2006 (7) TMI 357 - AT - Income Tax

Disallowance out of interest expenditure and out of depository and custodial charges - Expenditure incurred in relation to income not includible in total income - disallowance of Depreciation claimed on leased assets - assets were actually used by the lessee so as to entitle the lessor to claim depreciation thereon? - HELD THAT - The facts narrated clearly shows the intention to earn the profit on share trading and not to earn dividend income. Thus, the provisions of section 14A cannot be invoked to hold that the expanses by way of interest and depository/custodial charges were incurred in relation to dividend income which does not form part of the total income. We find that even but for the provisions of section 14A, the expenses incurred in relation to income which does not form part of the total income cannot be allowed. The expenses are allowable while computing the income chargeable to tax. If the income itself is not formed part of total income, the expenses cannot be said to have been incurred for anything else than the earning of the income and in such a situation the expenses could not have been allowed. Thus, in our opinion, the introduction of provisions of section 14A by Finance Act, 2001 with retrospective effect from 1-4-1962 has not material altered the situation. That is why section 14A has been amended by introducing sub-section (2) and sub-section (3) thereon by Finance Act, 2006 with effect from 1-4-2007. Thus, from the aforesaid amendment is clear that but for the prescribed method, the Assessing Officer cannot merely allocate the expenses in relation to trading results by proportionately disallowing the same. The provisions of sub-sections (2) and (3) to section 14A are to take effect from assessment year 2007-08 onwards and we do not find any implication to hold the same to be retrospective in nature. Thus, we hold that no part of the interest expenses and depository/custodial charges can be disallowed by holding the same as incurred in relation to earning as exempt income. Depreciation on Lease assets - HELD THAT - In the present case, the facts show that the assets were acquired prior to 23rd March, 1999 and were made available to the lessee. As per requirement of DGCA, the assessee had to obtain installation of such system. But this will not determine the date of assets being put to use. So far as appellant lessor is concerned the same can be considered as having been put to use for the purpose of its leasing business once the same are handed over to the lessee. We accordingly hold that the provisions of section 32 has been complied with and the claim of depreciation by such addition to the asset is allowable. In the result, all the appeals are allowed.

Summary

Issues Involved:
1. Disallowance of interest expenditure and depository/custodial charges under section 14A.
2. Disallowance of depreciation on the addition to the aircraft owned by the assessee and leased in the course of leasing business.

Issue-wise Detailed Analysis:

1. Disallowance of Interest Expenditure and Depository/Custodial Charges under Section 14A:

The first issue common in all the appeals relates to disallowance out of interest expenditure and disallowance out of depository and custodial charges. The disallowance is on the ground that the expenditure is incurred for earning the dividend income on shares which are held as stock-in-trade and such dividend income is not forming part of total income. The Assessing Officer invoked the provisions of section 14A disallowed proportionate interest expenses and depository and custodial charges in proportion to the various components of income like profit from share trading, interest received, and dividend.

The Assessing Officer noted that the assessee has borrowed the money for shares held as investments as well as for trading. The assessee is an investment company and the main object of the company is to earn income from investment, financing, leasing the equipment, trading in shares, etc. The Assessing Officer also held that earning profit from trading in shares and earning dividend are inseparable from each other.

Learned CIT(A) confirmed the action of the Assessing Officer. He held that any decision for investment in shares is being made to earn a dividend as well as to earn profit thereon. He further held that the activity of trading in shares and earning of dividend income is a composite activity that is inter-related and inter-dependent. Thus, the earning of dividend in the case of a dealer in shares is to be treated as business income and accordingly, the interest and depository/custodial charges in relation to such shares are to be proportionately disallowed on the basis of various components of income.

The learned counsel for the assessee submitted that the assessee being an investment and finance company was carrying on the business of financing, investments as well as trading/dealing in shares and securities. It had raised interest-bearing loans and advances, which were utilized in financing business as well as in the business of trading/dealing in shares and securities. The purposes of raising the interest-bearing loans were to use the money in the business of trading/dealing in shares and securities to earn profits therefrom. The profits and gains derived from such trading are chargeable to tax under the head 'Profits and gains of business or profession'. While the appellant was holding certain shares as stock-in-trade, it received dividends by virtue of being a shareholder on the record date. It is obvious that the dividend income is incidental to such holding of shares and the assessee was not holding the same with a view to earn a dividend. Accordingly, no interest cost was directly or indirectly incurred for earning such dividend income. He submitted that in the assessment year 1999-2000, total profit from share trading was Rs. 14.90 crores and the dividend from shares held as stock-in-trade was merely Rs. 13.49 lakhs. This comes to even less than 1 percent of the profit in share trading. Thus, the fact proves that earning the dividend income is not the main intention behind dealing in shares but it was merely to earn profit from such share dealing. The interest paid is allowable under section 36(1)(iii) of the Act provided the money is utilized for the purpose of business. The fact that the amount has been borrowed for the purpose of business, has not been denied. The learned CIT(A) has gone to the extent of holding that even the dividend income is to be treated as business income. Thus even under the provisions of section 14A, there cannot be proportionate disallowance so long as it is not held that the expenditure is incurred in relation to income which does not form part of the total income. Similarly, the depository and custodial charges are paid in respect of the demat account maintained for trading in shares. Since the expenses are incurred wholly and exclusively for the purpose of business and not merely for earning the dividend income, no part of such expenditure can be attributed to earn the dividend income and no disallowance can be made on a proportionate basis. The learned counsel for the assessee relied upon the decisions of Minos Trading (India) (P.) Ltd. v. CIT and Asstt. CIT v. Eicher Ltd.

The learned DR, on the other hand, strongly relied upon the appellate order. He submitted that since the assessee is earning the dividend income which is exempt under the provisions of section 10(33) of the Income-tax Act and since the total expenses are composite which are not bifurcated by the assessee either for the purpose of business or for earning dividend income, the Assessing Officer was justified in allocating the same in proportion to the income received. Thus, the action of the Assessing Officer as upheld by learned CIT(A) is required to be confirmed.

The Tribunal considered the relevant facts, arguments advanced, and the decisions relied upon. It was noted that the assessee has major activity in share trading, financing, and leasing etc. For assessment year 1999-2000, turnover in trading in shares exceeds Rs. 1,200 crores. The interest earned on advances is exceeding Rs. 23.78 crores whereas the dividend on investment on shares held as stock-in-trade is merely Rs. 13.49 lakhs. The Assessing Officer as well as learned CIT(A) has found as a matter of fact that earning profit by trading in shares and earning dividend are inseparable. However, the Tribunal found that the dividend is merely incidental to the holding of shares for a particular period when the dividend is declared. The intention seems to be clear that the shares were purchased merely for trading in the same and not for earning dividend thereon. Thus, it cannot be said that the expenses on interest were incurred or the depository/custodial charges were incurred merely to earn dividend income. The facts narrated above clearly show the intention to earn the profit on share trading and not to earn dividend income. Thus, the provisions of section 14A cannot be invoked to hold that the expenses by way of interest and depository/custodial charges were incurred in relation to dividend income which does not form part of the total income.

It was noted that even but for the provisions of section 14A, the expenses incurred in relation to income which does not form part of the total income cannot be allowed. The expenses are allowable while computing the income chargeable to tax. If the income itself is not formed part of the total income, the expenses cannot be said to have been incurred for anything else than the earning of the income and in such a situation the expenses could not have been allowed. Thus, the introduction of provisions of section 14A by Finance Act, 2001 with retrospective effect from 1-4-1962 has not materially altered the situation. That is why section 14A has been amended by introducing sub-section (2) and sub-section (3) thereon by Finance Act, 2006 with effect from 1-4-2007. The Tribunal referred to the decision of the Delhi Bench of the Tribunal in the case of Eicher Ltd. which held that the Assessing Officer can disallow only expenditure "incurred" by the assessee in relation to the exempt income. The word "incurred" clearly implies that it must be shown as a fact that some expenditure was in fact incurred by the assessee to produce exempted income. The Tribunal agreed with this view and held that no part of the interest expenses and depository/custodial charges can be disallowed by holding the same as incurred in relation to earning as exempt income.

2. Disallowance of Depreciation on the Addition to the Aircraft Owned by the Assessee and Leased in the Course of Leasing Business:

The next ground of appeal for assessment year 1999-2000 is against disallowance of depreciation on the addition to the aircraft owned by the assessee and leased in the course of leasing business. The Assessing Officer held that as per the annual accounts, depreciation is not charged on such addition to assets as the same were not put to use. Since the assessee has failed to furnish any evidence regarding the user of assets, the depreciation claimed cannot be allowed. The learned CIT(A) endorsed the view by holding that when the auditors themselves had certified that the asset was not put to use, the question of allowing depreciation on such addition does not arise.

The learned counsel for the assessee submitted that the appellant is the owner of one King Air C 90B Aircraft, on which lease rental income was received at Rs. 85.85 lakhs during the previous year relevant to assessment year 1999-2000. The said aircraft was acquired by the appellant in the year 1995 for a total cost of Rs. 6.87 crores. In the said aircraft, the Global Positioning System (GPS) is inbuilt/already installed. As per the Civil Aviation Department, Government of India guidelines, the existing GPS did not ensure adequate safety in hilly areas, therefore, as against the same a Ground Proximity Warning Signal System (GPWS) which was capable of providing enhanced flight safety especially while flying over the hilly areas and avoid fatalities was required to be installed. With a view to comply with the mandatory instructions issued by the Director General of Civil Aviation Department, Government of India (DGCA) the appellant had got installed GPWS which was imported from M/s. American Avionics Inc., USA. As per DGCA requirements, no person was permitted to operate turbine engine aeroplane unless it was equipped with GPWS system on or before the 31st December, 1988 (Later extended till 31st day of March, 1999). Therefore, to remove the legal obstruction/restrictions and to comply with the DGCA instructions, the appellant had bought the said part. If the appellant would not have incurred this expenditure, its aircraft would have come to a permanent halt and would have lost airworthiness. In the audited accounts dated 22nd October, 1999, the cost of the GPWS part was shown as additions to the aircraft and no depreciation in the books was charged. However, in the tax audit report under section 44AB, the statutory auditor shown the cost of GPWS as addition to aircraft and depreciation allowable thereon was computed at Rs. 3,41,149. In the return of income, the appellant claimed the depreciation as computed by the tax auditor in its tax audit report. In fact, the said GPWS system was installed on 31st March, 1999 but after installation, the aircraft was subjected to test flights to check the operation of GPWS in various modes and after having standard air worthiness practices issued by the DGCA, a formal installation certificate was issued on 8th April, 1999. He submitted that the assets are not used by the assessee himself but the aircraft has been leased and since the assets acquired are handed to the lessee before the end of the relevant financial year, so far as assessee is concerned, in the course of its leasing business, it should have been treated as used for the purpose of business so as to claim depreciation thereon. For this proposition, he relied on the decision of Hon'ble Supreme Court in the case of CIT v. Shaan Finance (P.) Ltd.

The learned DR, on the other hand, relied upon the appellate order. He submitted that when the auditors themselves certified that the assets were not put to use, the assessee on the basis of the tax audit report itself cannot claim the depreciation. The certificate was issued by Director General of Civil Aviation (DGCA) on 8-4-1999 i.e., after the end of the relevant financial year. Thus, it is clear that the asset was not put to use before the end of the relevant financial year and hence, the depreciation thereon is not admissible.

The Tribunal considered the rival submissions and the case laws cited. It was noted that the assessee is owning the aircraft and in the course of its business of equipment leasing, leased the same. As per the terms of the lease, the assessee is also required to keep the same airworthy so as not to interrupt flying of the same. As per the direction of DGCA, the assessee was required to install the same and hence, in fulfilment of its obligation installed the desired GPWS system. Such asset was acquired prior to 31-3-1999 and was handed over to the lessee before the end of the relevant financial year. In the case of lease of assets, it cannot be insisted that the assets were actually used by the lessee so as to entitle the lessor to claim depreciation thereon. The expression "owned by the assessee and used for the purpose of business or profession" in section 32 is to be understood from the point of view of the lessor. The words "used for the purpose of business" in section 32 are to be read in conjunction with the words "by the assessee". Thus, the user has to be seen in the hands of the assessee as lessor and not by the lessee. The assessee having parted with the assets by delivering the same to the lessee, it can be said that the assets are used for the purpose of business. In the present case, the facts show that the assets were acquired prior to 23rd March, 1999 and were made available to the lessee. As per the requirement of DGCA, the assessee had to obtain installation of such system. But this will not determine the date of assets being put to use. So far as appellant lessor is concerned the same can be considered as having been put to use for the purpose of its leasing business once the same are handed over to the lessee. The Tribunal accordingly held that the provisions of section 32 have been complied with and the claim of depreciation by such addition to the asset is allowable.

In the result, all the appeals are allowed.