Income Tax Appellate Tribunal - Mumbai
Prakash Heat Treatment And Industries ... vs Ito on 6 February, 2007
JUDGMENT
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 learned. Commissioner (Appeals) has erred in upholding the disallowance of interest at Rs. 4,89,225 without assigning proper and sufficient reasons. He has failed to appreciate that appellant had borrowed the funds for the purpose of business and hence deduction of interest is allowance under Section 36(1)(iii) of the Income Tax Act.
2. He has further erred in arbitrarily upholding disallowance of interest on the ground that Section 14A of the Income Tax Act is applicable. He has failed to appreciate that appellant had not made the investment in shares out of borrowed funds for the purpose of earning the dividend.;
2. Briefly stated, the facts of the case are that the assessee was engaged in the business of trading in iron and steel parts during the previous year relevant to the assessment year under appeal. The assessee acquired 7,45,000 shares at the rate of Rs. 10 per share of M/s. Spectra Industries Ltd., a sister concern of the assessee. The assessing officer noticed that the assessee had made the aforesaid investment in shares in order to earn dividend which was exempt from tax under Section 10(33) of the Income tax Act. The assessing officer further observed that the assessee had debited interest payments of Rs. 10,43,491 to the P & L Account. He also found that the assessee had borrowed huge money and paid substantial interest to others and that it had given substantial amount of Rs. 74,50,000 for purchasing the shares and earning the dividend thereon. He therefore proceeded to examined the issue in terms of provisions of Section 14A of the Income Tax Act and accordingly issued a notice to the assessee. In reply, the assessee submitted that it had made investment in shares of the sister concern for earning business profits and not for earning dividend income. The assessing officer however did not accept the aforesaid explanation and consequently apply Section 14A to make the impugned disallowance. On appeal, the Commissioner (Appeals) had confirmed the order of the assessing officer with the following observations:
5. In appellate proceedings, the appellant has filed detailed written submission dated 10-11-2003 and paper book to substantiate its contention. It is seen from the written submission that in appeal also the appellant has taken same arguments, which were there before the assessing officer. The only addition in the arguments is that the assessee has relied on the decision of Hon'ble Bombay ITAT 'C' Bench in the case of Mafatlal Holdings Ltd. v. ACIT, ITA No. 2935/M/03 for assessment year 1998-99 and the decision of Lucknow ITAT Bench in the case of G.R. Agencies v. Income Tax Officer 79 TTJ 416. Aforesaid both decisions relied by the appellant are distinguishable on facts. The facts of present case are different than the Case of Malatlal Holdings Ltd. that decision was given on the facts of that case and now the position is changed after insertion of Section 14A. Alternatively, the assesseehas claimed deduction undersection 36(1)(iii).
The main business of the assessee is dealing in steel items and investment in shares was made to earn the dividend income, which is exempted in view of Section 10(33) and 14A. Otherwise also the appellant has diverted its interest bearing funds to its sister concern which is against the decision of Bombay High Court. Not only this but the Madras High Court has also held recently in K. Somasundaram & Bros. v. CIT 238 ITR 939 that the business money should always remain in the business. So from his angle also disallowance of proportionate interest is justified. I do not find any force in the argument of the appellant that investment was made in earlier years and no disallowance was made in those years because every assessment year is a separate year. In view of all these facts and case laws and detailed facts given by the assessing officer in assessment order, I am satisfied that the assessing officer was justified in disallowing the proportionate interest out of the interest expenditure claimed by the assessee. Therefore, ground of appeal is dismissed.
3. We have heard the parties. It is not the business of the assessee to make investment in shares. Therefore, dividend earned on shares is liable to be assessed as income from other sources under Section 56 of the Income Tax Act. Learned. Commissioner (Appeals) has recorded a categorical finding that the assessee has failed to discharge his onus that interest paid on borrowings was used exclusively for the purposes of its business. He has also recorded a finding that interest bearing funds have been diverted for making investment in shares of the sister concern.
4. Deductions otherwise admissible under Section 36(1)(iii) and Section 67(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(1)(iii) or 57(iii).
5. 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, 2 006. 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 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; especially., business expenditure chargeable against revenue for a specific period. - expense, vb Cf. COST (1)." The "expense" has many forms, namely, accrued expense, administrative 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 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 incurred 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. Joint 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 in so far 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....
6. 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 (Chennai). 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. SG 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 has 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 TTJ (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.
7. 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.
8. 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 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.
9. In H. Cockerline & Co. v. IRC (1930) 16 TC 1 (CA) at 19, Lord Hanworth quoted with approval the following passage from thejudgment 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 materials for ascertaining it are available immediately." In Halsubury'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. CWT , 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 (1981) 48 STC 466 (SC), 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 AIR 1975 SC 1843, the Hon'ble Supreme Court has held at page 1849 of AIR 1975 SC: "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 intendment (See Delhi Cloth & General Mills Co. Ltd. v. ITC 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., (1) when by competent enactment such right of appeal is taken away expressly or impliedly with retrospective effect; and (2) when the court to which appeal lay at the commencement of the suit stands abolished (See Garikapatti Veeraya v. N. Subbiah Choudhry (1957) SCR 488 ; , and Colonial Sugar Refinning Co. Ltd. v. Irving (1905) AC 369 (PC))." Halsburys 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 .
10. 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. 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.
11. 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.
12. At this stage, we may also mention that the deduction under Section 36(1)(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 of 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(1)(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.
13. 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 subsections (2) and (3) thereof as also Section 36(1)(iii) of the Income Tax Act, after giving a reasonable opportunity of hearing to both the parties. We order accordingly.
14. Appeal filed by the assessee is treated as allowed for statistical purposes.