2011 (4) TMI 1562 - AT - Income Tax

Reassessment u/s147 and 14A disallowance upheld; government undertaking cannot resist reopening within four years

ITAT Delhi upheld the validity of reassessment u/s 147, holding that reopening within four years on the ground that certain income was not derived from ... Validity of reopening of assessment - issuance of a notice u/s 148 - disallowance of deduction admissible u/s 36 (1)(viii) - disallowance of expenses i.e. interest, administrative etc. u/s 14A - undertaking of Govt. of India which has been established under a special Act of Parliament - HELD THAT:- The allegation of the AO for reopening of the asstt. is that assessee has included certain items of income which cannot be termed as derived from such business of providing long term finance. There is no application of mind at the end of AO in the original round of asstt. order on this issue. The assessment has been reopened within four years and therefore, benefit of proviso appended to section 147 is not available to the assessee. We find that Ld. CIT(A) has considered this aspect elaborately in the impugned order and arrived at a conclusion that the case of the assessee comes within the ambit of explanation 2 appended to section 147. There is no change of opinion. Considering the detailed finding of Ld. CIT(A), we do not find any merit in the contention of Ld. Counsel for the assessee and grounds are rejected. There is no disparity on facts in the present asstt. year 2001-02 or 1999-2000. Disallowance made u/s 14A, Ld. Counsel for the assessee pointed out that asstt. has not been reopened by the AO for making this disallowance. He submitted that no disallowance ought to have been made by the Ld. CIT(A). We have considered this contention of the assessee and do not find any merit in it. Section 147 provides that after reopening of asstt., if any other item came to the notice of the AO which has escaped asstt. that can also be examined. Ld. CIT(A) on the basis of finding recorded by his predecessor in the earlier year came to the notice that assessee has dividend income and has not added expenses attributable to earning of such income for the purpose of section 14A in its computation. Therefore, he issued a notice for enhancement of income and worked out the disallowance. Considering our finding in asstt. year 2001-02 and 1999-2000, we direct the AO to give same effect in this asstt. year on these two issues. In the result, appeal of the assessee is partly allowed for statistical purpose. 1. ISSUES PRESENTED AND CONSIDERED 1.1 Whether the reassessment initiated under sections 147/148 to recompute deduction under section 36(1)(viii) was valid, or was vitiated as a mere change of opinion. 1.2 Whether various categories of income (interest on bank deposits, income on investments, service charges on SDF loans, interest on advances/deposits, miscellaneous receipts, dividend, etc.) formed part of 'profits derived from the business of providing long term finance' for the purposes of deduction under section 36(1)(viii), and the manner of computing disallowance, including netting of interest. 1.3 Whether and to what extent disallowance under section 14A was warranted, including (a) applicability of Rule 8D to the year in question, and (b) the power to make/enhance a section 14A disallowance in reassessment proceedings. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Validity of reopening under sections 147/148 Interpretation and reasoning 2.1 The reassessment was initiated on the ground that, while allowing deduction under section 36(1)(viii), the assessee had allegedly included income which did not constitute 'profits derived from' the business of providing long term finance, thereby claiming excess deduction on the special reserve. 2.2 The original assessment order under section 143(3) was brief and contained only a general statement that details regarding deduction under section 36(1)(viii) were called for, furnished, 'perused and placed on record'. There was no discussion or specific examination of the composition or computation of 'profits derived from' long term finance, or of the inclusion of the impugned income items in that profit. 2.3 On examination of the assessee's letter dated 3.12.2004 (relied on by the assessee to show application of mind by the Assessing Officer), the Tribunal found it to be general in nature and containing no working or specific computation relevant to section 36(1)(viii). Thus, there was no material to show that the Assessing Officer had formed any conscious opinion on the particular controversy now raised in reassessment. 2.4 The reassessment was initiated within four years from the end of the relevant assessment year; therefore, the protection of the proviso to section 147 (requiring failure to fully and truly disclose material facts) was not available to the assessee. 2.5 The Tribunal accepted the reasoning that the case fell within Explanation 2 to section 147, as excess relief had been allowed by omission to examine the proper computation of the eligible profits for section 36(1)(viii). In absence of prior formation of opinion on this precise point, the reassessment could not be treated as a 'change of opinion'. Conclusion 2.6 The reopening under sections 147/148 to revisit and restrict the deduction under section 36(1)(viii) was held valid; the assessee's challenge to reassessment was rejected. Issue 2 - Deduction under section 36(1)(viii): nature of eligible profits and computation Legal framework (as discussed) 2.7 Section 36(1)(viii), as applicable to the relevant years, allowed deduction in respect of any special reserve created and maintained by a financial corporation engaged in providing long term finance for industrial, agricultural or infrastructure development, to the extent of 40% of the 'profits derived from such business of providing long term finance', computed under the head 'Profits and gains of business or profession' before making any deduction under that clause. 2.8 'Long term finance' was defined to mean any loan or advance where the terms provide for repayment with interest over a period of not less than five years. Interpretation and reasoning - nature of income eligible as 'profits derived from' long term finance 2.9 The Tribunal noted that the same legal question, on essentially identical facts and categories of income (interest on bank deposits, income on investments including dividend, service charges on SDF loans, interest on advances/deposits, miscellaneous receipts), had already been comprehensively decided against the assessee in earlier years (notably assessment years 1999-2000, 2004-05 and followed in 2007-08). 2.10 Relying on its earlier detailed order (reproduced in the present judgment), the Tribunal reiterated that: (a) The statutory expression 'profits derived from such business of providing long term finance' is narrower than 'profits attributable to' that business. (b) By using 'derived from', the legislature intended to restrict the eligible source of profit to one not beyond the first degree of nexus with the core business of providing long term finance. 2.11 Applying the ratio of the Supreme Court in Liberty India (construing 'profits and gains derived from' eligible business under sections 80I/80IA/80IB), the Tribunal held that: (a) Certain receipts may be attributable to the business of providing long term finance but not 'derived from' that business in the strict sense required by the statute. (b) This interpretation governs section 36(1)(viii) as well, since the critical expression 'derived from' is identical, and the logic distinguishing 'derived from' from 'attributable to' applies with equal force. 2.12 On this basis, the Tribunal upheld the earlier findings that: (a) Dividend income on investments, including long-term investments in shares, arose from investment activity aimed at earning dividend, and not from the provision of long term finance; it could, at best, be income attributable to the financing business but not derived from it. (b) Interest on bank deposits (including short-term deposits of surplus funds) was interest from deposits with banks, not from loans/advances given as long term finance to borrowers; even if sourced from long-term funds, the immediate source of income was the bank deposit itself, not the long term finance business. (c) Service charges on SDF loans represented charges for services rendered where the financing itself was by the Government, not by the assessee; such charges were attributable to, but not derived from, the business of providing long term finance. (d) By parity of reasoning, other impugned receipts such as interest on advances/deposits and miscellaneous receipts similarly lacked the required direct nexus to qualify as profits 'derived from' the business of providing long term finance. 2.13 The Tribunal further reaffirmed earlier reasoning that: (a) Up to assessment year 1995-96, the statutory language of section 36(1)(viii) permitted deduction with reference to 'total income' before specified deductions, so earlier practice of allowing deduction on a broader base did not control interpretation after the 1995 amendment. (b) Following the 1995 amendment, the statutory shift to 'profits derived from such business of providing long term finance' mandated a narrower, source-based approach; past assessments where broader deduction had been allowed could not prevent the Revenue from correcting the position in later open years, particularly where limitation had expired for reopening earlier years. Interpretation and reasoning - computation and netting of interest 2.14 While holding that the impugned categories of income did not qualify for section 36(1)(viii) deduction, the Tribunal, in the earlier years and followed presently, accepted an alternative contention that, in computing the amount to be excluded from business profits for the purpose of the deduction, only net income (after allowing corresponding expenditure directly relatable to such income) should be excluded. 2.15 Specifically as regards interest on bank deposits: (a) The Tribunal agreed that if any part of the assessee's interest expenditure had a direct nexus with the earning of such bank interest, that portion of expenditure must be set off (netted) against the gross interest receipts. (b) Only the resulting net interest income, after such nexus-based allocation of interest expenditure, would be excluded from the eligible profits for section 36(1)(viii). (c) In support, the Tribunal followed the Delhi High Court judgment in CIT v. Shri Ram Honda Power Equipment, which lays down principles for netting of interest. 2.16 The Tribunal also rejected the argument that the Committee on Disputes' permission restricted the assessee from raising such an alternative computation plea, holding that once permission was granted on the question of allowability of deduction under section 36(1)(viii), the quantification aspect (including netting) fell within that permission. Conclusions 2.17 The Tribunal, following its coordinate bench decisions in earlier years, held that the assessee was not entitled to deduction under section 36(1)(viii) in respect of incomes such as interest on bank deposits, income on investments (including dividend), service charges on SDF loans, interest on advances/deposits and miscellaneous receipts, as these were not 'profits derived from' the business of providing long term finance. 2.18 However, in line with earlier orders, the Tribunal directed the Assessing Officer to recompute the disallowance of deduction under section 36(1)(viii) on a net basis, allowing the assessee to demonstrate and claim deduction of any expenditure having a direct nexus with the excluded incomes, so that only net income is excluded from business profits for computing the allowable deduction. 2.19 The Assessing Officer was directed to carry out this exercise after affording adequate opportunity to the assessee and in accordance with the guidance contained in the earlier Tribunal orders and the cited High Court decision. Issue 3 - Disallowance under section 14A: applicability of Rule 8D, quantum and power to enhance in reassessment Interpretation and reasoning - applicability of Rule 8D 2.20 For the relevant year, the Assessing Officer had made a disallowance under section 14A by applying Rule 8D of the Income-tax Rules, and the first appellate authority had modified but still based the computation on Rule 8D. 2.21 Relying on the Bombay High Court decision in Godrej & Boyce Mfg. Co. Ltd. v. DCIT, which held that Rule 8D is applicable prospectively from assessment year 2008-09, the Tribunal concluded that Rule 8D could not be applied for the year under consideration. Interpretation and reasoning - whether any disallowance is warranted and quantum 2.22 The assessee had received exempt dividend income of Rs. 4,59,000 on shares of Indian Potash Ltd., acquired initially in 1976 with subsequent rights and bonus issues. The shares had been held over a long period, and no specific expenditure was identified by the Revenue as incurred to earn this dividend. 2.23 The Tribunal accepted that no direct or substantial expenditure had been established as incurred exclusively for earning the dividend, but considered that some minimal administrative expenditure would necessarily be involved. 2.24 In the absence of Rule 8D and in the absence of precise evidence of expenditure, the Tribunal adopted an estimate and held that 10% of the dividend income would be a reasonable approximation of the expenditure incurred in relation to earning such exempt income. Interpretation and reasoning - power to make/enhance section 14A disallowance in reassessment 2.25 The assessee argued that no disallowance under section 14A could be made because the reassessment had not been initiated on that ground. 2.26 The Tribunal rejected this contention, holding that under section 147, once an assessment is validly reopened, the Assessing Officer is entitled to examine and assess any other income that has escaped assessment, and the first appellate authority is likewise empowered to enhance the assessment on any ground which properly arises from the assessment proceedings. 2.27 Since, in the course of appellate proceedings, it emerged (on the basis of earlier orders) that the assessee had earned exempt dividend income without any corresponding disallowance of expenditure under section 14A, the first appellate authority was justified in issuing notice for enhancement and working out a section 14A disallowance. Conclusions 2.28 Rule 8D was held inapplicable to the year under appeal; the disallowance under section 14A had to be made on a reasonable basis without invoking Rule 8D. 2.29 A disallowance of 10% of the dividend income (Rs. 4,590) was sustained as expenditure relatable to exempt dividend income; the Assessing Officer was directed to modify the assessment accordingly. 2.30 The Tribunal affirmed the authority of the Assessing Officer and the first appellate authority to make or enhance a section 14A disallowance in validly reopened assessment proceedings, even though such disallowance was not the original ground for reopening. 2.31 Consistent with findings in earlier years, the Assessing Officer was directed to give the same effect in this assessment year on both the section 36(1)(viii) and section 14A issues, and the appeal was treated as partly allowed for statistical purposes.