Validity of disallowance of Expenditure against exempt income on conversion of shares held as opening stock to investments by assessee
Overview :
Where AO had made addition of proportionate interest paid on borrowed funds on the allegation that assessee dealing in share-trading had converted its opening stock of shares to investments, the matter was remanded back to AO to determine the actual date of conversion of shares before computing any disallowance.
Assessee-company was engaged in real estate development as well as trading in securities. It had borrowed interest bearing funds which were invested in securities. AO disallowed proportionate interest on borrowed funds alleging that the taxpayer had converted its opening stock of shares to investments. AO thus invoked proportionate interest disallowance for the reason that said conversion took place on beginning of the relevant financial year and made proportionate interest disallowance for whole of the relevant previous year.
It is held that Revenue failed to dispute the clinching fact that neither AO nor the CIT(A) had examined the vital date of the conversion of assessee’s stock-in-trade to investment whilst computing the proportionate disallowance. Dispite the fact that assessee had made it clear that actual date of conversion was end of the relevant financial year. Therefore, the matter was remanded back to AO for factual verification of date of the stock-in-trade of shares to investments in issue to be followed by necessary computation of the proportionate interest disallowance.
Decision: Matter remanded.
Referred: CCI Ltd. v. Jt. CIT in (IT Appeal No. 359 of 2011, dt. 28-2-2012) : 2012 TaxPub(DT) 1786 (Karn-HC), CIT v. Delite Enterprises in (ITA No. 110 of 2009, dt. 26-2-2009) : 2012 TaxPub(DT) 2611 (Bom-HC), Ethio Plastics (P) Ltd. v. Dy. CIT in (ITA No. 848/Ahd/2012, dt. 10-12-2012) : 2013 TaxPub(DT) 1786 (Ahd-Trib), Apoorva Patni, & Ors. v. Addl. CIT in (ITA No. 239/PN/11, 193/PN/11, 192/PN/11, 273 to 276/PN/11, dt. 21-6-2012) and Yatish Trading Co. (P.) Ltd. v. Asstt. CIT in (IT Appeal No. 456 (Mum) of 2009, dt. 10-11-2010) : 2011 TaxPub(DT) 611 (Mum-Trib).
IN THE ITAT, KOLKATA BENCH
S.S. GODARA, J.M. & M. BALAGANESH, A.M.
MKJ Developers Ltd. v. ACIT
ITA No. 1562/Kol/2017
31 December, 2018
Appellant by: Ravi Tulsiyan, FCA
Respondent by: Pradip Majumdar, Addl. Commissioner-Sr. Departmental Representative
ORDER
S.S. Godara, J.M.
This assessee’s appeal for assessment year 2005-06 arises against the Commissioner (Appeals)-2, Kolkata’s Order, dt. 6-4-2017passed in case No. 244/Commissioner (Appeals)-2/14-15 involving proceedings under section 143(3) of the Income Tax Act, 1961; in short ‘the Act’.
Heard both the parties. Case file perused.
2. The assessee’s sole substantive ground challenges both the lower authorities action invoking section 36(1)(iii) proportionate interest disallowance of Rs. 1,02,00,000 during the course of assessment as affirmed in lower appellate proceedings. The Commissioner (Appeals)’s detailed discussion qua the instant issue reads as follows :–
“Grounds-1, 2, & 3
These grounds of appeal as raised by the assessee against the order of the assessing officer are as under :–
–That the learned assessing officer erred in disallowing proportionate interest of Rs. 1,02,00,000 on the borrowed fund utilized by the appellant in acquiring the shares which were held by it as investment.
–That since no dividend was received by the appellant from the shares held as investment, the learned assessing officer erred in disallowing proportionate interest of Rs. 1,02,00,000 apparently applying the provisions of section 14A of the Income Tax Act.
–That without prejudice to Grounds No. 1 and 2 the disallowable proportionate interest of Rs. 96,00,000 is excessive inasmuch as conversion of stocks and inventory to investments amounting to Rs. 8.50 crores took place on 31-3-2005 and not on 1-4-2004.”
The Authorised Representative of the appellant during the appellate proceedings furnished written submissions as under :–
‘1. In reference to the above the appellant would like to submit that the share trading was its business for the year under appeal. Purchase and sale of shares was carried out with the motive of earning profits an not dividend income. for the said purposes the appellant would like to point out that shares in the year under appeal were held by it as “stock-in-trade” and not as “Investments.”
1.2 Also, it may be noted that the appellant being engaged in the business of share trading, income arising from such share trading activities shall be offered to tax under the head “Profit & Gains from Business or Profession” and not under the head “Capital Gains”. In this regard the assessee would like to submit that there were no transactions in shares during the year under consideration and thus the assessee has not derived any income/loss out of such shares. Therefore the assessee has not credited any income out of such shares.
1.3 In connection to the above, the appellant would like to submit that since income form share trading activities was its primary source of income and income from such activities is taxed under the head “Profit & Gains from Business or Profession”, it need to be appreciated that corresponding expenses debited in the Profit & loss Account were of the nature of ‘Business Expenses”. The debited expenses was absolutely incurred just for the business activity of the appellant company being share trading. assessing officer committed an error in the matter of the date of conversion of the shares from stock in trade to investment while disallowing the interest of Rs. 1,02,00,000. The learned assessing officer presumed that such conversion was made with effect from the beginning of the financial year 2004-05 i.e. from 1-4-2004 itself. In other words the learned assessing officer presumed that for the entire Fin. Year: 2004-05, the converted shares were held by the appellant company as its Investments. Consequently he has argued that the interest attributable to such converted shares should be disallowed as the shares were no more the Appellant’s business asset with effect from 1-4-2004.
2.1 In light of the above the appellant company would like to submit that the shares valued at Rs. 8.5 Crores were converted with effect from 31-3-2005 and not from 1-4-2004 as wrongly presumed by the learned assessing officer (This is evidenced from the Ledger A/cs of both the Stock in Trade as well as Investments, copies of which are enclosed at pages 25-26 of the paper book) The appellant company by way of additional evidence is also producing herewith a copy of Board Resolution dated 28-2-2005 without which it could not have transferred the Shares from stock in trade to investment. (copy of which is enclosed herewith at pages 27 of the paper book)
2.2 Further, the appellant company would like to submit that the aforesaid fact was intimated to the learned assessing officer by its letter dated 18-12-2007. The learned assessing officer has not raised any question relating to the said letter dated 18-12-2007 submitted by the assessee. (copy of the letter dated 1812.2007 is enclosed at pages 28-29 of the paper book)
2.3 From the aforesaid discussion, it is clear that the learned assessing officer has disallowed the interest of Rs. 1,02,00,000 on the wrong premise that the shares valued at Rs. 8.5 crores was no more a business asset from the beginning of the financial year : 2004-05.
3. On the basis of this contention, the assessee submits that since assessee is dealing in trading in shares, the question of disallowance of interest does not arise. The assessee submits that if there is any borrowed money for the purpose of business purpose, the same shall be allowable under section 36(1)(iii) of the Income Tax Act, 1961.
3.1 It must be borne in mind that in the instant case, the assessee is a trader dealing specifically in shares and that his business is trading in shares. His income, therefore form trading in shares is required to be assessed under the head “business” and since the shares have been purchased out of borrowed funds, the interest on such borrowings is allowable under section 36(1)(iii) as this incurred for the purpose of his business section 36(1)(iii) reads as follows :–
3.1.1 ‘Other deductions. 36(1)–The deductions provided for in the following clauses shall be allowed in respect of the maters dealt with therein, in computing the income referred to in section 28–
(i) …. …
(ii) … …..
(iii) The amount of the interest paid in respect of capital borrowed for the purposes of the business or profession.”
3.1.2. Clause (iii) of section 336(1) makes allowance in respect of interest paid on capital borrowed for the purposes of business or profession. In the instant case the assessee has borrowed funds for the purpose of business and thus it stands allowable under section 36(1)(iii) of the Act.
4. Further to our submission made above, a question which arises is in respect of the applicability of provisions of section14A in this case on the interest claim of the appellant company. Therefore detailed submission is being made on section 14A as well.
4.1 From perusal of the facts as enunciated above it is clear that the assessee is a trader in shares and not investor in shares. Purchase & sale of shares was carried out with the motive of earning profits and not dividend income for the said purposes the appellant would like to point out that shares in the year under appeal were held by it a “Stock-in-trade” and not as “Investment”. Therefore section 14A will not be applicable in the case of the assessee as the main motive of the appellant is not to earn dividend income but to trade in shares. This has been held in many decisions of the Hon’ble ITAT as well as High Courts. Some of these are quoted here and below:–
–M/s. CCI Ltd. v. Jt. CIT (ITA No. 359 of 2011)
The Hon’ble High Court of Karnataka had held that :–
“Where no expenditure is cured by the assessee in earning dividend income, no notional expenditure could be deducted from the said income. it is not the case of the assessee retaining any shares so as to have the benefit of dividend 63% of the shares, which were purchased, are sold and the income derived there from is offered to tax as business income. the remaining 37% of the shares are retained. It has remained unsold with the assessee. It is those unsold shares have yielded divided, for which, the assessee has not incurred any expenditure at all. Though the dividend income is exempted from payment of tax, if any expenditure is incurred in earning the said income, the said expenditure also cannot be deducted. But in this case, when the assessee has not retained shares with the intention of earning dividend income and the dividend income is incidental to his business of sale of shares, which remained unsold by the assessee, it cannot be said that the expenditure incurred in acquiring the share has to be apportioned to the extent of dividend income and that should be disallowed from deductions. In that view of the matter, the approach of the authorities is not in conformity with the statutory provisions contained under the Act. Therefore, the impugned orders are not sustainable and require to be set aside.”
—Yatish Trading Co. (P) Ltd. v. ACIT 1(3), Mumbai (ITA No. 456/Mum/2009)
The Hon’ble ITAT, Mumbai had held that :–
“The assessing officer disallowed the administrative expenditures on the basis of the ratio of the taxable income and dividend income. At the outset the basis of apportionment is absolutely wrong, unreasonable and inappropriate because the expenditure does not depend on the profit or loss arising from the business activity. it is to be noted that if the basis of apportionment of expenditure is taken as income than in case of no income or loss no expenditure can be assigned to the said activity. It is to be noted that if the basis of apportionment of expenditure is taken as income than in case of no income or loss no expenditure can be assigned to the said activity. Therefore the proper and reasonable basis should be the turnover or volume of transactions frequency and nature of the transactions/activity. In case of transactions of purchase and sale of share and securities the reasonable basis for apportionment of the administrative expenditures among the different activities should be the volume and nature of the transactions under different activities of business. There cannot be a parity or equal basis for apportionment of the administrative expenses between the delivery based transactions and non-delivery based transactions as well as trading and investment activities. Undisputedly the labour hour and overhead expenses will be less in case of non-delivery based transactions of purchase and sale of shares & securities in comparison to the delivery based transactions. Similarly in case of collection of dividend through cheques or vouchers will cost more than direct credit in d-mat account. It is undisputable fact that the dividend was directly credited in the D-mat account. Secondly, the dividend income was is on the shares held for trading purposes.” (order copy enclosed at page. of the paper book)
—Ethio Plastics (P) Ltd. v. Dy. CIT, Circle-1(2) Baroda (ITA No:848/Ahd/2012)
The Hon’ble ITAT, Ahmedabad had held that :–
“After hearing both the parties and perusing the record we find that a is engaged in the business of dealing in shares and securities and there is no dispute about the fact that hares were held by the assessee a stock in trade. The intention of assessee was not to earn dividend income and this income being incidental to business of ale of shares, no notional expenditure could be deducted by invoking the provisions of section14A of the Act.” (order enclosed at pages… of the paper book)
—Apporva Apoorva Patni, & Ors. v. Addl. CIT in (ITA No. 239/PN/11, 193/PN/11, 192/PN/11, 273 to 276/PN/11, dt. 21-6-2012)
The Hon’ble ITAT Pune Bench had held that :–
“Where no expenditure is canvassed to have been incurred by the assessee in earning dividend income, no notional expenditure can be deducted by invoking section 14A of the Act. Further in a case when assessee has not retained shares with the intention of earning dividend income and dividend income is incidental to the business of sale of shares, it cannot be said that the expenditure incurred in acquiring the shares has to be apportioned to the extent of divided income, so as to be disallowed.”
Thus on the basis of the above decisions it can be concluded that no disallowance under section 14A can be made in the case of trader of shares. The said case of the assessee falls within the ambit of the decisions quoted above and hence no disallowance of interest can be made under section 14A as well as section 36(1)(iii).
4.2 Furthermore, it may be noted that disallowance under section 14A can be made only when there is tax free income i.e. dividend income. in the said case it is evident from the profit and loss accounts of the appellant company that the appellant has not earned any tax free income i.e. dividend income out of the said share during the year under consideration. Hence no disallowance can be made under section 14A of the Income Tax Act. Further, the Hon’ble Bombay High Court has recently ruled that no disallowance can be made under section 14A, when no exempt income is earned during the year. Attention is invited to the said decision in the assessee of :–
—CIT v. M/s. Delite Enterprises in (ITA No. 110 of 2009, dt. 26-2-2009) : 2012 TaxPub(DT) 2611 (Bom-HC). 14A disallowance if there is no tax-free income
The assessee, a partner in a firm, borrowed funds and advanced it to the firm on terms that the firm would pay interest if it made a profit. For one year, the firm paid interest which was offered as income by the assessee while for the second year it did not pay interest as it made a loss. The assessee claimed the interest paid on the borrowing as a deduction under section 36(1)(iii). The assessing officer disallowed the claim on the ground that as the borrowings had been invested in the firm and the income from the firm was exempt under section 10(2A), the interest expenditure was not allowable under section 14A. This was reversed by the Commissioner (Appeals). On appeal, the Tribunal upheld the Commissioner (Appeals) on the ground that as there was no exemption claimed under section 10(2A) by the assessee and there was no tax-free income, section 14A could not apply. The department filed an appeal in the High Court in which it argued that as the profits derived by the assessee form the firm was exempt under section 10(2AA), the interest on the borrowed funds used to invest in the firm was disallowable under section 14A HELD by the High Court dismissing the appeal: In so far as Question (A) is concerned, on facts we find that there is no (tax-free) profit for the relevant assessment year. Hence the question as framed would not rise. Hence disallowance made by the learned assessing officer in the backdrop of the above circumstances, is arbitrary and unreasonable.
6. Hence, it is being urged before your good-self that disallowance of interest amounting to Rs. 1,02,00,000 made by the learned assessing officer be kindly deleted and necessary relief be granted to the appellant.”
I have considered the submissions of the authorized representative of the appellant as well as the assessment order framed in the light of the materials available on record before the assessing officer during the assessment proceedings. The assessing officer has considered the submissions of the Authorised Representative during the assessment proceedings and made disallowance. The interest was disallowed while considering the share capital and reserve and surplus and unsecured loans. The assessing officer has also considered the conversion of share held in stock to investment. I agree with the assessing officer. in view of above, the order of the assessing officer is upheld and these grounds of appeals re dismissed.”
3. We have given our thoughtful consideration to rival contentions. Some key facts emerge from the instant lis. This assessee is a company engaged in real estate development as well as trading insecurities. Mr. Tulsiyan is very fair in stating that assessee had in fact borrowed interest bearing funds which were invested in securities in issue. We notice from assessment Order, dt. 28-12-2007 that the assessing officer disallowed 12% interest on borrowed funds of Rs. 8.5 crores coming to Rs. 1,02,00,000 in view of the reason that the taxpayer had converted its opening stock of shares worth of Rs. 8.5 crores to investments. He thus invoked proportionate interest disallowance for the reason that said conversion took place on 1-4-2004. All this resulted in impugned proportionate interest disallowance for whole of the relevant previous year. The Commissioner (Appeals)’s order has confirmed the same.
4. Learned counsel’s sole submission during the course of hearing is that assessee had in fact converted its shares held as stock-in-trade into investments only on 31-3-2005 than on 1-4-2004. He pleads that both the lower authorities have erred particularly in computing the impugned interest disallowance on erroneous assumption of facts that the convergent of shares to investment in fact took place of opening date of the relevant previous year. Learned Departmental Representative fails to dispute the clinching fact that neither the assessing officer nor the Commissioner (Appeals) have examined the said vital date of the impugned conversion of assessee’s stock-in-trade to investment whilst computing the proportionate disallowance in issue dispute the fact that the taxpayer’s statement of fact had made it clear that actual date of conversion was 31-3-2005 only. We therefore deem it appropriate to restore this sole substantive ground back to the assessing officer for factual verification of date of the stock-in-trade shares to investments in issue to be followed by necessary computation of the proportionate interest disallowance as per law after affording adequate opportunity of hearing to the assessee.
5. This assessee’s appeal is accepted for statistical purposes.
