Purely Equity Debentures Excluded From MAT Transition Amount And Rule EightD Disallowance Set Aside For Want Of Satisfaction
Issue
-
Whether fully convertible debentures (ZOFCDs/FCDs) holding purely equity components without any liability element can be classified as Compound Financial Instruments (CFIs) or “Other Equity” to trigger a book profit increase via the MAT transition amount under Section 115JB(2C).
-
Whether an Assessing Officer can compute a disallowance under Section 14A read with Rule 8D without first recording objective dissatisfaction regarding the correctness of the assessee’s suo motu disallowance with reference to their books of account.
Facts
-
Regarding MAT Computation [Section 115JB(2C)]: The assessee, a wholly-owned subsidiary, adopted Ind AS from A.Y. 2017-18. Under the previous IGAAP, its outstanding Zero Interest Optionably Fully Convertible Debentures (ZOFCDs) and Fully Convertible Debentures (FCDs) aggregating to Rs. 15,824.47 crores were shown as long-term borrowings. Upon transitioning to Ind AS, these were classified under “Other Equity.” The Assessing Officer (AO) treated them as CFIs, calculating a transition amount as of 01.04.2016 and adding a one-fifth portion (Rs. 3,164.89 crores) to the book profits for A.Y. 2018-19.
-
Regarding Disallowance [Section 14A r.w. Rule 8D]: The assessee earned exempt income during the relevant assessment years and offered a suo motu disallowance. The AO rejected the calculation via a standard show-cause notice and applied the formula under Rule 8D(2)(ii) to make an additional disallowance, ignoring the assessee’s detailed submissions on non-yielding subsidiary investments and recovered manpower costs. The CIT(A) deleted this addition, noting a complete absence of an evaluative satisfaction check by the AO.
Decision
-
Held, in favour of Assessee (MAT): The ZOFCDs and FCDs issued to the holding company did not possess any element of financial liability and comprised purely of equity. Therefore, they could not be categorized as CFIs or “Other Equity” for transition adjustments. The additions made to increase the book profit under Section 115JB(2C) were held to be completely impermissible.
-
Held, in favour of Assessee (Section 14A): The deletion of the Rule 8D disallowance was upheld. It is a mandatory prerequisite for the AO to record specific, objective dissatisfaction regarding the correctness of the assessee’s suo motu disallowance in light of their actual books of account before invoking the formulaic Rule 8D computation.
Key Takeaways
-
Substance Over Classification in Ind AS: For the purpose of computing the transition amount under Section 115JB(2C), the true characteristics of an instrument dictate its tax treatment. Pure equity instruments, regardless of past accounting nomenclature, cannot be used as a tool to artificially inflate MAT book profits.
-
Mandatory Jurisdictional Condition for Rule 8D: An AO cannot mechanical apply Rule 8D. The recording of an explicit, well-reasoned dissatisfaction with the taxpayer’s account books is a non-negotiable jurisdictional threshold; generic non-acceptance through a show-cause notice does not satisfy this statutory requirement.
IN THE ITAT MUMBAI BENCH ‘D’
ACIT
v.
Reliance Industrial Investments and Holdings Ltd
SAKTIJIT DEY, Vice President
and MAKARAND VASANT MAHADEOKAR, Accountant Member
and MAKARAND VASANT MAHADEOKAR, Accountant Member
IT Appeal Nos. 2398, 2399 and 4256 (Mum) OF 2025
[Assessment years 2018-19 to 2020-21]
[Assessment years 2018-19 to 2020-21]
MAY 21, 2026
Madhur Agarwal, Nimesh Vora and Ms. Mohsha Mehta for the Appellant. Umashankar Prasad, CIT-DR for the Respondent.
ORDER
Saktijit Dey, Vice President. – Captioned appeals by the Revenue arise out of three separate orders passed by National Faceless Appeal Centre (‘NFAC’ for short), Delhi pertaining to the assessment years (A.Ys. for short) 2018-19, 2019-20 and 2020-21.
2. The grounds raised in the appeals are identical in all respect, except variation in figures. However, at the outset, ld. Departmental Representative (‘ld. DR’ for short) requested that since the substantive order of the First appellate authority is in A.Y. 201920, the appeal for that year, being ITA No. 2399/Mum/2025, may be taken up as the lead appeal, for ease of reference.
3. Learned counsel appearing for the assessee agreed with the aforesaid submission of ld. DR. Hence, we propose to take up ITA No. 2399/Mum/2025 as the lead appeal.
ITA No. 2399/Mum/2025
4. As stated earlier, the grounds raised in all the appeals are identical, except variance in figures, hence, for ease of reference, we reproduce the grounds taken in ITA No. 2399/Mum/2025 hereunder:
| Sr. no. | Grounds of Appeal | Amount |
| 1 | Groundl. “Whether on the facts and in the circumstances of the case and in law, the Ld. CIT(A) is right in deciding the appeal in asses see’s favour on the addition made u/s.H5JB(2C) of the Act by placing reliance on the decision of the Hon’ble IT AT order in assessee’s own case whereby the Ld. PCIT us. 263 of the Act was reversed?” | 9s. 6819967429 |
| 2 | Ground2. “Whether on the facts and in the circumstances of the case and in law, the Ld. CIT(A) has failed to appreciate that Zero Coupon Unsecured Optionally Fully Convertible Debenture(ZOFCD or FCD) which is in the nature of Compound Financial Instrument which is to be considered as ‘transition amount within the provisions of section 115JB(2C) of the Act?” | Rs. 0 |
| 3 | Grounds. “Whether on the facts and in the circumstances of the case and in law, the Ld. CIT(A) has failed to appreciate that the Compound Financial Instrument (CFI) attributes both financial liability and equity instruments and the CBDT Circular No. 24/2017 dated 25/07/2017 which provides that items such as equity component of financial instrument is to be included in the ‘transition amount’, thereby to be taxed for MAT purposes over a period of five years u/s. 115JB/2C) of the Act? “ | Rs. 0 |
| 4 | Ground4. “Whether on the facts and in the circumstances of the case and in law, the Ld. CIT(A) is right in allowing addition made invoking provisions of section 115JB(2C) of the act disregarding the fact that the assessee itself in the note to the financials declared that convertible debenture issued by the company considered under Other Equity under Equity component of CFI?” | Rs. 0 |
| 5 | Grounds. “Whether on the facts and in the circumstances of the case and in law, the Ld. CIT(A) has failed to appreciate that ZOFCDs rightly falls under other equity(excluding capital reserve and securities premium) and also excluding the amount as defined in provisions of section 115JB(2C) of the Act for the purpose of determining ‘transition amount’? | Rs. 0 |
| Ground6. “Whether on the facts and in the circumstances of the case and in law, the learned Commissioner of Income Tax (Appeal) was justified in deleting the disallowance made u/s. 14A without appreciating that the disallowance u/s. 14A was required to be determined according to Rule SD of Income Tax Rules 1962 as had been done by the Assessing of ficer?” | Rs. 0 |
5. Ground nos. 1 to 5 are on the core and fundamental issue arising in the appeals, relating to, deletion of addition made on account of adjustment u/s. 115JB(2C) of the Income Tax Act, 1961 (‘the Act’ for short).
6. Briefly, the facts relating to this issue are, the assessee hitherto is a resident corporate entity and is a wholly owned subsidiary of Reliance Industries Ltd. (RIL). As stated, the assessee is engaged in the business of acquiring and holding investments in shares and securities, providing loans and trading in petroleum products and providing manpower services. In course of invest activities, the assessee had issued various types of convertible debentures to its holding company viz. RIL. In terms with section 129 of the Companies Act, 2013 every Indian Company is required to prepare and present the financial statements in compliance with Accounting Standards notified by the Central Government in terms with section 153 of the Companies Act. Till financial year 2015-16, the Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI), formerly known as Indian Generally Accepted Accounting Principles (IGAAP), were followed by all resident companies. In terms with IGAAP, in the financial statements for the year ended 31.03.2016, the assessee disclosed the outstanding instruments, i.e., the debentures issued to M/s. RIL, under the head ‘long term borrowings’. Vide notification dated 16.02.2015, the Central Government notified a new set of Accounting Standards known as Indian Accounting Standards (“Ind AS”) applicable from 01.04.2016. After change of Accounting Standards, the assessee started following Ind AS to prepare and present its financial statements from A.Y. 2017-18 onwards. In the financial statements prepared in accordance with newly introduced Ind AS, the assessee classified the debentures issued to RIL under the broad head ‘Other equity’ and sub-head ‘Instrument classified as Equity’, in absence of any other appropriate head. In the notes forming part of financial statements, precisely in Note.36.2 relating to reconciliation of profit and other equity between IGAAP and Ind AS, the amount representing the debentures issued to RIL was referred to as equity component of ‘Compound Financial Instrument (CFI)’. According to the assessee, though the debentures were required to be presented under a separate category titled as ‘equity in nature’, however, due to absence of specific guidelines, it was treated as ‘other equity’.
7. Be that as it may, for the assessment year under dispute, the assessee filed its return of income on 28.11.2019, declaring income of Rs.13,50,780/- under the normal provisions and book profit of Rs.18,14,08,406/- u/s. 115JB of the Act. Subsequently, the assessee filed a revised return of income declaring income of Rs.8,54,680/- under the normal provisions and book profit of Rs.18,14,08,406/- u/s. 115JB of the Act. The return of income so filed by the assessee was selected for scrutiny. In course of assessment proceeding, the Assessing of ficer (‘A.O.’ for short), while examining the balance sheet of the assessee, found that though the debentures issued by the assessee to RIL are in the nature of CFIs, hence, were required to be included in the transition amount for computation of MAT under the provisions of section 115JB(2C) of the Act, however, the assessee has not made such adjustment while computing the book profit in A.Ys. 2017-18 to 2021-22. In this context, the A.O. referred to the discussions made by the A.O. in the assessment order passed u/s. 143(3) of the Act in A.Y. 2018-19. He observed, in A.Y. 2018-19, the A.O. had found that the transition amount as on 01.04.2016 was to the tune of Rs.15824,47,15,000/-(Rs.15824.47 crores). The A.O. had observed that in terms with section 115JB(2C) of the Act, 1/5th of the aforesaid transition amount has to be added to the book profit in each of the five assessment years wherein the transition amount was reflected in the book of account, i.e., A.Y. 2017-18 and four succeeding A.Ys., i.e., A.Ys. 2018-19, 2019-20, 202021 and 2021-22. Since, the assessee had not carried out similar adjustment, the A.O. had issued a show cause notice to the assessee requiring to explain as to why the adjustment in terms with section 115JB(2C) of the Act should not be carried out. The A.O. observed, after considering the detailed submissions of the assessee, the A.O. in A.Y. 2018-19, had ultimately concluded that the outstanding instruments representing the convertible debentures amounting to Rs.15824.47 crores, being transition amount as per Ind AS r.w.s. 115JB(2C) of the Act, 1/5th of the amount has to be added to the book profit of the year. Thus, following the decision taken in A.Y. 2018-19, the A.O. added back an amount of Rs.3164,89,43,000/-, being the transition amount, to the book profit computed in terms with section 115JB(2C) of the Act.
8. The assessee contested the aforesaid addition before the first appellate authority. While deciding the issue in appeal, the first appellate authority noted that A.Y. 2017-18 was the initial year where the adjustment, if any, u/s. 115JB(2C) of the Act was to be made for the first time and in succeeding four assessment years, 1/5th of the amount has to be adjusted. He found that in assessment completed u/s. 143(3) of the Act in A.Y. 2017-18, the A.O. did not make any adjustment in terms with section 115JB(2C) of the Act. Whereas, the Principal Commissioner of Income Tax (PCIT), while examining the assessment records, was of the view that the A.O. having failed to make such adjustment, the assessment order is erroneous and prejudicial to the interest of the Revenue. Accordingly, he exercised his revisionary power u/s. 263 of the Act to revise the assessment order. While completing the proceedings u/s. 263 of the Act, the revisionary authority concluded that the convertible debentures issued by the assessee are in the nature of CFIs, hence, have to be treated as transition amount requiring adjustment to the book profit in terms with section 115JB(2C) of the Act. Accordingly, he set aside the assessment order with a direction to the A.O. to redo the assessment by carrying out adjustment u/s. 115JB(2C) of the Act.
9. The First appellate authority observed, against the order passed u/s. 263 of the Act, the assessee preferred an appeal before the Income Tax Appellate Tribunal (ITAT). While deciding the appeal, the ITAT not only held the assumption of jurisdiction u/s. 263 of the Act as invalid, but also decided the issue on merits by holding that no adjustment can be made to the book profit in terms with section 115JB(2C) of the Act by treating the amount representing the convertible debentures as transition amount. Thus, the First appellate authority held that since, in the initial year of conversion, i.e., A.Y. 2017-18, the issue has been decided in favour of the assessee by holding that no adjustment u/s. 115JB(2C) of the Act can be made, the adjustments in the subsequent assessment years are bound to fail. Accordingly, he allowed assessee’s claim.
10. Before us, in addition to detailed oral submissions made at the time of hearing, both the parties have furnished exhaustive written submissions as well. For better appreciation, we broadly summarise the rival contentions in a tabular format as under:
11. We have given a thoughtful consideration to rival contentions, perused materials on record and applied our mind to the decisions relied upon. It’s a fact that the First Appellate Authority has decided the issue relying upon the decision of the Coordinate Bench. However, before us learned DR had strenuously attempted to distinguish the order of the ITAT and had urged before us not to follow the said order. Since, we have heard the parties at length on the merits of the issue, we deem it appropriate to examine the issue on first principle, at the very outset, and then will analyze the applicability of the decision of the Coordinate Bench in assessee’s case in A.Y. 2017-18. Before we proceed to record our finding on merits, it would be appropriate to briefly discuss the undisputed factual position. As per the audited financial statements of the assessee as on 31.03.2016, the account of various debentures issued by the assessee to RIL are as under:
| Sr. No. | Nature of instrument | Quantity | Value as on 31.03.2016 | Onlue an on 11.03.2115 |
| 1 | Zero-coupon Optionally Fully Convertible Debentures (“ZOFCDs”) of5000 each | 8,83,140 | 441.57 crores | 441.57 crores |
| 2 | ZOFCD of Rs.lOeach | 151,03,00,000 | 15103 crores | 5,500 crores |
| 3 | Full Convertible Debentures (FCD) of Rs. 100/- each | 279,90,000 | 279.90 crores | 279.90 crores |
| 15,824.47 crores | 6221.47 crores |
12. It is to be noted that debentures mentioned at sr. no. 1 were issued on 30.06.1995. Debentures mentioned at sr. no. 2 were issued during F.Y. 2015-16. Whereas, debentures mentioned at sr. no. 3 were issued on 05.09.1996. It is a matter of fact that the assessee, though, was preparing its financial statements following IGAAP till A.Y. 2016-17, however, after notification of Ind AS, the assessee started following the freshly introduced accounting standard from A.Y. 2017-18 onwards. In the balance sheet prepared as at 31.03.2017, the assessee has shown the debentures as other equity under the head ‘equity and liabilities’. However, in the notes to the accounts, it was stated that all convertibles issued by the company considered as other equity are to be treated as equity component of CFI. At this stage, it is necessary to refer to certain provisions under section 115JB of the Act, which are relevant for our purpose.
13. Sub section (2A) of section 115JB of the Act provides that a company whose financial statements are drawn up in compliance to the Indian Accounting Standards specified in Annexure to the Companies (Indian Accounting Standards) Rules, 2015, the book profit has to be further increased or decreased in terms with the said provision. Sub section (2C) of section 115JB of the Act provides that in case of a company referred to in sub-section (2A), the book profit of the year of convergence and each of the following four previous years, shall be further increased or decreased, as the case may be, by one-fifth of the transition amount. Explanation (i) under section 115JB(2C) of the Act defines “year of convergence” to mean the previous year within which the convergence date falls. Explanation (ii) of section 115JB(2C) of the Act defines “convergence date” to mean the first day of the first Indian Accounting Standards reporting period as defined in the Indian Accounting Standards 101. Whereas, Explanation (iii) of section 115JB(2C) of the Act defines “transition amount” as under:
| (iii) | “transition amount” means the amount or the aggregate of the amounts adjusted in the other equity (excluding capital reserve and securities premium reserve) on the convergence date but not including the following:— |
(A) amount or aggregate of the amounts adjusted in the other comprehensive income on the convergence date which shall be subsequently re-classified to the profit or loss;
(B) revaluation surplus for assets in accordance with the Indian Accounting Standards 16 and Indian Accounting Standards 38 adjusted on the convergence date;
(C) gains or losses from investments in equity instruments designated at fair value through other comprehensive income in accordance with the Indian Accounting Standards 109 adjusted on the convergence date;
(D) adjustments relating to items of property, plant and equipment and intangible assets recorded at fair value as deemed cost in accordance with paragraphs D5 and D7 of the Indian Accounting Standards 101 on the convergence date;
(E) adjustments relating to investments in subsidiaries, joint ventures and associates recorded at fair value as deemed cost in accordance with paragraph D15 of the Indian Accounting Standards 101 on the convergence date; and
(F) adjustments relating to cumulative translation differences of a foreign operation in accordance with paragraph D13 of the Indian Accounting Standards 101 on the convergence date.
14. As per Explanation (iii), the transition amount means the amount adjusted in the other equity on the convergence date. To find the meaning of other equity, we need to refer to the format of balance sheet prescribed in Division II Schedule III to the Companies Act, 2013. The format of the balance sheet as per the Companies Act referred to above in respect of companies who are required to prepare the financial statements in accordance with the Ind AS is bifurcated into ‘assets’ and ‘liabilities’. Equity is further bifurcated to the following two types:
| (a) | Equity share capital |
| (b) | Other equity |
The schedule of other equities is as follows:
| (a) | Share application money |
| (b) | Equity component of compound financial instruments (CFI) |
| (c) | Reserve and surplus |
| (d) | Debt instruments through OCI |
| (e) | Equity income through OCI |
| (f) | Effective portion of cash flow hedge |
| (g) | Revaluation surplus |
| (h) | Exchange difference on translating the financial statement of foreign operation |
| (i) | Other items of OCI (to be specified) |
| (j) | Money received against share warrant |
15. As per the Schedule noted above, what is of importance is item (b) “Equity component of compound financial instruments (CFI)”. Ind AS-32 specifies the principle for presenting financial instruments as liabilities or equity. Further, it applies to the classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments, the classification of related interest, debentures, losses and gain and the circumstances in which the financial assets and financial liabilities should be of fset.
16. Para 11 of Ind AS-32 defines financial asset to include an equity instrument of another entity. Whereas, financial liability is defined to mean any liability that is:
| (a) | a contractual obligation |
| (i) | to deliver cash to another entity; or |
| (ii) | to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the entity; or |
| (iii) | a contract that will or may be settled in the entities nor equity’s own equity instruments in the following circumstances: |
| (i) | a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or |
| (ii) | a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. For this purpose, rights, options or warrants to acquire a fixed number of the entity’s own equity instruments for a fixed amount of any currency are equity instruments if the entity of fers the rights, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments. Apart from the aforesaid, the equity conversion option embedded in a convertible bond denominated in foreign currency to acquire a fixed number of the entity’s own equity instruments is an equity instrument if the exercise price is fixed in any currency. Also, for these purposes the entity’s own equity instruments do not include puttable financial instruments that are classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity’s own equity instruments. |
As an exception, an instrument that meets the definition of a financial liability is classified as an equity instrument if it has all the features and meets the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D.
An equity instrument is any contract tuat evidences a residual interest in the assets of an entity after deducting all of its liabilities.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. (See Ind AS 113, Fair Value Measurement.)
A puttable instrument is a financial instrument that gives the holder the right to put the instrument back to the issuer for cash or another financial asset or is automatically put back to the issuer on the occurrence of an uncertain future event or the death or retirement of the instrument holder.
17. Paragraph 15 of Ind AS-32 prescribes that the issuer of a financial instrument shall classify the instrument, or its component parts, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset and an equity instrument.
18. Paragraph 16 provides that financial instrument can be considered as an equity instrument rather than a financial liability if it meets the following conditions:
| (a) | The instrument includes no contractual obligation |
| (b) | If the instrument will or may be settled in the issuer’s own equity instruments under certain terms and conditions. |
19. Paragraphs 28 to 32 explain CFI. As per paragraph 28 of Ind AS-32, the CFI must have, both, component of liability and equity component. Further the right to convert to equity lies with the holder of the instrument.
20. Keeping in perspective the relevant provisions of section 115JB of the Act, Companies Act, 2013 and Ind AS-32, it needs to be examined whether the debentures issued by the assessee fall in the category of CFI or, for that matter, other equity so as to come within the ambit of section 115JB(2C) of the Act. As discussed earlier, the CFI must comprise of two components, i.e., ‘liability component’ and ‘equity component’. Once these conditions are satisfied, the transition amount forming part of other equity has to be added to the book profit in terms with sub section (2C) of section 115JB of the Act. It is a fact on record that the assessee, for the first time, prepared the financial statements changing over from IGAAP to Ind As-32 in financial year 2016-17 corresponding to A.Y. 2017-18. In fact, for comparability purpose, the assessee has restated its financial statements for the financial year 2015-16 corresponding to A.Y. 2016-17, as per the provisions of Ind AS. As discussed earlier, in the balance sheet prepared on 31.03.2017, the assessee has classified the debentures issued to RIL under the head ‘other equity’.
21. In Note no. 11 to the balance sheet, the assessee has shown the debentures under the sub heading ‘instrument classified as equity’. Thus, as could be seen from the above noting, the liability component is missing. However, in Note 36.2 of the notes to the financial statements, the auditor has stated that all convertibles issued by the company considered under other equity are equity component of CFI. Apparently, taking note of the said statement of the Auditor, the A.O. has treated the debentures issued to RIL to be in the nature of CFI, hence, forming part of the other equity as also the transition amount in terms of sub section (2C) of section 115JB of the Act.
22. In this context, ld. Counsel appearing for the assessee has strenuously urged before us that due to inadvertence the Auditor has erroneously stated that the convertible debentures notified under the head other equity are of the nature of CFI. He has submitted before us that in the books of account, the assessee has never treated it as a liability. Drawing our attention to the terms of conversion of the debentures, ld. Counsel submitted that though debentures can be converted to equity unilaterally by either of the party, however, redemption is not unilateral but mutual. For better appreciation, the details of debentures issued by the assessee with terms of conversion, as detailed in the written submissions of ld. DR are reproduced hereunder:
| SN | Title of instrument | Issue Date | Face Value | Issued | Status | ||
| Qty | Amount | Relevant Terms | |||||
| A. | Zero Coupon Unsecured Optionally Fully Convertible Debentures | 30.06.1995 | 5,000 | 8,83,140 | 4,41,57,00,000 | The Issuer and the Debenture holder will have an option for early to conversion at any time by giving one month’s notice. The conversion of the Debentures will be based on higher of the book value or face value of equity shares as atMarch 31, 2015. The Debentures are redeemable at a premium of 5% of the face value of the Debentures. In the event of the option not being granted by the Company or debenture holders not exercising their option to convert, it may redeem the said Debentures in part or in full at any time during the tenure of the said Debentures but not later than 25 years commencing from the respective dates of allotment. Premium payable on Debentures redeemed during any financial year will become due at the end of the said financial year. | Converted to Unsecured 7,23,88,77 0 Equity Yhares in FY 2020-21. |
| B. | Zeo coupon Unsecured optionally Fully Convertible Debenture | 25.3.2015 | 10 | 1,10,00,0 0,000 | 11,00,00,00,000 | The Issuer and the Debenture holder will have an option for early conversion at any time by giving one month notice. The conversion of the debentures will be based on higher of the book value or face value of equity shares as at March 31, 2015. The par Company will redeem the outstanding debentures on expiry of 15 years from the respective date of allotments: The Company and the debenture holders may mutually agree for early redemption. | Entire FODCDs redeemed in FY 2016-17 (Feb-March 2017) at par. |
| 28.09.2015 | 10 | 65,00,00, 000 | 6,00,00,00,000 | ||||
| 10.02.2016 | 10 | 50,00,00, 000 | 5,00,00,00,000 | ||||
| 31.03.2016 | 10 | 12,85,30, 00,000 | 1,08,53,00,00,0 00 | ||||
| 15,10,30, 00,000 | 1,51,03,00,00,0 00 | ||||||
| C. | 0% Fully Convertible Unsecured Debentures | 05-09-1996 1996 | 100 | 2,79,90,0 00 | 2,79,90,00,000 | The debentures are fully convertible into equity shares of the Company at any time after the expiry of 15 years but not later than 20 years from the respective date of allotments, starting with 12.08.1996. The conversion of the debentures will be based on higher of the books value or face value of equity shares as on March — 31, 2015 | Bought back by the Company during FY 2016-17 vide Board Resolution dated Mth July 2017 books aalue orface value of sqaity shares as on March 21, 2015 at par and the FCDs were cancelled. |
| 15,13,18,73,140 | 1,58,24,47,00,000 | ||||||
23. As could be seen from the details of debentures mentioned in Sr. No. B and C above, they were either redeemed or cancelled before the end of F.Y. 2016-17 itself. While, the ZOFCDs of 15103 crores were redeemed at par, FCDs of Rs.279.90 crores were bought back at par by the assessee vide Board Resolution dated 14.07.2016. Therefore, at the end of the year, these two items did not exist. The only instrument which remained was ZOFCDs of Rs.441.57 crores. These were converted to 7,23,88,770 equity shares in F.Y. 2020-21.
24. Thus, the materials on record clearly demonstrate that the debentures were never intended to be treated as liability as no payment on account of interest was either made or intended to be made. Though, of course, as per the terms of ZOFCDs at item no. A, the debentures were redeemable at premium of 5% of the face value, however, as discussed earlier, the redemption was not unilateral but mutual. Therefore, without the consent of the assessee, the debentures could not have been redeemed by the holder. On the contrary, as per the terms of the debentures the assessee could have unilaterally converted the debentures to equity at any stage upon giving one month’s notice. Thus the assessee was never under any compulsion to pay out cash. Even, in respect of debentures at item B and C the assessee could have exercised similar option of conversion to equity. Keeping in perspective the aforesaid factual position, it needs to be examined whether the debentures issued by the assessee to RIL could have been termed as CFIs?
25. As discussed earlier, to be classified as CFI, two conditions have to be fulfilled. Firstly, there must be a component of liability and secondly, there should be a component of equity. In the facts of the present case, the materials on record suggest that the instruments comprise purely of equity component without any element of liability. Therefore, in our considered opinion, the debentures could not have been categorized as ‘CFI’, or for that matter, ‘other equity’. Though, in the financial statements, the assessee indeed has shown the debentures under the head ‘other equity’, however, they have further been classified under the sub-head ‘instruments classified as equity’, without any liability component embedded therein. Explaining the reasons for classifying the instruments as other equity, the assessee from the stage of proceedings before the departmental authorities has consistently submitted that since, it was the initial year of conversion from IGAAP to Ind AS-32, there was lack of clarity on the accounting treatment to be given to such instruments. It was submitted that subsequently, ICAI had issued a guidance note on Division II, Ind AS, Schedule III to the Companies Act, 2013 in July, 2017 providing guidance for preparation of financial statements in accordance with Ind AS. We have examined the said guidance note placed at pg. 122 of the paper book. On perusal of the guidance note, it is noticed that it clarifies that the instruments classified as entirely equity in nature as per Ind AS-32 and do not come with the schedule of equity share capital, can be presented in the balance sheet separately from the schedule of equity share capital and other equities under a separate category titled ‘instrument entirely equity in nature’.
26. We have further noticed, after getting clarity from the guidance note, the assessee had re-casted its financial statements for F.Y. 2016-17 by classifying the debentures under a separate heading “instruments entirely equity in nature”, thereby, had corrected the mistake in note no. 36.2 of notes to accounts. This is evident from the re-casted financial statements, a copy of which is placed at pg. 115 of the paper book. We have further noticed that the FCDs of Rs.217.90 crores appearing at item no.(C) noted above were subjected to change in conversion terms vide Board Resolution dated 14.01.2016. As per the revised terms, the debentures were fully convertible to equity shares of the company after the expiry of 15 years, but not later within 20 years from the respective dates of allotment. Further, the conversion of debentures will be based on higher of the book value or face value as at 31.03.2015.
27. Learned DR has questioned the sanctity of the aforesaid board resolution by submitting that only after Pr. CIT initiated action u/s. 263 of the Act in A.Y. 2017-18 to examine applicability of section 115JB(2C) of the Act, the assessee has reclassified the nature of instrument through Board Resolution. We do not find much substance in such submission of ld. DR in absence of any corroborative material to demonstrate that the assessee reclassified the nature of instrument after initiation of proceedings u/s. 263 of the Act.
28. In our view, the misconception of ld. DR is based on the fact that the resolution was certified by the Company Secretary on 05.10.2021. This, in our view, does not alter the fact that the resolution was passed by the Board on 14.01.2016. On 05.10.2021, the company secretary has merely authenticated the Board Resolution, may be, for the purpose of submitting before the tax authorities. Be that as it may, it will have no impact in determining the nature and character of the financial instruments- whether purely equity or had component of liability.
29. In course of hearing before us, ld. DR has brought to our notice Circular No. 24/2017 dated 25.07.2017 issued by Central Board of Direct Taxes (CBDT). With reference to the said Circular, ld. DR has specifically drawn our attention to the following questions and answers:
Question 7: Under Section 115 JB of the Act, transition amount has been defined as the amount or the aggregate of the amounts adjusted in the ‘Other Equity’ (excluding capital reserve and securities premium reserve) on the convergence date. Whether changes in share application money on reclassification to ‘Other Equity’ would form part of the Transition Amount?
Answer: Share application money pending allotment which is reclassified to Other Equity on transition date shall not be considered for the purpose of computing Transition Amount.
Question 8: Under Ind AS, Investments in preference share is considered to be a liability and the corresponding dividend expense is debited to Profit and loss account as interest cost. Should such interest expenses on preference shares be deducted for the purpose of MAT computation?
Answer: For the purpose of computation of MAT, profit/Transition Amount shall be increased by dividend/interest on preference share (including dividend distribution taxes) whether presented as dividend or interest.
Question 9: How do we recount for items such as equity component, if any, of financial instruments like Non-Convertible debentures (NCDs), Interest free loan etc. included in other equity as per Ind AS for the computation of transition amount uader MAT?
Answer: Items such as equity component of financial instruments like NCD’s) Interest free loan etc. would be included in the Transition Amount.
Question 10: Where revaluation/fair value adjustments have been made to items of Property, Plant & Equipment (PPE) under Ind AS, as per section 115JB of the Act, the book profit of
30. In our view, what is of relevance is Q. No. 9. As could be seen from the said question and it’s answer, it refers to the financial instruments like non-convertible debentures (NCDs). Whereas, in assessee’s case, the financial instruments are not NCDs. Hence, the clarification provided in the Circular under reference would be of no help to the Revenue.
31. As discussed in the foregoing paragraphs, the facts on records as well as the terms of conversion of debentures, in no way demonstrate that they would come within the ambit of CFI or other equity. It appears, due to lack of proper guidance regarding the classification of the financial instruments, the assessee was compelled to show it under the head ‘other equity’. However, in the very same balance sheet, the assessee had shown it under the sub- head ‘instrument classified as equity’. Thus, it is established on record that the assessee has always treated the instruments as equity, having no component of liability. Merely, because in the notes to accounts, the auditor inadvertently stated that the financial instruments under the head other equity come within the ambit of CFI, said statement by itself will not change the character of the instruments. The statement under note 36.2 has to be seen in the context of the corresponding accounting entries and not on standalone basis. Thus, on overall consideration of facts and materials on record, we are persuaded to believe that the statement in Note 36.2 was due to inadvertent mistake. It is of ten said- ‘to err is human’. Each and every human being is susceptible to commit mistake. What needs to be seen is, whether the mistake is inadvertent, bonafide and due to lack of clarity. If it is so, the person committing the mistake is entitled to course correction. Therefore, after getting clarity on issuance of guidance note by ICAI, the assessee had re-casted the balance sheet showing correct classification. It is well accepted that accounting entries are not sacrosanct. Hence, a substance over form approach has to be taken. Therefore, the department cannot be permitted to take undue advantage of an inadvertent mistake. In fact, in the present case itself the department has committed a mistake by referring to RIL as the subsidiary of assessee, whereas, it is exactly the opposite.
32. Thus, in view of the discussions made in the foregoing paragraphs, we have no hesitation in holding that the ZOFCDs/FCDs issued by the assessee to RIL do not come either within the category of CFI or other equity, hence will not form part of transition amount so as to increase the book profit u/s 115JB(2C) of the Act.
33. Having independently examined the issue and recorded our finding, as aforesaid, now we need to analyze the applicability of Coordinate Bench’s decision in A.Y. 2017-18 to the present appeals.
34. As discussed earlier, ld. First appellate authority, has taken a view favorable to the assessee following the decision of the co-ordinate bench in assessee’s case in A.Y. 201718. In this context, we need to briefly recapitulate the relevant facts. In A.Y. 2017-18. The assessee had filed its return of income on 28.12.2019 declaring total income at Rs.490/-after setting of f of brought forward losses of Rs.2,83,53,180/-. Whereas, the assessee declared book loss of Rs.15,99,52,699/- u/s. 115JB of the Act. The return of income filed by the assessee was selected for scrutiny and the A.O. ultimately completed the assessment u/s. 143(3) of the Act vide order dated 28.12.2019, assessing the total income at Rs.194/-under the normal provisions and book profit at Rs.7,58,40,803/-.
35. The PCIT, in exercise of powers conferred u/s. 263 of the Act, called for and examined the assessment records. After examination, ld. PCIT was of the view that the assessment order is erroneous and prejudicial to the interest of the Revenue, as the A.O. not only failed to examine the applicability of section 115JB(2C) of the Act, but has also made no adjustment to the book profit under the said provision with regard to the transition amount, being debentures issued of Rs.15824.47 crores. In this context, the PCIT issued a show cause notice, requiring the assessee to explain why the assessment order should not be revised. In response to the show cause notice, the assessee furnished detailed submissions not only challenging the validity of assumption of revisionary jurisdiction, but also on merits of applicability of section 115JB(2C) of the Act. Ld. PCIT did not accept the contentions of the assessee. Vide order dated 17.03.2022, he not only held that exercise of power u/s. 263 of the Act is valid, but also recorded conclusive finding on merits of the issue and held that the ZOFCDs /FCDs of Rs.15824.47 crores, being categorized as ‘other equity’, should be part of the transition amount, hence, to be added to the book profits of the assessee in terms with section 115JB(2C) of the Act. Thus, he set aside the assessment order with the following observations:
7. It is observed from the assessment records that the Assessing of ficer did not examine this issue or made enquiries/verifications on the issue of transition amount. He failed to apply the provisions of section 115JB(2C) to the case. In view of the facts and the provisions of law mentioned in the preceding paras, the assessment order dt 28/12/2019 passed by the Assessing of ficer under section 143(3) is held to be erroneous in so far as it is prejudicial to the interest of revenue. Accordingly, the assessment order is set aside on the issue of computation of income as per provisions of Sec 115JB of the IT Act. The Assessing of ficer Is directed to make a fresh assessment applying the provisions of section 115JB(2C) of the Income-tax Act correctly. The Assessing of ficer may Initiate appropriate penal proceedings while making a fresh assessment on this issue.
36. Against the revisionary order passed u/s. 263 of the Act, the assessee preferred an appeal before the ITAT. In course of hearing of the appeal, exhaustive arguments were advanced by the parties on identical lines. After taking note of the factual and legal position, the submissions of the parties and ratio laid down in the judicial precedents, the co-ordinate bench vide order dated 29.03.2023 in Reliance Industrial Investment and Holdings Ltd. v. Dy. CIT (Mumbai – Trib.)/ITA No.1065/Mum/2022 has held as under:
54. We have heard both the parties, perused the relevant findings given in the impugned orders as well as documents and material referred to before us. The observations and findings of Ld. PCIT in the impugned order passed u/s 263 have already been discussed in detail in the foregoing paragraphs. The findings and reasoning of Ld. PCIT has to be tested, whether the assessment order passed by the AO accepting the computation of book profit is erroneous in so far as prejudicial to the interest of revenue. If both the conditions are satisfied, then Ld. PCIT’s order setting aside the assessment order will stand. However, if the reasoning itself does not lead to conclusion that no adjustment of the book profit can be made u/s 115JB on facts and in law, then setting aside the assessment order may not be required as it will be neither erroneous nor prejudicial to the interest of revenue. Ld. PCIT has to point out not only there is an error in the assessment order but also it is prejudicial to the interest of revenue. Thus, the issue of applicability ofsection115JB(2C) while computing the book profit needs to be examined on merits, because Ld. PCIT has arrived at the conclusion that assessee should have made adjustment on account of transition amount in section 115JB(2C).
55. The relevant provisions ofsub-section (2C) read with explanation are as under:-
Special provision for payment of tax by certain companies.
115JB. (1) Notwithstanding anything contained in any other provision of this Act, where in the case of an assessee, being a company, the income-tax, payable on the total income as computed under this Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April, 2012, is less than eighteen and one-half per cent of its book profit, such book profit shall be deemed to be the total income of the assessee and the tax payable by the assessee on such total income shall be the amount of income-tax at the rate of eighteen and one-half per cent: … …….
(2A) For a company whose financial statements are drawn up in compliance to the Indian Accounting Standards specified in Annexure to the Companies (Indian Accounting Standards) Rules, 2015, the book profit as computed in accordance with Explanation 1 to sub-section (2) shall be further—
(2C) For a company referred to in sub-section (2A), the book profit of the year of convergence and each of the following four previous years, shall be further increased or decreased, as the case may be, by one-fifth of the transition amount:
Provided that the book profit of the previous year in which the asset or investment referred to in sub-clauses (B) to (E) of clause (iii) of the Explanation is retired, disposed, realised or otherwise transferred, shall be increased or decreased, as the case may be, by the amount or the aggregate of the amounts referred to in the said sub-clauses relatable to such asset or investment: Providedfurther that the book profit of the previous year in which the foreign operation referred to in sub-clause (F) of clause (iii) of the Explanation is disposed or otherwise transferred, shall be increased or decreased, as the case may be, by the amount or the aggregate of the amounts referred to in the said sub-clause relatable to such foreign operations. Explanation.—For the purposes of this sub-section, the expression—
(i) “year of convergence” means the previous year within which the convergence date falls;
(ii) “convergence date” means the first day of the first Indian Accounting Standards reporting period as defined in the Indian Accounting Standards 101;
(ii (i) “transition amount” means the amount or the aggregate of the amounts adjusted in the other equity (excluding capital reserve and securities premium reserve) on the convergence date but not including the following:—
(A) amount or aggregate of the amounts adjusted in the other comprehensive income on the convergence date which shall be subsequently re-classified to the profit or loss;
(B) revaluation surplus for assets in accordance with the Indian Accounting Standards 16 and Indian Accounting Standards 38 adjusted on the convergence date;
(C) gains or losses from investments in equity instruments designated atfair value through other comprehensive income in accordance with the Indian Accounting Standards 109 adjusted on the convergence date;
(D) adjustments relating to items of Property, plant and equipment and intangible assets recorded at fair value as deemed cost in accordance with paragraphs D5 and D7 of the Indian Accounting Standards 101 on the convergence date;
(E) adjustments relating to investments in subsidiaries, joint ventures and associates recorded at fair value as deemed cost in accordance with paragraph D15 of the Indian Accounting Standards 101 on the convergence date; and
(F) adjustments relating to cumulative translation differences of a foreign operation in accordance with paragraph D13 of the Indian Accounting Standards 101 on the convergence date.
56. Ergo, a company whose financial statements are to be drawn in compliance to the Indian Accounting Standards specified in Annexure to the Companies (Indian Accounting Standards) Rules, 2015, the book profit of the year convergence, which means the first day of Indian Accounting Standards reporting period as defined in IAS 101, for each of the following four previous years, shall be further increased or decreased by one-fifth of the transition amount”. The .transition amount” has been defined as the amounts adjusted in the other equity (excluding capital reserve and securities premium reserve) on the convergence date. Certain exclusions for the „transition amount” have also been elaborated from clauses (A) to (F). Thus, the „transition amount” by its nomenclature presupposes that due to transition, certain items which otherwise would have impacted profit and loss account either not do or would do in such a manner so as to distort the book profits merely due to transition from one Accounting Standard to other, i.e., India GAAP to IAS.
57. The issue now which needs to be decided here is, whether the aggregate amount of the instruments issued by the assessee company falls under the ambit of „ transition amount” as defined in section 115IB(2C); and if answer is „ Yes”, then one-fifth of the same would be taxable for the year under consideration, if „Not”, then no adjustment is required to be made.
58. As on 31st March 2016, the assessee had outstanding Zero Coupon Unsecured Optionally Fully Convertible Debentures amounting to Rs 15,544.57 Crores (Rs. 15,103 crores plus Rs. 441.57 crores) and Zero Coupon Unsecured Fully Convertible Debentures of Rs 279.90 crores totaling to Rs 15,824.47 crores issued to RIL – its holding company. (Hereinafter collectively referred to as Convertible Debentures), raised earlier and the same were disclosed as “long-term borrowings” in the audited financial statements as on 31-3-2016 as per the requirements of Indian GAAP.
59. Since „Ind AS” had become applicable to the assessee company with effect from financial year 2016-17, it made a transition to Ind AS. Accordingly, it prepared and presented its financial statements from the financial year ending 31″ March 2017 under Ind AS. Due to the requirement of Presenting the comparative information for the previous financial reporting period commencing from 1″ April 2015, as per Ind AS 101; first time adoption of Indian Accounting Standards, the assessee prepared its first Ind AS Balance Sheet as on 1st April 2015. As per the requirement of Ind AS 101, for preparing this first Ind AS Balance Sheet, assessee reclassified items that it recognized in accordance with Indian GAAP as one type of asset, liability, or component of equity, as a different type of asset, liability, or component of equity in accordance with various applicable Ind ASs.
60. To comply with this requirement, assessee applied the requirements of Ind AS 32. Accordingly, it re-classified the Convertible Debentures of Rs. 15,824.47 crores, (which were presented as on 31st March 2016 in Indian GAAP balance sheet as “Long term borrowings”) as equity instrument in its first Ind AS balance sheet and presented them as “Instruments entirely Equity in nature”. These Convertible Debentures were not reclassified as Compound Financial Instrument (another category covered under Ind AS 32) by the assessee.
61. To understand whether the ZCOCDs and OFCDs issued by the assessee company contained any terms and conditions of any financial liability as contemplated in Ind AS 32, the key terms of issue of the „optionally fully convertible debentures” outstanding as on 31st March 2016 (after considering the modifications made to the original terms of issue of the various series of convertible debentures on or before 31st March 2016) needs to be understood. Same are summarized below:-
| • | The convertible debentures had a fixed term. |
| • | The convertible debentures were convertible into fixed number of equity shares of Rs. 10 each of the issuer at the rate of higher of book value or face value as at 31st March 2015. |
| • | The assessee or the debenture holder can opt for early conversion at any time by giving one-month notice. |
| • | The assessee can redeem the outstanding convertible debentures on expiry of the fixed term of the convertible debentures, if the option for conversion into equity shares is not taken up by the end of the term. |
| • | The assessee and the debenture holder may mutually agree for early redemption of the outstanding debentures on any date after expiry of 30 days from the date of allotment. |
62. Thus, the key terms of the issue of fully convertible debentures consist of conversion into equity shares of the company. This conversion will be based on higher of the book value or face value of the equity shares as at 31st March 2015.
63. As a preface, we have to analyse the relevant provisions of the Companies Act 2013 and new accounting standards as laid down in Ind AS. First of all, section 129 of the Companies Act, 2013 provided that the financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards notified under sec. 133 and shall be in the form or forms as may be provided for different class/classes of companies in Schedule III: Provided that the items contained in such financial statements shall be in accordance with the accounting standards. The Central Government by notification No.GSR lll(E) dated 16th February 2015, notified the companies (Indian Accounting Standards) Rules, 2015 (“Rules”) with effect from 1stApril 2016 (“Ind AS”).
64. Ind AS 101: where for the first time adoption of Indian Accounting Standards is to be adopted, it provides:-
Para 1:- The objective of this Ind AS is to ensure that an entity’s first Ind AS financial statements, and its interim financial reports for part of the period covered by those financial statements, contain high quality information that:
(a) is transparent for users and comparable over all periods presented;
(b) provides a suitable starting point for accounting in accordance with Indian Accounting Standards (Ind ASs); and (c) can be generated at a cost that does not exceed the benefits.
Para 2:- An entity shall apply this Ind AS in: (a) its first Ind AS financial statements; (b)..
Para 6:- An entity shall prepare and present an opening Ind AS Balance Sheet at the date of transition to Ind ASs. This is the starting point for its accounting in accordance with Ind ASs………
Appendix A: Definition of the term “date of transition to Ind AS The beginning of the earliest period for which an entity presents full comparative information under Ind ASs in first Ind AS financial statements.
Para 10:-………. an entity shall, in its opening Ind AS Balance Sheet:
(a) ; ……….
(b) ; ………..
(c) reclassify items that it recognised in accordance with previous GAAP as one type of asset, liability, or component of equity, but are a different type of asset, liability, or component of equity in accordance with Ind ASs;
(d) apply Ind ASs in measuring all recognised assets and liabilities.
65. The .transition amount” as discussed above is defined as amount adjusted in .other equity” and the constituent of the Schedule of ‘other equities’ as per the Companies Act are as follows:
(a) Share application money pending allotment;
(b) Equity component of compoundfinancial instruments;
(c) Reserve and surplus;
(d) Debt instrument through other comprehensive income;
(e) Equity instrument through other comprehensive income;
(f) Effective portion of Cash Flow Hedges; (g) Revaluation Surplus;
(h) Exchange differences on translating the financial statements of a foreign operation;
(i) Other items of Other Comprehensive Income (specify nature); and
(j) Money received against share warrants.
66. Concurrence between Assessee and DR is that the main issue is as to whether the instrument can be classified as Compound Financial Instrument (CFI) and equity component of it as per clause (b) above by application of Ind AS 32? The foundation of PCIT”s order is also based on the characterization of said instrument as CFI or otherwise.
67. Ind AS 32 defines the financial instruments in the recognition and characterization of the instruments. The objective of this Standard is to establish principles for presenting financial instruments as liabilities or equity. It applies to the classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments, etc. The following paragraphs define the scope of financial instruments:-
Para 11:-A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
A financial asset is any asset that is:
(a) cash;
(b) an equity instrument of another entity;
(c) a contractual right:
(i) to receive cash or another financial asset from another entity; or
(ii) …………….
An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. A financial liability is any liability that is: (a) a contractual obligation:
(i) to deliver cash or another financial asset to another entity; or
(ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or
(b) a contract that will or may be settled in the entity’s own equity instruments and is:
(i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments;
(ii)…………
Para 15:-The issuer of a financial instrument shall classify the instrument or its component parts, on initial recognition as a financial liability, a financial asset, or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset, and an equity instrument.
Para 16:-When an issuer applies the definitions in paragraph 11 to determine whether a financial instrument is an equity instrument rather than a financial liability; the Instrument is an equity instrument if, and only if, both conditions (a) and (b) below are met.
(a) The instrument includes no contractual obligation: (i) to deliver cash or another financial asset to another entity; or (ii)to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the issuer and
(b) If the instrument will or may be settled in the issuer’s own equity instruments, it is: (i) a nonderivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments;
(ii) ………….
Para 22:-………. a contract that will be settled by the entity (receiving or) delivering a fixed number of its own equity instruments In exchange for a fixed amount of cash or another financial asset is an equity instrument.
Compound financial instruments (Paras 28 to 32]
Para 28:- The issuer of a non-derivative financial instrument shall evaluate the terms of the financial instrument to determine whether it contains both a liability and an equity component. Such components shall be classified separately as financial liabilities, financial assets, or equity instruments in accordance with paragraph 15.
Para 29:-An entity recognises separately the components of a financial instrument that
(a) creates a financial liability of the entity; and
(b) grants an option to the holder of the instrument, to convert it into an equity instrument of the entity. For example, a bond or similar instrument convertible by the holder into a fixed number of ordinary shares of the entity is a compound financial instrument.
From the perspective of the entity, such an instrument comprises two components:
1) a financial liability (a contractual arrangement to deliver cash or another financial asset); and 2) an equity instrument (a call option granting the holder the right, for a specified period of time, to convert it into a fixed number of ordinary shares of the entity)
The economic effect of issuing such an instrument is substantially the same as issuing simultaneously a debt instrument with an early settlement provision and warrants to purchase ordinary shares or issuing a debt instrument with detachable share purchase warrants. Accordingly, in all cases, the entity presents the liability and equity components separately in its balance sheet.
But here that in this case, the debentures are convertible at the option of not just the holder but even the issuer has the option to convert the debentures into equity instruments. Hence, the example provided here in para 29 may not fit in the current situation.
Para 30:- Classification of the liability and equity components of a convertible instrument is not revised as a result of a change in the likelihood that a conversion option will be exercised, even when exercise of the option may appear to have become economically advantageous to some holders. Holders may not always act in the way that might be expected because, for example, the tax consequences resulting from conversion may differ among holders. Furthermore, the likelihood of conversion will change from time to time. The entity’s contractual obligation to make future payments remains outstanding until it is extinguished through conversion, maturity of the instrument or some other transaction.
Para 31:-Equity instruments are instruments that evidence a residual interest in the assessee of an entity after deducting all of its liabilities. Therefore, when theamount of a compound financial instrument is allocated to its equity and liability components, the equity component is assigned the residual amount after deducting from the fair value of the instrument as a whole the amount separately determined for the liability component. The value of any derivative features (such as a call option) embedded in the compound financial instrument other than the equity component (such as an equity conversion option) is included in the liability component. The sum of the carrying amounts assigned to the liability and equity components on initial recognition is always equal to the fair value that would be ascribed to the instrument as a whole. No gain or loss arises from initially recognising the components of the instrument separately,
Para 32:- Under the approach described in paragraph 31, the issuer of a bond convertible into ordinary shares first determine the carrying amount of the liability component by measuring the fair value of a similar liability (including any embedded non-equity derivative features) that does not have an associated equity component. The carrying amount of the equity instrument represented by the option to convert the instrument into ordinary shares is then determined by deducting the fair value of the financial liability from the fair value of the compound financial instrument as a whole Certain paras relating to compound financial instruments from Application Guidance Para AG 31:-
A common form of compound financial instrument is a debt instrument with an embedded conversion option, such as a bond convertible into ordinary shares of the issuer, and without any other embedded derivative features. Paragraph 28 requires the issuer of such a financial instrument to present the liability component and the equity component separately in the balance sheet, as follows:
(a) The issuer’s obligation to make scheduled payments of interest and principal is afinancial liability that exists as long as the instrument is not converted. On initial recognition, the fair value of the liability component is the present value of the contractually determined stream of future cash flows discounted at the rate of interest applied at that time by the market to instruments of comparable credit status and providing substantially the same cash flows, on the same terms, but without the conversion option.
(b) ……….
Para AG 35:-
An entity may amend the terms of a convertible instrument to induce early conversion, for example, by of fering a more favourable conversion ratio or paying other additional consideration in the event of conversion before a specified date. The difference, at thedate the terms are amended, between the fair value of the consideration the holder receives on conversion of the instrument under the revised terms and the fair value of the consideration the holder would have received under the original terms is recognised as a loss in profit or loss.
68. As noted above, the company had to prepare the financial statements for the FY 2015-16 and at that time it was prepared under GAAP and OFCDs were disclosed in the balance sheet as on 31st March 2016 as .long-term borrowings”. Since, Ind AS 32 was made effective to the Companies Act 2016 for the financial year commencing from 1st April 2015, the assessee company was required to prepare its opening Ind AS 32 balance sheet as on the date of transition, which is the beginning of the earlier periodfor which an entity presents fully comparative information under Ind AS 32. Whenever opening Ind AS 32 balance sheet is prepared, Ind AS 32 & 101 requires that in this opening balance sheet not only all the assets and liabilities should be recognized but also the classification should be in accordance with the requirements of Ind AS 32. With the classification of assets, liabilities, components of equity made as per the requirements of Previous GAPP was different from the one which is appropriate as per the requirement of Ind AS, then those should be classified so as to appropriate as per the Ind AS. In the balance sheet of the assessee company as on 31st March 2016 and the Indian GAPP, there were outstanding convertible debentures which were shown under .long term borrowings” in the in the component Ind AS balance sheet as on 1stApril 2015 and now the said debentures were required to recognize and classify as for the requirements of Ind AS 32.
69. Now whether the characteristic of the convertible debentures issued by the company falls within the scope and definition of .compounding financial instrument” as a provided in .Ind AS 32″ as defined therein in various paras which have been incorporated by us supra. First of all, a convertible debenture is a contract that has mainly two characteristics; ^
firstly, it gives rise to the financial assets for the party which is the holder of the instrument, since it gives a contractual right to receive cash and other financial assets, for example, financial asset in the form of equity instrument of issuer in case of convertible option; and
secondly, it gives rise to financial liabilities or equity instrument to the issue of the convertible debentures depending upon the terms of the convertible debentures, is a financial instrument as per the definition provided under Ind AS 32.
Ind AS 32 lays down the principles for presenting financial instruments as liabilities or equity from the perspective of the issuer which in the present case that is assessee. Thus, for presenting in the opening Ind AS 32 balance sheet and for the subsequent accounting of convertible debentures issued by the company, the principle laid down Ind AS 32 needs to be taken into account.
70. However, the requirement of Ind AS 32 about classification of financial instrumental is on initial recognition as per the substance of the contractual arrangement. It requires that the classification of a financial instrument or its component parts is to be made by the issuer as financial liability or equity instrument on initial recognition with the substance of the contractual arrangement and the definitions of a financial liability and an equity instrument. The term compounding financial instrument has not been independently defined under Ind AS 32. However, if there is such financial instrument, the accounting standard requires that the issuer should first determine the liability component and then separate the liability component from the fair value of the entire financial instrument. One has to ascertain the liability component which is sine qua non for treating it as a „ transition amount”. The financial instrument if it is categorized as a compound financial instrument, then there has to be a liability component embedded in it.
71. Ergo, we have to see, whether in the present case, what constitute financial liability. Ostensibly, there are two situations in relation to financial instrument which can be reckoned as financial liability; firstly, there is a contractual obligation to make settlement either by monetary payment or by delivering any other financial asset; or secondly, the settlement has to be made by exchange of variable number of its own equity instruments. If we keep this definition as provided in Ind AS 32 incorporated (supra),then the instrument is an equity instrument for the issuer only if both the conditions as stated above are satisfied, i.e., there is no contractual obligation for the issuer to make settlement either by monetary payment or by delivering any other financial assets and secondly, there is no contractual obligation for the issuer to make settlement by delivering variable numbers of its own equity instruments.
72. Here on facts of the present case, the convertible debentures can be converted into fixed number of equity shares either unilaterally by the investor or by the issuer without the consent or concurrence of the other party to the contract. In other words, the investors will exercise the option unilaterally to convert convertible debentures into equity shares in a situation where the fair value of the equity shares increases above the issue price of the convertible debentures at any time during the term of the convertible debentures. In second situation, the issuer will exercise the option unilaterally to controvert the convertible debentures into equity shares so as to avoid delivery of cash. The repayment in monetary terms by the issuer to the investor in respect of the convertible debentures upon the expiry of their term is contingent upon non exercise of the option to convert the convertible debentures both by the investor and the issuer. This eventuality may not arise here in this case, since the option to convert is available not only with the investor but also with the issuer and earlier redemption of the convertible debenture available to both, is not a unilateral option, but is subject to mutual agreement of both the investor and the issuer. This does not result in any vesting of right or foisting of any obligation unilaterally on any one or the other party to the contract. Accordingly, both have inferred to a conclusion that settlement of convertible debentures issued by the assessee will be through exchange of own equity instruments of the assessee company only and not by any financial liability as defined in Ind AS 32. This exchange, as per the terms, will be of a fixed number of equity shares. Accordingly, in the case of assessee, the criteria to classify the financial instrument of convertible debentures are not indicative of any compounding financial instrument albeit it is equity.
73. Now reiterating the same question, whether the convertible debentures under consideration before us can be classified as a „compound financial instrument” which has both a liability and an equity component. As specified under Ind AS 32, the liability component of the convertible debentures is represented by the present value of the aggregate of the following future payments:-
(i) Principal repayment
(ii) Periodical interest payments.
In the present case, the notional convertible debentures issued by the assessee, there is neither payment of interest component nor any kind of Premium at the time of repayment. The repayment of Principal in monetary terms will also not be there, as the settlement will be through issue of own equity instruments of the assessee company. Thus, the liability in monetary terms is „NIL” in the present case. Further when the entire financial instrument is classified as equity, there will be no charge on account of notional interest or any kind of financial liability in the statement of Profit and loss during the entire tenure of such instrument after initial recognition in the financial accounts. It was for this precise reason; the assessee company has neither provided any interest cost or claimed any kind of financial liability in the profit and loss account. Thus, to summarise, the financial instrument under consideration here in this case, we find that;
— firstly, there is no financial liability;
— secondly, it cannot be classified as compoundfinancial instrument; and
— lastly, the settlement purely on account of allotting equity shares.
74. One of the key arguments on behalf of the revenue and also by the Ld. PCIT in his order is that, assessee company itself has classified is optionally convertible debentures into „ other equity ” which is as per the definition under the „ transition amount” given in the Explanation gets covered. In order to understand the disclosure requirements of equity finds in the balance sheet which otherwise is called shareholder’s fund consists of equity shares capital and other equity share. As far as equity share capital is concerned, it consists of various types ofshare capital issued by the company. As regards the other equity, these consist ofvarious types of reserves which are available to the shareholders. In other words, the funds belongs to the share holders as per the new disclosure scheme, the shareholder has to be indicated how much funds are employed in the company.
75. We have to understand the term „other equity” which is part of the shareholder funds. The „other equity” consists of various types of reserves like general reserve, capital reserve, security premium reserve and other reserve similar to the profit and loss attributable to the shareholders. Thus, the disclosure of the total funds available in the account of the shareholders is for the purpose of valuation and to understand their stake in the company. Merely because the OFCD”s in the balance sheet has been classified under the head „other equity” that does not reach to a conclusion that it is a financial instrument which can be classified as „transition amount”.
76. Now to understand the term „transition amount”, what the Explanation envisages that aggregate amount adjusted in the other equity on the convergence date and there are certain exclusions provided in the Explanation as incorporated (supra). Thus, on the date of convergence the company has to determine various comprehensive incomes on the date of convergence and make their adjustment in the other equity. The comprehensive income should be the in the nature of reserves or income. It can never be in the form of a capital liability already recognized in the balance sheet, i.e., before the convergence date. The definition of transition amount itself excludes certain capital reserves, which is evident from the exceptions provided in the various clauses A to F in subclause (iii) of Explanation to sub-section 2C of section 115JB. These exclusions itself clarifies that certain reserves even though they are clearly part of the „other equity”, since they are capital in nature, but are earmarked for other purposes which Companies Act has imposed certain restrictions for their utilization, are not treated part of transition amount. In a nut shell, not all the reserves forming part of other equity are „transition amount” as understood by the Revenue authorities. In the earlier part of the order, we have also referred to the CBDT circular number 24/2017 (supra), wherein CBDT has clarified vide question No. 7, which itself indicates that already recognized capital liability cannot be part of the transition amount. What should be the part of the „other equity”, is, total comprehensive income determined on the date of convergence date based on adjustment determined as per the various accounting standards of Ind AS 101, 16, 38 and other similar adjustment as per the other parts of Ind AS. This also includes certain adjustment based on the reports of financial instrument as per Ind AS 32.
77. In the accounting standard, Ind AS 32, the respective companies has to determine comprehensive income/loss based on composite instrument which has element of equity or financial liability. There are various types of financial instruments which are debt based or equity based instrument for which terms are different for the various types of instruments. On the date of convergence, the company has to determine the comprehensive income or loss based on the status of future financial assets or liability to the respective companies. Accordingly, the company has to recognize only the comprehensive income or loss in the „transition amount” and not the capital liability which has already recognized in the balance sheet of Pre-convergence date.
78. The next issue is how to determine the financial gain or loss particularly of the debt financial instrument. First of all, one need to separate debt and equity from the above instrument and determine the impact of comprehensive income or loss in the equity portion and will impact their adjustment in the „ other equity “. This will be done in accordance with Ind AS 32. The Ind AS 32 provides an example how to compute the fair value and liability assigned to equity bond. For the sake of ready reference, the same is reproduced as under:-
An entity issues 2,000 convertible bonds at the start of year 1. The bonds have a three-year and are issued at par with a face value of currency unit [CD] 1,000 per bond, giving total proceeds of CU 20,00,000. Interest is payable annually in arrears at a nominal annual interest rate of 6 percent. Each bond is convertible at any time up to maturity onto 250 ordinary shares. When the bonds are issued, the prevailing market interest rate for similar debt without conversion option is 9 per cent. The liability component is measured first and the difference between the proceeds of the bond issue and the fair value of the liability is assigned to the equity component. The present value of the liability component is calculated using a discount rate of 9 per cent, the market interest rate for similar bonds having no conversion rights, as shown below:
| CU | |
| Present value of the principal CU 20,00,000 payable at the end of 3 years | 75,44,367 |
| Present value of the interest CU 1,20,000 payable annually in arrears for 3 years | 3,03,755 |
| Total liability component | 18,48,122 |
| Equity component (by deduction) | 1,51,788 |
| Proceeds of the bond issue | 20,00,000 |
The above illustrative example given in the IASB and the Ind AS 32 Appendix C-documents shows that the amount of CU 1,51,878 has been classified as equity component of the compound financial instrument on initial recognition. The liability component of CU 18,48,122 will have to equal CU 20,00,000 at the end of 3 years so that at the expiry of the term of the instrument, the same can be paid back to the investor. To this effect, the difference of CU 1,51,878 (CU 20,00,000 less 18,48,122) will have to be debited as notional interest in the statement of profit and loss during the remaining term of the compound financial instrument.
79. In case the financial instrument is classified as a compound financial instrument as covered in the illustrative example, then the accounting entries under Ind AS with respect to the data as per the said illustrative example, at the time of initial recognition of above convertible bonds in subsequent periods and at the time of redemption of bonds, will done in the following manner:-
80. The aforesaid illustrative and the example as given in Ind AS 32 goes to illustrate as to what should be the transition amoii.nl”. In the above illustration, the value of Instrument/Debenture of Rs. 20lakhs is not the financial liability but the value of Rs. 151,878/- is the value of compounding Income. If we apply the above example in the present case, then it is very difficult to fathom that how the entire optional convertible debentures can be classified and held as financial instrument, i.e., entire debenture is a financial liability so as to be classified under the head „transition amount”, as held by Ld. PCIT in his order. We have reiterated many times in the earlier part of the order that only the component of financial liability element alone i.e., (financial liability or assets) which has to be taken as „transition amount”. Ld. PCIT has completely erred in accounting principle while holding that the entire convertible debentures for sums aggregating to Rs.15544.57 crores is a „transition amount” which needs to be adjusted over the period of 5 years while computing the book profit. This finding itself vitiates the entire reasoning and the view taken by the Ld. PCIT.
81. If the above illustration is to be taken as a guideline to determine the „transition amount” which needs to be adjusted, then only the financial liability embedded in it alone can be treated as transition amount as per Ind AS 32. Here in this case, there was no kind of any financial liability or any interest component which can be ascertained or determined on the said convertible debentures. As we have already held above that, since these Zero Coupon Optionally Convertible Debenture is purely in the nature of equity and there was no financial liability embedded it, neither any liability has been debited to profit and loss account, nor it has been recognized by the assessee company in financial accounts. There is nothing flowing from the terms or substance of the contract of Zero Coupon OFCD or OFCD where one can inferred that there was any kind of interest or coupon rate or premium payable by the Assessee Company which can be inferred under the meaning of „ transition amount”, which required to classified under Ind AS 32 and needs to be adjusted while computing the book profit us 115JB (2C).
82. In the present case, the assessee has classified various types of liabilities based on its understanding at the time of preparation of balance sheet for the relevant financial year which is in question before us are as under:-
| (Rs. In crores) |
| Equity Fund | 31.10.2017 | 31.03.2016 |
| Equity Shares | 147.50 | 147.50 |
| Other Equity | 17704.36 | 16326.67 |
| Total | 17851.86 | 16474.17 |
In the statement of equity for the year ended 31st March 2017 under the head „other equity”, the assessee has taken optional convertible debentures and Zero Coupon unsecured fully convertible debenture of Rs. 10 each. Which are in the nature of capital liability or capital debt to the company until the same is not fully converted into Equity. There is no corresponding financial liability of such convertible debentures have been shown in the financial statement or in the profit and loss account. Though from the perusal of the financial statement, we find that assessee has shown debt/equity instruments through other comprehensive income which is though not the correct presentation of the debt instrument, because as stated above, the debt instrument has to be classified separately along with other capital liability on such instruments. Be that as it may, nothing turns out on such presentation as one thing which is clearly borne out from the financial accounts and facts of the case is that, in so far as Zero Coupon OFCDs and OFCDs in the case of assessee did not have any kind of financial liability to classify it as Compounding Financial Instrument and in turn to quantify the same as transition amount.
37. As could be seen from the aforesaid observations of the co-ordinate bench, not only the nature and character of the instruments but the issue of applicability of section 115JB(2C) of the Act to the amount of Rs.15,284.47 crores was examined in A.Y. 201718 and after a comprehensive analysis of facts and law, the co-ordinate bench has taken a view on merits that provisions of section 115JB(2C) of the Act are not applicable, as the amount in dispute cannot be classified as other equity to form part of the transition amount. There is no dispute between the parties that the year of conversion of the alleged transition amount of Rs.15,824.47 crores is A.Y. 2017-18. It is not the case of the department that some other instruments in addition to the amount of Rs.15,824.47 crores forms part of the transition amount in the years under appeal before us. As per the provisions of section 115JB(2C) of the Act, the book profit of the year of conversion and each of the following four previous years shall be further increased or decreased by 1/5th of the transition amount. Thus, the nature and character of the financial instrument, whether CFI and other equity, hence, would form part of the transition amount, has to be examined and determined in the year of conversion, which in the present case is A.Y.2017-18. In case, the nature and character of the financial instrument is determined as other equity in the year of convergence, the decision taken therein has to be automatically followed in the four succeeding assessment years. In other words, once the quantum of transition amount is decided in the year of convergence, in the succeeding four assessment years the A.O. has to simply undertake a mechanical exercise of increasing the book profit by 1/5th of the transition amount.
38. Undoubtedly, in case of the present assessee, in the year of convergence in A.Y. 2017-18, the co-ordinate bench, while deciding the issue, has categorically held that the financial instruments would not fall in the category of other equity so as to form part of the transition amount. When in the year of convergence, the co-ordinate bench has decided the issue in favour of the assessee, consequential effect has to be given in the four succeeding assessment years. This is so because, the issue has to be examined in the first year where the particular provision has to be applied and in subsequent assessment years only consequential effect has to be given. In this context, we deem it appropriate to refer to the following observations of Hon’ble Supreme Court in case of Shasun Chemicals & Drugs Ltd. v. CIT-II, Chennai [2016] 73 (SC) :
13. In the Income Tax Return which was filed for the Assessment Year 1995-96 the assessee had claimed that it had incurred a sum of Rs.45,51,890/- towards the share issue expenses and had claimed 1/10th of the aforesaid share issue expenses under Section 35D of the Act from the Assessment Years 1995-96 to 2004-05. This claim of the assessee was found to be justified and allowable under the aforesaid provisions and on that basis 1/10th share issue expenses was allowed under Section 35D of the Act. When it was again claimed for the Assessment Year 1996-97, though it was disallowed and on directions of the Appellate Authority, the Assessing of ficer made physical verification of the factory premises. He was satisfied that there was expansion of the facilities to the industrial undertaking of the assesseee. It is on this satisfaction that for the Assessment Year 1996-97 also the expenses were allowed. Once, this position is accepted and the clock had started running in favour of the assessee, it had to complete the entire period of 10 years and benefit granted in first two years could not have been denied in the subsequent years as the block period was 10 years starting from the Assessment Year 1995-96 to Assessment Year 2004-05. The High Court, however, disallowed the same following the judgment of this Court in the case of Brook Bond India Ltd (supra). In the said case it was held that the expenditure incurred on public issue for the purpose of expansion of the company is a capital expenditure. However, in spite of the argument raised to the effect that the aforesaid judgment was rendered when Section 35D was not on the statute book and this provision had altered the legal position, the High Court still chose to follow the said judgment. It is here where the High Court went wrong as the instant case is to be decided keeping in view the provisions of Section 35D of the Act. In any case, it warrants repetition that in the instant case under the very same provisions benefit is allowed for the first two Assessment Years and, therefore, it could not have been denied in the subsequent block period. We, thus, answer question No. 1 in favour of the assessee holding that the assessee was entitled to the benefit of Section 35D for the Assessments Years in question.
39. In fact, in a case of identical nature of dispute arising out of adjustment made u/s. 115JB(2C) of the Act, the co-ordinate bench, in case of Antony Lara Enviro Solutions (P.) Ltd. v. PCIT, Thane-1 (Mumbai – Trib.), has held as under:
4.6 We find considerable merit in the submission of the assessee. The transition amount under section 115JB(2C) is a one-time computation arising on the date of first-time adoption of Ind-AS. Statutorily, only one-fifth of such amount is to be added to the book profit in each of the four succeeding previous years. Once the foundational figure has been computed and examined in the first year-and, significantly, accepted by the Assessing of ficer-there is no statutory warrant for a fresh determination of the very same amount in subsequent years. What remains in later years is merely arithmetical apportionment, not a fresh adjudication.
4.7 In the present case, the assessment order for A.Y. 2018-19, placed before us, clearly indicates that the transition amount of Rs. 41,40,28,675/- was scrutinised and accepted. The learned PCIT does not dispute this fact; his grievance is only that the Assessing of ficer did not again verify the composition of the same transition amount in the year under consideration. In our considered opinion, such a view overlooks the settled principle that where a matter stands examined and accepted in the foundational year, the Assessing of ficer cannot be faulted for not reopening or redetermining it in every succeeding year, particularly when the assessee has consistently followed the same computation mechanism and furnished all requisite particulars.
40. Therefore, once the issue has been decided in a particular manner in the year of convergence, that decision will apply in full force to the subsequent assessment years and no different view can be taken.
41. Copiously referring to the observations of the Coordinate Bench in A.Y. 2017-18, ld. DR had made arduous attempt to punch holes in the said order. He had submitted that since, the order of the co-ordinate bench is in an appeal arising out of order passed u/s. 263 of the Act, the decision taken therein would not apply. Further, ld. DR has submitted that while deciding the appeal arising out of an order passed u/s. 263 of the Act, ITAT was not required to record its finding on merits. We are not at all impressed with the aforesaid submissions of ld. DR. Firstly, though, the appeal in A.Y. 2017-18 was against an order passed u/s. 263 of the Act, however, in the revisionary order, the Revisionary Authority did not restrict himself only to the jurisdictional error of the A.O. He not only examined the issue on merits but has recorded conclusive finding on the transition amount as also applicability of section 115JB(2C) of the Act. Such finding of the Revisionary Authority was binding on the A.O. That being the case, the co-ordinate bench was very much competent to examine not only the validity of exercise of jurisdiction u/s. 263 of the Act, but also the merits of the issue. More so, when assessee not only had raised grounds on merits but parties advanced arguments on merits.
42. Taking us through various observations of the Coordinate Bench, ld. DR attempted to find serious flaws in them. He had submitted that the observations are not only contradictory but overlooking crucial parts of Ind As 32. However, we are not at all impressed with such submissions. Being a bench of equal strength, we cannot assume the role of a superior appellate authority to seat in judgment over the order of the co-ordinate bench and put under a lens to dissect it sentence by sentence and word by word to find imaginary flaws. Even, momentarily accepting the contention of ld. DR that there are some contradictory observations by the bench, however, having carefully gone through the observations of the Bench, we are of the view that they are innocuous in nature and would have absolutely no bearing on the conclusion reached. Though, the ld. DR beseeched us not to follow the decision of the Coordinate Bench, however, we do not find even a single valid reason to do so. More so, when it is absolutely clear that the facts are identical. Such being the factual and legal position before us, not following the decision of the Coordinate Bench would militate against the well-established standards of judicial discipline and decorum, hence, wholly undesirable. The correctness of the decision of the Coordinate Bench can only be tested before a higher appellate authority and not before us. After carefully going through the observations of the Coordinate Bench in the context of facts and materials on record, we are of the firm view that there being no foreseeable difference in the factual position relating to the issue in dispute, the decision taken by the Coordinate Bench in A.Y. 2017-18 will apply in full force. Thus, in our view, the first appellate authority adopted the correct approach of following the decision of the higher appellate authority. In the final analysis, we do not find merit in the grounds raised.
43. One more issue raised by the department is in relation to disallowance u/s. 14A read with Rule 8D. In course of assessment proceeding, the A.O. noticed that in the assessment years in dispute though the assessee had earned considerable amount of exempt income, however, the suo motu disallowance made by the assessee was not in accordance with the method prescribed under Rule 8D. Accordingly, he issued a show cause notice to the assessee to explain why disallowance should not be made in terms with the method prescribed under Rule 8D. In response to the show cause notice issued, the assessee furnished a detailed reply justifying the suo motu disallowance and objecting to the disallowance proposed by the A.O. in the draft assessment order. The A.O., however, was not convinced with the submissions of the assessee. He even rejected assessee’s contention that the investments made in the subsidiaries not giving rise to any exempt income during the year should not be considered. Having held so, he proceeded to compute disallowance under Rule 8D(2)(ii) at 1% of the annual average of monthly average value of investment.
44. The assessee contested the disallowance before the first appellate authority. After considering the submissions of the assessee, in the context of the facts and materials on record, ld. First appellate authority observed that while rejecting assessee’s suo motu disallowance and proceeding to compute the disallowance under Rule 8D(2)(ii), the A.O. has not recorded his satisfaction. He further observed that various submissions made by the assessee were not at all examined by the A.O. Thus, he deleted the disallowances.
45. Before us, ld. DR submitted that disallowance u/s. 14A read with Rule 8D has to be made in terms with the methodology provided under Rule 8D(2). He submitted, since the disallowance made by the assessee was not in accordance with Rule 8D, the A.O. has proceeded to compute disallowance under Rule 8D(ii) after recording his dissatisfaction. He submitted, without properly examining the facts, ld. first appellate authority has deleted the disallowance.
46. We have considered rival submissions and perused the materials on record. As could be seen, in the draft assessment order, the A.O. had proposed disallowance in terms with Rule 8D(2)(ii) at a substantially higher figure than the suo motu disallowance. While raising objections against the proposed disallowance, the assessee had not only indicated the basis for suo motu disallowance but had brought to the notice of the A.O. that certain investments not giving rise to exempt income should be excluded. The assessee had further stated that certain expenses incurred by the assessee cannot be attributed to earning of exempt income as they have been specifically incurred for a particular purpose. A reading of sub section (2) of section 14A makes it clear that the A.O. has to record his satisfaction regarding the correctness of suo motu disallowance made by the assessee having regards to the books of accounts. Even Rule 8D also prescribes the same condition. In the facts of the present appeal, as could be seen from the submissions made by the assessee before the A.O., the assessee had stated that it had enough surplus interest free funds available with it to take care of the investments. Therefore, no part of interest expenditure can be attributed for earning of exempt income. The assessee had further stated that the expenditure incurred towards man power supply services having been recovered from the concerns to whom man power was supplied, there is no question of disallowing any part of such expenditure. The assessee had further stated that certain investments made in subsidiaries have not yielded any exempt income. Hence, should not be considered while working out the average value of investment. The assessee has also justified the suo motu disallowance. A reading of the assessment order does not reveal that the A.O. has recorded his dissatisfaction that suo motu disallowance made by the assessee is incorrect having regard to its books of account. The observations of the A.O. are general in nature. He has not even considered the specific submissions of the assessee that expenditure incurred on man power supply has subsequently been recovered as also the fact that investments made in subsidiaries have not yielded any exempt income during the year, hence, should not form part of the average value of investment. Thus, in our view, the A.O. has not recorded satisfaction as required by section 14A(2) of the Act. In this view of the matter, we do not find any infirmity in the decision of the first appellate authority in deleting the disallowance. Hence, grounds are dismissed.
47. The finding recorded in the foregoing paragraphs will apply to rest of the appeals.
48. In the result, the appeals are dismissed.