2012 (7) TMI 19 - AT - Income Tax

Dis-allowance u/s 14A - premium paid on redemption of premium notes - assessee being an investment and trading companies issued unsecured optionally convertible premium notes and invested the same in the purchase of shares of Reliance Utilities and Power Ltd (RUPL), income of which is exempt u/s 10(23G) - Held that - Proceeds of premium notes (OCPN) 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), however the same was exempt only for the specific period i.e. AY 1999-2000 to 2001-2002, extended upto AY 2004-05. Further, said investment had the potential of generating taxable income viz short term capital gain, income from stock lending, income by way of fees for providing of shares, as collateral etc. Therefore, such premium paid can not be regarded as expenditure incurred exclusively in relation to earning of exempt income so as to invoke the provisions of section 14A - Decided in favor of assessee.

Issues Involved:
1. Disallowance of premium paid on redemption of premium notes under Section 14A of the Income Tax Act.
2. Nature of business activity and whether the premium paid is an allowable business expenditure.
3. Applicability of Section 14A in the absence of exempt income.
4. Allocation of expenditure between taxable and exempt income.
5. Treatment of premium paid as part of the cost of acquisition of shares.

Detailed Analysis:

1. Disallowance of Premium Paid on Redemption of Premium Notes under Section 14A:
The main issue in these appeals is the disallowance made by the AO and confirmed by the learned CIT(A) on account of the premium paid on redemption of premium notes by invoking the provisions of Section 14A. The assessees issued unsecured optionally convertible premium notes and claimed the premium paid on redemption as a deductible business expenditure. The AO disallowed this expenditure under Section 14A, arguing that the funds were used to invest in shares of Reliance Utilities and Power Ltd. (RUPL), whose income was exempt under Section 10(23G). The AO held that the expenditure was incurred in relation to earning exempt income, thus attracting Section 14A.

2. Nature of Business Activity and Whether the Premium Paid is an Allowable Business Expenditure:
The assessees argued that they were engaged in the business of investment and finance, and the premium paid on redemption of premium notes was incurred in the normal course of their business. The AO, however, did not accept this contention, stating that making investments in shares was not conclusively a part of the business activities of the assessees for the year under consideration. The learned CIT(A) upheld this view, noting that the entire receipts of the assessees were from dividend and interest income, which were assessable under "Income from other sources" and exempt from tax.

3. Applicability of Section 14A in the Absence of Exempt Income:
The assessees contended that since no exempt income was actually earned during the year, Section 14A should not apply. They relied on various judicial precedents, including the decision of the Hon'ble Bombay High Court in the case of Godrej and Boyce Manufacturing Co. Ltd. and the Tribunal's decision in Delite Enterprises, which held that disallowance under Section 14A cannot be made if no exempt income is earned. The Tribunal agreed with this contention, noting that the investment had the potential to generate taxable income, and no exempt income was actually earned during the years under consideration.

4. Allocation of Expenditure Between Taxable and Exempt Income:
The assessees argued that the investment in shares of RUPL had the potential to earn taxable income, such as short-term capital gains and income from providing shares as collateral. The AO and CIT(A) rejected this argument, stating that the entire premium paid was related to earning exempt income. The Tribunal, however, found merit in the assessees' contention, noting that the investment had the potential to generate both taxable and exempt income, and the premium paid could not be regarded as expenditure incurred exclusively in relation to earning exempt income.

5. Treatment of Premium Paid as Part of the Cost of Acquisition of Shares:
As an alternative, the assessees argued that the premium paid on redemption of premium notes should be treated as part of the cost of acquisition of shares. The Tribunal did not specifically address this argument, as it decided the main issue in favor of the assessees based on the applicability of Section 14A and the nature of the business activity.

Conclusion:
The Tribunal held that the premium paid on redemption of premium notes could not be disallowed under Section 14A, as the investment had the potential to generate taxable income, and no exempt income was actually earned during the years under consideration. The Tribunal followed the decision of the Hon'ble Bombay High Court in the case of Delite Enterprises and deleted the disallowance made by the AO and confirmed by the CIT(A). All the appeals of the assessees were allowed.

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