IN THE ITAT DELHI BENCH ‘E’
Assistant Commissioner of Income-tax
Mohan Exports (P.) Ltd.
IT APPEAL NO. 3571 (DELHI) OF 2011
[ASSESSMENT YEAR 2008-09]
MARCH 2, 2012
K.G. Bansal, Accountant Member –
Two points have been taken by the revenue in this appeal regarding disallowance u/s 14A and disallowance of misuse charges.
2. In regard to the first issue, the AO found in the course of assessment that the assessee has made investments in shares of companies and units of mutual funds. The investments as on 31.03.2008 stood at Rs. 89,77,51,107/- as compared to Rs. 54,10,80,750/- as on 31.03.2007. The assessee was required to explain as to why appropriate disallowance should not be made from the expenditure debited to the books of account by invoking the provisions contained in section 14A of the Income-tax Act, 1961, read with Rule 8D of the Income-tax Rules, 1962. It was submitted that the assessee has made investments in shares of group companies, shares and units of unlisted companies or funds, and shares and units of listed companies and mutual funds. The shares of group companies have not yielded any dividend in this year. The shares and units of unlisted companies and mutual funds have also not yielded any income. The assessee has received dividend of Rs. 46.65 lakh from Foremost Factor Ltd. Therefore, it was argued that no amount is disallowable under the aforesaid provision. The AO considered the facts of the case and submissions made before him. It is mentioned that the investments have been made with a view to earn dividend. Such income is not to be included in the total income of the assessee. Therefore, provisions contained in section 14A and Rule 8D are applicable. Rule 8D lays down the procedure for calculating the amount which is attributed to earning tax-free income. This rule was applied. Consequently, disallowance was made under Rule 8D(2)(ii) and Rule 8D(2)(iii). The disallowance under former provision was calculated at Rs. 51,78,366/- and under the latter provision at Rs. 35,97,079/-. Thus, a total sum of Rs. 87,75,445/- was disallowed.
3. Various submissions were made before the ld. CIT (Appeals) by the assessee. He considered the assessment order and the submissions made before him. He also examined the bank account maintained by the assessee company with Citi Bank in order to ascertain immediate source of investment in shares and units. It was found that the investments have been made in this year from interest-free funds available with the assessee. In view thereof, it was held that no disallowance is warranted under Rule 8D(2)(ii).
3.1 Coming to the submission that no dividend had been received from various companies, the finding of the ld. CIT (Appeals) is that this does not mean that such companies will not declare dividend in future. For making disallowance u/s 14A, it is not necessary that all the investments must yield income in the year under consideration. The relevant consideration is the potentiality of earning income in future years. Therefore, rejecting this argument, the disallowance under Rule 8D(2)(iii), amounting to Rs. 35,97,079/-, has been sustained.
4. Before us, the ld. senior DR referred to the findings of the AO and the ld. CIT (Appeals). These findings have already been summarized by us. Our attention has been drawn towards page nos. 6, 18 and 22 of the paper book. Page 6 shows the investments made in the unquoted shares and units of the companies and mutual funds and income received therefrom. These details are reproduced below:-
|Name of the Company||Opening Balance||Closing Balance||Dividend received|
|Foremost Factors Ltd. (FFL)||69,146,235.00||69,146,235.00||27,99,015.00|
|Lord Krishna Bank Ltd. (LKBL)||443,333,506.00||0.00||0.00|
|Motherson Sumi-Infotech & Designs Ltd.||34,50,000.00||0.00||0.00|
|Gee Gee Facbrics Pvt. Ltd.||8,000,000.00||8,000,000.00||0.00|
|Madhusudan Cable Industries Pvt. Ltd. (MCIPL)||6,619,808.00||6,619.808.00||0.00|
|Crayon Capital Art Funds (Units)||2,500,000.00||2,500,000.00||0.00|
4.1 Page no. 18 contains the explanation of the assessee before the AO that the investments had been made in earlier years and there is no nexus between interest paid and investments made in this year. For investment of Rs. 6,92,12,607/- in shares of Hotline Teletubes Ltd. and Foremost Factors Ltd., the assessee had interest-free funds by way of share capital, reserve and surplus and current liabilities amounting to Rs. 4.96 crore, Rs. 60.27 crore and Rs. 43.86 crore respectively. Page 22 is a detailed chart of investments and income received thereon. This chart shows total investments of Rs. 54,10,80,750/- as on 31.03.2007 and Rs. 89,77,51,107/- as on 31.03.2008. The addition to the investment in this year is shown at Rs. 35,66,70,357/-. The corresponding increase in investments in immediately preceding year was Rs. 1,75,69,808/-. The case of the ld. DR is that there has been substantial increase in the investments in this year. The AO has followed proper procedure as mentioned in the decision in the case of Maxopp Investments Ltd. v. CIT  203 Taxman 364/15 taxmann.com 390 (Delhi). Therefore, it is argued that the order of the ld. CIT (Appeals) may be set aside on this issue and that of the AO may be restored.
5. In reply, the ld. counsel for the assessee submitted that it had sufficient interest-free funds and no part of the interest paid in this year is related to the investments made by the assessee in shares or units. No disallowance was made in the proceedings of assessment year 2007-08 as the return had been processed u/s 143(1). The ld. CIT (Appeals) has examined the bank account to ensure that there is no nexus between investment made in this year and the borrowed funds. Therefore, it is argued that no amount could be disallowed under Rule 8D(ii). It may be mentioned here that the assessee has not filed appeal against the disallowance upheld by the ld. CIT(Appeals) by invoking the provision contained in Rule 8D(2)(iii).
6. We have considered the facts of the case and submissions made before us. There is no evidence on record to suggest that any investment in shares or units has been made in this year out of borrowed funds on which interest is payable by the assessee. The ld. CIT (Appeals) has given a very specific finding that the examination of the bank account shows that such investments are out of interest-free funds available with the assessee-company. Rule 8D(2)(ii) deals with a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt in terms of the decision in the case of Maxopp Investments Ltd. (supra). The lower authorities were expected to examine whether the interest paid in this year is or is not directly attributable to any particular income or receipt. There is a finding that the interest is not directly related to receipts by way of dividends. Therefore, it follows that the payment of interest is in respect of income other than dividend income. In such a situation, the interest cannot be said to be a kind of general expenditure incurred for earning of various kinds of incomes. Therefore, the provision contained in Rule 8D(2)(ii) is not applicable. It was also the argument of the ld. senior DR that the AO has followed the procedure laid down in the case of Maxopp Investments Ltd. (supra). The decision is that the AO has to examine the expenditure and its nexus with the earning of tax-free income, as provided in sub-section (2) of section 14A. If there is no such nexus, the disallowance cannot be made, otherwise the disallowance can be computed as prescribed under Rule 8D. In view of the finding of the ld. CIT (Appeals), no interest expenditure had been incurred for earning tax-free income. Therefore, the provision contained in Rule 8D(2)(ii) cannot be invoked. Thus, ground nos. 2 and 2.1 regarding this issue are dismissed.
7. Coming to the second issue, the AO found that the assessee claimed the deduction of a sum of Rs. 67,31,919/-. Annexure ‘H’ of the audit report furnished the break-up of the expenditure as under:-
|(ii)||Interest on misuse charges||30,84,530/-|
|(iii)||Interest on conversion charges||1,25,420/-|
|(iv)||Interest on ground rent||99,822/-|
7.1 The assessee was required to state its case as to how the amount is deductible in computing the total income. It was submitted that the amount represents the demand raised by the Delhi Development Authority (‘DDA’ for short). The assessee had contested the demand. Finally, the demand notice dated 08.05.2007 was accepted by it. The demand was paid in the current year. Therefore, the same is deductible from the income. On getting the explanation, the AO issued a further show cause notice asking the assessee to state its case as to why the expenditure should not be disallowed. It was submitted that the assessee purchased two commercial plots in public auction in March, 1978. The master plan envisages that the residential premises will be constructed on second and third floors. The assessee-company protested against this policy. In the mean time, the assessee constructed the commercial centre on the plots and the space so constructed was also used for commercial purposes. The assessee accepted the demand from the DDA as finding equivalent commercial space in the vicinity would have cost more than the charges paid to the DDA. Therefore, it is argued that the expenditure was incurred for the purpose of business. The AO considered the submissions of the assessee. It has been held that the expenditure does not pertain to this year. Further, it has been held that commercial space has constructed been without the permission of the DDA which amounts to unauthorized construction. On noticing this, the DDA levied misuse charges and ordered demolition of the unauthorized construction. This point was contested for a long time. The assessee has paid the misuse charges and interest thereon in this year. There is no value addition to the building. The expenditure is also not revenue expenditure as it has been incurred for misuse of the residential premises as commercial premises. Thus, the expenditure has been disallowed.
7.2 Before the ld. CIT (Appeals), it has been submitted that the demand notices from the DDA are dated 08.05.2007 and 18.12.2007. This shows that the liability got crystallized in this year. The amount includes misuse charges of Rs. 34,22,147/-, interest on misuse charges amounting to Rs. 30,84,530/-, interest on conversion charges of Rs. 1,25,420/- and interest on ground rent of Rs. 99,882/-. The facts regarding allotment of the plots and construction thereon submitted before the AO were reiterated. The argument regarding the expenditure having been incurred in the course of the business was also reiterated. It is further submitted that the assessee has not violated any statute and, therefore, the misuse charges are not penal in nature. The interest paid thereon is also compensatory in nature. The DDA is purely commercial organization which acquires and sells the land. This activity is in the nature of business. Merely because the DDA is a government body, the charges of commercial nature cannot be categorized as penal in nature. The expenses are also not caught within the mischief of Explanation-1 to section 37.
7.3 The ld. CIT (Appeals) considered the facts of the case and submissions made before him. It is mentioned that the charges were paid on the basis of demand notice issued by the DDA in the months of May, 2007 and December, 2007. Both these dates fall in the current previous year. Therefore, it has been held that these are not prior period expenses.
7.4 Coming to deduction of expenses u/s 37(1), it has been held that the interest of Rs. 33,87,926/- is obviously compensatory in nature, therefore, it cannot be disallowed u/s 37(1). As far as misuse charges of Rs. 34,22,147/- are concerned, it is mentioned that the opinion of the AO is influenced by the fact that in its reply dated 03.12.2010, the assessee has used the term “penalty-DDA misuse”. The payment has been made for creating extra commercial space, which is not permitted under the master plan approved by the DDA. The space has been created because there was a business necessity to do so. Thus, the expenditure has been incurred by way of commercial expediency. It does not involve violation of any statutory provision. Therefore, it has been held that this amount is also deductible in computing the total income.
8. In regard to the finding that the expenditure does not pertain to this year, the ld. senior DR referred to page nos. 29 and 30 of the paper book. Page no. 29 is a letter dated 08.05.2007 from the DDA. It gives the break-up of a sum of Rs. 36,58,530/- in terms of misuse charges, and interest on belated payment of conversion charges and ground rent for the two plots of land. This letter has been written in reference to assessee’s letter dated 17.02.2007. On the basis of this date, it is argued that the amount had been computed prior to 17.02.2007 as the assessee had sought further clarification in its letter dated 17.02.2007. Page no. 30 is a letter dated 18.12.2007 from the DDA regarding execution of lease deed. In this letter, interest on misuse charges has been computed at Rs. 33,87,926/-. On the basis of these documents and aforesaid submissions, it is argued that the expenses are in respect of earlier period on which interest has also been levied in this year. It is argued that both these expenses are not deductible in computing the income.
9. In reply, the ld. counsel also referred to page nos. 29 and 30 of the paper book and submitted that the demand got crystallized in this year, therefore, the expenses cannot be said to be prior period expenses.
9.1 It is further submitted that the misuse charges pertain to the lower basement. This position is different from position submitted before the lower authorities that the 2nd and 3rd floors had to be constructed for residential purpose as per Master Plan. On receiving the letter from the DDA, this portion (the lower basement) was filled up. The expenditure has been incurred in pursuance of business expediency as hiring of equivalent space elsewhere would have led to higher expenditure than the payment made to the DDA. The expenditure does not involve violation of any law. Therefore, the expenditure has been incurred as a matter of business expediency, which is deductible in computing the income of the assessee.
10. We have considered the facts of the case and submissions made before us. The facts are that the assessee was required to pay misuse charges of Rs. 33,87,926/- in terms of the letter of the DDA dated 18.12.2007. This letter speaks of the earlier letter of 08.05.2007, which shows that there was some previous correspondence which took place between the assessee and the DDA in this matter on 08.05.2007. Both these dates fall in this year. Further, the assessee had to pay a total sum of Rs. 36,58,530/- in terms of the letter of the DDA dated 08.05.2007. This amount consists of misuse charges of Rs. 34,22,147/-. Thus, the two letters contain some what different amounts quantified as misuse charges. The letter dated 08.05.2007 also contains details of interest on belated payment of conversion charges and ground rent. These are the only evidences placed before us or the lower authorities for deciding the question regarding deduction of the overall sum of Rs. 67,31,919/-. The ld. counsel fairly submits that the nature of interest on misuse charges will partake the character of misuse charges in so far as its deductibility in computing the income is concerned. The question is – whether, misuse charges are deductible u/s 37(1) or not?
10.1 Before deciding this issue, we may refer to the precedents relied upon by the rival parties. The ld. senior DR has relied on the decision in the case of CIT v. Mamta Enterprises  266 ITR 356/135 Taxman 393 (Kar.). The assessee is a builder and is carrying on the business of building apartments and selling them. It claimed deduction of a sum of Rs. 89,960/- paid as compounding fine to Bangalore City Corporation. The AO disallowed the same. The CIT (Appeals) allowed the deduction by holding that it is incurred in the course of business. The Tribunal upheld this order by relying on the decision in the case of CIT v. Loke Nath & Co. (Construction)  147 ITR 624/17 Taxman 209 (Delhi), in which it had been held that compounding find paid by the assessee to regularize the construction of the building made in violation of building regulation is an integral part of profit earning process of the assessee. The Hon’ble Court considered the decision in the case of Haji Aziz and Abdul Shakoor Bros. v. CIT  41 ITR 350 (SC) and Maddi Venkataraman & Co. (P.) Ltd. v. CIT  229 ITR 534/96 Taxman 643 (SC). In the latter case, the Hon’ble Supreme Court observed that the assessee had indulged in transactions in violation of the provisions of the Foreign Exchange (Regulation) Act. The plea that unless it entered into such a transaction, it would have been unable to dispose off the unsold stock of inferior quality of tobacco and must have incurred loss, cannot be a justification for contravention of law. The assessee was engaged in tobacco business. It was expected to carry on the business in accordance with law. If it contravenes the provisions of FERA to cut down losses or making larger profit, it was only expected that proceedings will be taken against it. The expenditure incurred for evading the provision of the Act and also the penalty levied for such evasion cannot be allowed as deduction. It is not enough that disbursement was made in the course of trade, it must also be for the purpose of the trade. The purpose must be a lawful purpose. In the former case, it has been held that if a sum is paid by the assessee in conducting his business, because in conducting it he has acted in a manner which has rendered him liable to penalty, it cannot be claimed as a deductible expenses. The penalty paid for infraction of law cannot be called commercial losses incurred by the assessee as it is not a normal incident of the business. Relying on these cases, it has been held that the deduction allowed by the CIT and the Tribunal is totally unsustainable in law. Thus, the matter has been decided in favour of the revenue.
10.2 The decision in the case of Loke Nath & Co. (Construction) (supra) has been discussed in brief in the case of Mamta Enterprises (supra). In this case, the assessee had constructed extra space on the second floor of the building covering 50% of the area instead of 35% of the area sanctioned by the NDMC. The assessee applied for revised sanction of the plan of the building undertaking to construct only 12 storeys in place of 13 storeys originally sanctioned in view of the excess construction on the second floor. This plan was sanctioned and the infringement by way of additional coverage and other irregularities were condoned on the condition that the assessee shall pay ad-hoc penalty of Rs. 4.00 lakh. The NDMC proposed to revoke the revised plan but a writ petition filed by the assessee against this proposal was allowed by the High Court. The question was-whether, the sum of Rs. 4.00 lakh is allowable as a deduction in computing the business profits of the assessee? The ITO and the AAC decided the matter against the assessee by holding that the amount was paid as penalty for infringement of municipal by-laws. The Tribunal however came to the conclusion that the amount paid was compensation and not penalty. Thus, the deduction was allowed. The matter was agitated before the Hon’ble High Court, which mentioned that section 195 of Punjab Municipal Act ensured that the restrictions were observed by the builder. Such restrictions were enforceable by alteration, demolition or accepting a sum by way of compensation. This section does not create any penal offence. Therefore, the payment is not occasioned by infringement of any law or it is not against public policy. Therefore, the payment could not be held to be illegal. Accordingly, the deduction has been allowed.
10.3 In the case of Goldcrest Capital Markets Ltd. v. ITO  130 TTJ (Mum.) 446, it has been held that fines and penalties levied for violation of unfair trade practice specified in regulation 4.6 and rule IV(4)(e) of the NSE Rules cannot be equated with violation of a statutory rule or law. Although the working of the stock exchange is regulated by the SEBI and the Board of Directors of the NSE has nominees of the SEBI, yet violation of rules and regulations framed by such stock exchange cannot per se be considered as in violation of SEBI enactment. Any fine paid for non-observation of such internal regulation cannot be said to be the payment made for violation of the law.
10.4 In the case of Ashok Kumar Damani v. Addl. CIT  9 ITR (Trib.) 304/130 ITD 287/9 taxmann.com 69 (Mum.), it has been held that penalty levied by the stock exchange on account of short payment of margin money is in the nature of compensatory payment under the rules of the stock exchange. Such payment cannot be attributed to infraction of law and, therefore, it is revenue in nature.
10.5 Coming to the facts of the case at hand, it is seen that the assessee admittedly constructed commercial space in the basement which was not permissible as per master plan. The assessee used this business space for some time but thereafter the DDA directed it to remove the construction. Since the construction and user till this time was a fate accompli, the assessee was also directed to pay misuse charges of Rs. 34,22,147/-. The matter remained under dispute for some time and, therefore, the payment was not made. Consequently, the DDA charged interest on misuse charges and such interest was computed at Rs. 30,84,530/-. Although any particular provision of the rules or regulations has not been referred to, it is clear that the DDA acted as a sovereign when it directed the assessee to remove the irregularity caused by construction of commercial space in the basement. The constructed space was filled up. The levy of misuse charges was also in connection with the aforesaid violation as the assessee had already used the space which it should not have constructed. Therefore, the situation here is qualitatively different from the situation in the case of Loke Nath & Co. (Construction) (supra) where the irregularity could be removed by alteration, demolition or accepting compensation. The only recourse in this case was demolition, i.e., filling up the construction in the basement. This also brings out clearly that the DDA while ordering the removal of the infraction was not acting as a trader as in the case of a trader simplicitor, the seller will have no power to direct the buyer to make construction in one way or the other. The DDA in this case was acting as implementer of the master plan and only one course, i.e., removal of the infraction was permissible. Further, the misuse charges were paid in respect of the aforesaid space, therefore, it can be said that the misuse charges were also paid for illegally using the space for a period of time till the infraction was noticed by the DDA and it ordered the removal of the infraction. Thus, the payment of misuse charges is for violation of master plan drawn for the development of areas under the control of DDA. The ld. counsel has admitted that the nature of interest on misuse charges is the same as misuse charges. Such conclusion is obvious for the reason that the payment to be made for misuse charges was not the expenditure incurred in the normal course of business. Explanation-1 to section 37(1) provides inter-alia that any expenditure incurred for any purpose which is prohibited by law shall not be deemed to have been incurred for the purpose of business and no deduction or allowance shall be made in respect of such expenditure. To our mind, this provision is clearly applicable to the case of the assessee. We also find that the decision in the case of Goldcrest Capital Markets Ltd. (supra) was rendered on totally different facts. The main distinction is that the stock exchange has not been invested with any sovereign power and, therefore, any violation of rules framed by it would not lead to inference of violation of law or doing an act which is prohibited by law. The decision in the case of Ashok Kumar Damani (supra) proceeds on similar lines. Therefore, the ratio of these cases is not applicable to the facts of this case. In a nutshell, it is held that misuse charges and interest on misuse charges are not deductible in computing the total income of the assessee.
10.6 The result of the discussion is that ground Nos. 3 and 3.3 are allowed.
11. In the result, the appeal is partly allowed.