2008 (1) TMI 489 - AT - Income Tax

Computation of capital gain - Disallowed interest component is part of the cost to be taken into account for the purpose of cost of acquisition - Transfer of the capital asset - Applicability of s. 14A - Capital gain shown as income formed Part of the total income. When the income is shown under the head Capital gains , then the component of interest is an admissible factor to be allowed to the assessee or it is to be considered as not admissible in the light of the provisions of s. 14A being connected with the exempted incidental dividend income - HELD THAT - Within this narrow compass of admitted facts, we have examined the relevant section i.e. s. 48 of IT Act as discussed by the Revenue authorities. This section says that the capital gain is to be computed by deducting from the consideration the prescribed two amounts, first expenditure incurred wholly and exclusively in connection with such transfer and second, the cost of acquisition of the asset and the cost of any improvement thereto. The issue in hand falls under the second category. Once it is an established fact that the appellant had borrowed the funds for acquisition of those share scrips and the burden of interest had been capitalized, therefore, that interest burden cannot be segregated from the amount of investment. At this juncture, we may also like to mention an observation of learned CIT(A) that, quote thus, the expenditure by way of interest is part of cost only on the date purchase of share is made and after that whatever is interest cost, is incurred by the appellant for retaining or maintaining the capital asset and therefore cannot be allowed as deduction unquote. This observation makes it clear that he was agreeable that in case interest is part of the cost, then it falls within cl. (ii) of s. 48 of IT Act. However, he was apprehensive, that if the burden of interest is for retaining or maintaining a capital asset then not to be allowed. On this proposition of learned CIT(A). We are of the view that even if it is a situation that a capital asset is acquired out of the borrowed funds having liability of interest. and since it had been capitalized in the books of accounts treated as a part of cost of asset and never claimed as a revenue expenditure, then that too is towards enhancing the cost of such capital asset and cannot be segregated from the cost of acquisition. Thus, our view gets fortified by the legal proposition laid down by the Hon'ble Court in the case of K.S. Gupta 1976 (8) TMI 9 - ANDHRA PRADESH HIGH COURT . Thus, we arrive at the conclusion that the appellant is entitled to take into account the interest liability towards cost of the capital asset for the purpose of computation of the capital gain as prescribed under s. 48(ii) of IT Act . Applicability of s. 14A - non-exempt income by debiting the expenses incurred to earn the exempt income against taxable income - As capital gain shown by the assessee had formed part of the total income of the assessee. Otherwise also, capital gain is not exempt income and without any ifs and buts, always being taxed in the hands of a taxpayer. Therefore, the Revenue authorities have proceeded on a wrong premise that the interest expenditure was in respect of an income which was exempt, or did not form part of the total income. Confusion occurred in the minds of the Revenue authorities was due to the incidence of dividend income arising from the asset, i.e., share scrips - Undisputedly, the issue is related to the transfer of the capital asset and not the revenue generated thereout. To sum up, we hereby clarify that a situation may arise that on transfer of a capital asset, the gain is taxable but not the incidental income, and if so, the expenditure having nexus with the cost of acquisition has to be taken into account for the purpose of computation of the gain as prescribed under s. 48(ii) of IT Act. Though, it is not necessary for us to further make our observation clear but for the sake of completeness, we may like to add that there may be a situation where gain arising out of a capital asset is exempt from income-tax being not forming part of the total income, for example, agricultural land, then, naturally the expenditure incurred on such transfer or on acquisition of such an asset cannot be set off against the total income taxed under any other heads of income prescribed under Chapter IV of IT Act. With these reasonings, we hereby reverse the findings of the authorities below and allow the claim of the assessee. In this manner, both the grounds of the appellant are hereby allowed. In the result, the appeal is allowed.

Summary

Issues Involved:
1. Disallowance of interest component for computing the cost of shares while calculating short-term capital gain.
2. Applicability of Section 14A of the Income Tax Act concerning exempted dividend income and related interest expenditure.

Detailed Analysis:

Issue 1: Disallowance of Interest Component for Computing Cost of Shares
The primary issue in this appeal was whether the interest paid on borrowed funds for investing in shares should be considered part of the cost of acquisition for computing short-term capital gains. The appellant argued that the interest amounting to Rs. 71,30,560 should be included in the cost of shares. The Assessing Officer (AO) disallowed this interest component, reasoning that Section 48 of the Income Tax Act only allows deduction of expenses incurred wholly and exclusively in connection with the transfer and the cost of improvement, not interest.

The first appellate authority, CIT(A), upheld the AO's decision, stating that the term "cost" is not defined in the IT Act concerning Section 48, and thus, interest should not be included. CIT(A) also noted that the dominant intention behind acquiring the shares was to earn dividend income, which is exempt under Section 14A, making the interest expenditure inadmissible.

The Tribunal, however, disagreed with the CIT(A). It noted that the appellant had consistently capitalized the interest in the books of accounts and never claimed it as a revenue expenditure. The Tribunal cited several judicial precedents, including CIT vs. Mithlesh Kumari, where it was held that interest on borrowed funds for acquiring a capital asset should be included in the cost of acquisition. The Tribunal concluded that the interest burden is inseparable from the investment cost and should be considered under Section 48(ii) for computing capital gains.

Issue 2: Applicability of Section 14A of the Income Tax Act
The second issue was whether the interest expenditure should be disallowed under Section 14A, which pertains to expenditure incurred in relation to income that does not form part of the total income, such as exempt dividend income. The Revenue argued that since the interest was related to earning exempt dividend income, it should be disallowed under Section 14A.

The Tribunal analyzed Section 14A and clarified that it applies to expenses related to exempt income. However, in this case, the capital gain from the sale of shares was not exempt and formed part of the total income. The Tribunal emphasized that Section 14A should not be applied to disallow expenses that are part of the cost of acquisition of a taxable capital asset. The Tribunal concluded that the Revenue authorities had misunderstood the application of Section 14A in this context.

In summary, the Tribunal allowed the appeal, holding that the interest paid on borrowed funds for acquiring shares should be included in the cost of acquisition for computing short-term capital gains and that Section 14A was not applicable in this case. The Tribunal reversed the findings of the lower authorities and allowed the appellant's claim.