2006 (3) TMI 229 - AT - Income Tax

Interest Expenses Disallowed for Exempt Income; Penalty Cancelled Due to Procedural Lapse.

The Tribunal upheld the disallowance of interest expenses under sections 14A and 115-O(5) of the Income-tax Act, confirming the AO's decision that the ... Deduction of interest paid on monies borrowed for purchase of shares - distributed profits of domestic companies - Penalty levied u/s 271(1)(c) - For Concealment Of Income - HELD THAT:- The crux of the findings is that there is a direct nexus established between the interest bearing loans taken by the assessee and the investment made in the equity shares. The only income arising from the holding of the shares is dividend income which is exempt u/s 10(33). The assessee incurred expenditure for earning exempted dividend income. Section 14A which has been inserted by the Finance Act, 2001 with effect from 1-4-1962 laying down that no deduction would be allowed in respect of the expenditure incurred by the assessee in relation to the income, which does not form part of the total income under this head. The assessee is, therefore, not entitled for the above deduction of interest u/s 36(1)(iii) of the Income-tax Act. The authorities below, therefore, rightly disallowed the amount against the assessee. It is also established that the dividend income was earned by the assessee out of the investment in shares. Merely because the assessee did not earn dividend out of the investment in certain shares by itself would not prove that the provisions of section 14A are not applicable in this case. It is not a hard and fast rule that on each and every investment in shares, the assessee would earn dividend. The earning of the dividend is not certain, unless the concerned company declared and distributed the dividend because it depends on various factors. The established facts are that the entire borrowed unsecured loans have been invested in the shares for the purpose of earning dividend. Therefore, once the assessee claims exemptions on dividend income u/s 10(33) of the Income-tax Act then such dividend is directly related to the investment made in the entire shares. As such it is not possible to accept the alternative contention of the learned counsel for the assessee that part of the interest may be disallowed. This contention of the learned counsel for the assessee is also rejected. No other point is argued or pressed. Thus, we do not find any merit in the appeal of the assessee. The same is, therefore, dismissed. Penalty levied u/s 271(1)(c) - For Concealment Of Income - HELD THAT:- It is well-settled law that the quantum and penalty are independent proceedings. Section 271(1)(c) of the Act provides that if the Assessing Officer or the CIT(A) or the Commissioner in the course of any proceedings under this Act is satisfied that any person has concealed the particulars of his income or furnished inaccurate particulars of such income, he may direct that such person shall pay by way of penalty. The bare reading of the aforesaid provisions would make it clear that the Assessing Officer has to form his own opinion and record his satisfaction before initiating penalty proceedings. Merely because the penalty proceedings have been initiated, it cannot be assumed that such a satisfaction was arrived at in the absence of the same being spelt out by the order of the Assessing Authority. In the present case before us, the Assessing Officer has nowhere recorded his satisfaction with regard to the concealment of the particulars of income or furnishing inaccurate particulars of income in the assessment order or while dealing with the addition on account of disallowance of the interest paid on the borrowed funds by the assessee. As is noted, the assessment order passed by the Assessing Officer clearly shows that the satisfaction for initiating the penalty proceedings u/s 271(1)(c) was not recorded by the Assessing Officer in the assessment order and, therefore, we hold that the initiation of the penalty proceedings was not in accordance with law as envisaged by Delhi High Court in the cases of Ram Commercial Enterprises Ltd.[1998 (10) TMI 13 - DELHI HIGH COURT], B.R. Sharma [2005 (2) TMI 50 - DELHI HIGH COURT] and Super Metal Re-Rollers (P.) Ltd [2003 (9) TMI 51 - DELHI HIGH COURT] and as such penalty imposed in pursuance of such invalid proceedings is liable to be cancelled on this ground alone. The same is taken by the I.T.A.T., Delhi 'E' Bench in the case of Balka Services (P.) Ltd.[2005 (4) TMI 266 - ITAT DELHI-E]. Thus, the penalty is cancelled u/s 271(1)(c) of the Income-tax Act. As a result, the appeal by the assessee is allowed. Issues Involved:1. Disallowance of interest expenses on borrowed funds used for dividend-earning shares.2. Interpretation of sections 14A and 115-O(5) of the Income-tax Act.3. Characterization of shares as investments versus business activity.4. Allowability of interest deduction under section 36(1)(iii) of the Income-tax Act.5. Validity of the assessment order.6. Determination of losses to be carried forward.7. Penalty under section 271(1)(c) of the Income-tax Act.Detailed Analysis:1. Disallowance of Interest Expenses:The assessee's appeal against the disallowance of interest expenses amounting to Rs. 3,93,69,566 was based on the claim that the borrowed funds were used for acquiring shares to gain controlling interest in Jindal group companies. The Assessing Officer (AO) disallowed the interest expenses, citing a direct nexus between the borrowed funds and the investment in shares, which yielded exempt dividend income.2. Interpretation of Sections 14A and 115-O(5):The AO and CIT(A) interpreted sections 14A and 115-O(5) to disallow any deduction of expenses incurred in relation to income that does not form part of the total income. The AO noted that the dividend income of Rs. 20,00,690 was exempt under section 10(33), and thus, the interest expenses related to the borrowed funds used for acquiring these shares were not deductible.3. Characterization of Shares:The CIT(A) rejected the assessee's claim that the shares were held as part of its business activity to control group companies. The CIT(A) found that the shares were held as investments, as indicated in the balance sheet and the memorandum of association. The only income from these shares was dividend income, which was assessable under the head 'Income from Other Sources.'4. Allowability of Interest Deduction:The CIT(A) upheld the AO's decision, stating that the interest expenses on borrowed funds used for acquiring shares yielding exempt dividend income were not allowable under section 36(1)(iii). The CIT(A) emphasized that the provisions of section 14A were applicable, disallowing any expenditure incurred in relation to exempt income.5. Validity of the Assessment Order:The assessment order was challenged, but the CIT(A) and the Tribunal found no merit in the challenge. The assessment order was held to be valid.6. Determination of Losses:The AO determined the losses to be carried forward, adjusting the brought forward losses to the extent of the income. The Tribunal did not find any error in this determination.7. Penalty under Section 271(1)(c):The CIT(A) confirmed the penalty under section 271(1)(c) for filing inaccurate particulars of income. The Tribunal, however, cancelled the penalty, holding that the AO had not recorded the requisite satisfaction for initiating penalty proceedings in the assessment order. The Tribunal emphasized that the AO must form an opinion and record satisfaction before initiating penalty proceedings, as required by law.Conclusion:The Tribunal dismissed the assessee's appeal on the quantum issue, confirming the disallowance of interest expenses under sections 14A and 115-O(5). However, the penalty under section 271(1)(c) was cancelled due to the AO's failure to record satisfaction before initiating penalty proceedings. The appeals were thus disposed of, with the quantum appeal dismissed and the penalty appeal allowed.