2016 (2) TMI 1268 - AT - Income Tax

Disallowance u/s 14A r.w.r. 8D - suo moto disallowance by assessee - non recording of satisfaction - HELD THAT - After recording that satisfaction only AO can proceed to compute for determination of amount of expenditure incurred which is disallowable u/s 14A(2) of the Act. We could not find any such exercise made by the AO in the course of assessment proceedings. He has merely stated that the assessee company had disclosed expenditure at 10% of the exempt income disallowable u/s 14A is not proper. Therefore without putting across and questioning the reasoning of 10% and without regard to the books of accounts and after that failure to record satisfaction straight way invoking provision of section 14A and Rule 8D of the Income Tax Rules 1962 is not permissible. Recharacterizing the short-term capital gain as business income - Whether short-term capital gain arising as per investment in portfolio management scheme could not be said to be business income? - HELD THAT - On appreciation of cumulative facts are of the view that income of sale of mutual funds cannot be taxed under head business income but is chargeable to tax under the head capital gains. Furthermore regarding the short-term capital gains of shares which is Rs. 762840/- we could not note that in most of the cases the period of holding is more than 100 days. The numbers of shares bought and sold were approximately 10 strips. The amount of turnover was also small. Looking at the turnover and overall facts of the case we are of the view that profit on sale of share and mutual fund is chargeable to tax under the head capital gain only and not as business income. In view of the above facts we reverse the finding of the learned Commissioner of Income tax (Appeals) and direct the AO to charge profit on sale of mutual fund and shares including gain arising on mutual fund held in portfolio management scheme of the brokers under the head capital gain only. - Decided in favour of assessee.

Summary

Issues Involved:
1. Disallowance under Section 14A of the Income Tax Act, 1961 read with Rule 8D of the Income Tax Rules, 1962.
2. Recharacterization of short-term capital gains as business income.

Issue-wise Detailed Analysis:

1. Disallowance under Section 14A:
The assessee contested the disallowance of Rs. 31,28,928 made by the Assessing Officer (AO) under Section 14A of the Income Tax Act, read with Rule 8D of the Income Tax Rules. The AO found that the assessee had made investments in shares, mutual funds, and bonds, generating exempt income. The AO computed the disallowance as Rs. 37,62,910 but after considering the assessee's own disallowance of Rs. 13,43,545, the net disallowance was Rs. 24,20,365. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld a disallowance of Rs. 31,28,928, leading to a net disallowance of Rs. 17,85,383 after deducting the assessee's disallowance.

The Tribunal noted that the AO applied Rule 8D without recording satisfaction that the assessee's computation was incorrect. The AO issued a show-cause notice without examining the assessee's disallowance of 10% of the exempt income. According to the Tribunal, the AO must record satisfaction regarding the assessee's computation before invoking Rule 8D, as mandated by the Delhi High Court in CIT vs. Taikisha Engineering Ltd. The Tribunal also held that investments in subsidiaries are strategic and should not be included in the disallowance computation under Section 14A, citing CIT vs. Holcim India Pvt. Ltd.

The Tribunal found the disallowance of Rs. 30,18,766 out of Rs. 35,14,664 of indirect expenditure incomprehensible. Consequently, the Tribunal reversed the CIT(A)'s order and restricted the disallowance to Rs. 13,43,545, as computed by the assessee.

2. Recharacterization of Short-term Capital Gains as Business Income:
The assessee reported long-term capital gains of Rs. 75,01,260 and short-term capital gains of Rs. 32,35,452 from the sale of shares, mutual funds, and portfolio management schemes, classifying them as investment assets. The AO recharacterized the short-term capital gains as business income, arguing that the investments were made from business income and citing Form 10DC, which labeled the transactions as business activities. The CIT(A) upheld the AO's decision, noting the high turnover and intent to maximize profits.

The Tribunal observed that the investments were classified as investments in the balance sheet and funded by the assessee's own funds, not borrowed funds. The assessee's principal business was consultancy, not trading in securities. The Tribunal rejected the AO's reliance on Form 10DC, stating that it only reflects transaction values for securities transaction tax purposes and does not determine the nature of income. The Tribunal cited Delhi High Court rulings in Yamaha Ltd. vs. ACIT and Radials International vs. ACIT, which held that gains from mutual funds in portfolio management schemes are taxable as capital gains, not business income.

The Tribunal concluded that the short-term capital gains from mutual funds and shares should be taxed as capital gains, not business income. The Tribunal reversed the CIT(A)'s findings and directed the AO to tax the gains under the head capital gains.

Conclusion:
The Tribunal allowed the appeal, reversing the CIT(A)'s orders on both issues. The disallowance under Section 14A was restricted to Rs. 13,43,545, and the short-term capital gains were to be taxed as capital gains, not business income. The order was pronounced in the open court on 10.02.2016.