Income Tax Appellate Tribunal - Mumbai
Conwood Agencies (P.) Ltd. vs Ito on 6 February, 2007
ORDER
D.K. Srivastava, Accountant Member
1. The appeal filed by the assessee is directed against the order of the Commissioner (Appeals) on the following grounds :
1. On the facts and in the circumstances of the case and in law the ld. Commissioner (Appeals) has erred in confirming the stand taken by the assessing officer that the funds at interest have not been borrowed by your petitioner for the purpose of business of development and construction of residential project on land (Kandivli Project) and accordingly confirming the disallowance made by the assessing officer of interest of Rs. 5,04,56,580 attributable to the value of investment held in shares mainly of group companies and consequential reduction made in the value of project work-in-progress (Kandivli Project) by the like amount.
2. The ld. Commissioner (Appeals) ought to have held that the funds at interest have been borrowed by your petitioner for the purpose of business of development and construction of residential project on land (Kandivli Project) and hence, the interest expenditure of Rs. 5,04,56,580 (being part of the interest expenditure for the year) and allocated in the accounts to the cost of development and construction of Kandivli Project on land, and hence, disallowance of the said interest and consequential reduction made in the value of the project work-in-progress of Kandivli Project, by the assessing officer is required to be deleted.
2. At the time of hearing, the ld. Counsel for the assessee invited our attention to the order dated 26-9-2006 passed by this Tribunal in assessee's appeal for the assessment years 1994-95 and 1996-97 and submitted that similar issue as in the appeal before us was also involved in the aforesaid two appeals which have since been considered by this Tribunal and the matter restored to the file of the assessing officer for a fresh decision with the following observations :
2. In both years, the only issue involved is regarding allowability of interest on borrowed funds amounting to Rs. 36,39,751 in assessment year 1994-95 and Rs. 5,55,00,429 in assessment year 1996-97.
3. Both the sides agreed that this matter in both years may be restored to the assessing officer for a fresh decision in the line of the Tribunal judgment rendered in the case of Pramod S. Talwalkar (HUF) v. ACIT 75 ITD 492 (Pune), in which the Tribunal has followed the judgment of Hon'ble Apex court rendered in the case of East India Pharmaceuticals Works Ltd. v. CIT 224 ITR 627.
4. Accordingly, we set aside the order of ld. Commissioner (Appeals) in both years on this issue and restore this matter to the assessing officer in both years with the direction to allow the claim of the assessee if it is established that interest- free loans to sister concerns, loans given in the form of advances against expenses, loans given in the form of advances against shares and investment in shares/debentures were made out of business profits and interest-free receipts deposits in the overdraft account. We want to make it clear that the burden is on the assessee to demonstrate that all these interest-free advances and investments were made out of business profits and interest-free receipts deposited in the overdraft account and no such advances or investment was made out of borrowed funds by showing that on the date of giving of each advance or on the date of making of each investment, the assessee had sufficient funds available with it out of business profits and interest-free receipts deposited in the overdraft account business profits and interest-free receipts deposited in the overdraft account. The Assessing Officer should pass necessary order as per law in the line of the above direction and after allowing sufficient opportunities of being heard to the assessee.
3. We have heard the parties and considered their submissions. The assessee-company is engaged in the business of development of immovable properties. The assessee was found to have invested a sum of Rs. 25,72,11,709 in shares/debentures of its associate/group concerns (excluding investments in partnership firm). The assessee explained A before the assessing officer that the investments made in shares and debentures came out of interest-free deposits available with the assessee. The assessing officer noticed that there was consistent increase in the investment in shares accompanied by consistent increase in the borrowings. His observations are available in para 5.4 of the assessment order. For the reasons given in paragraph 5.4 of the assessment order, the assessing officer allocated interest of Rs. 5,04,56,580 to the investments g made by the assessee-company in shares and consequently excluded the same from work-in-progress in respect of construction projects. In para 5.4 of the assessment order, the assessing officer states :
Thus it is evident that while investment has increased, the interest bearing funds have also increased or fresh loans were required to be taken. It in itself shows that the interest-free advances available to the assessee were not adequate to make fresh investment in shares or to undertake the activities of the assessee. When the funds have got intermingled, it cannot be said with certainty that only the interest-free funds were invested in shares. Assessee, cannot be allowed to burden the business of construction activity with interest bearing funds alone and to pass on the entire interest cost to the projects at hand. In any case, the aspect of utilization of interest-free advances available to the assessee for interest-free loans given by it has already been accepted and no disallowance has been made on this account. Therefore, further relief claimed by the assessee on this account cannot be considered to be admissible particularly when it had to take loans in huge amounts in earlier years.
4. On appeal, the ld. Commissioner (Appeals) confirmed the view taken by the assessing officer following his order for the assessment year 1999-2000. The Commissioner (Appeals) has confirmed the action of the assessing officer mainly for three reasons. First reason is that the deduction claimed by the assessee under Section 36(\)(iii) is not allowable under that section as the scope of that section is limited to the amount of interest paid in respect of capital borrowed for the purpose of business or profession. According to him, the money invested in shares and debentures of sister companies could not be said to have been utilized for the purpose of the business as the purpose of the business was construction activity and not investment in shares or debentures. Second reason given by him is that the dividend income on shares was taxable under Section 56 and hence interest allocable to the investments made in shares was liable to be considered only under Section 57(iii) and not under Section 36(1)(iii). Third reason given by the ld. Commissioner (Appeals) is that the dividend income was exempt from taxation and hence no deduction was liable to be allowed under Section 14A in respect of the expenditure incurred by the assessee in relation to the income which did not form part of the total income under the Income Tax Act.
5. At the time of hearing, the learned counsel for the assessee placed reliance on the decision of this Tribunal in the assessee's own case for assessment years 1994-95 and 1996-97. We have perused the aforesaid order of the Tribunal as also the records of the case. We find that the issue in that case was whether the amount borrowed by the assessee was utilized for the purpose of development and construction of residential project known as Kandivli Project so as to make the interest relating thereto eligible for deduction under Section 36(1)(iii). The issue in the present case is substantially different in that the issue before us is whether the assessee (a) has used any part of borrowed capital for making investment in shares and (b) can be said to have incurred any interest expenditure in relation to the dividend income, which was exempt from tax. Provisions of Section 14A are squarely involved in the case before us whereas these provisions did not come up for consideration in the case of the assessee for earlier years namely 1994-95 and 1996-97 before this Tribunal.
6. It may be relevant to mention here that the Commissioner (Appeals) has followed his own order for assessment year 1999-2000 for confirming the order of the assessing officer and not the order of his predecessor for assessment years 1994-95 and 1996-97. The reasoning given by the learned Commissioner (Appeals) in his order for the assessment year under appeal therefore needs apprecia-tion. Besides, Sub-sections (2) and (3) have been inserted in Section 14A by the Finance Act, 2006. Hence the effect of those provisions insofar as they apply to the pending matters has also to be considered.
7. Deductions otherwise admissible under Section 36(1)(iii) and Section 57(iii) are now subject to the provisions of Section 14A. Therefore, the applicability of the provisions of Section 14A has to be examined first. If the expenses are not hit by Section 14A(1), their deductibility has then to be considered under Section 36(l)(iii) or 57(iii).
8. We shall therefore turn to Section 14A, which prohibits deduction of any expenditure incurred by the assessee in relation to income, which does not form part of the total income under the Income Tax Act. Sub-sections (2) and (3) have been inserted in Section 14A of the Income-tax Act by the Finance Act, 2006. Sub-section (2) provides that the Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under the Income Tax Act in accordance with such method as may be prescribed, if the assessing officer, having regard to the accounts of the assessee is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under the Income Tax Act. The prohibition for allowing the deduction under Section 14A for and from assessment year 1962-63 is "in respect of expenditure incurred by the assessee in relation to income" which does not form part of the total income. The term "expenditure"has A been defined at page 598 of Black's Law Dictionary (Seventh Edition) thus : "1. The act or process of paying out; disbursement. 2 A sum paid out."The term "expense"has been defined at the same page of the aforesaid dictionary as follows : "n. An expenditure of money, time, labour, or resources to accomplish a result; esp., business expenditure chargeable against revenue for a specific period. - expense, vb. Cf. COST (1)."The "expense"has many forms, namely, accrued expense, administrative g expense, business expense, capital expense, capitalized expense, current expense, deferred expense, educational expense, entertainment expense, extraordinary expense, fixed expense, funeral expense, general administrative expense, medical expense, moving expense, operating expense, ordinary and necessary expense, organizational expense, put-of-pocket expense, prepaid expense, travel expense. The term "expenditure"occurring in Section 14A would thus take in its sweep not only direct expenditure but also all forms of expenditure regardless of whether they are fixed, variable, direct, indirect, administrative, managerial or financial. The term "incur"has been defined at page 771 of the aforesaid dictionary as follows: "incur, vb. To suffer or bring on oneself (a liability or expense)."One of the meanings given to the word "relate"under the head "Law"at page 2534 in "The New Shorter Oxford English Dictionary (1993 Edition) is "Have some connection with, be connected to". The phraseology used in Section 14A prohibiting the deduction in respect of expenditure in-curred by the assessee in relation to exempt income is thus wide enough to cover all forms of expenses provided they have some connection with the exempt income. This is based on the principle that expenses must be allocated to that income to which they are connected to avoid distortions in the computation of both taxable as well as exempt income. This is also achieved by the matching principle of accountancy. In Taparia Tools Ltd. v. Jt. CIT , the Hon'ble jurisdictional High Court has explained the matching principle as under :
The mercantile system of accounting is based on accrual. Basically, it is a double entry system of accounting. Under the mercantile system of accounting, profits arising or accruing at the date of the transaction are liable to be taxed notwithstanding the fact that they are not actually received or deemed to be received under the Act. Under the mercantile system of accounting, therefore, book profits are liable to be taxed. The profits earned and credited in the books of account constitute the basis of computation of income. The system postulates the existence of tax insofar as monies due and payable by the parties to whom they are debited. Therefore, under the mercantile system of accounting, in order to determine the net income of an accounting year, the revenue and other incomes are matched with the cost of resources consumed (expenses).
Under the mercantile system of accounting, this matching is required to be done on accrual basis. Under this matching concept, revenue and income earned during an accounting period, irrespective of actual cash in-flow, is required to be compared with expenses incurred during the same period, irrespective of actual out-flow of cash. In this case, the assessee is following the mercantile system of accounting. This matching concept is very relevant to compute taxable income....
9. It is difficult to accept the hypothesis that one can earn substantial dividend income without incurring any expenses whatsoever including management or administrative expenses. By same logic, it is equally difficult to accept that the only expenses involved in earning the dividend income are those incurred on collection of dividend or on encashing a few dividend warrants. A company cannot earn dividend without its existence and management. Investment decisions are very complex in nature. They require substantial market research, day-to-day analysis of market trends and decisions with regard to acquisition, retention and sale of shares at the most appropriate time. They require huge investment in shares and consequential blocking of funds. It is well-known that capital has cost and that element of cost is represented by interest. Besides, investment decisions are generally taken in the meetings of the Board of Directors for which administrative expenses are incurred. It is therefore not correct to say that dividend income can be earned by incurring no or nominal expenditure. This aspect of the matter has also received careful attention of Chennai Bench of this Tribunal in Southern Petro Chemical Industries v. Dy. CIT (2005) 3 SOT 157. After comprehensive consideration of all the relevant aspects of the case including the provisions of law, the Chennai Bench has held that investment decisions are very strategic decisions in which top management is involved and therefore proportionate management expenses are required to be deducted while computing the exempt income from dividend. In Harish Krishnakant Bhatt v. Income Tax Officer (2004) 91 ITD 311 (Ahd.), the Ahmedabad Bench of this Tribunal has held that, the dividend income being exempt under Section 10(33), the interest on capital borrowed for acquisition of relevant shares yielding such dividend cannot be allowed deduction by operation of Section 14A. In Dy. CIT v. S.G. Investments & Industries Ltd. (2004) 89 ITD 44 (Cal.), the Calcutta Bench of this Tribunal has laid down two propositions: one, in view of Section 14A inserted in the Income Tax Act with retrospective effect from 1-4-1962, pro rata expenses on account of interest relatable to investment in shares for earning exempt income from dividend are to be disallowed against taxable income and only the net dividend income is to be allowed exemption after deducting the expenses; and two, the expression "expenditure incurred by the assessee in relation to income which does not form part of the total income"in Section 14A has to be given a wider meaning and would include both direct and indirect relationship between expenditure and exempt income. Following the decision of the Hon'ble Supreme Court in CIT v. United General Trust Ltd. . The Calcutta Bench of the Tribunal has also held that the interest paid by the assessee being attributable to the money borrowed for the purpose of making the investment which yielded the dividend and other expenses incurred in connection with or for making or earning the dividend income can be regarded as expenditure incurred in relation to dividend income. In Everplus Securities & Finance Ltd. v. Dy. CIT (2006) 101 ITD 151, the Delhi Bench of this Tribunal ha.s held that merely because the assessee did not earn the dividend out of investment in certain shares; does not imply that the provisions of Section 14A would not apply to that extent. In Assistant Commissioner v. Premier Consolidated Capital Trust (I) Ltd. (2004) 83 ITJ (Mum.) 843, the Mumbai Bench of this Tribunal has held that the assessing officer is justified in attributing a part of the financial and administrative expenses as expenditure incurred in relation to exempt income and disallowing the same in view of the provisions of Section 14A.
10. Keeping in view the provisions of Section 14A as also the aforesaid decisions of the co-ordinate Benches of this Tribunal, we hold that all expenses connected with the exempt income have to be disallowed under Section 14A regardless of whether they are direct or indirect, fixed or variable and managerial or financial in accordance with law. In this connection, the provisions of Sub-section (2)/(3) of Section 14A inserted by the Finance Act, 2006 deserve to be noted.
11. The procedure for computation of disallowance has now been provided in Sub-sections (2) and (3) of Section 14A of the Income Tax Act. It is no longer open to the assessing officer to apply his discretion in computing the disallowance or make ad hoc disallowance under Section 14A. Substantive provisions are contained in Sub-section (1) of Section 14A prohibiting deduction in respect of expenditure incurred in relation to exempt income while procedural provisions regarding computation of the aforesaid disallowance are contained in Sub-sections (2) and (3) thereof. Sub-sections (2) and (3) seek to achieve the underlying object of Section 14A(1) that any expenditure incurred in relation to exempt income should not be allowed deduction. It is fairly well-settled by a catena of decisions that procedural provisions apply to all pending matters and that the rule against retrospectivity does not hit them.
12. In W.H. Cockerline & Co. v. IRC (1930) 16 TC 1 (CA) at 19, Lord Hanworth quoted with approval the following passage from the judgment of Sargant L. J.: "The liability is imposed by the charging section, namely, Section 38, the words of which are clear. The subsequent provisions as to assessment and so on are machinery only. They enable the liability to be quantified, and when quantified to be enforced against the subject, but the liability is definitely and finally created by the charging section and all the rnaterials for ascertaining it are available immediately." In Halsbury's Law of England (Fourth edition, Vol. 23, paragraph 29), referring to the machinery provisions, it is stated : "It is important to distinguish between charging provisions, which impose the charge to tax, and machinery provisions, which provide the machinery for the quantification of the charge and the levying and collection of the tax in respect of the charge so imposed. Machinery provisions do not impose a charge or extend or restrict a charge elsewhere clearly imposed." In Kesoram Industries & Cotton Mills Ltd. v. CIT , Hon'ble Mr. Justice Shah observed : "Section 7(2) merely provides machinery in certain special cases for valuation of assets, and it is from the aggregate valuation of assets that the net wealth chargeable to tax may be ascertained.... This is an artificial rule adopted with a view to avoid investigation of a mass of evidence which it would be difficult to secure or, if secured, may require prolonged investigation." Though the aforesaid observation was part of the minority opinion, there is, however, nothing said to the contra in the majority view. In Associated Cement Co. Ltd. v. CTO , the Hon'ble Supreme Court has held : "It is settled law that a distinction has to be made by courts while interpreting the provisions of a taxing statute between charging provisions which impose the charge to tax and machinery provisions which provide the machinery for the quantification of the tax and the levying and collection of the tax so imposed. While charging provisions are construed strictly, machinery sections are not generally subject to a rigorous construction. The courts are expected to construe the machinery sections in such a manner that a charge to tax is not defeated."Bennion's Statutory Interpretation (First edition, page 446, paragraph 191) lays down as follows : "Because a change made by the legislator in procedural provisions is expected to be for the general benefit of litigants and others, it is presumed that it applies to pending as well as future proceedings." At page 447, it is stated: "Procedure and practice is the mere machinery of law enforcement. As Ormrod L. J. said: 'The object of all procedural rules is to enable justice to be done between the parties consistently with the public interest'. "In Jose Da Costa v. Bascora Sadashiva Sinai Narcornin , the Hon'ble Supreme court has held :
Before ascertaining the effect of the enactments aforesaid passed by the Central Legislature on pending suits or appeals, it would be appropriate to bear in mind two well-established principles. The first is that 'while provisions of a statute dealing merely with matters of procedure may properly, unless that construction be textually inadmissible, have retrospective effect attributed to them, provisions which touch a right in existence at the passing of the statute are not to be applied retrospectively in the absence of express enactment or necessary intendement' (See Delhi Cloth and General Mills Co. Ltd. v. 1TC AIR 1927 PC 242). The second is that a right of appeal being a substantive right the institution of a suit carries with it the implication that all successive appeals available under the law then in force would be preserved to the parties to the suit throughout the rest of the career of the suit. There are two exceptions to the application of this rule, viz., (0 when by competent enactment such right of appeal is taken away expressly or impliedly with retrospective effect; and (it) when the court to which appeal lay at the commencement of the suit stands abolished (See Garikapatti Veeraya v. N. Subbiah Choudhary and Colonial Sugar Refining Co. Ltd. v. Irving (1905) AC 369 (PC))."(p. 1849) Halsbury's Laws of England (Fourth edition, Vol. 44, paragraph 925) states: "The presumption against retrospection does not apply to legislation concerned merely with matters of procedure or of evidence; on the contrary, provisions of that nature are to be construed as retrospective unless there is a clear indication that such was not the intention of Parliament." All the aforesaid observations have been cited, with approval, by the Hon'ble Supreme Court in CWT v. Sharvan Kumar Swarup & Sons .
13. In view of the aforesaid, we hold that the provisions for quantification of disallowance as contained in Sub-sections (2) and (3) of Section 14A are procedural and therefore apply to all pending matters. It is no longer open to the assessing officer to make disallowance according to his own discretion or on ad hoc basis. He is statutorily required to compute the disallowance in the manner provided by Sub-sections (2) and (3) of Section 14A. All these aspects have neither been considered by the Assessing Officer nor the Commissioner (Appeals) while making the impugned disallowance. All these aspects have not been considered by the learned Commissioner (Appeals). Hence the matter deserves to go back to the Commissioner (Appeals) for a fresh decision in the light of the provisions of Section 14A. He will record as to whether any expenditure has at all been incurred in relation to the exempt income, and, if so, he will proceed to quantify the disallowance in terms of the provisions of Section 14A.
14. The assessee's main sources of income are business and dividend. Assuming for a while that the assessee was in the business of earning exempt income alone, like, dividend income, the entire expenses including those direct or indirect, fixed or variable, remote or proximate would have been disallowed under Section 14A being the expenses incurred in relation to earning the exempt income, i.e., dividend income. The same assessee, instead of having exempt income alone, like, dividend income, shows income from taxable sources also. Does it mean that what was earlier liable to be disallowed under Section 14A, when the assessee had exempt income alone, would become allowable against taxable income simply because the assessee claimed those expenses against taxable income. Converse is equally true. If the assessee earlier had taxable income and claimed expenses relating thereto, they would not cease to be so only because the assessee earned some exempt income provided the assessee is in a position to establish that the expenses so incurred are not in relation to exempt income. This example highlights the need for taking a reasonable approach in the matter of allocation of expenses relating to exempt income. We hope that all these aspects will be kept in view while deciding the matters afresh.
15. At this stage, we may also mention that the deduction under Section 36(l)(iii) can be allowed only when the assessee establishes that the money borrowed was utilized for the purpose of its own business, i.e., construction business not only in the initial year of borrowing but also continued to be utilized in the succeeding years in which deduction is claimed. In K. Somasundaram Bros. v. CIT , it has been held that it is not the object to Section 36(1)(iii) to enable an assessee to make a large borrowing and create a liability for payment of interest thereon not only in the year in which the borrowing is made, but in the subsequent years as well, keep the loan outstanding and thereafter divert the amount initially borrowed by taking it out of the business by giving it interest-free to the relatives of partners and thereby continue to pay interest out of the income of the business and claim the amount of interest paid as a business expenditure. The payment of interest on the amount not used for earning the business income under Section 28 cannot be regarded as business expenditure as the business does not derive any benefit by the outgoing by way of interest on an amount, which is no longer in the business, but had been diverted from the business for other purposes. The Hon'ble High Court has further observed that this provision cannot, therefore, be construed as enabling an assessee to burden the business with interest when the amount was initially borrowed for the business but subsequently taken out of the business by diverting it as interest-free loans to relatives of the partners. The assessee is in construction business and not in the business of dealing in shares. It therefore needs to be examined as to whether the borrowing initially made was subsequently necessary to be retained for use in the construction business or was actually utilized by the assessee for making investment in shares. The object of Section 36(l)(iii) is to allow genuine deduction for interest on money actually utilized for earning business income under Section 28 and not for earning the income from other sources under Section 56.
16. In view of the above, we consider it appropriate to set aside the order passed by the Commissioner (Appeals) in this behalf and restore the matter to his file for a fresh decision in the light of the provisions of Section 14A including Sub-sections (2) and (3) thereof as also Section 36(l)(iii) of the Income Tax Act, after giving a reasonable opportunity of hearing to both the parties. We order accordingly.
17. Appeal filed by the assessee is treated as allowed for statistical purposes.