2009 (1) TMI 331 - AT - Income Tax

Summary

Issues Involved:
1. Inclusion of interest on borrowed funds in the cost of acquisition of shares for computing capital gains.
2. Disallowance of expenditure on exempted income under Section 14A.
3. Inclusion of non-compete fees as part of the cost of acquisition of shares.

Detailed Analysis:

1. Inclusion of Interest on Borrowed Funds:
The first issue raised by the Revenue was whether the interest on borrowed funds should be included as part of the cost of acquisition of shares while computing capital gains. The assessee had capitalized the interest payable on the borrowed funds used to acquire shares and included it in the cost of acquisition. The AO excluded this interest, arguing it should be set off against any income accrued from the investment on a yearly basis, citing Circular No. 636 of 1992. The CIT(A) allowed the assessee's appeal, and the Tribunal upheld this decision, referencing the case of CIT vs. K. Raja Gopala Rao, where the Madras High Court held that mortgage interest paid till the date of sale should be included in the cost of acquisition. The Tribunal concluded that the interest paid for the acquisition of shares should be capitalized along with the cost of acquisition of shares.

2. Disallowance of Expenditure on Exempted Income (Section 14A):
The second issue was the disallowance of expenditure on exempted income under Section 14A. The CIT(A) allowed the assessee's appeal by taking the disallowance at 2 percent, following a previous order of the Tribunal. However, the Tribunal, referencing the Special Bench decision in Punjab State Industrial Development Corporation Ltd. vs. Dy. CIT, set aside this issue to the AO to allow only the actual expenses incurred for earning the dividend income, not an estimated percentage.

3. Inclusion of Non-Compete Fees:
The third issue was whether the non-compete fee paid to the promoters should be included as part of the cost of acquisition of shares. The assessee argued that the non-compete fee was essential to safeguard its investment and should be considered part of the acquisition cost. The AO and CIT(A) disagreed, stating that the non-compete fee was a separate arrangement to prevent competition and not directly related to the acquisition of shares. The Tribunal members were divided on this issue. The AM supported the inclusion of the non-compete fee as part of the acquisition cost, citing commercial expediency and the strategic nature of the investment. The JM, however, argued that the non-compete fee was primarily for the benefit of the holding company, ICL, and had no direct nexus with the acquisition of shares. The matter was referred to a Third Member, who agreed with the JM, concluding that the non-compete fee did not qualify as part of the cost of acquisition or improvement of shares under Sections 48 and 55(2) of the IT Act. Thus, the appeal of the assessee on this issue was dismissed.

Conclusion:
- The Tribunal upheld the inclusion of interest on borrowed funds in the cost of acquisition of shares.
- The issue of disallowance under Section 14A was set aside to the AO for fresh consideration based on actual expenses incurred.
- The non-compete fee was not considered part of the cost of acquisition of shares, and the assessee's appeal on this issue was dismissed.