We Have Heard Learned Counsel For The Parties v. Walfort Share And Stock Brokers F- Limited,(2010) 326Itr 1

IN THE HIGH COURT OF PUNJAB AND HARYANA ATCHANDIGARH ITA No.1885 of 201Date of decision: 1.10.2015 Commissioner of Income Tax, Jalandhar I, Jalandhar .....- Appe M/s Max India Limited ....mesponden CORAM: HON’BLE MR. JUSTICE AJAY KUMAR MITTALHON’ BLE MR. JUSTICE RAMENDRA JAIN 1. Whether Reporters of local papers may be allowed to see the judgment?2. To be referred to the Reporters or not?3. Whether the judgment should be reported 1n the Digest? Present: Mr. Vivek Sethi, Advocate for the appellant-revenue.Mr. Ajay Vohra, Sr. Advocate with Mr. Gaurav Jain, Advocate forthe respondent. | Ajay Kumar Mittal,J, 1]The appellant-revenue has filed this appeal under Section 260Aof the Income Tax Act, 1961 (in short, “the Act’) against the order dated8.3.2013, Annexure A.3 passed by the Income Tax Appellate Tribunal,Amritsar Bench, Amritsar (in short, “the Tribunal”) in ITA No.78(Asr)/2006for the assessment year 2001-02, claiming following substantial question oflaw:- “Whether the ITAT has erred in law and in facts 1n holding thatno disallowance can be made under section 14A unless a clearcut nexus 1s established between the expenses disallowed andincome earned ignoring the fact that both direct and indirect expenses are attributable to such investment?” |A few facts relevant for the decision of the controversy,involved as narrated in the appeal may be noticed. The assessee company 15in the business of manufacturing of pharmaceuticals, health care servicesetc. It is deriving its wncome from marketing of biaxially orientedpolypropylenes (BOPP) firms etc.- a flexible packaging material. Theassessee company filed its return on 30.10.2001 declaring loss of428,67,15,815/- and book profit of|L4.21,61,953/- under section LI5JB ofthe Act which was processed under Section 143(1) of the Act. The case ofthe assessee was taken up for scrutiny. Notices under Sections 143(2)/142(1) of the Act were issued to the assessee. Assessment in the case wascompleted under section 143(3) of the Act by the Assessing Officer on30.3.2004 at assessed income under section 115JB of the Act after settingoff of brought forward losses. The Assessing Officer while makingassessment made the following additions/disallowances:- Disallowance of expenses on account of earning of exemptincome. The AO has disallowed|L1.50 crore as expenses apportionedfor exempt income taking into account the extent of investment of theassessee and expenses in the corporate sector as the deduction 1s notallowable in respect of expenditure incurred by the assessee in relation toincome which does not form part of the total income under the Act. Copy ofthe order of assessment under section 143(3) of the Act dated 30.3.2004 15annexed as Annexure A.|. Aggrieved by the order, the assessee filed appealGURBAX SINGHbefore the Commissioner of Income Tax (Appeals) [CIT(A)]. Vide order2015.11.17 12:40I attest to the accuracy andintegrity of this documentHigh Court Chandigarh dated 19.1.2006, Annexure A.2, the CIT(A) partly allowed the appeal andrestricted the addition/disallowance made by the Assessing Officer underSection 14A of the Act to =a10 lacs only and deleted the addition of LT1.40crores. Still not satisfied, the assessee filed appeal before the Tribunal. Therevenue also filed appeal against the order of CIT(A) before the Tribunal.Vide order dated 8.3.2013, Annexure A.3, the Tribunal allowed the appealof the assessee and dismissed the appeal filed by the revenue. Hence theinstant appeal by the revenue. 3)We have heard learned counsel for the parties. 4Learned counsel for the revenue submitted that the order passedby the Tribunal is illegal and perverse in holding that no disallowancecould be made under Section 14A of the Act unless a clear cut nexus wasestablished between the expenses disallowed and the income earned,Reliance was placed upon judgment of the Apex Court inCommissioner ofIncome lax vs. Walfort Share and Stock Brokers F- Limited,(2010) 326ITR 1. 3)We have heard learned counsel for the parties. 4Learned counsel for the revenue submitted that the order passedby the Tribunal is illegal and perverse in holding that no disallowancecould be made under Section 14A of the Act unless a clear cut nexus wasestablished between the expenses disallowed and the income earned,Reliance was placed upon judgment of the Apex Court inCommissioner ofIncome lax vs. Walfort Share and Stock Brokers F- Limited,(2010) 326ITR 1. 4]Learned counsel for the assessee relied uponCIT ys,Metalman Auto P Limited, (2011) 336 ITR 434 andCIT vs. Hero CyclesLimited,(2010) 323 ITR 518 to submit that the revenue was underobligation to show that certain definite expenditure was claimed by theassessee 1n respect of which the income of the assessee was exempt. In theabsence of the same, no expenditure could be disallowed on estimate basis,It was further submitted that sub section (2) of section 14A was introducedby Finance Act, 2006 w.e.f 1.4.2007 and in pursuance thereto Rule 8B of the Income Tax Rules, 1962 (in short, “the Rules’) was notified by the CentralBoard of Direct Taxes (CBDT) with effect from 24.3.2008. Relying uponjudgments of Delhi High Court in Maxopp Investment Limited ys.Commissioner of Income Tax, New Delhi,(2012) 347 ITR 272 andBombay High Court 1nGodrej and Boyce Mfg. Co. Limited vs. DCIT andanother, (2010) 328 ITR 81, 1t was submitted that sub section 2 of Section14A of the Act and Rule 8B of the Rules have been held to be prospective. 6.|The solitary issue that arises for consideration in this appeal 1swhether the assessee had incurred any expenditure in respect of which it hasclaimed income to be exempt under the Act. If yes, what was theexpenditure which was incurred and claimed by the assessee as deductionunder the Act? TdThe Assessing Officer disallowed Lv1.50 crores as expensesapportioned for exempt income under Section I4A of the Act. The findingrecorded reads thus:- ‘“7.Expenditure incurred in relation to income not includible itotal income. A very huge portion of the assessee's capital 1s investedin strategic investments in subsidiary companies, jointventures and other investments. These investments are in theform of securities, therefore the objective of the company inholding them 1s to earn dividends. Total funds of-361.64 crore out of total capital andfunds of.=a654 crore 1.e. more than 55% of company's funds 1slying invested in such investments. The dividend income onsome of these investments amounting to v2,11,14,273/- 1sexempt under section 10(33) of the IT Act and has been excluded correctly by the assessee from its total income,However, the assessee has failed to allocate any expenditureas being related to this income and has not offered anything asdisallowable expenditure under the provisions of section I14AIt 1s to be mentioned that under this section, no deduction 1sallowable in respect of expenditure incurred by the assessee inrelation to income which does not form part of total incomeunder the Act.| In this scenario where the company had invested hugeamounts in such investments and had claimed a loss ofL14.82 crores on account of its corporate office, the assesseewas called upon to allocate its expenses towards itsinvestment activities and monitoring of these investments,Besides these expenses, large part of expenditure and energiesof the treasury division of the company are also devotedtowards these investments. The assessee replied to it vide letter dated 29.3.2004and its submissions regarding this can be summarized asunder- In this scenario where the company had invested hugeamounts in such investments and had claimed a loss ofL14.82 crores on account of its corporate office, the assesseewas called upon to allocate its expenses towards itsinvestment activities and monitoring of these investments,Besides these expenses, large part of expenditure and energiesof the treasury division of the company are also devotedtowards these investments. The assessee replied to it vide letter dated 29.3.2004and its submissions regarding this can be summarized asunder- 1) The direct expenses of one particular investment, related toatleast, in the form of foreign travelling has not beenclaimed by the assessee as revenue expenditure. Theassessee was not able to divide its expenses into thoserelatable to its running of businesses and those relatable toprotecting and planning its investments.atleast, in the form of foreign travelling has not beenclaimed by the assessee as revenue expenditure. Theassessee was not able to divide its expenses into thoserelatable to its running of businesses and those relatable toprotecting and planning its investments. 11) The total expense on salaries of directors and travelling 1only around“a80 lacs. The directors are not devoting muchtime to the investment activities.only around“a80 lacs. The directors are not devoting muchtime to the investment activities. 111) he assessee claimed that only the expenses incurred forearning the income i.e. specific to the securities on whichdividend has been received, 1s disallowable.earning the income i.e. specific to the securities on whichdividend has been received, 1s disallowable. iv) The assessee's contentions have been gone through and ar rejected in view of the following- a) Section 14A talks about expenditure incurred by assesseein relation to income which has much larger scope than thelimited scope of expenditure incurred for earning anincome. Therefore, all expenses in relation to the earningof dividend income would have to be allocated anddisallowed. b) Expenditure incurred in relation to investments whichwere there for earning dividend income but during the yeardid not yield any dividend, is also not allowable. Forexample, a person engaged in agriculture activities cannotclaim the expenses from other income even if the entirecrop fails. c) As discussed above, there are corporate expenses of=14.82 crore. A large part of it has definitely gone towardsholding and monitoring the investments which haveyielded/were meant for earning dividend. The investmentsmade in securities meant for earning dividend are more than55% of total capital and funds 1.e.L361.64 crores out of.4654 crores. The investments are even simple securities ofother companies but include lot of strategic investments inthe form of subsidiaries companies and joint ventures. Inthese investments, there ought to be much energies spent,lot of planning involved and expenses incurred for suchinvestments. d) Substantial time of its executives, expenses likeconveyance, travelling, expenses on meetings, telephoneand huge incidental expenses ought to be there on thisaccount. As these expenses are definitely relatable toearning of an exempt income, therefore, these ought to beapportioned as in the case of Distributors (Baroda) Pvt.Limited vs. Union of India, (1985) 155 ITR 120(SC). S|as under:- Looking to the extent of investments of the assessee and theexpenses in the corporate office, an amount of<a1.50 croreiS apportioned as being in relation to such exempt incomeand is disallowed under Section 14A of the IT Act, 1961.” The CIT(A) while allowing partial relief to the assessee recorded d) Substantial time of its executives, expenses likeconveyance, travelling, expenses on meetings, telephoneand huge incidental expenses ought to be there on thisaccount. As these expenses are definitely relatable toearning of an exempt income, therefore, these ought to beapportioned as in the case of Distributors (Baroda) Pvt.Limited vs. Union of India, (1985) 155 ITR 120(SC). S|as under:- Looking to the extent of investments of the assessee and theexpenses in the corporate office, an amount of<a1.50 croreiS apportioned as being in relation to such exempt incomeand is disallowed under Section 14A of the IT Act, 1961.” The CIT(A) while allowing partial relief to the assessee recorded “I have considered the rival positions and analysed theaverments of the appellant. Having done so, I am unable toacquiesce in the contentions of the appellant. It must beemphasized that the language of section 14A 1s very broad inits scope. The section does not specify that the expenditureincurred by an assessee for earning income which 1s excludedfrom the total income 1s to be disallowed. The section providesthat expenditure incurred 1n relation to income which does notform part of the total income will not be allowed. A judgmentof the Hon'ble Supreme Court in the case of Distributors(Baroda) Private Limited vs. Union of India 155 ITR 120throws light on this issue. The Hon'ble Supreme court had heldthat in order to compute income from dividend, interest onmoneys borrowed for earning such income is to be deducted.In view of the above, I hold that provisions of Section 14A areapplicable on the facts of the present case, But having held that a disallowance under Section 14A 1s calledfor, I feel that the AO has clearly erred in making a whoppingadhoc disallowance for=a1.50 crores. The AQO has notdischarged the onus of proving what amount had been incurredfor earning the dividend income before making thedisallowance. Further, to link the disallowance with the amountof investment is also not rational since making investment 1snot a regular activity and involves continuous monitoring,Moreover, the appellant has itself disallowed the direct expenditure incurred on investment activities. Further, since theappellant has been running a number of operating divisions likepharmaceutical, BOPP, Maxtfoil, Metaliser and Healthcare,considerable time of the corporate office employees could beexpected to be spent on these activities rather than investmentactivities. Taking the totality of the circumstances intoconsideration, I hold that the disallowance of =a1.50 crore madeby the Assessing Officer 1s excessive looking at the diversifiednature of the activities carried on by the appellant. Jaccordingly consider it just and fair to restrict the disallowanceunder Section |4A to=a10 lacs. Therefore while an addition ofTL1.4 crores 1s deleted, the disallowance of |“a10 lacs iscontfirmed. QThe Tribunal after examining the matter held that nodisallowance under section 14A could be made without establishing!proximate nexus on a reasonable basis between the expenditure incurredand the exempt income earned. The relevant findings recorded by theTribunal read thus:- “4a. Interest expenditure Investments as on |.4.2000 (a263.13 crores) A.I. Investments vesting on merger of MCL — |an195 48crores. As the beginning of the previous year relevant toassessment year 2000-01 (1.e. as on 1.4.2000), being the firstyear of disallowance under section 14A, the assessee heldtotal investment in shares/mutual funds/governmensecurities/bonds, aggregating to Ly263.13 crores. Out of theaforesaid total investments, investments to the extent of =195.48 crores, vested in the assessee on merger of MCL (PB-99 of supplementary PB). It would be pertinent to point out that the erstwhile MCL had “4a. Interest expenditure Investments as on |.4.2000 (a263.13 crores) A.I. Investments vesting on merger of MCL — |an195 48crores. As the beginning of the previous year relevant toassessment year 2000-01 (1.e. as on 1.4.2000), being the firstyear of disallowance under section 14A, the assessee heldtotal investment in shares/mutual funds/governmensecurities/bonds, aggregating to Ly263.13 crores. Out of theaforesaid total investments, investments to the extent of =195.48 crores, vested in the assessee on merger of MCL (PB-99 of supplementary PB). It would be pertinent to point out that the erstwhile MCL had not made investment in shares, out of borrowed funds in asmuch as the MCL did not had any interest bearing borrowedfunds, nor any interest expenditure was debited in the profitand loss account of that company, prior to merger with theassessee (PB-97 and 102 of supplementary PB).Therefore, the investments to the extent ofLy195.48 crores,held by the assessee as on 1|.4.2000 had no nexus with thborrowed funds| A.2 Balance investments<6/65 crores. A.2.1 Investments, not resulting in earning of exempt income LT36.01 crores. As regards the balance investments, amounting toL67.65crores (zy263.13 crore —|TL195.48 crores) held as on 1.4.2000the same included investment 1n shares of foreign subsidiarycompany and other Government securities/Bonds/mutualfunds, the income wherefrom was not exempt from tax underthe provisions of the Act, aggregated to—=a36.01 crores. Thebreak up of the aforesaid investments 1s as under (PB87-88 of supplementary PB): In view thereof, the interest expenditure incurred on borrowed funds, if any attributable to the atoresaidinvestments, income wherefrom is not exempt under theprovisions of the Act is ousted from the application of theprovisions of section 14A of the Act. A.2.2 Remaining investments, out of interest free funds<31.64 crores. The break up of balance investments, aggregating to.=a31 64crores 1S as under PB &7-88: Out of the aforesaid investments, aggregating toan31.64crores, it would be appreciated that, major investmentrelated to investment in shares of MT'VL amounting to=a30crores. The said total investment in shares of MIVL, it 1ssubmitted was made in the previous year ending 31.3.1996.On perusal of the cash flow statement of the assesseecompany for the year ending 31.3.1996 attached as AnnexureA to this Chart, it would be noted that the assessee had madea fresh issue of share capital at a premium, aggregating to=41.55 crores (Lv1.42+40.13 crores). Further, the assesseereceived funds of|22.65 crores from issue of zero couponfully convertible debentures (FCD) which did not carry anyinterest. In addition to above, the assessee generated cashfrom operations ofv6.34 crores. The aforesaid total interestfree receipts, it would be appreciated, were sufficient tomake investment 1n shares of MIVL. That apart, in that year, the assessee had made additionalinterest bearing borrowing ofa40.33 crores (Refer Schedule3 of balance sheet for year ending 31.3.1996) on account of secured redeemable non convertible debentures (NCD). It would be pertinent to point out that the aforesaid NCD of<40.33 crores (carrying interest) and Zero Coupon FCD(interest free) of=a22.65 crores were issued through a sameletter of offer, which was placed on record before learnedCIT(A) vide submission dated September 18, 2009 (PB 251).The object of aforesaid proceeds, as per the letter of offer,was to meet out the capital expenditure of the existingdivisions, working capital requirements, repayment of termloans and investment in joint ventures. However Note 3 of the offer document (PB-251) stipulatedthat proceeds ofNCD (interest bearing) were not utilized forinvestment in shares of group companies of joint ventures.The aforesaid object was to be met out of the proceeds ofzero coupon FCDs. The relevant portion of the aforesaid notereads as under:- It would be pertinent to point out that the aforesaid NCD of<40.33 crores (carrying interest) and Zero Coupon FCD(interest free) of=a22.65 crores were issued through a sameletter of offer, which was placed on record before learnedCIT(A) vide submission dated September 18, 2009 (PB 251).The object of aforesaid proceeds, as per the letter of offer,was to meet out the capital expenditure of the existingdivisions, working capital requirements, repayment of termloans and investment in joint ventures. However Note 3 of the offer document (PB-251) stipulatedthat proceeds ofNCD (interest bearing) were not utilized forinvestment in shares of group companies of joint ventures.The aforesaid object was to be met out of the proceeds ofzero coupon FCDs. The relevant portion of the aforesaid notereads as under:- “As per the SEBI guidelines for disclosure and investorprotection — clarification II, the proceeds of NCD issuecannot be utilized for acquisition of shares and/orproviding loan to any company belonging to the samegroup. “In line, with above, company's requirements for investmentsinto joint ventures in Phase I, 1s proposed to be met throughthe proceeds of FCD issue and/or preferential issue ofwarrants to the management group.” In view of the above, no portion of the interest bearing NCDwas utilized towards investment in shares of MTVL, a groupcompany of the assessee. Further, as 1s evident from the case flow statement of the yearending 31.3.1996, against the aforesaid aggregate interestbearing borrowing of aa40.33 crores (from NCD), theassessee had acquired fixed assets from an amount of= 35.20 crores and repaid existing loans ofL6.38 crores.In that view of the matter, the investment in shares of MT Vwas made of interest free funds and no portion of the interestbearing borrowed funds were utilized for making thatinvestment, which were utilized for other business purposesof the assessee and therefore, no portion of interestexpenditure in any year including the assessment year 2000-Ql and onwards, had no nexus with said investment,warranting disallowance under section 14A of the Act.”AA AD AA XK KAA /////////48. We have heard the rival contentions and perused the factsof the case. The disallowance was made by the AO on adhocbasis, proceeding on the assumption that some expendituremust have been incurred by the assessee towards earningexempt dividend income. The order of the learned CIT(A)also proceeds on the same basis, as the learned CIT(A) toohas reduced the disallowance on adhoc basis. We are of theview that no disallowance under section 14A can be madewithout establishing proximate nexus on a reasonable basisbetween the expenditure incurred and the exempt incomeearned. This position 1s now well settled by catena ofdecisions. We also find that cash flow statement was part ofthe audited accounts filed before the lower authorities andthe assessee has before us only submitted a data analysiswith reference to the figures available in the audited accountsto support its claim that no part of interest expenditure couldbe attributed to earning of except income and therefore, nodisallowance under section 14A of the Act was called for. Onperusal of cash flow statement, it 1s evident that the assesseehad sufficient surplus funds available with it for makinginvestments. Having regard to the various decisions cited bythe learned AR in the case of mixed pool of funds, 1f the surplus funds available with the assessee on an overall basisduring the financial year are sufficient to make investment,presumption needs to be drawn that surplus funds and notinterest bearing funds could be said to have been used formaking investments by the assessee in the financialinstruments yielding exempt income. Hence, no part ofinterest expenditure can be considered for the purpose ofcomputing disallowance under Section I14A of the Act.Further, 1n the absence of any proximate nexus having beenestablished by the lower authorities between theadministrative and other expenses and the exempt income, inour view, no disallowance under section I4A of the Actcould have been made for the assessment year underconsideration.” | 10,A perusal of the findings recorded above shows that in theopinion of the Assessing Officer, under Section 14A of the Act, nodeduction was allowable in respect of expenditure incurred by the assesseein relation to the income which did not form part of total income under theAct. Further the expenditure incurred in relation to investments which werefor earning dividend Income but during the year did not yield any dividend,was not allowable. The expenses like conveyance, travelling, telephone andother incidental expenses were relatable to earning of exempt income,Therefore, an amount ofLT1.50 crore was apportioned as being 1n relation tosuch exempt income and was disallowed under Section I4A of the Act. Onappeal by the assessee, the CIT(A) did not agree with the findings recordedby the Assessing Officer. It was observed by the CIT(A) that since theassessee had been running a number of operating divisions like pharmaceutical, BOPP, Maxfoil, Metaliser and Healthcare, considerabletime of the corporate office employees could be expected to be spent onthese activities rather than investment activities. Keeping 1n view the natureof activities carried on by the assessee, the CII(A) restricted thedisallowance to=a10 lacs only. The Tribunal after considering the matterheld that no part of interest expenditure could be considered for the purposeof computing disallowance under Section 14A of the Act. Further, in theabsence of any proximate nexus having been established by the lowerauthorities between the administrative and other expenses and the exemptincome, no disallowance under section I4A of the Act could have beenmade for the assessment year under consideration. Learned counsel for theappellant-revenue has not been able to show any illegality or perversity inthe approach of the Tribunal or that the findings recorded by it areerroneous. 11.In|Hero Cycles Limited'scase (supra), while dealing withidentical situation, 1t was observed by this court that whenever anydisallowance under Section 14A of the Act is to be made, then it has to beestablished that incurring of expenditure had direct nexus with the earningof the exempted income. It was held as under:- “4. In view of finding reproduced above, it 1s clear that theexpenditure on interest was set off against the income frominterest and the investment 1n the share and funds were out ofthe dividend proceeds. In view of this finding of fact,disallowance uncerSection 14Awas not sustainable. Whether,In a given situation, any expenditure was incurred which was tobe disallowed, 1s a question of fact. The contention of the revenue that directly or indirectly some expenditure 1s alwayswcurred which must be disallowed under.Section 14Aand theimpact of expenditure so incurred cannot be allowed to be setoff against the business income which may nullify the mandateof|Section |14, cannot be accepted. Disallowance underSection 14Arequires finding of incurring of expenditure whereit is found that for earning exempted income no expenditurehas been incurred, disallowance under Section 14Acannotstand....’ 12. | Similar view was expressed by this Court 1n.Metalman Auto P| revenue that directly or indirectly some expenditure 1s alwayswcurred which must be disallowed under.Section 14Aand theimpact of expenditure so incurred cannot be allowed to be setoff against the business income which may nullify the mandateof|Section |14, cannot be accepted. Disallowance underSection 14Arequires finding of incurring of expenditure whereit is found that for earning exempted income no expenditurehas been incurred, disallowance under Section 14Acannotstand....’ 12. | Similar view was expressed by this Court 1n.Metalman Auto P| Limited'scase (supra). It was concluded by this Court that disallowanceunder Section I4A of the Act requires a finding of incurrence of expenditurefor earning the exempt income. In case, no expenditure has been incurred,the disallowance under Section 14A 1s not justified. In other words, therecannot be presumption that certain expenditure 1s bound to be incurred forearning the exempt income. 13.Adverting to the judgment relied upon by the learned counselfor the appellant-revenue, it may be noticed that 1n|Walfort Share andStock Brokers P. Limited'scase (supra), the Tribunal held that the assesseewas entitled to set off loss from transactions against its other Incomechargeable to tax. The said view was affirmed by the High Court. Thequestion before the Apex Court was whether loss arising in the course ofdividend stripping transaction taking place prior to 1.4.2002 wasdisallowable on the ground that such loss was artificial as the dividendstripping transaction was not a business transaction. After examining thelegal and factual position therein, it was held that in cases arising before ITA No.185 of 201 (O&M) 16 1.4.2002, losses pertaining to exempted income could not be disallowed,Such 1s not the position in the present case.14In view of the above, the substantial question of law 1sanswered against the revenue. The appeal stands dismissed. (Ajay Kumar Mittal)Judge October 1, 2015;7"; (Ramendra Jain)Judge