O/TAXAP/383/2017 JUDGMENT IN HIGH COURT OF GUJARAT AT AHMEDABAD TAX APPEAL NO. 383 of 2017 TO TAX APPEAL NO. 389 of 2017 FOR APPROVAL AND SIGNATURE: HONOURABLE MR.JUSTICE AKIL KURESHI and HONOURABLE MR.JUSTICE BIREN VAISHNAV 1 Whether Reporters of Local Papers may be allowed to see judgment ? 2 To be referred to Reporter or not ? 3 Whether their Lordships wish to see fair copy of judgment ? 4 Whether this case involves substantial question of law as to interpretation of Constitution of India or any order made thereunder? GRUH FINANCE LTD.....Appellant(s) Versus DY. COMMISSIONER OF INCOME TAX CIRCLE 2(1) Appearance: MR.J.P.SHAH, LD. ADVOCATE for MR MANISH J SHAH, ADVOCATE for Appellant(s) No. 1 CORAM: HONOURABLE MR.JUSTICE AKIL KURESHI and HONOURABLE MR.JUSTICE BIREN VAISHNAV Date : 18/07/2017 COMMON ORAL JUDGMENT (PER : HONOURABLE MR.JUSTICE AKIL KURESHI) Page 1 of 13 HC-NIC Page 1 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT 1. These appeals filed by same assessee arises out of common factual background. We may note facts from Tax Appeal No.383 of 2017. This appeal is filed by one Gruh Finance Limited, company registered under Companies Act to challenge orders passed by Revenue authorities which were confirmed by Tribunal by impugned judgment dated 11.07.2016. Following questions have been presented for our consideration: (i) Whether on facts and in circumstances of case, Tribunal was right in law in holding that appellant will not be entitled to deduction of 40% of profits derived from business of providing long term finance computed under head Profits and Gains of Business in respect of income received on account of :EMI Residual? (ii) Whether interpretation done by Tribunal of clause (viii) of section 36(1) is in order because language is Profits derived from business of providing long term finance and not Interest from such business of providing long term finance? 2. For assessment year 2004 05, assessee had filed return of income, disclosing total income of Rs.12.18 crores (rounded off) which was taken in scrutiny by Assessing Officer. It was noticed that assessee was engaged in business of Page 2 of 13 HC-NIC Page 2 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT longterm housing finance and in said assessment year, assessee has claimed deduction of Rs.8.47 crores (rounded off) under section 36(1)(viii) of Income Tax Act 1961 ('the Act' for short) by creating reserve of Rs.8.50 crores. In many cases, loan portfolios were transferred to HDFC before completion of five years from date of sanction of loans. assessee in respect of such cases, was called upon to explain how income derived from such loan portfolios which were transferred to HDFC would be eligible for deduction under section 36(1) (viii) of Act. In response to such query of Assessing Officer, assessee pointed out that during period relevant to assessment year, assessee had assigned 5112 accounts to HDFC, of which, 87 accounts were more than five years old and tenure of remaining accounts was less than five years. With respect to such loan accounts also since assessee had fulfilled requirement of section 36(1)(viii) of Act, deduction should be granted. assessee contended that it was engaged in business of providing longterm finance and housing loan was given for period not less than Page 3 of 13 HC-NIC Page 3 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT five years. Once such longterm housing finance was made available and necessary reserve was created, deduction under section 36(1)(viii) of Act would be available. 3. assessee further pointed out that after transfer of particular portfolio, HDFC had claimed deduction in respect of such portfolio of long term housing finance to extent of interest received by it. assessee even after transfer of portfolio, would retain part of interest received from loanee and it is this interest component on which assessee claimed deduction. Assessing Officer considered contentions of assessee but, found that same cannot be accepted. He was of opinion that once portfolio was transferred, assessee was no longer engaged in business of long term housing finance with respect to such loan. Any income arising out of said transaction would not be eligible for deduction under section 36(1)(viii) of Act. He observed that financial corporations engaged in business of longterm housing finance would have greater risk exposure and legislature has Page 4 of 13 HC-NIC Page 4 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT therefore provided for deduction in relation to amount transferred to its special reserve which is to be created to meet with higher risk involved in longterm financing. He therefore disallowed sum of Rs.3.34 crores relatable to EMI of residential income of assesee for income deductible under section 36(1)(viii) of Act. 4. assessee carried matter in appeal. Commissioner of Income Tax (Appeals) accepted view of Assessing Officer, upon which, assessee approached Tribunal. Tribunal, by impugned judgment, confirmed view of Assessing Officer, making following observations: 20. As far as third limb is concerned, while considering issue, with regard to EMI residual in Asstt. Year 2000 01, we have reproduced finding of ITAT in Asstt. Year 2000 01. nature of income is by providing services to HDFC. It is not interest income as such earned by assessee from long term finance. ld.AO has also considered this aspect in finding extracted supra. Considering finding of Assessing Officer, in light of discussion made by ITAT in Asstt. Year 2000 01 and 2001 02 extracted supra, we are of view that income from EMI residual offered for taxation is income which represents difference of interest charged by assessee for services rendered by it for collecting EMI etc. on behalf of HDFC. It is not linked Page 5 of 13 HC-NIC Page 5 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT with long term finance. Therefore, this income will not form part of eligible profit derived from long term finance for purpose of calculating 40% of amount to claim deduction under section 36(1)(viii) of Act. To this extent, we uphold finding of AO, and rest of two folds of grievance of assessee are allowed. 5. Before us, learned counsel Shri J.P.Shah for assessee contended that assessee is engaged only in one business of longterm housing finance. Mere fact that particular portfolio was transferred before tenure of five years, would not mean that assessee ceased to be engaged in such business qua portfolio also. Even after transferring portfolio, assessee continued to collect EMI. Out of interest so received, assessee would retain 6.75% transferring rest to HDFC. It is towards this retention money that assessee claimed deduction. Tribunal committed serious error in rejecting assessee's claim. Counsel produced documents pertaining to assessment of assessee for earlier years and contended that in earlier years, claim under similar circumstances was accepted by Revenue. For later years, different view cannot be taken. Page 6 of 13 HC-NIC Page 6 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT 6. To appreciate precise nature of transfer and manner in which assessee earns or retains interest income, we had requested learned counsel to produce sample copy of agreement between assessee and HDFC. Under this agreement, loan portfolio would be transferred. We would refer to this document at later stage. For time being, we may recall that assessee had during period relevant to assessment year in question, transferred 5112 portfolios, of which, 793 were of period more than five years. rest were before end of such term and as observed by Assessing Officer in many cases, transfer took place barely within few months of sanctioning loans. According to assessee, even after transferring loan accounts, assessee would continue to act as collection agent. loanees would deposit EMIs with assessee. assessee would retain small portion of interest and transfer rest to HDFC. It is pointed out that HDFC receives benefit under section 36(1) (viii) of Act on such income. We have noticed that Revenue authorities and Tribunal have Page 7 of 13 HC-NIC Page 7 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT held that, that assessee for transferring portfolios cannot be stated to have been in business of longterm housing finance qua such accounts. 7. It was in this context we had desire to peruse agreement. copy of agreement produced before us is one dated 31.03.2004 executed by assessee and HDFC. Assessee is referred to as seller. HDFC is referred to as beneficiary. Article II of agreement pertains to sale/transfer of receivables. Under clause 2.1, seller agreed to sale, transfer and assign to beneficiary and beneficiary agreed to purchase from seller receivables set out in First Schedule subject to terms and conditions contained in said agreement. As per clause 2.2, beneficiary would at time of purchase of receivable and in any case not later than 28th March, 2002, pay to seller purchase price for purchase of receivables, upon which, seller would assign and transfer in beneficiary all rights, title and interest and entire ownership of receivables. Pending said transfer and assignment, beneficiary would be Page 8 of 13 HC-NIC Page 8 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT deemed to be trustee. 8. Article V pertained to servicing and administration. Clause 5.1 provided seller agreed to act as receiving and paying agent to discharge duties and obligations as such for purpose of receiving payments of amounts due and for making payment to beneficiary. As per clause 5.2, seller as receiving and paying agent, would collect all amounts falling due from time to time and enforce obligations against borrowers. As per clause 5.5, seller would continue to act as receiving and paying agent until all receivables have been paid. 9. Article VI referred to monthly payments to beneficiary and service charges. This chapter contained following two articles: 6.1 In consideration for Purchase Price paid by Beneficiary to Seller, Seller shall remit Amounts Due received in respect of Assigned Receivables to Beneficiary every month in such manner as may be directed by Beneficiary so as to reach Beneficiary by end of month for which same are due. 6.2 Seller shall be entitled to retain residual from interest component of each EMI after paying interest to Beneficiary (in addition to entire principal component of EMI) at rate of 6.75% per annum, on annual rest basis. Page 9 of 13 HC-NIC Page 9 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT 10. Article XI provided as under: Seller agrees that Seller shall hold all Amounts Due, Prepayment and Prepayment Premia as and when received and or collected by it in respect of Receivables in trust for and for benefit of Beneficiary and that full legal title in Receivables shall be held by Seller in trust for and for benefit of Beneficiary and shall deal with same only in accordance with this Agreement. 11. It can be seen that under said agreement, assessee transferred number of loan portfolios to HDFC in lieu of HDFC paying sale consideration. Despite transfer, seller continued as receiving and paying agent. As per clause 6.1, seller would remit amounts due in respect of assigned benefits of assigned receivables to beneficiary every month. As per clause 6.2, seller would retain residual from interest component at rate of 7.6% of each EMI. 12. It can thus be seen that under said deed, assessee as seller, had transferred all its rights and liabilities in connection with housing finance advances made to individuals. All profits, losses and risks would thus, be borne by HDFC. assessee merely continued to act as receiving and paying Page 10 of 13 HC-NIC Page 10 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT agent. For such services, assessee would receive 6.75% of interest component. Significantly, Article XI provided that seller would hold all amounts due and payments received from receivables in trust for and for benefit of beneficiary. In essence therefore, assessee transferred entire business of housing finance to HDFC in connection with loan portfolios in question. Neither profit, nor risk involved with such business remained with that of assessee. HDFC would receive EMI including interest and would also run risk of defaults in repayment of loans. assessee's involvement remained to extent of acting as receiving agent, transferring received EMIs to HDFC and in process, retaining small portion of 6.75% of interest component. 13. Section 36(1)(viii) of Act provides for deduction in respect of any reserve created and maintained by specified entity of amount not exceeding twenty per cent of profit derived from eligible business computed in heads of profit and losses of business or profession which is carried to its reserve account. Page 11 of 13 HC-NIC Page 11 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT 14. Term 'longterm finance' has been explained in clause (e) of explanation as to mean any loan or advance where term for which moneys are loaned or advanced provided for repayment along with interest thereof during period of not less than five years. fact that assessee company is financial corporation which is engaged in providing longterm finance including for residential purposes is not in dispute. However, with respect to loan portfolio which assessee company held for less than five years for transferring, in our opinion, after such transfer, assessee would cease to be engaged in business of longterm finance with respect to such loan accounts. income arising out of such activity would therefore not be assessee's income from business of providing longterm finance. 15. As noted, counsel for assessee had sought to press in service principle of consistency by producing certain returns and assessment orders for earlier years. However, no such documents were produced before lower authorities, no attempt was made to advance and develop these arguments. For Page 12 of 13 HC-NIC Page 12 of 13 Created On Sat Jul 22 10:09:36 IST 2017 O/TAXAP/383/2017 JUDGMENT first time before High Court, we would not permit raising of such ground which would essentially require examination of basic facts. Whether in earlier assessment years such precise question had come up, whether returns filed by assessee were accepted after scrutiny or otherwise and whether in such scrutiny assessments, this issue was considered by Revenue, are issues which cannot without proper examination of facts, be gone into. At this stage therefore, we do not enter into this arena. 16. In result, Tax Appeals are dismissed. (AKIL KURESHI, J.) (BIREN VAISHNAV, J.) ANKIT Page 13 of 13 HC-NIC Page 13 of 13 Created On Sat Jul 22 10:09:36 IST 2017 Gruh Finance Ltd. v. Dy. Commissioner of Income-tax Circle 2(1)(1)