1. These are two appeals filed by the assessee against the orders of the CIT(A)-VII. Mumbai, dt. 6th Nov., 2000 and 29th March, 2001 for asst. yrs. 1997-98 and 1998-99, respectively. Since common issue is involved in both these appeals, the same are being disposed of by the common order for the sake of convenience.
2. The common issue arising in these appeals relates to the deduction under Section 36(1)(iii) of IT Act, 1961 (Act) on account of interest paid on borrowings for the purpose of acquisition of shares of Trumac Engineering Co. Ltd. (Trumac).
3. Briefly stated, the facts giving rise to these appeals are these: The assessee-company was engaged in the business of distribution of various goods including textile machineries. It was a sole selling agent of Trumac since long. In the financial year 1996-97, the assessee had acquired certain shares of Trumac on 9th Nov., 1996 and 9th Jan., 1997 for a consideration of Rs. 388.97 lakhs. In addition, it had also acquired certain shares of other companies also. For this purpose, the assessee borrowed an amount of Rs. 395 lakhs on 15th Nov., 1996 from M/s Kotak Mahindra Finance Ltd. (Kotak) and paid interest of Rs. 17,14,779 for the period ending on 31st March, 1997 relevant to asst.
yr. 1997-98 and claimed the same as deduction under Section 36(1)(iii) of the Act. The dividend income declared for asst. yr. 1997-98 was Rs. 29,84,252 which was offered as income from other sources.
Similarly, the assessee had disclosed dividend income of Rs. 28,44,689 for asst, yr. 1998-99 which was claimed to be exempt from taxation under Section 10(33) of the Act. It also claimed deduction of Rs. 23,06,528 under Section 36(1)(iii) on account of interest paid to Kotak for asst. yr. 1998-99.
4. In the course of assessment proceedings, the AO was of the view that interest paid on borrowings had nexus with the acquisition of shares and therefore, the expenditure should be allowed under Section 57(iii) and not under Section 36(1)(iii). Consequently, the assessee was asked to show cause why the interest paid on funds borrowed should not be disallowed under Section 36(1)(iii) and in turn allowed under Section 57(iii).
5. In response to the show-cause notice, the assessee explained to the following effect: A joint venture company was formed in 1971 by the assessee-company and Mafatlal group of companies to manufacture machinery for textile industry in the name and style of Trumac Engineering Co, Ltd. The shareholding pattern was to the following effect:(a) Foreign collaborators 36%(b) Assessee-company 15%(c) Mafatlal Industries and other Indian associates 49% _________Total 100% _________ The chairman of the assesses-company was on the board of Trumac as nonexecutive chairman. However, in the year 1996, he was appointed as managing director as per obligatory provisions of Companies Act.
Mafatlal group of industries continued to hold investment for more than 15 years, but in 1994, the financial problems compelled the group to disinvest their entire holding in Trumac. In October, 1994, Kotak Mahindra, a group having a long established presence in Indian money market and vast experience in mercantile banking was persuaded to take over the holding of Mafatlal group as an interim investor.
Consequently, two companies of Kotak Mahindra group agreed to take over 28 per cent holding out of 35 per cent holding of Mafatlal in Trumac and the balance 7 per cent was taken over by Overseas Textiles Corporation with the understanding that holding of Overseas Textiles Corporation in Trumac will be subsequently taken over by the assessee-company.
In view of these facts, it was submitted by the assessee that shares of Trumac were purchased for the purpose of procuring and retaining agency agreement with Trumac and not with the purpose of earning any dividend income. The intention of the assessee was to see that holding of shares does not go to any outside parties which could jeopardize the long-term interest of the assessee company. According to it, such arrangements helped the assessee in earning sizeable income from the sale of Trumac products by way of commission. In support of its contention, the assessee also relied on the judgment of Gujarat High Court in the case of Addl. CIT v. Laxmi Agents (P) Ltd. (1980) 125 ITR 227 (Guj) and the judgment of the Calcutta High Court in the cases reported as CIT v.Jardin Henderson Ltd. and CIT v. Rajeev Lochan 6. The AO was not satisfied with the submissions of the assessee.
According to him, there was no dispute that the assessee borrowed the amount for acquiring shares of Trumac and thus there was clear nexus between the borrowed funds and the utilization for acquiring the shares. It was further observed by him that the present acquisition of shares did not give the company any extra advantage compared to the preceding years since it had been marketing the machinery manufactured by Trumac over several years and had been receiving the commission. It was also observed that the case of the assessee was not for acquiring of controlling interest to enable it to decide the business policies of Trumac, particularly when it was having presence in the board of Trumac even before acquiring the present shareholding. The AO also distinguished the judgments relied upon by the assessee. On the contrary, he relied on the judgment of Bombay High Court in the case of CIT v. Maganlal Chhaganlal (P) Ltd. wherein it was held that deduction under Section 80M was to be calculated with reference to the amount of dividend computed in accordance with the provisions of Act and forming part of gross total income i.e. after deduction of interest on money borrowed for earning such income. It was also observed by him that in the case of Maganlal Chhaganlal (supra), the assessee had acquired shares by using borrowed funds and held the shares as trading asset. Despite this fact, the claim of the assessee under Section 36(1)(iii) was not allowed and on contrary such interest was allowed under Section 57(iii) to arrive at the net dividend income under the head 'Income from other sources'. Accordingly, he disallowed the claim under Section 36(1)(iii) but allowed the same under Section 57(iii). As a necessary corollary, the AO reduced the claim of the assessee under Section 80M i.e. equal to the net dividend income.
7. The matter was carried in appeal before the CIT(A) before whom it was reiterated that the assessee had not invested in the shares of Trumac for the purpose of earning of dividend income but the investment was made for the purpose of safeguarding its selling agency. Thus, the decision of the assessee was commercial decision and therefore, the deduction was allowable under Section 36(1)(iii). Reliance was also placed on the decision of the Gujarat High Court in the case of Laxmi Agent (supra) as well as the decision of the Bombay High Court in the case of CIT v. Mahendra Sobhagchand Shah . Hence, it was prayed that expenditure by way of interest should be allowed under Section 36(1)(iii) and consequently the deduction under Section 80M should be allowed on the gross dividend.
8. The CIT(A) was not convinced with the submissions of the assessee.
It was observed by the CIT(A) that the shares of Trumac were purchased with the sole intention of earning dividend income and therefore, the deduction could not be allowed under Section 36(1)(iii). It was also observed that the assessee-company was on the way to acquire controlling interest in that company. The CIT(A) also relied on the judgment of Madras High Court in the case of P.V. Mohammed Ghouse v.CIT (1963) 49 ITR 127 (Mad) for the proposition that where the investment (in) shares is made, not by way of stock-in-trade but otherwise then deduction was not admissible against business income.
According to him, the judgment of Bombay High Court in the case of Maganlal Chhaganlal (supra) was quite appropriate to the facts of the instant case. The judgment of Bombay High Court in the case of Mahendra Sobhagchand Shah (supra) relied upon by the learned Counsel for the assessee was distinguished on the ground that in that case the assessee was a dealer in shares. Accordingly, he upheld the order of the AO by holding that interest was to be allowed as deduction under Section 57(iii) and consequently the deduction under Section 80M was to be restricted to the net income. Accordingly, appeals for both the assessment years were dismissed by the CIT(A) on this issue. Aggrieved by the said order of the CIT(A), the assessee is in appeal before the Tribunal for both the years.
9. The learned Counsel for the assessee has reiterated the stand of the assessee taken before the lower authorities. Further, it was pointed out that the observations of the CIT(A) that shares were purchased with a view to have controlling interest in Trumac was contrary to the observations of the AO to the effect that case of the assessee was not to acquire controlling interest. The learned Counsel for the assessee emphasized the sole purpose to safeguard the source of income, i.e., sole selling agency of Trumac products and, therefore, money was borrowed for the purpose of business, Consequently, the deductio was allowable under Section 36(1)(iii). In support of his submissions, he relied on the various judgments:Addl.. CIT v. Laxmi Agents (P) Ltd. 10. On the other hand, the learned Departmental Representative has relied on the reasoning given by the AO as well as the CIT(A) and, therefore, need not be repeated.
11. Rival submissions of the parties have been considered carefully.
The question for consideration is whether interest paid by assessee on borrowings for acquisition of shares of Trumac can be allowed as deduction under Section 36(1)(iii) considering the facts of the case and case law available on this point. There is no dispute between the parties that deduction is allowable if money is borrowed for the purpose of business. The expression 'for the purpose of business' is much wider than the expression 'for the purpose of earning profits' as held by Hon'ble Supreme Court in the case of India Cements Ltd. v. CIT . Thus, for the purpose of allowing deduction under Section 36(1)(iii) it would be irrelevant to consider whether borrowed money was utilized for meeting day-to-day expenses or for acquiring capital assets to be used in business. Therefore, interest for borrowing would be allowed even if borrowed fund is utilized for acquiring plant and machinery or land and building for use in business.
Reference can be made to jurisdictional High Court judgment in the case of Calico Dyeing and Printing Works v. CIT 12. In view of the above legal background, the question which survives for our consideration is whether on facts it can be said that money was borrowed for the purpose of business. Admittedly ' Trumac' was a joint venture of assessee and Mafatlal group of companies. In its reply to show-cause notice, the assessee had stated that promoters of assessee-company as well as of Mafatlal group had good business relationships having close association with Indian textile industry.
This fact has not been disputed by the Revenue at any stage. It is because of these facts, the chairman of assessee-company was on the board of 'Trumac' as non-executive chairman and could get sole selling agency for the distribution of the products manufactured by Trumac.
Since it was main source of income, it was natural for a prudent man to safeguard its business interest. Therefore, if the assessee decided to increase its holding in 'Trumac', in our opinion, the assessee was guided by business consideration to safeguard its selling agency. If shares are purchased by outsiders then there is possibility that outsider may jeopardize the business interest of assessee-company.
Therefore, in our opinion, act of borrowing money for the acquisition of shares was closely connected with or incidental to the carrying on of the business.. Consequently, the conditions of allowing deduction under Section 36(1)(iii) stood satisfied.
13. To fortify our view, we may refer to the judgment of Supreme Court in the case of State of Madras v. G.J. Coelho that case, assessee purchased an estate consisting of tea, coffee and rubber plantations in Nilgiri mountains for Rs. 3,10,000. For that purpose he borrowed Rs. 2,90,000 on interest and claimed the interest as deduction against plantation income. The claim was made under Clause (e) of Section 5 which is corresponding to Section 37 of IT Act, 1961.
The Court held that expenditure by way of interest was not in the nature of capital expenditure even though borrowed money was used for acquiring tea estate since such act was in connection with carrying on business. This decision was followed subsequently by the Hon'ble Supreme Court in the case of Bombay Steam Navigation Co. (1953) (P) Ltd. v. CIT (1965) 56 ITR 52 (SC). In the later case, the assessee, under the scheme of amalgamation, took over certain passenger and ferry services valued at Rs. 81.55 lakhs which was to be satisfied partly by allotment of shares and balance to be treated as loan bearing interest @ 6 per cent per annum. The question arose whether interest on such unpaid price (loan) could be allowed as deduction neither under Section 10(2)(iii) or Section 10(2)(xv) of 1922 Act corresponding to Section 36(1)(iii) or Section 37 of 1961 Act. The Supreme Court held that provisions of Section 10(2)(iii) were not attracted as money was not borrowed. However, the claim was allowed under Section 10(2)(xv) since payment of interest was for the purpose of business. It would be appropriate to refer to the following observations of their Lordships: (i) that the expression 'capital' used in Section 10(2)(iii), in the context in which it occurred, meant money and not any other asset; there was in truth no capital borrowed by the assessee in this case.
An agreement to pay the balance of consideration due by the purchaser did not in truth give rise to a loan. Therefore, the claim for deduction of the amount of interest under Section 10(2)(iii) was not admissible.
(ii) that, however, the interest paid by the assessee was business expenditure and was allowable as deduction under Section 10(2)(xv).
The transaction of acquisition of assets was closely related to the commencement and carrying on of the assessee's business and interest paid on the unpaid balance of the consideration for the assets acquired had, in the normal course, to be regarded as expended for the purpose of the business which was carried on in the accounting periods.
The above observations clearly show that if the expenditure is clearly related to the carrying on or conduct of the business, then such expenditure would be revenue in nature.
14. The decision of Gujarat High Court in the case of AddL. CIT v.Laxmi Agents (supra) is directly on the issue before us. In that case, the assessee was engaged in managing agency business. It borrowed money on interest for procuring shares of the managed company and claimed the interest as deduction against business income. It also claimed deduction of tax on inter corporate dividends on gross amount under Section 85A. The AO did not allow deduction against business income but allowed the same against dividend income and consequently claim under Section 85A was reduced. However, the Tribunal held to the effect "that it was common knowledge that the managing agents prefer to invest in shares of the managed company in order to have more and better control over it and therefore, the so-called trade investment in the managed company had close connection with the business activity of the assessee, namely the managing agency business. Further, 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.
Through income from dividend is required to be assessed under a separate head, payment of interest made on the borrowings, which related to the shares of the managed company, must be allowed as business expenditure." On reference, the High Court affirmed the decision of the Tribunal following judgment of Supreme Court in the case of India Cements (supra), the judgment of Bombay High Court in the case of Calico Dyeing & Printing Works (supra) and its earlier judgment in the case of CIT v. Alembic Glass Industries Ltd. .
This judgment is squarely applicable to the facts of the present case.
15. It would also be advantageous to refer to the binding judgment of jurisdictional High Court in the case of Modi (P) Ltd. (supra). In that case, the assessee purchased shares of managed company as well as of assessee (another) company with the help of borrowed money and claimed deduction under Section 37(1). The said claim was disallowed by the AO.However, the Tribunal held that acquisition of shares of managed company was closely related to the carrying on of business of assessee and therefore, claim was allowable under Section 37(1). On the other hand, interest payable in respect of shares of other company was deductible under Section 57(iii). This judgment is also an authority for the proposition that if acquisition of shares is related to carrying on of assessee's business then such claim can be allowed.
Thus, this judgment directly supports the case of assessee.
16. We may also refer to the judgment of Calcutta High Court in the case of Rajeev Lochan Kanoria (supra). In that case, assessee was a director of various companies. The assessee purchased shares of such companies and claimed deduction on account of interest paid against business income, The Court held that directorship was a vocation and therefore, shares purchased in order to acquire controlling interest was allowable as business expenditure under Section 36(1)(iii). Similar view was taken in subsequent case reported as 17. The judgment of Hon'ble Bombay High Court in the case of Maganlal Chhaganlal (P) Ltd. (supra) heavily relied upon by the Revenue, in our opinion, is quite distinguishable. In that case assessee claimed deduction under Section 80M on the gross amount while AO allowed the same on net dividend, i.e., after adjusting interest paid on borrowed money. The Hon'ble High Court, following Supreme Court judgment in the case of Distributors (Baroda) (P) Ltd. v. Union of India and Ors.
, held that deduction under Section 80M was allowable on net dividend. No doubt, the assessee was carrying on business of manufacturing as well as dealing in shares and investing in shares. But the question whether interest was allowable under Section 36(1)(iii) or 37 was neither raised nor considered by either by tax authorities or by Tribunal or the High Court. It is also not clear whether dividend arose from holding of shares as stock-in-trade or as an investment. In view of the same, the judgment does not help the Revenue.
18. The judgment of Madras High Court in the case of P.V. Mohammed Ghouse (supra) relied upon by the CIT(A) is also distinguishable on facts. In that case assesses was running business as bus operator and had purchased shares of another transport company which had nothing to do with assessee's business. There was no connection or nexus between the assessee and that transport company. In view of such facts it was held that interest on borrowings was not allowable as deduction under Section 10(2)(iii) of 1922 Act. But in the present case, there is business connection and therefore the said decision has no application to the facts of the present case.
19. In view of the above discussions and in the facts and circumstances of the case, we hold that the assessee is entitled to claim the deduction not only under Section 36(1)(iii) but also under Section 37 of the Act, 1961 to the extent interest is attributable to the amount borrowed and utilized for acquisition of shares of Trumac. However, the interest on money borrowed utilized for acquisition of shares of other companies would be deductible under Section 57(iii) against the dividend income. Accordingly, we set aside the order of the CIT(A) and direct the AO to allow deduction under Section 36(1)(iii)/37 of the Act and consequently allow the deduction under Section 80M with reference to gross dividend income received against the shares of 'Trumac' and net dividend income received against the shares of other companies.
20. The next issue arising from the appeal for asst. yr. 1997-98 relates to the deduction under Section 80HHC of the Act. This claim was disallowed by the AO on the ground that there was negative income if export incentives are excluded. The learned Counsel for the assessee has agreed that the issue is covered against the assessee by Supreme Court judgment in the case of IPCA Laboratory Ltd. v. Dy.
. However, it has been contended that Government of India has agreed to bring retrospective amendment to help the exporter.
In view of the same, the issue is decided against the assessee subject to the rider that the assessee would be at liberty to move the application under Section 254(2) in case any retrospective amendment is brought on the statute book by the legislature.
21. The last issue arising from the appeal for asst. yr. 1997-98 relates to disallowance of depreciation of Rs. 6,32,672. The learned Departmental Representative has pointed out that assessee did not press this ground before the CIT(A) and therefore, assessee cannot be said to be aggrieved from the order of the CIT(A) on this issue. However, the learned Counsel for the assessee has submitted that concession was made under mistake. Further, it is submitted that in case the ground is not considered then some observations be made that concession before CIT(A) would not affect the penalty proceedings.
22. After hearing both the parties, we hold that the assessee cannot be said to be aggrieved from the order of the CIT(A) on this issue since it conceded before the CIT(A) to the disallowance. However, we observe that such concession would not affect the penalty proceedings since both the proceedings are independent proceedings. Subject to these observations, the ground raised by the assessee is dismissed as not entertained.
23. In the result appeal in ITA No. 718 is partly allowed while appeal in ITA No. 34944s allowed.