TMI Blog2012 (11) TMI 499X X X X Extracts X X X X X X X X Extracts X X X X ..... sue remits back with direction to decides on the basis of above mention judgment. Issue remand back to AO Disallowance of expenses towards earning interest & dividend income – Whether provision of Sec. 14A is applicable where income is chargeable to tax on gross basis at special rate u/s 115A - Held that:- Following the decision in case of Rajasthan State Warehousing Corporation (2000 (2) TMI 5 - SUPREME COURT) that if an assessee is carrying an indivisible business then the entire expenditure including that which was incurred for earning the tax free income would be a permissible deduction. Section 14A does not provide that if income is liable to tax at a lower rate then also the proportionate expenditure should not be allowed as deduction against the other business income. Section 14A is the deduction of expenses incurred by the assessee in relation to income not at all chargeable to tax and not the income chargeable to tax at lower rate of tax. In favour of assessee Assessee received from and paid interest to overseas branches – Whether the provision of interest by a PE of a foreign enterprise payable to HO and/or other branches outside India is allowable deduction - AO ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... de under section 8(2) of the Interest Tax Act, 1976. The grounds by the assessee in both these appeals read as under: Grounds raised in ITA No.5374/Mum/2001: "Aggrieved by the order passed by the Commissioner of Income-tax (Appeals)-VII, Mumbai [hereinafter referred to as 'the learned CIT(A)'], under section 250 of the Income tax Act, 1961 ('Act'), and based on the facts and circumstances of the case, the Appellant respectfully submits that the learned CIT(A) erred in upholding the order of the Additional Commissioner of Income-tax, Special Range 32, Mumbai [hereinafter referred to as the 'learned Assessing Officer'], on the following grounds: 1. In upholding the disallowance of expenses amounting to Rs. 121,802,048 incurred at the head office directly in relation to the Indian branches. 2. In upholding the disallowance of expenses amounting to Rs. 54,243,810 incurred for solicitation of deposits from non- resident Indians. 3. In upholding the disallowance of Rs. 40,196,300, being an estimate by the learned Assessing Officer of the expenditure incurred by the Appellant for earning interest on tax free bonds. 4. In upholding the disallowance of Rs. 5,253,361, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... evenue in respect of assessment year 1997-98 and it was contended that Ground No. 1 to 5 of assessee's appeal are covered by the grounds raised by the assessee as well as revenue in respect of A.Y. 1997-98. We have passed a separate order in respect of assessment year 1997-98. The reference of which is being made in this order for grounds which are covered by the said order. 3. Ground No. 1 to 2 are covered by the following observations of the Tribunal in ITA No. 6022/Mum2000, A.Y. 1997-98. "2. First ground of the assessee's appeal is against the confirmation of disallowance of expenses amounting to Rs. 6,39,13,217 incurred for solicitation of deposits from non-resident Indians on the ground that such expenses were covered by the provisions of section 44C of the Income-tax Act, 1961 (hereinafter called the 'Act') and should, therefore, be allowed as deduction in the manner and to the extent provided in that section. The second ground is against the confirmation of disallowance of expenses amounting to Rs. 13,50,87,275 incurred at the head office directly in relation to Indian branches on the ground that such expenses were covered by the provisions of section 44C and should, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not section 37(1). It is further observed that the Tribunal, subsequently, in assessee's own case for assessment years 1993-94 to 1996-97, has decided similar issue in assessee's favour. A copy of the said Tribunal order for such later years dated 23rd July, 2010 in ITA No. 1187/Mum/2001 etc. is placed on record. 2.3 The ld. DR contended that the ratio decidendi in the case of Emirates Commercial Bank Ltd. (supra) cannot be applied to the facts and circumstances of the present case because here the expenditure is allocated and not exclusive. In principle, we are in full agreement with this contention that the judgment in the case of Emirates Commercial Bank Ltd. (supra) can operate for allowing deduction in full u/s 37(1) where the expenditure is exclusive. In a case of allocated expenses, the amount can be considered only u/s 44C. The Mumbai bench of the tribunal in the case of ADIT (I.T.) v. Bank of Bahrain Kuwait [2011] 44 SOT 693 (Mum.) has canvassed similar view by holding that the exclusive expenses incurred by the head office for Indian branch are outside the purview of sec. 44C and only common head office expenses are governed by this section. There can be no quarrel o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o direct specific expenses were incurred for earning such interest on tax free bonds. The Assessing Officer did not accept the assessee's contention and came to hold that the gross interest from bank cannot be allowed as exemption. Considering the language of section 10, he held that the exemption is available only in respect of 'income' and not the 'gross receipts'. He, therefore, went on to compute the 'Proportionate expenditure for earning Tax free income' which amount was determined by a mathematical exercise at Rs. 7.25 crore. After reducing the so calculated proportionate expenditure of Rs. 7.25 crore from the gross tax free interest, the exempt income u/s 10(15)(iv) was determined at Rs. 2.66 crore. The learned CIT(A) observed that there was no indivisible business carried on by the assessee in respect of such bonds from which tax free income was earned. Relying on the judgment of the Hon'ble Supreme Court in the case of Rajasthan State Warehousing Corporation v. CIT [(2000) 242 ITR 450 (SC)], the learned CIT(A) held that there was no justification for making the disallowance of Rs. 7.25 crore. The Revenue is aggrieved against this finding of the learned CIT(A). 4.3 We hav ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessment year under consideration. 4.4 In the opposition, the ld. AR stated that the securities on which exempt income was earned were stock-in-trade of the assessee bank. Relying on the judgment of the Hon'ble Supreme Court in the case of CIT v. Indian Bank Limited [(1965) 56 ITR 77 (SC)], the learned AR argued that the interest paid by bank in that case on deposits received in the course of its business and utilized for buying such tax free securities was held to be deductible in arriving at the taxable profit of the business notwithstanding that the interest earned by the bank on tax free securities could not be taxed. It was stated that the facts of the instant case are similar to those considered and decided by the Hon'ble Supreme Court. The learned AR submitted that no specific ground has been taken by the Revenue for sustaining any disallowance u/s 14A and as such it was too late in the day for the Revenue to request for sustaining disallowance under this section. Without prejudice to such submissions and taking his argument to next level, it was submitted that where exempt income is earned from securities held as stock-in-trade, no disallowance can be made u/s 14A as th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... about the exemption u/s 10(15)(iv) on gross or net interest basis. The bench, inter alia, held that section 14A is applicable and for computing the disallowance the matter was sent back to the AO. The extant position prevailing before us herein is more or less identical. Here also when the order was passed by the learned CIT(A), section 14A was not there and naturally the recourse to such action could not have been taken. Since the disallowance was made by the Assessing Officer on the ground that the proportionate expenditure for earning tax free income cannot be allowed as deduction, in a way he applied the same spirit as is there in section 14A. Even though there is no reference to section 14A in the ground taken by the Revenue, which naturally could not have been possible because of this provision being inserted later on, but challenging the deletion of proportionate expenditure in relation to exempt income in a wider sense amounts to requesting for the sustenance of disallowance u/s 14A itself. No material has been placed on record to indicate that the view taken by the co-ordinate bench in the case of Dresdner Bank AG (supra) has been modified or reversed by the Hon'ble juris ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... exempt income against the taxable income. This is against the basic principles of taxation whereby only the net income, i.e., gross income minus the expenditure, is taxed. On the same analogy, the exemption is also in respect of the net income. Expenses incurred can be allowed only to the extent they are relatable to the earning of exempt income'. The Special Bench of the Tribunal in the case of ITO v. Daga Capital Management Pvt. Ltd. (supra) considered the provisions of section 14A in the light of the above referred three Supreme Court judgments granting deduction of interest u/s 36(1)(iii) incurred in respect of borrowings utilized for making investments resulting into exempt income, against the taxable income on the theory of composite basis. In this case, the Special Bench has held that these judgments were rendered at time when the provisions of section 14A were not there and as such the insertion of section 14A has diluted their mandate. The special bench has also held that this section applies to all the heads of income and aims at disallowing expenditure incurred in relation to income which does not form part of the total income even though such expenditure may be allowabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4A. Let us examine the facts and ratio of Smt. Leena Ramachandran (supra). The assessee therein was running a business of trading of goods. During the year she paid an interest of Rs. 17,44,310 on funds borrowed for purchase of shares in a company called M/s Homefit Leasing Ltd. The assessee's claim was that the acquisition of shares with the borrowed funds was for the purpose of controlling the company which was engaged in leasing business. Since the borrowed funds were utilised for acquisition of shares of the company under the control of the assessee, she contended that the utilisation of the borrowed funds was for the business purpose entitling her to deduction of interest under section 36(1)(iii). The Assessing Officer disallowed the claim of interest. First appeal was dismissed confirming the assessment. The Tribunal relying, inter alia, on decision of the Supreme Court in S.A. Builders Ltd. v. CIT (Appeals) [2007] 288 ITR 1 (SC) substantially allowed the claim, but made a disallowance of Rs. 2 lakhs, being the interest stated to be attributable to the dividend income of Rs. 3 lakhs. Against this order, the Revenue preferred an appeal before the Hon'ble High Court. Reversing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t assessable under the Act, the disallowance under section 14A is squarely attracted and the Assessing Officer, in our view, rightly disallowed the claim.' It was emphasized that from the above sentences it was clear that the mandate of section 14A has been held to be not applicable in case of the holding of shares as stock in trade. We are unable to find any sanction given by the Hon'ble High Court for not making disallowance u/s 14A when the shares are held as stock in trade. What is provided in the first sentence is that the assessee would be entitled to deduction of interest under section 36(1)(iii) of the Act on the borrowed funds utilised for the acquisition of shares only if shares are held as stock in trade, which arises only if the assessee is engaged in trading of shares. It is obvious that these observations are in the context of allowing deduction u/s 36(1)(iii) and not for making disallowance u/s 14A. The provisions of section 14A come into play only when there is some exempt income. In these observations it has been nowhere said that the disallowance u/s 14A will not be made in respect of exempt dividend income arising from the shares held as stock-in-trade. It is the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng deep into the determination of the character of such shares and drawing a parity from the case of Smt. Leena Ramachandran (supra), which has been relied on by the ld. AR in his support, it can be seen that in both these cases the shares were held in group concerns or for controlling interest. Since in both the cases it has been held that the disallowance u/s 14A is warranted, we see no reason to hold that where the dividend income is only incidental to the shares held as stock in trade, the operation of section 14A shall cease. 4.13 Further, the ld. AR failed to point out, after thoroughly going through the judgment in Godrej Boyce Mfg. Co. Ltd. (supra), that reference in this case has been made to compute disallowance u/s 14A only in respect of shares held as investment and not as stock in trade. In that view of the matter, the obvious conclusion which follows is that the decision of the Special Bench in the case of Daga Capital Management Pvt. Ltd. (supra), which has been referred to at several places in this judgment, about the applicability of the provisions of section 14A with respect to dividend income earned by the assessee from the shares held as stock-in-trade also, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ainst the regular income, but shall slice away the amount chargeable to tax at lower rate. That is how, he applied lower rate of tax on the net income amounting to Rs. 6.12 lacs. However, while computing total income of the assessee at the end of the assessment order, he started with the gross total income as per the return of income. Then, he made certain disallowances, but omitted to disallow the proportionate expenditure of Rs. 83.90 lacs against the income chargeable to tax at the normal rate. Thereafter, he computed income chargeable to tax at lower rate u/s 115A on net basis at Rs. 6.12 lac. In this way he committed an error by allowing deduction of Rs. 83.90 lacs twice, firstly, by not adding it to the total income and then by specifically computing income u/s 115A on net basis. Unaware of the overall effect of the AO's action, the assessee challenged the computation u/s 115A made by the AO on net basis, before the ld. CIT(A). The ld. first appellate authority decided this issue in assessee's favour by holding that the provisions of section 115A apply on gross income. The Revenue has accepted the finding of the ld. CIT(A) on the question of taxability of the gross amount for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r income and the expenditure incurred on earning such income is allowed to be set off against other incomes, it amounts to undue benefit to the assessee, contrary to the intent of the statute. He submitted that the action of the ld. CIT(A) has unduly favoured the assessee, firstly, by the application of the reduced rate of taxation u/s 115A on such income and secondly, by allowing the deduction of expenditure incurred for earning income liable to tax at lower rate, against the income liable for tax at regular rates. 5.6 We are not convinced with the submissions made on behalf of the Revenue. It is undisputed that the Revenue is aggrieved against the allowability of expenditure incurred in respect of earning dividend and interest income liable to tax at special rate u/s 115A, against the income chargeable to tax at normal rate. It is not a case and cannot be that such dividend and interest income are not at all chargeable to tax. The contention which has been made is that the expenses incurred by the assessee in respect of income liable to tax at special rate u/s 115A should not be allowed as deduction against the income chargeable to tax at normal rate. This contention, in our co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lowed. 6. Apropos Ground No.6, this issue has been discussed by the AO at page 21 of the assessment order under the head "(V) Interest received from and paid to overseas branches." The AO noted that during the financial year ended as on 31/3/1998, the assessee had received interest amounting to Rs. 29,67,23,640/- on funds placed with its overseas branches and paid interest amount to Rs.19,09,987/- on funds placed with it by its overseas branches. The AO required the assessee to explain as to why the interest received from the funds placed by the assessee with its overseas branches should not be assessed as income and not being satisfied with the submissions of the assessee, the AO held that assessee is covered by section 9(1)(v)(c) of the Act as the interest is paid by the head office for carrying out the smooth business operations in India, therefore, interest income earned by the assessee from its head office is taxable in India and in this manner a sum of Rs. 29,48,13,653/- was added to the income of the assessee. Ld. CIT(A) has confirmed the disallowance and the assessee has raised the aforementioned ground. 7. It was submitted that this issue is covered in favour of the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Bank (supra), wherein it has been held that it is the income of PE/Indian Branches which accrues or arises in India that is taxable under the Act and, therefore, interest received by or interest paid by Indian branches of non-resident has to be taken into consideration while computing the income of such Indian branches/PE. 32. In the case of ABN Amro Bank (supra), the question before the Special Bench was as under: "Whether the provision of interest by a permanent establishment of a foreign enterprise payable to head office and/or other branches outside India is allowable deduction and if so, whether the provision of Section 40(a)(i) is attracted in respect of such payment/provision?" At the outset, it is pointed out that in the case before the Special Bench, there existed treaty between India and Netherlands. However, for the reasons given by the Special Bench in Para-25, it was held that provisions of treaty did not apply to the dis-allowability of interest paid to Head Office while computing the income of the PE/Indian branches of the bank and, therefore, the question whether such interest is to be disallowed or not has to be considered with reference to local law. Conside ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... its Branches in India would not be chargeable to tax in India even assuming that both are separate entities. 33. With reference to the second part of the question referred, the Special Bench considered the provisions of Section 40(a)(i) as well as Section 195 of the Act and then observed in Para-30 as under: "The assessee in this case is the corporate body and its branches are paying interest to its Head office and other offshore Branches i.e., the payment is by one wing of the assessee to its other wing or so to say by one hand to another. The tax is to be deductible under Chapter XVII-B of the Act and in case of a payment to non-resident it is section 195 of the IT Act. This section provide that "Any person responsible for paying to a non-resident not being a company, or to a foreign company, any interest or any other sum chargeable under the provisions of this Act (not being income chargeable under the head 'Salaries' shall at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode whichever is earlier deduct income tax thereon at the rates in force. The Branch/PE of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o self and, therefore, the same neither constitute income nor expenditure in the hands of Indian Branch; (iv) That even assuming that both are separate entity, the interest received by Head Office would not be taxable as interest accrued by Head Office would be cancelled by the expenditure allowed in the hands of Branch in India. 34. On the other hand, the Division Bench, in the case of Dresdner Bank (supra), took a different view even after considering the Special Bench Division. It is surprisingly to note that in Para-22, it agreed to the legal position that in case of foreign company, taxable unit under the Income Tax Act, 1961, is the foreign company and not its Branch or PE in India as apparent from the following observations: "This elementary analysis makes it clear that under the Income Tax Act, so far as foreign companies are concerned, taxable unit is a foreign company and not its branch or permanent establishment in India, even though the taxability of such foreign companies is confined to (i) an income which accrues or arises in India or is deemed to accrue or arise in India and (ii) an income which is received or is deemed to be received by or on behalf of such f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the case of Desdner Bank (supra). It is not in our domain to make any comment on the decision of the Division Bench. However, there is no dispute to the legal position that in case of conflict between the decisions of Special Bench and Division Bench, it is the decision of Special Bench which would prevail. In the present case, admittedly, there is no treaty between India and USA in the year under consideration. Accordingly, in view of the Special Bench, it is the local law i.e. the provisions of Income Tax Act, 1961 which would be applicable. Therefore, following the decisions of Special bench, it is held that income received/receivable by the Indian branch from head office is not chargeable to tax. The order of learned CIT(A) is therefore, upheld on this issue." 8. The Id. AR stated not to have any objection if the PE and the GE are treated as one, meaning thereby, that neither any deduction is allowed for the interest paid to HO or foreign branches nor income is recognized in respect of the interest earned in transactions between the HO and PE. It was submitted that the tribunal, in an earlier year, in its own case has held so following the special bench order in the case of A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... credited in the P L Account because P L Account is ultimately prepared from the accounts of the assessee. It is in this manner AO did not allow the claim of the assessee. 11. Ld. CIT(A) has dealt with this issue in para 31 to 34 of the impugned order and Ld. CIT(A) has rejected the claim of the assessee by upholding the observations of AO made in the assessment order. 12. After narrating the facts, Ld. A.R referred to the provisions of Section 43D of the Act, which is applicable in the case of income of Public Financial Institutions, Public Companies etc. and it will be relevant to reproduce the relevant part of the said section. "43D. Notwithstanding anything to the contrary contained in any other provision of this Act, (a) in the case of a public financial institution or a scheduled bank or a State financial corporation or a State industrial investment corporation, the income by way of interest in relation to such categories of bad or doubtful debts as may be prescribed23 having regard to the guidelines issued by the Reserve Bank of India in relation to such debts; (b) shall be chargeable to tax in the previous year in which it is credited ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... - - 419,250 JCT Electronics Ltd. 232,317 - 232,317 - - Core Parentals Ltd. 13,757,110 29,464,489 - - 43,221,599 168,433,057 58,713,862 46,851,736 - 180,295,182 11,862,126" Thus it was pleaded by Ld. A.R that claim of the assessee has wrongly been rejected and it should be allowed as per section 43D of the Act. 13. Ld. DR submitted that firstly Section 43D of the Act is applicable to the Scheduled Banks and assessee has not established that it is a Scheduled Bank. In response Ld. A.R submitted a copy of Explanatory Note dated 1/09/2010 obtained from the website of Reserve Bank of India in which at Point No. 14 it is mentioned that American Express Bank Ltd. is in existence/operation as on 31/3/2005 as merged/renamed/closed thereafter and at Sl. No. 9 in the said point assessee having eight branches has been merged with Standard Chartered Bank w.e.f. 5/3/2008. Thus it was submitted by Ld. A.R that assessee is a Scheduled Bank. 14. Ld. D.R further submitted that assessee had credited the interest in its ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eceived during the year. The relevant figures have already been reproduced in earlier part of this order. Ld. A.R has submitted that this issue may be restored back to the file of AO for making re-computation of the assessable interest as there is some wrong calculations in the computation of the assessable interest. 18. It has already been mentioned that interest on non-performing assets as described in section 43D of the Act can be assessed only in a condition that either they are credited to P L Account or it is actually received. In the present case of the assessee since interest is not credited on such assets to the P L Account, therefore, whatever interest is actually received on such assets is taxable. The same principle will be applicable to interest tax also. Keeping in view this principle, after hearing both the parties we direct the AO to recompute the assessable interest after giving the assessee a reasonable opportunity of hearing and if there is incorrectness in the interest computed as assessable the same may also be removed. With these directions the appeal filed by the assessee is treated as allowed for statistical purposes in the manner aforesaid. 19. In the r ..... X X X X Extracts X X X X X X X X Extracts X X X X
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