2025 (10) TMI 416 - AT - Income Tax

Tax officer ordered to delete excess disallowance of short-term capital losses; contractual penalties allowed; s.14A/Rule8D addition u/s115JB deleted

ITAT partly allowed the appeal. The AO was directed to delete the excess disallowance of short-term capital losses and to re-examine the loss on the ... Disallowance of bogus loss incurred by the assessee upon sale of listed shares - AO referred to a report published by the Directorate of Income tax Mumbai, which listed UIL as a penny stock scrip to arrange bogus LTCG/ loss - HELD THAT:- Assessee had purchased and sold 5,45,000 shares of UIL during the year which yielded short term capital loss of Rs. 73,26,040/-. Apart from the shares of UIL, the assessee have transacted in other listed shares as well in which it incurred short term capital loss of Rs. 1,16,27,717/-, with aggregate quantum of gross short term capital loss coming to Rs. 1,89,53,757/- [Rs.1,16,27,717 (+) Rs. 73,26,040]. It is observed that the ld. AO’s case concerned the short-term capital loss incurred in the shares of UIL alone, which he alleged to be bogus. We therefore find prima facie merit in the assessee’s plea that the correct quantum of loss incurred on sale of shares of UIL was Rs. 73,26,040/- and therefore, the lower authorities had grossly erred in disallowing the entire gross short term capital loss of Rs. 1,89,53,757/-. Accordingly, the ld. AO is directed to delete the excess loss incorrectly disallowed in the impugned order. Allowability of short-term capital loss incurred in sale of shares of UIL - It is observed that though the ld. AO has cited report(s) of the Investigation Wing enlisting UIL as a penny stock and statement(s) of several broker(s) / entry operator(s) who were purportedly manipulating the scrip of UIL, but none of these details were confronted to the assessee. It is seen that no show cause was also given to the assessee prior to making the impugned addition Assessee is entitled to a right of fair hearing, which requires that the material/ information/ statement sought to be used against the assessee ought to be confronted and the assessee be given sufficient opportunity to rebut the same. Hence, in all fairness, we set aside the issue involving the disallowance of loss incurred in shares of UIL back to the file of AO to examine the same de novo after allowing the assessee opportunity of being heard. AO shall provide the relevant material along with the statement(s) which he intends to use against the assessee and the assessee shall also cooperate in the proceedings. This ground is therefore partly allowed for statistical purposes. Disallowance of penalty expenses - whether the penalty expenses of Rs. 34,71,274/-incurred by the assessee was amenable to Explanation to Section 37(1) of the Act or not? - The aforesaid sum comprised of fines paid to third parties for breach of contract or delay in payment of dues or for failure to fulfill obligations arising out of contracts entered into in the course of business. AR, on sample basis, showed us that the assessee had paid fine of Rs. 20,500/- to M/s M. Hoque Enterprises for violating the agreed safety norms under the contract. Similarly, penal charge of Rs. 68,296/- was paid to M/s Treco Earth Movers Pvt Ltd for loss incurred due to accident while shifting iron pellets. Similar small fines/penalties were paid for stolen items or missing parts or damaged goods to private parties. Having perused the same, there is merit in the submission of the ld. AR that the impugned sum was not incurred for infraction of law but comprised of payments for breach of contracts and therefore in light of the decision of Apeejay Pvt Ltd [1978 (2) TMI 80 - CALCUTTA HIGH COURT] the impugned disallowance is held to be unjustified. Disallowance u/s. 14A r.w.r 8D while computing the book profits u/s. 115JB of the Act - As we find that the issue is settled in favour of the assessee by the decision of Vireet Investment Pvt. Ltd [2017 (6) TMI 1124 - ITAT DELHI] wherein as held that the disallowance by the ld. AO u/s. 14A read with Rule 8D of the Rules is not required to be made to the book profit u/s. 115JB of the Act. Accordingly, we direct the ld. AO to delete the addition made to the book profit u/s. 115JB of the Act Subsidies received by the assessee under the Foreign Trade Policy, is in the nature of capital receipt, not chargeable to tax. MAT computation - Treatment of incentives while computing book profit u/s. 115JB - The incentive received under the SHIS / FPS Scheme, being in nature of capital receipt is directed to be excluded from the computation of book profit u/s. 115JB of the Act. Exclusion of proceeds received upon sale of carbon credits while arriving at the book profit u/s. 115JB - It is observed that the carbon credit is neither received by producing or selling a product, or by-product or rendering any services in connection with the carrying on of the business. Rather, it is in the nature of ‘an entitlement’ received to improve world atmosphere and environment by reducing carbon, heat and gas emissions. Carbon credits are made available to the taxpayer on account of saving of energy consumption and non-emission of hazardous gases into the atmosphere and not because of it s business. It has been held by various judicial authorities cited above that “carbon credit is an offshoot of environmental concern”. We find that there are a plethora of judgments wherein it has been consistently held that income from sale of carbon credit is not chargeable to tax. Direct AO to allow the exclusion of carbon credit receipts from the computation of assessable book profit u/s. 115JB of the Act. ISSUES PRESENTED AND CONSIDERED 1. Whether the assessing authority correctly disallowed as bogus the short-term capital loss claimed on sale of listed shares of a particular scrip, including whether the correct quantum attributable to that scrip was identified and whether principles of natural justice were complied with. 2. Whether amounts characterised as fines/penalties paid to third parties for breach of contract or business obligations are disallowable under Explanation (1) to Section 37(1) of the Act. 3. Whether disallowance under Section 14A read with Rule 8D is required to be added to book profits for computation of tax under Section 115JB. 4. (a) Whether incentives received under government export promotion schemes (Status Holder Incentive Scheme and Focus Product Scheme) are capital receipts not includible in total income; (b) whether such incentives must be excluded while computing book profit under Section 115JB; (c) whether receipts from sale of carbon credits are capital receipts and excluded from book profit; and (d) whether the appellate forum can admit a fresh claim not raised before the assessing officer. ISSUE-WISE DETAILED ANALYSIS - Issue 1: Disallowance of alleged bogus short-term capital loss on sale of shares Legal framework: Assessment additions were made by invoking section 68 (cash credits) reasoning that losses were accommodation entries involving penny-stock manipulation; fundamental right to be heard and requirement to confront adverse material before making additions. Precedent treatment: Lower authorities relied on investigative reports and statements; appellate acceptance must still respect fair hearing principles. (As applied in the judgment: authorities that admitted investigative material must confront assessee and afford opportunity to rebut.) Interpretation and reasoning: The Tribunal examined the record and found a factual error in the assessing officer's computation - the total loss of Rs.1.89 crore was an aggregate across multiple scrips, whereas loss attributable to the specific scrip in question was Rs.73.26 lakh. The AO had mechanically disallowed the aggregate without isolating the scrip in issue. Further, the AO relied on Investigation Wing reports and third-party statements that were not furnished to the assessee nor were show-cause notices issued; the CIT(A) upheld the AO's cryptic addition without re-examining facts. The Tribunal held that material intended to be used against the assessee must be disclosed so the assessee can rebut and that the AO should have applied mind to correct quantum attributable to the particular scrip. Ratio vs. Obiter: Ratio - (a) where an assessing officer relies on investigative reports or third-party statements to disallow a claimed loss, those materials must be confronted to the assessee and an opportunity to rebut must be given; (b) the AO must correctly identify and disallow only the quantum legitimately attributable to the subject transaction. Obiter - observations on the general practice of entry operators and penny stocks as a context for caution. Conclusions: The Tribunal directed deletion of the excess disallowance of Rs.1.16 crore (the portion not attributable to the scrip) and remitted the issue of genuineness of the Rs.73.26 lakh loss to the AO for de novo examination after supplying the assessee with all material and giving an opportunity of hearing. Ground partly allowed for statistical purposes. ISSUE-WISE DETAILED ANALYSIS - Issue 2: Allowability of penalty expenses under Explanation (1) to Section 37(1) Legal framework: Explanation (1) to Section 37(1) disallows expenditure by way of fine or penalty for violation of any law as a deductible business expense; distinction between fines/penalties payable to State/public authorities and contractual penalties payable to private parties for breach of contract. Precedent treatment: The Tribunal relied on jurisdictional authority holding that contractual penalties payable to private parties for breach/delay are not penalties for infraction of law and thus are not covered by Explanation (1) to Section 37(1). Interpretation and reasoning: The challenged sum comprised fines/penal charges paid to private parties for contractual breaches, safety violations under contract, damage/loss to goods, delay penalties, etc., and did not arise from statutory penalties imposed by law. The Tribunal examined sample invoices and concluded payments were contractual in nature and deductible. Ratio vs. Obiter: Ratio - payments that are contractual penalties or liquidated damages to private parties for breach/delays are not disallowable under Explanation (1) to Section 37(1); they are allowable business expenses unless falling under some other disallowance. Obiter - distinguishing statutory penal payments from commercial contractual payments. Conclusions: The disallowance was deleted and the AO was directed to allow the penalty expenses of Rs.34.71 lakh. Ground allowed. ISSUE-WISE DETAILED ANALYSIS - Issue 3: Applicability of Section 14A/Rule 8D addition to book profit under Section 115JB Legal framework: Section 14A/Rule 8D permits disallowance of expenditure in relation to exempt income; Section 115JB imposes tax on book profit subject to certain adjustments. Precedent treatment: The Tribunal followed a binding coordinate bench decision holding that disallowance under Section 14A read with Rule 8D need not be added to book profit for computation under Section 115JB. Interpretation and reasoning: Relying on the cited special bench/coordinate bench authority, the Tribunal held the law settled that the mechanical 14A/8D disallowance is not to be incorporated into book profit for MAT purposes, and directed deletion of the addition made to book profit. Ratio vs. Obiter: Ratio - disallowance under Section 14A read with Rule 8D is not required to be made to book profit under Section 115JB (binding on the Tribunal as per cited coordinate bench ruling). Obiter - none additional beyond application of binding precedent. Conclusions: The AO was directed to delete the addition to book profit; Ground allowed. ISSUE-WISE DETAILED ANALYSIS - Issue 4: Treatment of government export incentives (SHIS/FPS) and carbon credits; admissibility of fresh claim on appeal Legal framework: Taxability depends on nature of receipt - revenue or capital; Section 2(24) definition of income and principles for inclusion in total income and in book profit under Section 115JB; appellate power under section 254 to entertain legal grounds raised for first time on appeal. Precedent treatment: The Tribunal admitted a fresh claim on appeal, relying on higher court precedents and coordinate bench decisions that permit appellate bodies to entertain legal grounds not raised before AO when the issue is one of law or where complex legal position led to non-admission before AO. On merits, the Tribunal followed higher court and coordinate bench decisions holding incentives under the Foreign Trade Policy schemes and receipts from sale of carbon credits to be capital receipts and therefore not includible in taxable income or in book profit under Section 115JB. Interpretation and reasoning: (a) Admissibility - the Tribunal analysed Supreme Court and High Court jurisprudence establishing that the Tribunal has power to entertain legal claims first raised on appeal; where the claim arises from a complex and evolving legal position, the appellate forum may admit the claim. (b) Merits - the FPS/SHIS incentives were found to be granted to promote export potential, technological upgradation and employment, and to create enduring industry-level benefits rather than to meet operational costs; therefore they are capital in nature. (c) Carbon credits were characterised as entitlements arising from environmental conservation (offshoot of environmental concerns), not from the routine business of producing or selling products or services; precedent supports treatment as capital receipt. (d) Inclusion in book profit - following authority, receipts that are not in the nature of income cannot be included in book profit under Section 115JB, which aims to reflect true working result; inclusion would tax non-income items and distort book profit. Ratio vs. Obiter: Ratio - (i) Appellate authorities may, under their statutory powers, admit and decide legal claims not raised before the assessing officer when principles of law permit; (ii) incentives under the FPS/SHIS and proceeds from sale of carbon credits are capital receipts and are not includible in total income; (iii) capital receipts not constituting 'income' under Section 2(24) are to be excluded from book profit for Section 115JB purposes. Obiter - policy observations on objectives of the Foreign Trade Policy schemes and ecological rationale for carbon credits. Conclusions: The Tribunal admitted the fresh claim on appeal, directed exclusion of the SHIS/FPS incentives (Rs.1.02 crore) from total income and from book profit under Section 115JB, and directed exclusion of carbon credit proceeds (Rs.4.29 crore) from book profit. Grounds 4(i)-(iii) allowed. OVERALL RESULT The appeal was partly allowed: the excess disallowance relating to aggregated losses was deleted and the genuineness of the loss attributable to the specific scrip was remitted for de novo verification after furnishing material and hearing; penalty expenses and the Section 14A/Rule 8D and book profit issues were decided in favour of the taxpayer; the fresh claim on export incentives and carbon credits was admitted and allowed with directions to exclude such capital receipts from both total income and book profit computation.