Section 14A – No disallowance can be made (i) in the absence of any exempt income earned during the year; or (ii) if investment is also capable of generating taxable income.
Facts:
All the assessees in the present case were investment and trading companies. They issued unsecured optionally convertible premium notes of Rs. 1 lakh each. As per the terms of the said issue, the premium note holders could convert the said premium notes into equity shares of the company at the end of maturity period or redeem the same at any time after the end of three years from the date of allotment. In case of early redemption, the premium note holders were entitled to a proportionate premium. During the year under consideration, the premium so paid was claimed by the assessee as deduction being allowable as business expenditure.
The AO found that the amount received by the assessee on issue of premium notes was utilised for making investment in the purchase of shares of Reliance Utilities and Power Ltd. (‘RUPL’) the income arising there from was exempt u/s 10(23G). As the expenditure incurred was for the purpose of earning exempt income, the AO held that the premium paid on redemption of premium notes was liable to be disallowed u/s 14A. He further held that the fact that no exempt income in the form of dividend was actually earned by the assessee in the year under consideration was not relevant. In this regard, he placed reliance on the decision of the Supreme Court in the case of CIT v. Rajendra Prasad Moody 115 ITR 519. As regards the assessee’s contention that the premium paid on redemption of premium notes was the expenditure incurred for the purpose of its business which should be allowed u/s 36(1)(iii), the AO observed that even though making of investment in shares was the object contained in the Memorandum and Articles of Association of the assessee companies, the same alone was not a conclusive yardstick to ascertain the nature of business activity carried on by the assessee in the year under consideration. Further, he noted that there was no cogent material to support and substantiate the case of the assessees that making of investments in the shares of RUPL was a part of their business activities.
On appeal, the CIT(A) upheld the disallowance made by the AO. He noted that the entire income credited to Profit and Loss account was assessable to tax under the head “Income from other sources” by virtue of section 56(2)(i). Accordingly, he held that the investments in securities made by the assessees were held by them as investment and not as a trading asset. Hence, the expenditure incurred on payment of premium on redemption was not the expenditure incurred for the purpose of business. He held that the premium paid on redemption of premium notes, which had been utilised by the assessee for making investment in shares/ debentures of RUPL was allowable as deduction only against interest/dividend income received from RUPL and such income being totally exempt from tax u/s 10(23G), the premium paid was rightly disallowed u/s 14A by the AO.
Before the tribunal, the revenue supported the orders of the lower authorities and contended that the assessee was not in the business of investment and the investment made in RUPL was only to earn dividend and for no other consideration. It was further contended that even otherwise, it makes no difference as far as disallowance of redemption premium u/s 14A was concerned, as the same was the expenditure incurred in relation to earning of exempt income. As regards the argument of the learned counsel for the assessee that the investment in shares had the potential of earning taxable income also, it was submitted that this aspect will not preclude the applicability of law u/s 14A as has been held by the Mumbai tribunal in the case of ITO v. Daga Capital Management (P) Ltd. (2008) 119 TTJ (Mum) (SB) 289. Regarding the argument of assessee that there being no exempt income earned by the assessees in the year under consideration, no disallowance of expenditure u/s 14A could be made, the revenue contended that it was wrong to claim that there should be tax free income in the same year for invoking the provisions of section 14A. In support of this contention, it placed reliance on the following decisions :
1. Everplus Securities & Finance Ltd. v. DCIT 102 TTJ (Del) 120.
2. Harsh Krishnakant Bhatt v. ITO 85 TTJ (Ahd.) 872.
3. ITO v. Daga Capital Management Pvt. Ltd. 117 ITD 169.
4. M/s Cheminvest Ltd. v. ITO and Others ITA No.87/ Del/2008 & ITA No.4788/Del/2007.
5. Godrej & Boyce Mfg. Co. Ltd. v. DCIT 328 ITR 81(Bom.).
Held:
The tribunal noted that the proceeds of premium notes on which the impugned redemption premium was paid by the assessee had been invested in the shares/debentures of RUPL and although the dividend income and income from long term capital gain from the said investment was exempt from tax u/s 10(23G), perusal of the Notification issued u/s 10(23G) showed that such exemption was initially granted only for the specific period i.e. assessment year 1999-2000 to 2001-2002 which was further extended upto assessment year 2004-05 subject to satisfaction of certain conditions. Keeping in view all these uncertainties and contingencies, the tribunal agreed with the contention of the assessee that the premium paid by the assessee on redemption of premium notes utilised for making investment in the shares/debentures of RUPL cannot be regarded as expenditure incurred, exclusively in relation to earning of exempt income so as to invoke the provisions of section 14A. It further noted that the said investment had the potential of generating taxable income also in the form of short term capital gains etc.
As the issue involved in the present cases as well as all the material facts relevant thereto were similar to that of the case of Delite Enterprises Pvt. Ltd. ((ITA No.2983/M/2005)), which was confirmed by the Bombay high court, the tribunal followed the said decision and deleted the disallowance made by the AO and confirmed by the learned CIT(A). As regards the case laws cited by the revenue, it observed that in none of those cases, the facts involved were similar to the case of the present assessees in as much as the investment made therein was not found to be capable of earning taxable as well as exempt income which was actually not earned by the assessee in the relevant period as were the facts of the case of the assessees.
