2007 (8) TMI 640 - AT - Income Tax

Disallowance u/s 36(1)(iii) - Interest paid on borrow funds - Disallowing deduction u/s 36(1)(iii) in respect of interest paid on borrowings which were utilized for acquiring shares as long-term investments? - Such Interest paid related to earning of dividend income which was exempt income u/s 10(33) and consequently the same was disallowable u/s 14A? - HELD THAT - The interest paid on the borrowed funds at the most could be allowed against the dividend income if investment is made to earn the dividend income. The contention of the assessee is that investment was not made to earn dividend income. Therefore such deduction could not be allowed even against the dividend income. Even otherwise such income being exempt the question of deduction against dividend income becomes academic. The interest paid as per the contention of learned counsel for the assessee could relate to the profits arising from sale of investments since the main object was to hold the investments. Since income arising from sale of investment has to be computed under the head Capital gains the deduction has to be allowed only in accordance with the provisions specified under the head Capital gains . The Legislature was aware of the aspect of inflation of price and therefore it made provisions to determine the indexed cost of acquisition which would take care of interest cost also. No separate deduction is allowable under this head in respect of interest paid on borrowed funds. Thus in our opinion no deduction is allowable to the assessee in respect of interest paid on borrowed funds. All the provisions contained in sections 30 to 43D provide that deduction shall be allowed in respect of the expenditure or allowance mentioned therein. The deduction pre-supposes the existence of receipts chargeable under this head. If the receipts are to be considered under other heads then question of deduction under the head Profits and gains from business or profession would not arise. As already pointed out receipts and expenditure must go together. We may clarify that the receipt may be actual or to be received in future. The receipt may be on accrual basis. There may be cases that there is no receipt in one year and it may be received in the next year. In such cases the loss may be computed because receipts may be expected in next year. The crux of the matter is that there must be receipts either actual or on accrual basis before a deduction can be allowed therefrom. Consequently if receipts in respect of which expenditures are incurred are considered under other heads then the question of determining any income under the head Profits or gains from business or profession does not arise. Hence the contention of the assessee is rejected. Another contention of learned counsel for the assessee is that interest paid should be allowed as deduction against the income by way of interest on debentures which has been assessed on business income. We are unable to accept this contention too. Assessee cannot plead that income from dealing in shares be taken at Rs. 50, 000 and deduction on account of interest on borrowed funds be set off against brokerage income. Thus it cannot declare loss from brokerage at Rs. 20, 000 and income from dealing in shares at Rs. 50, 000 and net income from business at Rs. 30, 000. In the eye of law it will have to compute in respect of each source of income and thus there will be loss of Rs. 70, 000 from dealing in shares and profit of Rs. 1, 00, 000 from brokerage business. Under section 70 the assessee can set off such loss but such provision is subject to other provisions of the Act and therefore such loss cannot be set off as per the provisions of the Explanation to section 73. In view of the above discussions it has to be held that the assessee is not entitled to deduct the interest payment from interest income from holding of debentures as there is no nexus between the borrowed funds and investment in debentures. Admittedly the borrowed funds were utilized for the purchase of shares of L T Ltd. and therefore interest paid cannot be set off against income by way of interest on debentures. It has also been submitted by learned counsel for the assessee that in the case of Nikhil Investment Co. the Assessing Officer has disallowed the interest at the same amount in both the years which is factually incorrect. This may be by way of inadvertent mistake and therefore need verification. Thus the orders of the learned CIT (A) in all the cases are upheld on this issue subject to the rider that the Assessing Officer shall rectify the mistake if the assessee s contention is found to be correct after verification. Disallowed the exemption income of dividend - Held that - This issue is covered in favour of the assessee by the decision of the Special Bench in the case of Punjab State Industrial Development Corporation Ltd. v. Deputy CIT 2007 292 ITR (AT) 268 (Chandigarh) SB wherein it has been held no ad hoc disallowance can be made in such cases. Respectfully following the same the orders of the Commissioner of Income-tax (Appeals) are set aside on this issue and consequently the disallowance sustained by him are hereby deleted.

Summary

Issues Involved:
1. Disallowance of deduction under section 36(1)(iii) of the Income-tax Act, 1961 for interest paid on borrowings used for acquiring shares as long-term investments.
2. Ad hoc disallowance of expenses attributable to exempted dividend income.
3. Computation of book profit under section 115JA for the assessment year 1999-2000.

Detailed Analysis:

1. Disallowance of Deduction under Section 36(1)(iii):
The main issue was whether the lower authorities were justified in disallowing the deduction under section 36(1)(iii) of the Income-tax Act for interest paid on borrowings utilized for acquiring shares as long-term investments. The assessee had borrowed funds and invested them in shares of L&T Ltd., claiming the interest paid as a deduction under section 36(1)(iii). The Assessing Officer disallowed this claim, stating that the shares were not purchased as stock-in-trade but as long-term investments, and the income from the sale of shares was offered under the head "Capital gains." The contention was that the borrowed funds were not utilized for business purposes but for earning dividend income, which was exempt under section 10(33) of the Act. The Commissioner of Income-tax (Appeals) upheld this disallowance, stating that the assessee was not engaged in the business of investments as the shares were acquired as investments and not as stock-in-trade.

The Tribunal examined whether the assessee could be considered to be engaged in the business of holding investments. It referred to the Supreme Court judgment in Distributors (Baroda) P. Ltd. and Amalgamations P. Ltd., which recognized that a company could be engaged in the business of holding investments if it carried out a real, substantial, systematic, or organized course of activity for profit. However, the Tribunal found that there was no material on record to prove that the assessee was engaged in such a business. Even if it was presumed that the assessee was engaged in the business of holding investments, the deduction under section 36(1)(iii) was not allowable because the income from such investments was not assessable under the head "Profits and gains from business or profession" but under "Capital gains" or "Income from other sources." Therefore, the interest paid on borrowed funds could not be deducted under section 36(1)(iii).

2. Ad Hoc Disallowance of Expenses Attributable to Exempted Dividend Income:
The next issue was the ad hoc disallowance of expenses attributable to exempted dividend income. The Tribunal found that this issue was covered in favor of the assessee by the decision of the Special Bench in the case of Punjab State Industrial Development Corporation Ltd. v. Deputy CIT, where it was held that no ad hoc disallowance could be made in such cases. Consequently, the Tribunal set aside the orders of the Commissioner of Income-tax (Appeals) on this issue and deleted the disallowance sustained by him.

3. Computation of Book Profit under Section 115JA for the Assessment Year 1999-2000:
The last issue related to the computation of book profit under section 115JA for the assessment year 1999-2000. This issue was not pressed before the Tribunal by the learned counsel for the assessee, and consequently, the ground raised by the assessee in this regard was dismissed.

Conclusion:
The appeals of the assessee were partly allowed. The Tribunal upheld the disallowance of the deduction under section 36(1)(iii) for interest paid on borrowings used for acquiring shares as long-term investments but deleted the ad hoc disallowance of expenses attributable to exempted dividend income. The issue related to the computation of book profit under section 115JA was dismissed as it was not pressed by the assessee.