Everplus Securities And Finance … vs Deputy Commissioner Of Income Tax on 17 March, 2006

ORDER

Bhavnesh Saini, J.M.

1. ITA No. 2422/Del/2004 by the assessee is directed against the order of the CIT(A)-XIV, New Delhi dt. 24th March, 2004 for the asst. yr. 2001-02 on the following grounds:

1. The CIT(A) erred in confirming disallowance of interest expenses of Rs. 3,93,69,566 alleged to have been incurred on deployment of borrowed funds in holding dividend-earning shares.

2. The authorities below wrongly interpreted the provisions of Sections 14A and 115-O(5) of the IT Act.

3. The CIT(A) erred in holding that shares of appellant were merely investments and if the same helps the appellant to control the management of Jindal group of companies, it cannot partake the character of a business activity. This finding is erroneous and based on surmises and conjectures.

4. The authorities below should have held that entire interest outgo is an allowable deduction under Section 36(1)(iii) of the IT Act.

5. The assessment order is bad and wrong in law.

6. The AO ought to have determined the losses to be carried forward in accordance with law.

7. The appellant prays that it may be permitted to add, amend or forego all or any of the above grounds of appeal.

2. ITA No. 3722/Del/2005 by the assessee is directed against the order of the CIT(A)-XIV, New Delhi, dt. 16th Aug., 2005, for the asst. yr. 2001-02 whereby the CIT(A) confirmed the penalty under Section 271(1)(c) of the IT Act, 1961.

3. Since both the matters arise on the same facts and of the same assessee for the same assessment year, both the appeals were heard together and we dispose of the same by this common order.

4. We have heard the learned Representatives of both the parties and gone through the observations of the authorities below and details pointed out by the learned Representatives of both the parties.

5. Now, we take up quantum appeal first for the purpose of disposal:

5.1 The facts as taken from the record are that the return of income was filed on 30th Oct., 2001, declaring a loss of Rs. (-) 3,55,10,280. The return of income was processed under Section 143(1) of the IT Act, 1961, on 28th June, 2002. The case was selected for scrutiny under Section 143(2)(i) of the IT Act and notice under Section 143(2)(i) was sent on 23rd Oct., 2002, asking the assessee to explain wrong claim of expenses paid to group companies on loans taken from these companies. The AO observed from the discussion that the assessee has paid the interest on the unsecured loans amounting to Rs. 3,93,69,566. These loans have been invested by the assessee in equity shares and the investments are shown at Rs. 35.56 crores. Thus, the assessee has financed its investment in equity shares from the unsecured loans taken by it. In the reply filed by the assessee, it has been stated as under:

The company has debited a sum of Rs. 3,93,69,566 under the head ‘Interest and bank charges’ in its P&L a/c in the above year. Break-up of such interest is enclosed. Perusal of such details would show that the interest has been paid to various companies who are all income-tax assessees.

Such interest has been paid for the purpose of company’s business. All the companies are independent companies.

Perusal of balance sheet would show that the company had total funds of Rs. 56 crores (capital Rs. 21 crores and loans Rs. 35 crores) as at 31st March, 2001. Such funds have been deployed as under:

        A. Holding of securities               Rs. 35.56 crores
      B. Current Assets                      Rs. 1.44 crores
                                             Rs. 37.00 crores
 
 

The difference between total funds and deployed funds represents accumulated loss of the company. Therefore, it would be apparent that the borrowed funds have been used mainly for the purpose of acquiring shares.
 

The company is engaged in the business of investment as appearing in the enclosed copy of main objects of the company.
 

Such investments have been made by the company with a view to get controlling interest, management, etc. Thus, the expenditure has been incurred for the advancement of its business and, therefore, would qualify for deduction under Section 36(1)(iii) of the Act.
 

We may also mention here that comparison of the balance sheet as at 31st March, 2001, with 31st March, 2000, would show that there is a decline in the loans from Rs. 39.49 crores to Rs. 35.08 crores as at 31st March, 2001. Thus, there is no fresh net inflows from loans as at 31st March, 2001. As the funds are old for which the interest has been allowed in the past, it is requested that interest may be allowed in this year as well being incurred for the purpose of company's business. 
 

5.2 The AO considering the reply of the assessee in the light of the fact that shares are held by the assessee in investment (as stated by the assessee and also written in its memorandum and articles of association) and the earning dividends is inextricably linked with it, observed that following analysis emerges.
 

5.3 The assessee has earned dividend of Rs. 20,00,690 which it has treated as exempt under Section 10(33) in its return. As per Section 10(33) dividend received from domestic company shall not be includible in the total income of the assessee. Section 115-O states that “notwithstanding anything contained in any other provision of this Act and subject to the provisions of this section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim order or otherwise) on or after the 1st day of June, 1997, whether out of current or accumulated profits shall be charged to additional income-tax (hereinafter referred to as tax on distributed profits) @ 10 per cent”. Clause (5) of Section 115-O further states that no deduction under any other provision of this Act shall be allowed to the company or the shareholders in respect of the amount which has been charged to tax under Sub-section (1). Thus, this clause has made it clear that no deduction has been allowed to the shareholders in respect of such dividend income. By necessary implications, it means that the interest paid for borrowings, used for the purpose of shares which has resulted in earning of dividend shall not be allowed as deduction since there is a direct nexus between such interest payments and earning of dividends. Therefore, according to the AO, the interest of unsecured loans paid by the assessee which are invested in the shares and on which dividend is earned shall not be allowed to the assessee.

5.4 The AO further observed that Section 14A clearly ruled out the grant of deduction of such expenditure as has been incurred in relation to any income which does not form part of the total income, Prior to the introduction of Section 115-O and Section 10(33), the dividend income was included as ‘income from other sources’. In such situation, when no dividend income was earned, the deduction under Section 57(iii) was still admissible in view of the judgment of the Hon’ble Supreme Court in the case of CIT v. Rajendra Prasad Moody 1978 CTR (SC) 141: (1978) 116 ITR 519 (SC). The Hon’ble Supreme Court in the case held “the plain natural construction of the language of Section 57(iii) of the IT Act, 1961, irresistibly leads to the conclusion that to bring a case within that section it is not necessary that any income should in fact have been earned as a result of the expenditure. What Section 57(iii) requires is that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. The section does not say that the expenditure shall be deductible only if any income is made or earned.” The AO on consideration of the facts and the case law observed that now since the dividend income is no longer taxed under the head ‘Income from other sources’, in view of the insertion of Sections 14A and 115-O, the decision of the Hon’ble Supreme Court is no longer valid. Consequently, any expense incurred for the purpose of acquiring shares on which dividend income was earned during the year (for whatever reasons) would also be disallowed. The AO accordingly disallowed the amount of the interest of Rs. 3,93,69,566 on the basis of above facts. The AO after computing the total income reduced the brought forward losses adjusted to the extent of income and he treated the taxable income of the assessee at ‘nil’.

5.5 The assessment order was challenged before the CIT(A) and it was submitted that the investment made by the assessee in the equity share capital of Jindal group is primarily as promoter, to acquire controlling interest, management, etc. of group companies: As such, the shares are held by the assessee as part of its business activity, the business being that of holding investments. The interest paid for acquiring these holdings is for the purpose of business and is, therefore, deductible under Section 36(1)(iii) of the IT Act. It is also stated that the Department has been holding the assessee to be engaged in the business in subsequent assessments also. It was further submitted that once it is noted that the assessee is engaged in business, then the deduction of interest is to be allowed under Section 36(1)(iii) of the Act. It was submitted that the Department should follow consistent view and should have allowed interest expenses in the year under consideration also. It was submitted that the shares were purchased with the intention to maintain the controlling interest in group companies. The dominant and primary intention in holding such shares is to retain the controlling interest in the group companies and not with the motive of earning dividend therefrom. It was submitted that the earning of the dividend is incidental and not the main purpose of acquiring the shares, as is evident from the stated fact that several shares held by the assessee for over years have not yielded any income. It was further submitted that the assessee has invested in equity shares of companies which unlike preference shares do not assure any dividend to the shareholder. An equity holder may go without dividend for several years at a row. A large number of shares held by the assessee did not yield any dividend at all. Earning of dividend is only incidental to this activity and the same is contingent upon the fact whether the company in question makes adequate profit and after earning profits decides to distribute the same by way of dividend instead of enhancing its reserves.

5.6 It was submitted that what Section 115-O(5) states is that no deduction in respect of the dividend shall be available to the shareholder or the company. This means that neither can the shareholders claim a deduction under Section 80L of the Act. Further, if the dividend income were eligible for any other deduction, even such deduction would not be available. It was submitted that the section does not refer to expenses not being deductible. If that were the intention of the legislation, then they would have specified that no deduction for any expenditure incurred in relation to the dividend income would be allowed.

5.7 The assessee further submitted that Section 14A deals with those expenses, which are incurred by it in relation to income which does not form part of the total income under this Act. The expression ‘in relation to’ has to be read in a broader sense. The words ‘in relating to’ signify or imply a direct and proximate relationship between expenditure and income. It cannot cover any expenditure relating to the source but not attributable to exempt income. It was, submitted that in a case of one indivisible business, Section 14A does not have any applicability. The assessee submitted that it holds shares as a part of the promoters’ stake and not as investment simpliciter. The main activity of the assessee is to have control over the investee companies. It was submitted that Section 14A of the Act can apply at best to an expenditure incurred in relation to income which does not form part of the total income. The provisions of Section 14A clearly postulate disallowance of expenditure only in a case where it is proved that the expenses incurred have a real relationship with the income which does not form part of the total income.

5.8 It was further submitted that the Section 115-O of the Act provides that, in case of a domestic company, any amount declared, distributed or paid by way of dividend shall be charged to income-tax at the specified rates. It was, therefore, submitted that under Section 115-O of the Act, dividend declared/ distributed by a domestic company is charged to tax not in the hands of a shareholder but directly in the hands of the company. It was further submitted that Section 115-O has only resulted in shifting the incidence of tax from the shareholders to the domestic company. In order to avoid double taxation, Section 10(33) was inserted in the statute simultaneously so as not to tax the shareholder in respect of such dividend. It is stated that it would, therefore, be erroneous to hold/contend that the dividend income declared by a domestic company does not form part of the total income of the assessee, which is sine qua non for applying/invoking provisions of Section 14A of the Act. It was further submitted that the tax paid by the domestic company under Section 115-O of the Act is the additional tax levied on the dividend income. The assessee relied upon unreported decision of the Mumbai Tribunal in the case of Mafatlal Holdings Ltd. v. Addl. CIT [reported at (2004) 85 TTJ (Mumbai) 821–Ed.], for the asst. yr. 1998-99, wherein the Tribunal has disagreed with the view that dividend income received by the shareholder is exempt from taxation. The Tribunal held that only the incidence of tax has been shifted from the shareholders to the company. The Tribunal thus rejected the contention of the Revenue that the dividend income is exempt from tax and, therefore, ho expenditure could be allowed against that income as being without any substance.

5.9 The assessee in view of the above submissions before the CIT(A) stated that it is in the business of making investment in the Jindal group of companies, the above investment in the shares of Jindal group was made to acquire controlling interest, management, etc. of the assessee and not merely to earn dividend on the shares held; interest paid during the year by it was towards money borrowed for making the above investment and the above interest paid is for the purpose of its business and is hence allowable as a deduction under Section 36(1)(iii) of the Act.

5.10 The CIT(A) considering the submissions of the assessee and material on record dismissed the appeal of the assessee and held that the provisions of Section 14A are attracted in the case of the assessee. The addition made by the AO was accordingly confirmed. The findings of the CIT(A) in paras 5, 5.1, 5.2, 5.3, 5, 4, 5.5, 5.6 and 6 are reproduced as under:

5. I have carefully considered the facts of the case and have gone through the order of the AO and the contentions raised by the appellant. I find that the undisputed facts are that the appellant borrowed certain unsecured loans, which were invested in the equity shares. The appellant paid interest of Rs. 3,93,69,566 on the said loans. Therefore, the facts show that the appellant has financed its investment in equity shares from out of the unsecured loans taken by it. In other words, there is a direct nexus established between the interest-bearing loans taken by the appellant and the investment made in the equity shares.

5.1 The appellant has tried to make out a case that it has made investment in the equity share capital of Jindal group of companies primarily as a promoter in order to acquire controlling interest and management of the group companies and, therefore, it should be treated to be part of its business activity and the interest paid should be allowed as a deduction under Section 36(1)(iii) of the Act. On careful consideration of the claim made by the appellant, I am unable to pursuade myself to accept the said contention of the learned Authorised Representative of the appellant. I find that the shares are clearly held by the appellant-company as investment portfolio, as is evident from the appellant’s own balance sheet and is found to be in accordance with the memorandum and articles of association. Moreover, the appellant-company is not engaged in the business of trading of shares which could be categorized to be in the nature of a business activity. The appellant is simply holding these shares as investment and if the same helps the appellant to control the management of Jindal group of companies, it cannot partake the character of a business activity. The only income arising from the holding of shares as investment is dividend income, which is clearly assessable under the head ‘Income from other sources’. Since the earnings in the form of dividend income cannot be brought to tax as business income, there is no merit in the contention of the appellant that the interest expenditure should be allowed as a deduction under Section 36(1)(iii) of the Act.

5.2 The dividend income of Rs. 20,00,690 earned by the appellant is specifically exempted under Section 10(33) of the Act, since the dividend received from domestic company is not includible in the total income. As per Section 14A of the Act, no deduction is to be granted in respect of the expenditure incurred in relation to any income which does not form part of the total income. Prior to the introduction of Section 10(33) and Section 115-O, the dividend income was includible as ‘income from other sources’ and the deduction under Section 57(iii) was admissible even in a case where no dividend income was actually earned. This was by virtue of the ratio of the decision of the Hon’ble Supreme Court in the case of CIT v. Rajendra Prasad Moody wherein it was held that Section 57(iii) only required that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income and it was not necessary that any income is actually made or earned. I am in agreement with the view of the AO that after introduction of Sections 10(33) and 115-O, the ratio of the above cited decision of the apex Court cannot be applied for allowing any deduction in respect of the expenditure incurred since the dividend income is no more includible in the total income. In view of this, I find merit in view of the AO that any expense incurred for the purpose of acquiring shares on which dividend income has been earned would not be allowable as a deduction. As already discussed hereinabove, there is a direct nexus between the investment of interest-bearing loans on the investment in shares, on which dividend income has been earned, On these facts, it is held that the appellant is not entitled to claim deduction of interest expenses incurred on the loans borrowed which were utilized for investment in the shares.

5.3 Coming to the decision of the Tribunal, Mumbai Bench, in case of Mafatlal Holdings Ltd. v. Addl. CIT in ITA No. 2935/Mum/2002 vide order dt. 23rd April, 2003 [reported at (2004) 85 TTJ (Mumbai) 821–Ed.]. I find that the thrust of the observations made by the Tribunal is in a different perspective. In that case, the main ‘business’ of the assessee was investment in shares and it carried on the activities in respect of the ingredients of an investment and finance company. The Tribunal observed that the main business of the assessee was to deal in investments and hence the dividend income earned by the assessee was income from main business carried on during the relevant year. The question for determination before the Tribunal was as to whether the deduction in respect of interest on borrowings utilised by the assessee for investment in shares was allowable under Section 57(iii) or under Section 36(1)(iii) or under Section 37(1) of the Act. With respect to the above question, the Tribunal has observed that the dividend income earned by the assessee is out of its investment in shares which is the main activity of the assessee-company. It has been observed that the dividend income is income of the assessee from business and not income from other sources. The Tribunal accordingly was of the view that the dividend income is to be assessed as ‘business income’ and not as ‘income from other sources’. Accordingly, the claim of allowance of interest payment as business expense was allowed by the Tribunal, reversing the orders of the AO and the learned CIT(A). As would be seen from the above, the Hon’ble Tribunal in the above case, relied upon by the appellant, was determining the nature of dividend income and the taxability of the same as income from business or income from other sources. It was also examining the question of allowance of deduction in respect of interest on borrowings from the dividend income. The above question and the decision of the Tribunal are on a different footing and in a different context. The Tribunal was not at all seized with the applicability of the provisions of Section 14A of the Act for deciding the question of disallowance of interest paid on borrowings utilised for investment in shares, which yielded dividend income. In the instant case before me, the question for determination is not as to whether the income from dividend is assessable under the head ‘Profits and gains from business or profession’ or under the head ‘Income from other sources’. The question for consideration is as to whether the interest-bearing loans have been utilized by the appellant-company for investment in shares which have yielded dividend income, and as to whether disallowance by invoking provisions of Section 14A is required to be made in respect of such interest payout as discussed hereinabove. The facts of the case clearly show that the interest-bearing loans have undisputedly been utilized for investment in shares yielding dividend income, which is exempted from tax by virtue of Section 10(33) of the Act. On these facts, it cannot be said that the provisions of Section 14A are not to be invoked.

5.4 Coming to the legal position, certain incomes are not includible while computing the total income, as these are exempt under various provisions of the Act. There have been cases where deductions have been claimed in respect of such exempt income. This in effect means that the tax incentive given by way of exemptions to certain categories of income, is being used to reduce the tax payable on the non-exempt income by debiting the expenses incurred to earn the exempt income against taxable income. This is against the basic principle of taxation whereby only the net income, i.e., gross income minus the expenditure, is taxed. On the same analogy, the exemption is also in respect of the net income. Expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income. By the Finance Act, 2001, a new Section 14A has been inserted so as to clarify the intention of the legislature since the inception of the IT Act, 1961, that no deduction can be made in respect of any expenditure incurred by an assessee in relation to income which does not form part of the total income under the Act. This amendment takes effect retrospectively from 1st April, 1962, and accordingly, applies to the asst. yr. 1962-63 and subsequent assessment years.

5.5 At this juncture, I would like to refer to the decision of the Hon’ble Supreme Court in the case of Rajasthan State Warehousing Corporation v. CIT This reference is being made since the appellant might claim that it carries on an indivisible business and a part of its profit is not liable to tax, so the entire expenditure incurred for the purpose of the business should be allowed, although a part of the expenses may have been incurred for earning the non-taxable profits. I find that the apex Court was examining the issue as to whether the ventures carried on by an assessee constituted one indivisible business. It was held that if they do, the entire expenditure will be a permissible deduction, but if they don’t, the principle of apportionment of the expenditure will apply, because there will be no increase ‘ between the expenditure attributable to the venture not forming an integral part of the business and the expenditure sought to be deducted as the business expenditure of the assessee. With respect to the above decision, it is worthwhile to note that the same pertains to asst. yr. 1977-78, when Section 14A was not on the statute. Section 14A has been inserted by the Finance Act, 2001, with retrospective effect from 1st April, 1962, laying down that no deduction shall be allowed in respect of the expenditure incurred by the assessee in relation to the income, which does not form part of the total income under this Act. The ratio of the said decision of the apex Court would, therefore, not govern the operation of Section 14A of the Act, which has been inserted subsequent to even the date of order of the apex Court, i.e., 23rd Feb., 2000. The provisions of the new Section 14A supersede the principles of law laid down by the above decision, as also by various Courts, in which it was held that where an assessee carries on an indivisible business and a part of its profit is not liable to tax, the entire expenditure incurred for the purpose of the business should be allowed, although a part of the expenses may have been incurred for earning the non-taxable profits. Therefore, in my humble view, the principles of law laid down by the apex Court in the above case stand superseded by the insertion of new provision in the form of Section 14A of the Act.

5.6 On an overall consideration of the facts of the case and the legal position, I am of the considered view that the provisions of Section 14A are attracted in the case of the appellant. The addition made by the AO on this account is accordingly upheld.

6. In the result, the appeal is dismissed.

5.11 The learned Counsel for the assessee reiterated the submissions made before the CIT(A). He has submitted that the assessee is a promoter of Jindal group of companies and shares are held as stock-in-trade. He has referred to p. 39 of the paper book to show the main aims and objects of the company. He has submitted that the assessee being promoter is already accepted by the Department in the earlier years. He has filed copy of the assessment order for the asst. yr. 1995-96 and submitted that the submissions of the assessee that the company had commenced business of making investment in Jindal group of companies and engaged as promoter/investor to acquire controlling interest, management, etc. of the group companies have been accepted. He has submitted that with this view the assessee has acquired shares/securities. He has further submitted that the assessee is also promoter of other companies as declared by the SEBI. The learned Counsel for the assessee thus submitted that the assessee-company (is) having object of carrying on business as an investment company. It was holding the shares of various companies of Jindal group with the primary object of acquiring, retaining and controlling interest. He has referred to p. 86 of the paper book to show that the shares are held as stock-in-trade of various companies of Jindal group in which approximately 35 crores of rupees have been invested. He has also referred to p. 88 of the paper book to show that the assessee-company has pledged 1 crore equity shares of Jindal Vijayanagar Steels Ltd. with IFCI for credit facilities granted to Jindal Iron & Steel Co. Ltd. The learned Counsel for the assessee also referred to p. 38 of the paper book giving details of the dividends received during the financial year relevant to the assessment year in question and submitted that the assessee earned dividend in a sum of Rs. 20,03,690 from five companies having cost of the shares at Rs. 1,40,058,596. He accordingly submitted that it is approximately 1.4 per cent of the investment. He has further submitted that the other shares held by the assessee did not yield any dividend because of the processing. The learned Counsel for the assessee submitted that there is no nexus between the income and the expenditure and as such Section 14A is not applicable in this case and disallowance of the interest on investment of the shares is unjustified. The learned Counsel for the assessee further submitted that the purpose of acquiring and holding the shares was not earning dividend and the declaration of the dividend is incidental to the main aim and objects of acquiring and retaining the control of interest being promoted, group. Therefore, Section 14A is not applicable in this case. The learned Counsel for the assessee relied upon the decisions of the Hon’ble Supreme Court in the case of CIT v. Chugandas & Co. and in the case of CIT v. Cocanada Radhaswami Bank Ltd. . The learned Counsel for the assessee further submitted that heads of the income do not decide the nature and character of the income because it depends upon the intention and objects. He has submitted that the dividend is income from other sources as specified in the Act, therefore, it is to be held as income from other sources. However, he has contended that if the real character of the dividend income was the business income, the interest is deductible under Section 36(1)(iii) of the Act. He has relied upon the decision of the Hon’ble Gujarat High Court in the case of Addl. CIT v. Laxmi Agents (P) Ltd. (1980) 125 ITR 227 (Guj). He has further submitted that the assessee claimed deduction under Section 36 of the Act which is also accepted in the earlier year. He has further submitted that the borrowings are made by the assessee for the purpose of business for making investment to acquire the control in the Jindal group of companies. He has further submitted that income is there on transfer of the shares, securities and dividend income. Source of the income is the sale of shares and in earlier years on sale of shares, business income is accepted. He has referred to p. 84 of the paper book. The learned Counsel for the assessee also relied upon the decisions in the cases of CIT v. Rajeeva Lochan Kanoria (Call CIT v. Amritben R. Shah CIT v. Excellent Commercial Enterprises & Investments Ltd. (2005) 197 CTR (Del) 187, order of the Tribunal, Delhi Bench (SMC-1), New Delhi, in the case of Maxpak Investment Ltd. (supra), CIT v. Ramnath Goenka of the Tribunal, Mumbai Bench, in the case of Mafatlal Holdings Ltd. v. Addl. CIT (supra). The learned Counsel for the assessee also referred to the statement of computation of income filed at pp. 77 to 84 of the paper book. He has submitted premiums is attached to share and on transfer assessee earned income. He also relied on CIT v. Amalgamations (P) Ltd. ( and 225 ITR 188 (sic).

5.12 The learned Counsel for the assessee further submitted that part of the borrowed funds used for giving loans and, therefore, allocation should be made of the same. In alternative submission, the learned Counsel for the assessee submitted that dividend of approximately Rs. 20 lakhs is earned on the investment of Rs. 14 crores, only that part of the interest paid could have been disallowed instead of the whole addition made by the AO by disallowing the entire interest on the matter in issue.

5.13 On the other hand, the learned Departmental Representative relied upon the orders of the authorities below and submitted that the purpose of investment is to earn profit. The learned Departmental Representative further submitted that earning income is from the dividend or sale of share. If the shares are sold then there is no question of acquiring the control of group companies. The learned Departmental Representative submitted that investment is made by the assessee for the purpose of earning income which is earned only from the dividend and since the dividend is exempt, therefore, the assessee cannot claim deduction of the payment of interest on the same source of income. The learned Departmental Representative further submitted that holding of the shares is not business activity because it did not yield any income to the assessee. The learned Departmental Representative further submitted that in the asst. yr. 1995-96 the AO did not examine the point in issue and has only made the observation on the basis of submissions of the assessee. The learned Departmental Representative also referred to p. 86 of the paper book which is a schedule of stock-in-trade of the shares and submitted that there is no movement of the shares and the position of investments is static except in the case of the shares of Jindal Steel & Power Ltd. in which on 31st March, 2000, the number of shares were 1,54,378 and the same have increased as on 31st March, 2001, at 1,86,625 shares. The learned Departmental Representative pointed out that the position of the remaining shares is same as were held in the earlier year and in the year under consideration and as such the assessee has not been able to show as to what income is earned on transfer of the shares. He has further submitted that there is no transfer of the shares in the years under consideration. Therefore, the assessee has only source of income from dividend, which is exempt under the Act and as such there is no business activity of sale and purchase of the shares in the year under consideration because there is no change in the investment and as such the authorities below were justified in rejecting the claim of the assessee for deduction of the interest paid on the borrowed capital. The learned Departmental Representative also referred to the order of the Tribunal, SMC Delhi Bench, and also relied upon the decision of the Tribunal Kolkata Bench, in Dy. CIT v. S.G. Investments & Industries Ltd. (2004) 84 TTJ (Kol) 143: (2004) 89 ITD 44 (Kol). The learned Departmental Representative further submitted that there is no trading in shares. The learned Departmental Representative, therefore, submitted that the authorities below were justified in rejecting the claim of the assessee and as such the appeal of the assessee is liable to be dismissed.

5.14 We have considered the rival submissions and material pointed out by the parties and the observations of the authorities below. Section 115-O of the IT Act provides tax on distributed profits of domestic companies as under:

(1) Notwithstanding anything contained in any other provision of this Act and subject to the provisions of this section, in addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) on or after the 1st day of June, 1997, but on or before the 31st day of March, 2002, whether out of current or accumulated profits shall be charged to additional income-tax (hereinafter referred to as tax on distributed profits) at the rate of ten per cent.

(2) Notwithstanding that no income-tax is payable by a domestic company on its total income computed in accordance with the provisions of this Act, the tax on distributed profits under Sub-section (1) shall be payable by such company.

(3) The principal officer of the domestic company and the company shall be liable to pay the tax on distributed profits to the credit of the Central Government within fourteen days from the date of–

(a) declaration of any dividend; or

(b) distribution of any dividend; or

(c) payment of any dividend, whichever is earliest.

(4) The tax on distributed profits so paid by the company shall be treated as the final payment of tax in respect of the amount declared, distributed or paid as dividends and no further credit therefor shall be claimed by the company or by any other person in respect of the amount of tax so paid.

(5) No deduction under any other provision of this Act shall be allowed to the company or a shareholder in respect of the amount which has been charged to tax under Sub-section (1) or the tax thereon.

5.15 Section 14A of the IT Act inserted by the Finance Act, 2001, w.e.f. 1st April, 1962, provides:

14A. For the purposes of computing the total income under this chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act:

Provided that nothing contained in this section shall empower the AO either to re-assess under Section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under Section 154, for any assessment year beginning on or before the 1st day of April, 2001.

5.16 Section 10(33) as is relevant to the assessment year under appeal provides that any income by way of dividend referred to in Section 115-O would not form part of total income.

5.17 Before dealing with the facts of the case, it would be relevant to discuss the case law relied upon by the learned Counsel for the assessee. In the case of Chugandas & Co. (supra), the Hon’ble Supreme Court considered the facts that the assessee-firm, a dealer in securities, holding securities as its stock-in-trade, had been charged to tax under the Indian IT Act, 1922, in respect of business. It received Rs. 4,13,992 and Rs. 1,01,229 as interest on securities in the years 1946 and 1947, respectively. The firm discontinued its business on 30th June, 1947. The question was whether the interest on securities formed part of the assessee’s business income for the purpose of the exemption from tax under Section 25(3) of the Indian IT Act, 1922. It was held that the assessee was entitled to exemption under Section 25(3) in respect of the interest on securities as well. It is also observed that the business income, as observed by the Court, was broken up under different heads only for the purpose of the computation of the total income and, therefore, by that breaking up the income did not cease to be the income of the business, the different heads of income being only the classification prescribed by the IT Act for computation.

5.18 The Hon’ble Supreme Court in the case of CIT v. Cocanada Radhaswami Bank Ltd. (supra) considered the fact that the assessee-bank had earned income by way of interest from securities. Securities held by the bank were part of the trading assets. The Supreme Court held that though for the purpose of computation of income, interest on securities was separately classified; it did not cease to be part of the income from business if the securities were part of the trading assets.

5.18A The Hon’ble Gujarat High Court in the case of Laxmi Agents (P) Ltd. (supra) considered the facts that during the course of assessment, the ITO refused to deduct the interest paid on the borrowings from assessee’s business income, but deducted the same from its dividend income from shares. He accordingly computed the deduction contemplated by Section 85A on the dividend income reduced by the amount of interest paid on the borrowings. This view was taken by the ITO on the ground that the borrowings on which the interest was paid were mainly for the purpose, of investment in shares and, therefore, there was no question of this interest being deducted from business income. However, the AAC held that the investment made for the purpose of purchasing the shares of the managed company was for the purpose of business of managing agency and, therefore, the interest paid on the borrowings was deductible from the business income and not from the dividend income. On further appeal, the Tribunal found, after referring to the balance sheet of the assessee-company, that investments made by the assessee were all trade investments, and related to the business activities of the assessee. According to the Tribunal, therefore, the investments made by the assessee in the present case were not investments simpliciter but they were for the purpose of business of the assessee. The relevant question referred on the issue was, whether, on the facts and the circumstances of the case, the Tribunal was right in holding that though the income from dividend has to be assessed under a separate head, the payment of interest by the assessee on amounts borrowed for purposes of investments must be allowed as business expenditure ? The Hon’ble High Court considered the question in the light of the requirement of Section 36(1)(iii) of the Act and held that if once it is established that capital was borrowed for the purpose of business, it is immaterial how that borrowed capital was applied because all that Clause (iii) of Section 36(1) requires is that borrowings, on which interest is paid, should be for the purpose of business. The Hon’ble High Court, therefore, concluded on second issue that the Tribunal was right in holding that though the income from dividend has to be assessed under a separate head, payment of interest by the assessee on amounts borrowed for the purpose of investment must be held as a business expenditure and not as a expenditure incurred for earning dividend.

5.19 The Hon’ble Calcutta High Court in the case of CIT v. Rajeeva Lochan Kanoria (supra) held:

Held, that directorship is nothing but a vocation. The assessee was admittedly a director of several controlled companies. The activity of controlling, managing, administering and financing companies is nothing but a business/professional/vocational activity. A businessman, like the assessee in this case,, did not purchase shares of different companies for acquiring controlling interest therein (but) only for earning dividends. Acquiring controlling interest in companies and managing, administering, financing and rehabilitating companies under control were for business and/or professional purpose. Interest on capital borrowed for investment in shares was deductible.

5.20 The Hon’ble Bombay High Court in the case of CIT v. Amritaben R. Shah (supra), considered facts where, admittedly, shares in a company were purchased by the assessee for the purpose of acquiring controlling interest in the company and not for earning dividend, held ;

Held, that the expenditure incurred by way of interest on the loan taken by the assessee for the said purpose could not be held to be expenditure incurred wholly and exclusively for the purpose of earning income by way of dividends, From the nature of transaction, it was clear that the expenditure was not for the purpose of earning income by way of dividends but for the purpose of acquiring controlling interest in the company and, therefore, it would not be allowable as a deduction under Section 57(iii) of the Act.

5.21 The Hon’ble Madras High Court in the case of CIT v. Ramnath Goenka (supra) held that business loss carried forward can be set off against dividend income from shares held as stock-in-trade, even if such dividend (is) assessable under the head “Other sources”.

5.22 The Hon’ble Delhi High Court in the case of CIT v. Excellent Commercial Enterprises & Investments Ltd. (supra) held that he assessee-company having earned dividends on shares held as stock-in-trade, same was rightly treated as income from business and not income from other sources and brought forward loss under Section 72 was rightly allowed against the dividend income.

5.23 The Tribunal (SMC-I), Delhi Bench, New Delhi, in the case of Maxpak Investment Ltd., New Delhi, in ITA No. 2632/Del/2003 vide order dt. 14th Sept., 2004, considered the facts that the assessee is a public limited company engaged in investment business. The assessee holds certain shares/securities as investment for the purpose of earning dividend income and capital appreciation. Certain investments are held as trade investments with an intention to trade in the same or for the purpose of acquiring or retaining controlling interest in the companies whose shares are acquired. The Tribunal (SMC-I) Delhi Bench, after going through the material on record observed that undisputedly the assessee is purchasing shares to earn the dividend and also purchased shares for trading purpose. Separate accounts have been maintained for the same. Whatever investment is made for the purchase of shares for getting them as investment, they have been shown separately and whatever investment is made for the purpose of trading have been shown separately under the head “stock-in-hand”. Therefore, it cannot be said that the assessee’s purpose was for earning dividend interest. In earlier years, the AO himself accepted the claim of the assessee that it is dealing in shares for investment purpose and deals in shares for trading purpose. The Tribunal (SMC-I) Delhi Bench by giving such findings was of the view that it was not a case of disallowance of interest, in view of the provisions of Section 14A of the IT Act because the investment made by the assessee was not for the purpose of earning dividend only.

5.24 The Tribunal, Mumbai ‘C’ Bench, in the case of Mafatlal Holdings Ltd. v. Addl. CIT (supra) considered the facts that interest on capital borrowed for business (was) disallowed by the AO mainly on the ground that the assessee did not carry on any business activity during the relevant previous year. The Tribunal did not find it to be justified because as per the balance sheet, the assessee did carry on transaction in the name of the sale of investment utilised on opening cash and bank balance, there may be unsecured loans and the utilization of those borrowings for its business purpose or dividend income and incurred various business expenditure. The Tribunal, therefore, held that all the conditions of Section 36(1)(iii) are fulfilled.

5.25 The learned Departmental Representative relied upon the order of the Tribunal, Kolkata Bench ‘C, in the case of S.G. Investments & Industries Ltd. (supra), in which the similar issue was considered and the findings of the Tribunal in paras 11, 12 and 13 are reproduced as under:

11. A closer look at the provisions contained in Section 10(33) and Section 115-O of the Act makes it abundantly clear that income by way of dividend referred to in Section 115-O shall not be included in computing the total income of a previous year of any person. Section 115-O, which has been inserted by the Finance Act, 1997, provides the provision relating to tax on distributed profits by way of dividends of domestic companies.

Sub-section (5) of Section 115-O further states that no deduction under any other provisions of the Act shall be allowed to the company or a shareholder in ‘ respect of the amount which has been charged to tax under Sub-section (1) of Section 115-O or the tax thereon. The liability to pay additional tax on dividends declared and paid by the domestic company under Section 115-O of the Act is notwithstanding anything contained in any other provisions of the Act and is subject to the provisions of Section 115-O. The Section 115-O(1) beginning with the expression ‘notwithstanding anything contained in any other provisions of this Act’ is to give the provisions of Section 115-O(1) in case of conflict, an overriding effect over any other provisions of the IT Act, 1961. It is thus clear that Section 115-O(1) is a specific provision overriding in case of conflict, the general provisions. The Sub-section (5) of Section 115-O has made it clear that no deduction under any other provisions of IT Act shall be allowed to the company or a shareholder in respect of dividend income which has been charged to tax under Section 115-O(1) or the tax thereon. Thus, this sub-section has restricted the allowability of all deductions, which may otherwise be allowable under any other provisions of the Act, against dividend income. It means that the interest paid for borrowings used for purpose of acquiring shares which has resulted in earning of dividend, and all other expenses in relating to the earning of dividend income will not be allowed as deduction under any other provisions of the IT Act.

12. Prior to insertion of Sections 10(33) and 115-O of the Act, any dividend declared, distributed or paid by a company to its shareholders was chargeable to tax under the head ‘Income from other sources’ irrespective of the fact whether shares were held by the assessee as investment or stock-in-trade as provided in Section 56 of the Act. Section 57 of the Act provides for certain deductions in computing the income chargeable under the head ‘Income from other sources’. Reading Section 57 and 58 of the Act, it is plain that the expenditure, not in the nature of capital expenditure and personal expenses of the assessee, laid out or expended wholly and exclusively for the purpose of making or earning the income during the relevant years are permissible deduction in computing the income chargeable under the head ‘Income from other sources’.

13. Regarding the claim for deduction of interest paid on monies borrowed for purchase of shares held as investment, we may observe that before insertion of Sections 10(33) and 115-O of the Act, the deduction for interest paid On monies borrowed for acquiring the shares held as investments could have been normally claimed under Section 57(iii) of the Act against dividend income. It cannot be claimed so now due to the explicit provisions of Sub-section (5) of Section 115-O read with Section 14A of the Act inasmuch as such dividend income does not form part of total income chargeable to tax.

5.26 The Tribunal, Kolkata Bench, on consideration of the provisions of Sections 14A and 115-O was of the view that the contention of the assessee is now devoid of any merits particularly in the light of insertion of new Sections 14A and 115-O of the Act. It is now immaterial whether the shares are held as stock-in-trade or investment portfolio as an integral part of the business or held as investment as such from the point of allowability of deduction for expenditure incurred in relation to dividend income which does not form part of the total income by virtue of Section 10(33) of the Act. It was further observed that now the situation is clarified as a result of insertion of Section 14A and the decisions of various Courts not allowing the apportionment of interest against dividend income are of no help to the assessee. The purpose of inserting Section 14A is to nullify the decision in Rajasthan Warehousing Corporation v. CIT to the extent it relates to the cases of indivisible business. The Tribunal also observed that it is common knowledge that no dividend could be earned without making investment as the dividend could have been earned only after investments are made. When it is found that the investments in shares are made out of borrowed capital, it is then not understood as to why interest paid on such borrowings should not be regarded as expenditure incurred in relation to earning of dividend income. The amount of such interest is, therefore, required to be deducted from the dividend income before computing the amount of dividend on which the exemption under Section 10(33) is to be allowed. The Tribunal allowed the appeal of the Revenue in this case.

5.27 On consideration of the facts and legal proposition mentioned above, we are of the view that the facts of the case of the present assessee are clearly distinguishable from the cases relied on by learned Counsel of assessee. The CIT(A) in para 5 of the impugned order has specifically mentioned that undisputed facts are that the assessee borrowed certain unsecured loans which were invested in the equity shares. The assessee paid interest of Rs. 3,93,69,566 on the said loans. The CIT(A), therefore, found from the facts that the assessee has financed its investment in the equity shares from out of the unsecured loans taken by it. The CIT(A), therefore, found that there is a direct nexus established between the interest-bearing loans taken by the assessee and the investment made in the equity shares. These facts had not been controverted by the learned Counsel for the assessee during the course of arguments. At p. 86 of the paper book, the assessee has filed the details of the investment made in the equity shares ending on 31st March, 2000, and 31st March, 2001. In the end of the financial year, relevant to the assessment year i.e., 31st March, 2001, the assessee has made investments in the shares in a sum of Rs. 35,56,51,409.94. At p. 83 of the paper book, the assessee has filed copy of the balance sheet as on 31st March, 2001, showing unsecured loans in a sum of Rs. 35,08,34,089 and in the share capital in a sum of Rs. 21,02,50,200. Thus, the assessee-company has total funds of Rs. 56,10,84,289 as per balance sheet filed on the paper book. It is also not disputed that the assessee paid the interest on the borrowed loans in a sum of Rs. 3,93,69,566. These facts clearly support the findings of the CIT(A) that the assessee borrowed unsecured loans which were invested in equity shares upon which the assessee paid the interest. These facts, therefore, clearly show that the assessee had financed its investment in the equity shares from out of the entire unsecured loans taken by the assessee and as such there is direct nexus established on record between the interest-bearing loans taken by the assessee and the investment made in the equity shares.

5.28 The assessee submitted that the assessee has made investment in the equity share capital of Jindal group of companies being promoter in order to acquire controlling interest and management of the group companies and, therefore, it should be treated to be part of its business activity and interest paid should be allowed as deduction under Section 36(1)(iii) of the Act. The CIT(A), however, did not accept the contention of the assessee because according to him the shares are clearly held by the assessee as investment portfolio as was evident from the assessee’s own balance sheet which was found to be in accordance with the memorandum and articles of association. The CIT(A) also found that the assessee-company is not engaged in the business of trading in shares which could be categorised to be in the nature of business activity. The CIT(A) also found that the assessee has simply held these shares as investment and if the same helps the assessee to control the management of Jindal group of companies, it cannot partake the character of business activity. The CIT(A) found that only income arising from the holding of shares as investment is dividend income which is clearly assessable under the head ‘Income from other sources’. The assessee at p. 39 of the paper book filed a copy of the memorandum of association of the assessee showing the main objects of the assessee-company. However, on going through such memorandum of association, we find that the CIT(A) was justified in rejecting the contention of the assessee because the objects of the assessee-company did not provide anywhere for making investment in the shares of Jindal group of companies for the purpose of acquiring or controlling the management of such group. The assessee in the balance sheet ending on 31st March, 2001, has mentioned the sources of funds out of shareholders’ funds and from unsecured loans as mentioned in this order. There is no other source of funds and also mentioned application of the funds, in current assets/loans advanced, closing stock, current liability and miscellaneous expenses, etc. The list of the equity shares, preference shares filed at p. 86 shows that the total investment in the previous year ending 31st March, 2000, was in a sum of Rs. 34,99,02,371. This list gives investment in shares of equity shares (quoted) in the category of A-1 to A-6 in Jindal group of companies and from A-7 to A-13 other investment in the equity shares and from B-1 to B-7 are the equity shares (unquoted) of Jindal group of companies and the category C-1 shows that preference shares (unquoted). At sl. No. A-2 there is entry in the name of Jindal Steel & Power Ltd. In the year ending 31st March, 2000, the assessee was having investment in shares in 1,54,638 number of shares having total value of Rs. 3,57,05,123 in this company. The assessee has made further investment in number of shares of this company as shown in the year ending on 31st March, 2001, and as such the number of shares has increased to 1,85,625 having the value of Rs. 4,14,54,162. We may mention that the position of number of shares and investment in other shares at other serial number is static in the year under appeal as compared to the previous year ending on 31st March, 2000. The aforesaid list of the equity and preference shares thus shows that the assessee was not engaged in trading of the shares either in the preceding assessment year or in the assessment year under appeal. There is only enhancement in purchase of shares of Jindal Steel & Power Ltd. in the year under appeal. Position of other investments in shares of other companies is same as was in preceding assessment year. Therefore, there is no sale by assessee of shares. No business or trading activity is undertaken by assessee in the year under appeal. The assessee has not entered into any transaction of trading activity either in the preceding assessment year or in the assessment year under appeal. There is only further investment in the equity shares of Jindal Steel & Power Ltd. as mentioned above. Therefore, these facts clearly support the findings of the CIT(A) that the shares were held by the assessee-company as investment portfolio only which is evident from the assessee’s own balance sheet and was in accordance with the memorandum and articles of association. The CIT(A), therefore, decided the point against the assessee. We may also mention that the assessee has filed copy of the P&L a/c ending 31st March, 2001, at p. 84 of the paper book in which the income is shown under various heads which includes interest on loans, dividend, interest on income-tax refunds, miscellaneous income and sale of securities. This would also show that the assessee was not trading in the shares either in the preceding assessment year or in the assessment year under appeal. The assessee also filed copy of the computation of income at p. 77 of the paper book in which the assessee has shown net loss as per P&L a/c and also shows the loss on trading operation (speculative loss). The assessee has claimed deduction on account of dividend income exempt under Section 10(33) of the IT Act. It would also show that the assessee has merely claimed speculative loss in the trading operation and also claimed exemption of the dividend income. There is no trading activity or sales shown for dealing in the shares. These facts clearly show that there was no business activity of the assessee dealing or trading in the shares in the previous year, relevant to the year under appeal. Thus, there is no business or trading activity of the assessee in the year under consideration dealing in the shares. The CIT(A) was, therefore, justified in holding that the assessee-company was not engaged in the business of trading of shares which could be categorised to be in the nature of business activity. The CIT(A) is also justified in holding that the assessee was simply holding these shares as investment and if the same helps the assessee to control the management of Jindal group of companies, it cannot partake the character of the business activity. The CIT(A) was also justified in holding that the only income arising from holding of the shares as investment is the dividend income which is clearly assessed under the head “Income from other sources”. The above facts clearly show that the assessee claimed the dividend income of Rs. 20,00,690 exempted under Section 10(33) in the computation of income for the purpose of filing the return of income.

5.28A The learned Counsel for the assessee conceded before us that the main activity of the company for making investment in shares (of) group companies was to acquire and retain control of the group companies. The question that requires to be considered is whether this activity itself constitutes a business when the real intention of the company is not to earn profit but to acquire and exercise control of the group companies. In order to constitute activity of the assessee for carrying on the business, it is essential that such activity must be with a motive of earning profit. Such earning of profit should be by the company itself and not by the other group company. This issue came to be considered by the Hon’ble Madras High Court in the case reported in CIT v. K.S. Venkata Subbiah Reddiar where it was held that the IT Act defines the term “business” only inclusively. The two essential requirements for an activity to be considered as “business” are (i) it must be continuous course of activity, and (ii) it must be carried on with a profit motive. This issue also came to be considered by the Delhi High Court in the case reported in Bharat Development (P) Ltd. v. CIT where it was observed that the expression “business” is a word of indefinite import. In taxing statute, it is used in the sense of a occupation or profession which occupies the time, attention and labour of the person, normally with the object of making profit. To regard an activity as business there must be a course dealings either actually continued or contemplating to be continued with the profit motive, and not for support or pleasure. Whether a person carries on business in a particular commodity must depend upon the volume, frequency, continuity and transaction of purchase and sale in class of goods and the transaction must ordinarily be entered into with a profit motive. Now, when we apply the ratio of the aforesaid decisions to the facts of the present case, we find that in this case the action of the assessee is not actuated by the profit motive: In fact, we find very few transactions of purchase and sale of shares of group companies except what had already been made in the earlier years. Only shares of one group company was purchased and there was no transaction of purchase and sale of shares of group companies. Therefore, such transactions could not be regarded as carrying on business for the purpose of Section 28 of the IT Act. It was conceded before us that object of making investment in the shares for earning dividend is only incidental but the activity carried on by the assessee could only involve earning of dividend income. Now, when transactions for purchase and sale of shares are carried on with the object of business, the profit motive is the dominant factor. One would like to sell shares when the prices are the maximum but if the purpose is only to acquire and retain the control of group companies, the assessee would not sell shares of group companies even if the prices go up because the object is not to make profit. Therefore, it could not be held that investment made in shares was for carrying on business. Thus, the activity of the assessee though incidental could only be considered for earning of the dividend income incidental to the purchase of the shares of the group companies.

5.29 The learned Counsel for the assessee also tried to argue that since the assessee-company pledged equity shares of Jindal Vijayanagar Steel Ltd. with IFC for group facilities granted to Jindal Iron & Steel Co, it should be held to be in the nature of acquiring and controlling of management of Jindal group of companies. We may mention that the purpose of business is to earn profit by taking certain trading activities. However, in the present case, the facts and the circumstances would clearly justify that the assessee did not enter into any business or trading activity during the year under consideration. Merely because the assessee pledged the shares for the benefit of other companies by itself would not prove that the assessee would earn any profit out of providing credit facilities to other group of companies. Since no trading activity has been conducted during the year under consideration, therefore, it is simpliciter clear that the assessee made investment for the purpose of earning dividend which is ultimate source of assessee during the year under consideration. We also do not agree with the submission of the learned Counsel for the assessee that the assessee made investment in the equity shares for the purpose of acquiring and controlling the management of Jindal group of companies because according to the learned Counsel for the assessee no profit is earned from some of the other companies by way of dividend for several years. The facts and the circumstances mentioned above clearly prove that the purpose of the assessee was to earn the dividend because there was no element of business activity for the purpose of earning profit in the year under consideration. The only source of income of the assessee is dividend earned by the assessee from other companies in whose shares investments have been made out of borrowed funds. Merely because the assessee has shown the investment of the shares as claimed stock-in-trade in the balance sheet by itself would not prove that the assessee was doing any business activity or trading activity dealing in the shares in the year under consideration. In assessment order for the asst. yr. 1995-96, the AO did not consider the case of assessee for applicability of Sections 14A and 115-O of the IT Act. The AO merely mentioned the version of assessee. Therefore, this assessment order would not support contention of the assessee.

5.30 Section 115-O was inserted into the Act by the Finance Act, 1997, w.e.f. 1st June, 1997, which has brought substantial changes in the system of taxation of dividend. The new scheme provides that once domestic company is chargeable in respect of profit distributed by it to its shareholders, dividend received by the shareholders of such company would be exempt under Section 10(33) of the IT Act. Section 14A of the IT Act is inserted in the Act by the Finance Act, 2001, w.e.f. 1st April, 1962. As per Section 14A of the Act no deduction is to be allowed in respect of the expenditure incurred in relation to any income which does not form part of the total income. After introduction of Sections 10(33) and 115-O any expenses incurred for the purpose of acquiring shares on which the dividend income has been earned would not be allowable as a deduction. Since the authorities below found that there is direct nexus between the interest-bearing loans and in the investment in the shares, on which the dividend income earned, the authorities below were justified in holding that assessee is not entitled to claim deduction of interest expenses.

5.31 The question for consideration before the CIT(A) was as to whether the interest-bearing loans have been utilized by the assessee-company for investment in shares which have yielded dividend income and as to whether the disallowance by invoking the provisions of Section 14A is required to be made in respect of such interest paid. The facts noted above clearly proved that the interest-bearing loans have undisputedly been invested in shares which yielded the dividend income which is exempt from tax by virtue of Section 10(33) of the IT Act. Therefore, the CIT(A) was justified in confirming the findings of the AO by invoking of the provisions of Section 14A of the IT Act in this case. The decisions referred by the learned Counsel for the assessee are clearly distinguishable and more particularly in those cases the applicability of the provisions of Section 14A of the Act for deciding the question of disallowance of interest paid on borrowing utilised for investment in shares, which yielded the dividend income was not at all considered. In the order of the Tribunal, (SMC-I), Delhi Bench, in the case of Maxpak Investment Ltd. (supra), the finding of fact is clearly distinguishable on facts because in that case the SMC Bench found that separate accounts have been maintained by the assessee to show that whatever investment is made for the purchase of shares for keeping them as investment, they have been shown separately and whatsoever investments is made for the purchase of trading have been shown separately under the head “Stock-in-hand”. In this case, the AO has himself accepted the claim of the assessee that it is dealing in the shares for investment purposes and not dealing in shares for trading purposes. However, in the appeal before us, the assessee could not prove that it had been engaged in trading in shares. The assessee might have shown the investment in the shares in the stock-in-trade but nothing has been proved on record that the assessee was at all engaged in the trading activity and as such merely showing the investments in the shares as stock-in-trade is not enough to prove the contention of the assessee. The contention of the assessee was that it made investment in shares for the purpose of controlling the group companies of Jindal group. That itself would show that the investment in the shares could not be held to be stock-in-trade because it should have been shown as capital investment in those companies of Jindal group. The decisions cited by the learned Counsel for the assessee are, therefore, not applicable to the present case and more particularly because of the insertion of Sections 14A and 115-O in the IT Act.

5.32 On the other hand, the observations of the Tribunal, Kolkata Bench, in the case of Dy. CIT v. S.O. Investment & Industries Ltd. (supra) clearly support the view of the Revenue.

5.33 The learned Counsel for the assessee after hearing is over also filed copy of order of the Tribunal, Delhi ‘D’ Bench, in the case of Mohair Investment & Trading Co. (P) Ltd. dt. 16th Sept., 2004 in ITA No. 878/Del/1999. This order would also not support the contention of the assessee because in this case it was admitted by the AO himself that the assessee held the shares as trading asset. The dividend income earned by the assessee had to be taxed under the head “Income from other sources” because of the provisions of Section 14 of the Act. Despite that real character of the dividend income was of the business income and hence it was held that the brought forward business losses could be set off against the dividend income.

5.34 The crux of the findings is that there is a direct nexus established between the interest-bearing loans taken by the assessee and the investment made in the equity shares. The only income arising from the holding of the shares is dividend income which is exempt under Section 10(33). The assessee incurred expenditure for earning exempted dividend income. Section 14A which has been inserted by the Finance Act, 2001, w.e.f. 1st April, 1962 laying down that no deduction would be allowed in respect of the expenditure incurred by the assessee in relation to the income, which does not form part of the total income under this head. The assessee is, therefore, not entitled for the above deduction of interest under Section 36(1)(iii) of the IT Act. The authorities below, therefore, rightly disallowed the amount against the assessee.

5.35 The learned Counsel for the assessee in the alternative submission submitted that the assessee earned dividend of Rs. 20,03,690 on the investment of Rs. 14,00,58,596, therefore, the relatable interest expenditure comes to Rs. 1,44,74,238 and it will thus be appreciated that out of the total interest expenditure of Rs. 3,93,69,566 interest expenditure at the most of Rs. 1,44,74,238 could be relatable to earning of dividend income. We do not agree with the alternative contention of the learned Counsel for the assessee. It is established clearly on record that entire borrowed unsecured loans were invested in the purchase of equity shares upon which the assessee paid interest of Rs. 3,93,69,566 on the said loans. It is also established that the dividend income of Rs. 20,03,690 was earned by the assessee out of the investment in shares. Merely because the assessee did not earn dividend out of the investment in certain shares by itself would not prove that the provisions of Section 14A are not applicable in this case. It is not a hard and fast rule that on each and every investment in shares, the assessee would earn dividend. The earning of the dividend is not certain, unless the concerned company declared or distributed the dividend because it depends on various factors. The established facts are that the entire borrowed unsecured loans have been invested in the shares for the purpose of earning dividend. Therefore, once the assessee claims exemptions on dividend income under Section 10(33) of the IT Act, then such dividend is directly related to the investment made in the entire shares. As such, it is not possible to accept the alternative contention of the learned Counsel for the assessee that part of the interest may be disallowed (sic-allowed). This contention of the learned Counsel for the assessee is also rejected. No other point is argued or pressed.

5.36 Considering the above facts, circumstances and discussion, we do not find any merit in the appeal of the assessee. The same is, therefore, dismissed.

6. ITA No. 2422/Del/2004 is accordingly dismissed.

7. ITA No. 3722/Del/2005: The assessee challenged the order of the CIT(A)-XIV, New Delhi, dt. 16th Aug., 2005, for the same assessment year whereby the CIT(A) confirmed the penalty under Section 271(1)(c) of the IT Act, 1961.

8. The facts are similar as have been discussed in the quantum appeal in ITA No. 2422/Del/2004 upon which we have confirmed the disallowance of interest in a sum of Rs. 3,93,69,566. The AO on the basis of the aforesaid disallowance initiated the penalty proceedings under Section 271(1)(c) for filing the inaccurate particulars of income. Show-cause notice was issued to the assessee and in reply thereto the assessee reiterated the same submissions as made on the quantum. In addition thereto, it was submitted that there is no concealment of income or filing of inaccurate particulars as such the AO assumed jurisdiction against the law. It was also submitted that essential prerequisites for initiation of the proceedings under Section 271(1)(c) are not satisfied in this case and as such the proceedings are bad in law. It was further submitted that assessee furnished all informations of particulars of income, expenditures and investments both truly and correctly; during the course of the assessment proceedings, there has been no concealment of any amount whatsoever on the part of the assessee. It was also submitted that there is no concealment at all of any particulars of income. Claim of deduction of interest was made bona fidely in respect of the funds borrowed for the purpose of carrying on the business. The AO, however, did not agree with the submissions of the assessee and vide separate orders imposed the penalty under Section 271(1)(c) of the IT Act. The penalty order was challenged before the CIT(A) and written submissions were made. The CIT(A), however, dismissed the appeal of the assessee because of the fact that the disallowance of interest was confirmed by invoking the provisions of Section 14A of the IT Act. The assessee is in appeal before us on various grounds of appeal. In the grounds of appeal, it is stated that the CIT(A) has erred on facts and in law in not holding that the penalty under Section 271(1)(c) of the IT Act is invalid, bad in law and void ab initio. It is also mentioned that the CIT(A) failed to appreciate the fact that there was no recording of satisfaction prior to the initiation of penalty proceedings by the AO which is sine qua non for levy of the penalty under Section 271(1)(c) of the IT Act and thus penalty proceedings were bad in law ab initio. It is also stated that the assessee has neither concealed the particulars of income nor furnished inaccurate particulars thereof so as to be liable to penalty under Section 271(1)(c) of the IT Act. It is also stated that the addition is made due to bona fide difference of opinion between the assessee and the AO in interpreting the provisions of the Act. The learned Counsel for the assessee submitted that the AO has not recorded satisfaction prior to the initiation of the penalty proceedings and as such penalty is liable to be cancelled on this fact alone. He has relied upon the following decisions of the Hon’ble Delhi High Court:

(i) CIT v. Ram Commercial Enterprises Ltd.

(ii) CIT v. B.R. Sharma

(iii) CIT v. Super Metal Re-Rollers (2003) 185 CTR (Del) 349: (2004) 265 ITR 82(Del);

(iv) CIT v. Auto Lamps Ltd. Order of the Tribunal, Delhi ‘E’ Bench in ITA No. 4815/Del/2004, dt. 4th April, 2005 in the case of Balka Services (P) Ltd. v: ITO [reported at (2006) 102 TTJ (Del) 115–Ed.]

Copy of the same is filed in the paper books.

9. The learned Counsel for the assessee submitted that the issue is highly debatable as the arguments made on quantum appeal itself would prove that the assessee bona fidely believed that the deduction is allowable on account of interest paid for borrowed funds and as such it is not a case of filing of inaccurate particulars or concealment of income. As such, the penalty should not have been imposed in the matter. He has submitted that the assessee bona fidely claimed the deduction as per provisions of law and the addition is made to the assessed income out of bona fide difference of opinion between the assessee and the AO in interpreting the provisions of law. As such, it is not a fit case for imposition of penalty.

10. On the other hand, the learned Departmental Representative relied upon the orders of the authorities below and submitted that the AO has recorded his satisfaction in the assessment order after computation of income at the time of initiation of proceedings. Therefore, the AO assumed a. valid jurisdiction in the matter and that on quantum the CIT(A) confirmed the addition, which is subject-matter before the Tribunal. The learned Departmental Representative accordingly submitted that penalty is justified and should be confirmed.

11. We have considered the rival submissions and material available on record. It is well-settled law that the quantum and penalty are independent proceedings. Section 271(1)(c) of the Act provides that if the AO or the CIT(A) or the CIT in the course of any proceedings under this Act is satisfied that any person has concealed the particulars of his income or furnished inaccurate particulars of such income, he may direct that such person shall pay by way of penalty. The bare reading of the aforesaid provisions would make it clear that the AO has to form his own opinion and record his satisfaction before initiating penalty proceedings. Merely because the penalty proceedings have been initiated, it cannot be assumed that such a satisfaction was arrived at in the absence of the same being spelt out by the order of the assessing authority. In the present case before us, the AO has nowhere recorded his satisfaction with regard to the concealment of the particulars of income or furnishing inaccurate particulars of income in the assessment order or while dealing with the addition on account of disallowance of the interest paid on the borrowed funds by the assessee. The AO after computing the taxable income at ‘nil’ has initiated the penalty proceedings under Section 271(1)(c) of the Act by mentioning “penalty proceedings under Section 271(1)(c) of the IT Act, 1961, have been initiated for filing of inaccurate particulars of income.” The CIT(A), considering, the decision of the Hon’ble Supreme Court in the case of CIT v. S.V. Angidi Chettiar held that the AO while passing the order has recorded in the footnote initiate penalty proceedings under Section 271(1)(c) of the IT Act, which shows that the AO was satisfied in the course of assessment proceedings that the company had concealed its income. The CIT(A) on that basis decided the point on the issue against the assessee and rejected the appeal of the assessee. However, the identical point was considered by the Hon’ble Delhi High Court in the case of CIT v. Ram Commercial Enterprises Ltd. (supra) and held:

A bare reading of the provisions of Section 271 and the law laid down by the Supreme Court makes it clear that it is the assessing authority which has to form its own opinion and record its satisfaction before initiating the penalty proceedings. Merely because the penalty proceedings have been initiated, it cannot be assumed that such a satisfaction was arrived at in the absence of the same being spelt out by the order of the assessing authority. Even at the risk of repetition we would like to state that the assessment order does not record the satisfaction as warranted by Section 271 for initiating the penalty proceedings.

As we have already held that the question suggested by the Revenue does not arise as a question of law from the order of the Tribunal, no fault can be found with the Tribunal rejecting the Department’s application under Section 256(1) of the Act.

12. The Hon’ble Delhi High Court in the case of CIT v. B.R. Sharma (supra) held:

It is clear from the above referred judgments that the consistent view of this Court has been that the AO is under an obligation to record satisfaction prior to the initiation of the penalty proceedings in terms of Section 271(1)(c) of the Act. The order of the AO should apparently show that there is application of mind. Application of mind can only be gathered by the reasons stated in the order and reference to other records may not be very relevant for this purpose. The satisfaction contemplated under Section 271(1)(c) of the Act may be subjective but must be arrived at objectively so that the underlining of these provisions which would require a strict construction of the provisions being penal in nature, would stand frustrated.

13. The Hon’ble Delhi High Court in the case of CIT v. Auto Lamps Ltd. (supra) held:

The bare reading of the above order passed by the AO on 6th Feb., 2003, shows that there is no application of mind and no opinion has been formed and no satisfaction has been recorded by the AO before or at the time of initiating penalty proceedings. In fact, in the impugned order it is recorded that penalty proceedings under Section 271(1)(c) for furnishing inaccurate particulars of the income had been initiated separately. This itself shows that without even mentioning the essential ingredients which the AO is obliged to record for initiation of penalty proceedings, the impugned order was passed. To pass an order initiating penalty proceedings while passing the assessment order in a routine manner would be an apparent violation of the relevant provisions. In our opinion, the impugned order clearly suffers from the infirmity of non-application of mind. The AO had failed to record requisite satisfaction in consonance with the settled principles of law.

In these circumstances, we see no reason to interfere with the concurrent view taken by the first appellate authority and the Tribunal. In our view, no question of law arises for consideration of the Court in the present appeal and the same is dismissed while leaving the parties to bear their own costs.

14. The Hon’ble Delhi High Court in the case of CIT v. Super Metal Re-Rollers (supra) took the same view and held:

Held, dismissing the appeal, that it had been submitted that the satisfaction of the AO as contemplated in Section 271(1)(c) of the Act was inherent in the queries raised by him during the course of the assessment proceedings and that the AO had directed the issue of notice for levy of penalty under the section after being satisfied that the assessee concealed the particulars of its income. This was not sufficient. The cancellation of penalty by the Tribunal was justified. No substantial question of law arose from its order.

15. The decisions, referred to above, clearly held that the satisfaction has to the assessee having concealed the particulars of income or furnished inaccurate particulars of such income is to be arrived at by the AO during the course of the assessment proceedings under the Act. The AO, therefore, shall have to record his satisfaction before conclusion of the proceedings under the Act and not at the time of issue of the notice or initiation of the penalty proceedings under Section 271(1)(c) of the Act.

16. The Hon’ble Delhi High Court in the cases of Ram Commercial Enterprises, B.R. Sharma and Super Metal Re-Rollers (supra) has considered the decision of the Hon’ble Supreme Court in the case of Angidi Chettiar (supra) as is relied upon by the CIT(A) while dismissing the appeal of the assessee. The Hon’ble Delhi High Court also considered the decision of the Hon’ble Supreme Court in the case of DM. Manasvi v. CIT 1972 CTR (SC) 437 in the aforesaid decisions and have held that the satisfaction as to the assessee having concealed the particulars of income or furnishing inaccurate particulars of such income is to be arrived at by the AO during the course of assessment proceedings without which the very jurisdiction in initiating penalty proceedings is not conferred on the AO by reference to Section 271(1)(c) of the IT Act. The Hon’ble jurisdictional High Court, therefore, upheld the orders of the Tribunal cancelling the penalty imposed under Section 271(1)(c) of the IT Act on the ground that the assessment order did not record satisfaction as warranted by Section 271(1)(c) of the IT Act for initiating penalty proceedings. As is noted above, in the present case, the assessment order passed by the AO clearly shows that the satisfaction for initiating the penalty proceedings under Section 271(1)(c) was not recorded by the AO in the assessment order and, therefore, we hold that the initiation of the penalty proceedings was not in accordance with law as envisaged by Delhi High Court in above cases and as such penalty imposed in pursuance of such invalid proceedings is liable to be cancelled on this ground alone.

17. The same (view) is taken by the Tribunal, Delhi ‘E’ Bench, in the case of Balka Services (P) Ltd. (supra).

18. Considering the discussion, the penalty is cancelled under Section 271(1)(c) of the IT Act.

19. Since we have cancelled the penalty in the matter on the aforesaid ground, therefore, there is no need to discuss the merits of the claim of the parties because the same would be of academic interest only.

20. As a result, the appeal by the assessee is allowed.

21. As a result, the appeal of the assessee on quantum in ITA No. 2422/Del/2004 is dismissed and ITA No. 3722/Del/2005 is allowed.