TMI Blog2022 (9) TMI 1235X X X X Extracts X X X X X X X X Extracts X X X X ..... t under the mercantile system of accounting, interest accrues to the assessee as income, irrespective of actual receipt of payment. In the case of preference shares, such an inference cannot be drawn and the repayment of the face value of the preference shares as well as the premium on redemption is uncertain. In such circumstances, the action of the Revenue authorities in making the impugned additions cannot be sustained. We, therefore, hold that the income brought to tax by the Revenue authorities cannot be sustained and the said addition is directed to be deleted. Whether the revenue authorities can overlook the legal effect when a person holds cumulative preference shares and treat as loan instrument rather than a share capital/equity instrument? - The revenue authorities cannot disregard the legal effect of issue of cumulative preference shares and say that the same is akin to debt and therefore the cumulative preference shares which is a capital instrument is a debt or in the nature of debentures. The decision of ENAM SECURITIES (P.) LTD. [ 2012 (5) TMI 257 - BOMBAY HIGH COURT] is a complete answer to the question that the revenue authorities cannot disregard the leg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... investment in an unlisted and unquoted security and is therefore definitely exigible to tax. Section 14A comes into play only in the case of investment, income from which, is completely exempt from tax. Hence the question of any disallowance u/s 14A in respect of interest paid on loans, which are utilised to make the investment, is to be allowed as a business expenditure. If the same is claimed and allowed as a business expenditure, the same cannot be treated as part of cost of investment and be allowed for indexation while determining cost at the time of redemption of the shares. Therefore, the disallowance cannot be sustained even by application of the provisions of Sec.14-A of the Act. We hold that the Revenue authorities were not justified in adding a sum being notional premium receivable on preference shares as income of the assessee. The appeal of the assessee is accordingly allowed. Interest on delayed remittance of TDS - Whether such interest partakes the character of tax and hence is not an allowable deduction? - HELD THAT:- In so far as the nature on the interest on delayed remittance of TDS is concerned, this Tribunal has been taking a consistent view following t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eal of the assessee is allowed while appeal of the Revenue is partly allowed. - ITA No.2332/Bang/2019 And ITA No.2550/Bang/2019 - - - Dated:- 19-9-2022 - Shri N.V. Vasudevan, Vice President And Ms. Padmavathy S, Accountant Member For the Assessee : Shri V. Chandrashekar, Advocate For the Respondent : Shri Manjunath Karkihalli, CIT(DR)(ITAT), Bengaluru ORDER PER N. V. VASUDEVAN, VICE PRESIDENT: ITA No.2332/Bang/2019 is an appeal by the assessee while ITA No.2550/Bang/2019 is an appeal by the Revenue. Both these appeals are directed against the Order dated 17.09.2019 of CIT(A) - 2, Bengaluru, to Assessment Year 2016-17. 2. First, we shall take up for consideration ITA No.2332/Bang/2019, being appeal by the assessee. The only issue that arises for consideration in this appeal by the assessee is as to whether the Revenue authorities were justified in adding a sum of Rs.17,09,02,887/- being notional premium receivable on preference shares as income of the assessee. The grievance of the assessee in this regard is projected in ground Nos.3 to 5 raised by the assessee before the Tribunal, which reads as follows: 3. The learned Commissioner of Income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ence shares subscribed to by the assessee contains features of equity and debt as the dividend payments to preference shareholder (assessee) is fixed from the beginning. Like a bond or debenture, the receipt of financial benefit/interest/premium is assured from the beginning. The assessee maintains books of accounts on mercantile basis. Therefore, the taxability of the same does not depend upon receipt of the premium or otherwise. What is important here is that the rate of dividend or rate of interest is 8% on cumulative basis or 14% interest on IRR basis, which is fixed in the offer document subscribed to the assessee. Cumulative Preference shares ensures that missed out dividend payments are carried forward. The fixed rate ensures the dividend due to the investor during the year. Its' payment may be uncertain, but its accrual is certain in case of a cumulative preference shares. Therefore, income need to be taxed on due basis. For the above reasons, the AO treated the cumulative preference shares as akin to debt instrument on which the assessee is entitled to a fixed rate of premium/ dividend The AO therefore, treated the dividend on Preference share as equal to interest. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and will be taxable as interest income (where the bonds are held as investments) or business income (where the bonds are held as trading assets). According to the AO, though the Circular No.2/ 2002 specifies Deep Discount Bonds and Strips, it has a bearing on the assessee's case which is holding of Preference shares, which is hybrid of both debt and equity instrument. 8. For the above reasons, the sum of Rs. 17,09,02,857/ - credited to the books of accounts as premium on preference shares was brought to tax under the head Income from Other Sources , by the AO. 9. Aggrieved by the aforesaid addition made by the AO, the assessee preferred before the first appellate authority, Commissioner of Income Tax (Appeals) [CIT(A)]. Before CIT(A), assessee submitted that the view taken by the AO is not correct for the following reasons: 1. The assessee had in its return of income originally filed, had mistakenly, offered the premium to tax on an annualized basis. On realizing its mistake, it promptly filed a revised return, well in time, by withdrawing the same as income. The assessee did not make any other change in its revised return. 2. The act of Redemption of Preference S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Shares are different from Bonds and Debentures and being Capital in nature is eligible to benefit of indexation. 6. The assessee, submitted that the alternate case made out by the AO, by applying the provisions of Sec.14A of the act, cannot be sustained because, the premium on redemption is exigible to tax under the head 'Income from Capital Gains' and is not exempt from tax. Further the investment in preference shares is to be regarded as an investment in an unlisted and unquoted security is therefore definitely exigible to tax. Section 14A comes into play only in the case of investment, income from which, is completely exempt from tax. Hence the question of any disallowance u/s 14A in respect of interest paid on loans, which are utilised to make the investment, is to be allowed as a business expenditure. If the same is claimed and allowed as a business expenditure, the same cannot be treated as part of cost of investment and be allowed for indexation while determining cost at the time of redemption of the shares. 10. The CIT(A) however concurred with the view of the AO. He formulated the issue that he has to decide viz., Whether the AO was right in adding the shar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the share to determine whether it exhibits the fundamental characteristic of a financial liability. For example, a preference share that provides for redemption on a specific date or at the option of the holder contains a financial liability because the issuer has an obligation to transfer financial assets to the holder of the share. The potential inability of an issuer to satisfy an obligation to redeem a preference share when contractually required to do so, whether because of a lack of funds, a statutory restriction or insufficient profits or reserves, does not negate the obligation. An option of the issuer to redeem the shares for cash does not satisfy the definition of a financial liability because the issuer does not have a present obligation to transfer financial assets to the shareholders. In this case, redemption of the shares is solely at the discretion of the issuer. An obligation may arise, however, when the issuer of the shares exercises its option, usually by formally notifying the shareholders of an intention to redeem the shares. AG26 When preference shares are non-redeemable, the appropriate classification is determined by the other rights that attach to them ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gains tax on it or can claim if there is any capital loss after computing indexed cost of acquisition. The CIT(A) also distinguished the two decisions of Hon ble Supreme Court in the cases of Anarkali Sarabhai Vs CIT 224 ITR 422 and Karthikeya Sarabhai Vs CIT 228 ITR 163 and the decision of ITAT Mumbai in the case of M/s Parley Biscuits Pvt Ltd Vs ACIT in support of its argument by observing that all these case laws address the issue of whether redemption of preference shares would amount to transfer within the meaning of Section 2(47) of the Income-tax Act. In these cases, the investment of the assessee in preference shares were redeemed which resulted in some capital gains to the assessee because the shares were redeemed at a higher price compared to the issued price and the assessee was contesting that it was not liable to pay capital gains tax as there was no capital gain since the redemption of preference shares did not amount to transfer u/s 2(47) of the Income tax Act. The Supreme Court ruled that the redemption of preference shares amounted to transfer within the meaning of Section 2(47) of the Income tax Act and the assessee was liable to pay the tax on capital gains it r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cited before us. Further, learned Counsel placed reliance on the decision of the Hon ble Bombay High Court in the case of Aditya Prakash Entertainment Pvt. Ltd., Vs. Magikwand Media Pvt. Ltd., CP No.404/2016, judgment dated 05.03.2018. In the aforesaid decision, the preference shareholders filed a petition for winding up of the company under section 433(e) of the Companies Act, 1956, to wind up the company on the ground that the company is unable to pay its debts. It was a case of the petitioners that they were holders of redeemable preference shares and despite exercising of option to redeem the preference shares, the company did not make payment and despite the fact the company had profits. The Hon ble Bombay High Court, on consideration of several decisions, held that when a company issues redeemable preference shares, it is not obtaining loan as it could by issuing debentures. There is a fundamental difference between the capital made available to a company by issue of a share and money obtained by a company under a loan or a debenture. Respective incidences and consequences of issuing a share and borrowing money on loan or on a debenture are different and distinctive. Relying ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... INR 1,000/- (Rupees One Thousand Only) each. 4. Redemption Premium Preference Shares shall be redeemed at such price, so as to net a premium of 16.5% per annum. Such premium shall accrue on a year on year basis and shall be payable on the Redemption Date. 5. Voting The Shareholder shall not have the right to receive notice of, or to attend and vote at a shareholders/general meeting of the Company. 6. Redemption Methodology At any time after the date of issue of the Preference Shares, the Company, subject to the approval of the Board of Directors, may redeem all or part of the Preference shares at a redemption price equal to the face value of the Preference Shares. 7. Liquidation In the event of liquidation or winding-up of the Company, each Shareholder shall be ranked lower than creditors but higher than equity shareholders and shall have priority of payment of capital over the equity shareholders. 17. A read ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... capital instrument is a debt or in the nature of debentures. A similar question arose for consideration before the Hon ble Bombay High Court in the case of Enam Securities Pvt. Ltd. (supra). The facts of the case before the Hon ble Bombay High Court were that the assessee in that case had subscribed to the purchase of 4 lakh preference shares each of Rs.100/- of an aggregate value of Rs.4 crores from a company by the name of Enam Finance Consultants Pvt. Ltd. in 1992. The preference shares were to carry a dividend of four percent per annum and were to be redeemable after the expiry of ten years from the date of allotment. During the course of Assessment Year 2001-02, the assessee redeemed three lakh shares at par and claimed a long-term loss of Rs. 2.73 crores after availing of the benefit of indexation. The Assessing Officer disallowed the claim of set off of long-term capital loss that arose on redemption against long term capital gain on the sale of other shares on the ground that (i) Both the assessee and the Company in which the assessee held the preference shares, were managed by the same group of persons; and (ii) There was no transfer and that the assessee was not entitled ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fer of a long term capital asset being bonds or debentures other than capital indexed bonds issued by the Government. The Assessing Officer was of the view that the principal characteristic of a bond is a fixed holding period and a fixed rate of return. According to him, the four percent non-cumulative redeemable preference shares which the assessee redeemed also had a fixed holding period and a fixed rate of return and on this basis denied the benefit of cost indexation to the assessee. 8. The entire basis on which the Assessing Officer denied the benefit of cost indexation was in our view flawed and was justifiably set right in the order of the Tribunal . The Income Tax Act, 1961, does not contain a definition of bonds or debentures. Both those concepts have a well settled connotation in law, particularly in the provisions of the Companies' Act, 1956. Section 2(12) of the Companies' Act, 1956 defines the expression debenture to include debenture stock bonds and any other securities of a company, whether constituting a charge on the assets of the company or not. Under Section 80(1) a company limited by shares may, if so authorised by its articles, issue preference sh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... performed, as the case may be . Debt securities typically are regarded as consisting of notes, debentures and bonds. Technically, a 'debenture' is an unsecured corporate obligation while a 'bond' is secured by a lien or mortgage on corporate property. However, in commercial parlance, the expression bond is often used indiscriminately to cover both bonds and debentures. As a matter of fact, the Companies' Act, 1956 in Section 2(12) defines 'debenture' to include debenture stock bonds and any other securities of a company, whether or not they constitute a charge on the assets of the Company. A bond is a formal document constituting the acknowledgement of a debt by an enterprise and normally contains a provision regarding repayment of principal and interest. There is a clear distinction between bonds and share capital because a bond does not represent ownership of equity capital. Bonds are in essence interest bearing instruments which represent a loan. This distinction has been accepted by the Supreme Court in R.D. Goyal vs. Reliance Industries Ltd. The Supreme Court noted that a debenture is simply an instrument of acknowledgement of debt by a company wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ore, specific Action Plan, viz., Limiting Base Erosion Involving Interest Deductions and Other Financial Payments ( BEPS Action Plan 4 ) has been devoted by the OECD to tackle BEPS through payments in the nature of interest and payments economically equivalent to interest. In BEPS Action Plan 4, OECD has set out the best practice approaches for countries to prevent erosion of their tax base by way of excess interest deductions claimed by multinational group entities. BEPS Action Plan 4 is focused on the use of third-party, related-party, and intra group debt to obtain excessive deductions or to finance the production of exempt or deferred income. Adopting the recommendations of BEPS Action Plan 4, India introduced section 94B in the domestic tax law, viz., Income-tax Act, 1961 ( the Act ), as an anti-tax avoidance provision to restrict deduction of interest paid to non-resident associated enterprises (AEs). As already stated, the said provisions are applicable only when interest is paid to non-resident associated enterprises and such a feature is absent in the present case. 20. With regard to the alternate case made out by the AO by placing reliance on the provisions of Sec. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed by the AO. The assessee, during the course of assessment proceedings, clarified that the nomenclature that Interest Paid on Delayed Payment of Tax is misleading and the actual components of the same are as under: 24. Before the CIT(A), the assessee filed the details of the above payments called for during the course of the appellate hearing before the CIT(A). Before the CIT(A), the assessee placed reliance on the decision of the Kolkata bench of the ITAT in the case of DCIT vs. Narayani Ispat Pvt Ltd in ITA No.2127/KoI/2014, by order dated 30/08/2017, wherein the ITAT, following the decision of the Hon'ble Supreme Court in the case of Lachmandas Mathura vs CIT 254 ITR 799, held that interest paid for reasons of delay in remittance of Service Tax TDS is compensatory in nature and not in the nature of Penalty. The ITAT held that remittance of TDS is not the same as payment of Income tax. 25. The CIT(A) agreed with the contention of the assessee and held that from the details furnished it was clear that there is not a single payment which is in the nature of penalty. The interest paid is on delayed payment to Vendors, Delayed remittance of statutory liabilities s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Megaspace IT Solutions 420018 Trishitha Consltancy 941417 iDeccan Systems 5853634 Hexoct Geospatial 1902224 Wipro 19758387 Esyasoft Technologies Pvt Ltd 20646026 IBM India Pvt Ltd 8627573 The AO made the aforesaid addition of Rs.8,09,73,776/- to the total income of the assessee on the ground that the assessee failed to prove the genuineness and creditworthiness of the credits, in spite of repeated reminders. 29. Before CIT(A), the assessee has produced the ledger account extracts, confirmation of balances, PAN No's, Addresses reconciliation statement, where required of the sundry creditors. Before CIT(A), the assessee submitted that in all these cases, the bills raised on the assessee are subjected to Sales Tax or Service Tax as the case may be and are all genuine transactions. Most of the entities are highly reputed organizations and the question of suspecting the genuineness of these transactions does not arise. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A.Y. 2015-16, which included Service Tax of Rs.1,74,052/-. The Assessee after deducting TDS of Rs.1,40,818/- was due to pay an amount of Rs. 14,41,417/-. The Assessee has made payment of Rs. 5,00,000/- to the Creditor and the balance o/s as on 3.1/03/2016 is Rs. 9,41,417/-. Further this amount is also the opening balance due as on 01/04/2015 and cannot be added in this impugned assessment year. iDeccan Systems: The AO has added the entire closing balance of Rs. 58,53,634/- as on 31/03/2016. Further this amount is also the Opening balance due as on 01/04/2015 and cannot be added in this impugned assessment year in any case. However, the Assessee had a dispute with the Creditor on the quality of work done by the Creditor and has had to incur a sum of Rs. 51,47,916/- in the A.Y. 2018-19, as a result of lapses on the part of the Creditor and has debited the Party by this amount. The addition made is deleted. Hexoct Geospatial: The AO has added the entire closing balance of Rs. 19,02,224/- as on 31/03/2016. The Assessee has made payment of Rs. 10,00,000/- to the Creditor on 02/06/2016, Rs. 5,00,000/- on 12/09/2016, Rs.2,00,000/- on 18/00/2017 Rs.2,02,224/- on 23/10/2017, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wer that the Commissioner has made the enquiry and therefore no fault can be found in the action of the CIT(A). It was further submitted that the Hon ble Karnataka High Court in the case of CIT Vs. Sanu Family Trust (2012) 209 Taxman 529 (Karnataka) has taken a view that rigors of the Rule 46A(1) to (3) will not be attracted when the Commissioner exercises his inherent power under 46A(4) of the Rule and calls for evidence for the purpose of deciding an issue in the appeal. Learned DR pointed out that in the present case, the additional evidence was filed by the assessee by itself and the CIT(A) did not call for any additional evidence under the Rule 46A(4) of the Rules and therefore the decision cited by the learned Counsel for the assessee will not be applicable to the facts of the present case. 32. We have given a very careful consideration to the rival submissions. It is no doubt true that under section 250(4) of the Act, the CIT(A) hearing an appeal can make such further enquiries as it thinks fit. But the aforesaid provision cannot be construed in a manner to say that the CIT(A) should not follow the procedure laid down in Rule 46A of the Rules, except with an exception pro ..... X X X X Extracts X X X X X X X X Extracts X X X X
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