$~37&38
* IN THE HIGH COURT OF DELHI AT NEW DELHI
Decided on 19.01.2017
+ ITA Nos.709/2004, 37/2005 & 636/2004
COMMISSIONER OF INCOME TAX VI ..... Appellant
Through: Mr. Zoheb Hossain, Sr. Standing
Counsel in both appeals.
versus
M/S VIRAT INVESTMENT & MERCANTILE CO. ..... Respondent
Through: Mr. Shashwat Bajpai with Mr. Sharad
Agarwal, Advocates.
CORAM:
HON'BLE MR. JUSTICE S. RAVINDRA BHAT
HON'BLE MR. JUSTICE NAJMI WAZIRI
S.RAVINDRA BHAT, J.(ORAL)
1. Learned counsel for the parties submit that another appeal, i.e.,
ITA 636/2004 has to be heard together with these two appeals as the
question of law framed is identical.
2. With consent of counsel for the parties, that appeal - ITA
636/2004 was listed and heard for final disposal along with the other
appeals.
3. The following questions of law arise for consideration in these
appeals: -
"Whether the assessee was entitled to deduction of
interest/service charges paid on funds raised to subscribe to
ITA Nos.709/2004, 37/2005 & 636/2004 Page 1 of 9
the rights issue and for retaining control of 28% of its
holding in M/s Shreyans Industries Limited?."
4. The brief facts are that the assessee, an investment company
had reported for the assessment years 1992 -93, a loan transaction to
fund its subscription to the tune of `1,50,00,000/- in Shreyans
Industries Ltd. The assessee was a shareholder in that company and
wished to subscribe to certain debentures which had both convertible
and non-convertible elements. The assessee was an existing
shareholder with 28% equity holding in the company. The LIC
Mutual Funds which financed these debentures, through an
agreement, required the assessee to ensure that the debentures were
subscribed in its name; the advance carried an interest of 19.5%
annually. Upon the repayment of the principal and liquidation of all
liabilities, the converted shares (being part of the convertible portion)
were to be registered and made over to the assessee. It is not in
dispute that during the first assessment year 1992-93, after allotment
of the debentures to the assessee, it ensured the sale of the non-
convertible portion of the debentures at 11% discount. Concededly,
the AO accepted this transaction - as is evidenced by the acceptance
of the capital loss reported in that regard. The assessment was
finalized under Section 143 (3) for AY 1992-93 as well as later years.
On 07.04.1997, during the course of regular assessment, the AO was
of the opinion that the interest component should not have been
allowed and, therefore, not only proceeded to bring that to tax for the
concerned period/year but also issued notice for reassessment. In the
reassessment proceedings, the AO disallowed the interest paid to the
ITA Nos.709/2004, 37/2005 & 636/2004 Page 2 of 9
creditor, i.e., LIC Mutual Funds Corporation on the ground that the
assessee had wrongly claimed it and that it was inadmissible by virtue
of Section 57 (iii) of the Income Tax Act, 1961 (hereafter referred to
as "Act"). The assessee's appeals were accepted by the CIT (A) for
all the years in which the reassessments were concluded. The
Revenue's appeal was rejected by the ITAT by different orders. In
these circumstances, the Revenue had approached this Court by filing
different appeals - two of them being ITA 147/2005 (relating to AY
1992-93) and ITA 675/2004 (relating to AY 1995-96) were rejected
by this Court on 19.04.2011 on the ground that the tax effect was
lower than the stipulated amounts at that period of time. It is, in these
circumstances, that the surviving appeals for AY 1993-94 (ITA
709/2004); for AY 1996-97 (ITA 37/2005) and for AY 1994-95 (ITA
636/2004) are listed for disposal. The amounts disallowed in these
three cases are `10 lacs (for AY 1993-94), `15 lacs (AY 1994-95)
and `23 lacs (AY 1996-97).
5. The Revenue contends that object of the expenditure ultimately
was to retain control of the 28% share holding and in that sense it had
to be treated on the capital side. Learned counsel relies upon the
judgment of the Bombay High Court in Commissioner of Income Tax
v. Amritaben R. Shah, (1999) 238 ITR 777 (Bom) and submits that
under similar circumstances where the Revenue had to deal with
interest on loans borrowings by the assessee for acquiring shares with
the intention to retain or acquire control, the Court had categorically
ruled that the expenditure lay properly in the capital side and,
ITA Nos.709/2004, 37/2005 & 636/2004 Page 3 of 9
therefore, had to be disallowed under Section 57 (iii). He also relied
upon Bombay High Court's judgment in Chinai and Co. Pvt. Ltd. v.
CIT (1994) 206 ITR 616 (Bom). Learned counsel further relied upon
the judgment of the Supreme Court reported as Brooke Bond India
Ltd. v. Commissioner of Income Tax, W.B.III, Calcutta, (1997) 10
SCC 362 as well as Punjab State Industrial Development Corpn. Ltd.
v. CIT (1997) 10 SCC 184.
6. Counsel for the assessee relied upon the findings of the CIT (A)
and also contended that the Revenue in effect accepted the nature of
the transaction irrespective of the fact that the debentures were
nominally allotted to LIC Mutual Funds - which was the rationale for
allowing the capital loans reported in the year of commencement in
the stream of expenditure, i.e., 1992-93. In these circumstances, for
the later years, there could have been no question for different
treatment. Counsel relied upon the judgment of the Madras High
Court reported as CIT v. M Ethurajan (2005) 273 ITR 95 (Mad.); CIT
v. Model Manufacturing Company, (1990) 122 ITR 767 (Cal.) and
India Cements Ltd. v. CIT, (1966) 60 ITR 52 (SC).
7. In the present case, shorn of complexities which followed the
transaction, LIC Mutual Funds financed the assessee's acquisition of
the debentures which it invested in. No doubt, in the first instance,
the LIC Mutual Funds was an allotee. This appears to be one of the
important consideration which weighed with the Revenue in
disallowing the interest expenditure apart from others. On this aspect,
the CIT (A) found as follows: -
ITA Nos.709/2004, 37/2005 & 636/2004 Page 4 of 9
"5.3 It is also seen that whatever service charges were paid
by the appellant were debited to interest expenditure account
after reducing interest/dividend received from
debentures/shares. This fact was duly mentioned by the
auditors in the audited statement of accounts for the financial
years 1991-92 to 1994-95. A copy of these accounts has been
filed by the appellant company and this has been verified.
Thus, it would be seen that the treatment given in the accounts
both by the buyers (appellant company) and the subscribers
(LIC Mutual Fund) suggests clearly that for all practical
purposes the appellant company was the de-facto buyer of these
debentures.
5.4 To view the matter in its proper perspective it would be
necessary to examine what have been the effect in accountancy
terms, had the appellant company raised a normal loan from
some other source to make the said investment. It is very clear
that in such a case interest paid on such borrowings would
have been allowable straightway as a revenue expenditure.
Therefore, the allowability of the interest paid to LIC Mutual
Fund cannot be disputed merely because the LIC had
subscribed to the shares under a buy back agreement. In fact,
by entering into such an agreement the LIC Mutual Fund has
only protected its interest by subscribing to these
debentures/shares instead of giving a loan to the appellant
company to invest in the said debentures. Thus the substance of
the contract makes it clear that the LIC Mutual Fund did not
wish to advance a straight loan to the appellant company but
intended to give it in an indirect manner with checks and
balances, as per the terms of the agreement.
5.5 It is very clear that had the appellant company not
subscribed through LIC Mutual Fund to the right offer the
holdings of the promoters would have fallen below 28% in M/s
ITA Nos.709/2004, 37/2005 & 636/2004 Page 5 of 9
Shreyans Industries Limited. Therefore, the business
exigencies demanded that the promoters, including the
appellant company, get the right offer subscribed and this
compulsion became the genesis of the said buy back agreement,
which was necessary because the appellant-company was
facing a paucity of funds."
In light of the above findings, the CIT (A) granted relief for AY 1995-
96 which appears to be the main order that was followed in all other
years. The ITAT had the following to say on the subject: -
"16. After examining the rival contentions, we are of the view
that there is no merit in the submissions made by the ld. DR on
behalf of the Revenue. The CIT (A) has aptly set out relevant
facts of the case and has relied on relevant case law to initially
come to the conclusion that it is the substance of the agreement
with the LIC Mutual Fund, which is to be examined in proper
perspective rather than its form. He has thereafter referred to
relevant causes of the agreement to ultimately come to the
conclusion that for all practical purposes, the Respondent
company was the de-facto buyer of the debentures. The
treatment given in their respective accounts by the Respondent
company and the LIC Mutual Fund has also been taken into
account to reach the same conclusions."
8. The Revenue's contention essentially is reflected in Amritaben
R. Shah (supra) in the following submission of law by the Bombay
High Court: -
"3. We are supported in our opinion by the decision of the
Gujarat High Court in the case of Sarabhai Sons (P.) Ltd v.
CIT [1993] 201 ITR 464. In that case, it was held that if the
dominant purpose for which the expenditure was incurred was
not to earn the income, the expenditure incurred in that behalf
ITA Nos.709/2004, 37/2005 & 636/2004 Page 6 of 9
would fall outside the purview of Section 57(iii) of the Act. We
are also supported in our above conclusion by the decision of
this court in Chinai and Co. Pvt. Ltd. v. CIT [1994] 206 ITR
616. In that case, there was a dispute in regard to deduction of
expenditure under Section 37 of the Act. The expenditure was
incurred by the assessee in fighting another group of
shareholders to protect the investment in the erstwhile managed
company. The court held that such an expenditure was not a
business expenditure. It was observed that Section 37 of the Act
dealt with deductions, inter alia, of any expenditure laid out or
expended wholly and exclusively for the purposes of business or
profession. Such deduction has to be in respect of any
expenditure for business which was carried on by the assessee
at any time during the previous year. It was held that
expenditure incurred in proxy war should not be deducted as
business expenditure.
4. It may be pertinent to mention the distinction in the
language used by the Legislature in Sections 37(1) of the Act
and 57(iii) of the Act. Section 37 provides for deduction of
expenditure incurred wholly and exclusively "for the purpose of
business" whereas Section 57(iii) provides for deduction only of
expenditure incurred wholly and exclusively "for the purpose of
making or earning such income". "Such income" refers to
"income from other sources". The expression "for the purpose
of business" is narrower than the expression "for the purpose of
making or earning such income". In order that an expenditure
may be admissible under Section 57(iii) it is necessary that the
primary motive of incurring it is directly to earn income falling
under the head "Income from other sources". That is not so
under Section 37 which allows deduction of expenditure
"incurred wholly and exclusively for the purposes of the
business". Under Section 57(iii), deduction will not be allowed
if the expenditure is not incurred for the purpose of earning
income falling under the head "Income from other sources"."
ITA Nos.709/2004, 37/2005 & 636/2004 Page 7 of 9
9. The other case cited by the Revenue is Sarabhai Sons (P.) Ltd.
v. Commissioner of Income Tax, (1993) 201 ITR 464 (Guj), where too
identical reasoning was applied. This Court is of the opinion that the
Revenue's argument is fallacious. First and foremost the acceptance
of the assessee's contentions that it suffered a capital loss in the first
year, i.e., 1992-93 has gone uncontested; in fact that was given the
treatment that it reported. This meant that the expenditure was treated
as capital, even though the debentures were not allotted in the name
of the assessee. In this regard, the CIT (A) and the ITAT's findings
that the assessee's status as the beneficiary or de facto owner of the
debentures remains undisputed. Such being the case, the question of
the essential nature of the transaction not reflecting as such in the
hands of the assessee for later years, does not arise.
10. Consequently and more fundamentally the interest expenditure
in the present case is not of the kind that went into capital stream. In
Brooke Bond (supra) as well as Punjab State Industrial Development
Corporation (supra) - both cited by the Revenue, the expenditure was
not towards interest but rather towards expenses which was the
integral part of the capital raising activity. In both cases, the assessee
had issued offers to the public and expenditure laid out was towards
such capital generation. The conclusions of the Court that such
expenditure could not be allowed since they were capital in nature
was logical. However, in this case, the expenditure clearly is not
towards acquisition of the capital nor is it an integral part of it, it is
only the service alone. It is of a similar kind that would otherwise
ITA Nos.709/2004, 37/2005 & 636/2004 Page 8 of 9
have been permitted under Section 37 of the Income Tax Act. Since
this expenditure does not pertain to the stream of income covered by
Section 37 and is not excluded by Section 57 (3), it had to be and was
correctly allowed.
11. In view of the above conclusions, the question of law framed is
answered against the Revenue and in favour of the assessee. The
appeals are accordingly dismissed.
S. RAVINDRA BHAT
(JUDGE)
NAJMI WAZIRI
(JUDGE)
JANUARY 19, 2017
/vikas/
ITA Nos.709/2004, 37/2005 & 636/2004 Page 9 of 9
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