2012 (10) TMI 667 - AT - Income Tax

Loss arising from sale and purchase of shares - dis-allowance of set off of losses against other income on ground of it being speculative Loss under the provisions of Explanation to section 73 - dis-allowance of interest in relation to trading in shares and treating the same as part of speculation loss - trading and investment company - Held that - Though Explanation to S73, exempts the companies, the principal business of which is the business of banking or granting of loans and advances, however in present case, assessee itself submitted that the assessee was a trading and investment company having its main business of making investment in equities and trading in shares, therefore, the arguments of the assessee that principal business of the assessee was granting loans and advances cannot be accepted and loss from trading in shares has to be treated as speculation loss. Further, authorities are also justified in allocating interest expenses towards the loss arising from trading of shares as while computing the profit or loss from trading of shares all expenses have to be considered. Dis-allowance of interest and treating the same as part of speculation loss in all the years under consideration is upheld. Dis-allowance u/s 14A of interest expenditure in relation to dividend income - Held that - Assessee had made huge borrowings on which interest of Rs. 12.68 crores had been paid. Net capital of company was negative to the tune of Rs. 20.57 crores and there were no reserves nor any other interest free funds available in AY 2001-02. The conclusion of the AO that the borrowed funds had been utilized for investment in shares is, therefore, reasonable and dis-allowance of interest in relation to such investment is required to be made u/s 14A. However, interest relating to the borrowings used in the purchase of trading shares from which dividend had been received is required to be excluded from such dis-allowance. Dis-allowance of interest u/s 36(1)(iii) - huge borrowings on one side - amount advanced on other side towards application money for purchase of shares of group companies which had been pending for a long time - assessee has argued that trading and investment in shares was business of the assessee - Held that - Assessee had advanced money for purchase of shares of the group companies for the purpose of acquiring controlling interest and for the acquisition of other companies for the group. The acquisition of controlling interest in companies was not the business of the assessee as the assessee had not acquired controlling interest in any company with a view to managing the same. Therefore, the interest expenses incurred by the assessee towards such interest free advances made for share application in group companies or for acquisition of other companies from the group has to be considered for dis-allowance.

Summary

Issues Involved:
1. Treatment of losses from trading in shares as speculation loss under Explanation to Section 73 of the Income Tax Act.
2. Disallowance of interest under Section 14A of the Income Tax Act.
3. Disallowance of interest under Section 36(1)(iii) of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Treatment of Losses from Trading in Shares as Speculation Loss:
The primary issue revolves around whether the losses declared by the assessee from trading in shares should be treated as speculation loss under the provisions of Explanation to Section 73 of the Income Tax Act. The assessee declared substantial losses from trading in shares for the assessment years 2001-02 to 2003-04, which the Assessing Officer (AO) treated as speculation loss. The CIT(A) confirmed this treatment, rejecting the assessee's argument that the losses, including those from the valuation of shares, should not be treated as speculation losses. The Tribunal upheld the CIT(A)'s decision, citing precedents like the Calcutta High Court's decision in CIT v. Arvind Investments Ltd. and the Tribunal's Special Bench decision in AMP Spg. & Wvg. Mills (P) Ltd. v. ITO, which stated that the provisions apply even if there are no purchases and sales during the year. The Tribunal concluded that the assessee's principal business was trading and investment in shares, making the provisions of Explanation to Section 73 applicable, and upheld the disallowance of interest expenses related to trading in shares as part of speculation loss.

2. Disallowance of Interest under Section 14A:
The second issue pertains to the disallowance of interest under Section 14A of the Income Tax Act for the assessment year 2001-02. The AO disallowed interest attributable to investments in shares, which yielded tax-exempt dividend income, arguing that the investments were made from borrowed funds. The CIT(A) upheld this disallowance. The Tribunal, while considering the assessee's argument that dividend income was incidental to the business income, referred to the Karnataka High Court's decision in CCI Ltd. v. Jt. CIT, which held that disallowance should not be made if the shares were held for trading purposes. The Tribunal directed the AO to recompute the disallowance, excluding interest related to trading shares, and to consider only the interest related to long-term strategic investments in group companies.

3. Disallowance of Interest under Section 36(1)(iii):
The third issue involves the disallowance of interest under Section 36(1)(iii) of the Income Tax Act for the assessment years 2001-02 to 2003-04. The AO disallowed interest on borrowings used for advancing funds to group companies and for share application money, considering these advances as not being for business purposes. The CIT(A) confirmed the disallowance for the assessment years 2001-02 and 2002-03. For the assessment year 2003-04, the CIT(A) noted that the assessee had substantial interest-free funds and directed the AO to compute the disallowance on a proportionate basis. The Tribunal upheld the CIT(A)'s decision for the assessment year 2001-02, noting that the assessee had no interest-free funds. For the assessment years 2002-03 and 2003-04, the Tribunal directed the AO to recompute the disallowance, taking into account the availability of interest-free funds and the negative balance in the Profit & Loss Account, and to exclude interest related to trading transactions and investments in shares yielding taxable dividend income.

Conclusion:
The appeals were partly allowed for statistical purposes, with the Tribunal providing detailed directions for the recomputation of disallowances under Sections 14A and 36(1)(iii), while upholding the treatment of trading losses as speculation losses under Explanation to Section 73.