ITAT Deletes ₹4.26 Crore Section 14A Disallowance Against PNB Gilts

Addl. CIT Vs PNB Gilts Ltd. (ITAT Delhi)

Summary: The Income Tax Appellate Tribunal, Delhi Bench, dismissed the Revenue’s appeals concerning PNB Gilts Ltd. for Assessment Years 2012-13 and 2013-14 and upheld the relief granted by the CIT(A). For AY 2012-13, the Assessing Officer had made disallowances of ₹4.26 crore under Section 14A read with Rule 8D, ₹30.61 lakh under Section 36(1)(iii) and ₹6.56 crore towards diminution in the market value of securities held as stock-in-trade. The Tribunal noted that the assessee, an RBI-registered NBFC and Primary Dealer, held the relevant securities as stock-in-trade in its ordinary securities-trading business. It had interest-free funds of ₹577.64 crore, substantially exceeding the securities yielding exempt income, and also earned net positive interest income. The Tribunal further observed that a valid and reasoned satisfaction was necessary before invoking Rule 8D and that the availability of sufficient interest-free funds supported the presumption that the securities were acquired from such funds. The separate disallowance under Section 36(1)(iii) was also unsustainable because the borrowings were used for business purposes and the same interest expenditure could not effectively be disallowed twice. Regarding diminution in value, the Tribunal accepted that the securities were consistently valued at cost or market value, whichever was lower, following RBI guidelines and recognised accounting principles. The resulting ₹6.56 crore diminution represented a permissible valuation loss rather than an unascertained provision. As the facts and grounds for AY 2013-14 were identical, the findings for AY 2012-13 were applied mutatis mutandis, and both Revenue appeals were dismissed.

Key Takeaways

• Sufficient interest-free funds supported deletion of the interest disallowance under Section 14A read with Rule 8D(2)(ii).
• Rule 8D could not be mechanically invoked without recording proper dissatisfaction after examining the assessee’s accounts.
• Interest on borrowings used for the securities-trading business remained deductible under Section 36(1)(iii).
• The same interest expenditure could not effectively be disallowed under both Section 14A and Section 36(1)(iii).
• Diminution in securities held as stock-in-trade was allowable where valuation at cost or market value, whichever was lower, was consistently followed in accordance with RBI norms.

Cases Discussed

• Maxopp Investment Ltd. v. Commissioner of Income Tax, New Delhi [2018] 402 ITR 640 (SC).
• CIT v. Walfort Share & Stock Brokers (P.) Ltd. [2010] 326 ITR 1 (SC).
• PCIT-7 v. Punjab & Sind Bank, ITA Nos. 904/2019 and 906/2019, order dated 16.10.2019 (Delhi High Court).
• PCIT v. State Bank of Patiala [2017] 391 ITR 218 (Punjab & Haryana High Court).
• CIT v. Reliance Utilities & Power Ltd. [2009] 313 ITR 340 (Bombay High Court).
• CIT v. HDFC Bank Ltd. [2014] 366 ITR 505 (Bombay High Court).
• Godrej & Boyce Manufacturing Company Ltd. v. Deputy Commissioner of Income-tax [2017] 394 ITR 449 (SC).
• CIT v. Reliance Industries Ltd., Civil Appeal No. 10 of 2019 (SC).
• Pr. CIT v. Ashok Apparels (P.) Ltd. [2020] 423 ITR 412 (Bombay High Court).
• CIT v. C. Parakh & Co. (India) Ltd. [1956] 29 ITR 661 (SC).
• CIT v. Bharat General Reinsurance Co. Ltd. [1971] 81 ITR 303 (Delhi High Court).
• United Commercial Bank v. CIT [1999] 240 ITR 355 (SC).
• DCIT v. PNB Gilts Ltd., ITA No. 810/Del/2015 (AY 2010-11).

FULL TEXT OF THE ORDER OF ITAT DELHI

Summary: The Income Tax Appellate Tribunal, Delhi Bench, dismissed both Revenue appeals concerning PNB Gilts Ltd. for Assessment Years 2012-13 and 2013-14. The appeals arose from orders of the Commissioner of Income Tax (Appeals)-7, New Delhi, which had partly allowed the assessee’s appeals against assessment orders passed under section 143(3) of the Income-tax Act, 1961.

The assessee is a Non-Banking Financial Company registered with the Reserve Bank of India and engaged in trading in Government securities, debt instruments and market instruments. For AY 2012-13, the assessee had declared income of Rs.25,77,78,259/-. The Assessing Officer made additions of Rs.4,26,85,000/-, Rs.30,61,000/- and Rs.6,56,24,000/-. The CIT(A) sustained a disallowance of Rs.34.25 lakhs but deleted the balance disallowance of Rs.3,92,60,000/- under section 14A, besides deleting the additions of Rs.30,61,000/- under section 36(1)(iii) and Rs.6,56,24,000/- towards diminution in market value of stock-in-trade.

On the section 14A issue, the assessee submitted that the shares and bonds yielding exempt income were held as stock-in-trade in the ordinary course of its securities trading business. The exempt income comprised dividend of Rs.4,78,249/- and interest on tax-free bonds of Rs.4,15,80,043/-. The assessee contended that earning exempt income was incidental to its business and that no expenditure had been incurred for earning such income. It also submitted that borrowings were mandatorily invested in accordance with RBI guidelines and that sufficient interest-free funds were available.

The Tribunal recorded that the CIT(A) had relied upon the availability of interest-free funds of Rs.577.64 crores against the securities generating exempt income. The assessee also relied upon Maxopp Investment Ltd. v. CIT and the distinction recognised in respect of shares held as stock-in-trade, as well as CIT v. Walfort Share & Stock Brokers (P.) Ltd.. Reliance was also placed on Godrej & Boyce Manufacturing Company Ltd. v. Deputy Commissioner of Income-tax concerning the requirement of recording proper satisfaction before applying Rule 8D.

The assessee further relied upon the principle that where sufficient interest-free funds are available, investment is presumed to have been made from such funds. In support, reliance was placed on CIT v. Reliance Utilities & Power Ltd., CIT-2, Mumbai v. HDFC Bank Ltd., CIT v. Reliance Industries Ltd. and Pr. CIT v. Ashok Apparels (P.) Ltd. The assessee also pointed out that its interest/discount income of Rs.17,528.20 lakhs exceeded interest expenditure of Rs.12,567.26 lakhs, resulting in a net surplus of Rs.4,960.94 lakhs.

In relation to section 36(1)(iii), the assessee contended that borrowed funds had been used exclusively for business purposes and that securities were held as stock-in-trade. It argued that the mere earning of tax-free income during business operations did not establish diversion of borrowed funds for non-business purposes. The assessee also contended that the same interest expenditure could not be disallowed both under section 14A and section 36(1)(iii). The Tribunal recorded the issue as covered by the assessee’s own case, DCIT v. PNB Gilts Ltd., ITA No.810/Del/2015 for AY 2010-11.

The third issue concerned the Rs.6,56,24,000/- provision for diminution in the market value of stock-in-trade. The assessee explained that the provision was created at year-end and reversed in the immediately succeeding year, in accordance with its regular accounting policy. Securities were consistently valued at cost or market value whichever was lower. The assessee, being a Primary Dealer regulated by RBI, relied upon RBI guidelines requiring valuation of securities and recognition of net depreciation where the market value was lower than cost.

The assessee relied upon section 145A and the Supreme Court decision in United Commercial Bank v. CIT [1999] 240 ITR 355 (SC), submitting that diminution arising from valuation of stock-in-trade at cost or market value whichever is lower constituted an allowable business loss.

After considering the rival contentions, the Tribunal held that the issues were covered by the assessee’s own case and the judicial principles relied upon. It rejected the Revenue’s grounds and dismissed the appeal for AY 2012-13. Since the facts and grounds for AY 2013-14 were stated to be identical, the Tribunal applied its observations for AY 2012-13 mutatis mutandis to ITA No.7434/Del/2017. Consequently, both Revenue appeals were dismissed.

Cases Discussed

• Maxopp Investment Ltd. v. Commissioner of Income Tax, New Delhi [2018] 402 ITR 640 (SC).
• CIT v. Walfort Share & Stock Brokers (P.) Ltd. [2010] 326 ITR 1 (SC).
• PCIT-7 v. Punjab & Sind Bank, ITA Nos. 904/2019 & 906/2019, order dated 16.10.2019 (Delhi High Court).
• PCIT v. State Bank of Patiala [2017] 391 ITR 218 (Punjab & Haryana).
• CIT v. Reliance Utilities & Power Ltd. [2009] 313 ITR 340 (Bombay).
• CIT-2, Mumbai v. HDFC Bank Ltd. [2014] 366 ITR 505 (Bombay).
• Godrej & Boyce Manufacturing Company Ltd. v. Deputy Commissioner of Income-tax [2017] 394 ITR 449 (SC).
• CIT v. Reliance Industries Ltd., Civil Appeal No.10 of 2019.
• Pr. CIT v. Ashok Apparels (P.) Ltd.[2020] 423 ITR 412 (Bombay).
• CIT v. C. Parakh & Co. (India) Ltd. [1956] 29 ITR 661 (SC).
• CIT v. Bharat General Reinsurance Co. Ltd. [1971] 81 ITR 303 (Delhi).
• United Commercial Bank v. CIT [1999] 240 ITR 355 (SC).
• DCIT v. PNB Gilts Ltd., ITA No.810/Del/2015 (AY 2010-11).

Alternative SEO Titles

1. ITAT Delhi Dismisses Revenue Appeals on Section 14A and Securities Valuation

2. ITAT Delhi Upholds Relief on Interest and Stock-in-Trade Valuation Disallowances

3.  ITAT Delhi Rejects Revenue Challenge to PNB Gilts Disallowances for Two Years

4. ITAT Delhi Dismisses Appeals on Section 14A, Interest and Securities Valuation

5. ITAT Delhi Sustains CIT(A) Relief on PNB Gilts Interest and Valuation Issues

FULL TEXT OF THE ORDER OF ITAT DELHI

The appeals filed by the Assessee are against orders dated 25.11.2016 and 28.09.2017 of Learned Commissioner of Income Tax (Appeals)-7, New Delhi, [hereinafter referred to as ‘the Ld. CIT(A)’] passed u/s 250(6) of the Income Tax Act, 1961, [hereinafter referred to as ‘the Act’] arising out of assessment orders dated 02.03.2015 and 04.03.2016 of Ld. Assessing Officer/DCIT, Circle-19(1) &(2), New Delhi [hereinafter referred as ‘the AO’] u/s 143(3) of the Act for Assessment Years 2012-13 and 2013-14 respectively.

2. Both the appeals have similar facts, grounds of appeal and issues. Therefore, both appeals were heard together.

3. Brief facts of the case in ITA No.682/Del/2027 are that the assessee filed return of income on 20.09.2012 declaring income of Rs.25,77,78,259/-. The return of income was processed u/s 143(1) of the Act. The case was selected for scrutiny under CASS. Notice u/s 143(2) was issued. Sana Baqai CA, Authorized Representative appeared in assessment proceedings and filed details. Assessee is a NBFC. During the assessment proceedings, various claims made by the assessee were examined and various replies and explanation filed by the assessee were considered. The assessee was issued to show cause dated 09.12 2014. Assessee filed reply dated 29.12.2014. On completion of proceedings, Ld. AO vide order dated 02.03.2015 made additions of Rs.4,26,85,000/-, Rs.30,61,000/- and Rs.6,56,24,000/-. Against order dated 02.032015 of Ld. AO, the assessee filed appeal before Ld. CIT(A) which was partly allowed vide order dated 25.11.2016. The disallowance of Rs.34.25 lacs was sustained and balance disallowance of Rs.3,92,60,000/- deleted and additions of Rs.30,61,000/- and Rs.6,56,24,000/- were deleted.

4. Being aggrieved, appellant Department of Revenue preferred present appeal on following grounds:

“1. On the facts and in the circumstances of the case, the Ld. CIT(A) has erred in deleting disallowance of 3.92,60,000/- u/s 14A of the Income Tax Act, 1961.

2. On the facts and in the circumstances of the case, the Ld. CIT(A) has erred in deleting disallowance of Rs. 30,61,000/- u/s 36(i)(iii) of the Income Tax Act, 1961.

3. On the facts and in the circumstances of the case, the Ld. CIT(A) has erred in deleting disallowance of Rs. 6,56,24,000 on account of provision for diminution in market value of stock in trade.

4. The appellant craves to be allowed to add any fresh ground(s) of appeal and/or delete or amend any of the ground(s) of appeal.”

5. Ld. Departmental Representative submitted that Ld. CIT(A) erred in deleting the additions made by Ld. AO. Reliance was placed on following decisions in Maxopp Investment Ltd. reported in [2018] 91 taxmann.com 154 held vide order dated 12.02.2018. Hon’ble Supreme Court in CIT v. Welfort Share & Stock Brokers (P.) Ltd. [2010] 192 Taxmann 211326 ITR 1 (SC).

6. Ld. Authorized Representative for respondent assessee submitted as under:

“6.1 The Assessee is a Non-Banking Financial Company (hereinafter referred to as “NBFC”) registered with Reserve Bank of India (hereinafter referred to as “RBI”). The Assessee Company is a trader in the Government Securities markets, debts instruments and market instruments. The Assessee filed its return of income for assessment year (hereinafter referred to as “A.Y.”) 2012-13 on 20.09.2012 declaring an income of Rs. 25,77,78,259/-under the normal provision of the Act and book profit of Rs.31,99,78,981/- computed u/s 115JB of the Act. The case of the Assessee was selected for scrutiny and a notice u/s 143(2) of the Act was issued. During the course of assessment multiple queries relating to the return of income filed by the Assessee were raised by the AO and the same were responded time to time by the Appellant.

RE: DISALLOWANCE UNDER SECTION 14A OF THE ACT

6.2 During the course of assessment, the Assessing Officer (hereinafter referred to as “AO”) sought to invoke the provisions of Section 14A of the Act to make disallowance of expenses with respect to the exempt income earned by the Assessee during the year under consideration, which is as under:

(a) Dividend on equity shares Rs. 4.78.249-

(b) Interest on Tax Free Bonds Rs. 4,15,80,043/-

Total Tax-free income Rs. 4,20,58,292-

6.3 In response to the queries of the AO regarding the disallowance of expense u/s 14A of the Act, the Assessee submitted the shares and bonds on which the exempt income has been earned are not investments’ but the same are held as stock-in-trade and hence earning of tax free income is incidental to the normal course of procurement of stock-in-trade, and no additional expenditure can be said to be incurred, therefore, no disallowance has been made in return of income filed. The Assessee also submitted that there is no nexus between the expenditure incurred and the tax-free income earned by the Appellant.

6.4. It was asserted that the borrowings done by Assessee had to be mandatorily invested as per the RBI guidelines and no exempt income was earned thereon, and hence the interest expenditure which has direct nexus with other investments, cannot be taken into consideration for computing disallowance under Rule. 8D(2)(ii). The Assessee submitted that in the assessments for A.Y. 2007-08, 2008-09 and 2009-10, the AO has accepted this contention of the Assessee and has not made any disallowance under Rule 8D(2)(ii) of the Rules. Regarding, rule 8D(iii), the Assessee submitted that in the absence of any investment which has resulted in earning of tax-free income, no disallowance can be made hereunder. Without prejudice to the above-mentioned contentions, the Assessee during the course of the assessment proceedings, submitted an alternate plea for computation of disallowance under Section 14A, if any, to be done under Rule 8D(2)(iii), which worked out to be Rs. 34.25 lacs. The AO, however, rejected the contentions of the Assessee. The AO made P disallowance under Section 14A of the Act as per the computation provisions provided under Rule 8D(2)(ii) of the Rules and worked out a disallowance of Rs. 392.60 lacs and 34.25 lacs under Rule 8D(2)(iii). Therefore, a total disallowance of

Rs. 4,26,85,000/- was made under section 14A of the Act as per Rule 8D(2)(ii) and Rule 8D (2)(iii) of the Rules.

6.5 Herein it is relevant to refer to the judgement rendered by Hon’ble Delhi High Court, vide order dated 16.10.2019 in the case of PCIT-7 v. Punjab & Sind Bank (ITA Nos. 904/2019 & 906/2019), wherein High Court upheld the deletion of disallowance under section 14A in respect of dividend earned on shares held as stock-in-trade, observing that such shares were held in the course of business and dividend income arose merely by a “quirk of fate”; consequently, no substantial question of law arose and the Department’s appeal was dismissed. It is further submitted that the Hon’ble Supreme Court in Maxopp Investment Ltd. v. Commissioner of Income Tax, New Delhi [2018] 402 ITR 640 (SC) examined the identical situation and clarified that while the dominant purpose test is irrelevant for investments, a distinct treatment applies where shares are held as stock-in-trade as part of business activity. In such cases, dividend income is merely incidental to trading operations. The Supreme Court, while affirming the judgment of the Punjab & Haryana High Court in PCIT v. State Bank of Patiala [2017] 391 ITR 218 (Punjab & Haryana), recognized the distinction between shares held as investment and those held as stock-in-trade and held that expenditure incurred in the course of business of trading in securities cannot be disallowed under section 14A merely because incidental exempt dividend income is earned. Thus, where shares constitute stock-in-trade and dividend income arises incidentally in the course of business, disallowance under section 14A is not sustainable.

6.6. The issue under consideration also stands covered by Assessee own case DCIT v. PNB Gilts Ltd. [ITA No. 810/DEL/2015 (A.Y 2010-11)).

6.7. CIT(A) granted relief to Assessee on the premise that Assessee had interest free funds by way of share capital and reserve and surplus of Rs. 577.64 crores whereas the average value of stock in trade from which exempt income was earned is at Rs. 6850.45 lacs and therefore, placing reliance on Hon’ble Bombay High Court’s decision in the cases of CIT v. Reliance Utilities & Power Ltd. [2009] 313 ITR 340 (Bombay) and CIT-2, Mumbai v. HDFC Bank Ltd. [2014] 366 ITR 505 (Bombay), it held that when there is sufficient interest free fund available with the Assessee, it would have to be presumed that the investment is made out of the interest free funds available with the Assessee and no disallowance of interest under Rule 8D(2)(ii) is called for.

6.8 It is respectfully submitted that no disallowance under Section 14A could have been made in the absence of a valid and reasoned satisfaction recorded by the Assessing Officer. The so-called satisfaction recorded in the assessment order is mechanical and bereft of application of mind. The Appellant is admittedly an NBFC engaged in trading of securities, and the dividend and interest income exempt from tax has arisen from shares and bonds held as stock-in-trade. Despite this undisputed factual position, the Assessing Officer proceeded on an erroneous presumption that dividend income necessarily involves administrative expenditure on account of investment decisions, market research and analysis. Once it is established that the exempt income is merely incidental to the core business activity of trading in securities, the assumption that expenditure was incurred for the purpose of earning dividend income is factually and legally untenable. It is settled law that recording of proper satisfaction is a sine qua non for invoking Section 14A. The Hon’ble Supreme Court in Godrej & Boyce Manufacturing Company Ltd. v. Deputy Commissioner of Income-tax |2017) 394 ITR 449 (SC) has categorically held that before applying Rule SD, the Assessing Officer must, having regard to the accounts of the assessee, record dissatisfaction with the correctness of the claim made. In the present case, no such objective examination of accounts has been undertaken.

6.9 Without prejudice, even otherwise, no disallowance of interest under Section 14A read with Rule 8D(2)(ii) can be made as the Appellant had sufficient interest-free funds. The share capital and reserves amounting to Rs. 577.64 crores far exceed the average value of securities held as stock-in-trade yielding exempt income, being Rs. 65.80 crores (approx.). In view of the law laid down by the Hon’ble Supreme Court in CIT v. Reliance Industries Ltd. Civil Appeal No. 10 of 2019] and the Hon’ble Bombay High Court in Pr. CIT v. Ashok Apparels (P.) Ltd. [2020] 423 ITR 412 (Bombay), where sufficient interest-free funds are available, a presumption arises that investments are made out of such funds and no interest disallowance can be made.

6.10 It is further submitted that the expenditure incurred would have remained the same even if no dividend had been earned, and therefore no proportionate allocation can be made. In fact, the Appellant had net positive interest income, as interest/discount income of Rs. 17528.20 lakhs exceeded interest expenditure of Rs. 12567.26 lakhs, resulting in a net surplus of Rs. 4960.94 lakhs. In such circumstances, no interest disallowance can be sustained. Investments yielding exempt income constitute only 13.22% of the total interest-free funds available. Even while invoking Rule 8D, the Assessing Officer failed to provide cogent reasons for rejecting the factual submissions made. The alternate plea raised during assessment for limited disallowance under Rule 8D(2)(iii) cannot operate as estoppel against law. It is trite that there is no estoppel against statute, as held by the Hon’ble Supreme Court in CIT v. C. Parakh & Co. (India) Ltd. [1956] 29 ITR 661 (SC) and by the Division Bench in CIT v. Bharat General Reinsurance Co. Ltd. [1971] 81 ITR 303 (Delhi). Tax can be levied only in accordance with law, as mandated by Article 265 of the Constitution.

RE: DISALLOWANCE UNDER SECTION 36(1) (iii) OF THE ACT

6.11 The AD also disallowed an amount of Rs. 30.61 lacs under Section 36(1)(iii) of the Act holding that the Assessee has earned substantial tax-free interest income and therefore, use of funds to earn tax free income cannot be allowed. The AO also failed to take into account the fact that Assessee had sufficient capital and reserve and surplus amounting to Rs. 577.64 crores which is in excess of amount of bonds and shares on which tax-free income has been earned and therefore, it is to be presumed that the tax-free income is earned on account of interest free funds available with the Appellant. The issue under consideration also stands covered by Assessee own case DCIT v. PNB Gilts Ltd. (ITA No. 810/Del/2015 (Λ.Y. 2010-11).

6.12 It is respectfully submitted that the loan borrowings have been utilised exclusively for the purposes of the business and, therefore, the interest paid thereon is allowable as a deduction under section 36(1)(iii) of the Act. Merely because certain tax-free income has been earned during the course of the business activities does not imply that the borrowed funds were not used for business purposes. The learned Assessing Officer has failed to appreciate that the borrowings were utilised wholly and exclusively for business purposes. Further, the Assessing Officer has effectively made a double disallowance of the same interest expenditure, once under section 14A and again under section 36(1)(iii) of the Act. Once the interest expenditure has already been considered for disallowance under section 14A in relation to exempt income, a further disallowance of the same amount under section 36(1)(iii) is unjustified and contrary to law. It is further submitted that disallowance under section 36(1)(iii) can be made only where the borrowed capital is not utilised for the purposes of business. In the present case, the investments in securities were made in the normal course of business and the same were held as stock-in-trade. The mere fact that certain exempt income arose from such securities cannot lead to the conclusion that the borrowed funds were not used for business purposes. Because, when undisputedly the interest expenditure is on account of business activities of the Appellant, no disallowance u/s 36(1)(iii) of the Act can be made. Pertinently, there is no dispute that borrowed funds had been used for business purpose and therefore the interest is allowable u/s 36(1)(iii) of the Act. Accordingly, the disallowance made under section 36(1)(iii) is unsustainable in law

RE: DIMINUTION IN MARKET VALUE OF THE STOCK:

6.13 Furthermore, the AO disallowed the provision for diminution in market value of the stock amounting to Rs. 6,56,24,000/-. In this regard, it was submitted by the Assessee that the said provision is created at the end of the year and immediately reversed in the next year and it is in the normal course of business as per the regular accounting policies followed by the Appellant. Following the accounting standards and regular accounting policies followed by the Appellant, the stock in trade is valued at cost or market value whichever is lower, as also accepted under section 145A of the Act. Any change in the value at the end of the year is reversed in the immediately succeeding year to bring it back to the book value.

6.14 The assessee company has been granted a license by the Reserve Bank of India (RBI) to carry on the activities of a Primary Dealer. The company is engaged in trading in the Government Securities market and is registered as a Non-Banking Financial Company (NBFC) with RBI. All securities in which the company deals are treated as stock-in-trade in the ordinary course of its business. Since the securities are held as stock-in-trade, the same are valued in accordance with the well-established principle of accounting, namely cost or market value whichever is lower. During the year under consideration, the market value of certain securities had declined substantially and therefore the difference between the cost and market value has been recognized as depreciation in the value of securities. It is submitted that this method of valuation has been consistently followed by the assessee since inception, and therefore forms part of its regular system of accounting.

6.15 Further, the assessee is statutorily regulated by the Reserve Bank of India, which has issued various guidelines for Primary Dealers regarding the valuation of securities. In terms of RBI Circular dated 31 January 1998, quoted current investments are required to be valued category-wise at cost or market value whichever is lower, and where the aggregate market value of investments in a category is lower than the aggregate cost, the net depreciation is required to be provided. Subsequently, RBI has also directed Primary Dealers to adopt the mark-to-market valuation method for securities transactions in order to ensure transparency and development of an active secondary market.

6.16 Further RBI guidelines have also prescribed that the valuation of the securities portfolio should be undertaken independently by obtaining prices declared by the Fixed Income Money Market and Derivatives Association of India (FIMMDA). The assessee has been strictly following these regulatory requirements while valuing its securities portfolio. It is further submitted that Accounting Standard-2 (AS-2) issued by the Institute of Chartered Accountants of India excludes financial instruments held as stock-in-trade from its scope. Nevertheless, the RBI guidelines for valuation of securities broadly align with the established accounting principle of valuing inventory at cost or market value whichever is lower. Accordingly, the securities held as stock-in-trade have been valued on the said basis.

6.17 It is submitted that the assessee is statutorily required to follow the mark-to-market guidelines prescribed by RBI, and therefore the provision for depreciation in securities represents nothing but the valuation of closing stock in accordance with regulatory norms and accepted accounting principles. Even under Section 145 of the Income-tax Act, 1961, the valuation of stock-in-trade is required to follow recognized accounting principles. The settled law is that closing stock may be valued either at cost or market value whichever is lower, and the method of accounting consistently followed by the assessee cannot be disregarded merely because the Revenue prefers another method.

6.18 In accordance with this consistent practice, the assessee determines whether there is any loss in respect of securities by comparing the market value with the cost price. Where the market value at the end of the year is lower than the cost, the difference is recognized as diminution in the value of stock-in-trade, which represents a legitimate business loss. It is also clarified that such diminution is computed on the actual market value as on the balance sheet date.

6.19. The allowability of such diminution in value of securities held as stock-in-trade stands settled by judicial precedents, including the decision of the Hon’ble Supreme Court in United Commercial Bank v. CIT [1999] 240 ITR 355 (SC), wherein it has been held that banks are entitled to value their stock-in-trade at cost or market value whichever is lower, and the resultant diminution represents an allowable deduction.

6.20 Accordingly, the depreciation in value of securities provided in the books of account represents a legitimate valuation loss of stock-in-trade, computed in accordance with RBI guidelines, recognized accounting principles, and the consistent method of accounting followed by the assessee. Therefore, the same has rightly been claimed as a deduction while computing the taxable income.

6.21 It is humbly submitted that the facts of AY 2013-14 are identical in nature and the captioned written submissions may kindly be read as part and parcel of the same.”

7. From examination of record in light of aforesaid rival contention, it is crystal clear that Ld. AO made disallowance under Section 14A of the Act as per the computation provisions provided under Rule 8D(2)(iii) of the Rules and worked out a disallowance of Rs.4,26,85,000/- was made under section 14A of the Act as per Rules 8D(2)(iii) and Rule 8D(2)(iii) of the Rules.

7.1 The issue under consideration also stands covered by Assessee own case DCIT vs. PNB Gilts Ltd. [ITA No.810/Del/2015 (A.Y.2010-11).

7.2 LD. CIT(A) granted relief to Assessee on the premise that Assessee had interest free funds by way of share capital and reserve and surplus of Rs. 577.64 crores whereas the average value of stock in trade from which exempt income was earned is at Rs. 6850.45 lacs and therefore, placing reliance on Hon’ble Bombay High Court’s decision in the cases of CIT v. Reliance Utilities & Power Ltd. [2009] 313 ITR 340 (Bombay) and CIT-2, Mumbai v. HDFC Bank Ltd. [2014] 366 ITR 505 (Bombay), it held that when there is sufficient interest free fund available with the Assessee, it would have to be presumed that the investment is made out of the interest free funds available with the Assessee and no disallowance of interest under Rule 8D(2)(ii) is called for.

7.3 No disallowance under Section 14A could have been made in the absence of a valid and reasoned satisfaction recorded by the Assessing Officer. The so-called satisfaction recorded in the assessment order is mechanical and bereft of application of mind. It is settled law that recording of proper satisfaction is a sine qua non for invoking Section 14A. The Hon’ble Supreme Court in Godrej & Boyce Manufacturing Company Ltd. v. Deputy Commissioner of Income-tax |2017) 394 ITR 449 (SC) has categorically held that before applying Rule SD, the Assessing Officer must, having regard to the accounts of the assessee, record dissatisfaction with the correctness of the claim made. In the present case, no such objective examination of accounts has been undertaken.

7.4. Even otherwise, no disallowance of interest under Section 14A read with Rule 8D(2)(ii) can be made as the Appellant had sufficient interest-free funds. The share capital and reserves amounting to Rs. 577.64 crores far exceed the average value of securities held as stock-in-trade yielding exempt income, being Rs. 65.80 crores (approx.). In view of the law laid down by the Hon’ble Supreme Court in CIT v. Reliance Industries Ltd. Civil Appeal No. 10 of 2019] and the Hon’ble Bombay High Court in Pr. CIT v. Ashok Apparels (P.) Ltd. [2020] 423 ITR 412 (Bombay), where sufficient interest-free funds are available, a presumption arises that investments are made out of such funds and no interest disallowance can be made.

7.5 The expenditure incurred would have remained the same even if no dividend had been earned, and therefore no proportionate allocation can be made. In fact, the Appellant had net positive interest income, as interest/discount income of Rs. 17528.20 lakhs exceeded interest expenditure of Rs. 12567.26 lakhs, resulting in a net surplus of Rs. 4960.94 lakhs. In such circumstances, no interest disallowance can be sustained. Investments yielding exempt income constitute only 13.22% of the total interest-free funds available. Even while invoking Rule 8D, the Assessing Officer failed to provide cogent reasons for rejecting the factual submissions made. The alternate plea raised during assessment for limited disallowance under Rule 8D(2)(iii) cannot operate as estoppel against law. It is trite that there is no estoppel against statute, as held by the Hon’ble Supreme Court in CIT v. C. Parakh & Co. (India) Ltd. [1956] 29 ITR 661 (SC) and by the Division Bench in CIT v. Bharat General Reinsurance Co. Ltd. [1971] 81 ITR 303 (Delhi). Tax can be levied only in accordance with law, as mandated by Article 265 of the Constitution.

7.6 The AO also disallowed an amount of Rs. 30.61 lacs under Section 36(1)(iii) of the Act holding that the Assessee has earned substantial tax-free interest income and therefore, use of funds to earn tax free income cannot be allowed. The AO also failed to take into account the fact that Assessee had sufficient capital and reserve and surplus amounting to Rs. 577.64 crores which is in excess of amount of bonds and shares on which tax-free income has been earned and therefore, it is to be presumed that the tax-free income is earned on account of interest free funds available with the Appellant. The issue under consideration also stands covered by Assessee own case DCIT v. PNB Gilts Ltd. (ITA No. 810/Del/2015 (Λ.Y. 2010-11).

7.7 The AO disallowed the provision for diminution in market value of the stock amounting to Rs. 6,56,24,000/-. In this regard, it was submitted by the Assessee that the said provision is created at the end of the year and immediately reversed in the next year and it is in the normal course of business as per the regular accounting policies followed by the Appellant. Following the accounting standards and regular accounting policies followed by the Appellant, the stock in trade is valued at cost or market value whichever is lower, as also accepted under section 145A of the Act. Any change in the value at the end of the year is reversed in the immediately succeeding year to bring it back to the book value.

7.8 The allowability of such diminution in value of securities held as stock-in-trade stands settled by judicial precedents, including the decision of the Hon’ble Supreme Court in United Commercial Bank v. CIT [1999] 240 ITR 355 (SC), wherein it has been held that banks are entitled to value their stock-in-trade at cost or market value whichever is lower, and the resultant diminution represents an allowable deduction.

7.9 The depreciation in value of securities provided in the books of account represents a legitimate valuation loss of stock-in-trade, computed in accordance with RBI guidelines, recognized accounting principles, and the consistent method of accounting followed by the assessee. Therefore, the same has rightly been claimed as a deduction while computing the taxable income.

8. In view of the above, grounds of appeal are rejected. Appeal of the Revenue is dismissed.

ITA No.7434/Del/2027 for Assessment Year 2013-14

9. As stated above, facts and grounds in both appeals are identical and both the parties have stated similar arguments, thus, observations made hereinabove in ITA No.682/Del/2017 for Assessment Year 2012-13 are mutatis mutandis applied in ITA No.7434/Del/2017 for Asst. Year 2013-14.

10. In the final result, both the appeals filed by the Revenue are dismissed. Order is pronounced in the Open Court on 25.03.2026.