Adv. Sri.harisankar v. Menon For R1

IN THE HIGH COURT OF KERALA AT ERNAKULAM PRESENT : THE HONOURABLE MR. JUSTICE C.N.RAMACHANDRAN NAIR & THE HONOURABLE MR. JUSTICE P.S.GOPINATHAN MONDAY, THE 14TH JUNE 2010 / 24TH JYAISTHA 1932 ITA.No. 1784 of 2009() ---------------------- AGAINST THE ORDER DATED 06/05/2009 IN ITA.1065/COCH/2005 of I.T.A.TRIBUNAL,COCHIN BENCH .................... APPELLANT/RESPONDENT ---------------------------------------- THE COMMISSIONER OF INCOME TAX, THRISSUR. BY ADV. SRI.JOSE JOSEPH, SC, FOR INCOME TAX RESPONDENT/APPELLANT ------------------------ SMT.LEENA RAMACHANDRAN, M/S.HOMFIT, OLAVAKKODE, PALAKKAD. ADV. SRI.HARISANKAR V. MENON FOR R1 THIS INCOME TAX APPEAL HAVING BEEN FINALLY HEARD ON 14/06/2010, THE COURT ON THE SAME DAY DELIVERED THE FOLLOWING: C.N.RAMACHANDRAN NAIR &P.S.GOPINATHAN, JJ. .................................................................... I.T. Appeal No.1784 of 2009 .................................................................... Dated this the 14th day of June, 2010. C.R. JUDGMENT Ramachandran Nair, J. This is an appeal filed by the department against order of theTribunal holding that assessee is entitled to deduction of substantialamount paid towards interest on borrowed funds utilised for acquisitionof shares in a company of which assessee acquired controlling interestof upto 90% in the course of ten years. We have heard Senior StandingCounsel appearing for the department and Adv. Sri.Harisankar V.Menon appearing for the respondent-assessee. 2. Assessee was running a business as proprietrix engaged intrading of goods. During the previous year relevant for the assessmentyear 2001-2002 (wrongly written in the original order, Annexure-C, as2002-2003, which was corrected by the Tribunal through Annexure-Dorder) the assessee paid an interest of Rs.17,44,310/- towards interest at24% p.a. on funds borrowed for purchase of shares in a company by I.T.A. No.1784/2009 name Homefit Leasing Limited. The assessee's case was that thecompany in which assessee made investments through acquisition ofshares was engaged in leasing of household articles and assessee asproprietrix of the business sold such articles to the said leasingcompany. The said company was registered in 1991 and assesseestarted acquiring shares ever since formation and by the year ending31st March, 2001, assessee has acquired 90% shares. The assessee'sclaim was that the acquisition of shares with borrowed funds was forthe purpose of controlling the company which was engaged in leasingbusiness. Since the borrowed funds were utilised for acquisition ofshares of the company under the control of the assessee, assesseecontended that the utilisation of borrowed funds was for businesspurpose entitling her for deduction of interest under Section 36(1)(iii)of the Income Tax Act. The Assessing Officer, however, held that theassessee made investments by utilising borrowed funds in the form ofacquisition of shares in the company and the only benefit assessee gotwas dividend income. In fact, during the previous year relevant for theassessment year assessee had received a dividend income of Rs.3 lakhs I.T.A. No.1784/2009 I.T.A. No.1784/2009 from the very same leasing company in which she made investments inthe form of shares. Since Section 14A of the Income Tax Act bars anydeduction pertaining to any expenditure incurred by the assessee forearing any income which do not form part of the total income, theAssessing Officer disallowed the claim of interest of Rs.17,44,310/-which is the total interest paid by the assessee during the accountingyear for the funds borrowed for the acquisition of shares in the leasingcompany. First appeal was dismissed confirming assessment, againstwhich assessee preferred second appeal before the Tribunal. TheTribunal by relying on decision of the Supreme Court inS.A.BUILDERS LTD. VS. COMMISSIONER OF INCOME TAX(APPEALS) reported in (2007) 288 ITR 1 and the decision of theCalcutta High Court in COMMISSIONER OF INCOME TAX VS.RAJEEVA LOCHAN KANORIA reported in (1994) 208 ITR 616,substantially allowed the claim, but made a disallowance of Rs.2 lakhsbeing the interest stated to be attributable to the dividend income ofRs.3 lakhs earned by the assessee from the leasing company during theprevious year. Against this order, Revenue has preferred this appeal. I.T.A. No.1784/2009 3. Senior counsel appearing for the Revenue contended that thedecision of the Calcutta High Court has no application because theCalcutta High Court only held that borrowed funds used for incurringcapital expenditure in business is also an allowable deduction underSection 36(1)(iii) of the Act. However, the said decision was renderedin the context of assessments for 1982-83 and 1983-84 when Section14A was not in the statute. So far as the applicability of decision of theSupreme Court in S.A.BUILDERS' case is concerned, Senior counselrelied on Division Bench judgment of this court in COMMISSIONEROF INCOME TAX VS. POPULAR VEHICLES & SERVICES LTD.reported in (2010) 189 TAXMAN 14(KER) wherein this courtdistinguished the decision of the Supreme Court and held thatborrowed funds used for advancing interest free loans to a partnershipfirm of which assessee was a partner, was not an allowable deduction.Counsel appearing for the assessee on the other hand contended thatassessee's business was inextricably linked with the business of theleasing company in as much as the items sold by the assessee to thecompany only were leased out by that company to earn business I.T.A. No.1784/2009 income at the hands of the company. Since financial stability of thecompany was required to promote it's business which in turn helps theassessee to do her business, the funds advanced were for businesspurpose and the decision of the Supreme Court referred to above issquarely applicable is the argument of the assessee. 4. On facts we find that the interest paid by the assessee duringthe previous year for the funds borrowed for acquisition of shares inthe company was at the rate of 24% p.a. and the total interest paid inthe accounting year alone is as much as Rs.17,44,310/-. It is on recordthat assessee had received only a dividend income of Rs.3 lakhs and noother benefit is derived from the company for the business carried onby it. The disallowance prohibited under Section 14A is expenditureincurred for earning any income which does not constitute total incomeof the assessee. In other words, any expenditure incurred for earningany income which is not taxable under the Act, is not an allowableexpenditure. Dividend income is exempt under Section 10(33) of theIncome Tax Act and so much so, dividend earned by the assessee onthe shares acquired by her with borrowed funds does not constitute I.T.A. No.1784/2009 I.T.A. No.1784/2009 total income in the hands of the assessee. So much so, in our view,disallowance was rightly made by the Assessing Officer. In fact, theTribunal itself has estimated disallowance of Rs.2 lakhs by applyingSection 14A. We do not know how the Tribunal can restrict thedisallowance to Rs.2 lakhs and allow balance above Rs.15 lakhs whenthe whole borrowed funds were utilised by the assessee for purchase ofshares in the company. In our view, the reasoning given by theTribunal for disallowance of Rs.2 lakhs i.e. by applying Section 14A,squarely applies for the interest paid on borrowed funds because it is onrecord that the entire funds borrowed were utilised for acquisition ofshares by the assessee in the company. In fact, in our view, assesseewould be entitled to deduction of interest under Section 36(1)(iii) of theAct on borrowed funds utilised for the acquisition of shares only ifshares are held as stock in trade which arises only if the assessee isengaged in trading in shares. So far as acquisition of shares is in theform of investment and the only benefit assessee derived is dividendincome which is not assessable under the Act, the disallowance underSection 14A is squarely attracted and the Assessing Officer, in our I.T.A. No.1784/2009 view, rightly disallowed the claim. As already pointed out, theCalcutta High Court decision which pertains to the period prior tointroduction of Section 14A, has no application. The decision of theSupreme Court also does not apply because in this case apart frominvestment in shares of the company, there is nothing to indicate thatthe assessee's business was fully linked with the business of the leasingcompany or that assessee's business is solely dependent on the businessof the leasing company. In fact, the whole transaction was a totalfiasco in as much as, as against Rs.17,44,310/- paid towards interest onborrowed funds serviced at the rate of interest of 24% p.a., the dividendincome received by the assessee during the previous year was a meagresum of Rs.3 lakhs. This only shows that the business carried on by theleasing company was not very substantial to justify the assessee'sinvestment through borrowed funds. Therefore, in our view, theprinciple of commercial expediency gone into by the Supreme Courtdoes not apply to the facts of this case. Therefore, we hold that theTribunal in principle rightly held that the utilisation of borrowed fundsfor acquisition of shares will not entitle the assessee for claiming I.T.A. No.1784/2009 deduction of interest paid on such borrowed funds. However, we holdthat the Tribunal was not justified in allowing the claim in excess ofRs.2 lakhs. For the same reasoning applied by the Tribunal, theassessee is not entitled to deduction of any amount towards interestpaid on funds borrowed by way of fixed deposits taken for acquisitionof shares in the company, which helped the assessee only to earn somedividend. Consequently we allow the appeal by reversing the order ofthe Tribunal and by restoring the disallowance confirmed in firstappeal. C.N.RAMACHANDRAN NAIRJudge P.S.GOPINATHANJudge pms