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2015 (12) TMI 1666 - ITAT MUMBAI

2015 (12) TMI 1666 - ITAT MUMBAI - TMI - Deferred compensation expenses on account of ESOP - allowable business expenses - Held that:- The deductibility of expenses on account of ESOP being discount under the ESOP has been decided in Biocon Limited v. DCIT [ 2014 (12) TMI 838 - ITAT BANGALORE] held that discount under ESOP is in the nature of employees cost and is hence deductible during the vesting period w.r.t. the market price of share at the time of grant of options to the employees. The Hon .....

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ught to our notice by the Revenue to controvert the decision of the Special Bench of Bangalore ITAT with respect to this issue. - Thus deduction being deferred employee compensation expense (ESOP) debited under the head employee cost as an allowable business expenditure under the head ‘profit and gains of business or profession’ incurred wholly and exclusively for the purposes of business of the assessee company. We further hold that the amount of discount claimed as deduction during the ve .....

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2008-09, the Hon’ble Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (2010 (8) TMI 77 - BOMBAY HIGH COURT) has already held that the Rule 8D is applicable for A.Y. 2008-09 and hence in our considered view, the investment of ₹ 4,61,37,00,000/- made by the assessee company in its subsidiary namely M/s India Infoline Investment Services Ltd. of ₹ 4,61,37,00,000/- will be included in the average investment for the purpose of computation of disallowance u/s 14A r.w.r 8D(2)(iii) of the I .....

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- Dated:- 1-12-2015 - Joginder Singh (Judicial Member) And Ramit Kochar (Accountant Member) For the Assessee : Pritesh Mehta For the Revenue : Samuel Darse CIT-DR ORDER Joginder Singh (Judicial Member) These cross appeals by the assessee company and the Revenue are directed against the order dated 03.01.2013 of the Commissioner of Income Tax (Appeals)-20, Mumbai (Hereinafter called the CIT(A) ) for the assessment year 2008-09. 2. The assessee company has raised following grounds of appeal in th .....

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f the shares offered to employees under the stock option scheme was held to be allowable expenditure under similar circumstances. The revenue has raised the following grounds of appeal in the memo of appeal filed by the Revenue, the appeal being ITA No. 2490/Mum/2013:- 1. Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) is correct in excluding ₹ 4,61,37,00,000/- being investment made by the assessee in the shares of its subsidiary M/s India Infoline Investment .....

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). 4. During the course of assessment proceedings u/s 143(3) read with Section 143(2) of the Act, the assessee company was asked by the AO that why the deferred employee compensation expenses of ₹ 5,99,74,467/- debited under the head employee cost was claimed as revenue expenditure by the assessee company as these expenses being related to issue of fresh equity shares (ESOP) by the assessee company and hence are capital in nature not allowable as revenue expenditure u/s 37(1) of the Act. T .....

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s nothing but a means of remunerating employees in the normal course of business and hence these expenses are in the nature of ESOP and are incurred wholly and exclusively for the purposes of business of the assessee company in the normal course of operations and should be allowed as business deductions while computing income from business of the assessee company. The assessee company relied upon the judgment of SSI Ltd. v. DCIT (2004) 85 TTJ 1049 (Chen.). 5. The AO rejected the contentions of t .....

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lso held that even if it is perquisite in the hands of the employee but the same is not allowable as business expenditure in the hands of the assessee company which is providing perquisite to the employee as it is independent of the perquisite. The AO relied upon the decision in the case of Ranbaxy Laboratories Ltd. v. ACIT [124 TTJ 771] (2009) (Delhi Tribunal) to hold that such expenditure shall not be allowed as revenue expenditure. The difference between the market price and the issue price/g .....

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the assessee company and the benefit or income foregone cannot be considered as business expenditure. In view of the above, the expenditure of ₹ 5,99,74,467/- on ESOP was disallowed by the AO. 6. Aggrieved by the assessment order of the AO passed u/s 143(3) of the Act, the assessee company carried the matter in appeal before the CIT(A) and reiterated its submissions as were submitted before the AO which are detailed in the preceding para s, which are not repeated for the sake of brevity. T .....

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y the AO in the Ranbaxy Laboratories Ltd. v. ACIT 124 TTJ 771 (Delhi Tribunal) and M/s VIP Industries Ltd. TIOL 654, supports the finding of Assessing Officer that such ESOP is not allowable expenditure, hence the contentions of the assessee were rejected and the appeal of the assessee company was dismissed on this ground. 7. Aggrieved by the orders of the CIT(A), the assessee company is in appeal before the Tribunal. The assessee company submitted that the decision of Bangalore Special Bench of .....

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P) being deferred employee compensation expense debited under the head employee cost should be allowed as revenue expenditure while computing income from business of the assessee company. The assessee company also reiterated the submissions as submitted before the authorities below which are detailed in preceding para s and not repeated again for the sake of brevity. On the other hand, the ld. DR relied upon the order of the authorities below and contended that such expenses cannot be allowed as .....

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uctible during the vesting period w.r.t. the market price of share at the time of grant of options to the employees. We have observed that the issue in hand is squarely covered by the decision of Hon ble Special BenchBangalore Tribunal reported in (2013) 35 taxmann.com 335(SB) Biocon Limited v. DCIT(LTU) in favour of the assessee company whereby the Hon ble Special Bench has held as under : 7. We have heard Shri H. Padam Chand Khincha for the appellantassessee; Shri Rohit Jain for the Intervener .....

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Employees compensation expense or simply the Discount etc., is an allowable deduction in the computation the income under the head "Profits and gains of business or profession"? This larger question can be answered in the following three steps, viz., I. Whether any deduction of such discount is allowable ? II. If yes, then when and how much? III. Subsequent adjustment to discount 8. We will take up these three steps one by one for consideration and decision. I. WHETHER ANY DEDUCTION O .....

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the assessee incurs any expenditure, which thereafter satisfies the requisite conditions of the sub-section (1). He submitted that the word "expenditure" has been described by the Hon'ble Supreme Court in the case of Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66 as denoting spending or paying out, i.e. something going out of the coffers of the assessee. It was put forth that by issuing shares at discounted premium, nothing is paid out by the company. Once there is no " .....

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face value of the shares, being the share premium, is itself a capital receipt, any under-recovery of such share premium on account of obligation to issue shares to employees in future at a lower premium, would be a case of short capital receipt. If at all it is to be viewed in terms of expenditure, then, at best, it would be in the nature of a capital expenditure. He supported his view by relying on the order passed by the Delhi Bench of the Tribunal in Ranbaxy Laboratories Ltd. v. Addl. CIT [ .....

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.] 9.2.2 Per contra, the learned AR submitted that it is not a case of any short receipt of share premium but that of compensation given to employees. He supported the admissibility of deduction of the amount of discount on the strength of the order passed by the Chennai bench of the tribunal in the case of S.S.I. Ltd. (supra) granting deduction of such discount by treating it as an employee cost. He submitted that the above view taken by the Chennai Bench has been approved by the Hon'ble Ma .....

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(URO). 9.2.3 Let us examine the facts of the case of Ranbaxy Laboratories Ltd. (supra), which has been strongly relied by the learned Departmental Representative. It deals with a situation in which the assessee granted stock option to its employees. The shares were to be issued at ₹ 559 per share as against the face value of ₹ 10 and the market price on the date of grant at ₹ 738.95 per share. The assessee treated the difference between ₹ 738.95 and ₹ 595 as employ .....

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10 as its income during the year, there was no loss of income. It was further noticed that by issuing shares at below the market price, there was no incurring of any expenditure. Rather it resulted into short receipt of share premium which the assessee was otherwise entitled to. As the receipt of share premium is not taxable, any short receipt of such premium will only be a notional loss and not actual loss requiring any deduction. The Tribunal further noticed that incurring of such notional los .....

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erstand the concept of ESOP. Section 2(15A) of the Indian Companies Act, 1956 defines "employee stock option" to mean 'the option given to the whole-time Directors, Officers or employees of a company, which gives such Directors, Officers or employees, the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a predetermined price". In an ESOP, the given company undertakes to issue shares to its employees at a future date at a pric .....

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ompany, such options vest with the employees. The options are then exercised by the employees by making application to the employer for the issue of shares against the options vested in them. The gap between the completion of vesting period and the time for exercising the options is usually negligible. The company, on the exercise of option by the employees, allots shares to them who can then freely sell such shares in the open market subject to the terms of the ESOP. Thus it can be seen that it .....

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discounted premium on the issue of shares. 9.2.5 The core of the arguments of the ld. DR in this regard is twofold. First, that it is not an expenditure in itself and secondly, it is a short capital receipt or at the most a sort of capital expenditure. In our considered opinion both the legs of this contention are legally unsustainable. 9.2.6 There is no doubt that the amount of share premium is otherwise a capital receipt and hence not chargeable to tax in the hands of company. The Finance Act, .....

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39;Income from other sources'. But for that, the amount of share premium has always been understood and accepted as a capital receipt. If a company issues shares to the public or the existing shareholders at less than the otherwise prevailing premium due to market sentiment or otherwise, such short receipt of premium would be a case of a receipt of a lower amount on capital account. It is so because the object of issuing such shares at a lower price is nowhere directly connected with the ear .....

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y object of this exercise is not to raise share capital but to earn profit by securing the consistent and concentrated efforts of its dedicated employees during the vesting period. Such discount is construed, both by the employees and company, as nothing but a part of package of remuneration. In other words, such discounted premium on shares is a substitute to giving direct incentive in cash for availing the services of the employees. There is no difference in two situations viz., one, when the .....

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on to employees and hence deductible. In the same way, if the company, instead, issues shares to its employees at a premium of ₹ 40, the discounted premium of ₹ 60, being the difference between ₹ 100 and ₹ 40, is again nothing but a different mode of awarding remuneration to employees for their continued services. In both the cases, the object is to compensate employees to the tune of ₹ 60. It follows that the discount on premium under ESOP is simply one of the mode .....

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expenditure. It is nothing but the employees cost incurred by the company. The substance of this transaction is disbursing compensation to the employees for their services, for which the form of issuing shares at a discounted premium is adopted. 9.2.7 Now we espouse the second part of the submission of the ld. DR in this regard. He canvassed a view that an expenditure denotes "paying out or away" and unless the money goes out from the assessee, there can be no expenditure so as to qua .....

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ust be laid out or expended wholly and exclusively for the purpose of business so as to be eligible for deduction u/s 37(1). There is absolutely no doubt that section 37(1) talks of granting deduction for an 'expenditure', and the Hon'ble Supreme Court in Indian Molasses Co. (P.) Ltd. (supra) has described 'expenditure' to mean what is 'paid out or away' and is something which has gone irretrievably. However, it is pertinent to note that this section does not restrict .....

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we read the definition of the word "paid" u/s 43(2) in juxtaposition to section 37(1), the position which emerges is that it is not only paying of expenditure but also incurring of the expenditure which entails deduction u/s 37(1) subject to the fulfilment of other conditions. At this juncture, it is imperative to note that the word 'expenditure' has not been defined in the Act. However, sec. 2(h) of the Expenditure Act, 1957 defines 'expenditure' as : 'Any sum of m .....

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s seen that by undertaking to issue shares at discounted premium, the company does not pay anything to its employees but incurs obligation of issuing shares at a discounted price on a future date in lieu of their services, which is nothing but an expenditure u/s 37(1) of the Act. 9.2.8 Though discount on premium is nothing but an expenditure u/s 37(1), it is worth noting that the Hon'ble Supreme Court in the case of CIT v. Woodward Governor India (P.) Ltd. [2009] 312 ITR 254/179 Taxman 326 h .....

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e word "expenditure" is, therefore, required to be understood in the context in which it is used. Section 37 enjoins that any expenditure not being expenditure of the nature described in sections 30 to 36 laid out or expended wholly and exclusively for the purposes of the business should be allowed in computing the income chargeable under the head "profits and gains of business or profession". In sections 30 to 36 the expression "expenditure incurred", as well as al .....

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of law by the Hon'ble Summit Court, there remains no doubt whatsoever that the term 'expenditure' in certain circumstances can also encompass 'loss' even though no amount is actually paid out. Ex consequenti, the alternative argument of the ld. DR that discount on shares is 'loss' and hence can't be covered u/s 37(1), also does not hold water in the light of the above judgment. In view of the above discussion, we, with utmost respect, are unable to concur with th .....

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riod, it is only a contingent liability and no deduction is admissible under the provisions of the Act for a contingent liability. The options so granted may lapse during the vesting period itself by reason of termination of employment or some of the employees may not choose to exercise the option even after rendering the services during the vesting period. It was, therefore, argued that the discount is nothing but a contingent liability during the vesting period not calling for any deduction. I .....

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and there can be no quarrel over the settled legal position that deduction is permissible in respect of an ascertained liability and not a contingent liability. Section 31 of the Indian Contract Act, 1872 defines "contingent contract" as "a contract to do or not do something, if some event, collateral to such contract does not happen". We need to determine as to whether the liability arising on the assessee-company for issuing shares at a discounted premium can be characteri .....

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it becomes obligatory on the part of the company to honor its commitment of allowing the vesting of 25% of the option. It is at the end of the first year that the company incurs liability of fulfilling its promise of allowing proportionate discount, which liability would be actually discharged at the end of the fourth year when the options are exercised by the employees. Now the question arises as to whether the liability at the end of each year can be construed as a contingent one? 9.3.3 The H .....

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be a contingent liability and hence not a permissible deduction. When the matter finally came up before the Hon'ble Supreme Court, it was held that the provision for meeting the liability for encashment of earned leave by the employee was an admissible deduction. In holding so, the Hon'ble Apex Court observed that : "the law is settled : if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantif .....

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the above enunciation of law by the Hon'ble Supreme Court, it is manifest that a definite business liability arising in an accounting year qualifies for deduction even though the liability may have to be quantified and discharged at a future date. We consider it our earnest duty to mention that the legislature has inserted clause (f) to section 43B by providing that "any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee" shall be allowed .....

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act that the quantification is not precisely possible at the time of incurring the liability would not make an ascertained liability a contingent. 9.3.4 Almost to the similar effect, there is another judgment of the Hon'ble Supreme Court in the case of Rotork Controls India (P.) Ltd. v. CIT [2009] 314 ITR 62/180 Taxman 422. In that case, the assessee-company was engaged in selling certain products. At the time of sale, the company provided a standard warranty that in the event of certain par .....

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iability was merely a contingent liability and hence not allowable as deduction u/s 37 of the Act. When the matter finally came up before the Hon'ble Supreme court, it entitled the assessee to deduction on the "accrual" concept by holding that a provision is recognized when : "(a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources will be required to settle the obligation : and (c) a reliable estimate can be made .....

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employees becoming entitled to exercise options at the end of the vesting period and it is only then that the actual amount of discount would be determined, is akin to the quantification of the precise liability taking place at a future date, thereby not disturbing the otherwise liability which stood incurred at the end of the each year on availing the services. 9.3.6 As regards the contention of the ld. DR about the contingent liability arising on account of the options lapsing during the vest .....

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a the group of employees as a whole, it loses the tag of 'contingent' because such lapsing options are up for grabs to the other eligible employees. In any case, if some of the options remain unvested or are not exercised, the discount hitherto claimed as deduction is required to be reversed and offered for taxation in such later year. We, therefore, hold that the discount in relation to options vesting during the year cannot be held as a contingent liability. C. Fringe benefit 9.4.1 The .....

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n employer to his employees (including former employees) by reason of their employment.' Charging section 115WA of this Chapter provides that : "In addition to the income-tax charged under this Act, there shall be charged for every assessment year………..fringe benefit tax in respect of fringe benefits provided or deemed to have been provided by an employee to his employees during the previous year………….". Section 115WB gives meaning to .....

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as fringe benefit. Explanation to this clause clarifies that for the purposes of this clause,- (i) "specified security" means the securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and, where employees' stock option has been granted under any plan or scheme thereof, includes the securities offered under such plan or scheme. Thus it is discernible from the above provisions of the Act that the legislature itself contempla .....

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ability; and (iii) it cannot be treated as a short capital receipt. In view of the foregoing discussion, we are of the considered opinion that discount on shares under the ESOP is an allowable deduction. II. IF YES, THEN WHEN AND HOW MUCH? 10.1 Having seen that the discount under ESOP is a deductible expenditure u/s 37(1), the next question is that 'when' and for 'how much' amount should the deduction be granted ? 10.2 The assessee is a limited company and hence it is obliged to .....

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incurring of liability and the resultant deduction cannot be marred by mere reason of some difficulty in proper quantification of such liability at that stage. The very point of incurring the liability enables the assessee to claim deduction under mercantile system of accounting. We have noticed the mandate of the Hon'ble Supreme Court in Bharat Earth Movers (supra) that if a business liability has definitely arisen in an accounting year, then the deduction should be allowed in that year it .....

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possible at the material time. Whereas in the first case, there cannot be any question of allowing deduction, in the second case, deduction has to be allowed for a sum determined on some rational basis representing the amount of liability incurred. 10.3 We have earlier underlined the concepts of grant of options, vesting of options and exercise of options. The period from grant of option to the vesting of option is the 'vesting period'. It is during such period that an employee is suppos .....

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allotted at the end of the vesting period, but it is during such vesting period that the entitlement is earned. It means that 25 options vest with the employee at the end of each year on his rendering service for the respective year. If during the interregnum, he leaves the service, say after one year, he will still remain entitled to exercise option for 25 shares at the discounted premium at the time of exercise of option. In that case, the benefit which would have accrued to him at the end of .....

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ompany. An obligation falls upon the company to allot shares at the time of exercise of option depending upon the length of service rendered by the employee during the vesting period. The incurring of liability towards the discounted premium, being compensation to employee, is directly linked with the span of service put in by the employee. In the above illustration, when 25 out of 100 shares vest in the employee after rendering one year's service, the company also incurs equal obligation at .....

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for total discounted premium representing the employees cost over the vesting period at the rate at which there is vesting of options in the employees. 10.5 From the above discussion it is lucid that at the event of granting options, the company does not incur any obligation to issue the shares at discounted premium. Mere granting of option does neither entitle the employee to exercise such option nor allow the company to claim deduction for the discounted premium. It is during the vesting perio .....

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income earned during the vesting period. In the same manner, though the company becomes liable to issue shares at the time of the exercise of option, but it is in lieu of the employees compensation liability which it incurred over the vesting period by obtaining their services. From the above it is apparent that the company incurs liability to issue shares at the discounted premium only during the vesting period. The liability is neither incurred at the stage of the grant of options nor when suc .....

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three years. The CIT revised such order by directing the A.O. to disallow ESOP expenditure of ₹ 66.82 lakh. When the matter came up before the Tribunal, it was held that the expenditure in that behalf was an ascertained liability and not contingent upon happening of certain events. It was further noticed that the assessee claimed deduction of such discount on ESOP by following the SEBI Guidelines. As the expenditure itself was an ascertained liability, the Tribunal held that the same to be .....

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ion price of ₹ 10 as against the market price of such shares at ₹ 110 on that date. Further suppose that the vesting period is four years with equal vesting @ 25% at the end of each year. Total discount comes to ₹ 100 (Rs. 110 - ₹ 10). These Guidelines provide for claiming deduction in the accounts for a total discount of ₹ 100 divided over the vesting period of four years on straight line basis at the rate of ₹ 25 each. The case of S.S.I. Ltd. (supra) deals w .....

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d, we hold that the liability to pay the discounted premium is incurred during the vesting period and the amount of such deduction is to be found out as per the terms of the ESOP scheme by considering the period and percentage of vesting during such period. We, therefore, agree with the conclusion drawn by the tribunal in S.S.I. Ltd.'s case (supra) allowing deduction of the discounted premium during the years of vesting on a straight line basis, which coincides with our above reasoning. III. .....

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hat the assessment years 2003-2004 to 2007-2008 are under consideration and during these years ESOP 2000 has come to an end and the ESOP 2004 has started. Further, the extant issue is a vital part of the overall question of the deductibility or otherwise of the amount of discount under ESOP. 11.1.2 We have noticed above that the company incurs a definite liability during the vesting period, but its proper quantification is not possible at that stage as the actual amount of employees cost to the .....

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t is but natural that there is no employee cost to that extent and hence there can be no deduction of discount qua such part of unvested or lapsing options. But, as the amount was claimed as deduction by the company during the period starting with the date of grant till the happening of this event, such discount needs to be reversed and taken as income. It is so because logically when the options have not eventually vested in the employees, to that extent, the company has incurred no employee co .....

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ested options and the options lapsing at the end of the exercise period shall be reversed at the appropriate time. As the accounting treatment directed through the Guidelines accords with the taxation principle of not allowing deduction for the amount of discount on unvested/lapsing options and further the assessee has admitted to have offered such amount as income in the relevant years, we stop here by holding that the amount of discount claimed as deduction earlier in respect of unvested/lapsi .....

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o the assessment years 1997-98 to 1999-2000 has held that the allotment of shares to employees under ESOP subject to a lock in period of five years and other conditions could not be treated as a perquisite as there was no benefit and the value of benefit, if any, was unascertainable at the time when options were exercised. The Finance Act, 1999 inserted section 17(2)(iiia) with effect from 1st April, 2000 providing that : "the value of any specified security allotted or transferred, directl .....

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effect from 1st April, 2001. After certain changes to the relevant provisions in this regard, the position which now stands is that the discount on ESOP is taxable as perquisite u/s 17(2)(vi) for : 'the value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at concessional rate to the assessee'. Clause (c) of Explanation to section 17(2)(vi) provides that : 'the value of any specifi .....

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dering the fair market value of the shares on 'the date on which the option is exercised' by the assessee as reduced by the amount actually paid. The position that such amount was or was not taxable during some of the years in the hands of the employees is not relevant in considering the occasion and the amount of benefit accruing to the employee under ESOP. Any exemption or the deductibility of an allowance or benefit to employee from taxation does not obliterate the benefit itself. It .....

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employees in the hands of the company. We have noticed earlier that an expense becomes deductible on the incurring of liability under the mercantile system of accounting. Although the stage of taxability of perquisite in the hands of the employee may differ from the stage of the deductibility of expense in the hands of the company depending upon the method of account followed by the company, but the amount of such discount or employees remuneration can never be different. If the value of perqui .....

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lpable that since the remuneration to the employees under the ESOP is the amount of discount w.r.t. the market price of shares at the time of exercise of option, the employees cost in the hands of the company should also be w.r.t. the same base. 11.1.6 The amount of discount at the stage of granting of options w.r.t. the market price of shares at the time of grant of options is always a tentative employees cost because of the impossibility in correctly visualizing the likely market price of shar .....

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yees, the provisional amount of discount availed as deduction during the vesting period needs to be adjusted in the light of the actual discount on the basis of the market price of the shares at the time of exercise of options. It can be done by making suitable northwards or southwards adjustment at the time of exercise of option. This can be explained with the following example with the assumption of vesting period of four years and the benefit vesting at 25% each at the end of 1st to 4th years .....

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mpany can rightly claim deduction at the rate of ₹ 25 each at the end of first, second, third and fourth year of vesting. But this total deduction for discount of ₹ 100 over the vesting period needs to be adjusted at the time of exercise of option by the employee when the shares are issued. In Situation I, the market price of shares at the time of exercise of option is at ₹ 110, which is similar to the market price at the time of grant of option. As the total amount of discount .....

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of the compensation has turned out to be ₹ 120, the company is entitled to a further deduction of ₹ 20 at the time of exercise of option. In Situation III, the market price of the share at the time of exercise of option has come down to ₹ 90. The amount of real compensation to employees is ₹ 80 as against the tentative compensation of ₹ 100, which was allowed as deduction during the vesting period. As the actual quantification of the compensation has turned out to b .....

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or the amount of discount during the vesting period on the basis of the market price of shares at the time of grant of options and also reversed the proportionate discount on unvesting/lapsing of options at the appropriate time on the basis of the SEBI Guidelines. If this contention is correct, it would mean that the first two stages have been rightly given effect to. But the appellant assessee does not appear to have made any downward adjustment to the amount of discount at the time of exercise .....

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ision dealing with an issue in the Act, then the accounting principles should be adhered to while determining the total income of the assessee. In this regard, he relied on the judgment in the case of Challapalli Sugars Ltd.'s (supra), wherein the Hon'ble Supreme Court has held that the interest payable on capital borrowed by the assessee for purchase of plant and machinery before the commencement of business should be capitalized on the basis of accepted accountancy rule. Similarly in t .....

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the computation of total income, the accounting principles formulated by way of the SEBI Guidelines are required to be followed. 11.2.2 In the oppugnation, the learned Departmental Representative submitted that the SEBI Guidelines cannot mandate the deductibility or otherwise of an amount under the provisions of the Act. He relied on the judgments of the Hon'ble Supreme Court in Tuticorin Alkali Chemicals & Fertilizers Ltd. (supra) and Godhra Electricity Co. Ltd. (supra) in support of t .....

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d, issued by any autonomous or even statutory bodies including the Institute of Chartered Accountants of India, or for that matter, the SEBI are meant only to prescribe the way in which the transactions should be recorded in books or reflected in the annual accounts. These guidelines do not have the force of an Act of Parliament. Since the subject matter of tax on income falls in the Union List as per Part XI of the Indian Constitution, it is only the Parliament which can legislate on its scope. .....

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ern the deductibility or taxability of unspecified items. For example, the definition of 'income' u/s 2(24) has been given by the Act in an inclusive manner. There have been enshrined clauses (i) to (xvi) dealing with the items specifically listed. However, the provision has been couched in such a way so as to include general items of receipts having character of income, even though not specifically mentioned. Similar is the position regarding deductions. Under the head 'Profits and .....

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pect of the unspecified or the general categories of expenses. Discount on ESOP is a general expense and hence covered by the specific provision of section 37. The contention of the ld. AR that there is no provision in the Act dealing with the deductibility of ESOP discount, is therefore, devoid of any merit. This concludes the question of granting of deduction of discount during the vesting period. 11.2.5 The SEBI Guidelines have been taken shelter of to contend that there is no requirement for .....

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useful to have a glimpse at the following observations of the Hon'ble Supreme Court in the afore noted case: 'It is true that this court has very often referred to accounting practice for ascertainment of profit made by a company or value of the assets of a company. But when the question is whether a receipt of money is taxable or not or whether certain deductions from that receipt are permissible in law or not, the question has to be decided according to the principles of law and not in .....

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levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a hypothetical income, which does not materialise.' 11.2.7 It follows that accounting principles have absolutely no role to play in the matter of determination of to .....

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ing principle has been followed. It simply means that the taxation principle has been followed and the accounting principle, which is in line with such taxation principle, has been simply taken note of. If however, an accounting principle runs counter to the taxation principle, then there is no prize for guessing that it is only the taxation principle which shall prevail. 11.2.8 The plea now raised before us by the ld. AR, relying on the case of Challapalli Sugars Ltd. (supra), was also taken up .....

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ompany. This court held that "cost" is a word of wider connotation than "price". There was a difference between the price of a machinery and its cost. This court thereafter pointed out that the expression "actual cost" had not been defined in the Act. It was, therefore, necessary to find out the commercial sense of the phrase. ………….The judgment in Challapalli Sugar Ltd's case (supra), goes to show that the court was not in any way dep .....

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which came to be affirmed by the Hon'ble Madras High Court in PVP Ventures Ltd. (supra). We have noticed above that the said case dealt a situation falling within one of the three years of the vesting period, in which it was held that one third of the total amount of discount computed on the basis of the market price of the shares at the time of grant of option, is deductible. It is evident from the SEBI Guidelines that these deal with the deductibility of discount in the hands of company d .....

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e Tribunal in SSI Limited (supra) to the SEBI Guidelines is indicative of the fact that it dealt with a year during which the options were vesting with the employees and the company claimed discount during the vesting period. The Hon'ble Madras High Court in the case of PVP Ventures Ltd. (supra) has upheld the view taken by the Chennai Bench in the case of S.S.I. Ltd. (supra). The granting of the binding force to the SEBI Guidelines by the Hon'ble Madras High Court should be viewed in th .....

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High Court nor it dealt with a situation in which the market price of the shares at the time of exercise of option is more or less than the market price at the time of grant of option. It is a situation which has also not been dealt with by the Guidelines. Accordingly, the aforenoted taxation principle of granting deduction for the additional discount and reversing deduction for the short amount of discount at the time of exercise of option, needs to be scrupulously followed. 11.3 We, therefore .....

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in the amount of discount calculated with reference the market price at the time of grant of option and the market price at the time of exercise of option. No accounting principle can be determinative in the matter of computation of total income under the Act. The question before the special bench is thus answered in affirmative by holding that discount on issue of Employee Stock Options is allowable as deduction in computing the income under the head 'Profits and gains of business or profes .....

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ons becomes imperative. We, therefore, set aside the impugned orders on this issue and remit the matter to the file of the AO for finding out the correct amount of deduction accordingly. 12.2 It would be imperative to highlight certain points having bearing on the issue which have come to our notice during the course of hearing. The AO is directed to look, inter alia, into these aspects in quantifying the amount of eligible deduction. a. The assessee-company was a closely held company in the pre .....

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e of such shares on the date of grant of option as the company came to be listed on a stock exchange in a subsequent year. On a pointed query, the ld. AR furnished the details of such claim by showing that it granted 71,510 options with discount of ₹ 909 per option making total discount at ₹ 6.50 crore. He stated that the face value of shares is at ₹ 10 against which the deduction for discounted premium over the vesting period has been claimed at ₹ 909, meaning thereby th .....

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vesting period. The assessee claimed deduction for discount amounting to ₹ 3.38 crore for the A.Y. 2003-04. On being called upon to furnish bifurcation of such claim, the assessee filed a chart showing its detail comprising of four amounts. First amount of ₹ 1.62 crore has been shown as the first tranche of 25% option. Second amount of ₹ 81.25 lakh as the second tranche of 25% option; third amount of ₹ 54.16 lakh as the third tranche of 25% option and the last amount of & .....

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onalities. When the options vest equally over a period of four years, it is but natural that the company would incur equal liability for the discounted premium @ 25% of total discount on receipt of services of the employees at the end of each year. The way in which the assessee has claimed deduction runs contrary even to the SEBI Guidelines, which also provide for deduction on straight line basis. The manner of the assessee's claiming deduction has resulted in needlessly increasing the amoun .....

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ion of one year from the date of grant of option. The assessee was required to indicate the date of grant of options in respect of which deduction has been claimed in the instant year. Two letters granting options to Shri Murali Krishnan K.N. and Neville Bain have been randomly filed which are dated 2nd April, 2002. If the options are granted on 2nd April, 2002, then 25% of the total option shall vest in the employees at the end of the first year from this date, which date would be 1st April, 20 .....

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evant time. There is no finding either in the assessment or the impugned order in this regard. This fact should also be verified by the AO to ensure that the overall expenditure booked by the company is restricted only to the extent of the exercised options. The Hon ble Special Bench of Tribunal in the case of Biocon Limited (supra) has held that discount under ESOP is in the nature of employees cost and is hence deductible during the vesting period w.r.t. the market price of share at the time o .....

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rcise of option. No contrary decision is brought to our notice by the Revenue to controvert the decision of the Special Bench of Bangalore ITAT with respect to this issue. Respectfully following the decision of Special Bench ITAT Bangalore, we hold that the assessee company is entitled to the deduction of ₹ 5,99,74,467/- being deferred employee compensation expense (ESOP) debited under the head employee cost as an allowable business expenditure under the head profit and gains of business o .....

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ion and the market price at the time of exercise of option. We order accordingly and hence the appeal of the assessee company is allowed. 9. The Revenue is aggrieved by the exclusion of ₹ 4,61,37,00,000/- being investment made by the assessee company in the shares of its subsidiary M/s India Infoline Investment Services Ltd. while working out the average value of investment for the purpose of computation of disallowance u/s 14A of the Act read with Rule 8D of the Income Tax Rules, 1962. 10 .....

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necessarily to be incurred . 10.1. The assessee company submitted before the AO that the assesee company has not incurred any expenses for earning such exempt income in the form of dividend income. The assessee company has made investment in short term surplus funds in liquid schemes of mutual funds out of own funds and no borrowed funds have been used to make investments. Similarly, assessee company has made investment in subsidiary companies to retain management control of the said subsidiarie .....

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rej & Boyce Manufacturing Co. Ltd. vs. DCIT in ITOA No.626/2010 & Writ Petition No.758/2010, whereby the Hon ble Bombay High Court has held in favour of the Revenue, thus, the total disallowance was made of ₹ 9,20,55,758/- under Rule 8D (2)(ii) & (iii) of Income Tax Rules,1962 read with Section 14A of the Act as per details in para 4.6 of the AO order consisting of the disallowance of ₹ 6,61,27,995/- made under Rule 8D(2)(ii) while ₹ 2,59,27,763/- was disallowed by .....

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vices. It is also submitted that the AO has erred in applying the provision of Rule 8D(2)(ii) and (iii) of Income Tax Rules, 1962 without application of mind and the AO failed to appreciate that no expenses have been incurred by the assessee company in order to earn exempt income being dividend income. The assessee company submitted that it has invested its own funds and no borrowed funds were utilized. It is minimal activity relating to exempt income and strategic investments are made in subsid .....

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; 93,78,29,789/- and interest expenditure of ₹ 21,16,26,394/- and it is wrong to claim on the part of the assessee company that no direct or indirect expenditure has been incurred in relation to the exempt income. The CIT(A) while restricting the disallowance held that out of the total investments of ₹ 915,68,01,378/- as appearing in Schedule G investment in non 115O dividend foreign subsidiary is of ₹ 21,15,15,974/- and further investment in Series A NCD Ordyn Technology Priva .....

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ce the disallowance was restricted to ₹ 39,427,835/-. I. Investment as on 1 April 2007 1,714,503,772 Less: Investment in Debentures, etc yielding taxable income 200,000,000 Less: Investment in shares of Foreign Companies likely to yield taxable dividend 11,755,102 Eligible Investment as on 1 April 2007 1,502,748,670(A) Total Assets as on 1 April 2007 6,662,626,622(B) Investment as on 31 March 2008 9,156,801,378 Less: Investment made in India Infoline Investment services 4,613,700,000 Limit .....

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Paid during F.Y. 2007-08 98,888,920(G) Dis-allowance u/r 8D(2)(ii) 24,091,499(G*E/F) II Average Investment out of borrowed funds for F.Y. 2007-08 3,067,267,037(E) 0.5% of Average Investment out of borrowed funds for F.Y. 2007-08 15,336,335 Dis-allowance u/r 8D(2)(iii) 15,336,335 Total Disallowance u/r 8D 39,427,835(I +II) 11. Aggrieved by the orders of the CIT(A), the Revenue is in appeal before us and contended that the CIT(A) erred in excluding ₹ 4,61,37,00,000/- being the investment ma .....

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that the investment of ₹ 4,61,37,00,000/- have been made in the subsidiary company M/s India Infoline Investment Services Ltd. as strategic investment in February 2008 out of the proceeds of fresh shares issued by the assessee company in January 2008 which is also reflected in the CIT(A) orders and no borrowed funds whatsoever had been utilized for the purpose of investment. The assessee company submitted that the company has made fresh issue of shares in January 2008 and the proceeds ther .....

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e company has made investment in the subsidiary company namely M/s India Infoline Investment Services Ltd. of ₹ 4,61,37,00,000/- on 4th February, 2008 out of proceeds of fresh shares issued by the assessee company in January 2008 which is duly reflected from the orders of the authorities below and it is stated by the Ld. Counsel of the assessee company before us that no borrowed funds whatsoever has been utilized by the assessee company for the purpose of making the investment in the said .....

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(ii) of the Income Tax Rules, 1962 r.w.s. 14A of the Act. Coming to the submission of the assessee company that these are strategic investments and no disallowance can be made towards the administrative, interest and other expenses. We would like to mention that under normal circumstances strategic investment are made for the purposes of doing business with a long term horizon and no doubt that the objective is to earn profits/returns from the investment but normally the said profit/returns will .....

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es is not income arising from investment but it is arising from the sale of investment and cannot justifiably in our considered view be considered for exclusion of the strategic investment for computation of disallowance under Rule 8D of Income Tax Rules, 1962 read with Section 14A of the Act. In these type of strategic investments, the investor has to normally devote significant time to plan, execute and monitor these investments regularly and periodically to ensure that these strategic investm .....

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etings of the Board of Directors/Shareholders for which administrative and management expenses are incurred and in some businesses regulatory approvals are required before setting up the same. There will be regular monitoring of these investments which also may require participation in the meetings of committees, Board of Director and Shareholder meetings. There will definitely be an expenditure incurred towards administrative and management cost etc. towards planning, executing and maintaining .....

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ct of any expenditure incurred by the assessee in relation to income, which does not form part of the total income under the Act against the taxable income (see Circular No. 14 of 2001 dated 22-11-2001). In other words, section 14A clarifies that expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income. In many cases the nature of expenses incurred by the assessee may be relatable partly to the exempt income and partly to the taxable income. In the .....

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certain incomes are not includible while computing total income as these are exempt under certain provisions of the Act. In the past, there have been cases in which deduction has been sought in respect of such incomes which in effect would mean that tax incentives to certain incomes was being used to reduce the tax payable on the non-exempt income by debiting the expenses, incurred to earn the exempt income, against taxable income. The basic principle of taxation is to tax the net income, i.e., .....

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orm part of total income under the Act". It means that if an income does not form part of total income, then the related expenditure is outside the ambit of the applicability of section 14A. Further, section 14 specifies five heads of income which are chargeable to tax. In order to be chargeable, an income has to be brought under one of the five heads. Sections 15 to 59 lay down the rules for computing income for the purpose of chargeability to tax under those heads. Sections 15 to 59 quant .....

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e for the purpose of chargeability to tax. The theory of apportionment of expenditures between taxable and non-taxable has, in principle, been now widened under section 14A. Reading section 14 in juxtaposition with sections 15 to 59, it is clear that the words "expenditure incurred" in section 14A refers to expenditure on rent, taxes, salaries, interest, etc. in respect of which allowances are provided for (see sections 30 to 37). ii) The Hon ble Bombay High Court in the judgment in Go .....

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essment year. The relevant extracts are as under: B. Facts 7. The assessee filed its return of income for the assessment year 2002-03 on 29-10-2002, declaring a loss of ₹ 45.90 crores. The assessee had claimed a dividend of ₹ 34.34 crores as exempt from the total taxable income under section 10(33). During the course of scrutiny proceedings, the assessee was called upon to explain why the net dividend income from tax free securities should not be exempted instead of the gross dividen .....

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n a few recent assessment years, has the Income-tax department attributed any interest or expenditure towards the earning of this dividend income". The assessee contended that it had reserves of ₹ 274 crores and capital of ₹ 6.55 crores which would be more than adequate to cover the investments. The assessing officers were, according to the assessee, satisfied in the earlier years with its explanation and it was contended that there was consequently no allocation of interest to .....

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applicable for the assessment year 2002-03 is not includible in computing the total income of the assessee. Consequently, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to such income which does not form part of the total income under the Act, by virtue of the provisions of section 14A(1); (ii) The payment by a domestic company under section 115O(1) of additional income-tax on profits declared, distributed or paid is a charge on a component of the pr .....

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he Income Tax Act 1961, are constitutionally valid; (iv) The provisions of rule 8D of the Income-tax Rules as inserted by the Income-tax (Fifth Amendment) Rules, 2008, are not ultra vires the provisions of section 14A, more particularly sub-section (2) and do not offend article 14 of the Constitution; (v) The provisions of rule 8D of the Income-tax Rules which have been notified with effect from 24-3-2008, shall apply with effect from the assessment year 2008-09; (vi) Even prior to the assessmen .....

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e to place all germane material on the record; (vii) The proceedings for the assessment year 2002-03 shall stand remanded back to the assessing officer. The assessing officer shall determine as to whether the assessee has incurred any expenditure (direct or indirect) in relation to dividend income/income from mutual funds which does not form part of the total income as contemplated under section 14A. The assessing officer can adopt a reasonable basis for effecting the apportionment. While making .....

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l dividend income without incurring any expenses whatsoever including management or administrative expenses. By same logic, it is equally difficult to accept that the only expenses involved in earning the dividend income are those incurred on collection of dividend or on encashing a few dividend warrants. A company cannot earn dividend without its existence and management. Investment decisions are very complex in nature. They require substantial market research, day-to-day analysis of market tre .....

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r nominal expenditure. This aspect of the matter has also received careful attention of Chennai Bench of this Tribunal in Southern Petro Chemical Industries v. Dy. CIT (2005) 3 SOT 157 (Chennai-Trib). After comprehensive consideration of all the relevant aspects of the case including the provisions of law, the Chennai Bench has held that investment decisions are very strategic decisions in which top management is involved and therefore proportionate management expenses are required to be deducte .....

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d down two propositions: one, in view of section 14A inserted in the Income Tax Act with retrospective effect from 1-4-1962, pro rata expenses on account of interest relatable to investment in shares for earning exempt income from dividend are to be disallowed against taxable income and only the net dividend income is to be allowed exemption after deducting the expenses; and two, the expression "expenditure incurred by the assessee in relation to income which does not form part of the total .....

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connection with or for making or earning the dividend income can be regarded as expenditure incurred in relation to dividend income. In Everplus Securities & Finance Ltd. v. Dy. CIT (2006) 101 ITD 151 (Del), the Delhi Bench of this Tribunal has held that merely because the assessee did not earn the dividend out of investment in certain shares does not imply that the provisions of section 14A would not apply to that extent. In Asstt. CIT v. Premier Consolidated Capital Trust (I). Ltd. (2004) .....

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y, these investments in shares were made during the course of the carrying on of business and as is evident from the records, substantial investments had been made by the assessee in earlier years, and during the current year as well the assessee made an investment of ₹ 19 crores. Whether to invest or not to invest and whether to retain the investments or to liquidate the same are very strategic decisions which the management is called upon to take. These are mind-boggling decisions and to .....

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ust Ltd. (supra), applying the decision oi Hon'ble Supreme Court in the case of Distributors (Baroda) (P) Ltd. v. Union of India (1985) 47 CTR (SC) 349: (1985) 155 ITR 120 (SC), reversed the decision of the Hon'ble Bombay High Court in CIT v. United General Trust (P) Ltd. (supra), wherein the question was as under: "Whether, on the facts and in the circumstances of the case and in law, the Tribunal was justified in applying the decision of the Bombay High Court in the case of CIT v. .....

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uting the dividend income. In the decision of the Hon'ble Calcutta High Court, relied upon by the learned counsel for the assessee, Mr. Dastur, in the case of CIT v. United Collieries Ltd. (supra), it has been held that if the facts of a particular case so warrant, the allocation can be made towards expenses. In view of the aforementioned discussion and keeping in view the submissions of the learned Departmental Representative, we restore this matter to the assessing officer to verify the qu .....

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