2016 (6) TMI 385 - HC - Income Tax

Disallowance on total investment made in shares of subsidiary company - whether the investment made for the purchase of shares of subsidiary company was not a legitimate business activity of the appellant - Held that - The Tribunal s finding that the investment made by the assessee company for purchase of shares in the subsidiary company was not a legitimate business activity, was in fact, an expansion beyond what the Assessing Officer had himself envisaged. It was not even the case of the Revenue that investment made by the assessee in subsidiary company was for some illegitimate purpose or a mere device to divert its tax bearing income. - Decided in favour of assessee

Summary

Issues Involved:

1. Legitimacy of the disallowance made by the Assessing Officer on the total investment made in shares of a subsidiary company.
2. Determination of whether the investment made for the purchase of shares of the subsidiary company was a legitimate business activity of the appellant.

Detailed Analysis:

1. Legitimacy of the Disallowance Made by the Assessing Officer:

The appellant, a company registered under the Companies Act, filed its return of income for the assessment year 2007-2008, which was scrutinized by the Assessing Officer. The Officer noted that the appellant had invested ?7.86 crores in the shares of a subsidiary company, Dinesh Remedies Ltd., without charging any interest on this investment. The Officer disallowed ?66.97 lacs, calculated at an interest rate of 9.5%, on the grounds that the investment was made with the intention of earning exempted income and not for business purposes. The Officer argued that the appellant should have used its reserves and surplus to repay its loans instead of investing in the subsidiary, thereby disallowing the interest on the borrowings to the extent of the investment.

The Commissioner of Income Tax (Appeals) [CIT(A)] overturned the disallowance, stating that the investment in the subsidiary was a legitimate business activity. The CIT(A) noted that a substantial part of the investment was made in earlier years without any disallowance and that the funds used for the investment were from the company's internal accruals.

However, the Income Tax Appellate Tribunal (ITAT) reversed the CIT(A)'s decision, holding that the investment was not a legitimate business activity of the appellant, as the appellant was not in the business of finance but manufacturing suitings. The ITAT emphasized that each assessment year is independent and that the appellant failed to prove the utilization of non-interest-bearing funds for the investment.

2. Legitimacy of the Investment as a Business Activity:

Before the High Court, the appellant's counsel argued that the company had sufficient interest-free funds for the investment, which were utilized for the subsidiary. The counsel cited previous court decisions to support the claim that the investment was for business purposes and that the interest on borrowings was allowable under section 36(1)(iii) of the Income Tax Act.

The respondent's counsel contended that the appellant failed to demonstrate the availability of interest-free funds for the investment and that the principle laid down by the Supreme Court in S.A. Builders Ltd. v. Commissioner of Income-tax (Appeals) did not apply.

The High Court found that the Assessing Officer misdirected himself by focusing on the non-charging of interest on the investment rather than examining whether the investment was a disguised loan. The Court noted that the appellant had demonstrated business prudence in making the investment and that the funds used were from the company's internal accruals. The Court also referenced previous judgments, including Raghuvir Synthetics Ltd. and Hitachi Home and Life Solutions (I) Ltd., which supported the appellant's position that substantial interest-free funds were available and the investment was for business purposes.

The High Court concluded that the ITAT's finding that the investment was not a legitimate business activity was beyond the scope of the Assessing Officer's original premise. The Court held that the investment in the subsidiary was a legitimate business activity and allowed the appeal, reversing the ITAT's judgment.

Conclusion:

The High Court answered the questions in favor of the appellant, allowing the appeal and reversing the ITAT's judgment on the issue. The tax appeal was disposed of accordingly.