No disallowance u/s 14A if tax-free investments capable of taxable income

All the assessees in the present case are investment and trading companies. They issued unsecured optionally convertible premium notes of Rs. 1 lakh each. As per the terms of the said issue, the premium note holders could convert the said premium notes into equity shares of the company at the end of maturity period or redeem the same at any time after the end of three years from the date of allotment. In case of early redemption, the premium note holder were entitled to a proportionate premium. During the year under consideration, the holders of premium notes got the said notes redeemed and accordingly proportionate premium was paid by the assessees to the premium note holders on redemption.

The premium so paid was claimed by the assessee as deduction being allowable business expenditure. During the course of assessment proceedings, the claim of the assessee for deduction on account of premium paid on redemption of premium notes was examined by the AO. On such examination, he found that the amount received by the assessee on issue of premium notes was utilized for making investment in the purchase of shares of Reliance Utilities and Power Ltd. (‘RUPL’ in short) He also found that income arising from the said investment was exempt u/s 10(23G) of the Income-tax Act. He, therefore, required the assessee to explain as to why the premium paid on redemption of premium notes should not be disallowed u/s 14A. In reply, it was submitted on behalf of the assessee companies that they were engaged in the business of investment and finance since incorporation and since the amount received on issue of premium notes was invested in the shares of RUPL in the normal course of their business, the premium paid on redemption of premium notes was the expenditure incurred for the purpose of its business which should be allowed u/s 36(1)(iii). As regards the applicability of section 14A, it was submitted that the only income by way of dividend on shares was exempt from tax in respect of securities notified for the purpose of section 10(23G). It was submitted that since the said shares were also capable of generating other income in the form of short term capital gain, income from stock lending, income by way of fees for providing of shares, as collateral etc., and it was not a case wherein the borrowed funds were exclusively utilized for making investment in order to earn the exempt dividend income. It was contended that the premium paid on redemption of premium notes, therefore, could not be considered as expenditure incurred in relation to income which did not form part of total income of the assessee companies so as to attract the provisions of section 14A.

INCOME TAX APPELLATE TRIBUNAL, MUMBAI

ITA No.5779/Mum/2006 – (Assessment Year: 2003-04)
ITA No.208/Mum/2009 – (Assessment Year: 2004-05)

Avshesh Mercantile P. Ltd. (And 15 Others) Vs DCIT