The issue under consideration is whether the interest on bank deposit earned by assessee engaged in money lending covered under head of Business Income or Income from Other Sources?
ITAT states that, the assessee is engaged in the business of money lending and investments. The ‘money’ is the stock in trade of the assessee and any income earned by the assessee by rotating that money, i.e. stock in trade is nothing but income from business only and it cannot be considered as income from other sources. Being so, ITAT decide this issue in favour of the assessee.
FULL TEXT OF THE ITAT JUDGEMENT
These two appeals by the assessee are directed against the different orders of the CIT(A)-II, Kochi dated 23/11/2014 and pertain to the assessment years 2010-11 and 2011-12.
2. The assessee has raised the following common grounds of appeals:
1. The Officers below are not justified in invoking the provisions of section 14A r.w.s Rule 8D for the reason that the appellant had not incurred assessment year expenditure to earn the exempted income.
2. The Officers below failed to establish that the appellant had incurred any expenditure to earn such exempted income.
3. The Officers below having accepted the system of accounting to be cash, assessment of deemed interest on the overdrawing of the partners is opposed to the cannons of taxation.
4. The Officers below went wrong in not appreciating the fact that the loan from bank has been reduced, so much so, the partners have compensated such borrowed funds.
5. Treatment of interest earned from bank under other sources was not in order as these are in the nature of investment in trade and to be charactered as income from business.
3. The first ground, Ground Nos. 1 & 2 in ITA Nos. 92 & 93/Coch/2019 is with regard to addition of Rs.18,36,878/- on account of disallowance u/s. 14A r.w.s. Rule 8D of the Act.
4. The facts of the case as narrated in ITA No. 92/Coch/2015 are that during the course of verification it was found that in the computation of income, the dividend earned during the year was Rs.40,51,846.68/- which is exempt u/s. 10 of the I.T. Act. While going through the accounts and other details, the Assessing Officer noticed that the assessee has not segregated the expenditure in respect of dividend income. On verification of balance sheet, it was noticed that the assessee had made investments to the tune of Rs.19,17,67,946.92 as on 31.03.2010 and during preceding assessment year the total investment was Rs.19,22,23,220/-. Section 14A of the I.T. Act specifies the methodology to be adopted for computation of expenditure in respect of exempted income which cannot be allowed and Rule 8D gives the guidelines on the method of working.
4.1 I.T.A. Nos.92 & 93/Coch/2015 4.1 The Assessing Officer relied on the judgment of the Jurisdictional High court in assessee’s own case in ITA No. 296/2010 for the assessment year 2004-05 wherein it was held that even if investments in shares yields dividends which mean nontaxable, interest on borrowed fund, diverted for acquisition of such shares will not be eligible for deduction u/s. 14A of the Act. Thus, according to the Assessing Officer, these investments does not form part of the primary business of money lending of the assessee. Rule 8D gives guidelines on the method to be adopted for computing the expenditures attributable to such non-taxable income shall be the aggregate of the following:
i) Expenditure directly related to the income.
ii) In a case where expenditure have been incurred by way of interest during the previous year which is not directly attributable to any particular income or receipt an amount computed in accordance with the formula suggested.
|AxB where||A = Amount of Expenditure||Rs. 48,94,127/-|
|C||B = The average value of investments||Rs. 19,19,95,583/-|
|C = The average value of fixed assets||Rs.1,07,15,59,895/-|
The value as worked out from the above formula comes to Rs.8,76,900/-.
(iii) Amount equal to one half percent of the average value of the investment income from which were not part of the total income as appearing in the balance sheet of the assessee on the first day of the year and the last day of the year.
The details of investment on the first day and the last day of the previous year are as under:
a. As on 01/04/2008 Rs.19,22,23,220/-
b. As on 31/03/2009 Rs.19,17,67,945/-
5. On appeal, the CIT(A) referred to the provisions of section 14A:
14A (1) For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not for part of the total income under this Act.
(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not for part of the total income under this Act.
(3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this
5.1 Thus, according to the CIT(A), as per section 14A, if an expenditure has a relation or connection with or pertains to exempt income, it cannot be allowed as a deduction even if it otherwise, qualifies under the other provisions of the said Act. The CIT(A) observed that while earning any income from investments, some active and passive expenditure is involved in which event, the provisions of section 14A are applicable. The assessee could not establish that there was no nexus between the expenditure made and investment made with regard to any segmental cash flow alongwith any identifiable banking transactions. According to the CIT(A), there are incidental administrative expenses relating to earning of income which are embedded in the indirect expenses. The CIT(A) relied on the CBDT Circular no. 5/2014 dated 11th February 2014 wherein it was clarified that disallowance can be made by invoking the provisions of section 14A of the Act attracted even when no exempt dividend income was earned and even if there was no specific expenditure that can be exclusively related to earning of the exempt income. Accordingly, the CIT(A) confirmed the addition of Rs.18,36,878- made by the Assessing Officer by invoking the provisions of section 14A r.w. Rule 8D of the I.T. Rules.
6. Against this, the assessee is in appeal before us. The Ld. AR submitted that no expenditure had been incurred relating to earning of dividend claimed as exempt and the dividend was automatically credited to the bank account. It was submitted that the assessee being a firm engaged in financing, money is the stock in trade and investments have been made in the ordinary course of carrying on of the business with a view to optimize the profit and in such cases, provisions of section 14A could not be invoked. For this purpose, he relied on the decision of the ITAT, Delhi Bench in the case of CIT vs. Maharashtra Seemless Ltd. reported in 52 DTR Tribunal 5 wherein it was held that since investment for earning tax free income was made from mixed funds and it is not possible to ascertain as to whether the investment in tax free bonds was not out of own funds and the Assessing Officer has not established the nexus between borrowed funds and investment in tax free bonds, disallowance on pro-rata basis was not proper. It was submitted that from the balance sheet as on 31/03/2010, it could be seen that there was unsecured loan of Rs.52,52,46,792/- from Muthoot Chitty Fund, Kozhencherry of which no interest had been paid whereas the investment was only of Rs.19,17,67,946/- which was far less than interest free funds available. It was submitted that the Assessing Officer could not establish that any interest bearing funds had been diverted for earning exempt income.
7. The Ld. DR relied on the order of the authorities below.
8. We have heard the rival submission and perused the material on record. We find that a similar issue came up for our consideration in the case of Muthoot Bankers vs. ACIT in ITA Nos. 12 to 17/Coch/2018 dated 03/10/2018 for the assessment years 2008-09 to 2013-14 wherein it was held as under:
“6. We have heard the rival submissions and perused the material on record the Assessing Officer had made disallowance by invoking the provisions of section 14A of the I.T. Act r.w. Rule 8D(2)(iii) and Rule 8D(2)(iii) of the I.T. Rules. The disallowance made by invoking Rule 8D(2)(iii) of the I.T. Rules is for administrative and common expenses when the assessee derives exempted income. In the instant case, in each of the assessment year’s huge investments are made which is given rise to exempted dividend income. Investment decisions are very complex and strategic and obviously they would have incurred administrative expenses such as salary, wages, general expenses, stationery etc. Therefore, it cannot be said that no expenditure was incurred for making the said investments. Hence, we confirm the disallowance made by the Assessing Officer by invoking provisions of section 14A of the I.T. Act r.w. Rule 8D(2)(iii) of the I.T. Rules.
6.1 Insofar as the disallowance of indirect interest expenditure by invoking the provisions of section 14A of the I.T. Ac r.w. Rule 8D(2(ii) of the I.T. Rules, is concerned, the contention of the assessee is that it is having interest free funds in the form of reserves and advances from associate concern and no part of the interest bearing funds were diverted for making investments which had yield exempted income. However, this particular contention of the assessee was not demonstrated neither before the Assessing Officer nor before the CIT(A). Admittedly, interest on borrowed funds used for business purposes cannot be computed for disallowance u/s. 14A of the I.T. Act r.w. Rule 8D(2)(ii) of the I.T. Rules. It is the duty of the assessee to prove that interest was incurred on borrowings are used for the specific business purpose and non-interest bearing funds were utilized for making investments which has given rise to exempted income. The assessee to prove that it is having its own funds to make investment which had yielded exempted income, necessarily has to furnish cash flow statement. The cash flow statement would disclose as on the date of making investments, which had given rise to the exempted income, that the assessee had interest free funds available with it. In the interest of justice and equity, we deed it fit to remand the case to the Assessing Officer for fresh consideration. the Assessing Officer shall afford a reasonable opportunity of hearing to the assessee. The assessee shall prove its case that it is having interest free funds for making investments, by furnishing cash flow state for the respective assessment years. It is ordered accordingly.”
8.1 In view of the above order of the Tribunal, we remit this issue in dispute to the file of the Assessing Officer on similar directions. Thus, this ground of appeals of the assessee is partly allowed for statistical purposes.
9. The next common ground, Ground Nos. 3, 4 & 5 is with regard to disallowance of Rs.11,27,947/- u/s. 36(1)(iii) of the I.T. Act on account of funds having been diverted for non business purposes.
10. The facts of the case as narrated in ITA No.92/Coch/2015 are that on verification of records it was noticed that the assessee had taken secured loans of Rs.2,59,288/- from Dhanalakshmi Bank, Rs.25,18,151/- from HDFC and Rs.66,23,178/- from Syndicate Bank. For the above loans, during the year the assessee had paid interest of Rs.48,94,127/- (Rs.17,99,941.49 + Rs.30,94,186) which was debited to P&L account. During the verification of Partners Current Account of Shri Thomas Muthoot, it was noticed that he had shown a debit balance of Rs.7,29,10,831/- and withdrawn an amount of Rs.21,66,556/- during the year from his current account which he had utilized for his personal use. Therefore, the Assessing Officer made proportionate disallowance of interest bearing fund. For this purpose, the Assessing Officer relied on the judgment of the Jurisdictional High Court in the case of CIT vs. V.I. Baby & Co. 254 ITR 248 and the judgment of the Allahabad High Court in the case of Marolia & Sons vs. CIT 129 ITR 475. Section 36(1)(iii) of the I.T. Act deals with the deduction on the amount of interest paid in respect of capita borrowed for the purposes of business or profession. It would be found from clause (iii) of sub-section (1) of section 36 of the Act that three conditions must be established by the assessee for getting the benefit under the aforesaid clause:
(i) Interest should have been payable
(ii) There should be a borrowing and
(iii) Capital must have been borrowed or taken for business purposes. If the capital borrowed is not utilized for the purposes of the business, the assessee will not be entitled for deduction under this clause.
In case, after having borrowed the capital for business purposes, the firm gives the same to its partner, Shri Thomas Muthoot for his personal utilization, the firm would not be entitled to claim deduction on the amount diverted for utilization for other purposes or other persons. Therefore, he made disallowance u/s. 36(1)(iii) of the Act and added back to the total income of the assessee.
11. On appeal, the CIT(A) observed that section 36(1)(iii) of the I.T. Act provides for deduction of payment of interest only if the assessee borrowed capital for its own business. If such amounts are used by the partners of the assessee firm for their personal use, the same cannot be considered as the business of the assessee and the assessee had not earned any income on these investments. Therefore, according to the CIT(A), interest attributable to the proportionate interest paid by the assessee was not allowable as deduction u/s. 36(1)(iii) of the Act.
12. Against this, the assessee is in appeal before us. The Ld. AR submitted that the assessee is following the cash system of accounting which was accepted by the Assessing Officer and notional income cannot be assessed in such system. It was submitted that the assessee had paid only a sum of Rs.46,00,000/- to the partners, whereas the amount payable to them worked out to Rs.6,13,44,403/- and interest disallowance for not collecting any interest from Shri Thomas Muthoot can be made only if entire interest payable to all the other 7 partners had been considered in the accounts. The Ld. AR relied on the decisions in the case of S.A. Builders 288 ITR 1 and Munjal Sales Corporation 295 ITR 295. The Ld. AR relied on the judgment of the Jurisdictional High Court in the case of in the case of CIT vs. Muthoot Finance Corporation 284 ITR 704. The firm is having the same system of accounting for all transactions. The matter is not clear from the order of the Tribunal. Further, Counsel for the Revenue on the basis of the decision of CIT vs. A. Krishnaswami Mudaliar 53 ITR 122; Sundaram and Co. Ltd. vs. CIT 35 ITR 162 (Mad) and CIT vs. British Paints India Ltd. 188 ITR 44 (SC) contends that even if in the system of accounting, the Assessing Officer can exercise the power under the proviso when he finds that the method of accounting is not propr. Hence, the High Court set aside the order of the Tribunal and directed the Tribunal to reconsider the matter on the basis of the above directions.
13. The Ld. DR relied on the order of the authorities below.
14. We have heard the rival submissions and perused the material on record including the case laws cited by the parties. The AO made addition u/s. 36(1)(iii) of the Act by disallowing the portion of interest paid by the assessee as huge amount had been lent by the assessee to its partners. The contention of the assessee is that since the assessee was following the cash system of accounting, the interest receivable from partners on the amount lent to the partners cannot be offered to tax and it would be offered to tax only on receipt basis which was not actually received by the assessee in the year under consideration. Hence, it was not offered for tax. For this purpose, he relied on the judgment of the Jurisdictional High Court in the case of CIT vs. Muthoot Finance Corporation cited supra. In the present case, we observe that the Assessing Officer disallowed the portion of interest paid by the assessee as the interest bearing borrowings were diverted by the assessee by lending money to the partners without any interest and had not used for the purpose of the assessee’s business. In other words, the Assessing Officer had not brought to tax the notional interest receivable from the partners. As such, the judgment of the High Court in the case of CIT vs. Muthoot Finance Corporation cited supra cannot be applied to the assessee’s case. More so, the High Court has not given any findings on this issue and it was remitted to the file of the Assessing Officer for fresh consideration and there is no ratio deceindi . Hence, we do not find any infirmity in the order of the CIT(A) and the same is confirmed. This ground of appeals of the assessee for both the assessment years is dismissed. The next common ground, Ground No. 5 in ITA Nos. 92&93/Coch/2015 is with regard to addition and treatment of interest income earned from Banks as income from other sources and not as income from business.
16. The facts of the issue as narrated in ITA No.92&93/Coch/2015 are that the Assessing Officer made the addition by observing that interest on Bank deposits was in the nature of income from other sources. For this proposition, he relied on the judgment of the Apex Court in the case of Bokaro Steel Ltd. vs. CIT (170 ITR 545) wherein it was held that the surplus moneys not required for the business, if kept in short term deposits in Banks, then the Bank interest on such deposits is to be treated as income from other sources. chargeable under the head income.
17. On appeal, the CIT(A) confirmed the addition made by the Assessing Officer by relying on the judgment of the Apex Court in the case of Pandian Chemicals Ltd. (262 ITR 278) wherein it was held that certain income falling within the parameters of being incidental to business can fall within the scope of the business of the assessee, yet it cannot be said to have been derived from the eligible industrial undertaking of the assessee so as to be eligible for deduction u/s. 80IA of the Act. Thus, the CIT(A) held that irrespective of the nature of business of the assessee, if interest is earned from Bank deposits, the same is to be assessed as income from other sources.
18. Against this, the assessee is in appeal before us. The Ld. AR submitted that the assessee was acting as a controlling firm for various firms in the Group which were carrying on the business of money lending and investment. It was contended that such deposits had twin advantage of liquidity and security, apart from earning reasonable income by way of interest. Hence, it was argued that such Bank deposits form integral part of assessee’s business and therefore, interest on such Bank deposits was business income of the assessee. It was submitted that the department had treated such interest income as business income in the earlier years.
19. The Ld. DR relied on the order of the authorities below.
20. We have heard the rival submissions and perused the record. The assessee is engaged in the business of money lending and investments. The ‘money’ is the stock in trade of the assessee and any income earned by the assessee by rotating that money, i.e. stock in trade is nothing but income from business only and it cannot be considered as income from other sources. Being so, we decide this issue in favour of the assessee and against the revenue. Hence, this ground of appeals of the assessee for both the assessment years is allowed.
21. In the result, the appeals of the assessee are partly allowed for statistical purposes.