2022 (2) TMI 1514 - AT - Income Tax

Tax appeal partly allowed: s.14A interest disallowance deleted; Rs.2,89,107 allocated to exempt income; s.36(1)(iii) not attracted

ITAT set aside the AO's disallowance of interest under s.14A and directed deletion; allowed allocation of Rs.2,89,107 administrative expenses to exempt ... Disallowance of interest expenses u/s 14A - HELD THAT:- We set aside the finding of the CIT(A) and direct the AO to delete the addition made by him on account of interest expenses. Disallowance of the administrative expenses, we note that the decisions for making the investments or disinvestments in the securities are taken up in the Board meetings. These are very strategic decisions. Before taking such decision, lot of research and market studies are conducted. Likewise, the support of administrative division is also required while holding the Board meetings for the purpose of decision-making. Therefore, it cannot be said that no expenses was incurred by the assessee against such dividend income. Accordingly, we are not convinced with the argument of assessee that there was not incurred any expense against the dividend income. Allocation of the administrative expenses based on exempted and non-exempted income by the Revenue, we find that the basis adopted by the authorities below have not been challenged by the assessee. But what was alleged by the assessee is this that amount of administrative expense was wrongly taken by the authorities below. As per the assessee, the correct amount of administrative expenses stands at Rs. 64,01,125/- which has not been challenged by the learned DR at the time of hearing. Accordingly, we hold that the amount of expense towards the administrative division stands at Rs. 2,89,107 which could be allocated to exempted income. Whether the amount of capital gain represents the exempted income? - For claiming the exemption of long term capital gain on share or securities u/s 10(38), it is prerequisite that on transfer of such share or securities, Securities Transaction Tax must have been paid, but in the present case of the assessee, same has not been done. Rather the learned CIT(A) has given a categorical finding that the assessee has paid taxes at the rate of 20% on the impugned capital gain. At the time of hearing the DR has not brought anything on record contrary to the finding of the CIT(A). Accordingly we hold that, there cannot be any disallowance of the expenses u/s 14A of the Act against the capital gain declared by the assessee as alleged by the AO. Hence the ground of appeal of the assessee is partly allowed whereas the ground of appeal of the revenue is hereby dismissed. Expenses incurred by the assessee in connection with the Power project which should have be allowed as deduction - We note that the issue is arising from assessment year 2008-09, where assessee has claimed certain expense incurred on power project which included expenses incurred in earlier year as well as in A.Y. 2008-09. The AO in assessment proceeding under section 143(3) for A.Y. 2008-09 disallowed the expenses being dead loss whereas the learned CIT (A) provided the partial relief. Against which the assessee is in appeal before us. The impugned issue has been dealt by us in paragraph number 76 of this order where we have disallowed the claim of the assessee in entirety. Thus the question of allowing the same in the year under consideration i.e. A.Y. 2006-07 does not arise. Hence the ground of appeal of the assessee is hereby dismissed. Deduction on account of education, secondary & higher education cess paid on income as well as on surcharge - Since the claim of the assessee is purely legal claim and entire facts are available on record. Thus, it is not justified in not admitting the purely legal ground raised by the assessee for the first time. Furthermore, we note that the term education cess was introduced for the first time by the Finance Bill 2004 with the specific objective to provide the finance to the Government's commitment to universalize quality basic education. Assessee is entitled for the deduction of education cess. Addition on account of accrued interest and interest on deep discount bond held and sold during the year - whether the assessee is liable to recognize the interest on deep discount bond on accrual basis? - whether profit on transfer of bond before maturity should be treated as capital gain or interest? - HELD THAT:- We note that, this issue is squarely covered in favour of the assessee by the order of this tribunal in the own cases of the assessee for the assessment year 2002-03 [2013 (2) TMI 787 - ITAT AHMEDABAD] as held the assessee on its part, in our opinion, succeeded in establishing the change of bona fide because it has ceased to have any business income and had adopted the change well before the search as well as completion of assessment for block period and also before coming of Circular of No. 2 of 2002 on the Statute. Since the assessee has followed the same system in all the subsequent years, we see no reason as to the assessee's choice/preference to adopt the changed system of accounting be not accepted - Assessee had right to adopt the changed system of accounting and by changing the system of accounting from mercantile to cash was a bonafide change. Whether the profit on transfer of deep discount should be capital gain or interest income is also covered in the favour of the assessee by the combined order of this tribunal in own case of the assessee along with the case of Hiren-bhai Patel for A.Y. 2002-03 [2013 (2) TMI 787 - ITAT AHMEDABAD] uphold the order of the learned CIT (A) with the direction to the AO to delete the addition made by him. Addition under the provisions of section 36(1)(iii) - diversion of interest-bearing fund for noncommercial purposes - HELD THAT:-As own fund of the assessee exceeds the amount of interest free loan and advances provided by it. The own fund of the assessee as on 31st March 2006 stands at Rs. 571 crores whereas interest-free loans and advances stand at Rs. 274.16 crores. Accordingly a presumption can be drawn that the assessee has provided interest-free loan advances out of its own fund. In holding so we draw support and guidance from the judgment of Torrent Power Ltd. [2014 (6) TMI 185 - GUJARAT HIGH COURT] as held assessee had sufficient funds for making the investments and it had not used the borrowed funds for such purpose. This aspect of huge surplus funds is not disputed by the revenue which earned it the interest on bonds and dividend income. Loss on the sale purchase of the shares disallowed - We note that the issue involved on hand is covered in favour of the assessee by the order of this tribunal in case of sister concern of the assessee namely Nirma Industries Limited for AY 2004-05 [2016 (3) TMI 413 - ITAT AHMEDABAD] as held when the assessee converted it into stock in trade, the loss suffered between the date of investment to the date of conversion was treated as loss under capital gain assessable in the year when sale was made and loss from the date of conversion to the date of sale was to be treated as business loss, which assessee claimed. The valuation on date of conversion into stock in trade was taken on the basis of report of Chartered Accountant. There was no contrary sale price available on the date of conversion. When the purchase & sales are genuine and purchases & sale prices are accepted, the parties are independent and not related to the assessee u/s. 40A(2)(b) of the Act and there was no evidence that suppressed sale price difference came back to the assessee, the loss on sale could not be disallowed as loss arising from sham transaction or as bogus loss. Hence, the addition made by the Assessing Officer was rightly deleted by the CIT(A) Addition of interest expenses - There cannot be any disallowance of interest expenses in a situation where own fund exceeds the amount of investments. Dead loss - assessee has incurred expenses on the power project which were claimed as deduction without showing any corresponding income in the books of accounts - HELD THAT:- Whether such expenses on the power project can be allowed against the unconnected business of the assessee. The answer stands in negative. It is for the reason that the provisions of section 37 of the Act stipulates that the expenses which have been incurred for the purpose of the business can only be allowed as deduction. Thus such expenses at the most can be claimed under section 35D of the Act as held by the ld. CIT-A after the commencement of business. There was common management, administration and interlacing of the fund in the power project. But to our, understanding it is not sufficient to have the common management, administration and interlacing of the fund for allowing the expenses until and unless someone nexus is established between the existing as well as new of activity of the assessee. In the case law cited by the learned AR for the assessee, we find that there was a common thread in all those case laws that there was interconnection between the different businesses of the assessee and therefore the Hon’ble Courts were pleased to allow the deduction by holding that the expenses were incurred in connection with the existing business. Therefore, the principles laid down by the courts in those cases are distinguishable from the present facts of the case. In the given facts and circumstances the assessee was carrying on the business of investment in shares and securities which had no connection with the power projects of the proposed business of the assessee. Accordingly, we hold that there cannot be any deduction of the expenses claimed by the assessee with respect to power projects. Hence, the ground of appeal of the assessee is dismissed. ISSUES PRESENTED AND CONSIDERED 1. Whether interest expense attributable to investments yielding exempt income is disallowable under section 14A where the assessee's own funds exceed the amount of investments. 2. Whether administrative and employee-related expenses attributable to exempt income are disallowable under section 14A and Rule 8D, and the correct basis for allocation between exempt and taxable income. 3. Whether accrued interest on deep discount bonds (DDBs) must be recognised on accrual/mark-to-market basis (per CBDT Circular No.2/2002) or treated on transfer as capital gains, and whether profit on pre-maturity sale of DDBs is interest or capital gain. 4. Whether notional accruals mandated by the CBDT circular are ultra vires the Act or inapplicable to bonds acquired before issuance of the circular. 5. Whether interest disallowance under section 36(1)(iii) is warranted where interest-bearing borrowings allegedly diverted to interest-free advances - the requisite proof of nexus and effect of own funds exceeding advances. 6. Whether pre-commencement expenses incurred for a proposed power project are deductible as revenue expenses under section 37 or must be capitalized/amortised under section 35D; and whether such expenses can be allowed against unrelated existing business where only common management or interlacing of funds exists. 7. Whether education cess (including secondary & higher education cess) paid on income-tax and surcharge is an allowable deduction in computing business income. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Disallowance of interest under section 14A where own funds exceed investments Legal framework: Section 14A disallows expenditure in relation to exempt income; Rule 8D prescribes a method for computing disallowance. Precedent treatment: Reliance placed on jurisdictional High Court authority (Torrent Power Ltd.) and Tribunal's own earlier decisions in the assessee's cases showing that where own funds substantially exceed investments, a presumption arises that investments were made out of own funds and not out of borrowed funds. Interpretation and reasoning: The Tribunal examined balance-sheet figures showing capital and reserves far exceeding investments (e.g., own funds Rs. 571.48 crores vs investments Rs. 66.12 crores for AY 2006-07; similar for other years). On that factual matrix a presumption that investments were financed from own (non-interest-bearing) funds is permissible and rebutted the AO's assumption that interest-bearing borrowed funds were utilised for investments. Ratio vs. Obiter: Ratio - where own funds materially exceed investment amounts, section 14A disallowance of interest cannot be sustained absent specific evidence that borrowed funds were actually used for investments. Conclusion: Addition of interest expenses under section 14A deleted; direction to AO to delete interest disallowances where own funds exceed investments (applied across relevant assessment years). Issue 2 - Disallowance of administrative/employee expenses under section 14A and Rule 8D Legal framework: Section 14A; Rule 8D provides a formulaic basis for attributing expenses to exempt income where necessary. Precedent treatment: Authorities below applied proportional allocation; the Tribunal accepted application of Rule 8D and prior Tribunal decisions recognising that at least part of overheads must be attributable to investment activity. Interpretation and reasoning: The Tribunal rejected the narrow contention that no administrative expenses related to exempt income were incurred. It reasoned that investment decisions, record-keeping and follow-up consume administrative resources; therefore some allocation is warranted. The Tribunal examined the parties' figures and corrected the base administrative expense where the AO had used an incorrect total, adopting the correct amount supplied by the assessee where undisputed by Revenue. Ratio vs. Obiter: Ratio - administrative expenses reasonably attributable to exempt income must be disallowed under section 14A; Rule 8D can operate where appropriate. Quantification must use correct expense bases and may be adjusted where the assessee has already allowed part in its computation. Conclusion: Interest component disallowed under section 14A deleted (see Issue 1); administrative disallowance upheld in principle but recalculated/restricted to the correct attributable sum (specific reductions made in each assessment year). Issue 3 - Tax treatment of accrued interest on Deep Discount Bonds (DDBs) and character of gain on pre-maturity sale Legal framework: Income chargeability depends on nature (interest vs capital gain); CBDT Circular No.2/2002 directed valuation/accrual treatment for DDBs for tax purposes and guidance by RBI valuation principles. Precedent treatment: Tribunal relied on earlier coordinate-bench decisions (including multiple orders in the assessee's own earlier years and other Tribunal decisions) holding that (a) where DDBs are held as capital assets and sold after holding more than 12 months, gains on sale are taxable as long-term capital gains; (b) accrual/MTM treatment may be a matter of accounting choice, and taxing on protective basis where disputed had been frequently deleted by appellate authorities following those precedents. Interpretation and reasoning: The Tribunal found facts identical to earlier tribunal decisions that had consistently deleted AO additions treating sale proceeds as interest income; DDBs held >12 months were capital assets and gains were appropriately declared as long-term capital gains. The CBDT circular's applicability was considered in light of accounting practice and prior consistent appellate outcomes; Revenue produced no binding contrary higher authority decision or distinguishing facts. Ratio vs. Obiter: Ratio - profit on transfer of DDBs held as capital assets for more than 12 months should be taxed as capital gain where facts mirror previous Tribunal rulings; protective assessment treating such profits as interest not sustainable without distinguishing facts or higher authority precedent. Conclusion: Additions treating accrued interest or sale-profits on DDBs as interest were deleted and long-term capital gains treatment accepted for transfers before maturity in the facts of these years. Issue 4 - Ultra vires challenge to CBDT circular (applicability to pre-circular acquisitions) Legal framework: Administrative circulars/guidelines cannot override statute; applicability depends on their retrospective effect and the facts. Precedent treatment: Assessing officers relied on the CBDT circular; tribunals and the CIT(A) in several instances declined to apply it to reverse the taxpayer's position where earlier accounting/tax treatment and holdings in prior years favored the assessee. Interpretation and reasoning: Where investments predated the circular and earlier treatment was adopted consistently (and appeal outcomes favored the assessee), the Tribunal followed precedent and did not accept the AO's invocation of the circular to impose accrual taxation in the year under consideration absent distinguishing evidence. Ratio vs. Obiter: Obiter in respect of general vires; operational conclusion driven by precedential consistency and facts rather than a broad declaration on circular's vires. Conclusion: CBDT circular did not justify changing tax character in the present facts; AO's protective assessments were deleted. Issue 5 - Disallowance under section 36(1)(iii) for diversion of borrowed funds to interest-free advances Legal framework: Section 36(1)(iii) disallows interest where borrowings are diverted to non-business purposes; Revenue must establish nexus between borrowed funds and the amount advanced. Precedent treatment: Authorities relied on multiple Tribunal/High Court decisions establishing that burden lies on Revenue to prove diversion and nexus; where own funds suffice, presumption favors assessee (e.g., Reliance Utilities & Power Ltd.; Torrent Power Ltd.). Interpretation and reasoning: The Tribunal found own funds (capital & reserves) materially exceeded interest-free advances; AO failed to establish specific nexus demonstrating diversion of borrowings to non-business advances. Earlier decisions reversing similar disallowances were followed. Ratio vs. Obiter: Ratio - AO must prove diversion/nexus before disallowing interest; where own funds suffice to meet advances, disallowance not justified. Conclusion: Disallowance under section 36(1)(iii) deleted where Revenue failed to discharge onus and own funds exceeded interest-free advances. Issue 6 - Deductibility of power-project expenses (pre-commencement) and treatment under section 35D Legal framework: Section 37 allows revenue expenses for business purpose; section 35D permits amortisation of preliminary expenses after commencement of business. Precedent treatment: Authorities and courts have on facts allowed certain pre-project/exploratory expenses as revenue where connected to existing business or where promoter activities were in furtherance of business, but have required capitalization/amortisation where expenses pertain to new non-commenced business. Interpretation and reasoning: The Tribunal accepted genuineness of expenses but found no sufficient nexus with existing business of investments in shares and securities. Common management/interlacing of funds alone was insufficient to treat pre-commencement power-project expenses as deductible against unrelated business. CIT(A)'s direction that prior period expenses be amortised under section 35D after commencement was affirmed in substance; contemporaneous expenses of the relevant assessment year which were incurred in that year and evidenced were allowed, but earlier year expenses were to be capitalised/amortised when the project commences. Ratio vs. Obiter: Ratio - pre-commencement expenses of a new, unconnected business are not deductible under section 37 against an existing, unrelated business; such expenses, if genuine, are claimable under section 35D after commencement. Conclusion: Amounts attributable to earlier years disallowed for the year in question and directed to be dealt with under section 35D upon commencement; current-year project expenses allowed to the extent evidenced. Issue 7 - Deductibility of education cess on income-tax and surcharge Legal framework: Deductions under business/incidental expenses; legislative history of section 40(a)(ii) omitting the word 'cess'; CBDT circulars interpreting omission. Precedent treatment: Tribunal followed High Court decisions (including Sesa Goa Ltd., Chambal Fertilisers) and CBDT circular reasoning that 'cess' is not included in the statutory phrase 'any rate or tax levied' and that education cess payable on income tax is deductible; considered contrary treatment relying on Supreme Court authority on surcharge inapposite where that case did not address cess. Interpretation and reasoning: The Tribunal admitted the additional legal ground and treated the cess as distinct from tax/surcharge for the purpose of deductibility. It relied on legislative history and CBDT circular that omission of 'cess' from disallowance provision permits deduction; distinguished Supreme Court authority on surcharge as not addressing cess, and followed High Court determinations granting deduction. Ratio vs. Obiter: Ratio - education cess (and similar cesses) paid on income-tax/surcharge are deductible as business expenses where facts on record permit raising the question before the Tribunal; omission of 'cess' from statutory disallowance supports allowability. Conclusion: Education cess and secondary & higher education cess paid on income tax and surcharge were allowed as deductible expenses.