Deputy Commissioner of Income-tax vs Gujarat Narmada Valley Fertilizers Co. Ltd

These appeals are filed by the Revenue against the order of the learned Commissioner of Income-tax (Appeals)-VI, Baroda, dated March 15, 2010, for the assessment years 2001-02 and 2002-03 respectively.

The facts as culled out from the orders are as under.

The assessee is a company engaged in the business of manufacturing of fertilizers, various chemicals and information technology business. The assessee had filed its return of income for the assessment year 2001-02 on October 29, 2001, declaring total income of Rs. 54,30,57,988 and for the assessment year 2002-03 on October 30, 2002, declaring a total income of Rs. 78,83,38,249. The assessment was framed under section 143(3) vide order dated December 31, 2003, determining total income of Rs. 66,57,27,300 for the assessment year 2001-02 and for the assessment year 2002-03, vide order dated February 28, 2005, total income was determined at Rs. 89,98,24,992. The assessee and the Revenue had filed appeals before the hon''ble Income-tax Appellate Tribunal against the order of the Commissioner of Income-tax (Appeals). The hon''ble Income-tax Appellate Tribunal vide order I.T.A. Nos. 1351/Ahd/2005 and 1227/Ahd/2005 dated September 30, 2008 and November 7, 2008, has set aside certain issues to the file of the Assessing Officer for the assessment year 2001-02 and also for the assessment year 2002-03 vide order in I.T.A. No. 1010/Ahd/2005. Pursuant to the hon''ble Income-tax Appellate Tribunal''s direction, the Assessing Officer vide his order dated December 29, 2009, passed under section 143(3) read with section 250 of the Income-tax Act had determined the total income at Rs. 63,25,16,401 for the assessment year 2001-02 and Rs.79,34,34,060 for the assessment year 2002-03. Aggrieved by the order of the Assessing Officer, the assessee carried the matter before the Commissioner of Income-tax (Appeals). The Commissioner of Income-tax (Appeals), vide his order dated March 15, 2010, allowed the appeal of the assessee. Aggrieved by the aforesaid order of the Commissioner of Income-tax (Appeals), the Revenue is now in appeal before us and raised following effective grounds in both assessment years :

For the assessment year 2001-02

1(i) On the facts and in the circumstances of the case and in law, the learned Commissioner of Income-tax (Appeals) erred in deleting addition of Rs. 7,97,82,157 on account of disallowance of interest on interest-free loans/advances given by the assessee to its subsidiaries and associate concerns.

(ii) The Commissioner of Income-tax (Appeals) failed to appreciate the legal principle, that onus under section 36(1)(iii) lies on the assessee to prove that each loan is used for the purposes of its business, as settled in the case of Kishinchand Chellaram v. CIT [1978] 114 ITR 654 (Bom), R. Dalmia v. CIT [1982] 133 ITR 169/9 Taxman 171 (Delhi), CIT v. M. S. Venkateswaran [1996] 222 ITR 163 (Mad), K. Somasundaram & Bros. v. CIT [1999] 238 ITR 939 (Mad) and CIT v. Motor General Finance Ltd. [2002] 254 ITR 449/122 Taxman 447 (Delhi) which was confirmed in principle by the Supreme Court in the case of Motor General Finance Ltd. v. CIT [2004] 267 ITR 381/138 Taxman 235 (SC). Hence, appeal to the Income-tax Appellate Tribunal is proposed on this issue.

2(i). On the facts and in the circumstances of the case and in law, the learned Commissioner of Income-tax (Appeals) erred in deleting the disallowance of interest expenses of Rs. 64,00,000 under section 14A of the Act in respect of dividend income of Rs. 10,18,43,271 which is exempt from tax in the hands of the assessee-company.

(ii). The Commissioner of Income-tax (Appeals) failed to appreciate that the assessee had taken interest bearing loans and the assessee did not discharge its onus to establish that interest bearing fund was not utilised for the purpose of investment. Since the assessee failed to furnish any quantification, in respect of loan taken and investment made, the disallowance under section 14A was rightly made by the Assessing Officer.

For the assessment year 2002-03

1(i) On the facts and in the circumstances of the case and in law, the learned Commissioner of Income-tax (Appeals) erred in deleting the disallowance of interest expenses of Rs. 64,00,000 under section 14A of the Act in respect of dividend income of Rs. 7,13,01,338 which is exempt from tax in the hands of the assessee-company.

(ii) The Commissioner of Income-tax (Appeals) failed to appreciate that the assessee had taken interest bearing loans and the assessee did not discharge its onus to establish that interest bearing fund was not utilised for the purpose of investment. Since the assessee failed to furnish any quantification, in respect of loan taken and investment made, the disallowance under section 14A was rightly made by the Assessing Officer.

The first ground for the assessment year 2001-02 is with respect to the addition of Rs. 7,97,82,157 on account of interest-free loans given by the assessee :

During the course of assessment proceeding in the first round, the Assessing Officer noticed that the assessee-company had advanced various interest free advances to the subsidiaries and associate concerns and on the other hand, the assessee was paying heavy interest on the secured and unsecured loan. The Assessing Officer was of the view that the assessee has parted the borrowed funds for loan and advances to the parties, the details of which are as under :

1 GNAL 40,82,08,176

2 Narmada Education and Scientific Society 3,48,99,629

3 Gujarat Narmada Finance & Investment Co. Ltd. 1,27,483

Total 44,32,35,288

The Assessing Officer further observed that the assessee was having interest-free funds of Rs. 1,75,469.32 lakhs and investment of Rs. 2,61,646.15 lakhs. If the secured loan were also considered for purchases of assets, the total fund worked to Rs. 2,31,291.63 lakhs. Thus, the Assessing Officer held that the borrowed funds were utilised for making interest-free advances and made addition of Rs. 7,97,82,157. The hon''ble Income-tax Appellate Tribunal set aside the issue to the Assessing Officer for the reason that the issue was not considered from the angle of business expediency. Pursuant to the directions of the hon''ble Income-tax Appellate Tribunal, the Assessing Officer asked the assessee to furnish the details of interest-free advances along with the reasons and to prove that the money was advanced as a measure of commercial expediency. The assessee, inter alia, submitted that no fresh advance was given to the subsidiaries during the year. It also submitted the explanation with respect to the advances given to three partners. The submission made by the assessee was not found acceptable to the Assessing Officer. He disallowed the claim of the assessee by holding as under:

"5.5 I have carefully considered the reply of the assessee-company. While deciding the case of S.A. Builders Ltd. v. CIT (Appeals) [2007] 288 ITR 1/158 Taxman 74 (SC), the hon''ble Supreme court has held that (page 9) "We wish to make it clear that it is not our opinion that in every case interest on borrowed loan has to be allowed if the assessee advances it to a sister concern. It all depends on the facts and circumstances of the respective case. For instance, if the directors of the sister concern utilise the amount advanced to it by the assessee for their personal benefit, obviously it cannot be said that such money was advanced as a measure of commercial expediency. However, money can be said to be advanced to a sister concern for commercial expediency in many other circumstances (which need not be enumerated here). However, where it is obvious that a holding company has a deep interest in its subsidiary, and hence if the holding company advances borrowed money to a subsidiary and the same is used by the subsidiary for some business purposes, the assessee would, in our opinion, ordinarily be entitled to deduction of interest on its borrowed loans''. It is therefore, the assessee-company has to file the purpose of advances given to its subsidiary companies and also to explain the use of the fund by the subsidiary company to explain business expediency of the fund. The assessee has simply submitted that the advances given in the earlier years is not a point because the assessee has paid and claimed the interest expenses on the funds borrowed by the assessee and used by the sister concerns and there is no whereabouts made available on records regarding the use of the fund.

5.5.1. In respect of advance to the Narmada Education and Scientific Research Society, the assessee-company has submitted that the company made advances to the society out of imminent business sense for ensuring educational facilities to the children of its employees, which in turn would enable it to attract and retain talented employees for the purposes of its business. The NE and SRS is an education institute and the children of the employees as well as outsider benefit from the said institute. Merely submission that the children of the staff members/officers are benefited from the education institute is not sufficient to prove business expediency.

5.5.2. In respect of advances to Gujarat Narmada Finance and Investment Co. Ltd. the assessee-company has totally failed to prove business expediency as directed by the hon''ble Income-tax Appellate Tribunal and decided in the case of S.A. Builders Ltd. [2007] 288 ITR 1 (SC). The assessee-company has to establish nexus between the expenditure and the purpose of the business.

5.5.3. To avoid/reduce the taxability, the assessee-company has taken the loan and paid and claim the interest in its own case and diverted the fund into the loss making company.

5.5.4. After considering all the facts of the case and submission made by the assessee-company it is concluded that the assessee-company has totally failed to prove the business expediency of the interest-free advances to the subsidiary companies and hence by applying the rate of interest of 18 per cent. per annum interest payment of Rs. 7,97,82,157 is hereby disallowed and added back to the total income of the assessee-company. Penalty proceeding for furnishing inaccurate particulars and thereby concealment of income is initiated."

Aggrieved by the order of the Assessing Officer, the assessee carried the matter before the Commissioner of Income-tax (Appeals). The Commissioner of Income-tax (Appeals), after considering the submissions of the assessee held that a similar issue has arisen for the assessment year 2007-08 and where the assessee had proved the commercial expediency. He was further of the view that since the facts on the basis of which the Assessing Officer decided the issue and the contention of the assessee was identical in the assessment year 2007-08, he following his own decision in the appeal for the assessment year 2007-08 allowed the claim of the assessee. Aggrieved by the aforesaid order of the Commissioner of Income-tax (Appeals), the Revenue is now in appeal before us.

Before us, the learned Commissioner of Income-tax-Departmental representative submitted that there was factual difference as compared to the facts of the assessment year 2007-08 as interest-free funds were less as compared to the investment made. He further submitted that the assessee had advanced to the loss making concerns and the commercial expediency was not proved before the Assessing Officer. He, thus, supported the order of Assessing Officer. The learned authorised representative, on the other hand, submitted that the assessee has not granted any fresh advance to Gujarat Narmada Auto Ltd. (GNAL) and the Narmada Education and Scientific Research Society (NE and SRS) during the assessment year 2001-02, however small advance of Rs. 0.03 lakhs was given to Gujarat Narmada Finance and Investment Co. Ltd. The learned authorised representative submitted that the advance to Gujarat Narmada Auto Ltd. represented payment made by the assessee to the financial institution towards settlement of the borrowal accounts. The settlement was made out of commercial expediency and in view of the fact that the assessee had guaranteed the borrowing facilities of Gujarat Narmada Auto Ltd. and the company was legally liable to pay those debts. It was further submitted that by making the payments to the financial institution, the assessee became the only secured creditor of Gujarat Narmada Auto Ltd. and thereby gained control over securities. It was further submitted that the business carried on through the wholly subsidiary Gujarat Narmada Auto Ltd. is the assessee''s business in accordance with the memorandum of association. With respect to advance of Narmada Education and Scientific Research Society, the learned authorised representative submitted that the aforesaid trust was established in the year 1985 by the assessee with the objecting of establishing english medium higher education institutions in the district of Bharuch to ensure educational facilities for the children of employees. The advance was made to the society out of imminent business sense for ensuring educational facilities to the children of its employees which in turn would enable it to attract and retain talented employees for the purposes of its business. Thus, the loan is for business purpose for education of children was a part and parcel of staff welfare activity. It was further submitted that the funds were given out of surplus funds available with the company. It was, thus, submitted that the case of the assessee was covered by the hon''ble Supreme Court''s decision in the case of S.A. Builders Ltd. v. CIT (Appeals) [2007] 288 ITR 1/158 Taxman 74. The learned authorised representative further submitted that on identical facts for the assessment years 1992-93, 1993-94 and 1994-95, the Revenue had preferred appeal before the hon''ble Gujarat High Court. The hon''ble Gujarat High Court dismissed the appeals of the Revenue. He placed on record the copy of the judgments in Tax Appeal Nos. 399, 400 and 401 of 2000 at page Nos. 119 to 126 of the paper book. He further submitted that in this matter, before the hon''ble High Court, the three concerns to which the advances were made were same as in the present case. The assessee has also placed on record a copy of its balance-sheet to point out that the interest-free shareholders'' funds in the form of capital and reserves and surplus was to the extent of Rs. 84,450.27 lakhs, which was far in excess amount advanced to the concerns. It was, thus, submitted that the assessee was having sufficient interest-free funds at its disposal. He thus supported the order of the Commissioner of Income-tax (Appeals).

We have heard the rival submissions and perused the material on record. It is an undisputed fact that the assessee had granted loans and advances to its associates and the loans and advances outstanding as on March 31, 2001, to its subsidiaries and its associates was same as that on March 31, 2000, except for an increase of Rs. 0.03 lakhs, which supports the contentions of the assessee that no new loans and advances have been granted to the aforesaid concern during the year. Further, from the balance-sheet as on March 31, 2001, the assessee has demonstrated that it was having sufficient interest-free funds at its disposal. Further, the Assessing Officer has not brought out any tangible evidence to support his contention that interest bearing loans taken by the assessee for the purpose of its own business have been used for non-business purpose and the nexus between interest bearing loans and interest-free advances has not been proved by the Assessing Officer. In the assessee''s own case the hon''ble Gujarat High Court dismissed the appeal of the Revenue by holding as under :

"10. Thus, it is apparent that the Supreme Court was dealing with the question of allowability of interest on borrowed funds which were given as interest-free loan to the sister company. It is in the context of the aforesaid facts that the court held that the test in such a case is whether this was done as a measure of commercial expediency. In the facts of the present case, the Tribunal has upon going through the figures in the balance-sheet of the assessee-company found as a matter of fact that the share capital and the reserves and surplus together with the accumulated depreciation, far exceeded the loans and advances made to the aforesaid three concerns. The percentage of loans and advances in relation to the own funds of the assessee-company was very small. The Tribunal upon appreciation of the evidence on record found that there were sufficient funds available with the company on which no interest was paid and out of which loans and advances to the aforesaid concerns could be made. It was further found that there is no clear evidence that the interest bearing loans taken by the assessee-company for the purpose of its own business have been diverted for non-business purposes and that no direct nexus had been proved by the Assessing Officer between interest bearing loans taken and interest-free advances given. In the light of the aforesaid findings, the decision of the Supreme Court in the case of S.A. Builders Ltd. v. CIT (Appeals) [2007] 288 ITR 1 (SC) would not be applicable to the facts of the present case. When no interest bearing funds have been diverted to the sister concern by way of interest-free advances. The question of going into the commercial expediency of such loans would not arise. In fact, in the light of the findings recorded by the Tribunal, the question as formulated while admitting the appeals would not arise as on facts there is no diversion of interest bearing funds to interest-free advances. In the circumstances, the Tribunal was justified in deleting disallowance made under section 36(1)(iii) of the Act."

Respectfully following the decision of the hon''ble Gujarat High Court, we find no reason to interfere with the order of the Commissioner of Income-tax (Appeals) and thus, we uphold the order of the Commissioner of Income-tax (Appeals) and therefore, this ground of Revenue is dismissed.

The second ground for the assessment year 2001-02 and the first ground for the assessment year 2002-03 are with respect to the disallowance under section 14A: During the course of assessment proceeding, the Assessing Officer noticed that the assessee had received dividend income of Rs.10,18,43,271 for the assessment year 2001-02 and Rs. 7,13,01,338 for the assessment year 2002-03. He further noticed that the assessee has raised funds out of which Rs. 12,893.23 lakhs for the assessment year 2001-02 and Rs. 9,664.24 lakhs for the assessment year 2002-03 have been utilised for investment in UTI and domestic companies. According to the Assessing Officer, investment worked out to 70 per cent. of funds raised. He, accordingly, made an addition of Rs. 64 lakhs, i.e., 70 per cent. of Rs. 87.73 lakhs under section 14A. The hon''ble Income-tax Appellate Tribunal had set aside the issue before the Assessing Officer for reconsideration. In the second round, the assessee submitted that the investment in UTI and shares of domestic companies from which the assessee has earned dividend income were made in the earlier years and no fresh investment were made during the year. It was further submitted that the assessee had incurred no expenditure for earning dividend. The assessee further relied upon the decision in the case of CIT v. Hero Cycles Ltd. [2010] 323 ITR 518/189 Taxman 50 (Punj. & Har.). The contention of the assessee was not found acceptable to the Assessing Officer as he was of the view the year of investment or source of investment does not matter but since, the assessee has earned tax free dividend income disallowance under section 14A has to be worked out and he accordingly worked out disallowance under section 14A of Rs. 87.73 lakhs.

Aggrieved by the order of the Assessing Officer, the assessee carried the matter before the Commissioner of Income-tax (Appeals). The Commissioner of Income-tax (Appeals), after considering the submissions made by the assessee, deleted the addition in both years by holding as under :

"5.2 I have gone through the submissions of the authorised representative and the assessment order. I have also gone through the Income-tax Appellate Tribunal order which has restored this issue to the file of the Assessing Officer with specific direction. The Assessing Officer ought to have looked in to only the aspect with reference to which the Income-tax Appellate Tribunal had set aside the issue. The appellant has clearly established that dividend income is earned out of the investment made in the earlier years. No disallowance of interest was made in past. Similarly the Assessing Officer has not established nexus between interest bearing borrowing and investment from which exempt income is earned. The appellant has huge share capital and reserves and surplus which do not carry any interest. The making of investment is not a distinct activity with an objective of earning tax free income. The borrowing made by the company is always for the purpose of businesses and the income from which is taxable. Considering all these aspects and also considering the judicial pronouncements cited by the learned authorised representative, I hold that the Assessing Officer has erred in making disallowance of Rs. 64 lakhs under section 14A. This ground of appeal is therefore allowed."

Aggrieved by the order of the Commissioner of Income-tax (Appeals), the Revenue is in appeal before us.

Before us, the learned Commissioner of Income-tax-Departmental representative submitted that the onus was on assessee to prove that no interest bearing fund has been used for the purpose of making investment and which the assessee had not discharged. He placed reliance on the decision of the Special Bench in the case of ITO v. Daga Capital Management (P.) Ltd. [2009] 117 ITD 169/[2008] 26 SOT 603 (Mum.) (SB) for the proposition that the onus is on the assessee to prove that no expenditure was incurred for earning tax free income. He also placed reliance in the case of Dhanuka & Sons v. CIT [2011] 339 ITR 319/201 Taxman 105/12 taxmann.com 227 (Cal). The learned authorised representative, on the other hand, submitted that no new investment has been made by the assessee in the current year. The investments were made in the earlier years from the funds generated by the assessee. He further placed reliance on the decision in the case of CIT v. Reliance Utilities & Power Ltd. [2009] 313 ITR 340/178 Taxman 135 (Bom) and in the case of Hero Cycles Ltd. (supra).

We have heard the rival submissions and perused the material on record. It is an undisputed fact that no fresh investments have been made by the assessee during the year. It is also a fact that as per the balance-sheet of the assessee, the interest-free funds in the form of capital, reserves and surplus are to the extent of Rs. 84,45,567 lakhs whereas the investments are to the extent of Rs. 22.707 lakhs. Thus, the shareholders'' funds are far in excess of the investments. In the case of Reliance Utilities & Power Ltd. (supra), the hon''ble Bombay High Court has held as under (page 344):

"The principle, therefore, would be that if there are funds available both interest-free and over draft and/or loans taken, then a presumption would arise that investments would be out of the interest-free fund generated or available with the company, if the interest-free funds were sufficient to meet the investments."

In the case of Hero Cycles Ltd. (supra). The hon''ble High Court held as under (page 521):

"The contention of the Revenue that directly or indirectly some expenditure is always incurred which must be disallowed under section 14A and the impact of expenditure so incurred cannot be allowed to be set off against the business income which may nullify the mandate of section 14A, cannot be accepted. Disallowance under section 14A requires finding of incurring of expenditure where it is found that for earning exempted income no expenditure has been incurred, disallowance under section 14A cannot stand."

In the present case, the Assessing Officer has not given a specific finding with respect to the expenditure incurred by the assessee for earning tax free income. Further, the interest-free funds available with the assessee are far in excess of investments. Thus relying upon the aforesaid decision of the High Courts, we are of the view that in the present case, no addition under section 14A can be made. We, therefore, find no reason to interfere with the order of the Commissioner of Income-tax (Appeals) and thus, dismiss this appeal of the Revenue.

In the result, the Revenue''s appeals for both years are dismissed.