Commissioner of Income Tax vs Gujarat State Fertilizers and Chemicals Ltd.

Sonia Gokani, J.—Aggrieved by the order of the income tax Appellate Tribunal, Ahmedabad (hereinafter referred to as ''the Tribunal'') dated July 13, 2012, the present Tax Appeal is preferred by the Revenue u/s 260A of the income tax Act, 1961 (hereinafter referred to as ''the Act''), proposing the following substantial questions of law for our consideration: (I) Whether on the facts and circumstances of the case, the Appellate Tribunal was right in law in restricting the addition u/s. 14A of the Act towards interest and other expenses incurred in relation to exempted income of dividend on ad hoc basis of Rs. 1,14,43,040/- being 10% of the total income to 5 lakhs without appreciating that the assessee was maintaining mixed funds and failed either to furnish day-to-day cash-flow statement or to establish that it had its own surplus funds for investment in dividends?

(II) Whether on the facts and circumstances of the case, the Appellate Tribunal was right in directing to allow corporate debt restructuring expenses of 2.57 crores on payment to financial consultants in connection with waiver of loans, by spreading it over a period of 6 years disregarding the fact that such expenditure in relation to capital assets constitutes capital expenditure, which is specifically excluded in section 37(1) of the Act?

(III) Whether, on the facts and circumstances of the case, the Appellate Tribunal was right in directing to exclude the waived amount of 11.63 crores out of the principal loans, from the total income, disregarding the inclusive definition of income u/s. 2(24) and the profits and gains business in section 28 and the ratio settled in the landmark decision in the case of Commissioner of Income Tax, Madurai Vs. T.V. Sundaram Iyengar and Sons Ltd., holding that waiver of such loans received in the course of business constitutes income receipt on being written off, by virtue of section 28(1) itself?

(IV) Whether, on the facts and circumstances of the case, the Appellate Tribunal was right in restricting the disallowance of interest expenses on exempted income of dividend on ad hoc basis of Rs. 1,14,43,040/- being 1096 of the total income in computation of income u/s. 115JB of the Act to Rs. 5 lakhs without appreciating that the assessee was maintaining mixed funds and failed either to furnish day-to-day cash-flow statement or to establish that it had its own surplus funds for investment in dividends?

We have exhaustively heard Shri K.M. Parikh, learned counsel appearing on behalf of Revenue and Shri Manish J. Shah, learned counsel appearing on behalf of respondent-Assessee and with their assistance examined the orders of the Revenue authorities and other material brought on record. 2. The first question concerns disallowance made by the Assessing Officer of the sum of Rs. 1,14,43,040/- u/s 14A of the Act towards interest and other expenses incurred in relation to exempted income of dividend. The Assessing Officer on the ground that the respondent-assessee utilised the interest bearing borrowed funds for non-business purpose disallowed such expenses to the tune of 10% of the dividend income. The Assessing Officer was of the opinion that the onus was not discharged by the respondent-assessee to establish that the investment from where dividend has been received during the Assessment Year 2004-05, was out of its own funds and no borrowed funds have been utilised for making such investment on the basis of cash/fund flows statement and, therefore, on estimated basis it deducted 10% of the total dividend income as expenditure including the interest in relation to earning of exempt income and the sum of Rs. 1,14,43,040/- was disallowed as per the provision of section 14A of the Act.

2.1 Being aggrieved by such decision, the respondent-assessee moved the CIT (Appeals). The CIT (Appeals) held that the Assessing Officer has failed to clearly show that any particular expenditure was incurred by the assessee to earn exempt dividend income, ad hoc disallowance made of Rs. 1,14,43,040/- is deleted.

2.2 The Revenue challenged this ground before the Tribunal. The Tribunal was of the firm opinion that the respondent-assessee''s own funds were higher than the investment made by the respondent-assessee and, therefore, it was not possible to hold that the interest bearing funds were diverted for making investment in shares and, therefore, u/s 14A of the Act, it held that there was no question of disallowance in respect of interest expenditure. For other expenses, the request was made for restoring the matter back to the Assessing Officer, however, the respondent-assessee with a view to put an end to the entire dispute had agreed with disallowance of Rs. 5 lakh, which according to the Tribunal was meeting the ends of justice and, therefore, the Tribunal had confirmed disallowance of Rs. 5 lakh in respect of administrative expenses.

2.3 The learned counsel Shri K.M. Parikh appearing on behalf of Revenue has vehemently submitted before us that in absence of any material to indicate that the assessee had discharged his burden of establishing that it had interest free funds available with it, the Tribunal''s finding requires interference. He also urged this Court that as far as the calculation is concerned, in the Assessment Year 2004-2005, the Rule 8D which has come into being subsequently and it being prospective in nature, the authorities ought to have considered the judgment of the Delhi High Court while calculating such expenses. He has relied on the decision of the Delhi High Court in the case of Commissioner of Income Tax Vs. Ms. Sushma Kapoor, wherein the assessee had taken a loan from the bank on which she paid interest of huge amount, but she had granted interest-free advances. The Assessing Officer held that there was no business transaction to those whom the assessee gave loan and he disallowed the proportionate interest which had been paid to the assessee by the bank. The Tribunal held that to the extent it could be proved that investment was made from the borrowed funds, the expenses had been disallowed u/s 14A of the Act. When the Revenue carried it in appeal, the High Court dismissed it on the ground that the issues raised by the Revenue were factual in nature where findings of facts were recorded in favour of the assessee. The Court also held that the investment was made in the preceding year and no part of the investment was correlated with the borrowed funds.

2.4 The Delhi High Court in the case of Maxopp Investment Ltd. Vs. Commissioner of Income Tax, New Delhi, was examining the provision of section 14A of the Act and sub-rule (2) of rule 8D qua the method for determining the expenditure in relation to exempt income. It held thus:

Section 14A, even prior to the introduction of sub-sections (2) & (3) would require the Assessing Officer to first reject the claim of the assessee with regard to the extent of such expenditure and such rejection must be for disclosed cogent reasons. It is then that the question of determination of such expenditure by the Assessing Officer would arise. The requirement of adopting a specific method of determining such expenditure has been introduced by virtue of sub-section (2) of section 14A. Prior to that, the assessing officer was free to adopt any reasonable and acceptable method. So, even for the pre-Rule 8D period, whenever the issue of section 14A arises before an Assessing Officer, he has, first of all, to ascertain the correctness of the claim of the assessee in respect of the expenditure incurred in relation to income which does not form part of the total income under the said Act. Even where the assessee claims that no expenditure has been incurred in relation to income which does not form part of total income, the Assessing Officer will have to verify the correctness of such claim. In case, the Assessing Officer is satisfied with the claim of the assessee with regard to the expenditure or no expenditure, as the case may be, the Assessing Officer is to accept the claim of the assessee insofar as the quantum of disallowance u/s 14A is concerned. In such eventuality, the Assessing Officer cannot embark upon a determination of the amount of expenditure for the purposes of section 14A(1). In case, the Assessing Officer is not, on the basis of objective criteria and after giving the assessee a reasonable opportunity, satisfied with the correctness of the claim of the assessee, he shall have to reject the claim and state the reasons for doing so. Having done so, the Assessing Officer will have to determine the amount of expenditure incurred in relation to income which does not form part of the total income under the said Act. He is required to do so on the basis of a reasonable and acceptable method of apportionment.

2.5 Per contra, the learned counsel Shri Manish Shah appearing on behalf of respondent-assessee has submitted that there would not arise any question of deduction of any expenditure incurred in relation to the income under total income, nor would arise the question of applying method for determining the amount of expenditure in relation to the income not includable in total income under Rule 8D. He has also argued that this Court has held that Rule 8D is prospective in nature and even otherwise considering the availability of funds, this would not have any application.

2.6 On thus having heard both the sides, it can be said that the object behind insertion of Section 14A is amplified by the Supreme Court in the case of Commissioner of Income Tax, Mumbai Vs. Walfort Share and Stock Brokers P. Ltd., which clarifies that the expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income. In absence of Section 14A, the expenditure incurred in respect of exempt income was also being claimed against taxable income and such practice since was to be curbed, Section 14A has been inserted. It is clarified that sub-section (1) of Section 14A of the Act clearly stipulates that for the purpose of computing total income under Chapter IV, no deduction is permissible in respect of the expenditure incurred in relation to the income which does not form part of the total income under the said Act.

2.7 In the case of an income, like dividend income, which does not form part of the total income, any expenditure incurred by the assessee in relation to such non-taxable income, the claim of deduction of such expenses incurred cannot be allowed.

2.8 The moot question here is as to whether the CIT (Appeals) and the Tribunal were right in setting aside the order of Assessing Officer, whereby it disallowed the sum of Rs. 1,14,43,040/-, applying the provisions of Section 14A of the Act on the ground that the assessee had used interest bearing borrowed funds for earning dividend during the assessment year under question. The dividend income earned was of Rs. 1,14,43,040/- and the estimate of expenditure was assessed at the rate of 10% of the total income. Had the Revenue been successful in establishing that the assessee had incurred the expenses to earn the dividend income from the borrowed funds, the entire discussion of application of Section 14A of the Act could be understood. However, when both the CIT (Appeals) and the Tribunal have noted that the assessee had sufficient funds available with it, which was more than the amount it invested for earning the dividend income, both these authorities have correctly approached the issue by setting aside the order of disallowance u/s 14A of the Act in respect of interest expenditure. When the very basis for employing Section 14A of the Act on factual matrix is lacking, the disallowance to the extent of 10% of dividend income was not permissible. When it transpires from record that the assessee''s own funds were at higher, then the investment made by it and with nothing to indicate that the borrowed funds were utilised for the purpose of investment in shares and for earning dividends, the Tribunal committed no error in disallowing the sum of Rs. 1,14,43,040/-.

2.9 As far as other administrative expenses are concerned, the Revenue had requested to restore the matter back to the Assessing Officer. However, to put an end to the entire dispute with regard to other expenses, the assessee permitted disallowance of Rs. 5 lakh. The Tribunal considering the volume and quantum of investment disallowed the said amount of Rs. 5 lakh, which though is on estimated basis, it is a reasonable base and, therefore, the first question merits no consideration.

2.10 Needless to specify at this stage that when from the facts that have emerged from record, the employment of Section 14A of the Act is not found correct, there does not arise any question of determining the amount of expenditure in absence of Rule 8D, on the basis of reasonable and acceptable method of apportionment as pressed into service by the Revenue basing on the judgment of the Delhi High Court.

Insofar as the second question is concerned, it pertains to Corporate Debt Restructuring (hereinafter referred to as ''the CDR'') expenses of Rs. 2.57 crore on payment to financial consultants in connection with waiver of loans, the Assessing Officer noted that the respondent-assessee paid the sum of Rs. 2.57 crore to the financial consultant M/s. Brescon Corporate Advertisers Ltd., who provided their professional services in connection with the scheme of CDR by negotiating with the banks and financial institutions, which eventually helped the reduction of interest burden of the assessee. They were claimed to be the revenue expenditure aimed at reduction of recurring revenue expenditure of interest. The Assessing Officer held that the assessee would derive benefit of enduring nature as a result of CDR exercise and, therefore, it was of the opinion that all the expenses are to be treated as capital expenditure and the same were needed to be disallowed and added to the income of the assessee. The Assessing Officer relied upon the decision of the Supreme Court in the case of India Cements Ltd. Vs. Commissioner of Income Tax, Madras, and dismissed the plea of the assessee.

3.1 The assessee on being aggrieved by such order travelled to the CIT (Appeals), which considered this issue in detail. It noticed that the amount of Rs. 60.13 crore had been waived under the CDR and interest had also been reduced for the financial year 2003-04. The CIT (Appeals) on discussing various cases held that the same cannot be considered to be having an enduring benefit.

3.2 The Tribunal on this very issue relied on the decision of the M/s. Madras Industrial Investment Corporation Ltd. Vs. The Commissioner of Income Tax, Tamil Nadu-I, Madras, , wherein the question arose, whereby the Supreme Court was deciding whether a particular expenditure was revenue expenditure incurred for the purpose of business or capital in nature. It held that such question needs to be determined on a consideration of all the facts and circumstances of the case and by application of principle of commercial trading. While holding the expenditure as revenue in nature, it spread the same over a period. The Tribunal further held that:

We have considered the rival submissions, perused the materials on record and gone through the orders of authorities below and various judgments cited by ld. AR of the assessee. We find that Ld. CIT(A) has decided this issue in favour of assessee by following these very judgments of Hon''ble Apex Court which are cited by the Ld. AR of the assessee before us and considering the facts of the present case, we do not find any good reason to interfere in the order of Ld. CIT(A) on this issue. We therefore decline to interfere in the order of Ld. CIT(A) on this issue. This ground of Revenue is also rejected.

3.3 In the present case also, the CDR expenses to the tune of Rs. 2.57 crore have been rightly held by both the CIT (Appeals) and the Tribunal as revenue in nature and the same has rightly not been held to be capital in nature. For the waiver of the loan, the payment has been made to the financial consultants. This was for the purpose of business and the same was held to be allowable u/s 37(1) of the Act. Having held the said amount to be revenue in nature applying the decision of the Supreme Court in the case of Madras Industrial Investment Corpn. Ltd. (supra), when the amount has been spread over a period of six years, no error is committed by both the authorities. Once the expenditure is held to be revenue in nature incurred wholly and exclusively for the purpose of business, it can be allowed in its entirety in the year in which it is incurred. However, considering the decision in the case of Madras Industrial Investment Corpn. Ltd. (supra), when the spreading is done for over a period of six years and as the assessee-respondent has no objection to such revenue expenditure being spread out, though it could have insisted for this amount allowed in the year under consideration, with no such objection having been raised, the Revenue would not succeed in this issue as the expenditure is held to be revenue in nature. Thus, the second question also does not merit any consideration.

The third question pertains to excluding the waived amount of Rs. 11.63 crore out of the principal loans. What is found is that the Assessing Officer dismissed the claim of the respondent-assessee of Rs. 11.63 crore as a capital receipt essentially on two grounds. Firstly that the waiver of the principal amount of loan had made assessee richer by that amount and the liability to pay had seized. Therefore, this being a benefit or perquisite arising from the business, this has to be construed as an income u/s 28(iv) of the Act. A strong reliance was placed by the assessee on the decision of this Court rendered in the case of Commissioner of Income Tax Vs. Chetan Chemicals Pvt. Ltd.,

4.1 In the case of Chetan Chemicals (P.) Ltd. (supra), during the course of his business of inorganic chemicals procured unsecured loans from various creditors. Due to financial crunch of the company, the creditors arrived at a compromise before the competent Court and they remitted the unsecured loans amounting to Rs. 1.77 lakh along with interest that had accrued in its favour. The interest was an income liable to tax but not the remission of loan. This loan amount was taxed by invoking provisions of section 28(iv) of the Act. The Tribunal held in favour of the assessee. On reference, this Court upheld the version of the Tribunal by holding:

It was an admitted position that there had been no allowance or deduction in any of the preceding years and, hence, there was no question of applying the provision as such. Section 28 of the Act deals with profits and gains of business or profession and clause (iv) thereof says that the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession shall be chargeable as income under head ''Profits & Gains of business or profession''.

4.2 As the assessee company was not found to be carrying on the business of obtaining loan, the Court held that the remission of such loan by the creditors was a benefit arising out of such business and, therefore, such remission of unsecured loan was not taxable at the ends of the assessee.

4.3 The CIT (Appeals) upheld in favour of the assessee by holding thus:

...I have gone through the appeal order for A.Y. 2004-05. The facts of A.Yr. 2005-06 being identical to A.Y. 2004-05, I am in agreement with my predecessor Ld. CIT(A) that the decision of Gujarat High Court in the case of Commissioner of Income Tax Vs. Chetan Chemicals Pvt. Ltd., and Mumbai Tribunal''s decision in the case of Helios Food Improvers Pvt. Ltd. fully apply to appellant''s case and the amount of loan of Rs. 11.63 crores waived by the Financial Institution cannot be brought to tax as appellant''s income u/s. 28(iv) and/or sec. 41(1) of I.T. Act. Addition of Rs. 11.63 crores is deleted.

4.4 This issue was carried to the Tribunal. The Tribunal also concurred with the findings of the CIT (Appeals) in the following manner:

We have considered the rival submissions and perused the materials on record and gone through the orders of authorities below. We find that we have decided identical issue in A.Y. 2004-05 while deciding the ground No. 5 of the Revenue''s appeal in that year. Since no difference in facts could be pointed out by Ld. DR of the Revenue in present year, we do not find any reason to take a contrary view in the present year. Hence, this ground of Revenue''s appeal is also rejected.

4.5 On thorough examination of the issue, we are of the firm opinion that the issue is squarely covered by the decision of this Court rendered in Chetan Chemicals (P.) Ltd. {supra). In the present case also, the facts are almost identical and, therefore, the CIT (Appeals) and the Tribunal have rightly held in favour of the respondent-assessee. No error is committed requiring any indulgence from this Court.

So far as the fourth question is concerned, it pertains to addition of Rs. 1,14,43,040/- u/s 115JB of the Act being the expenditure estimated on earning of dividend income u/s 14A of the Act.

5.1 The Assessing Officer on referring to the said provision of Section 115JB(2) of the Act added the said amount considering that any amount of expenditure relatable to the income exempted u/s 10 of the Act shall need to be added in the profit shown in the ''Profit and Loss Account''.

5.2 When the matter travelled to the CIT (Appeals), since it deleted the addition of Rs. 1,14,43,040/- while deciding the question No. 1, it consequently deleted such addition u/s 115JB of the Act on the ground that this would not serve any purpose.

5.3 The Tribunal decided the said issue as follows:

We have considered the rival submissions and we find that similar issue was raised by Revenue as per ground No. 3 above in respect of regular assessment of income and while deciding that ground, we have already upheld that disallowance of Rs. 5 lakh in respect of administrative expenses will meet the ends of justice and no disallowance is called for in respect of interest expenditure. Hence, for the purpose of computing book profit u/s. 115JB of the Act also, we hold accordingly and confirm the addition of Rs. 5 lakh. This ground of Revenue''s appeal is partly allowed.

5.4 As rightly held by both, the CIT (Appeals) and the Tribunal, this issue has a direct correlation with the first question. It was argued by the Revenue that while computing the book profit u/s 115JB of the Act, the disallowance of interest expenditure on exempt income was wrongly negatived by both the authorities on the ground that it was not the liability for expenses, but a liability relating to assets.

5.5 We find no fault in the approach adopted by both the authorities. The addition u/s 115JB of the Act of a sum of Rs. 1,14,43,040/- when was made as an expenditure estimated on earning of dividend income u/s 14A of the Act, without reiterating the rationale of confirming deletion of such amount as has been elaborately done at the time of deciding question No. 1, this deletion requires to be confirmed. Resultantly, no question of law much less any substantial question of law arises and the present Tax Appeal is, accordingly, dismissed.