Penalty paid to Stock Exchange allowable as regular business expenditure

ACIT Vs M/s Arihant Capital Markets Ltd. (ITAT Indore)

The assessee paid penalty of Rs.1,62,098/-levied by Stock Exchange for procedural defaults such a delay in submission of return, etc. but nowhere it has been mentioned that it is for infringement of any law. The learned Assessing Officer disallowed this expenditure. However, the learned Commissioner of Income Tax (Appeals) deleted the disallowance. From a perusal of the finding of the learned Commissioner of Income Tax (Appeals) as well as going through the submissions given by the assessee in the light of the judgment of the Hon’ble High Court of Bombay in the case of CIT vs The Stock & Bond Trading Company ITA No. 4117 of 2010 , we are of the considered view that the assessee made no offence prohibited by law which can be contemplated to be covered under Explanation to section 37 of the Act and, therefore, the payment of penalty made by the assessee to the Stock Exchange is a regular business expenditure and the impugned disallowance has rightly been deleted by the learned Commissioner of Income Tax (Appeals). We uphold the same.

FULL TEXT OF THE ITAT JUDGMENT

The revenue has filed the appeal whereas the assessee has filed the cross objection relating to the assessment year 2013-14 against the order of the learned Commissioner of Income Tax (Appeals)-I, Indore, dated 28.2.2017 arising out of the order u/s 143(3) of the Income Tax Act dated 15.3.2016 framed by the DCIT 1(1), Indore.

2. In its appeal, the revenue has taken the following grounds of appeal :-

(i) “On the facts and in the circumstances of the case, the learned CIT(Appeals) erred in restricting the disallowance made by A.O. u/s 14A of the Income Tax Act read with Rule 8D of the Income Tax Rules to 0.05% without appreciating the facts and evidences brought into light by the A.O. during assessment proceedings.

(ii) “On the facts and in the circumstances of the case, the learned CIT(Appeals) erred in deleting the addition made by the A.O. of Rs. 1,62,098/- on account of disallowance of penalty and Rs.15,508/- on account of disallowance of prior period expenses without appreciating the facts and evidences brought into light by the A.O. during assessment proceedings.”

In Cross Objection the assessee has taken the following grounds :-

“(i) The learned CIT(A) erred in confirming the addition u/s 14A to the extent of Rs. 5,77,013/-. That on the facts and in the circumstances of the case, the disallowance confirmed is wrong and uncalled for.

(ii) The learned CIT(A) erred in confirming the addition of Rs. 1,99,500/- out of prior period expenses made by the learned A.O. That on the facts and in the circumstances of the case, the disallowance confirmed is wrong and uncalled for.”

3. At the outset, the learned counsel for the assessee requested for not pressing both the grounds raised in cross objections. The learned DR has no objection. We, therefore, dismiss the grounds raised in cross objection of the assessee.

4. Now we are left with the revenue’s appeal. Apropos ground no. 1 relating to disallowance u/s 14A of the Act read with Rule 8D, briefly stated the facts are that the assessee declared income of Rs.3,14,87,710/- in the return of income filed for the assessment year 2013-14 on 26.9.2013. Case selected for scrutiny and necessary notices u/s 143(2) and 142(1) of the Act duly served upon the assessee. The Assessing Officer on going through the financial statements observed that the assessee has made investments in quoted/unquoted shares and also incurred expenditure on interest. However, no expenditure has been disallowed u/s 14A of the Act. The Assessing Officer accordingly applying the method provided under Rule 8D of the Income Tax Rules read with section 14A of the Act made disallowance of Rs. 52,26,627/- which comprised of interest disallowance of Rs. 42,64,143/- and disallowance for administrative expenses of Rs. 9,62,484/-.

5. Aggrieved with the findings of the Assessing Officer, the assessee went in appeal before the learned Commissioner of Income Tax (Appeals) and majorly succeeded as the learned Commissioner of Income Tax (Appeals) deleted total disallowance for interest expenditure and sustained administrative expenditure disallowance of Rs. 5,77,013/-.

6. Now the revenue is in appeal before us.

6. The learned DR vehemently argued supporting the order of the Assessing Officer and further heavily relied upon the judgment of the Hon’ble Apex Court in the case of Maxopp Investment Limited vs. CIT; 101 CCH 0092.

7. Per contra, the learned counsel for the assessee supported the findings of the learned Commissioner of Income Tax (Appeals) and further added that no expenditure was incurred in relation to earning exempt income. The investments were made out of the own capital and reserves and the assessee has no effective borrowing on the contrary it had huge bank balance. The assessee has earned net interest income at the close of the year and there is a direct nexus of interest expenditure with the earning of taxable income. It was also submitted that major investments were brought forward from earlier years and they majorly included unlisted shares of subsidiary companies which never yielded any income. The learned counsel for the assessee also differentiated the facts of the assessee’s case with the facts eminating in the case of Maxopp Investment Ltd. (supra) which mainly focused on the point that in the case of Maxopp Investment Ltd. (supra) case, the investments were made out of the borrowed funds on which interest expenditure was incurred whereas in the case of the assessee investments were made out of own capital and reserves and, hence, no interest was incurred in respect of such investment. Reliance was placed on the judgment of Hon’ble Bombay High Court in the case of CIT vs. Reliance Utilities & Power Limited; 313 ITR 340 and another judgment of Hon’ble Bombay High Court in the case of HDFC Bank Ltd.; 366 ITR 505. The learned counsel for the assessee further placed reliance on the following judgments :

8. We have heard both the parties and perused the material available on record and have also gone through the judgments referred to and relied upon by both the parties. The issue before us is with regard to disallowance u/s 14A which relates to disallowance of expenditure incurred for earning exempted income. The total disallowance made by the Assessing Officer u/s 14A of the Act ofRs. 52,26,627/- comprised of two items –

(i) Under Rule 8D(2)(ii) Indirect interest expenses Rs.42,64,143/-

(ii) Under rule 8D2(iii) other expenses Rs. 9,62,484/-

9. First of all, we would like to deal with the interest disallowance of Rs.42,64,143/-.

10. The investments held by the assessee, as reflected in the balance sheet at page 5 of the paper book are summarised as follows :-

11. The assessee earned dividend income of Rs.38,46,571/-during the year. Total interest expenditure incurred during the year is Rs.2,04,36,402/- and the interest income from FDRs and other sources is Rs.5,79,73,438/- thereby showing net interest income of Rs. 3,75,37,036/-. The assessee has also taken working capital loan on which interest expenditure has been incurred. The above chart clearly shows that the investments during the year majorly consists of investments in unquoted equity shares as well as shares of subsidiary companies valued at Rs.7,71,46,480/-.

12. We also find that the assessee possessed share capital and reserve surplus totaling Rs. 50.86 crores and Rs. 51.67 crores approximately as on 31.3.2012 and 31.3.2013, respectively. These accumulated capital and reserves are much more than the investments made in the equity shares fetching exempted income. As on 31.3.2012 and 31.3.2013 investment in quoted shares fetching exempted income is Rs.12.71 crores (approx) and Rs. 6.37 crores (approx) which is not more than 20% of the total interest free capital & reserves.

13. In the background of above facts, we observe that the learned Commissioner of Income Tax (Appeals) deleted the interest disallowance observing as under :-

“5. Ground No. 1 : This ground of the appellant is directed against the disallowance of Rs. 5226627/- u/s 14A of the Act. The detailed facts of the case as per the assessment order are reproduced at Para No. 2 above and the detailed submissions of the appellant are reproduced at Para No. 3 above.

5.1 On perusal of the assessment order it is seen that the A.O. has rejected the contention of the appellant that no interest bearing funds were utilised in making investments yielding exempt income and such rejection is without considering the detailed explanation of the appellant. From the material placed on record which was also before the A.O. it is seen that the major investments were made in the earlier years from own funds and no borrowed funds were utilised in making these investments. Further the investments made during the year under consideration were also not made from borrowed funds. The capital and reserve funds with the appellant stood at Rs. 51.66 crores as on 31.3.2012 and these were at Rs.52.44 as on 31.3.2013 while the Non Currente investments increased marginally from 7.70 Cr to 7.71 Crore and the current investments reduced from 12.70 Crore to 10.37 crore and the stock in trade stood at Nil as on 31.3.2013 as against 6.81 crores as on 31.3.2012. The own capital and disposable reserves far exceeded the investments. Majority of the investments were made in the earlier year and as seen from the appellate orders for A.Y. 2010-11 the investment in that year was also only Rs. 78.98 lacs and in the appellate orders for both A.Y. 2009-10 and 2010-11 it has been held that the investment was far less than the own funds and therefore no interest expense can be said to be incurred in relation to investment earning exempt income. The only fresh investment made in mutual funds for Rs. 4.0 crores during the year under consideration was also established to have no nexus with the interest bearing funds. These facts have not been repudiated by the A.O. by placing any details establishing that this is not the case. In view of the above it cannot be said that the investments yielding exempt income if any were out of borrowed funds and therefore interest qualified for disallowance u/s 14A of the Act. Further asa per the extant legal position also it is held in the case of CIT vs. Reliance Utilities And Power Ltd. (2009) 366 ITR 505 that if both funds are available with the assessee i.e. interest bearing funds and interest free funds then the presumption would arise that investment made would be out of interest free funds available with the company, if the interest free funds are sufficient to meet the investments and in view of the above no presumption can be drawn in the absence of definite material brought on record to show that the interest bearing funds were utilised for investments earning exempt income. No such definite material is on record to show that the brought forward investments are out of interest bearing funds and the investments made during the year are already established to be out of interest free funds.

5.2 It is also to be noted that the appellant further explained that interest income offered ofRs. 30929734/- is mainly received from banks on FDRs and also interest of Rs. 27043704/-received from its clients as deferred payment charges totaling to Rs. 57973438/- whereas the interest payment of Rs. 20436402/- is on its working capital borrowings during the year and the net interest income earned of Rs. 37537036/- has been assessed as business income. The appellant as a broker of both BSE and NSE has taken working capital limits to cater to the pay-in and pay-out obligations of these exchanges. At the end of the every trading session the appellant needs to meet out the margins and payouts of the exchanges according to the open positions taken by its customer. The customers generally pay the amount to the appellant towards their outstanding in 3-4 working days whereas the appellant is required to pay to the exchanges on regular basis. For this reason the ap-p hasa taken working capital limits from bank and on utilisation of such limit the appellant has incurred the interest expense. From the sanction letter issued by the bank in respect of the overdraft limit taken for working capital purpose by the appellant, it is verifiable from the page 2 of the letter that the purpose of the loant aken was “Working capital requirement/Stock Exchange Obligations”. From the perusal of the security clause mentioned on the same page it is apparent that the limit taken from banbk was secured against the FDRs made and pledged by the appellant. The overdraft facility taken by the appellant is utilised only for pay outs on account of positions held by th clients to stock exchange. The appellants interest cost on overdraft against FDs is thus directly related to the core broking business of the appellant. In view of the abvove it is thus evident that the interest expenditure was outside the scope of section 14A of the Act. It has been held in the case of Pr CIT vs. Bharti Overseas Pvt. Ltd.; 237 Taxmann 417 (2015) (Delhi) that while apportioning interest expenditure under clause (ii) of Rule 8D(2) of the Rules, interest expenditure incurred for earning taxable income should be excluded from consideration.

5.3 The A.O. has further rejected the contention of the appellant that no disallowance is called for when there is no exempt income earned during the year. The A.O. has relied primarily on the decision of the Special Bench of ITAT Delhi in the case of Cheminvest Ltd. The said decision has been reversed by the Delhi High Court by holding as under ;-

“(i) The expression “does not form part of the total income” in section 14A of the envisages that there should be an actual receipt of income which is not includible in the total income during the relevant previous yeasr for the purpose of disallowing only expenditure incurred in relation to the said income/. In other words, section 14A will not apply if no exempt income is received or receivable during the relevant previous year. The decision of the Supreme Court in Rajendra Prasad Moody (supra) was rendered in the context of allowability of deduction under section 57(iii) of the Act, where the expression used is “for the purpose of making or earning such income”. Section 14A of the Act on the other hand contains the expression “in relation to income which does not form part of the total income.” The decision in Rajendra Prasad Moody cannot be used in the reverse to contend that even if no income has been received, the expenditure incurred can be disallowed under section 14A of the Act.”

5.4 The A.O. has also rejected the contention of the appellant that investments in shares of unlisted private limited subsidiary companies/associate concerns and the shares held as stock in trade are made out of commercial business expediency and does not attract disallowance u/s 14A. Investments made in stock in trade is not made for the purpose of earning of tax exempt income in form of Dividend. The dividend income earned on the shares held as stock in trade is incidental to its holding Dividend declared by various listed companies is miscule in comparison to their market rates and no investment is made with the intention of earning such nominal dividend. In the case of CCI Ltd. vs. JCIT (Kar) 206 Taxmann 563 it has been held that 14A does not apply in respect of shares held as stock in trade. Disallowance on notional basis is invalid “When no expenditure is incurred by the assessee in earning dividend income, notional expenditure cannot be disallowed u/s 14A. The assessee had not retained shares with the intention of earning dividend. The dividend income was incidental to the business of sale of shares which remained unsold by the assessee. It canot be said that the expenditure incurred in acquiring the shares had to be apportioned to the extent of dividend income and that there should be a disallowance u/s 14A”.

5.5 Considering the above discussion and keeping in view the appellate decisions in the appellant’s own case for A.Y. 2009-10 and A.Y. 2010-11 as the facts for the year under consideration are identical to the facts prevailing in the earlier years, the disallowance worked out by the A.O. under section 14A read with Rule 8D at Rs. 5226627/- is directed to be restricted to 0.05% of the average investments excluding the investment in unquoted subsidiaries and also excluding the investment in stock in trade which works out to Rs. 577013/-. This ground of the appellant is therefore partly allowed.”

14. Further, during the course of hearing, the learned DR relied upon the judgment of the Hon’ble Apex Court in the case of Maxopp Investment Ltd (supra). We, however, find force in the contention of the learned counsel for the assessee that the facts of the assessee’s case are altogether different from that of Maxopp Investment Ltd. (supra). Both can be differentiated in the following manner :-

On the basis of the above distinguishable facts of both the cases the case of the assessee is clearly distinguishable on facts and is on a much better footings than the case of Maxopp Investments Limited, rather the observations of the Hon’ble Apex court further strengthens the appellant’s contention in so far as that the disallowance can be contemplated only when exempt income is earned and there is some expenditure incurred. The Honourable Supreme Court also upheld its own findings rendered in CIT v/s Wallfort Shares & Stock Brokers Pvt. Ltd. (2010) 326 ITR 1 (SC) that the basic principal of taxation is to tax the net income and on the same analogy the exemption is also in respect of net income  entailing that when there is no exempt income, disallowance is not attracted.

15. The above distinguishing facts prove that the finding of the Hon’ble Apex Court cannot be applied to the facts of the assessee’s case because it is well evident that the borrowed funds have not been utilised for the purpose of making investments in shares and securities. It has also been consistently held by various Hon’ble Courts that if the assessee possesses sufficient capital and reserves as well as interest free funds and if there is no finding by the revenue authorities that interest bearing funds have been applied for investing in shares and securities, it has to be presumed that the assessee has invested its own capital and reserves i.e. interest free funds for making the investments. We find support from the judgment of ther Hon’ble High Court of Bombay in the case of Reliance Utilities (supra) and HDFC Bank (supra). We, therefore, respectfully following the above judgments of the Hon’ble Courts, are of the considered view that the learned Commissioner of Income Tax (Appeals) has rightly deleted the interest disallowance of Rs. 42,64,143/-.

16. As regards the disallowance of administrative expenditure of Rs.9,62,484/-, we find no reason to interfere with the finding of the learned Commissioner of Income Tax (Appeals) who has sustained the addition of Rs. 5,77,013/- by keeping in view the investments made in quoted shares as well as unquoted shares as well as looking to the aspect that the assessee is engaged in the business of purchase and sale of shares. We accordingly uphold the same.

17. In the result, ground no. 1 of revenue’s appeal is dismissed.

18. Apropos ground no. 2 wherein the revenue has challenged the deletion of addition of Rs. 1,62,098/- on account of disallowance of penalty and Rs. 15,508/- on account of disallowance of prior period expenses, the learned DR supported the observations of the Assessing Officer whereas the learned counsel for the assessee has relied upon the findings of the learned Commissioner of Income Tax (Appeals). The learned counsel for the assessee also referred to the decision of the Hon’ble High Court of Bombay in the case of CIT vs. Stock & Bond Trading Company; ITA No. 4117 of 2010 wherein it has been held that payments made to the stock exchange for violation of their regulation are not on account of offence which is prohibited by law and, hence, the invocation of Explanation to section 37 of the Act is not justified.

19. We have heard both the parties and perused the material available on record. The assessee paid penalty of Rs.1,62,098/-levied by Stock Exchange for procedural defaults such a delay in submission of return, etc. but nowhere it has been mentioned that it is for infringement of any law. The learned Assessing Officer disallowed this expenditure. However, the learned Commissioner of Income Tax (Appeals) deleted the disallowance. From a perusal of the finding of the learned Commissioner of Income Tax (Appeals) as well as going through the submissions given by the assessee in the light of the judgment of the Hon’ble High Court of Bombay in the case of CIT vs The Stock & Bond Trading Company (supra), we are of the considered view that the assessee made no offence prohibited by law which can be contemplated to be covered under Explanation to section 37 of the Act and, therefore, the payment of penalty made by the assessee to the Stock Exchange is a regular business expenditure and the impugned disallowance has rightly been deleted by the learned Commissioner of Income Tax (Appeals). We uphold the same.

20. As regards the disallowance of Rs. 15,508/- being treated as prior period expenses by the learned Assessing Officer we find that the payment related to service tax and the necessary proof of payment was placed on record. Therefore, as the liability has crystalised during the year, the learned Commissioner of Income Tax (Appeals) has rightly allowed the assessee’s claim of expenditure of Rs.15,508/-. No interference is, therefore, called for in the findings of the learned Commissioner of Income Tax (Appeals). We accordingly uphold the same. Revenue’s ground no. 2 is, therefore, dismissed.

21. In the result, the appeal of the revenue and cross objection of the assessee stand dismissed.

Pronounced in open Court on 31st May, 2018.

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