2018 (4) TMI 861 - AT - Income Tax

Tribunal adjusts GP addition, refers Deemed Dividend issue back to AO. Revenue's appeal dismissed.

The Tribunal partially allowed the assessee's appeal by adjusting the Gross Profit (GP) addition and referring the Deemed Dividend issue back to the ... Disallowance under section 40A(2)(a) - computation of gross profit as proxy for concealed income - deemed dividend under section 2(22)(e) including beneficial shareholder and Explanation 3 - trade advances versus non trade advances in the context of section 2(22)(e) - disallowance under section 14A read with Rule 8D where no exempt income is earned - allowability of advertisement expenditure - remuneration to partners under section 40(b) and computation of book profit - disallowance under section 36(1)(iii) - interest attributable to interest free advances - treatment of interest on gold deposit scheme paid to partnersDisallowance under section 40A(2)(a) - computation of gross profit as proxy for concealed income - Whether the addition made by AO under section 40A(2)(a) on account of alleged higher purchase prices from sister concerns should be sustained or substituted by an estimated gross profit. - HELD THAT: - Assessing Officer disallowed excess payments to sister concerns. CIT(A) followed Tribunal's earlier decision in the assessee's own case (AY 2009-10) and rejected AO's methodology, substituting an estimated GP of 0.90% on total sales. The Tribunal examined the transaction pattern, market variations, defects in the recast trading account and held the average price method unsuitable; in the present appeal the Bench found the facts and accounting similar and that an upward adjustment in GP should meet the ends of justice, but the magnitude adopted by CIT(A) (0.90%) was excessive. Considering the prior Tribunal finding (which had increased GP by 0.07% for the earlier year) and the turnover and GP declared in the year under appeal, the Tribunal increased GP from 0.61% declared by the assessee to 0.70% of total audited sales and rejected the AO's direct disallowance under section 40A(2)(a). [Paras 18, 20, 21, 22, 24]AO's disallowance under section 40A(2)(a) is rejected; gross profit is to be computed at 0.70% of audited sales and the resulting balance GP is to be added to income.Deemed dividend under section 2(22)(e) including beneficial shareholder and Explanation 3 - trade advances versus non trade advances in the context of section 2(22)(e) - Whether amounts reflected as debit balances/advances from group companies constitute deemed dividend under section 2(22)(e) or are trade/current account advances excludable from that provision. - HELD THAT: - Record shows the assessee is a beneficial shareholder in group companies (details of beneficial holdings recorded); Explanation 3 and judicial precedents establish that beneficial shareholders are covered by section 2(22)(e). However, the assessee contends the balances arise from trade/current account transactions. The Tribunal observed that while current account transactions are ordinarily outside section 2(22)(e), in this case closing debit balances had swollen and several vital questions remained unanswered: why group companies paid advances substantially in excess of normal business requirements, treatment in earlier/subsequent years, and evidence to show advances were bona fide trade advances. The Tribunal held that the provisions are to be interpreted strictly and the initial onus lies on AO to demonstrate that excess payments are non trade advances and to show use of such funds for non business purposes. It also accepted the assessee's submission, supported by precedent, that current year business profits should not be included in accumulated profits for computing deemed dividend. Given these unanswered factual aspects, the Tribunal directed remand to the AO for de novo adjudication after opportunity to the assessee. [Paras 25, 26, 27, 28, 29]Partly allowed for statistical purposes; issue remanded to the Assessing Officer for fresh decision de novo after affording opportunity and applying the principles noted.Disallowance under section 36(1)(iii) - interest attributable to interest free advances - Whether proportionate interest on interest free advances to third parties is disallowable under section 36(1)(iii). - HELD THAT: - AO disallowed interest proportionate to interest free advances where assessee could not substantiate recovery attempts or write offs. CIT(A) confirmed the disallowance after noting absence of evidence from the assessee that loans were written off or that claim of doubtful recovery was supported. The assessee did not place documentary evidence to controvert CIT(A)'s conclusion. [Paras 30]Addition of interest of Rs.3,08,889 is confirmed.Disallowance under section 14A read with Rule 8D where no exempt income is earned - Whether disallowance under section 14A read with Rule 8D is warranted when no exempt (tax free) income has been earned in the year. - HELD THAT: - Assessee held investments in group companies but did not receive any dividend or other exempt income in the year. Tribunal relied on precedents including the Special Bench in Vireet Investments and subsequent decisions holding that Rule 8D computations should consider only those investments yielding exempt income during the year. In absence of any exempt income, disallowance under section 14A/Rule 8D is not called for. [Paras 32]Disallowance under section 14A/Rule 8D deleted; revenue's ground dismissed.Allowability of advertisement expenditure - Whether advertisement expenditure incurred (including in cities where assessee had no outlets) is disallowable. - HELD THAT: - Assessing Officer did not dispute genuineness; assessee explained advertisements promoted business and costs were shared among group entities on turnover basis, a practice not challenged in earlier years. Tribunal found AO's objection (no local outlet) without merit and accepted that promotion in other cities was justified for business expansion; also noted ledger evidence of consistent treatment and absence of prior objection. [Paras 33]Advertisement expenditure disallowance deleted.Remuneration to partners under section 40(b) and computation of book profit - Whether remuneration to partners is allowable where brought forward losses/unabsorbed depreciation exist and how book profit is to be computed for section 40(b). - HELD THAT: - CIT(A) allowed remuneration, holding that deduction under section 40(b) (based on 'book profit') is to be allowed first and only thereafter brought forward losses are to be set off under section 72. Tribunal agreed with precedent (Ahmedabad Bench) that book profit must be computed as per Chapter IV D and remuneration should be allowed before setting off brought forward losses; hence deletion of AO's addition was sustained. [Paras 34]Addition on account of excess remuneration to partners is deleted; assessee's claim allowed.Treatment of interest on gold deposit scheme paid to partners - Whether the excess interest paid to partners on gold deposit scheme is disallowable as a colourable device. - HELD THAT: - Tribunal referred to its earlier decision in the assessee's own case (AY 2009 10) where it held that if interest paid to partners on gold deposits is within permissible limits, no disallowance is warranted notwithstanding differing rates at which partners pay customers. No distinguishing material was furnished by revenue for the present year. In light of identical facts and prior Tribunal finding, the revenue's ground was dismissed. [Paras 35]Disallowance in respect of interest on gold deposit scheme to partners is deleted.Final Conclusion: Appeal of the assessee is partly allowed: AO's 40A(2)(a) disallowance rejected and gross profit substituted at 0.70% of audited sales; disallowances under sections 14A, 40(b) (remuneration), and interest on gold deposit scheme are deleted; interest disallowance under section 36(1)(iii) is confirmed. The addition claimed under section 2(22)(e) is remanded to the Assessing Officer for fresh adjudication in accordance with the Tribunal's observations. The Department's appeal is dismissed. Issues Involved:1. Gross Profit (GP) Addition.2. Addition under Section 2(22)(e) - Deemed Dividend.3. Disallowance of Interest under Section 36(1)(iii).4. Disallowance under Section 40A(2)(a).5. Disallowance under Section 14A.6. Disallowance of Advertisement Expenses.7. Disallowance of Remuneration to Partners.8. Disallowance of Interest Paid to Partners.Detailed Analysis:1. Gross Profit (GP) Addition:The assessee challenged the GP addition of Rs. 5,65,54,895/- made by the Commissioner of Income Tax (Appeals) (CIT(A)). The assessee argued that the GP addition was unjustified as the purchases from sister concerns were at prevailing rates inclusive of making charges. The Tribunal noted that in the previous assessment year 2009-10, the GP was estimated at 1.20% instead of 1.13%. For the assessment year 2010-11, the GP declared was 0.61%, and CIT(A) estimated it at 0.90%. The Tribunal found the addition of 0.29% too high and concluded that increasing the GP rate by 0.09% to 0.70% was reasonable.2. Addition under Section 2(22)(e) - Deemed Dividend:The assessee contested the addition of Rs. 10,16,06,967/- under Section 2(22)(e), arguing that the transactions with group companies were trading in nature and not loans/advances. The Tribunal observed that the assessee, being a partnership firm, cannot be a registered shareholder, but it can be a beneficial shareholder. The Tribunal referred to the Supreme Court’s decision in Gopal and Sons (HUF) vs. CIT, which held that Section 2(22)(e) applies to beneficial shareholders. The Tribunal remanded the issue back to the Assessing Officer (AO) to determine if the advances were trade advances or otherwise and to exclude current year’s business profits from accumulated profits for deemed dividend computation.3. Disallowance of Interest under Section 36(1)(iii):The assessee sought deletion of Rs. 3,08,889/- disallowed under Section 36(1)(iii). The CIT(A) confirmed the disallowance, noting that the assessee failed to provide evidence supporting its claim that the loans given to unrelated parties had become doubtful of recovery. The Tribunal upheld the CIT(A)’s findings due to the lack of evidence from the assessee.4. Disallowance under Section 40A(2)(a):The Revenue challenged the deletion of Rs. 33,31,94,731/- disallowed under Section 40A(2)(a). The Tribunal noted that similar disallowances were made in the previous year and were deleted by the Tribunal. The Tribunal found that the assessee’s transactions with sister concerns were at Jalgaon rates, and the AO’s comparison with Bombay Bullion Market rates was incorrect. The Tribunal upheld CIT(A)’s decision to estimate GP at 0.90% but modified it to 0.70%.5. Disallowance under Section 14A:The Revenue contested the deletion of Rs. 6,21,87,028/- disallowed under Section 14A. The Tribunal noted that the assessee had not received any exempt income from its investments in group companies during the year. Following the Special Bench decision in ACIT vs. Vireet Investments (P) Ltd., the Tribunal held that no disallowance under Section 14A is warranted when no exempt income is earned.6. Disallowance of Advertisement Expenses:The Revenue challenged the deletion of Rs. 37,70,543/- disallowed as advertisement expenses. The Tribunal observed that the assessee had incurred expenditure for promoting its business, including in cities where it did not have business outlets. The Tribunal found no merit in the AO’s reasoning and upheld CIT(A)’s decision to allow the expenditure.7. Disallowance of Remuneration to Partners:The Revenue contested the deletion of disallowance of excess remuneration paid to partners. The Tribunal noted that remuneration to partners is based on current year’s book profits and should be deducted before setting off brought forward losses. The Tribunal upheld CIT(A)’s decision, aligning with the Ahmedabad Bench’s ruling in M/s. Shree Yogeshwar Developers vs. ITO.8. Disallowance of Interest Paid to Partners:The Revenue challenged the deletion of disallowance of interest paid on gold deposit scheme to partners. The Tribunal referred to its decision in the previous year, where it held that interest paid to partners within permissible limits should not be disallowed. The Tribunal upheld CIT(A)’s decision to delete the disallowance.Conclusion:The Tribunal partly allowed the assessee’s appeal by modifying the GP addition and remanding the deemed dividend issue back to the AO. The Revenue’s appeal was dismissed in its entirety.