Essar Investments Ltd. Vs. Deputy Commissioner of Income - Court Judgment

Excerpt:
this appeal by the assessee arises out of the order dated 2-4-1993 of the commissioner of income tax (appeals)-v, chennai for the assessment year 1986-87. the first dispute in this appeal relates to the taxability of dividend of rs. 26,63,863 received by the assessee during the previous year relevant of the assessment year under consideration in respect of 11% cumulative preference shares. according to the assessee, the said amount of dividend was in respect of earlier six financial years 1978-79 to 1982-83 and 1984, which years much before the acquisition of the preference shares. since they were in the nature of cumulative preference shares and by virtue of being the owner of the preference shares, the assessee has received the dividend in question.but nonetheless, it is only a capital.....

Judgment:
This appeal by the assessee arises out of the order dated 2-4-1993 of the Commissioner of Income Tax (Appeals)-V, Chennai for the assessment year 1986-87. The first dispute in this appeal relates to the taxability of dividend of Rs. 26,63,863 received by the assessee during the previous year relevant of the assessment year under consideration in respect of 11% cumulative preference shares. According to the assessee, the said amount of dividend was in respect of earlier six financial years 1978-79 to 1982-83 and 1984, which years much before the acquisition of the preference shares. Since they were in the nature of cumulative preference shares and by virtue of being the owner of the preference shares, the assessee has received the dividend in question.

But nonetheless, it is only a capital receipt which will go to reduce the cost of acquisition of the preference shares. Reliance was placed on the decision in the case of Globe United Engg. & Foundry Co. Ltd. v.Industrial Finance Corpn. of India (1974) 44 Comp. Cas. 347 (Del). Our attention was also invited to the decision of the Hon'ble Supreme Court in CIT v. India Discount Co. Ltd (1970) 75 ITR 191 (SC) wherein it was held that arrears of uncollected dividend received by the buyer was not taxable as the income of the buyer. The learned Departmental Representative, on the other hand, strongly supported the impugned order.

The relevant facts relating to this issue are that the assessee has purchased 50,000 shares of 11% redeemable cumulative preference shares of the erstwhile Karnataka Shipping Corporation Ltd. of the face value of Rs. 50 lakhs, for a sum of Rs. 5,00,000 only from the Government of Karnataka in 1983. No dividend was declared by the said shipping corporation for years as it was always in loss. After the acquisition in 1983 by the Essar group, the said corporation was merged with M/s.

Bulk Carriers, a profit making concern of the same group in 1984-85.

The company so merged was later on named as Essar Shipping. This concern declared the dividend for the first time in the period relevant to the assessment year 1986-87. A part of the dividend on the aforesaid 11% redeemable cumulative preference shares related to six financial years viz. 1978-79 to 1983-84. The assessee's case is that the dividend relating to earlier years, when it was not even the owner of the shares, was not taxable in its hands.

We have carefully considered these facts as also the discussions in the impugned order. We have also considered the submissions of the parties before us. Section 85 of the Companies Act, 1956 provides two kinds of share capital m-preference share capital and equity share capital. The preference shares are entitled to either or both of the following rights namely : (ii) as respect capital, a preferential right to the re-payment on a winding up.

Where preference shares are non-cumulative they are entitled to priority only in respect of the amount of dividend due to them in the current. Where they are cumulative, they are entitled to priority for total accumulation in the year in which the company is proposing to pay a dividend. Further, redeemable cumulative preference shares carry a fixed rate of dividend. If the dividend on such shares cannot be paid owing to inadequacy of profits in any year, arrears of such dividend are accumulated and paid out of all the profits earned by the company in any subsequent year. If the company makes sufficient profits, the arrears of such dividend can be paid along with the current year. The rights of preference shareholders arise from the memorandum and articles of association of the company and also the terms of the issue of such preference shares. Section 205 of the Companies Act, 1956 states that no dividend shall be paid except out of profits. Right to claim any dividend arises only upon the company earning the profit and after a dividend has been declared by the company in its General Body Meeting. Unless and until it is so declared, shareholders have no right or claim against the company in respect of the dividend. Shareholders cannot compel the company by any process of law to declare a dividend.

Dividend when declared becomes a debt and a shareholder is entitled to sue for the same after expiry of the period prescribed under section 207 of the Companies Act, 1956.

Now coming to the taxing provisions, dividend income is subject-matter of discussion in section 8 of the Income Tax Act, 1961, which makes dividend taxable only when it is declared by the company or distributed or paid by it and it shall be deemed to be the income of the previous year in which it was declared, distributed or paid, as the case may be.

In other words, dividend to be treated as income within the various sub-clauses of section 2(22) of the IT Act, the same must be declared or distributed or paid, as the case may be. In this case, there is no dispute as to the fact that the so-called dividend was in arrears and it came to be declared by the successor company after the assessee became the owner of these shares. We, therefore, in the light of the aforesaid provisions, confirm the order of the Commissioner of Income Tax (Appeals). The Commissioner of Income Tax (Appeals) has elaborately discussed the case-laws relied upon by the assessee in this regard and has upheld the order of the assessing officer in the light of the clear provisions of section 8 of the Income Tax Act, 1961. We approve his findings by affirming his order on the disputed issue.

The next dispute relates to the assessee's claim for depreciation in respect of certain properties owned by it and used for the purpose of its business. The assessing officer denied the claim of the assessee on the ground that the immovable properties were not registered in the name of the assessee. We have heard both the parties to the dispute and have gone through the records. In our view, the claim of the assessee deserves to be accepted in the light of the decision of the Hon'ble Supreme Court in Mysore Minerals Ltd. v. CIT (1999) 239 ITR 775 (SC).

It is ordered accordingly.

The next dispute relates to the disallowance of advertisement expenses of Rs. 7,51,666. These advertisement expenses were incurred by the assessee in connection with the business of its subsidiary company. We have heard the parties to the dispute and have gone through the record.

In our opinion, the assessee's claim for deduction is well-founded.

These advertisement expenses are incurred in the normal course of business to enhance its own business potentials and brand image. We, therefore, reverse the order of the Commissioner of Income Tax (Appeals) on this issue and direct the assessing officer to delete the disallowance.

The next dispute relates to the disallowance of consultation charges of Rs. 11,046 incurred for exploring the viability of setting up a power generation unit. The assessee is engaged in the business of promotion of industrial enterprises. It is stated that the assessee had a plan to set up a power generation business and had paid the impugned consultation charges with a view to understand the business potential in power business and to explore the possibilities of investments in power projects only as a promoter. The assessee claimed this expenditure as a deduction for the year under consideration on the plea that it was for the purposes of business, though no business could be procured during the year. The assessing officer disallowed the same on the ground that it was a capital expenditure. The Commissioner of Income Tax (Appeals) concurred with the assessing officer, observing as under : "The claim of the appellant is not acceptable. The appellant had incurred the expenditure of Rs. 11,184 to see whether any business in the powerline was viable or not. No power unit was finally put by the appellant. Its expenditure was abortive. The expenditure incurred by the appellant was in connection with its plan to set up a new power unit. Such an expenditure is covered by the provisions of section 35(D)(1)(ii). The expenditure incurred by the appellant was not related to the existing business and, accordingly, was not allowable under section 37 of the Income Tax Act, 1961. The judgments relied upon by the appellant cannot help its cause as the expenditure incurred in those cases was directly relatable to the existing business. No new viable lines of business were explored in those cases. In view of the above discussion the claim of the appellant is rejected." We have heard the parties to the dispute and have gone through the records. In our opinion, the findings of the Commissioner of Income Tax (Appeals) are reasonable, in the facts and circumstances of the case, and do not call for any interference. The Commissioner of Income Tax (Appeals) has already recorded a finding that the judicial pronouncements relied upon by the assessee before him are distinguishable on facts. We, therefore, uphold the order of the Commissioner of Income Tax (Appeals) on this issue and reject the assessee' ground.

The next dispute relates to deduction under section 80M of the Act.

During the year under consideration, the assessee received gross dividend of Rs. 2,51,35,880 and claimed deduction under section 80M of the Act at the rate of 60% thereof. However, the assessing officer made the following deductions from the dividend income : The assessing officer deducted the proportionate expenses observing that the business expenses incurred by the assessee are common from various heads that the assessee had not allocated the expenditure to the income from dividend and that proportionate expenditure is to be disallowed. This action of the assessing officer was challenged before the Commissioner of Income Tax (Appeals) by way of additional ground.

The Commissioner of Income Tax (Appeals) disposed of this ground of the assessee as under : "Now, from the discussion above, it is seen that the Deputy Commissioner apportioned part of the expenditure debited under the five heads of expenses (7.1 ante) against the dividend income also. There was no justification for him to apportion the expenditure of Rs. 2,14,876 incurred on assets maintenance against the dividend income because the expenditure under this head had no bearing on dividend income. Further, the Deputy Commissioner had separately disallowed expenditure relating to earlier years (Rs. 7,04,386) and part of the total depreciation of Rs. 5,77,321, as per discussion in paragraphs 13 and 8 respectively in the assessment order. By setting off a part of these expenses against the dividend income, the Deputy Commissioner committed an apparent mistake. The provisions of section 37(1) and section 57(iii) are alike and serve the same purpose. Having disallowed certain expenses under section 37, as per the discussion in the aforesaid paragraphs, the Deputy Commissioner should not have apportioned and allowed part of the same expenditure undersection 57(iii). It is also seen that out of the administration expenses of Rs. 15,63,947, some of the expenses like 'advertisement', 'conveyance as per Rule 6D' etc. were disallowed by the Deputy Commissioner in the earlier part of the assessment order (paragraphs 9 and 11 of the assessment order). He, therefore, should not have apportioned and allowed the same expenditure against the dividend income. The pro rata set off of the entire expenditure against the dividend income was also not justified. The Deputy Commissioner should have found those items of expenditure which were laid out of expended wholly and exclusively for the purpose of making or earning the dividend income. Without doing such an exercise, he should not have reduced the dividend income of the appellant by Rs. 34,15,304. Considering the circumstances, this issue is remitted to the file of the assessing officer. He is directed to give a clear finding about the expenditure incurred for making or earning the dividend income. It may be repeated that no fault can be found in the method in which the Deputy Commissioner has allocated the expenditure towards the dividend income. The rate of 251 (gross dividend income) to 266 (the total income) cannot be said to be unreasonable. Thus, the assessing officer may proportionately allocate the expenditure which was incurred for making or earning the dividend income subject to the discussion above." We have heard the parties to the dispute and have gone through the record. The claim of the assessee was that it was having composite business activities and hence no part of the expenses is allocable against the dividend income. It is also seen that in the assessee's own case for assessment year 1992-93 deduction under section 80M was allowed on net dividend income, but in appeal, the Commissioner of Income Tax (Appeals) had directed to allow the deduction with reference to gross dividend income. In the assessment year under consideration, the assessing officer apportioned the business expenses claimed by the assessee between business income and the dividend earned and on that basis allowed deduction under section 80M on the net dividend. No doubt, by now it is settled law that deduction under section 80M is to be allowed only on the net dividend, i.e., after deducting the expenses incurred for earning such dividend income. What is to be deducted is the actual expenditure incurred for earning the dividend income and not on notional basis by apportioning the expenses between business income and dividend. The Hon'ble Bombay High Court has considered this issue in the case of CIT v. General Insurance Corpn. of India (No. 1) (2002) 254 ITR 203 (Bom) and has held as under : "As regards question No. 2 is concerned the assessing officer has held that while deductions under section 80M, expenses incurred on account of salary paid to staff. Stamp duty, transfer fee and safe custody charges are relatable to earning of dividend. We do not find any merit.

The above expenses on account of salary paid to staff are not directly relatable to earning of dividend. So also payments of stamp duty, transfer fees and safe custody are not relatable to earning of dividend. They may be relatable to acquisition of share but not to dividend being earned." Since the Commissioner of Income Tax (Appeals) has restored the issue to the file of the assessing officer with a direction to give a clear finding about the expenditure incurred for earning the dividend income, we modify his order and direct the assessing officer to keep in mind the above decision of the jurisdictional High Court while determining the actual expenses that incurred for earning the dividend income, which would be required to be deducted from the gross dividend for the purposes of granting deduction under section 80M of the Act. This ground is treated as allowed to the above extent.