In the ITAT Mumbai Bench ‘I’

Assistant Commissioner of Income-tax, Rg. 4(1), Mumbai

v.

Claridges Investments & Finances (P.) Ltd.

I. Section 14A, read with section 10(33), of the Income-tax Act, 1961 - Expenditure incurred in relation to income not includible in total income - Assessment year 2001-02 - Whether provisions of section 14A apply only when there is expenditure in relation to an exempt income and it does not create any legal fiction to deem any expenditure as expenditure incurred in relation to exempt income - Held, yes - Assessee-company which was dealing in securities in stock exchanges, required substantial funds to deal in same which was met from borrowed funds in addition to own funds - Thereafter, assessee had invested certain sum in mutual funds and shares and earned dividend income on same - Department held that as dividend income was earned by assessee which was exempt under section 10(33) expenditure relatable to such income was disallowable under section 14A - Whether since dividend income was merely an incidental income for which no borrowing was made, impugned disallowance made by Assessing Officer was not justified and was liable to be deleted - Held, yes

II. Section 28(i), read with section 36(2), of the Income-tax Act, 1961 - Business loss/deductions - Allowable as - Assessment year 2001-02 - Whether any bona fide loss arising in ordinary course of carrying on of business which is of a revenue nature is to be allowed as a business loss even if provisions relating to deduction of bad debt do not apply - Held, yes - Assessee-company purchased shares of a company ‘C’ on behalf of another company CCL and total amount receivable on this account was Rs. 2,47,69,500.69 - Assessee claimed that it did not receive said amount as two cheques issued by CCL of Rs. 1,25,00,000 each bounced - Assessee, therefore, claimed that amount of Rs. 2,47,69,500 be allowed as business loss/bad debt - Assessing Officer disallowed assessee’s claim holding that since assessee had in its custody 6,40,000 shares of ‘C’ worth Rs. 74,56,000 and also had with it margin money of Rs. 15 lakhs, loss of Rs. 2,47,69,500 could not be claimed by assessee - Assessing Officer further held that assessee’s claim for allowing this amount was not acceptable, as amount had not been written off also in books of account and requirements of provisions of section 36(2) were not met with - Whether since assessee had purchased shares on behalf of ‘CCL’ in ordinary course of its profit-making activity, it was entitled to deduction of money lost - Held, yes - Whether however, since assessee had with it security deposit of Rs. 15 lakhs and also had 6,40,000 shares of company ‘C’ worth Rs. 74,56,000, disallowance to extent of Rs. 27,80,000 was justified and balance amount was allowable as a business loss - Held, yes

III. Section 45 of the Income-tax Act, 1961 - Capital gains - Chargeable as - Assessment year 2001-02 - Assessee-company disclosed investments in equity shares at Rs. 1,332.48 lakhs - It had converted said investments into stock-in-trade by passing a journal entry in account books and market value of said shares on date of conversion was Rs. 1,064.74 lakhs - Assessing Officer, in terms of provisions of section 45(2), treated difference between cost of investments and market value of shares as capital loss as against assessee’s claim of business loss and, accordingly, did not allow benefit of set-off of loss against business income of assessee - Whether Assessing Officer was justified in his action - Held, yes

IV. Section 28(i) of the Income-tax Act, 1961 - Business loss/deductions - Allowable as - Assessment year 2001-02 - Assessee entered into various transactions in shares through three Kolkata based brokers - For relevant assessment year, assessee claimed deduction of Rs. 26.44 crores as business loss stating that Kolkata based brokers had defaulted in making payments - Assessing Officer, however, disallowed assessee’s claim - Whether since assessee’s transactions in shares through aforesaid brokers were supported by movement of shares as reflected in demat account; movement of money, as reflected in bank account; entries in books of account of assessee; prevalent market quotations of CSE; contract notes and delivery bills issued by Kolkata brokers and their statements in response to enquiries made by Assessing Officer, it could not be said that these transactions were shown only in order to generate loss or profit and were not genuine share transactions - Held, yes - Whether further, since loss, in question was no longer recoverable, denial of deduction of loss on ground that loss had not crystallized during relevant financial year was also untenable - Held, yes - Whether, therefore, deduction of loss in question was to be allowed - Held, yes

Facts-I

The assessee-company was dealing in securities in stock exchange. It required substantial funds to deal in securities which was met from borrowed funds in addition to own funds. Thereafter, assessee had made investment in schemes of mutual funds and shares and received dividend income on same. The Assessing Officer held that as dividend income was earned by assessee which was exempt under section 10(33) the expenditure relatable to such income was to be disallowed under section 14A.

On appeal, the Commissioner (Appeals) upheld the disallowance made by the Assessing Officer.

On second appeal :

Held-I

The disallowance made by the Assessing Officer and upheld by the Commissioner (Appeals) was assailable on several counts. Firstly, the lower authorities had merely applied an ad hoc formula and made no attempt to make the disallowance on actual basis. This approach could not be permitted. The assessee required substantial funds to deal in securities of the Stock Exchanges, which was met by it from the borrowed funds in addition to own funds. During the year under consideration, the total turnover of the assessee in shares was Rs. 9,218 crores. According to the requirements of the Stock Exchange, the assessee had to keep margin money of 20 per cent of its turnover. Therefore, the assessee had to utilize borrowed funds for payment of this huge margin money to the Stock Exchange. When borrowed funds were utilized for day-to-day running of the business, there could not be any justification for disallowance of the interest. Secondly, the Assessing Officer as also the Commissioner (Appeals) had simply assumed that all the shares had been purchased out of borrowed funds. It could not be accepted that merely because the payments were made from the overdraft account it entailed utilization of borrowed funds as distinguished from the assessee’s own funds. [Para 20]

As a matter of legal proposition also it is not acceptable that even in the case of a dealer/broker in shares, as distinguished from an investor in shares, the borrowed funds utilized for acquisition of shares should be related to earning of dividends. Where the shareholding is on trading account or on behalf of a third party the interest expenditure cannot be said to have been incurred for earning of dividend. There was force in the contention of the assessee that the dividend income, in the instant case, had been to a larger extent merely incidental income for which no borrowing was made. The legal position in this regard is not altered by the provisions of section 14A that apply only when there is expenditure in relation to an exempt income. These provisions do not create any legal fiction to deem any expenditure as expenditure incurred in relation to exempt income. [Para 21]

Therefore, the Commissioner (Appeals) had erred in upholding the disallowance made by the Assessing Officer; therefore, the impugned disallowance made by the Assessing Officer was liable to be deleted. [Para 22]

Facts-II

The assessee-company purchased shares of a company ‘C’ on behalf of another company CCL on 18-1-2001 and the total amount receivable on this account was Rs. 2,47,69,500.69. The assessee claimed that it did not receive the said amount, as the two cheques issued by CCL of Rs. 1,25,00,000 each bounced. The assessee, therefore, claimed that the sum of Rs. 2,47,69,500 be allowed as business loss/bad debt. The Assessing Officer held that since the assessee had in its custody 6,40,000 shares of ‘C’ worth Rs. 74,56,000 and also had with it the margin money of Rs. 15 lakhs, the loss of Rs. 2,47,69,500 could not be claimed by the assessee. The Assessing Officer further held that the assessee’s claim for allowing this amount was not acceptable, as the amount had not been written off also in the books of account and the requirements of the provisions of section 36(2) were not met with. The Assessing Officer, therefore, disallowed the assessee’s claim.

On appeal, the Commissioner (Appeals) held that the amount in question was allowable neither as a bad debt nor as a business loss. He also held that the claim of loss was premature because the assessee had not made any efforts to recover the debt and instead made claim of business loss in an undue haste.

On second appeal :

Held-II

The Assessing Officer was correct in that the condition precedent as enumerated in section 36(2) was not satisfied as respects the amount expended for purchase of shares on behalf of CCL. From that it did not follow that the assessee could not at all claim deduction of money lost. Undisputedly, the assessee had purchased the shares on behalf of CCL in the ordinary course of its profit-making activity. Any bona fide loss arising in the ordinary course of carrying on of business which is of a revenue nature is to be allowed as a business loss even if the provisions relating to deduction of bad debt do not apply. Therefore, there was no merit in the argument of the Assessing Officer that the assessee’s claim of deduction should fail for want of satisfaction of section 36(2) requirement. [Para 31]

The Commissioner (Appeals) had relied upon no material to arrive at the finding that the loss was claimed in an undue haste and, therefore, the same was not warranted on the facts and in the circumstances of the case. The assessee had demonstrated that there was a sharp erosion in the value of the shares of ‘C’ that had become dud. The cheques issued by CCL had bounced. It was not understood as to how the Commissioner (Appeals) had termed it ‘undue haste’. Therefore, the assessee, on an honest appraisal of ground realities, came to an honest belief that the amounts outstanding against CCL had resulted into a business loss. [Para 32]

The main objection of the Assessing Officer was that there was security of Rs. 15 lakhs and the assessee had in its custody 6,40,000 shares of ‘C’ purchased on behalf of CCL. There was force in the contention of the assessee that on this ground the Assessing Officer could not disallow the entire business loss of Rs. 2,47,34,748, when as per the Assessing Officer himself shares of company ‘C’ were worth Rs. 74,56,000 only. Even as regards that value alleged by the Assessing Officer the assessee had pointed out that the post-dated cheques of Rs. 1,25,00,000 each were deposited by it on 18-3-2001. The same were returned as bounced on 19-3-2001. Immediately, the assessee tried to sell the shares but there were no takers. From 19th to 22nd March on an average one trade took place and during those four days the total volume of the shares transacted in the Exchange was 19 shares only, i.e., less than 5 shares per day. Thereafter, the quoted price at the BSE plummeted to Rs. 2 only and that too for minuscule quantity of shares. These submissions of the assessee had not been controverted by the Assessing Officer and the Commissioner (Appeals) in any manner. Therefore, the value of those shares at the material time should be taken at approximately Rs. 2 only. However, one could not accept the entire amount being claimed as business loss when the assessee had with it the security deposit of Rs. 15 lakhs and also had in its custody 6.40 lakh shares. Therefore, taking into consideration the security deposit and the value of the shares in the assessees custody, the disallowance to the tune of Rs. 27,80,000 was liable to be sustained and the balance amount was allowable as a business loss. [Para 33]

Facts-III

The assessee had disclosed investments in equity shares at Rs. 1,332.48 lakhs in the balance-sheet as on 31-3-2000 . On 2-4-2000, the assessee had converted the said investments into stock-in-trade by passing a journal entry in the books of account. The market value of the shares on the date of conversion was Rs. 1,064.74 lakhs. The Assessing Officer, in terms of the provisions of section 45(2), treated the difference between the cost of investments (Rs. 1,332.48 lakhs) and the market value of shares (Rs. 1,064.74 lakhs) as capital loss as against the assessee’s claim of business loss and, accordingly, did not allow the benefit of set-off of the loss against business income of the assessee.

On appeal, the Commissioner (Appeals) upheld the impugned order.

On second appeal :

Held-III

The treatment given by the Assessing Officer was in accordance with the statutory provisions of section 45(2). There was no force in the argument of the assessee that these provisions would come into play only when there was profit or gain and not when there was loss. For that matter even the provisions of section 45(1) speak of “profits or gains arising from the transfer of a capital asset” only but in computation of income chargeable to tax the capital loss also has to be given effect to. The expression ‘Profit’ in that sense includes negative profit. The stand taken by the revenue had its statutory foundation in the provisions of section 71(3). As to the contention of the assessee, that there was merely a rectification of mistake, no such case had been set-up with relevant evidence. Moreover, the provisions of section 45(2) do not draw any distinction depending upon an assessee’s reasons for conversion of a capital asset into or treatment as stock-in-trade. Therefore, the impugned order was to be upheld. [Para 56]

Facts-IV

During the relevant previous year ended on 31-3-2001, the assessee-company entered into various transactions in shares through the three Kolkata based brokers. For the relevant assessment year, the assessee claimed deduction of Rs. 26.44 crores as business loss stating that the Kolkata based brokers had defaulted in making payments on account to it. The Assessing Officer disallowed the assessee’s claim on the grounds that the share transactions through the aforesaid brokers were shown only in order to generate loss or profit and were not genuine share transactions; that the loss had not crystallized during the relevant financial year, as the assessee had received a sum of Rs. 1 crore, subsequently, from the three brokers, which indicated that the business loss claimed by the assessee was premature and not crystallized during the financial year 2000-01, as claimed by the assessee; and that in any case the transactions being in violation of the SEBI’s prescriptions the business loss was not an allowable deduction. The Assessing Officer had given three reasons for treating the transactions through the brokers as non-genuine. The first reason given by the Assessing Officer was that the special auditor had made adverse comments with regard to these transactions in his main report as well as the subsequent additional report. Secondly, as confirmed by the Calcutta Stock Exchange (CSE) these transactions had not taken place on the floor of the exchange nor had these transactions been reported to the exchange by the three brokers as per the relevant rules and regulations, since they were off market transactions. Further, if these transactions were spot transactions, the brokers were required to report all such transactions on the same day to the concerned stock exchange as per the SEBI instruction. Further, the settlement of spot transactions had to take place within 48 hours and that was not done.

On appeal, the Commissioner (Appeals) upheld the impugned order.

On second appeal :

Held-IV

The special auditor appointed under section 142(2A) in his report dated 6-8-2004 did not say that the transactions were not genuine; he only said that as far as speculation transactions were concerned the genuineness of the loss (not transactions) could not be certified for want of voluminous data required for such certification. Further, the special auditor in the additional report dated 26-8-2004 acknowledged that the assessee forwarded 11 contract notes in prescribed Form B whenever there was a transaction between two brokers’ constituents, in support of the transactions in question. He, however, pointed out that there were columns for ‘Order No.’ ‘Trade No.’ and ‘Trade Time’ but those columns had been left blank. The additional report acknowledged that the assessee had furnished demat slips, demat statements and clearing house statements of the brokers. However, the special auditor observed that those documents only confirmed the delivery of the shares and to and from whose account it had been transferred but these did not conclusively prove that the transactions of sales were effected on the floor of the exchange or that they were market trades. Hence, as far as the assessee’s transactions with the three Kolkata brokers were concerned the report of the special auditor finally was only that the documentation did not conclusively prove that the transactions of sales were effected on the floor of the exchange or were market trades. Therefore, the observations of the special auditor were a far cry from the conclusion of the Assessing Officer that these transactions were shown only in order to generate loss or profit and were not genuine share transactions. [Para 68]

As to the reply received from the Calcutta Stock Exchange, it only stated that in the absence of the trade numbers in the contract notes “it was not possible for the Exchange to confirm whether the trades done by the said persons were through the trading system of the Exchange or not”. It stated that the prescribed format (Form B) required that the Contract Note be furnished with Trade No., Trade Time, delivery statement, difference bills, etc. These observations of the CSE also were a far cry from the conclusion of the Assessing Officer that these transactions were shown only in order to generate loss or profit and were not genuine share transactions. The CSE did not say that the transactions were not genuine. [Para 69]

As to the enquiries made with the Kolkata brokers, they all confirmed having carried out the transactions with the assessee. It was not the case of the Assessing Officer that the transactions were not found recorded or recorded differently in the books of the brokers. As to the formalities, the statement of the CSE lends no support to the hypothesis of the Assessing Officer that the transactions were intended to generate loss on paper only. [Para 70]

Therefore, the assessee’s transactions were supported by the movement of shares as reflected in the Demat account; movement of money, as reflected in the bank account; entries in the books of account of the assessee; prevalent market quotations of the CSE; Contract Notes and Delivery Bills issued by the Kolkata brokers and their statements in response to the enquiries made by the Assessing Officer. Further, the assessee had shown net profit of Rs. 16.18 crores. As against these, the case of the revenue was that certain material information was not given in the Contract Notes and columns in that respect were left blank. Copy of Form B was not filed with the CSE. For these reasons, it was not verifiable as to whether the trades in question were done through the trading system of the exchange or not. The answer of the assessee to these deficiencies and irregularities was that it could not be held responsible for the same. It was not the assessee but the three Kolkata brokers who were the members of the CSE. It was the obligation of the Kolkata parties to comply with the prescriptions of the CSE. Be that as it may, therefore, the conclusion of the Assessing Officer, that these transactions were shown only in order to generate loss or profit and were not genuine share transactions, could not be arrived at for reason only of deficiencies and irregularities in the documentation at the end of the Kolkata brokers. The Assessing Officer did not have support from the special auditors, the CSE or any other quarter to that effect, whereas the assessee had relied upon cogent evidence and material. Therefore, the Assessing Officer was to be directed that the profit/loss from the assessee’s transactions with the three Kolkata brokers be assessed as shown in the books of account of the assessee. [Para 72]

Further, the loss of Rs. 26.44 crores was reflected in the books of account. Money for the transactions had gone out from the bank accounts. Shares sold had gone out from the demat accounts of the assessee. There was nothing to indicate that any of those moneys and shares were returned to the assessee in some form or the other. Therefore, the loss could not be disallowed on objections like time of transaction not recorded or client code not mentioned or Trade No. not mentioned. The defects in these respects were in the documentations done by the third parties and not by the assessee. The disallowance on the ground of infraction of law can be made only if there is serious breach or defiance of law or contumacious conduct. The technical or venial defaults would not justify the harsh action of disallowance of an expenditure actually incurred. Further, it was the case of non-recovery of dues and not any expenditure incurred by the assessee for or in consequence of an infraction of any law. Therefore, the denial of deduction of loss on the ground of non-genuineness of loss was untenable. Further, in the absence of any material to implicate the assessee in any serious breach or contravention of law and in view of the fact that there was no material to show that the pertinent authorities ever took exception to the assessee’s role in the transactions in question the disallowance of loss on the ground of infraction of law also was not tenable. [Para 73]

According to the revenue, the assessee’s claim of loss was premature because there was, subsequently, recovery of approx. Rs. 1 crore from the Kolkata brokers after the revenue contended that all hopes of recovery were not lost and there was possibility of amounts being recovered. The assessee submitted that after constant efforts only a sum of Rs. 1 crore could be recovered over a period of three and half years. That showed that there was slim chance of any further recovery. Hence, the circumstance relied upon by the revenue should be held as establishing the assessee’s case. Therefore, the loss of Rs. 26.44 crores, claimed by the assessee being dues against the three Kolkata brokers, was no longer recoverable. Therefore, the Assessing Officer was to be directed to allow deduction of business loss of Rs. 26.44 crores as claimed by the assessee. [Para 74]

Editor’s Note

1. Where borrowed funds had been utilized by the assessee for the purpose of business, interest paid on borrowed funds would be eligible for deduction under section 36(1)(iii).

2. Where there was no material to suggest that the assessee received any brokerage, in cash or kind, outside the books of account, the Assessing Officer was not justified in making addition to income of the assessee on account of excess brokerage income.

3. Where the Assessing Officer failed to prove that the assessee had diverted borrowed funds for non-business purposes, in such circumstances, interest paid on borrowed capital could not be disallowed.

4. The Assessing Officer was not justified in making a proportionate disallowance under section 14A out of demat charges, stock exchange expenses and administrative expenses, claimed by the assessee.

5. The expenditure incurred by the assessee on purchase of software was allowable as revenue expenditure.

6. Where the Assessing Officer, out of the total expenses incurred by the assessee towards promotion of business, had fully disallowed expenses involving payments in foreign currency on the ground of absence of full details and further, had disallowed 50 per cent of expenses paid in domestic currency by way of hotel and restaurant bills or by way of purchase of luxury goods treating the same as having been incurred for non-business purposes, the action of the Assessing Officer was justified.

7. It was also held by the Tribunal that the disallowance of Rs. 2,07,731 made by the Assessing Officer under the head ‘General expenses’ was not justified, as it could not be said that the expenses were not genuine and claimed only to reduce the incidence of tax, but in the absence of full details of expenses, it would suffice if only 50 per cent of these expenses were disallowed.

8. Where the assessee had received cash credits from some creditors and had furnished the letter of confirmation along with PAN of said creditors, the Assessing Officer was not justified in doubting genuineness of credit and making addition under section 68. However, the Commissioner (Appeals) was justified in sustaining addition under section 43B, since the evidence of service tax payment prior to the due date of filing was not furnished before him.

9. Where a reference under section 142(2A) is made without allowing the assessee an opportunity of being heard on the matter, such reference would be vitiated in law.