MUMBAI H BENCH INCOME TAX OFFICER v. RHINO BAGS (P) LTD. November 3, 2006 JUDGMENT INCOME TAX OFFICER vs. RHINO BAGS (P) LTD.* Order R.S. Syal, A.M.: This appeal by Revenue and cross-objection by assessee arise out of order passed by CIT(A) on 16th Feb., 2003 in relation to asst. yr. 2000- 01. only effective ground projects grievance of Revenue as under: "On facts and in circumstances of case and in law, learned CIT(A) erred in directing AO to rework income on basis of disallowance of Rs. 13.70 lakhs as expenditure towards earning of dividend, as against Rs. 1,26,11,357 treated by AO as expenditure incurred towards earning of dividend income under s. 14A of IT Act." Briefly stated facts of case are that assessee furnished its return declaring loss of Rs. 1,28,24,439. During course of assessment proceedings it was noticed that assessee had claimed dividend income of Rs. 50,25,603 and interest on debentures of Rs. 70,250 as examined under ss. 10(33) and 10(23G), respectively. assessee was asked to explain why disallowance out of interest and other administrative expenses should not be made under s. 14A corresponding to exempted incomes shown above. It was stated on behalf of assessee that it has earned dividend income on shares of Reliance Industries Ltd., Telco and units of Morgan Stanley amounting to Rs. 50,95,853 and earning of such income was incidental to holding of shares purchased in earlier assessment years. It was claimed that expenses charged to P&L a/c were mainly in nature of financial and administrative expenses-incurred for purposes of carrying on business. It was further submitted that administrative expenses and interest on borrowings had not been incurred by assessee in relation to income which did not form part of total income. AO observed that assessee s major income comprises of dividend on long-term investments of Rs. 50.25 lakhs and interest on debentures at Rs. 70,250. It was also seen by AO that assessee s administrative and other expenses comprised of service charges of Rs. 1.5 lakhs, loss on redemption of SPN and loss on sale of borrowed stock of Rs. 57.96 lakhs. Out of these expenses, assessee had disallowed loss on redemption of SPN of Rs. 72,751 and partly disallowed loss on sale of borrowed stock pertaining to earlier years to extent of Rs. 35.71 lakhs. It was, therefore, observed that after disallowing expenses referred to above, administrative and other expenses incurred were primarily against exempted income comprising of dividend and interest on debentures. On perusal of P&L a/c, it was noted that assessee had debited interest at Rs. 105.73 lakhs. Considering facts in detail, it was opined that assessee had no business activity during year as income arose primarily by way of dividend income, interest on debentures and other incomes which were held as long-term investment. He worked out total amount of expenditure in relation to income not includible in total income under s. 14A as under: (a) Administrative and other expenses - Rs. 1,73,000 (b) Loss on borrowed stock relatable to this assessment year - Rs. 22,24,560 (c) Interest paid to M/s Reliance Capital Ltd. - Rs. 1,05,72,637 Rs. 1,29,70,197 He, therefore, worked out disallowance under s. 14A in following manner: Exempted income X (a+b+c) -------------------------------------------------------------------------------- Total Income Rs. 50.96 lakhs X Rs. 1,29,70,197 = Rs. 1,26,11,357 -------------------------------------------------------------------------------- Rs. 52.41 lakhs Accordingly, abovesaid sum of Rs. 1.26 crore was disallowed under s. 14A as expenditure incurred in relation to income not includible in total income. In first appeal, learned CIT(A) principally upheld invoking of provisions of s. 14A. He further took view that apportionment of interest and administration expenses should be made in ratio of investments on which dividend was earned to total investment which worked out at Rs. 13.70 lakhs as under: Total interest & Administrative expenses X dividend bearing investments -------------------------------------------------------------------------------- Total investments -------------------------------------------------------------------------------- X 604.45 = Rs. 13.70 lakhs Accordingly, disallowance under s. 14A was restricted to Rs. 13.70 lakhs. Both sides are in appeal against their respective stands. learned Departmental Representative vehemently contested action of learned CIT(A) in making disallowance by ratio of investment on which dividend was earned to total investment. Relying on order passed by Delhi Bench of Tribunal in case of Everplus Securities & Finance Ltd. vs. Dy. CIT (2006) 102 TTJ (Del) 120: (2006) 101 ITD 151 (Del), it was contended that disallowance was to be made with reference to investment, income of which was exempt irrespective of fact that whether or not it fetched dividend in this year. In opposition, learned counsel for assessee took us to p. 63 of paper book containing detail of interest of Rs. 1,05,72,637 which was paid to Reliance Capital Limited. By referring to pp. 60 to 62 of paper book, being copy of account of Reliance Capital Limited in books of assessee from 1st April, 1997 to 31st March, 2000, it was argued that payment of interest related to borrowings made from Reliance Capital Limited. He further took us to p. 64 of paper book to contend that funds received from Reliance Capital Limited were utilised in securities/shares other than those from which dividend income was earned by assessee. It was contended that since funds received from Reliance Capital Limited were utilised in making payments other than shares/securities from which dividend was earned, hence provisions of s. 14A were not attracted. Referring to second item considered by AO at Rs. 22,24,560 being loss on borrowed stock, it was submitted that it related to capital loss and hence could not be considered as having any nexus with dividend yielding shares or other securities. As regards last item amounting to administrative and other expenses of Rs. 1.73 lakhs, it was stated that this amount related to general administration of company. He relied on order passed by Tribunal in assessee s own case for asst. yr. 1999-2000 in ITA. Nos. 4717 and 4727/Mum/2003 in which disallowance was reduced to Rs. 25,000 because assessee had received only two dividend warrants. We have heard both sides and perused relevant material on record. Sec. 14A, inserted by Finance Act, 2001, with retrospective effect from 1st April, 1962, clearly provides that no deduction shall be allowed in respect of expenditure incurred by assessee in relation to income which does not form part of total income under this head. Clearly reference to disallowance of expenses is "in relation to incomes which do not form part of total income of assessee". Here it is relevant to note that what is contemplated in this section for making disallowance is expenditure as relatable to income which is exempt from tax. Merely because assessee did not earn dividend out of investment in certain shares that would not push case out of purview of s. 14A. restriction of deduction as per this section is in relation to any income which does not form part of total income. narrow interpretation given by learned CIT(A) in considering only those investments on which dividend was actually earned cannot be upheld. We, therefore, hold that expenditure has to be considered for purposes of s. 14A which is incurred in relation to incomes which do not form part of total income. Our view is fortified by order of Delhi Bench of Tribunal in case of Everplus Securities & Finance Ltd. (supra). Now we turn to examination of facts of case to decide as to how much amount has been incurred in relation to incomes which are exempt from tax. Second item as considered by AO amounting to Rs. 22,24,560 has been explained as capital loss relatable to borrowed stock which has absolutely no connection with exempt income. learned Departmental Representative has not controverted this assertion of learned counsel for assessee by which nature and mechanism of loss arising out of borrowed stock was explained. We, therefore, exclude this amount from consideration of expenditure in relation to income not includible in total income under s. 14A. Insofar as administration and other expenses of Rs. 1.73 lakhs are concerned, same cannot be excluded for reason that they are general in nature meant for earning both incomes exempt from tax and liable to tax. Coming to major item of interest paid to Reliance Capital Limited amounting to Rs. 1.05 crore, learned Authorised Representative has explained that amount of loan from Reliance Capital Limited has been utilised for securities other than shares, income from which is exempt under s. 10(33) of Act. In this connection, chart has been placed on p. 64 of paper book divulging utilisation of funds received from Reliance Capital Limited. On pointed query from Bench, learned Authorised Representative could not explain as to whether or not such chart of utilisation of funds was placed before AO for examination of matter. Obviously if funds have been utilised for any purpose other than earning of income which is exempt from tax, disallowance of interest for purpose of s. 14A is not tenable. If on contrary, borrowed interest bearing funds have been utilised, wholly or partly, in purchase of assets, income from which is exempt under s. 10, then interest on whole or part of amount so utilised has to be considered for making disallowance under this section. Since there is no discussion in assessment or impugned order qua utilisation of funds from Reliance Capital Limited, we are of considered opinion that it would be fair if impugned order on this score is set aside and matter is restored to file of AO. We order accordingly and remit matter back to file of AO for fresh decision as per law and in accordance with our above referred observation after allowing reasonable opportunity of being heard to assessee. In result, appeal as well as cross-objection are allowed for statistical purposes. *** INCOME TAX OFFICER v. RHINO BAGS (P) LTD.