2011 (3) TMI 496 - AT - Income Tax

Business income or capital gain - Disallowance u/s 14A - Rule 8D of I.T. Rules - Held that - Merely because the memorandum permits the assessee to undertake the business in shares, that does not mean that even when the assessee made investment in shares, that is to be treated as adventure in the nature of trade - whether a transaction is in the nature of investment or trading is to be judged by initial intention of the person at the time of purchases of shares/units - surplus arising on the sale of shares/units of Mutual Funds held as investment is to be treated as capital gain and not the business income Regarding disallowances u/s 14A - in Godrej Boyce Mfg. Co. Ltd. vs. DCIT 2010 -TMI - 78448 - BOMBAY HIGH COURT , it has been held that Rule 8D of the Rules is prospective in nature and is applicable from assessment year 2008-09 - Appeal is allowed by way of remand

Issues Involved:
1. Classification of net surplus as 'Capital Gains' vs. 'Business Income'.
2. Disallowance of expenditure under Section 14A of the Income Tax Act, 1961.

Detailed Analysis:

1. Classification of Net Surplus as 'Capital Gains' vs. 'Business Income':
The primary issue in the Revenue's appeal was whether the net surplus of Rs.3,74,97,575/- should be treated as 'Capital Gains' or 'Business Income'. The Assessing Officer (A.O.) had classified this surplus as business income, arguing that the assessee was engaged in systematic and organized trading of shares/units, thereby constituting business activities. The A.O. also noted that the assessee had borrowed funds for purchasing shares, which should be considered as stock-in-trade.

However, the Commissioner of Income Tax (Appeals) [C.I.T.(A)] directed the A.O. to treat the net surplus as 'Capital Gains'. The C.I.T.(A) relied on various judicial pronouncements, including the ITAT, Kolkata Bench decision in DCIT vs. Reliance Trading Enterprises Ltd. The C.I.T.(A) observed that the original intention of the assessee was to treat shares as investments, not stock-in-trade, as evidenced by entries in the books of account and balance sheet. The C.I.T.(A) concluded that the assets categorized under 'investment' should be treated as capital assets, and profits from their sale should be taxable under 'Capital Gains'.

The Departmental Representative argued that the C.I.T.(A) had incorrectly applied the decision of Reliance Trading Enterprises Ltd. and failed to consider the volume and frequency of transactions. However, the assessee's representative countered that separate accounts were maintained for investments and stock-in-trade, and most of the shares/units were held for a long period, supporting the classification as investments.

The Tribunal upheld the C.I.T.(A)'s decision, noting that the assessee had maintained separate accounts for investments and stock-in-trade, and the investments were accepted in the assessment year 2004-05. The Tribunal also observed that the assessee's share capital and reserves were sufficient to cover the investments, and there was no evidence that borrowed funds were used for investments. The Tribunal concluded that the surplus from the sale of shares/units held as investments should be treated as 'Capital Gains'.

2. Disallowance of Expenditure under Section 14A:
The assessee's cross-objection concerned the disallowance of expenses under Section 14A of the Income Tax Act, 1961. The C.I.T.(A) had upheld the A.O.'s disallowance of Rs.12,44,988/- being proportionate expenses attributable to dividend income, applying Rule 8D of the Income Tax Rules based on the Special Bench decision in Daga Capital Management P. Ltd.

The assessee argued that the decision in Daga Capital Management P. Ltd. had been overruled by the Bombay High Court in Godrej Boyce Mfg. Co. Ltd. vs. DCIT, which held that Rule 8D is prospective and applicable from the assessment year 2008-09. The Tribunal agreed with the assessee and set aside the orders of the authorities below on this issue, directing the C.I.T.(A) to re-adjudicate the matter in light of the Bombay High Court's decision in Godrej Boyce Mfg. Co. Ltd., after giving the assessee a reasonable opportunity to be heard.

Conclusion:
In conclusion, the Tribunal dismissed the Revenue's appeal and upheld the C.I.T.(A)'s decision to treat the net surplus as 'Capital Gains'. The Tribunal allowed the assessee's cross-objection for statistical purposes, directing the C.I.T.(A) to re-adjudicate the disallowance under Section 14A in accordance with the Bombay High Court's ruling in Godrej Boyce Mfg. Co. Ltd.

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