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Interest on Loan to acquire share allowable if Assessee engaged in share trading

HIGH COURT OF ANDHRA PRADESH

Commissioner of Income tax

Versus

Peninsular Investment Ltd.

I.T.T.A. NO. 309 OF 2012

SEPTEMBER 27, 2012

JUDGMENT

M.S. Ramachandra Rao, J. – This appeal is filed by the Revenue under Section 260-A of the Income Tax Act, 1961 (for short “the Act”) challenging the order dated 31-07-2008 in I.T.A.No.506/Hyd/2007 of the Income Tax Appellate Tribunal, Bench “A”, Hyderabad.

2. The issues in this appeal are:

(a)  whether the decision of the assessing officer in computing the income of the assessee for the assessment year 2003-04 under the head “business income” is correct and

(b)  whether the assessee was entitled to claim a deduction of interest paid by it on loans taken by it amounting to Rs. 3,65,14,210/- under Section 36(1)(iii) of the Act.

3. The assessee is M/s. Peninsular Investments Limited engaged in the business of investment in shares. It is a part of ITC group of Companies along with other companies such as M/s. Russel Credit Ltd and M/s. Russel Investments Ltd. In the financial year 2002-03 (relevant to the assessment year 2003-04), the assessee had taken a loan of Rs. 60.19 crores from M/s. Russel Credit Ltd and M/s. Russel Investments Ltd and utilized Rs. 23.78 crores from such loan for purchase 10,33,323 shares of M/s. E.I.H Limited (another group company). It later sold 8,70,000 shares of the said company.

4. It filed its return of income for the assessment year 2003-04 declaring nil income and an amount of Rs. 3,28,614/- under the provisions of Section 115JB of the Act. As per the profit and loss account enclosed to the return of income, the assessee showed an amount of Rs. 3,65,14,210/- as interest paid during the year towards loan taken for purchase of shares. A dividend of Rs. 6,23,502/- was earned on 1,03,917 shares and this was shown as “dividend” income in the return filed by the assessee for the assessment year 2003-04. The return was processed under Section 143(1) on 31-03-2004. The case was selected into scrutiny and a notice under Section 143(2) of the Act was issued to the assessee on 18-10-2004.

5. The assessee contended that it was entitled to claim the said amount of Rs. 3,65,14,210/- as a deduction under Section 36(1)(iii) of the Act as it was capital borrowed for the purpose of its business i.e. investment in shares.

6. The Revenue disputed the contention of the assessee and contended that in the financial year relevant to the assessment year 2003-04, the assessee had taken a loan of Rs. 60.19 crores of which only Rs. 23.78 crores was utilized for the purpose of business and the rest of the borrowed amount was repaid with interest. It contended that this indicates the intention of the assessee to benefit the persons who granted the loan by paying them the requisite interest and at the same time taking the benefit of claiming such interest against the taxable receipts and thus reducing the taxable income.

7. The assessing officer by order dated 28-11-2005 agreed with the Revenue and disallowed the deduction under Section 36(1)(iii) of the Act of the amount of Rs. 3,65,14,210/- on the ground that the amount was not borrowed for the purpose of business, that the assessee had not utilized the borrowed funds for earning any income and claiming interest on the unutilized borrowed amount is merely an attempt to reduce the taxable income and that it was a colourable transaction. He held that parties who were involved in the transactions were related as seen from the shareholding pattern i.e. M/s. Russel Credit Limited and M/s. Russel Investments Limited (who had granted loan to the assessee) held 25.57% and 24.04% shares in the assessee company. He held that if funds are kept idle only with a view to pay interest to a related concern and thus reduce the incidence of tax, such interest is not allowable as a deduction against business receipts. So the proportionate amount of interest paid on the unutilized loan of Rs. 36.41 crores (Rs. 60.19-23.78) was disallowed and added back. He however accepted the dividend income as “business income”.

8. Aggrieved thereby the assessee preferred I.T.A. No. 263/DC-16(3)/CIT(A)-V/2005-2006 to the Commissioner of Income Tax (Appeals)-V, Hyderabad. By order dated 21-02-2007, the CIT (Appeals) held that during the earlier year i.e. financial year 2001-02 (relevant to assessment year 2002-03) the assessee had taken Rs. 51.32 crores from 3 companies, namely M/s Russel Credit Ltd, M/s Russel Investment Ltd and M/s Mimec Ltd and repaid it at the end of the said financial year, that again in 2002-03 financial year (relevant to the subject assessment year 2003-04) it had taken the loan of Rs. 60.19 crores from M/s Russel Credit Ltd and M/s Russel Investment Ltd, that this constitutes a fresh loan in the hands of the appellant during the previous year , that the assessee having shown the income from sale of shares under the head “long term capital gains” and not as “income from business”, it follows that the assessee was not engaged in any business of purchase and sale of shares during the previous year relevant to the assessment year 2003-04. He also held that the assessee had shown the shares and securities purchased by it as “investment” in the balance sheet and not as “stock-in-trade”, and so the dividend income should be treated as “income from other sources” taxable u/s. 56 of the Act. So interest on funds borrowed for purchase of shares cannot be allowed as deduction under S.36(1)(iii) of the Act. He partly allowed the appeal of the assessee.

9. Aggrieved thereby the assessee filed I.T.A. No. 506/Hyd/2007 to the Income Tax Appellate Tribunal, Hyderabad Bench “A”, Hyderabad. The said appeal was allowed by the said Tribunal by order dated 31-07-2008.

10. The Tribunal noted that as per the Memorandum of Association of the assessee-company, its main object inter alia was to carry on the business of investment, financing, buying, selling, investing, transferring, disposing of and otherwise dealing in shares, stocks etc. and that it is also a non-banking financial company registered with the R.B.I. It held that in view of Section 45-I (c) of the R.B.I. Act, the assessee company is entitled to do business in the acquisition of shares, stocks etc. or other marketable securities. It held that pursuant to the above objects of acquiring shares as part of its business, it had been borrowing funds from its sister concerns and repaying the outstanding loan with interest at the end of each financial year and as a part of this policy, it took back a loan at the beginning of the following financial year. Thus every year there is a break of a few days between the loans repaid and obtained back but in substance there is no break in the policy and practically the same loan continues. It recorded a finding of fact that the assessee is in the business of investment in shares and that the monies have been borrowed for the purpose of business. It therefore held that the entire interest of Rs. 3,65,14,210/- paid by the assessee towards loans taken by it is allowable as a deduction under Section 36(1)(iii) of the Act, that income earned from investment in shares has to be treated as “business income” as per the provisions of sec. 28 – sec. 44A of the Act. Consequently, it held that proceeds of sale of shares should also be treated as “business receipts/income” and not as per provisions of the Act pertaining to “capital gains”.

11. Aggrieved thereby, the present appeal is filed by the Revenue.

12. Heard Sri J.V. Prasad, Senior Standing Counsel for the Revenue.

13. The Revenue contends that the Tribunal erred in directing the assessing officer to allow the above amount as a deduction under Section 36(1)(iii) of the Act, that the Tribunal’s view that the assessee is engaged in the business of investment in shares is perverse, that the Tribunal should have seen that the shares were not held for the purpose of business, that the assessee had not declared any income from trading in shares during the previous year and the receipts on the sale of part of the shares were shown under the head “long term capital gains” and therefore the said order of the Tribunal is liable to be set aside.

14. We have considered the above submissions.

15. Admittedly the Memorandum of Association of the assessee-company provided that the assessee can carry on the business of investment, financing, buying, selling, investing, transferring, disposing off and otherwise dealing in shares, stocks etc. There is also no dispute that the assessee is registered with the R.B.I. as a “non-banking financial company” and under Section 45-I (c) of the R.B.I. Act, it can carry on the acquisition of shares, stocks etc. or other marketable securities as it is also a financial institution. Therefore from these facts, it is clear that it is the intention of the assessee to do business of investment in shares and to sell them.

16. During the financial year 2001-02 (relevant to assessment year 2002-03), admittedly the assessee had borrowed Rs. 51.32 crores from 3 companies, namely M/s Russel Credit Ltd, M/s Russel Investment Ltd and M/s Mimec Ltd and repaid it at the end of the said financial year. Again in the financial year 2002-03 (relevant to the subject assessment year 2003-04), it had taken the loan of Rs. 60.19 crores from M/s Russel Credit Ltd and M/s Russel Investment Ltd and utilized Rs. 23,78,98,324/- out of the said loan for purchase of 10,33,323 shares of M/s. E.I.H Limited (another group company). The assessee sold 8,70,000 shares of the said company during the financial year 2002-03. This shows that in order to acquire the shares, the assessee has been borrowing funds from its sister concerns and repaying the outstanding loan with interest at the end of each financial year and again taking a loan at the beginning of the following financial year. This policy was being followed without a break and the borrowing of funds by the assessee had assumed the characteristic of a continuing loan. Thus, in our opinion, the Tribunal had rightly held that the assessee is in the business of investment in shares and the loans borrowed by the assessee were utilized for the purpose of acquiring shares.

17. The material on record also shows that the assessee-company was a part of the I.T.C. group of companies, that it invests in shares of group companies for acquiring and maintaining controlling interest and that in the shares of M/s. E.I.H. Limited, which is also a group company, it holds 6% of the total share capital. Although the assessee was doing business in investment in shares that does not mean that there has to be regular/hectic trading activity. As rightly held by the Tribunal, “holding of shares” is also part of doing “investment in shares”. It is common for group concerns to have share holding in a group company so that the group can exercise control by putting together all their holdings in such a group company.

18. The tax audit report filed by the assessee was as per Form No.3 C A which was applicable to the assessees carrying on business or profession. In the audit report, the nature of business was referred to as investment company and the method of valuation of closing stock was stated to be the lower of cost or market value which method is applicable in case of business stock only.

19. Merely because the assessee had shown the receipts on sale of part of shares as “long term capital gains”, that is not conclusive and the Tribunal has rightly held that entries in the books or classification of a particular item in the annual accounts does not determine the character of income or asset.

20. In our view, the Tribunal has correctly appreciated the evidence on record and came to the conclusion that the business of the assessee is to invest in shares, that the borrowing was for the purpose of business and that the entire amount of Rs. 3,65,14,210/- paid by the assessee on the loans taken by it is allowable as a deduction under Section 36(1)(iii) of the Act. The findings of the Tribunal cannot be termed as perverse. There is no substantial question of law arising from the facts of the case.

21. We do not find any merit in the appeal and the same is dismissed without costs.

Sandeep Kanoi

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