No deemed dividend if shareholding of a common shareholder is less than 20%

IN THE ITAT MUMBAI BENCH ‘A’

Income-tax Officer-2(1)(1)

V/s.

Anand Rathi Direct India (P.) Ltd.

IT APPEAL NO. 2556 (MUM.) OF 2010

[ASSESSMENT YEAR 2006-07]

MAY 4, 2012

ORDER

B. Ramakotaiah, Accountant Member – This is Revenue appeal against the order of CIT(A)-Mumbai dated 4.10.2010. The revenue has raised eight grounds on four issues.

2. We have heard learned CIT -DR and learned Counsel in detail. The learned Counsel also placed on record reconciliation of turnover which was relevant for Ground Nos.3 to 6. After hearing them, the grounds were considered as under:

3. Ground Nos. 1 & 2: The Revenue has raised grounds as under:

“1.  On the facts and circumstances of the case and in law, the learned CIT(A) erred in deleting the addition of Rs. 67,10,483/- made by the Assessing Officer under section 2(22)(e) of the I.T. Act, 1961 without considering the facts that the provisions of section 2(22)(e) are clearly applicable in this case.

 2.  On the facts and circumstances of the case and in law, the learned CIT(A) erred in not considering the decision of the ITAT in the case of M/s. Unisol Infraservices Pvt. Ltd v. Income Tax Officer-8(3)(4) vide ITA No. 2088/Mum/2008 dated 11.7.2009″.

4. Assessing Officer while scrutinizing the return noticed that assessee company borrowed an amount of Rs. 67,10,483/- from M/s. Amit Capital & Securities Pvt. Ltd. On noticing that the details filed on record shows that M/s Predict Investment & Financial Consultants (P) Ltd is a common share holder in both the companies and is holding 18.99% in M/s Amit Capital & Securities Pvt. Ltd., of total share holding of company and is also holding 19.72% of total share holding of assessee company. As there was surplus to the tune of Rs. 89,31,955/- as reserves in the balance sheet of M/s Amit Capital & Securities Pvt. Ltd., Assessing Officer invoked provisions of section 2(22)(e) to make an addition of loan amount of Rs. 67,10,483/- as deemed dividend. It was submission of assessee that moneys were advanced in the ordinary course of business and charged interest on advance and M/s Predict Investment & Fin. Con. (P) Ltd does not have any substantial interest on assessee company as per Explanation (3) to section 2(22). Neither party has any substantial interest and the assessee is not a share holder in M/s Amit Capital & Securities Pvt. Ltd. so as to attract provisions of section 2(22)(e). These objections were negatived by Assessing Officer while making addition. However, CIT(A) deleted the addition on the reason that assessee is not covered under section 2(22)(e) as assessee is not holding even a single share in lender company Amit Capital & Securities Pvt. Ltd. Further, M/s Predict Investment & Fin. Con (P) Ltd is holding though more than 10% but less than 20% so as to have ‘substantial interest’. Revenue is aggrieved and preferred above grounds.

5. The learned Departmental Representative relied on orders of Assessing Officer whereas learned Counsel not only submitted that the issue under section 2(22)(e) was decided by Special Bench in the case of Asst. CIT v. Bhaumik Colour (P.) Ltd. [2009] 118 ITD 1 (Mum) which in turn was confirmed by the Hon’ble Bombay High Court in CIT v. Universal Medicare (P.) Ltd. [2010] 324 ITR 263/190 Taxman 144 (Bom). It was further submitted that Assessing Officer did not accept that M/s Predict Investment does not have any substantial share holding and reasoned that explanation-3 covers only an individual and not company, whereas he has not considered section 2(32) where a person who has a substantial interest in a company refers to a person carrying not less than 20% of voting power. Therefore, even on that reason, addition cannot be made.

6. We have considered the issue. As seen from order of Assessing Officer, he has considered that a common share holder M/s Predict Investment has substantial share holding of more than 10%. While analyzing substantial interest, Assessing Officer has only considered Explanation 3 with reference to a person having beneficial interest entitled to not less than 20% of income of such concern so as to attract provisions of section 2(22)(e). However, Assessing Officer has not examined definition given in section 2(32) with reference to company which has a substantial interest in company, wherein it was specifically mentioned of carrying not less than 20% of voting power. Admittedly M/s Predict Investment has less than 20% share holding in both companies i.e. assessee as well as M/s Amit Capital & Securities (P.) Ltd. Therefore, reasoning given by Assessing Officer of a common share holding by Predict Investment does not hold good. Further, it is an admitted fact that assessee is not owning any share in M/s Amit Capital &Securities (P.) Ltd and as held by the Hon’ble Bombay High Court in the case of Universal Medicare (P.) Ltd. (supra), provisions of section 2(22)(e) does not apply unless assessee is a share holder in the company. For both the reasons, we uphold order of CIT(A) and dismiss the grounds raised by Revenue. It is to be noted that the decision relied upon by Revenue in ground was not approved by Special Bench in the case of Bhaumik Colour (P.) Ltd (supra). Therefore, there is no need to consider and analyse the Coordinate Bench Decision stated in Ground No. 2. The grounds are rejected.

7. Ground Nos. 3 to 6: Ground Nos. 3 to 6 raised by Revenue are as under:

“3. On the facts and circumstances of the case and in law, the learned CIT(A) erred in deleting the addition of Rs. 5,60,89,831/- made by the Assessing Officer by way of rejecting the books of account.

4. On the facts and circumstances of the case and in law, the learned CIT(A) erred in deleting the addition of Rs. 5,60,89,831/- made by the Assessing Officer as the assessee has failed to reconcile the turnover disclosed in the Profit & Loss A/c with reference to the gross sales and purchases in all the securities traded by the assessee.

5. On the facts and circumstances of the case and in law, the learned CIT(A) erred in deleting the addition of Rs. 5,60,89,831/- made by the Assessing Officer without appreciating the facts that the assessee had not added the grey trading/speculative transactions as well as the assessee was not able to reconcile the turnover with STT.

6. On the facts and circumstances of the case and in law, the learned CIT(A) erred in deleting the addition of Rs. 5,60,89,831/- made by the Assessing Officer estimating the income at the rate of 1% of total turnover as the assessee had failed to reconcile the turnover”.

8. The issue in above grounds is with reference to failure of assessee to reconcile turnover disclosed in Profit & Loss A/c and consequently rejection of books of account by Assessing Officer and estimating income at 1% of turnover. The facts as stated in AO order is as under:

“Para No.7:

During the course of assessment proceedings the assessee was asked to reconcile the turnover disclosed in the Profit & Loss A/c with reference to the gross sales and purchases in all the securities traded by the assessee. The assessee has furnished the arbitrage turnover scrip-wise which is stated at Rs. 347,07,03,891/- on purchase side and Rs. 347,06,31,082/-on sale side. Since the said details submitted by assessee does not include day trading/speculative transaction, a comprehensive effort was made to co-relate the transaction with reference to STT and transaction charges paid and claimed by the assessee. The assessee was asked to reconcile the same with reference to STT and transaction charges paid. A show cause notice dated 24.11.2008 was served on assessee.

In response the assessee made the following submissions as per its letter dated 05-12-2008.

In respect of STT charges, we would like to bring to your notice the correct rates as under:-

It may be noted that the STT rate of 0.025% was not applicable during the period covered under the relevant previous year. Further in case of same day square off transaction in cash segment and transactions in derivative segments STT is charged only one side on sale. The Turnover and STT paid on the same are properly reflected and disclosed. We enclose herewith Form 10DB showing the amount of turnover and STT paid for each segments in support of our claim of rebate under section 88E of I. Tax Act.

Similarly transaction charges are different for different kinds of Trades as detailed hereunder.

From the above table, it may be observed that Transaction Charges are not normally half of STT charges as stated in your letter. There are definite rates at which Transaction Charges an STT are charged in the bills. In view of above the estimated working of profitability made by you in the letter is not valid and justified on any ground and are baseless.

The above submissions of the assessee only refer to the prescribed rate of STT and transaction charges levied by the exchanges. The assessee did not furnish the reconciliation of the transactions asked from it from it’s books of account but only placed reliance on form 10DB issued by the broker. This is a clear refusal of submitting the information as required for the purpose of scrutiny. Even the transactions disclosed in the form No.10DB were also not reconciled by the assessee with reference to the profits shown in the Profit & Loss A/c filed with the record. This attitude of assessee only leads to conclusion that assessee neither have any details nor willing to bring the material facts on record for determination of the correctness of the income disclosed in the return filed for the year. The details available in form 10DB are summarized as under:

The client codes given above being:

01. STT attracted on purchases

02. STT attracted on sales

03. STT attracted on sales side on non-delivery based transaction

04. STT attracted on sale side of derivatives being option in securities

05. STT attracted on sales side of derivatives being Futures in securities.

Even by applying the above transaction codes, the sales can be stated at Rs. 560,89,83,102/- and purchases can be worked out at Rs. 559,34,34,075/- (without taking profit element into consideration). Whereas the assessee has shown the same at Rs. 347,07,03,891/- on purchase side and Rs. 347,06,31,082/-on sales side. The above differences in sales of Rs. 212,27,30,184/- and purchases of Rs. 213,83,52,020/- are clear and apparent and not explained by assessee.

Therefore, in view of the foregoing Paras, the assessee’s accounts does not reflect a true and fair view of the accounts of the assessee company, the books of account are accordingly rejected within the meaning of provisions of section 145(3) of the IT Act, 1961 and the assessment is accordingly finalized as per the provisions of section 144 of the Act”.

9. Aggrieved, the matter was carried to CIT(A) and submitted as under:

  i.  The books of account as prescribed under the I. Tax Act and companies Act are maintained properly and audited as per law.

ii.  The Tax Audit Report in Form 3CA with 3CD as prescribed u/s 44AB of the Act was obtained from the Chartered Accountant and filed with the return as its turnover of arbitrage of share business activity exceeded Rs. 40 lacs.

iii.  There were no discrepancies found by the Statutory Auditor and Tax Auditor and none of the reports were qualified.

iv.  All transactions and entries were correctly entered and entries are not complicated in books and all entries wherever asked were explained.

 v.  The appellant has maintained all such books of account and submitted all information that would enable the Assessing Officer to compute the profits and there was no difficulty in making the assessment and therefore provisions of section 271A of the Act are not attracted. This view is supported by the decisions of the Tribunal in the case of Harilal Dhanwani and Papalal Gaur.

In the appellant’s Case the appellant is regularly maintaining all required books of account which would enable the assessing officer to complete the assessment and hence under the above circumstances, we request your honour to treat that all books of account are maintained by the as required to complete the assessment and rejection of the books by the Learned Income Tax Officer is erroneous and such rejections of books of accounts be quashed. Consequent to the rejection of books the income taken on estimation basis at Ra. 5,60,89,831 by invoking section 145(3) r.w.s. 144 of the Act is erroneous.

The learned Income Tax officer erred in trying to match the figures on arbitrary basis and when not satisfied on her working she rejected the books of account and took 1% Income on turnover derived by herself on hypothetical, assumption and surmise basis.

The learned Income Tax officer has failed to appreciate the following facts:

  i.  The difference in turnover as alleged by the learned Income Tax Officer is due to the turnover of derivative segment which she has ignored.

 ii.  Meaning of Arbitrage Business i.e. purchasing shares of a particular company at one stock exchange and simultaneously selling them at other stock exchange and earning a small percentage of difference is known as arbitrage which is the difference in the price of the shares of that particular company at two different stock exchanges. Further it is to be noted that during Arbitrage activity, normally the overall position of a particular client used to be NIL across the exchange/segments. In arbitrage business, the numbers of transactions are huge and the accounting for the same is done on day to day basis based on the contracts/bills of the broker. The appellant does not prepare the statement of scrip vise gain/loss as the purpose of arbitrage is to earn interest/return based on price .differentials. The scrip wise details as desired could not be submitted for want of time as it takes voluminous time to serve the similar objective & substance of the transaction is Arbitrage which is not looked at all.

The Learned Assessing Officer isolated the loss in derivative segment ignoring the other leg of transaction of profit in cash segment and vice versa. In respect of loss of Rs. 56,03,776/- in Market to Market (M to M) margin in derivative segment, there is profit of more than this amount in cash segment. It may be noted that in case of Arbitrage activities the cash to derivative segment, the transactions are done in such way that there is exactly reverse position in another segment. For example if,” there is buy position in cash market, there will be equal sell position/in derivative segment. In such case with the movement in price of underline scrip, there will be profit in one segment and loss in another however the profit would normally be more than loss, ultimately resulting in net profit. In view of the above facts the net loss in Market to Market cannot be segregated from the profit in cash segment and net result should be counted.

iv. The figures as the Learned Income-tax Officer has estimated is not correct since the Learned income Tax Officer has estimated the turnover on the basis of STT rate @ .025 which was not applicable during the year. The rates of STT on all segments at BSE and NSE are not same as taken by the Learned Income Tax Officer. The rates of all segments are different and not equal. The rates can not be taken arbitrary as there are different& definite rates at which STT and transaction charges to be charged prescribed by the Govt. of India. It may be appreciated that all transactions of appellant have been undertaken on Recognized Stock Exchanges (BSE and NSE) of eligible equity shares only. The estimated working of profitability in those circumstances is not valid and justified. All the transactions are -completely transparent and can be verified from 10DB certificate. We therefore request your honour to take the actual figures as declared and direct the learned Income Tax officer not to take any income on estimation basis and request to allow the all expenses as claimed an4 also allow security transaction tax paid as Rebate u/s 88E of the Act and oblige.

In case of arbitrage activity, profit margin is very low and if the appellant company does the arbitrage activity other than its own broker house it will have to pay more brokerage and in that case there will hardly be any earning of profit. Therefore arbitrage activity is done mostly through in house brokerage where brokerages are nominal.

vi.  Further the transactions in the nature of jobbing or arbitrage and in derivative segments are not doomed to be speculation transaction as provided in the provisions (c) & (d) of section 43(5) of I. Tax Act which roads as under:

“(5) ‘Speculative transaction’ means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips:

Provided that for the purposes of this clause

(c) a contract entered into by a member of a forward market or a stock exchange in, the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; or

(d) an eligible transaction in respect of trading in derivatives referred to clause 2 of the Securities contract Act carried out in a recognized stock exchange shall not be deemed to be a speculative transaction;”

The above section clearly states that transactions in the nature of jobbing or arbitrage and in derivative segments are not deemed to be speculative transactions as provided in the provisions (c) & (d) of section 43(5) of I. Tax Act and the same has been substantiated by the clarificatory circular of CBDT w.e.f. 25.12006 and also supported by various judicial decisions including Mumbai tribunals in the case of DCIT v. SSSKI Investors (P) Ltd. (113 TTJ 511) and in the case of RKB Securities (P) Ltd v. ITO (118 TTJ 465). In view of the same it is clear that the question of treating the loss incurred, if any, in the derivative segment even till 25.1.2006, the date from which the said circular came into effect as speculative losses u/s 43(5) of the Act does not arise and the estimated profit as above taken i.e. 1% income on turnover derived by the Learned Income Tax Officer is unjustified and uncalled for and liable to be deleted”.

10. After considering the submissions, CIT(A) deleted the estimation of income resorted to by Assessing Officer stating as under:

15. I have thoroughly gone through the assessment order and the submissions made by the authorized representative of the appellant. I find that the reasons given by the Assessing Officer to substantiate her decision of rejection of books of account are very vague and she failed to understand the nature of the business of the appellant and worked out turnover of the appellant in a summary and vague manner. By no stretch of imagination a reverse turnover can be worked out based on STT rules which were different at different times and nature of trading involved is different in different segments at BSE and NSE. All transactions are duly made on either of the exchanges and recorded in books. If a close look at the STT statement is given, the figures are voluminous and to arrive arbitrarily at any figures by rejecting the books of account and estimating the income at 1% is not called for. Hence I hold that the decision of the Assessing Officer regarding the rejection of the books of account of the appellant cannot be upheld. This ground of appeal is allowed.

11. Before us learned CIT-DR vehemently argued stating that CIT(A) erred in not upholding order of Assessing Officer as assessee failed to give reconciliation of turnover and in the absence of any verification of turnover the books of account cannot be accepted. She supported the order of Assessing Officer.

12. The learned Counsel however, submitted that assessee is involved in various business activities in stock exchange both delivery based and non delivery based, arbitrage etc. There is no allegation that assessee has transactions outside the stock exchange. The books of account were audited and tax returns were submitted. The assessee has reconciled the turnover and referred to Page Nos. 6, 7, 8 & 9 of the paper book which indicate the scrip-wise turnover and total Buy amounts at Rs. 662,18,10,511.54 and the total Sale amount at Rs. 662,09,25,442.50 and it was further submitted that the above turnover does not include turnover on account of auction participation and close out credit. It was further submitted referring to the order of Assessing Officer while arriving at turnover of Rs. 560/- crores, Assessing Officer made mistakes and gave following reconciliation in explaining that assessee turnover tallies, if one consider the mistakes committed by him, which are as under:

13. It was learned Counsel’s submission that referring to the order of Assessing Officer, the main focus of Assessing Officer out of 44 pages of order upto page 33 was with reference to investment in unquoted shares and how those transactions are to be treated as business income but not capital gain. Inspite of explaining that there are different STT charges as stated in page 34 of the order and furnishing complete details, evidence on the basis of the form 10DB furnished by various clients, Assessing Officer not only considered amounts wrongly but arrived at decision of rejecting books of account and estimated turnover at 1% without any basis or comparative figures, arbitrarily. He explained reconciliation made before CIT(A) and supported order of CIT(A).

14. We have examined the issue. The assessee shows turnover of direct purchase and sale in the books of account whereas in F&D segment, arbitrage, auctions etc., only net amounts are accounted while STT was paid on value of transaction. Therefore, reconciling the turnover on the basis of STT is if not impossible, virtually cumbersome considering the nature of the business, turnover involved and different rates of STT paid for different transactions. On certain transactions in F&AO there is no STT on buy amounts but only on sale amounts. Therefore, the Assessing Officer exercise of asking the assessee to reconcile turnover, may be valid according to law but not practical considering that all the gross amounts are not accounted for in the books of account of the assessee and assessee to a large extent filed form 10DB explaining various turnovers undertaken by the company. The books of account cannot be rejected simply because the assessee failed to reconcile the turnover to the satisfaction of AO. There is no allegation that the assessee was indulging in any transactions outside the books outside the stock exchange. The books of account were also audited. Scrutiny assessments were completed in all earlier years without rejecting books of account. Considering the explanation given by the assessee, turnover reconciliation placed on record, we are of the view that the CIT(A) was correct in rejecting Assessing Officer’s action. We uphold order of the CIT(A) and dismiss the Revenue grounds.

15. Ground No.7: Revenue’s ground No.7 is as under:

“7.On the facts and circumstances of the case and in law, the learned CIT(A) erred in deleting the addition of Rs. 31,20,337/- under the head “Income from Business & Profession” instead of correctly treated by the Assessing Officer as “Income from other source” without appreciating the facts of the case”.

16. The Assessing Officer treated the amount of Rs. 31,20,337/- shown as ‘other income’ to tax as “Income from other sources”. The CIT(A) after accepting the assessee’s application did not affirm the action of the Assessing Officer by stating as under:-

“I have thoroughly gone through the assessment order and the grounds of appeal submitted by the appellant. I found that the “Miscellaneous and Other Income” of Rs. 21,30,337/- is nothing but the Business Income of the appellant as the assessee has earned this income by way of participating in auction market. The same cannot be treated as “Income from Other Sources” and therefore, I direct the Assessing Officer to treat the same as business income only”.

17. We have perused the record and analyzed the contentions of rival parties. The details shown as “other income” are as under:

There is no dispute with reference to the IPO referral fee and auction charges being part of business operations and business income. The only issue that may arise is with reference to interest received of Rs. 5,58,562/-. Further details of the above amounts are as under:

Except the Income-tax refund interest of Rs. 3,300/-, all amounts are received in the course of business and there was payment of interest also which was allowed as business expenditure, on which there is no dispute from Assessing Officer. Considering these, we are of the opinion that the CIT(A) order is to be upheld. Since there is no effect by treating the small interest on income tax refund either as ‘income from other sources” or ‘business income’, even though legally interest on Income Tax refund is not a business income, we uphold the order of the CIT(A) as it does not have any tax impact on the small amount of Rs. 3,300/-. On the facts of the case there is no merit in the revenue contention.

18. We also note that the Revenue has raised in ground an amount involving Rs. 31,30,337/- which is not correct. It was only Rs. 21,30,337/- as can be seen from assessment order as well as CIT(A) order. Therefore, above reconciliation was only to the extent of Rs. 21,20,337/- which is the correct amount involved in this ground. The ground is, therefore, rejected.

19. Ground No.8. The ground No.8 raised by the Revenue is as under:

“8. on the facts and circumstances of the case and in law, the learned CIT(A) erred in deleting the addition of Rs. 62,45,345/- made by the Assessing Officer on account of administrative and other expenses by way of rejecting the books of account”.

This ground arises consequent to the action of Assessing Officer in rejecting the books of account and estimating income at 1% of turnover, thereby not allowing expenditure of Rs. 62,45,345/-. Consequent to the decision in upholding the action of the CIT(A) in accepting the assessee’s books of account and rejection of estimation at 1% therein, the action of the CIT(A) in allowing the expenditure cannot be faulted. Since this is consequent to the Ground Nos. 2 to 6, in line with the decision taken therein, we reject the ground. Revenue has not made out any case why expenditure cannot be allowed to assessee which was claimed in the books of account. The ground is rejected.

20. In the result, Revenue’s appeal is dismissed.