No section 14A disallowance when assessee had not shown any exempt income

Feroze B. Andhyarujeena and S.A. Kanji for the Appellant. Neil Philip for the Respondent.

ORDER

Rajendra, Accountant Member – Challenging the order dated December 20, 2007 of the Commissioner of Income-tax (Appeals)-XXIX, Mumbai, the assessee and the Assessing Officer (AO) have filed cross-appeals for the abovementioned assessment year (AY). Grounds of appeal filed by the assessee reads as under :

“Ground No. 1 : On the facts and in the circumstances of the case and in law : The learned Commissioner of Income-tax (Appeals) erred in confirming the disallowance of foreign travelling expenses of Rs. 5,87,765 out of total amount of Rs. 8,52,235 made by the Assessing Officer. The appellant prays that the same may please be allowed.

Ground No. 2 : The learned Commissioner of Income-tax (Appeals) erred in confirming the disallowance of diminution in value of inventories of work-in-progress amounting to Rs. 1,95,00,000. The appellant prays that the same may please be allowed.

The appellant-company craves leave to add, alter, amend or delete any of the grounds as and when advised.”

I.T.A. No. 1495/Mum/2008

2. The Assessing Officer has raised the following grounds of appeal :

“1. On the facts and in the circumstances of the case and in law, the learned Commissioner of Income-tax (Appeals) erred in holding that the interest of Rs. 26,44,597 relating to borrowed funds, invested in assets generating income not includible in gross total income, could not be disallowed under section 14A of the Income-tax Act, 1961 on the ground that the assessee had not earned such income during the year.

2. On the facts and in the circumstances of the case and in law, the learned Commissioner of Income-tax (Appeals) erred in deleting the addition of Rs. 54,56,353 on account of cessation of liability under section 41 of the Income-tax Act without appreciating the findings of the Assessing Officer that the liability was outstanding for a long time and there was no movement in transaction.”

I.T.A. No. 1859/Mum/2008 :

3. The assessee, engaged in the business of manufacturing textile machinery, filed its return of income on November 24, 2003 declaring loss of Rs. 3,44,59,980. The Assessing Officer completed the assessment under section 143(3) of the Act on January 31, 2006 determining the income of the assessee at Rs. 58,10,320.

4. First ground of appeal filed by the assessee deals with disallowance made under the head foreign travelling expenses. During the course of assessment proceedings, the Assessing Officer observed that the assessee had debited to profit and loss account Rs. 8,52,235 on account of foreign travelling charges, that out of that an amount of Rs. 2,64,470 was incurred towards the cost of tickets, that for other expenses, to the tune of Rs. 5,87,765, the assessee had not filed any clarification in this respect. The Assessing Officer made a disallowance of Rs. 5.87 lakhs and added back it to the total income of the assessee.

5. In the appellate proceedings, the assessee submitted before the first appellate authority (FAA) that the assessee had exported goods and earned foreign exchange of Rs. 53.25 lakhs, that foreign travel undertaken by the marketing consultant was for convincing the prospective buyers and for getting orders from abroad, that the expenditure was incurred for the purpose of the assessee’s business. After considering the submissions of the assessee, the first appellate authority held that the Assessing Officer had disallowed part of the foreign travel expenditure as no details had been filed, that expenditure could not be allowed as the veracity of the same had not been established either before the Assessing Officer or himself. Accordingly, he rejected the appeal filed by the assessee.

6. Before us, the authorised representative (AR) stated that the Assessing Officer and the first appellate authority had allowed the ticket booking, that they had disallowed foreign exchange purchased by the assessee, that the foreign exchange taken by the assessee was refunded or was encashed, that the Assessing Officer had not doubted the foreign tours, that the disallowance was 10 per cent. of total export. He referred to page nos. 64, 65, 68 and 69 of the paper book. He relied upon the decision of the Ahmedabad Tribunal in the case of ITO v. Krishnonics Ltd. [2009] 119 ITD 49. The Departmental representative (DR) supported the order of the first appellate authority.

7. We have heard the rival submissions and perused the material before us. We find that the assessee had furnished the details about the encashment/surrender of foreign exchange before both the lower authorities. Page No. 64 onwards evidence the encashment/surrender of foreign exchange. The Assessing Officer or the first appellate authority had not doubted the foreign tours undertaken by the employees of the assessee-company. After considering the material on record, specially page Nos. 65 to 96 and the judgment of Krishnonics Ltd. (supra), we are of the opinion that the addition upheld by the first appellate authority was not based on facts available on the record. The assessee had filed all the details before the Assessing Officer. Therefore, reversing the order of the first appellate authority, we decide ground No. 1 in favour of the assessee.

8. Next ground of appeal is about disallowance of diminution in value of inventories of work-in-progress amounting to Rs. 1,95,00,000. During the assessment proceedings, the Assessing Officer found that in the notes on accounts in Schedule 17 the assessee had mentioned that work-in-progress (WIP) included the revaluated figures. The assessee contended that work-in-progress had been revaluated after technical revaluation of the material which were impossible to be sent for delivery but were not accepted by the customers. The Assessing Officer rejected the claim made by the assessee and held that it had deviated from valuing the stock correctly, that it presented distorted picture by diminishing the value of work-in-progress by Rs. 1.95 crores. Finally, he made the disallowance of the above amount and added back to the total income of the assessee.

9. Aggrieved by the order of the Assessing Officer, the assessee preferred an appeal before the first appellate authority. After considering the submission of the assessee and the assessment order, the first appellate authority held that the Assessing Officer had not accepted the claim made by the assessee on the ground that it was following the mercantile system of accounting and had not intimated the change of accounting system during the year, that the assessee could not reduce the value of closing stock, that it had reduced the profit for the year under appeal, that all the goods were manufactured on the order of the clients, that in case of the domestic business the order was received from one party, that the net realisable value was reduced to Rs. 5 lakhs from Rs. 2.13 crores in that case, that if the manufacturing was done on a specific order it must have received an advance, that it was not possible to manufacture such quantity without specific order, that the explanation given by the assessee was not satisfactory, that it had not informed as to what safeguards were taken by it for such transactions. Finally, he upheld the order of the Assessing Officer.

10. Before us, the authorised representative stated that there was no change in method of accounting, that the assessee had followed the provisions of section 145(1), that the first appellate authority had taken wrong figures of local sales. He relied upon the cases of Chainrup Sampatram v. CIT [1953] 24 ITR 481 (SC) and Alfa Laval India Ltd. v. Dy. CIT [2004] 266 ITR 418 He further stated that the issue had arisen only during the year under consideration, that the assessee had entered into an agreement, that letter of credit was not opened even after the agreement, that because of the global recession the transaction had taken place. The Departmental representative supported the order of the first appellate authority.

11. We have heard the rival submissions and perused the material before us. We find that the assessee had filed explanation/reconciliation of opening and closing stock along with the details of work-in-progress which included jobs undertaken by it for customers (page No. 59 of paper book). We find that the assessee had stated that the customers had not fulfilled the commitments and had not taken deliveries of the machinery, that it obtained technical evaluation regarding the valuation of the material and accordingly stocks had been carried at net realisable value. Vide its letter dated January 30, 2006 (pages 61 and 62 of the paper book), the assessee had made submission in this regard. We find that in the case of Alfa Laval India Ltd. (supra) in the almost identical circumstances, the hon’ble Bombay High Court had held that the assessee was entitled to value the closing stock at market value or at cost whichever was lower, that the assessee had proved that goods were sold at the lesser price in the subsequent year as compared to the revalued price.

12. In our opinion, there was no change in the method of valuing the stock and therefore the assessee was not required to report the change in the return about valuing the stock. It is a fact that because of the recession, the assessee could not export the goods or sell the goods in the local market. Considering the peculiar circumstances it revalued the inventory. In our opinion the Assessing Officer/first appellate authority should have made further enquires in this regard. We find that in the case of Alfa Laval India Ltd. (supra), the hon’ble Bombay High Court had held that in the subsequent assessment year the goods in question were sold at the lesser price than shown in the closing stock. We find that the Assessing Officer had not carried out any exercise in this regard. In our opinion, in the interest of justice, the matter should be restored back to the file of the Assessing Officer for fresh adjudication. He is directed to verify the correctness of the figure of local sales adopted by the first appellate authority and disputed by the assessee. He should also verify the realised value of the inventory wherein reduction was made by the assessee during the year under consideration. In case it is found that goods were sold at the price or at the lesser price shown by the assessee as on the last date of the accounting year under consideration, the claim made by it has to be allowed. We want to make it clear that issue is being restored to the file of the Assessing Officer for limited purpose. Ground No. 2 is decided in favour of the assessee, in part.

I.T.A. No. 1495/Mum/2008 :

13. First ground of appeal filed by the Assessing Officer pertains to disallowance made under section 14A of the Act. During the course of assessment proceedings, the Assessing Officer found that the assessee had made investment of Rs. 1,00,50,000 and Rs. 3,02,82,000 respectively in its sister concerns M/s. SM India Ltd. (SMIL) and M/s. SM Dychem Ltd. (SMDL). He found that there was no return on these investments from its sister concerns. He held that 38.4 per cent. of investment in shares (Rs. 4,09,32,000 i.e., Rs. 1,57,17,888) was attributable to secured loan taken by the assessee. He applied section 14A of the Act and disallowed the interest on proportionate basis which worked out to Rs. 26,44,597. He added it back to the total income of the assessee.

14. Aggrieved by the order of the Assessing Officer, the assessee preferred an appeal before the first appellate authority. Before him, it was argued that from the analysis of Schedule 3 of the balance-sheet, the details of working capital loan and hire purchase loan it was clear that the assessee had utilised loan amounts for making investment in shares, that it had used its reserve funds for purchasing shares.

15. After considering the facts of the case and submission made by the assessee, he held that the disallowance of Rs. 26,44,597 was made on the ground that the assessee had made investment of Rs. 4.09 crores in two sister concerns while an amount of Rs. 1.37 crores had been paid interest, that the Assessing Officer had considered the investment in sister concern as to be covered under section 14A, that the Assessing Officer erred in invoking provisions of section 14A, that the assessee did not have any income during the year which was not forming part of the total income, that a deduction was allowable under section 37 of the Act, if the expenditure was not capital or personal in nature and has not been incurred fully and exclusively for the purpose of business, that section 14A made an exception in respect of income if it was not forming part of the total income, that it was not the case of the Assessing Officer that the investment made in sister concern was not fully and exclusively for the purpose of business, that disallowances was made because in the opinion of the Assessing Officer the investment would generate tax-free income, that it was merely a presumption and no disallowance could be made on the basis of such presumption. He finally held that interest expenditure on borrowed fund was allowable on the facts of the case and provisions of section 14A was not applicable.

16. Before us, the Departmental representative (DR) supported the order of the Assessing Officer. The authorised representative (AR) stated that there was no evidence to prove that the assessee had earned exempt income and for that it had claimed some expenditure.

17. We have heard the rival submissions and perused the material before us. We find that the Assessing Officer had invoked the provisions of section 14A of the Act without understanding the real nature of the transactions. The assessee had not shown any income under the head exempt income under Chapter III of the Act for which it had claimed incurring of expenditure. Until and unless both these conditions are fulfilled provisions of section 14A cannot and should not be invoked. The first appellate authority had given a categorical finding of fact in this regard. Secondly, the Assessing Officer has not found any evidence that the interest expenses incurred by the assessee were not for wholly and exclusively for the business of the assessee. In these circumstances, we are of the opinion that the order of the first appellate authority does not suffer from any legal or factual infirmity. So, his order on both the counts-deletion of section 14A disallowance and allowing the interest expenditure under section 37 has to be upheld. Ground No. 1 is decided against the Assessing Officer.

18. Next ground is about addition made under the head cessation of liability, under section 41 of the Act, amounting to Rs. 54.56 lakhs. During the assessment proceedings, the Assessing Officer found that in case of 22 parties credit balances were outstanding. He prepared a chart of those parties and held that the outstanding balance of sundry creditors as on March 31, 2003 was at Rs. 54,56,353 were no more payable, that the assessee also failed to justify the balances shown as payable, that as per the provisions of section 41 of the Act, when the liability ceased to exist the same could not be allowed, that the liability shown by the assessee was no more payable, that creditors were shown since so many years, that the assessee also failed to file the correspondence made with the creditors, that it was not possible to consider the liability as payable. Finally, he made an addition of Rs. 54.56 lakhs.

19. In the appellate proceedings, the assessee submitted that it had not received any payments or intimation from the creditors that their credit balances were forfeited by them, that merely because of credit balances remained unpaid for three years the same could not be added as income of the assessee, that the Assessing Officer had not proved that the credit balance outstanding had been taken into computing the total income in earlier year or that the assessee had obtained in cash or in any other manner whatsoever any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission on cessation thereof, that the Assessing Officer did not give any such findings but merely stated that the liability was “no more payable” as the “creditors were shown since so many years”, that the Assessing Officer’s conclusion that the provisions of section 41 of the Act were applicable was not supported by any evidence.

20. After considering the facts of the case and submission made by the assessee, the first appellate authority held that the Assessing Officer had disallowed an amount of Rs. 54,56,353 under section 41(1) of the Act, that the Assessing Officer was of the opinion that the sundry creditors appearing in the balance-sheet were constant for last three years and therefore the liabilities had ceased to exist, that the amounts under consideration were appearing as sundry credits in the balance-sheet of the assessee for more than three years, that merely because they have remained outstanding for some years they did not come automatically under section 41(1) of the Act, that there should be some evidence on record that in respect of such loss or expenditure or trading liability claimed in earlier years the assessee has obtained in some manner some benefit by way of cessation or remission, that there should be some evidence on record that liability ceased to exists in respect of the outstanding, that there was no presumption in law that liability which remained outstanding for three years that ceased to exists, that the Assessing Officer had not brought anything on record to prove that even if these were trading liability they had ceased to exists, that onus in respect of the outstanding that they were not in the nature of trading liabilities was on the assessee, that the onus regarding their cessation was on the Assessing Officer. Finally, he deleted the disallowance.

21. Before us, the Departmental representative supported the order of the Assessing Officer. The authorised representative stated that the liabilities had not ceased, that the Assessing Officer had not proved that there was cessation of liability. We have heard the rival submissions and perused the material before us. As per the taxation jurisprudence the very first condition for invoking section 41(1) of the Act is that an allowance or deduction ought to have been made in the assessment for any year in respect of any loss, expenditure or trading liability incurred by the assessee. The Assessing Officer has not discussed as to when the deduction was allowed. On the contrary the records reveal that no allowance or deduction had been made in the assessment of the assessee in any earlier year. Consequently, there was no question of invoking section 41(1). So, in our opinion the order of the first appellate authority does not suffer from any legal infirmity. Confirming his order, we decide ground No. 2 against the Assessing Officer.

22. As a result, the appeal filed by the assessee stands partly allowed and the appeal of the Assessing Officer stands dismissed.