2018 (12) TMI 1059 - AT - Income Tax

Gain on sale of investment - long term capital gain OR business income - Held that - Without there being any material changes in facts for the year under consideration, there is no reason for the AO to deviate from the stand taken in earlier and subsequent assessment years. Hence, we are of the considered view that profit derived from sale of shares is assessable under the head capital gains as declared by the assessee. The Ld.CIT(A), after considering relevant facts, has rightly directed the AO to assessee profit derived from sale of shares under the head long term capital gain / short term capital gain. Disallowance u/s 14A by invoking rule 8D(2) - Disallowance of expenses incurred in relation to exempt income - assessee has earned dividend income from shares and mutual funds and claimed exemption u/s 10(38) - Held that - Although the assessee has disallowed direct expenses being PMS charges and demat charges, but did not disallow interest expenses and other expenses. Insofar as interest expenses, the assessee has filed necessary evidences to prove availability of own funds. In view of the binding nature of decision of Reliance Power & Utilities Ltd vs CIT 2009 (1) TMI 4 - BOMBAY HIGH COURT and HDFC Bank Ltd vs CIT 2014 (8) TMI 119 - BOMBAY HIGH COURT once the availability of funds is established even though there is borrowed funds, then a general presumption is drawn in favour of the assessee that investment is made out of own funds. Therefore, the question of disallowance of interest expenses does not arise. Accordingly, we direct the AO to delete disallowance made towards interest expenses u/r 8D(2)(ii) of I.T. Rules, 1962. As regards other expenses .CIT(A) has directed the AO to restrict the disallowance to the extent of 2%, we find that considering the nature of expenses incurred by the assessee and quantum of exempt income, the rate applied by the Ld.CIT(A) appears to be on lower side. Therefore, to meet the ends of justice, we deem it appropriate to direct the AO to restrict the disallowance of expenses to the extent of 5% of total exempt income u/r 8D(2)(iii) for AY 2006-07 & 2007-08. Insofar as AY 2008-09, there is no dispute with regard to the direct expenses which have already been disallowed by the assessee on its own. Insofar as interest expenses, our findings given for AYs 2006-07 & 2007-08 holds good as the assessee has proved availability of own funds. As regards other expenses, from AY 2008-09 onwards rule 8D(2) came into picture and accordingly disallowance contemplated u/s 14A shall be determined by applying the prescribed formula provided u/r 8D(2)(iii). The AO has determined other expenses @0.5% of average value of investments.

Summary

Issues Involved:
1. Treatment of income from the sale of shares as capital gains versus business income.
2. Disallowance of interest expenses under Section 14A of the Income Tax Act.
3. Application of Rule 8D for disallowance of expenses related to exempt income.

Issue-wise Detailed Analysis:

1. Treatment of Income from Sale of Shares:
The primary issue was whether the income from the sale of shares should be treated as capital gains or as business income. The revenue argued that the assessee's share transactions were voluminous, with short holding periods, indicating a business activity rather than investment. The assessee contended that the shares were held as investments, managed by a Portfolio Management Service (PMS), and should be treated as capital gains.

The CIT(A) accepted the assessee’s claim, noting that the investments were made through a PMS and that the assessee had substantial long-term gains in previous years, which were accepted by the AO. The CIT(A) followed the Bombay High Court decision in Gopal Purohit vs CIT, which supports treating such gains as capital gains when investments are managed by a PMS and held for substantial periods.

The Tribunal upheld the CIT(A)’s decision, noting that the assessee had sufficient own funds for investments, and the AO’s findings of systematic trading were not supported by evidence. The Tribunal emphasized the CBDT Circular No. 6 of 2016, which allows taxpayers to treat shares held for more than 12 months as capital assets, and noted that the AO had accepted similar claims in previous and subsequent years.

2. Disallowance of Interest Expenses under Section 14A:
The second issue was the disallowance of interest expenses related to exempt income under Section 14A. The AO invoked Rule 8D to disallow interest and other expenses, arguing that the assessee had mixed funds (own and borrowed) and could not prove that investments were made solely from own funds.

The CIT(A) restricted the disallowance to 2% of total exempt income for AYs 2006-07 and 2007-08, as Rule 8D was not applicable before AY 2008-09. For AY 2008-09, the CIT(A) directed the AO to reconsider the disallowance of interest expenses, acknowledging the assessee’s evidence of sufficient own funds and the principle established in Reliance Power & Utilities Co Ltd vs CIT.

The Tribunal agreed with the CIT(A), noting that the provisions of Rule 8D are not applicable before AY 2008-09. It directed the AO to delete the disallowance of interest expenses, given the assessee’s sufficient own funds. For other expenses, the Tribunal found the CIT(A)’s 2% rate too low and directed the AO to apply a 5% rate for AYs 2006-07 and 2007-08. For AY 2008-09, the Tribunal upheld the AO’s application of Rule 8D(2)(iii) for other expenses.

3. Application of Rule 8D for Disallowance of Expenses Related to Exempt Income:
The AO applied Rule 8D to disallow expenses related to exempt income for all assessment years. The CIT(A) noted that Rule 8D is not applicable before AY 2008-09 and restricted the disallowance to 2% of total exempt income for AYs 2006-07 and 2007-08. For AY 2008-09, the CIT(A) directed the AO to apply Rule 8D but reconsider the disallowance of interest expenses based on the assessee’s evidence of own funds.

The Tribunal upheld the CIT(A)’s approach, emphasizing that Rule 8D is not applicable before AY 2008-09 and directing the AO to restrict disallowance to 5% of total exempt income for AYs 2006-07 and 2007-08. For AY 2008-09, the Tribunal upheld the AO’s application of Rule 8D(2)(iii) for other expenses, finding no error in the AO’s action.

Conclusion:
The Tribunal partly allowed the revenue’s appeals and the assessee’s appeal for AY 2008-09, upholding the CIT(A)’s decisions with modifications to the disallowance rates for expenses related to exempt income. The Tribunal emphasized the importance of consistent treatment of income from share transactions and the proper application of Rule 8D and Section 14A based on the availability of own funds and the nature of expenses.