Income Tax Appellate Tribunal - Mumbai
Sunash Investment Co. vs Assistant Commissioner Of Income Tax on 8 December, 2006
Equivalent citations: (2007)106TTJ(MUM)855
ORDER
Sunil Kumar Yadav, J.M.
1. These appeals are preferred by the assessee against the respective orders of CIT(A). Since these appeals were heard together, these are being disposed of by this consolidated order. We, however, prefer to adjudicate them one by one.
ITA No. 963/Mum/20042. This is an appeal by the assessee in quantum against the order of GIT(A) on various grounds, which are as under:
(I) 1. The CIT(A) erred in confirming the disallowance of interest expenditure as pertaining to acquisition of shares under Section 14A of the IT Act, 1961.
2. He failed to appreciate and ought to have held that the provisions of Section 14A of the Act are not applicable to the case of the appellant, since the interest expenses was business expense.
3. The appellant prays that it be held that the disallowance of interest expenses as above be deleted.
(II) 1. The CIT(A) erred in confirming disallowance of stamp duty of Rs. 71,156.
2. He failed to appreciate and ought have held that the expenditure was for the purpose of the appellant and hence was fully allowable.
3. The appellant prays that the above expenses of stamp duty be fully allowed as business expenses of the company.
(III) 1. The CIT(A) erred in not considering the cost of shares on account of stamp duty as addition to closing stock of shares.
2. He failed to appreciate and ought to have held the claim for treating the same as addition to closing stock of shares was valid and tenable and should be allowed.
3. The appellant prays that the claim be allowed.
(IV) 1. The CIT(A) erred in confirming non-allowance of the claim for the carry forward of business loss as claimed.
2. He failed to appreciate and ought to have held the claim for allowance of carried forward of business loss was valid and tenable and should be allowed.
3. The appellant prays that the carry forward of business loss be allowed as claimed in the return of income.
3. Ground No. 1 relates to an issue, whether an interest expenditure incurred on borrowed funds which were invested in acquisition of shares is an allowable expenditure against the other income of the assessee under Section 36(1)(iii) of the IT Act (hereinafter called as an "Act").
4. We have heard the rival submissions and carefully perused the orders of authorities below and documents placed on record. The relevant facts borne out from the record are that as per return of income, the assessee is deriving income from trading in shares and finance, etc. The assessee has borrowed a sum of Rs. 4,50,00,000 from HDFC Ltd. having pledged the shares of M/s Blue Star Ltd. with HDFC and some portion of the borrowed funds were given as loans to various parties on interest varied from 19.5 per cent to 22 per cent. The other portion of this borrowed fund was invested in shares of M/s Ashok Sunil & Co. (P) Ltd. The assessee has claimed the interest paid on the borrowed funds as an allowable expenditure under Section 36(1)(iii) of the IT Act against the interest income of the assessee. The AO proposed to disallow the claim of the assessee on the ground that dividend income is exempted under Section 10(33) of the Act. As such, the interest expenditure incurred on the borrowed funds, which was invested in acquisition of shares, cannot be allowed against the interest income. In response thereto, it was contended on behalf of the assessee that assessee was engaged in trading in shares and finance. Besides, he was also engaged in share controlling of the associate concern by holding majority of shares. Since the entire expenses were incurred during the course of business activity of the assessee, the assessee is entitled for deduction of interest expenditure on the borrowed funds under Section 36(1)(iii) of the Act. Being not convinced with the explanation of the assessee, the AO disallowed the claim of the assessee, against which the assessee has preferred an appeal before the CIT(A) and reiterated its contentions. The CIT(A) relying upon the observation of the AO that during the impugned assessment year there was no transaction in shares in M/s Blue Star Ltd. and M/s Ashok Sunil & Co., has treated the acquisition of shares by the assessee as an investment and not as a business transaction. The assessee placed reliance upon the order of the Tribunal in the case of Mafatlal Holdings Ltd. v. Addl. CIT (2004) 85 TTJ (Mumbai) 821 in which it has been held by the Tribunal that the investment company need not to pay tax on interest payable on loans. The CIT(A) examined the issue in the light of the provisions of Section 14A of the IT Act and confirmed the disallowance after having observed that borrowed funds were utilized for investment in shares.
5. Aggrieved, the assessee has preferred an appeal before the Tribunal and placed heavy reliance upon the judgment of the apex Court in case of Rajasthan State Warehousing Corporation v. CIT in which it has been held that when assessee is carrying on one indivisible business in various ventures and some amongst them yield taxable income and others do not, the entire expenditure is a permissible deduction without any apportionment. During the course of hearing, the learned Counsel for the assessee further contended that he has borrowed the funds to acquire the controlling shares of Blue Star Ltd. and M/s Ashok Sunil & Co. to protect the hostile takeover of the company. Since the acquisition of controlling shares in the group concern is also one of the business activities of the assessee, the interest expenditure incurred on borrowed funds is a business expenditure and is allowable under Section 36(1)(iii) of the IT Act. In support of this plea, the learned Counsel for the assessee has relied upon the following judgments:
1. CIT v. Model Manufacturing Co. (P) Ltd. ;
2. CIT v. Indian Bank Ltd. ;
3. CIT v. Rajeeva Lochan Kanoria ;
4. Addl. CIT v. Laxmi Agents (P) Ltd. (1980) 125 ITR 227 (Guj);
5. Mafatlal Holdings Ltd. v. Addl. CIT (supra);
6. CIT v. Tata Chemicals Ltd. (2002) 175 CTR (Bom) 443 : (2002) 256 LTR 395 (Bom).
6. With regard to provisions of Section 14A of the Act, the learned Counsel for the assessee has invited our attention to the provisions of Section 115-0, according to which tax on distributed profits of domestic companies is charged as an additional tax @ 12-1/2 per cent. Since the allocated dividend is subject to tax before distribution amongst the shareholders, it cannot be called to be non-taxable income in the hands of the recipient, i.e. the shareholder and the interest expenditure incurred on borrowed funds which were invested in acquiring the shares on which dividend is received cannot be disallowed for the reason that borrowed funds were invested to earn non-taxable income as per provisions of Section 14A of the IT Act. In support of this proposition, the learned Counsel for the assessee has relied upon the order of the Tribunal in the case of Admo Holdings (P) Ltd. v. Jt. CIT ITA No. 2151/Mum/2001.
7. The learned Departmental Representative, on the other hand, has submitted that the assessee has borrowed funds, out of which some part was invested in acquiring shares of M/s Blue Star Ltd. and M/s Ashok Sunil & Co. and some were utilized to advance loans. Before any of the lower authorities, the assessee has not raised any plea or argument that it has made the investment in shares of M/s Ashok Sunil & Co. to have the controlling shares in the company. This argument is raised for first time before the Tribunal and since it requires the factual verification, it cannot be entertained at this stage. So far as the judgment of the apex Court in the case of Rajasthan State Warehousing Corporation v. CIT (supra) is concerned, the learned Departmental Representative has invited our attention to the object of introduction of Section 14A with the submission that Section 14A has been inserted by the Finance Act, 2001 with retrospective effect from the 1st day of April, 1962 to nullify the decision of the Supreme Court in the case of Rajasthan State Warehousing Corporation (supra). Through Section 14A it has been made emphatically clear by the legislature that for the purpose of computing total income under Chapter IV, no deduction shall be allowed in respect of the expenditure incurred by the assessee in relation to income which does not fall part of the total income under the Act. When this provision with retrospective effect has prompted the Department to reopen those completed assessments in which principle laid down by the apex Court has been followed, this has created hardship to taxpayers. The Board has taken note of the hardship and issued a Circular No. 11 of 2001, dt. 23rd July, 2001 (2001) 169 CTR (St) 1 directing the Department not to reopen the assessment which has become final before 1st April, 2001 in which expenditures incurred towards exempt income was allowed following the judgment of the apex Court in the case of Rajasthan State Warehousing Corporation (supra). Later on this circular was converted into a statutory provision by inserting proviso to the section. This series of events shows that Section 14A was inserted to nullify the decision of the Supreme Court in the case of Rajasthan State Warehousing Corporation (supra). As such, placing the reliance upon the judgment of the apex Court in the case of Rajasthan State Warehousing Corporation (supra) is not proper, as it cannot be followed in the light of the statutory amendment. The learned Departmental Representative further contended that as per Section 115-0, additional tax is to be paid by the company on any amount declared, distributed by the company by way of dividend @ 12-1/2 per cent in addition to the income-tax chargeable in respect of total income to a domestic company for any assessment year. This additional income-tax was not charged at a scheduled rate of tax, as such, the tax suffered on the distributed amount cannot be called the tax paid by the recipient on the dividends and make the dividend income as taxable to take it out from the purview of non-taxable income in order to have an escape from the clutches of Section 14A of the Act. For the purpose of Section 14A it is only to be examined whether the income received by the assessee is taxable or non-taxable. If the assessee is not required to pay the tax on that income, which forms a part of total income, the expenditure incurred in earning that non-taxable income cannot be allowed against the other income of the assessee. It has no relevance whether the income received by the assessee has already suffered tax in the hands of the payer. If the contention of the assessee is accepted, then no income would be taxable in the hands of the recipient if it has already suffered a tax in the hands of the payer. The learned Departmental Representative further invited our attention to the observations of the Tribunal in the case of Mafatlal Holdings Ltd. (supra) in which the Tribunal has held that the dividend income received by the shareholder is non- exempted income after quoting an example that if total dividend declared by the assessee-company is Rs. 1,000 and the tax paid by the shareholder on this amount is @ 10 per cent then net income remains in the hands of the shareholder is Rs. 900 only with the submission that the shareholder is only concerned with the dividend amount received in his hands, i.e. only Rs. 900 and he is not concerned about the amount which was declared by the domestic company and the interest paid thereon. The example quoted by the Tribunal before declaring the dividend income as non-exempted income is misquoted, as Section 14A only talks about the income received by the recipient and not the amount paid by the payer. In support of his contention the learned Departmental Representative has also placed reliance upon the following judgments:
1. Chinai & Co. (P) Ltd. v. CIT ;
2. Harish Krishnakant Bhatt v. ITO (2004) 85 TTJ (Ahd) 872 : (2004) 91 ITD 311 (Ahd);
3. Nawn Estates (P) Ltd. v. CIT 1977 CTR (SC) 19 : (1977) 106 ITR 45 (SC);
4. Ever Plus Securities & Finance Ltd v. Dy. CLT (2006) 102 TTJ (Del) 120 : (2006) 101 ITD 151 (Del).
7.1 The learned Departmental Representative further contended that the queries raised by the learned Counsel for the assessee during the course of argument were all answered by the Tribunal either in the case of Harish Krishnakant Bhatt v. ITO or Ever Plus Securities & Finance Ltd. (supra). Since the Tribunal has already concluded that the interest on borrowed funds, which were invested in shares either for acquiring controlling shares or otherwise is not an allowable expenditure in the light of provisions of Section 14A of the IT Act against the dividend income of the assessee. It was also held by the jurisdictional High Court in the case of Chinai & Co. (P) Ltd. (supra) that a mere investment in shares by itself cannot lead to the conclusion that the assessee company carried on any business during the relevant previous year. Under these circumstances Revenue authorities are justified in disallowing the claim of the assessee.
8. Having given a thoughtful consideration to the rival submissions and from the careful perusal of the orders of the authorities below, we find that the assessee was admittedly engaged in the business of investment and finance and he has borrowed the funds to utilize it in its business. Some portions of the borrowed funds were utilized in its finance business and some were invested in shares of M/s Blue Star Ltd. and M/s Ashok Sunil & Co. It is not the case of the assessee that he is engaged in trading of shares. Undisputedly, the part of borrowed funds were invested in shares and the assessee claimed the entire interest paid on the borrowed funds as an allowable expenditure against the dividend income as well the interest income, on the basis of the judgment of the apex Court in the case of CIT v. Indian Bank Ltd. (supra), CIT v. Maharashtra Sugar Mills Ltd. and Rajasthan State Warehousing Corporation v. CLT (supra). The judgments which were relied by the assessee in support of its legal proposition that where the assessee carried the indivisible business and a part of the business income is not assessable under the Act, the interest on funds borrowed would be allowed in its entirety against the taxable income, cannot be applied to the instant case. While taking a plea the assessee lost the sight of the provisions of Section 14A which were introduced by the Finance Act, 2001 with retrospective effect from 1st day of April, 1962. We have examined the aforesaid judgments of the apex Court and the legislative intent of the introduction of Section 14A and we find that certain incomes are not includible while computing the total income as these are exempt under various provisions of the Act. There have been cases where deduction has been claimed in respect of such exempt income. This in effect means that the tax incentives given by way of exemptions to certain categories of income are being used to reduce also the tax payable on the non-exempt income by debiting the expenses incurred to earn the exempt income against the taxable income. This is against the basic principle of taxation whereby only the net income, i.e. the gross income minus expenditure, is taxed. On the same analogy, the exemption is also in respect of the net income. To nullify the decision of the Supreme Court in Rajasthan State Warehousing Corporation v. CIT (supra) in which it was held that the income of the assessee arises under any of the heads of the income but from different items, i.e. different house properties or different securities, etc., and income from one or more items alone is taxable whereas income from other items is exempt under the Act, the entire permissible expenditure in earning income under that head is deductible and that if assessee carries on business for various ventures, some of which yield taxable income and others do not and business is one indivisible, the entire expenditure of this indivisible business would be deductible, the legislature has inserted Section 14A by the Finance Act, 2001 with retrospective effect from 1st April, 1962, according to which, for the purpose of computing the total income under this chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.
8.1 The scope and effect of this new provision was also explained by the Board through Circular No. 14 of 2001, dt. 12th Dec, 2001 (2002) 172 CTR (St) 13]. Through this circular, it was explained by the Board that certain incomes are not includible while computing the total income, as these are exempt under various provisions of the Act. There have been cases where deductions have been claimed in respect of said exempt income, but the tax incentives are being used to reduce the tax payable on the non-exempt income by debiting the expenses incurred to earn the exempt income against the taxable income. This retrospective insertion of Section 14A has prompted the Department to reopen those completed assessments in which principle laid down by the Supreme Court has been followed and this has created hardship to tax payers. Having taken note of this hardship, the Board has issued another Circular No. 11 of 2001, dt. 23rd July, 2001 in which it has been directed that assessment where the proceedings have become final before 1st day of April, 2001, should not be reopened under Section 147 of the Act to disallow the expenditures incurred to earn exempt income by applying provisions of Section 14A. There administrative instructions were converted into statutory provisions by way of insertion of proviso to Section 14A. The object and scope of Section 14A were again clarified by the Board through their Circular No. 8 of 2002, dt. 27th Aug., 2002 (2002) 178 CTR (St) 9 : (2002) 258 ITR (St) 13 by saying that through Finance Act, 2001 new section namely 14A was inserted in the IT Act retrospectively w.e.f. 1st April, 1962 to clarify the intention of the legislature that no deduction shall be allowed in respect of any expenditure incurred by an assessee in relation to income which does not form part of the total income under the IT Act. The intention of inserting the new section retrospectively was to set the existing controversy on this issue at rest and not to unsettle the case by raising the issue afresh. Through proviso to Section 14A it was also clarified that AO shall not reassess the case under Section 147 or pass an order enhancing the assessment or reducing the refund already made or otherwise incurring the liability of the assessee under Section 154, for any assessment year beginning on or before 1st April, 2001.
9. From a careful reading of the various Board circulars with regard to Section 14A it has become abundantly clear that legislature has no intent to allow any expenditure incurred in earning exempted income against the taxable income. The judgments relied on by the assessee relate to the pre-amendment period and were rendered following the judgment of Supreme Court in the case of CTT v. Indian Bank (supra) and Rajasthan State Warehousing Corporation (supra), which cannot be relied on in the light of newly inserted Section 14A of which object was to nullify the effect of the judgment of the apex Court.
10. We have also carefully examined the judgment of the jurisdictional High Court in the case of CIT v. Amntaben R. Shah in which the Hon'ble Bombay High Court has categorically held that in order to get deduction under Section 57(iii) the expenditure should be incurred wholly and exclusively for the purpose of making or earning the income from other sources and that it should not be in the nature of capital expenditure. The shares in question were purchased by the assessee for the purpose of acquiring controlling interest in the company and not for earning dividend. That being so, the expenditure incurred by way of interest on the loan taken by the assessee for the said purpose cannot be held to be an expenditure incurred wholly or exclusively for the purpose of earning income by way of dividends. From the nature of transaction, it is clear that expenditure was not for the purpose of earning income by way of dividends but for the purpose of acquiring controlling interest in the company and, therefore, it would not be allowable as deduction under Section 57(iii) of the IT Act.
11. Now we come to another argument of the assessee that the dividend income cannot be called to be an exempted income as it has already suffered tax in the hands of the company, which distributes it amongst its shareholder at the time of its declaration and distribution. In support of this contention, the assessee has placed reliance upon the Tribunal order in the case of Mafatlal Holdings (supra) in which the Tribunal has quoted an example before holding that dividend income is a non-exempt income. Through this example the Tribunal has explained that the assessee is in receipt of net dividend after having suffered tax by the domestic company. While dealing with the issue the Tribunal has placed reliance upon the judgment of the Gujarat High Court in the case of Dy. C1T v. Core Health Care Ltd. and CIT v. Tata Chemicals Ltd. (supra) in which the Hon'ble High Court have not examined the object and scope of Section 14A introduced by Finance Act, 2001 and have laid down the ratio following the judgment of the apex Court in the case of CIT v. Indian Bank Ltd. (supra) and Rajasthan State Warehousing Corporation v. CTT (supra). While dealing (with) this taxable and non-taxable income for the purpose of Section 14A one has to look to the nature of receipts in the hands of the recipient and not in the hands of the payer. If income is non-taxable in the hands of the recipient, the provisions of Section 14A would certainly apply and expenditure incurred in earning that non-taxable income will not be allowed to be deducted against the taxable income. If it is permitted it would be a violence to the newly inserted Section 14A. In the instant case since the dividend income earned on investment in shares is exempted from tax by virtue of Section 10(33), any expenditure incurred to earn the dividend income is not allowable against the taxable income of the assessee. In the instant case, since the interest expenditures are indivisible as the investments in shares and advancement of loan was made out of the common funds, the pro rata interest incurred on funds invested in shares, cannot be allowed against the interest income of the assessee. This aspect was also examined by the Tribunal's Ahmedabad Bench in the case of Hansh Krishankant Bhatt v. ITO (supra) in which it has been held that the dividend income is now exempted from tax by virtue of Section 10(33) and therefore as a consequence thereof, the interest paid on borrowed capital utilized in purchase of shares held as investment, being the expenditure incurred in relation to dividend income not forming part of assessee's total income, cannot be allowed as deduction. The relevant observations of the Tribunal are extracted hereunder:
The shares were acquired by the assessee in earlier year when-dividend was taxable under the head 'Other sources' under Section 56 and interest paid by the assessee has been claimed and allowed in earlier years as having been incurred for earning and making income from dividend. There is thus no dispute that interest payment in this case is an expenditure incurred for making or earning income from dividend. In view of the provisions of Section 10(33), there is also no dispute that dividend received by the assessee does not form part of its total income. That being so, the provisions of Section 14A providing for disallowance of expenditure incurred by the assessee in relation to income which does not form part of total income under the Act come into play. Apparently, therefore, the expenses incurred by the assessee in relation to such dividend income cannot be allowed as a deduction in computing the income of an assessee under Chapter IV. The expression 'for the purpose of charge of income-tax and computation of total income' used in Section 14 amply clarifies the intention of the legislature and the scheme of the IT Act, 1961. Thus, there could be no such intention of the legislature and a scheme of the Act to allow deductions related to income not forming part of the total income against the income includible in the total income and chargeable to tax. Such an intention has been clarified in the provisions of newly inserted Section 14A by the Finance Act, 2001, with retrospective effect from 1st April, 1962 as well as in the Memorandum Explaining the Provisions, Notes on Clauses relating to the Finance Bill, 2001 and in the Board's Circular No. 14 of 2001, dt. 22nd Nov., 2001 (2002) 172 CTR (St) 13 and Circular No. 8 of 2002, dt. 27th Aug., 2002 (2002) 178 CTR (St) 9. It is thus clear, that from whatever angle one may look at the transaction, result is the same, viz., when the dividend is not taxable at all, the interest pertaining to that would also not be allowed because there is no taxable income of the assessee against which such interest can be allowed; another way to consider the issue is that if interest is allowable, it would be allowable against dividend income and the net dividend income after allowing that, alone would be excluded from total income under Section 10(33). Section 14A was inserted to clarify this intention of the legislature to set the existing controversy on this issue at rest. The interest incurred is relatable to earning of dividend on the shares purchased and held as investment. The dividend income is now exempted from tax by virtue of Section 10(33) and, therefore, as a consequence thereof, the interest paid on borrowed capital utilized in purchase of shares held as investment, being the expenditure incurred in relation to dividend income not forming part of assessee's total income, cannot be allowed as a deduction. There is no chargeable income against which it can be allowed as a deduction. It cannot be also allowed against any other taxable income inasmuch as the interest so paid is not relatable to the earning of taxable income. This is what is provided by the legislature in the scheme of the IT Act even without the existence of Section 14A with retrospective effect from 1st April, 1962.
The tax payable by the domestic company under Section 115-0 is paid not out of the amount declared or distributed or paid by way of dividend to the shareholder. It is the tax paid with respect to and on the amount of dividend declared, and not out of the amount of dividends so paid to the shareholder. The tax so paid by the company cannot be regarded as tax paid by the shareholder as both are distinct and separate legal and taxable entities as aforesaid. It would be wrong to say that the tax paid by the company under Section 115-0 is a change of mode of tax paid by the shareholder on the dividend income. The amount paid to the shareholder by way of dividend is the full amount that is declared as dividend by the company in its general meeting and not the amount after deducting the tax payable by such company under Section 115-0 on the amount of dividend declared or distributed or paid to the shareholder. The shareholder has nothing to bear towards the tax liability of a company payable under Section 115-0. This incidence of tax under Section 115-0 is borne by the company itself and is not passed on to the shareholders. In this view of the matter, one can say that the amount declared or distributed or paid by way of dividend has not suffered any tax in the hands of the shareholder. It is fully exempted in his hands by virtue of Section 10(33). Even otherwise, the company and shareholders are two different entities and tax paid or payable by the company is not the tax paid or payable by the assessee-shareholder.
12. A similar view was also expressed by the Tribunal in the case of Ever Plus Securities & Finance Ltd. (supra) by holding that where interest-bearing loans had been invested in shares which yielded dividend income which is exempt from tax by virtue of Section 10(33), AO was justified in disallowing the interest paid on such loans by invoking Section 14A of the IT Act. The relevant observations of the Tribunal is also extracted hereunder:
The facts clearly showed that the assessee had financed its investment in the equity shares from out of the entire unsecured loans taken by the assessee and as such, there was direct nexus established on record between the interest bearing loans taken by the assessee and the investment made in the equity shares.
The CIT(A) was, therefore, justified in holding that the assessee-company was not engaged in the business of trading of shares which could be categorized to be in the nature of business activity. The CIT(A) was also justified on holding that the assessee was simply holding those shares as investment and if the same helped the assessee to control the management of 'J' group of companies, it could not partake the character of the business activity. The CIT(A) was also justified in holding that the only income arising from holding of the shares as investment was the dividend income which was clearly assessed under the head 'Income from other sources'. The said facts clearly showed that the assessee claimed the dividend income of Rs. 20,00,690 exempted under Section 10(33) in the computation of income for the purpose of filing the return of income.
The assessee conceded that the main activity of the company for making investment in shares of group company was to acquire and retain control of the group companies. The question that required to be considered was as to whether that activity itself constituted a business when the real intention of the company was not to earn profit but to acquire and exercise control of the group companies. In order to constitute activity of the assessee for carrying on the business, it is essential that such activity must be with a motive of earning profit. Such earning of profit should be by the company itself and not by the other group company. The issue came to be considered by the Delhi High Court in the case of Bharat Development (P) Ltd. v. CIT wherein it was observed that the expression 'business' is an word of indefinite import. In taxing statute, it is used in the sense of an occupation or profession which occupies the time, attention and labour of the person, normally with the object of making profit. To regard an activity as business, there must be a course of dealings either actually continued or contemplating to be continued with the profit motive, and not for support or pleasure. Whether a person carries on business in a particular commodity, must depend upon the volume, frequency, continuity and transaction of purchase and sale in class of goods and the transaction must ordinarily be entered into with a profit motive. Applying these principles to the instant case, it was found that the action of the assessee was not actuated by the profit motive. In fact, very few transactions of purchase and sale of shares of group companies were found except what had already been made in the earlier years. Only shares of one group company were purchased and there was no transaction of purchase and sale of shares of group companies. Therefore, such transactions could not be regarded as carrying on business for the purpose of Section 28. It was conceded that object of making investment in the shares for earning dividend was only incidental but the activity carried on by the assessee could only involve earning of dividend income. When transactions for purchase and sale of shares are carried on with the object of business, the profit motive is the dominant factor. One would like to sells shares when the prices are the maximum but if the purpose is only to acquire and retain the control of group companies, the assessee would not sell shares of group companies even if the prices go up because the object is not to make profit. Therefore, it could not be held investment made in shares was for carrying on business. Thus, the activity of the assessee though incidental could only be considered for earning of the dividend income incidental to the purchase of shares from the group companies.
The purpose of business is to earn profit by taking certain trading activities. However, the facts and the circumstances in the instant case would clearly justify that the assessee did not enter into any business or trading activity during the year under consideration. Merely because the assessee pledged the shares for the benefit of other companies by itself, it would not prove that the assessee would earn any profit out of providing credit facilities to other group of companies. Since no trading activity had been conducted during the year under consideration, it was simpliciter clear that the assessee made investment for the purpose of earning dividend which was ultimate source of income during the year under consideration. The submission of the assessee that it made investment in the equity shares for the purpose of acquiring and controlling the management of 'J' group of companies because according to the assessee no profit was earned from some of the other companies by way of dividend for several years, could not be accepted. The facts and the circumstances clearly proved that the purpose of the assessee was to earn the dividend because there was no element of business activity for the purpose of earning profit in the year under consideration. The only source of income of the assessee was dividend earned by the assessee from other companies in whose shares had been made out of borrowed funds. Merely because the assessee had shown the investment of the shares as stock-in-trade in the balance sheet that, by itself would not prove that the assessee was doing any business activity or trading activity dealing in the shares in the year under consideration.
Section 115-0 was inserted into the Act by the Finance Act, 1997 w.e.f. 1st June, 1997 which has brought substantial changes in the system of taxation of dividend. The new scheme provides that once domestic company is chargeable in respect of profit distributed by it to its shareholders, dividend received by the shareholders of such company would be exempt under Section 10(33). Section 14A is inserted in the Act by the Finance Act, 2001 w.e.f. 1st April, 1962. As per Section 14A, no deduction is to be allowed in respect of the expenditure incurred in relation to any income which does not form part of the total income. After introduction of Sections 10(33) and 115-0, any expenses incurred for the purpose of acquiring shares on which the dividend income has been earned would not be allowed as a deduction. Since the authorities below found that there was direct nexus between the interest bearing loans and the investment in the shares, on which the dividend income earned, the authorities below were justified in holding that the assessee was not entitled to claim deduction of interest expenses.
The question for consideration before the CIT(A).was as to whether the interest-bearing loans had been utilized by the assessee-company for investment in shares which had yielded dividend income and as to whether the disallowance by invoking the provisions of Section 14A was required to be made in respect of such interest paid. The facts noted clearly proved that the interest bearing loans had undisputedly been invested in shares which yielded the dividend income which was exempt from tax by virtue of Section 10(33). Therefore, the CIT(A) was justified in confirming the findings of the AO by invoking the provisions of Section 14A, in the instant case. The crux of the findings was that there was 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 was dividend income which was exempt under Section 10(33). The assessee incurred expenditure for earning exempted dividend income. Section 14A had been inserted by the Finance Act, 2001 w.e.f. 1st April, 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 that head. The assessee was, therefore, not entitled to the said deduction of interest under Section 36(1)(iii). The authorities below, therefore, rightly disallowed the amount against the assessee.
It was established clearly on record that entire borrowed unsecured loans were invested in the purchase of equity shares upon which the assessee paid interest of Rs. 3,93,69,566 on the said loans. It was also established that the dividend income of Rs. 20,03,690 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, that by itself, would not prove that the provisions of Section 14A were not applicable in the instant 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 were that the entire borrowed unsecured loans had been invested in the shares for the purpose of earning dividend. Therefore, once the assessee claimed exemption on dividend income under Section 10(33), then such dividend was directly related to the investment made in the entire shares. As such, it was not possible to accept the alternative contention of the assessee that part of the interest might be allowed. That contention of the assessee was also to be rejected.
Consequently, there was no merit in the appeal of the assessee and the same was, therefore, to be dismissed.
13. We have also examined the aforesaid judgment referred to by the assessee with regard to a plea that assessee made investment to acquire controlling shares in group concern and to have a controlling share in companies is its business activity, and as such interest expenditure should be allowed under Section 36(1)(iii) and we find that these judgments were rendered prior to the insertion of the Section 14A of the Act when the dividend income was to be computed under the head "Income from other sources" and the net dividend income was allowed to be exempted under Section 10(33) of the Act after giving a set off of the expenditure permissible under Section 57(iii) of the Act. But after the insertion of Section 14A all expenditure relating to exempted income or an income which does not form part of total income of that previous year are not allowable to be deducted against the taxable income of the assessee. Whatever case laws were relied on by the assessee, it were rendered without taking into account the scope and object of Section 14A of the IT Act. The legislative intent of introducing Section 14A has been made emphatically clear through various Board circulars.
14. In the instant case, the assessee was admittedly engaged in the business of finance and investment in shares though its object may be to have controlling shares in the group concern, but whatever income is generated on these investments by way of dividend income, it is exempted from tax under Section 10(33) of the IT Act. In the light of the provisions of Section 14A of the IT Act, the expenditure incurred relating to an income exempted from tax is not an allowable expenditure. So far as the argument of the assessee that to have controlling shares in the group concern of the assessee, is also a business activity of the assessee, is concerned, we find that the business has been defined under Section 2(13) of the IT Act, according to which, definition of business in the clause is an inclusive one and not exhausted. The enumerated four items, i.e. trade, commerce or manufacture and any adventure or concern in the name of trade, commerce or manufacture are the major heads in the business but they do not exhaust all the activities to be reckoned in the business. It has been also made clarified by the apex Court in the case of Bengal & Assam Investor Ltd v. CIT that mere holding of investment would not by itself lead to the inference that the person holding the investment carries on business. Therefore, apart from showing investment it is essential to establish that transactions have been carried out in relation to the investment in the normal course of business and in the case of shares held as investments it is essential to prove that the holder of the shares has been carrying on business in respect of those shares, otherwise the profit or loss on the sale of shares cannot be claimed as falling under the head 'Business' nor can any expenses, deductions or allowances in respect of those dealings be claimed as admissible while computing the income. This view was subsequently affirmed by the various High Courts. Therefore, if shares and securities are acquired and held as investments for deriving income by way of dividends or interest, it cannot be said that the holder of the shares and securities carries on any business. In order that income can be brought to tax under the head "Profits and gains of business or profession" it is essential that the activities of the person must constitute the carrying on of a business. Mere motive to derive income by way of dividend or interest or even appreciation of the value of the investment would not constitute business activity and in relation to shares, the investment must be in the course of carrying on a business in order that the income derived therefrom would be covered by Section 28. An investor in share can come under Section 28 of the Act only by converting his shares held as investments into stock-in-trade, that is, by carrying on the business of dealing in stocks and shares after such conversion as held in the case of CIT v. Bai Shinnbai K. Kooka . It was also observed by the apex Court that in the case of CIT v. Distributors (Baroda) (P) Ltd. that "the expression 'business' is a well-known expression in the income-tax law. It means some real, substantial and systematic or organised course of activity or conduct with a set purpose. It was also made clear that there should be a profit motivation in the business. But it has also been made clear that the business need not necessarily result in profit. The word 'business' must be understood in a commercial sense as involving any activity designed to earn profit. He may not actually obtain profit and the business may end in loss, the test is not whether he actually gets profit or loss but the object that which trading activity is carried on. The issue whether investment in shares in order to acquire controlling interest in the group concerns without actively engaged in trading of shares amounts to business activity was examined by the jurisdictional High Court in the case of Chinai & Co. (P) Ltd. v. CIT (supra) and their Lordship has finally held that mere investment in shares by itself cannot lead to the conclusion that the assessee-company carried on any business during the relevant previous year. The relevant observations of the jurisdictional High Court are extracted hereunder to understand the controversy raised before them:
It was submitted that, although the managing agency had come to an end, certain obligations of the assessee-company as managing agents remained to be fulfilled; such as an obligation to ensure that the accounts for the period during which they had functioned as the managing agents were presented and accepted at the next AGM to be held in 1970. This does not lead to the conclusion that the business of managing agency continued during the year 1970. A mere obligation to have the accounts presented and passed at the AGM is not enough to hold that the business of managing agency continued. Even after the cessation of the business of the managing agency, certain obligations may be required to be carried out during the next year. This does not mean that the business of managing the company, which is the essential nature of a managing agency business, continues. In fact, this would be in violation of the statutory prohibition against continuation of managing agency. It was next submission that, although the company may have ceased to be the managing agents, it still continues to hold a substantial block of shares in the managed company. The investment in these shares must be considered as a business investment because it was necessary for carrying on the business of managing agents. The company continued to hold these shares during the previous year in question. Hence, the company must be held to carry on business in the said previous year. This argument is advanced for the first time. It was not advanced at any earlier stage. Even if it be assumed that the investment in the shares of managed company was originally a business investment, once the business of managing agency has come to an end, a mere holding of such shares by itself cannot be considered as carrying on any business. There are also no facts on record which would indicate that the company carried on any business such as that of buying and selling stocks and shares during the said previous year. A mere investment in shares by itself cannot lead to the conclusion that the assessee-company carried on any business during the relevant previous year.
15. We have carefully perused the judgments referred to by the assessee in which it has been held that investment with the object to have controlling shares in the company is also a part of the business activity or a profession and the expenditures incurred on the borrowed funds is allowable as business expenditure, but in this judgment, the effect of Section 14A was not examined. In the light of the aforesaid proposition of law, we examine the facts of the case and we would find that the assessee has made investment of borrowed funds in the shares to have a controlling interest in the group companies. Though the assessee has claimed that he has shown the shares in stock-in-trade, but there was no trading activity of shares in which investments were made during the relevant assessment years. Once he himself has admitted that he made the investment in group companies to have controlling shares, it cannot be called that the assessee was engaged in trading of invested shares. If the object of the investment in shares (was) either not to earn a dividend income but to have a controlling power in the group concern, how it result in profit to the assessee, it is beyond our comprehension. We, however, carefully examined the judgment referred to by the parties and we find that most of the queries with regard to the hardship being faced by the assessee in application of provisions of Section 14A of the IT Act raised during the course of argument were already answered by the Tribunal either in the case of Harish Krishnakant Bhatt (supra) or in the case of Ever Plus Securities & Finance Ltd. (supra).
16. Turning to the case in hand in the light of above discussions, we are of the view that whatever income is generated on this investment by way of dividend that is exempted under Section 10(33) of the Act and in that case the interest expenditure incurred on the borrowed funds which were invested in shares is not allowable against the dividend income or other income of the assessee in view of the provisions of Section 14A of the IT Act. If the assessee succeeds in proving that by having controlling shares in the group companies it earns this much of profit, which is chargeable to tax, the pro rata interest expenditure may be allowed to be deducted but it has not been proved so far. In these circumstances, we are of the view that after the insertion of Section 14A one has to look to the investment and income earned therefrom in the light of provisions of Section 14A and not otherwise. We (are) therefore, of the view that the Revenue authorities are justified to disallow the pro rata interest expenditure from the taxable income.
17. In view of the decision with regard to ground No. 1 stamp duty paid cannot be allowed, as it increases the capital of the assessee. Hence, ground Nos. 2 and 3 are dismissed.
18. Ground No. 4 is consequential in nature. ITA No. 6593/Mum/2005
19. Through this appeal, the assessee has assailed the order of the CIT(A), who has confirmed the penalty levied under Section 271(1)(c) of the IT Act.
20. Having carefully examined the rival submissions and from the careful perusal of the orders of authorities below, we find that AO has levied the penalty under Section 271(1)(c) on account of an addition made for disallowance of the pro rata interest expenditure incurred on the borrowed funds, which were invested in finance as well as purchase of shares, against the interest income of the assessee, after invoking the provisions of Section 14A of the IT Act. During the course of hearing, the learned Counsel for the assessee has invited our attention to the various judgments, which were referred to by the parties in the foregoing appeals with the submission that the issue where the expenditure incurred to earn taxable and non-taxable income is indivisible, the entire expenditure are to be allowed against the taxable income is a debatable one and once the assessee has taken a particular view in the light of some judicial pronouncement, the act of the assessee does not attract any penal action, i.e. penalty under Section 271(1)(c) of the Act. Albeit the situation has been changed after the introduction of Section 14A to a statute, but it does not mean that its violation attracts the penalty under Section 271(1)(c) of the Act. From the perusal of record, we find that assessee has raised the claim under the bona fide belief, as such it cannot be held that assessee is guilty of concealment of income or furnishing of inaccurate particulars. We, therefore, do not find any merit in the penalty levied under Section 271(1)(c) by the Revenue authorities. Accordingly, we set aside the order of the CIT(A) and delete the penalty.
21. In the result, ITA No. 963/Mum/2004 is dismissed and ITA No. 6593/Mum/2005 is allowed.