2016 (3) TMI 978 - AT - Income Tax

Disallowance u/s 14A of the Act read with Rule 8D(2)(ii) and (iii) of the Rules - Held that - The relevant assessment year under appeal is 2005-06 at which point of time, the provisions of Rule 8D was not in force and the same was made applicable only from Asst Year 2008-09 as decided in the decision of Godrej & Boyce Manufacturing 2010 (8) TMI 77 - BOMBAY HIGH COURT . However, it is not in dispute that the assessee had derived taxable income as well as tax free income and incurred expenditure for deriving both the incomes and hence disallowance is definitely warranted in terms of section 14A which is brought in the statute book with retrospective effect from 1.4.1962. The disallowance had to be made only on an estimated basis with regard to the expenditure incurred for the purpose of earning tax free income. Thus we direct the Learned AO to disallow 1% of exempt income under this issue - Decided partly in favour of assessee Transactions of frequent purchase and sale of shares in a systematic and organized manner - assessed as capital gains OR business income - Held that - There is no material brought in by the revenue to show that separate accounts of two portfolios are only a smokescreen and there is no real distinction between two types of holdings. This could have been done by showing that there is intermingling of shares and transactions and the distinction sought to be created between two types of portfolios is not real but only artificial and arbitrary. Therefore, in absence of any material to the contrary, and on appreciation of cumulative effect of several factors present as culled out above , we hold that the surplus is chargeable to capital gains only and assessee is not to be treated as trader in respect of sale and purchase of shares in investment portfolio - Decided against revenue

Issues Involved:
1. Disallowance under Section 14A of the Income Tax Act read with Rule 8D(2)(ii) and (iii) of the Income Tax Rules.
2. Classification of income from frequent purchase and sale of shares as capital gains or business income.
3. Disallowance of losses based on wrong appreciation of facts.

Detailed Analysis:

1. Disallowance under Section 14A of the Income Tax Act read with Rule 8D(2)(ii) and (iii) of the Income Tax Rules:
The first issue revolves around the disallowance under Section 14A of the Income Tax Act, which pertains to the expenditure incurred in relation to income that does not form part of the total income. The assessee, an investment company, derived a dividend income of Rs. 4,63,906 for the Assessment Year (AY) 2005-06. The Assessing Officer (AO) disallowed 5% of the dividend income amounting to Rs. 23,125, invoking Section 14A. On appeal, the CIT(A) directed the AO to adopt Rule 8D(2)(iii) for disallowance. The assessee argued that Rule 8D could only be applied from AY 2008-09 as per the Bombay High Court's decision in Godrej & Boyce Manufacturing. The Tribunal held that Rule 8D was not applicable for AY 2005-06 and followed the jurisdictional High Court's decision in CIT vs. R.R. Sen & Brothers P Ltd, directing the AO to disallow 1% of the exempt income. Consequently, the revenue's ground was partly allowed, and the assessee's cross-objection was also partly allowed.

2. Classification of income from frequent purchase and sale of shares as capital gains or business income:
The second issue concerns whether the income from frequent purchase and sale of shares should be classified as capital gains or business income. The AO treated the gains from the sale of investments as business income, arguing that the transactions were systematic and organized. The CIT(A) reversed this, treating the gains as capital gains. The Tribunal upheld the CIT(A)'s decision, emphasizing the assessee's consistent practice of maintaining dual portfolios for investment and trading, which was accepted by the revenue in earlier and subsequent years. The Tribunal noted that the mere frequency of transactions does not determine the nature of income, and the intention of the assessee at the time of purchase is crucial. The Tribunal also considered the principle of consistency as upheld by the Supreme Court in Radhasaomi Satsang and other relevant case laws. The revenue's grounds were dismissed for both AYs 2005-06 and 2006-07.

3. Disallowance of losses based on wrong appreciation of facts:
The last issue pertains to the disallowance of losses amounting to Rs. 18,385 for AY 2006-07. During the hearing, the assessee's representative stated that they would not press this ground due to the smallness of the amount. Consequently, this ground was allowed in favor of the revenue.

Conclusion:
In conclusion, the Tribunal partly allowed the revenue's appeal and the assessee's cross-objection for AY 2005-06, and partly allowed the revenue's appeal for AY 2006-07. The Tribunal directed the AO to disallow 1% of the exempt income under Section 14A and upheld the CIT(A)'s decision to treat the gains from the sale of investments as capital gains. The disallowance of losses for AY 2006-07 was allowed in favor of the revenue due to the assessee not pressing the ground.

Pronouncement:
This order is pronounced in open court on 20-01-2016.

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