investments written off due to fall in their value / loss on sale of investments, which was disallowed by the assessing officer on the ground that it is capital in nature - HELD THAT:- This court is of the opinion that Government securities are only stock-in-trade and not capital investment and the loss, if any, on sale of them cannot be treated as capital loss and hence, the assessees are entitled for deduction of loss on sale of investments / diminution in value of investments. Therefore, the Tribunal was right in deleting the disallowances made by the assessing officer and the same need not be interfered with. Accordingly, the issue raised by the Revenue qua loss on sale of investments/ diminution in value of investments, stands answered in favour of the assessees. Loss arising out of Derivatives / hedging transactions in foreign exchange - whether the Tribunal was right in holding that the loss arising out of derivatives / hedging transactions in foreign exchange, is an allowable deduction in computing the business income of the assessees? - HELD THAT:- As per section 2 (7) of the Sale of goods Act, “goods means every kind of movable property other than actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale;” No person other than the authorised dealer can deal with foreign currency except with the permission of the RBI under section 8 of the Foreign Exchange Regulations Act, 1973 or Section 3 of the Foreign Exchange Management Act, 1999. As the foreign currency cannot be called as “commodity” as well, the hedging contracts are not speculative and hence, Section 43(5) is not applicable. Though the assessing officer examined the issue in detail, he erred in treating the transactions done by the assessees as speculative transactions and disallowing the claim made by them. On the other hand, the appellate authorities rendered concurrent findings in favour of the assessees, to the effect that the derivative contracts, foreign exchange swap transactions against fluctuations in interest rate are hedge transactions and the loss arising out of the same is allowable as business loss. Such findings of the appellate authorities cannot be found fault with and therefore, the same are hereby confirmed. Accordingly, this issue stands answered against the Revenue. Disallowance u/s 14A r/w Rule 8D - mandation of recording satisfaction - HELD THAT:- In the instant cases, the assessing officer made disallowances u/s 14A r/w Rule 8D, but there was no reason recorded by him, as to why he was not satisfied with the claim made by the assessees. Further, there was no examination by the assessing officer about the nature of investment by the assessees in their subsidiary companies and expenditure incurred by them. The CIT(A)/Tribunal pointed out certain errors committed by the assessing officer, accepted the contentions raised by the assessees and directed the assessing officer to modify the disallowances under section 14A, by the orders impugned herein. Such course adopted by the appellate authorities cannot be countenanced, when the mandatory procedure envisaged under section 14A r/w Rule 8D has not been complied with. Without holding that, in the absence of specific findings and reasons, the question cannot be addressed. Though, it is trite law that any question of law affecting the rights of the parties would not by itself be a substantial question of law, this court is of the opinion that in the absence of specific findings on fact and adherence to the procedure, the substantial questions of law on the issue ought not to be decided. Thus sets aside the orders of the appellate authorities and remands the matter to the assessing officer. Interest u/s 234D - The Tribunal in [2016 (1) TMI 1433 - ITAT CHENNAI] while rejecting the contentions of the assessees, held that interest under section 234D is on par with the interest charged under section 234A or 234B or 234C of the Act and that, the Government has not advanced any money to the assessees so as to call it as a loan; the interest levied on the assessees is compensatory and it cannot be allowed as a business deduction, while computing the business income. This court finds no reason much less valid reason to interfere with the findings so rendered by the authorities below, as the interest was levied on the amount refunded to the assessees, which they are not legally entitled to and for the period during which they were holding the same and hence, the same is not eligible for deduction. Therefore, this issue relating to disallowance of interest under section 234D, is decided against the assessees. Disallowance u/s 40(a)(ia) - Assessee did not adduce any evidence to support their claim and also in view of the settled legal position that the liability to deduct tax at source is mandatory and a person who does not adhere to the said statutory obligation, has to suffer the consequences which are stipulated in the Act itself, this court does not find any reason much less valid reason to disagree with the findings so rendered by the authorities below, qua disallowance u/s 40(a)(ia) of the Act. Alternative plea that the amount disallowable is only 30% of the expenditure in view of the amendment to section 40(a)(ia) by Finance (No. 2) Act, 2014 - The proviso to section 40(a)(ia) of the Act as inserted by the Finance Act, 2014 does not apply to the case at hand pertaining to the assessment year 2012-13 and hence, the contention of the assessee for curative benefit with reference to the said proviso does not hold good. Having considered the rival contentions, the Tribunal was of the view that the amendment restricting the disallowance to 30% of the expenditure, came into effect only with effect from 01.04.2015 and the assessment year under consideration was 2012-13 and hence, the said amendment was not applicable to the case of the assessee. Accordingly, the alternative plea raised by the assessee was rejected by the Tribunal. The said view of the Tribunal appears to be just and proper and it needs no interference by this court, in the light of the judgment of the Hon'ble Supreme Court in Shree Choudhary Transport Company [2020 (8) TMI 23 - SUPREME COURT] as clearly observed that the amendment to section 40(a)(ia) by the Finance No. 2 Act 2014 with effect from 01.04.2015, is applicable only from the assessment year 2015-16. Issues Involved:1. Statutory Reserve Fund2. Bad Debts3. Royalty4. ESOP Expenditure5. Loss on Sale of Investments / Diminution in Value of Investments6. Loss Arising out of Derivatives / Hedging Transactions in Foreign Exchange7. Section 14A r/w Rule 8D8. Interest under Section 234D9. Section 40(a)(ia)Issue-wise Detailed Analysis:Statutory Reserve Fund:The assessees, being Non-Banking Financial Companies (NBFCs), transferred amounts to a statutory reserve under section 45 IC of the RBI Act and claimed deductions under the Income Tax Act. The assessing officer disallowed the claims, considering them as an application of income rather than an expenditure. The Tribunal upheld this view, stating that the transfer to the reserve fund is an appropriation of profits and not a diversion of income by overriding title. The court affirmed this, referencing the Supreme Court's decision in Associated Power Co. Ltd. and Seshasayee Paper Boards Ltd., which held that statutory reserves are appropriations of profits and not deductible expenses.Bad Debts:The assessees claimed deductions for bad debts written off under section 36(1)(vii). The assessing officer disallowed part of these claims, treating them as mere provisions. The CIT(A) and Tribunal allowed the claims, except in some cases where the Tribunal remanded the matter for verification. The court held that once bad debts are written off in the profit and loss account, they are deductible, even if the assessees maintain two sets of books. The court referenced the Supreme Court's decision in Vijaya Bank, which clarified that actual write-offs are deductible.Royalty:The assessees claimed royalty payments as revenue expenses. The assessing officer treated these as capital expenditures, allowing depreciation instead. The CIT(A) and Tribunal treated the royalty payments as revenue expenses. The court upheld this, stating that the royalty payments were for the use of trademarks and did not result in the acquisition of any enduring advantage or asset. The court referenced the Supreme Court's decision in CIT v. Ciba of India Ltd., which held that payments for the use of trademarks are revenue expenses.ESOP Expenditure:The assessees claimed ESOP expenses as revenue expenditures. The assessing officer disallowed these claims, treating them as capital expenditures. The CIT(A) and Tribunal allowed the claims, treating ESOP expenses as employee compensation. The court upheld this, referencing its own decision in CIT v. PVP Ventures Ltd., which held that ESOP expenses are revenue expenditures aimed at employee retention and motivation.Loss on Sale of Investments / Diminution in Value of Investments:The assessees claimed deductions for losses on the sale of investments and diminution in the value of investments. The assessing officer disallowed these claims, treating the investments as capital assets. The CIT(A) and Tribunal allowed the claims, treating the investments as stock-in-trade. The court upheld this, referencing its own decision in Lakshmi Vilas Bank v. CIT, which held that government securities held by banks are stock-in-trade and not capital investments.Loss Arising out of Derivatives / Hedging Transactions in Foreign Exchange:The assessees claimed deductions for losses arising from derivatives and hedging transactions in foreign exchange. The assessing officer treated these losses as speculative and disallowed them. The CIT(A) and Tribunal allowed the claims, treating the transactions as hedging against business risks. The court upheld this, referencing the Delhi High Court's decision in CIT v. Industrial Finance Corporation of India Ltd., which held that such transactions are not speculative if they are meant to hedge business risks.Section 14A r/w Rule 8D:The assessees claimed deductions for expenses incurred to earn exempt income. The assessing officer disallowed these claims under Rule 8D. The CIT(A) and Tribunal allowed the claims, stating that Rule 8D is applicable only from the assessment year 2008-09 onwards. The court upheld this, referencing the Bombay High Court's decision in Godrej & Boyce Mfg. Ltd. v Deputy Commissioner of Income Tax, which held that Rule 8D is prospective in application.Interest under Section 234D:The assessees claimed deductions for interest charged under section 234D. The assessing officer disallowed these claims, treating the interest as penal in nature. The CIT(A) and Tribunal upheld this view. The court affirmed this, stating that the interest charged under section 234D is compensatory and not deductible as business expenditure.Section 40(a)(ia):The assessee in TCA No. 406 of 2019 made payments without deducting tax at source and claimed deductions for these payments. The assessing officer disallowed these claims under section 40(a)(ia). The CIT(A) and Tribunal upheld this view. The court affirmed this, stating that the liability to deduct tax at source is mandatory, and failure to do so attracts disallowance under section 40(a)(ia).Conclusion:The court disposed of the tax case appeals with specific directions, affirming the decisions of the lower authorities on most issues while allowing some appeals in favor of the assessees. The court emphasized the importance of adhering to statutory requirements and procedures under the Income Tax Act.No costs.