Disallowance of Interest Expenses on the ground that the borrowed funds were used for acquiring Shares of group Companies.

Macintosh Finance Estates Ltd. vs Additional Cit on 27 February, 2006

Bench: T Sharma, A Garodia

ORDER A.K. Garodia, Accountant Member

1. This appeal is an assessee’s appeal directed against the order of learned Commissioner (Appeals)-I, Mumbai, dated 26-6-2002 for assessment year 1998-99. Ground No. I raised by the assessee is regarding disallowance of interest of Rs. 44,21,079 paid on various borrowings on the ground that the borrowed funds were used for acquiring Shares of group Companies.
2. Briefly stated, the facts are that the assessee-company filed return of income on 27-11-1998 showing a net loss of Rs. 40,85,260. In course of assessment proceedings, it was found by the assessing officer that the funds available with the assessee-company are Rs. 24,10,200 on account of Paid-up Share Capital and Rs. 655,20,000 on account of Unsecured Loans; Total Rs. 679.30 lakhs. Out of this, the investment of the assessee company in shares amounted to Rs. 656.42 lakhs and investment in Government Securities amounted to Rs. 7.32 lakhs; total Rs. 663.74 lakhs.’ On the borrowed funds, the assessee-company has paid interest of Rs. 44.21 lakhs and claimed the same as an expense against income of Rs. 2.52 lakhs on account of interest on Government Securities, Rs. 1.26 lakhs on account of Interest on Income Tax Refund and Rs. 16.44 lakhs as Dividend. In the profit & loss account, there is neither any purchase/ sale of shares, nor any opening/closing stock of shares. It was held by the assessing officer that the assessee has borrowed funds from group companies and invested the same in acquiring shares of group companies, there is no business activity being carried on by the assessee and hence the interest is not allowable under Section 36(l)(iii) or under Section 37 of Income Tax Act. It is also held by him that since the dividend income is exempt, the interest is not allowable under Section 57 also. For these reasons, the assessing officer disallowed the interest expenses ofs. 44.19 lakhs. On appeal, learned Commissioner (Appeals) upheld the disallowance made ‘by the assessing officer by holding that in view of Section 14A, interest paid on borrowed money utilized for earning exempt income is not ‘allowable as an expense. Now, the assessee is in further appeal before us.
3. It was submitted by learned AR of the assessee that the assessee is a Non-Banking Financial Company (NBFC) and hence the provisions of RBI Act is applicable to the assessee and reliance was placed on the Tribunal order rendered in the case of Tedco Investment & Financial Services (P.) 87 ITD 298 (Delhi). Our attention was drawn to the Balance Sheet of the assessee-company as appearing on page 9 of the Paper Book and it was submitted that Shares of Rs. 326.98 lakhs were held 4 stock-in-trade and shares of only Rs. 322.13 lakhs were held as ,investment out of total investment in shares of Rs. 649. 10 lakhs. Regarding no stock being shown in the profit & loss account, it was submitted that the opening and closing stock of stock-in-trade is same and the company only shows decrease or increase in stock in the P&L Account and since there is no decrease or increase in stock-in-trade, it is not reflected in the P&L Account. Break up of Dividend Income was submitted as per which, the dividend of Rs. 996,819 was received on account of shares held as inventory and dividend of Rs. 646,712 was received on account of shares held as investments out of total dividend income of Rs. 16,43,531. It was submitted that in spite of the fact that dividend income is exempt, the interest with regard to borrowings for business is allowable and in support of this, reliance was placed on the judgment of Hon’ble Jurisdictional High Court rendered in the case of CIT v. Tata Chemicals Ltd. , wherein it was held that if the investment are made in course of business than the interest on fund borrowed for acquiring such investment is allowable as business expenditure even though income from such investment is Tax Free. It was also submitted that in earlier years, the assessing officer has accepted the stand of the assessee that holding of investment per se and as stock-in-trade is a business activity and has allowed the claim for expenses. It is also submitted that in assessment year 1991-92, it is held by learned Commissioner (Appeals) that though the dividend income is taxable as income from other sources, the loss from the activity of holding shares as investment and stocks were allowed to be carried forward as business loss. It was submitted that the department has accepted this order of learned Commissioner (Appeals) copy of which is available on pages 105 to 107 of the paper book.
4. It was also submitted that as per the order dated 23-8-2001 of Hon’ble Jurisdictional High Court, the assessee-company has merged with Hamilton & Co. Ltd. with effect from 1-4-1999 and after merger, in the Balance Sheet of Hamilton & Co. Ltd. also, stock-in-trade of the assessee-company is shown as its own stock and on sale of the same in assessment years 2004-05 and 2005-06, the income is offered to tax as business income and our attention was drawn to the profit and loss account and computation of the Hamilton & Co. Ltd. as appearing on pages 52, 58, 64, 84, 90 and 96 and also to pages 108 to 112 of Paper Book-I. It was contended that interest should be allowed to the extent the borrowed funds are used for acquiring stock-in-trade.
5. As against this, learned DR the revenue strongly supported the order of learned Commissioner (Appeals). Reliance was placed on the Tribunal order rendered in the case of Dy. CIT v. S. G. Investments &Industries Ltd. (2004) 89 ITD 44 (Kol.), wherein it was held that interest expenses attributable to earning of dividend income is not allowable as business expenses and only net dividend after deducting that portion of interest expenses is exempt under Section 10(33). Reliance was also placed on another Tribunal order rendered in the case of Gagan Trading Co. Ltd. v. Asstt. CIT (2005) 93 ITD 426/94 TTJ (Mum.) 343 in support of this contention. It was also submitted that the shares of group company were acquired by the assessee-company for acquiring controlling interest and hence interest expenses is not allowable and in support of this contention, reliance was placed on the judgment of Hon’ble Jurisdictional High Court rendered in the case of CIT v. Amritaben R. Shah .
6. In the rejoinder, it was submitted by learned AR of the assessce that the holding of the assessee-company in Group Company i.e. S&S Power Switchgear Ltd. was only 18.93 per cent and our attention was drawn to letter dated 9-1-2001 filed with the assessing officer, copy of which was furnished and kept on record. It was submitted that this does not amount to acquiring of controlling interest and hence the judgment of Hon’ble Jurisdictional High Court rendered in the case of Amritben R. Shah (supra) relied upon by learned DR of the revenue is not applicable in the present case.
7. We have considered the rival submissions and perused the materials on record and we find that the disallowance was made by the assessing officer on the basis that entire investment in shares is as investment because there is no purchase/sale or opening/closing stock of shares in the P & L account but as per the balance sheet of the assessee-company, the investment to the extent of Rs. 326.98 lakhs was held as stock-in-trade and shares of only Rs. 322.13 lakhs were held as investment out of total investment in shares of Rs. 649. 10 lakhs. The assessee has also submitted the break up of dividend income on shares held as stock-in-trade and on shares held as investment. In view of these facts, we are of the considered opinion that interest on borrowings, which was used for acquiring stockin-trade is allowable as business expenses but even out of that portion of interest, the amount of dividend received on shares held as stock-in-trade is to be reduced and only the balance has to be allowed as business expenses but since these facts were not brought on record before the assessing officer, this matter has to go back to the file of the assessing officer for quantifying the amount of allowable interest as per above discussion. While holding so, we find that the judgment of Hon’ble Jurisdictional High Court rendered in the case of Amritaben R. Shah (supra) is not applicable in the present case because the facts are different and nothing is brought on record to show that the shares were acquired by the assessee for acquiring controlling interest in these companies. Regarding the interest on borrowed funds used for acquiring shares as investment, it is now settled position that income from investment i.e., dividend is exempt and hence as per the provisions of Section 14A, no interest expenses on this account is allowable. The judgment of Hon’ble Jurisdictional High Court rendered in the case of Tata ChemicaLs Ltd. (supra) does not help the case of the assessee because in this case, it is held by Hon’ble High Court that a positive finding is given by the Tribunal that investment in tax-free bonds has been in the course of business and since it is a finding of fact, no substantial question of law arises. The Tribunal order in this case was passed on 14-1-1999 whereas Section 14A was inserted with retrospective effect by Finance Act, 2001 and hence Section 14A was not available before the Tribunal. In view of above discussion, we set aside the order of learned Commissioner (Appeals) on this issue and restore this issue to the file of the assessing officer with a direction to quantify the amount of interest expenses allowable with regard to investment in stock-in-trade out of borrowed funds and dividend received on shares held as stock-in-trade. The assessing officer should allow the interest as per above discussion after providing adequate opportunity of being heard to the assessee. This ground is partly allowed for statistical purposes.
8. As per ground No. 2, it is contended that the interest expenses incurred for holding shares as investment be added to the cost of investment.
9. Learned AR of the assessee relied upon the following judicial pronouncements:

(a) CIT v. MaithreyiPai

(b) CIT v. Mithlesh Kumari

(c) Addl CIT v. K.S. Gupta

10. As against this, it was submitted by the learned DR of the revenue that interest is not cost of acquisition or cost of improvement and hence the same cannot be added to the cost of investment. Reliance was placed on the following judicial pronouncements:

(a) CIT v. L.N. Dalmia

(b) CIT v. Octavious Steel& Co. Ltd.

(c) Addl. CIT v. K.S. Gupta

11. In the rejoinder, it was submitted by learned AR of the assessee that the judgment of Hon’ble Apex Court rendered in the case of Saharanpur Electric Supply Co. Ltd. v. CIT(1992) 194 ITR 294 (SC) also supports the case of the assessee because it was held in this case that the cost of asset is not a static figure and it can be recomputed. The Hon’ble Apex Court has referred to the judgment of Hon’ble Delhi High Court rendered in the case of Mithlesh Kumari (supra). Regarding the judgments relied upon by learned DR of the revenue i.e. CIT v. L.N. Dalmia and CIT v. Octavious Steel & Co. Ltd. , it was submitted that the judgments in favour of assessee should be followed and in support of this contention, reliance was placed on the judgment of Hon’ble Apex Court rendered in the case of CIT v. Vegetable Products Ltd. .
12. We have considered the rival submissions and have gone through the judgments cited by both sides. We find that this contention was never raised by the assessee before the learned Commissioner (Appeals) for allowing of adding the interest expenses in the cost of investment. On merit also, we find no substance in this contention of the assessee in the facts of this case because in the present case, the assessee is earning dividend income from investment of shares and it is settled position that such interest is allowable under the head Income from other sources’ and in this year, the same is not so allowable because of Section 14A as per which, no expenses is allowable, which are incurred for earning an exempt income and since dividend has been made exempt under Section 10(33) from 1-6-1997 being the date from which Section 115-0 was inserted by the Finance Act, 1997. Once we find that interest expenses is an allowable expenditure under the head Income from other sources’, it cannot be allowed to be added to the cost of investment only because in this year, no deduction is allowable because the dividend income has been made exempt. It will result into allowing of double deduction. This was the view of Hon’ble Karnataka High Court in the case of Maithreyi Pai (supra) and we reproduce the penultimate Para of this judgment, being relevant Mr. Bhatt however submitted that Section 48 should be examined independently without reference to Section 57. Section 48 provides for deducting from the full value of consideration received the cost of acquisition of the capital asset and the cost of improvement, if any. The interest paid on borrowings for the acquisition of a capital asset must fall for deduction under Section 48. But if the same sum is already the subject-matter of deduction under Section 57, we cannot understand how it could find a place again for the purpose of computation under Section 48. No assessee under the scheme of the Income Tax Act, could be allowed, deduction of the same amount twice over. We are firmly of the opinion that if the amount is already allowed under Section 57 while computing the income of the assessee, the same cannot be allowed as deduction for the purpose of computing the ‘Capital gains’ under Section 48.

The matter was remanded back to the Tribunal for deciding afresh in the light of these observations. In this case, the judgment of Hon’ble Delhi High Court rendered in the case of Mithlesh Kumari (supra) was also considered by their Lordships. In view of this judgment of Hon’ble Karnatka High Court, the issue in the present case stands covered against the assessee because admittedly, the interest expenses for borrowings made for acquisition of shares is allowable as deduction under Section 57 and only because of Section 14A, 10(33) and 115-0, this deduction is not available to the assessee in this year but that will not entitle the assessee to add the same in cost of investment for claiming deduction under Section 48 in the year of sale of investment. Facts in the case of Mithlesh Kumari (supra) are different because there was purchase of open plot of land in that case from which, no income was to be generated and hence interest was not allowable as deduction under any other head of income. The judgment of Hon’ble Andhra Pradesh High Court rendered in the case of K.S. Gupta (supra) is relied upon by both sides. We find that in this case also, the judgment of Hon’ble Delhi High Court rendered in the case Mithlesh Kumari (supra) was considered by their Lordships. But this judgment also does not help the case of the assessee because the facts are different. In this case, Their Lordships have reproduced the head note from the judgment of Hon’ble Apex Court rendered in the case of Challapalli Sugars Ltd. v. CIT . As per these head note, the interest incurred before commencement of production can be capitalized. in this case also, a plot was purchased and interest paid was neither claimed nor allowed as expenses. Under these facts, it was held that interest was to add to the cost of plots but in the present case, the asset is investment in shares from which, dividend-income is generated and deduction of such interest is held to be allowable under the head “Income from other sources” irrespective of actual dividend amount and hence the facts of the present case are different.

13. The judgment of Hon’ble Apex Court rendered in the case of Saharanpur Electric Supply Co. Ltd. (supra) is not applicable in the present case because in this case, the issue involved was that the figure of actual cost of asset can be altered in view of subsequent factual or legal information. In the present case, there is no such issue of altering the cost in the light of subsequent factual or legal information and hence this judgment also does not help the assessee in this case.
14. The issue in the present case is squarely covered against the assessee by the judgment of Hon’ble Calcutta High Court rendered in the case of L.N. Dalmia (supra). In this case also, the judgment of Hon’ble Delhi High Court rendered in the case of Mithlesh Kumari (supra) was considered by Their Lordships and the same was distinguished because in this case, the investment was in shares whereas in the case of Mithlesh Kumari (supra) the investment was in plots of land. The relevant Para on pages 103 and 104 of the report is reproduced below:

The last issue that arose in the case is whether the interest paid on the borrowed money for acquisition of the said shares could be added to its cost of acquisition for computation of capital loss. On this issue, the appellate authorities answered it in the affirmative. The interest was paid allegedly on the moneys borrowed for the acquisition of the shareholding by the assessee. The interest was not claimed as capital investment and no claim was made for the capitalization of the same. The assessing officer held that the assessee did not earn anything from the shares purchased out of the borrowed amount. As there was no income from the shares held by him, the interest could not be allowed. The appellate authorities held that this interest was incurred in respect of borrowed funds utilized for the purpose of acquisition of shares and such interest would be considered as a capital investment and directed accordingly to capitalize the same and after the sale, the capitalization would increase the amount of loss to that extent. The Tribunal affirmed this decision. In coming to this decision reliance has been placed in the case of CIT v. Mithlesh Kumari , holding that interest paid on borrowed capital is to be allowed as capital expenditure. In this case, the Delhi High Court considered the interest as part of the capital investment where the facts were that the interest was paid on money borrowed for purchase of an open plot of land which constituted part of the actual cost. The facts before us are different from the facts in the case cited. There the plot of land was for a building purpose and it was not intended for using as income-earning investment while the investment in shares in the case before us are investments made with a view to earning dividend. In the Delhi High Court case in CIT v. Mithlesh Kumari, the interest paid on borrowed amount for the acquisition of such plot of land, therefore, constituted part of the cost of acquisition. The investment in shares is quite different from that and we do not actually know-how the interest paid for the borrowed amount has been claimed and treated in earlier years. Moreover, it has been submitted on behalf of the assessee that the assessee is entitled to submit before this Court that the said deduction should be allowed under the head ‘Other sources’, though against the decision of the Tribunal that such interest was to be capitalized being part of the cost of acquisition of shares has not been appealed against. It is well-settled that an allowance for deduction can be upheld on a ground other than that on which it was allowed by the Tribunal. We accordingly, hold that the interest in question in the present case cannot be part of the cost of acquisition. It is allowable against the income from the investment in question and it can be considered to be set off against the income from other sources. In the circumstances, this issue is answered, saying that the said sum on account of interest is allowable as deduction under the head ‘other sources’.

15. In the light of the above analysis of various judgments cited by both sides and of the facts of this case, this issue is decided against the assessee and this ground is rejected.
16. In the result, this appeal of the assessee is partly allowed for statistical purposes.