ITA Nos.72 & 85/PNJ/2012 Sesa Goa Ltd., Panaji, Goa IN THE INCOME TAX APPELLATE TRIBUNAL PANAJI BENCH, PANAJI BEFORE: SHRI P.K. BANSAL, ACCOUNTANT MEMBER AND SHRI D.T. GARASIA, JUDICIAL MEMBER ITA No.72/PNJ/2012 Assessment Year : 2009-10 Sesa Goa Ltd. JCIT Range-1 Panaji - Goa Vs. Panaji (Appellant) (Respondent) PAN No.AACCS 7101B ITA No.85/PNJ/2012 Assessment Year : 2009-10 ACIT Circle-1(1) Sesa Goa Ltd. Panaji Vs. Panaji - Goa (Appellant) (Respondent) Appellant By: Shri Vinod Kumar, CA Shri Sanjeev Bindal CA & Shri Vijay Gupta, CA Respondent By: Shri M.V. Sheshachala (DR) Shri B.L. Guruprasad Date of hearing : 19.02.2013 Date of pronouncement : 08.03.2013 ORDER
PER SHRI P. K. BANSAL, AM These cross appeals are filed against the order of the CIT(A) dated 31.08.2012. The assessee in his appeals taken detailed grounds of appeals when the Bench asked to file the grounds of appeal in brief. The assessee accordingly filed the grounds of appeal in brief as under: -
1.1 The Learned CIT(A) erred in upholding the addition of Rs. 12,29,25,0497- made by A.O., U/s 14A of the Act read with Rule 8D of the Rules, as expenditure incurred in relation to exempt income.
1.2. The learned CIT (A) ought to have appreciated that the said addition has been made by the A.O. without considering the underlying ITA No. 72&85/PNJ/2012 facts pertaining to the pattern of investments and income arising out of the same which does not warrant application of section 14A.
2. The Learned CIT(A) erred in confirming the disallowance by the A.O. of the' expenditure of Rs. 9,88,29,729/- towards payment of sales commission to the nonresident agents.
3. The Learned CIT (A) erred in confirming the disallowance made by the A.O., u/s. 40(a)(i) of the Act, of the expenditure of Rs. 36,05,767/- incurred by the Appellant by way of payment of demurrage to the non- resident Buyers of iron ore.
4. The Learned CIT(A) erred in confirming the disallowance by the A.O. the expenditure of Rs. 1,19,70,782/- towards demurrage on ships payable to the non resident ship-owners, having failed to appreciate that neither the provisions of section 195 nor section 40(a)(i) were applicable to such tax payments.
5. The Learned CIT (A) erred in holding that the Appellant's claim for deduction of expenditure towards payment of the Education cess and the Secondary and High Secondary Cess of Rs. 19, 72, 00,814 /-, was not maintainable.
6. The Learned CIT(A) erred in holding that the Appellant is not eligible for deduction u/s. 10B of the Act, totaling Rs.257,23,14,771 in respect of its 100% Export Oriented Unit at Amona in Goa. The CIT(A) ought to have appreciated the unit set up in the year 2002-03 satisfies the condition of new undertaking as required under section 10-B of the Act.
7. The Learned CIT(A) erred in holding that the Appellant is not eligible for deduction u/. 10B of the Act, totaling Rs. 185,34,16,650 in respect of its 100% Export Oriented Unit at Chitradurga hi Karnataka.
8. The Learned CIT(A) erred in holding that the activity carried on by the Appellant at its EOU at Amona and Chitradurga cannot also be 2 ITA No. 72&85/PNJ/2012 considered as "production" to make the Appellant eligible for deduction u/s. 10-B of the Act in respect of the said EQUs.
9.1 .The Learned CIT(A) erred in holding that the activities carried on the EOU at Codli cannot be considered as "manufacture" and hence the Appellant is not eligible for deduction of Rs. 8,70,52,701/- u/s. 10-B of the Act.
9.2.The Learned CIT(A) erred in holding that the activity carried on by the Appellant in its EOU at Codli cannot also be considered as "production" to make the Appellant eligible for deduction u/s. 10-B of the Act in respect of the said EOU at Codli.
10. The Learned CIT(A) erred in holding that the Appellant is not eligible for deduction of Rs. 90,57,484/- as additional depreciation claimed u/s. 32(l)(iia) of the Act, in respect of plant and machinery acquired and installed in its met-coke division.
11. The Learned CIT(A) erred in confirming the disallowances by the A.O. of additional depreciation u/s. 32(1) (iia) of the Act of Rs. 10,01,21,951/-, in respect of plant and machinery acquired and installed by the Appellant in its business of mining operation.
2. During the course of hearing vide letter dt. 19/12/2012, Ld.AR requested that the ground No. 6.11 in detailed grounds of appeal filed on 24/09/2012 should also be added as ground No. 7A in the grounds of appeal filed in brief.
3. The Ld. DR also agreed that this ground is already there in detailed as ground no. 6.11. We accordingly admit ground No. 7A also for adjudication after ground no. 7 in grounds filed by the assessee in brief.
Revenue has taken the following grounds in their appeals: -
1. The order No. In ITA No.561/PNJ/2011-12/JCIT, dated: 31.08.2012 in the above case is opposed to law and facts of the case.
3ITA No. 72&85/PNJ/2012
2. The learned CIT (A) has erred in appreciating the issue of "Disallowance of Expenditure on Research & Development" to the tune of Rs. 1,94,55,376 for Assessment Year 2009-10, as Section 43(4)(i) of the I.T. Act, 1961 defines scientific research as any activities for the extension of knowledge in the fields of natural or applied science including agriculture, animal husbandry or fisheries. The case of the assessee is clearly not covered under this definition. Moreover, the assessee has also not taken approval of the designated authority that this activity tantamount to scientific research. For the A.Y 2006-07 also same issue was confirmed by CIT (Appeal).
3. The learned CIT (A) has failed to appreciate the "Disallowance of Foreign exchange notional loss/loss on forward contracts" to the tune of Rs.1,59,00,000/-. Board's Circular No. 23 (XXXIV-4) D of 1960 dated: 12/09/1960 and Instruction No.3 - 2010 dated: 23/03/2010 clearly says that the losses incurred by the assessee on forward contracts is to be treated as speculative loss and not hedging loss.
4. The learned CIT (A) has failed to appreciate the addition with respect to "Expenditure incurred in respect of issue of Bonus Shares" to the tune of Rs.61,35,482/-, which is mainly related to expansion of capital base and therefore it is in the nature of capital expenditure but not revenue expenditure.
5. For this and other grounds that may be urged at the time of hearing, it is prayed that the order of learned CIT (A) be cancelled and that of the Assessing Officer be restored.
4. The brief facts of the case are that the assessee filed return declaring an income of Rs. 28,84,80,920/-. Assessment u/s 143(3) was made vide order dt. 30/12/2011 u/s 143(3) after making various disallowances and the addition at an income of Rs. 4,90,07,85,742/-. The assessee went in appeal before the CIT(A) who partly allowed the appeal of the assessee.
4ITA No. 72&85/PNJ/2012
5. Ground nos. 1.1 & 1.2 in the appeal of the assessee relate to the disallowance u/s 14A of the I. T. Act. The brief facts relating to this ground are that AO has noted that the assessee has received dividend income of Rs. 1,42,72,73,668/- exempt from tax. The AO asked the assessee to explain why the disallowance u/s 14A read with rule 8D should not be made for the expenses incurred. The assessee submitted the explanation that he has not borrowed any money for purchase / investment on which dividend is received. No interest has been debited to profit and loss account. Interest and other charges appearing in the profit and loss account relate to Bank charges in connection with collection of outstation cheques. No administration expenditure was incurred on earning dividend income as investment in mutual funds was made just to park the surplus funds. The assessee has already disallowed a sum of Rs. 25,78,156/- in the computation of income. The AO did not agree and he was of the view that the company has made substantial investment in mutual funds. Investment of such magnitude requires proper analysis of the market condition to the stock movement etc. and therefore, the assessee must have incurred substantial expenditure for earning the dividend. The assessing officer by invoking the provision of section 14A read with Rule 8D worked out the disallowance as under:
i. Amount of expenditure directly relating to income which does not form part of total income - Nil ii. In a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely:- [AxB]/C = A. Amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year - Nil B. The average of value of investment, income from which does not or shall not form part of the total income appearing in the balance sheet of the assessee on the first day and the last day of the previous year Rs.20,00,44,93,634 + Rs.30,19,67,88,502 = Rs.50,20,12,82,136/-5
ITA No. 72&85/PNJ/2012 Average of the above = Rs.25,10,06,41,068/-
C. The average of total assets as appearing in the balance sheet of the assessee, on the first day of the last day of the previous year - Nil
(i) an amount equal to one-half per cent of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year.
= Rs.25,10,06,41,068 x .005 = Rs.12,55,03,205 Less: Administrative expenditure already disallowed Rs. 25,78,156 by the assessee Rs.12,29,25,049
Accordingly, a sum of Rs.12,29,25,049/- is disallowed u/s 14A read with Rule 8D as expenditure incurred for earning the exempted income and same is added to the total income.
6. The assessee went in appeal before the CIT(A). The CIT(A) confirmed the disallowance by holding as under:
"4.1 During the appellate proceedings, the authorised representative of the assessee vehemently argued on behalf of the appellant and pleaded for deletion of the disallowances made by the Assessing Officer. It was specifically stated that rule 8D provides for computation of disallowance only if the Assessing Officer, having regard to the accounts of the previous year is not satisfied with the correctness of the claim of expenditure computed by the assessee. It was claimed that a careful reading of both section 14A(2) as well as rule 8D(1)(b) brings out clearly that resort to making disallowance by applying threshold of 0.5% to the total value of investment is to be made only after the AO was not satisfied with the claim of the assessee regarding the computation of such expenses. Following the decision in the case of Jindal Photo Ltd. ITA no I.T.A. No. 4539/Del./2010, it was claimed that it was mandatory for the assessing officer to record his dissatisfaction about the claim of the assessee regarding computation of expenses incurred for earning the exempt income and the onus is on Assessing Officer to bring out the factual incurrence of expenses. The assessee also relied on various other authorities including that in the case of CIT vs. Hero Cycles Ltd (323 ITR
518), CIT vs Walfort Share and Stock Brokers (P) Ltd (310 ITR 421), etc, to substantiate its claim. In this regard it was also stated that that the reasoning of the Assessing Officer that the investment of such high magnitude would require a regular analysis and monitoring of the investments would have been relevant in the context of investment in equity shares or equity oriented mutual funds. Whereas, the entire investment in the case of the assessee is 6 ITA No. 72&85/PNJ/2012 into debt oriented mutual funds which do not require any significant efforts either in making such investment or in tracking the same. It was therefore claimed that the estimated disallowance of Rs.25,78,156/- made by the appellant was reasonable and therefore, the same should have been accepted by the assessing officer.
4.2 I have carefully considered the submissions of the assessee as well as the observations of the Assessing Officer. The primary contention of the assessee is that before invoking the provisions of section 14A for making disallowance of expenditure by applying rule 8D of the Income tax Rules, the assessing officer ought to have recorded his dissatisfaction for rejecting the quantification of the expenditure relating to the tax exempted income made by the assessee. Before proceeding further it will be relevant to examine the provisions of section 14A providing for disallowance of expenditure relating to exempt income.
Section 14A: For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.
Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001.
(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.
(3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this section.
From the plain reading of the provisions of section 14A of Income Tax Act, it is clear that no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act. Rule 8D of the Income Tax Rules expressly provides the method for determining the amount of expenditure in relation to the exempt income. Therefore, the position with respect to assessment year 2008-09 onwards is that in all cases where the assessing officer is not satisfied with the correctness of the claim of the assessee in respect of the expenditure incurred on earnings that do not form part of the total income, expenditure on this account has to be computed as provided under Rule 8D of Income Tax Rules. There can be no other basis of estimating such expenditure to be disallowed.
7ITA No. 72&85/PNJ/2012 4.3. From the assessment order it is observed that the assessing officer has taken not accepted the claim of the assessee that since most of the investments were made in mutual funds primarily to invest the surplus funds of the company, no administrative expenditure was incurred in this regard.The assessing officer had specifically taken note of the fact that there was substantial investment made by the company resulting in receipt of substantial amount of dividend income and considering the magnitude of both the investment held and the dividend received by the company, it was not plausible to accept that no administrative expenditure was incurred in the hands of the company in this regard. It is also important to note that the assessing officer had specifically recorded his dissatisfaction about the correctness of disallowance of Rs.25,78,156/- made by the assessee. The fact that the assessing officer had properly examine the matter and had applied his mind to the issue of disallowance of expenditure is also evident from the fact that the assessing officer had considered and accepted the explanation of the assessee regarding the claim that no borrowed funds were used by the company for such investments and hence no disallowance of interest u/s14A was called for.
4.4 On careful consideration of the facts of the case, it is observed that there is an inherent contradiction in the submissions made by the assessee. While on one hand the assessee vehemently claims that no direct expenditure was incurred to earn the dividend income, on the other hand it had quantified certain expense on a notional basis which could relate to earning of dividend income from such investments. The fact, that the assessee had made an notional disallowance of Rs.25,78,156/- as the estimated administrative expenditure relatable to the earning of dividend income, shows that it was only an adhoc quantification of the expenditure without having any direct co-relation with the actual expenditures incurred.
In this regard it is relevant to refer to the annexure submitted by the assessee during the scrutiny proceedings, furnishing details of the computation of the amount Rs.25,78,156/-. From the information furnished in the annexure, it is clearly noticed that for the purpose of allocation of expenditure relating to the exempt income, the assessee has considered expenses only under three heads including ‗maintenance of office equipments', ‗printing and stationery' and ‗postage and telephone'. The other administrative expenses such as professional and legal charges (Rs.23.56 crores), auditors fees (Rs. 0.53 crores), traveling and representation expenses of Directors (Rs.4.22 crores) and miscellaneous expenses (Rs.3.60 crores) were not considered by the assessee for allocation. No specific reasons have been furnished in this regard to justify why these heads are not relevant in this regard. It is relevant to note that the expenditure referred to in section 14A should comprise of expenditures such as salary, rent, taxes, interest, etc. In fact, in the decision in the case of Godrej & Boyce Mfg.Co. Ltd., the Hon'ble Bombay High Court has held that, the expression 'expenditure incurred' in section 14A refers to expenditure on rent, taxes, salaries, interest, etc., in respect of which allowances are provided for. [Para 43]. Therefore, it was necessary for the assessee to allocate all the expenditures relevant for incurring the tax exempt income instead of limiting the allocation only to three heads of expenditure, as discussed above.
8ITA No. 72&85/PNJ/2012 Further, it is also seen that for the purpose of allocation of the expenses, the assessee has allocated the expenses on a pro rata basis by taking into consideration the turnover of different types of receipts such as, sales, hire charges of transhipper, sale of gas, sale of carbon credits etc. However, in respect of dividend income, the assessee has taken ‗income' as the basis for the purpose of allocation instead of considering the total investment, which should correspond to ‗turnover' as in the case of other receipts. This is patently wrong because the basis of allocation should be similar for all items and when the assessee has considered turnover as the basis for all other kind of receipts, it ought to have also considered the total turnover of the investment for allocating the expenses in respect of the dividend income. Therefore, allocating the expenditure taking income as the basis in the case of dividend income and turnover as the basis in the case of other receipts, gives rise to major distortion in the allocation of expenditure. Further, it is also seen that the allocation of the expenditure incurred towards Salary, Gratuity, PF etc, which alone accounted for 38% of the total administrative expenditure, has not been made on a proportionate basis. No justification has been adduced in this regard. If the total salary expenditure of Rs.21.85 crores is allocated on a pro rata basis, the proportionate amount relatable to dividend income will be Rs.62.10 lacs instead of Rs.17.03 lacs, as computed by the assessee in the annexure. This clearly shows that the basis adopted by the assessee for quantification of the expenditure incurred in relation to the exempted income is grossly flawed and erroneous.
Further, it is also seen that the sales and other receipts of the assessee, excluding dividend income is around Rs.4853 crores. The average value of the investments as per the balance sheet is found to be Rs.2510 crores. Put together, the total turnover including investment in mutual funds comes to Rs.7363 crores approximately. Therefore, if the total administrative expenditure of Rs.56.59 crores is allocated on a proportionate basis, the expenditure incurred in relation to the dividend income shall amount to Rs.19.29 crores. As against this, the assessee had computed an amount of Rs.25.78 lacs as the proportionate expenditure.
Similarly, on a different analogy, it may be seen that in the explanation baa under section 80HHC of the income tax act, the statute provides for deduction of 90% of various receipts such as sale of license, duty drawback, commission, interest, etc, for computing the business profits. This implies that in such cases 10% of such receipts could be reasonably held to be the expenditure in relation to the receipts. Taking this into consideration, the expenditure incurred in relation to making investment in shares and mutual funds could be reasonably estimated by taking a similar figure of 10% of the total transactions in such shares and mutual funds. By adopting this method of computation, the expenditure incurred in relation to the mutual fund investments in the case of the assessee comes to Rs.25.10 crores being 10% of the average investment of Rs.2510 crores, which is very close to the estimation made by the Assessing Officer.
4.5 The above discussions and comparisons clearly show that the quantification of the expenditure at Rs.25.78 lacs made by the assessee is grossly understated and without any basis. As discussed above the assessee 9 ITA No. 72&85/PNJ/2012 has not allocated the total salary expenditure of Rs. 21.85 crores proportionately. Instead, it has taken adhoc figure of Rs. 17.03 Lacs as the salary expenditure incurred in relation to earning of dividend income, which is without any basis. It has been also shown above that if the salary expenditure was allocated proportionately, the expenditure incurred for earning the dividend income would have been Rs.62.10 lacs instead of Rs.17.03 lacs, as computed by the assessee. Considering the above deviations and discrepancies, it is clearly established that the method adopted by the assessee for the allocation of expenditure in relation to the exempted income is grossly flawed and erroneous and therefore, the Assessing Officer was fully justified in not being satisfied with the correctness of the claim of the assessee and for invoking the provisions of section 14A(2) of the I. T. Act.
4.6 The assessee has relied on various judicial decisions such as in the case of CIT vs. Hero Cycles Ltd , 323 ITR 518(P&H) and CIT vs Walfort Share and Stock Brokers (P) Ltd, 326 ITR (SC), to substantiate this ground of appeal. However, on examination of these cases it is observed that these decisions relate to the assessment year 2004-05 and 2000-01 respectively, which was prior to the insertion of rule 8D. Careful reading of both section 14A(2) as well as rule 8D(1) clearly brings out that the Assessing Officer can derive jurisdiction to invoke the provisions of this section only if he is not satisfied with the correctness of the claim of the assessee in respect of the expenditure, which the assessee claims to have incurred in relation to the exempt income. Section 14A clearly mandates that once the Assessing Officer is satisfied that the claim of the assessee is not correct, he has no other option but to invoke the methods prescribed in Rule 8D for quantifying the expenditure incurred in relation to the exempt income. In the present case, there are more than sufficient reasons, as discussed above, for the Assessing Officer to reject the claim of the assessee. In view of the glaring errors as discussed above, the Assessing Officer is fully justified in invoking the provisions of I.T. Rule 8D for quantifying the expenditure incurred in relation to the exempt income. Admittedly, the assessee has not raised any objection as far as the computation of the expenditure under Rule 8D is concerned. Therefore, in my considered view, the assessing officer was correct for not being satisfied with the correctness of the claim of the assessee in respect of such expenditure incurred in relation to the exempt income. Having clearly recorded his dissatisfaction about the correctness of the claim made by the assessee, he was fully within his jurisdiction to invoke the provisions of section 14A(2) and quantify the amount to be disallowed as prescribed under rule 8D(1)(b). Therefore, considering the facts of the case and for the reasons as discussed above, I confirmed the disallowance of expenditure of Rs.12,29,25,049/- made by the Assessing Officer under section 14A of the I.T. Act. The first ground of appeal is accordingly dismissed.‖
7. Before us the Ld. AR submitted that the assessee has not borrowed any funds for the investment in mutual funds. Therefore, no interest has been debited. The assessee has merely parked his surplus funds in debt mutual funds. The assessee has not invested any equity 10 ITA No. 72&85/PNJ/2012 shares. Therefore, the assessee has not carried out any analysis of the market condition, stock investment, etc. The assessee himself worked out the disallowance at Rs.25,78,156/- in the following manner:
SESA GOA LIMITED Allocation of Maint. of Office Equipment, Printing & Stationery, Postage and Telephone Expenses on the basis of income and part salary of the Finance Team for the financial year 2008-09 for the purpose of subsection (2) of section 14A Particulars Income Maint. of Print. & Post & Salary Total Off. Equip. Stat. Tel.
Sales<PHONE_NUMBER>8 13090545 5806553 14129124
Hire of 77622414 21405 9495 23103
Transhipper
Sale of 37827915 10431 4627 11259
Materials
Sale of Carbon 27606793 7613 3377 8217
Credits
Sale of gases 36427301 10045 4456 10842
Hire Charges of 25362117 6994 3102 7549
Barges 2696889
11
ITA No. 72&85/PNJ/2012
Proceeds from 114783174 31652 14040 34164
various
services
Interest 428301292<PHONE_NUMBER>9 127478
Dividends<PHONE_NUMBER><PHONE_NUMBER>78<PHONE_NUMBER>935
Profit on sale of 629444 174 77 187
assets
Other receipts 14278125 3937 1746 4250
Profit on sale of 301014801 83007 36819 89593
investments
Provision for
doubtful debts
written back
49962317722 13777486 6111258 14870566 1703935
Allocation of Expenditure on exempt income (on Dividends) DIVIDENDS Expenditure SGL - Dividends 1,42,72,51,668 25,78,156 SIL - Dividends 6,57,29,601 1,18,733 Total Dividends 1,49,29,81,269 26,96,889 Designation Chief Treasury Managing of Financial Total Officer Director Employee Officer Salary - 4,02,475 25,48,920 1,32,84,603 1,62,35,998 CTC basis Percentage 100% 25% 5% of salary Amount 4,02,475 6,37,230 6,64,230 17,03,935
8. The assessing officer mainly observed that he is not satisfied with the disallowance made with the assessee and applied rule 8D. The 12 ITA No. 72&85/PNJ/2012 assessee company did not borrow any funds for making such investments and the same was made out of its own funds. No direct administrative expenses were incurred in respect of such investments. Even assuming that the expenditure incurred as referred to in section 14A covers also indirect expenditure, a proportion of administrative expenditure of Rs.25,78,156/- (which could be relatable to such investments) had already been offered for disallowance u/s 14A . The said disallowance offered by the assessee included part of salaries of its respective officials engaged in such investment work and related incidental administrative expenses. The AO accepted the fact that no borrowings were made for such investments, hence no disallowance was made in relation to interest expenses or any direct expenses but the AO applied rule 8D and made disallowance @ 0.5% of the average amount of investments at the beginning and closing of the year and a disallowance of Rs 12,29,25,049/- was made. It was pointed out that the AO made following averments: -
a) No administrative expenditure was incurred on earning of dividend income.
b) The disallowance made by the assessee towards administrative expenditure is very low considering the magnitude of the investments and dividend income received.
c) An investment of this magnitude cannot be made without a proper analysis of the market condition/stock movement.
The Ld. AR drew our attention towards the findings of the CIT (A) and stated that CIT (A) in brief gave the following findings: -
a) There is an inherent contradiction in the submissions of the assessee. On one hand it argues that no direct expenditure was incurred to earn dividend income and on the other hand it quantified certain expenses on a notional basis.
b) The assessee has considered expenses only under three heads, i.e., (a) maintenance of office equipments, (b) printing and stationery, and (c) postage and telephone. Other administrative expenses were not considered by the assessee for allocation and no specific reasons have been furnished for the same.13
ITA No. 72&85/PNJ/2012
c) The assessee has allocated the expenses on pro-rata basis by taking into consideration the turnover of different types of receipts such as sales, hire charges, sale of gas and carbon credits. However, in respect of dividends, the assessee has considered the dividend income instead of total investment in mutual funds which is wrong because the basis of allocation should be similar for all items.
d) Further, salary has not been allocated correctly on proportionate basis. If the entire salary expenditure of Rs. 21.85 crores is allocated then proportionate amount relatable to dividend income would be Rs. 62.10 lacs instead of Rs. 17.03 lacs as computed by the assessee.
e) If the total administrative expenses of Rs. 56.59 Crores are allocated among the sale and other receipts of business (Rs. 4,853 Crores) and value of investments in mutual funds (Rs. 2,510 crores), then it shall amount to Rs. 19.29 crores in respect of dividends.
f) As per section 80HHC Explanation baa, 10% of receipts could reasonably be held as the expenditure in relation to other receipts. Then the expenditure comes to Rs. 25.10 crores being 10% of the investment of Rs. 2,510 crores which is very close to the estimation of the AO.
g) On the basis of above deviations and discrepancies, it is clearly established that the method adopted by the assessee is erroneous and flawed and the AO is fully justified in invoking Rule 8D and therefore confirmed the disallowance.
9. It was submitted by the Ld. Counsel that the assessee invested funds on the advice of mutual fund managers. Mutual fund officials came to the doorstep of the assessee to collect the forms and cheques and rendered all services and in some cases dividends are reinvested in the mutual funds itself and thus practically no cost was incurred by the assessee in making investments and receiving dividends. The assessee invested in debt mutual funds. Page Nos. 457-458 of (Initial) PB Vol. II containing details of investments exhibit that the assessee invested in a limited number of mutual 14 ITA No. 72&85/PNJ/2012 funds only. Further, Page No. 20 of (Initial) PB Vol. I exhibit the details of profit on sale of investments which has been offered for taxation by the assessee as capital gain and due taxes have been paid thereon. Therefore, undisputedly taxable income was earned from these investments. Accordingly, section 14A cannot be applied when investments are yielding taxable income as well. Further only few transactions of purchase and sale have been undertaken by the assessee. The assessee need not spend day to day time to decide about the investments as the assessee has not churned out / shifted the investments on daily / regular basis. It can be seen that once an investment is made, it lies there; just a few of them were sold to encash profit on them and which was subjected to capital gains tax. Only one person was full-time engaged for the investment activity and who used to analyse various options and then the decision to invest was taken by the CFO and approved by the Managing Director. Therefore, the assessee itself disallowed u/s 14A the salary of the said persons to the extent of their involvement in the activity of investments as mentioned on Page No. 109 of (Initial) PB Vol. I. However, CIT (A) presumed that each staff and personnel was participating in the investment activity and probably therefore felt the need to allocate the entire salary in some proportion. But this proposition is prima facie fallacious since all employees are not supposed to undertake or be engaged in each and every business activity. Their strength is pre- determined accordingly to the manpower requirement and their duties are also pre-assigned accordingly. It must be appreciated that the primary business of the appellant is „mining‟ which definitely entails a huge manpower need and in comparison to which the manpower required to assist in investing surplus funds with mutual funds is absolutely insignificant. Thus, the entire salary expenses of the entire staff cannot be allocated proportionately between taxable and exempt incomes as averred by the CIT (A), especially when a proper person-wise allocation to the investment activity is practically possible.
10. The assessee has also made the proportionate disallowance out of certain expenses relatable to earning of exempt income as mentioned on Page No. 108 of (Initial) PB Vol. I, which was considered relatable to earning exempt income. No expenses such as rent, legal and professional 15 ITA No. 72&85/PNJ/2012 fees, travelling expenses of director, etc., were particularly incurred for this investment activity and therefore no disallowance was made. Hon‟ble Supreme Court in CIT Vs Walfort Share & Stock Brokers (P) Ltd. (2010) 326 ITR 1 (SC) held that the AO is required to prove that the disallowance is necessary due to proximate cause and nexus of expenditure to earn the exempt income. Likewise, in Maxopp Investment Ltd Vs. CIT (2011) 15 Taxmann. Com 390 (Delhi), it has been held that the Assessing Officer is required to satisfy as regards the incorrectness of the claim of expenditure.It was for the AO to point out the expenses actually incurred for earning the exempt income and point out discrepancy in the computation of disallowance made by the assessee. But no such effort has been made by the AO and no such discrepancy has been pointed out as can be seen from the assessment order. No evidence has been brought on record by the AO that the explanations of the appellant were not correct. A reasonable amount of expenditure of more than Rs. 25.78 lacs including salaries was disallowed by the appellant himself. The AO did not record his satisfaction as to why the disallowance made by the assessee-company was incorrect. He merely alleged that the said disallowance is low as compared to the magnitude of investment and disallowance which cannot be a reason for applying Rule 8D. Referring to section 14A(2), it was pointed out that the satisfaction of the assessing officer about the incorrectness of the claim of the assessee in respect of the expenditure relating to the dividend income should be with regard to the accounts of the assessee. No such satisfaction has been arrived at by the assessing officer. He has not rejected the accounts of the assessee. He has not pointed out any mistake in the accounts of the assessee. The Ld. A.R. in this regard relied on the decision of the jurisdictional High Court in the case of Godrej & Boyce Manufacturing Company Ltd. Vs. DCIT 328 ITR 81 (Mum.).
11. Rule 8D provides for the computation of the disallowance in this connection, only if the assessing officer, having regard to the accounts of the previous year is not satisfied with the correctness of the claim of the expenditure computed/worked out by the assessee. The assessing officer must, in the first instance determined whether the claim of the assessee in that regard is correct and the determination must be made having regard 16 ITA No. 72&85/PNJ/2012 to the accounts of the assessee. The satisfaction of the assessing officer must be arrived at on an exact basis. The CIT (A) concluded that the assessee made a contrary claim that no administrative expenditure was incurred but worked out the disallowance on notional basis. There is no contradiction in the statement of assessee. The assessee stated that there was no directly relatable expenditure which was incurred to earn dividends and the disallowance was made for other expenses. This was, in fact, accepted by the AO who also did not make any disallowance u/r 8D(1)(i). The CIT (A) tried to justify the application of Rule 8D by the assessing officer on surmises and presumptions which is not permissible at all. One assertion made by the CIT (A) was that the amount of investment corresponds to the amount of turnover/sales in case of dividends and therefore the same should be considered for the purpose of allocation of indirect expenses, but it is submitted that it is not correct proposition. The corresponding base figure to the value of investment made in mutual funds can at best be the stock of iron-ore/finished goods, but it can never be said to correspond to the turnover of iron-ore, etc. in any manner because the basic nature of receipts and income is such that they can never correspond to stock or value of investment at all. Further, the turnover of mutual funds, i.e., the value of redemption of mutual funds is subject to tax as capital gains [since exemption/s 10(38) is not available on liquidation of a debt-oriented mutual fund] and therefore the said basis cannot be considered for the purpose of computation of disallowance u/s 14A. Thus, to allocate the indirect expenses, only dividend receipts / income could have been considered as has been done by the assessee. Thus, the presumption of the CIT (A) to consider the value of investment for allocation of expenses is baseless. Another preposterous proposition of the CIT (A) is to apply section 80HHC which is entirely a different code for an entirely different purpose. The basis of 10% adopted therein cannot be considered while computing disallowance u/s 14A. If that basis was to be adopted then there was no need to introduce Rule 8D. The intention behind enacting the provisions of section 14A and rule 8D is to bring equity in levy and collection of taxes by providing that if an income stream is not taxable then expenses incurred in relation thereto should not/cannot be allowed - (which if not done, then may allow a sort of double 17 ITA No. 72&85/PNJ/2012 advantage to an assessee). However in the same corollary of argument, it should be appreciated that the intention behind provisions laid down in Rule 8D is not to embark upon an unwarranted high level of disallowance of expense when the available facts and circumstances do suggest otherwise.
12. Reliance was placed in this regard on the decision in the case of CIT Vs. Jindal Photo Ltd. in ITA No.4539/DLI/010 dated 7/1/11 for the proposition of the law that the assessing officer must record his dissatisfaction about the claim of the assessee regarding computation of expenses incurred for earning exempt income with regard to the accounts of the assessee. No ad-hoc disallowance can be made. Again Delhi Bench of this Tribunal for the assessment year 2008-09 in the case of the same assessee i.e. DCIT Vs. Jindal Photo Ltd. vide order dated 23/9/2011, the Tribunal followed the same principle and took the view that a mechanical application of rule 8D is not permissible. The onus is on the assessing officer to record his satisfaction as to the incorrectness of the claim of the assessee about the expenses incurred in relation to the exempt income and assessing officer has to establish a clear finding of the expenses incurred in relation to the exempt income. Reliance was also placed on the decision of Justice S.P. Barucha Vs. Addl. Income Tax Officer in ITA No.3889/Mum/2011. But this decision, in our opinion, is not applicable to the facts of the case as in this case, the assessee has not claimed any expenditure being incurred for earning the exempt income. Reliance was also placed on the decision of the `F‟ Bench, Mumbai in ITA No. 5779/2006 and ITA No. 208/2009 in the case of Avshesh Mercantile Pvt. Ltd. and others Vs. DCIT for the proposition of the income when the assessee has both taxable as well as exempt income, the provisions of section 14A will not apply. Reliance was also placed on the decision of apex court in the case of CIT Vs. Walfort Share and Stock Brokers Ltd., 326 ITR 1, it was stressed that the intention beyond provision laid down in rule 8D is not embarked upon an unwarranted high level of disallowance of expenditure when the available factors and circumstances do suggest that an ad-hoc application would provide such result as has happened in assessee‟s case. It was pointed out that, as a result of computation of 18 ITA No. 72&85/PNJ/2012 disallowance by the assessing officer u/s 14A, the disallowance in relation to exempt income comes at Rs.12,55,03,205/- i.e. about 8.8% of total exempt dividend income. Whereas, as per the audited accounts, the total administrative expenses incurred for the whole year are only Rs.56.59 crores with regard to the total turnover of Rs.4,996.23 crores, including the exempt dividend income. This works out only at 1.7%. It is impossible for a company to incur almost 1/5th of Rs.56 crores in earning an income which is from investment and not from the main stream.
13. The Learned D.R. on the other hand submitted that the assessee‟s investment in shares, etc. are Rs.2,510 crores. Dividend income earned from this investment is Rs.142,72,73,668/-. The assessee has worked out the disallowance at Rs.25,78,156/- u/s 14A on ad-hoc basis by taking into account expenditure incurred towards maintenance of office equipment, printing & stationery and postage & telephone. The assessing officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee as the explanation of the assessee that no administrative expenditure incurred on earning dividend income not acceptable, considering the magnitude of investment and dividend income received. The disallowance made by assessee u/s. 14A of the Act towards administrative expenditure is low on comparing the magnitude of purchase and sale made by the assessee and investment of large magnitude cannot be made by proper analysis of the market condition stock movement etc. Appellate Commissioner confirmed finding of the Assessing Officer that having regard to the accounts of the assessee is not satisfied with the correctness of the claim. Submission of the assessee on the one hand that there was no administrative expenditure and on the other hand there was administrative expenditure which was worked out on notional basis is self contradictory. Ad-hoc administrative expenditure worked out by the assessee on "maintenance of office equipment", "printing and stationery" and "postage and telephone".
Other administrative expenses such as:-
Professional legal charges Rs.23.56 crores
Auditors fee Rs. 0.53 crores
19
ITA No. 72&85/PNJ/2012
Travelling and representation expenses of
Directors Rs. 4.22 crores
Miscellaneous expenses Rs. 3.60 crores
Not taken into consideration.
Administrative expenditure such as salary rent, taxes, interest not taken into consideration in working out ad-hoc basis as held in Godrej & Boyce Mfg. Co. Ltd. Expenses on prorate basis was worked out by taking into consideration the turnover of different types of receipts such as sales, higher charges of trans chipper, sale of gas, sale of carbon credits etc., However, in respect of dividend income assessee has taken into consideration income as the basis. Accuracy of assessee‟s ad-hoc quantification not correct.
Sales and other receipts (excluding dividend). Rs.4,853 crores Average value of investment as per balance sheet Rs.2,510 crores Total turnover is Rs.7,363 crores Total administrative expenditure declared is Rs.56.59 crores Proportionate expenditure of dividend income Rs.19.29 crores Whereas, assessee had declared Rs.25.78 lakhs as expenses.
Satisfaction of the Assessing Officer has been clearly recorded in order to invoke Section 14A of the Act. Satisfaction of the Assessing Officer must in the first instance make the determination, it does not prohibit the Appellate Commissioner to revise the determination or exercise the power which the ITO could exercise. Admittedly, assessee works out the administrative expense which is found to be incorrect. Admittedly, assessee cannot workout the expense as per Section 14A of the Act on ad-hoc basis and said Section 14A of the Act is not applicable or no administrative expense incurred. Contention that no expenditure incurred for earning substantial dividend income cannot be accepted. No dispute regarding computation of Rs.12,29,25,049/- in accordance with Rule 8D of the I T Rules. He relied on the following cases:-
1. (2007) 111 TTJ (Mumbai) 82 ACIT Vs. Citicorp Finance (India) Ltd.,
2. (2005) 93 TTJ (Chennai) 161 Southern Petro Chemical Industries Vs. DCIT 20 ITA No. 72&85/PNJ/2012
3. (2004) 83 TTJ (Mumbai) 843 ACIT Vs. Premier Consolidated Capital Trust (I) Ltd.,
4. (2010) 328 ITR 81 (Bom) Godrej & Boyce Mft. Co. Ltd. Vs. DCIT & Anr.,
5. (1962) 44 ITR 739 (SC) CIT & Anr. VS S.V. Angidi Chettiar
6. (1958) 33 ITR 182 (SC) CIT Vs. McMillan & Co.
7. (2005) 278 ITR 3 (GUJ) CIT Vs. Parmanand M. Patel
14. We have carefully considered the rival submissions along with the order of the authorities below. We have also gone through various case laws and the provisions of the IT Act in this regard. The issue involved before us relate to the disallowance made by the AO by applying the provisions of sec.14A of the IT Act read with Rule 8D of the IT Rules. Sec.14A was inserted by the Finance Act, 2001 w.e.f. 1.4.1962. Originally this sec. provides that in computing the total income of the assessee no deduction shall be allowed in respect of the expenditure incurred by the assessee in relation to the income which does not form part of the total income under the Act. Subsequently, by Finance Act, 2002 with retrospective effect from 11/5/2001 proviso was added which states that this sec. shall not empower the AO either to re-assess or pass an order enhancing the assessment or reducing the refund already made or otherwise increasing the liability of the assessee for any assessment year beginning on or before 1/4/2001. With effect from 1/4/2007 by Finance Act, 2006 sub-sec. (2) empowers the AO to determine the amount of expenditure incurred in relation to such income which does not form part of the total income in accordance with the method as may be prescribed. Such power is to be exercised if the AO having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of the expenditure mentioned in sub-sec.(1). Before applying Rule 8D, it is apparent that the AO must be satisfied with the correctness of the claim of the assessee having regard to the accounts of the assessee. Such satisfaction is an objective satisfaction that it has to be judicious and based on the material on record. It cannot be an impression that 21 ITA No. 72&85/PNJ/2012 it is much more than the gossip or hearsay, it means judgment or belief that it is a belief or a connection resulting from what one thinks on a particular question. It must be based on the reasons and ground as seems good to him and while making such satisfaction, the AO must give regard to the accounts of the assessee. He must record deficiency in the accounts with regards to the claim of the assessee. Sub-sec.(3) provides that provisions of sub-sec.(2) shall also apply where assessee claims that no expenditure had been incurred in relation to income not forming part of the total income. This is not the case of the assessee as in the case of the assessee, assessee himself estimated the expenses relating to the exempt income and disallowed the same. Rule 8D was inserted by gazette notification dated 24/3/2008 in view of the power conferred under sub-sec (2). This Rule prescribes the method for computing the expenditure incurred in relation to the income not forming part of the total income. This is an undisputed fact that in this case, the assessee has invested in debts mutual funds. The assessee computed disallowance u/s 14A(2) at Rs.25,78,156/- and disallowed the same, while computing its total income. The working of the said disallowance claimed by the assessee is given herein above in the submissions made by the assessee. The AO was not satisfied with the correctness of the claim of the assessee especially the explanation of the assessee that no administrative expenditure incurred on earning the dividend income. Considering the magnitude of the investments and the dividend income received, the AO was of the view that the disallowance made by the assessee u/s 14A of the IT Act towards the administrative expenditure is low on comparing the magnitude of purchase and sales made by the assessee and the investments of large magnitude cannot be made without proper analysis of the market condition/stock movement etc. The revenue was of the opinion, that the assessee has worked out the administrative expenditure and had not considered all the administrative expenditure. Both the parties before us vehemently relied on the decision of Godrej Boyce Mfg Co. Ltd. Vs DCIT 328 ITR 81 (Mum).
15. We have gone through this decision and we noted that in this case, the assessee claimed exemption in respect of dividend income of 34.34 crores u/s 10(33). The AO issued notices for disallowance of interest u/s 14A of the IT Act. The explanation of the assessee was that (i) 95% of the shares were 22 ITA No. 72&85/PNJ/2012 bonus shares for which no cost was incurred; (ii) No investment in shares was made in the current year and no disallowance was made in earlier years and
(iii) There were sufficient interest free funds available in the form of share capital, reserves etc. which were more than investment in shares. The AO was not satisfied with the explanation of the assessee and he made disallowance u/s 14A on prorata basis. The CIT(A) following his orders for earlier years, accepted the appeal of the assessee. The Tribunal following the decision of the Special Bench in the case of ITO Vs Daga Capital Management (P) Ltd 117 ITD 169 (SB) restored the matter to the file of the AO for the consideration in the light of the provisions of sub-sec.(2) & (3) of Sec.14A of the IT Act. The assessee, being aggrieved, filed appeal as well as Writ Petition challenging the constitutional validity of sub-sec. (2) & (3) and Rule D. The Hon‟ble High Court gave the following findings;
1. The provisions of sec. 14A and Rule 8D are constitutionally valid.
2. The provisions of sub-sec. (2) & (3) of Sec.14A and Rule 8D are prospective and not retrospective, in nature and therefore, would apply from assessment year 2007-08.
3. The basic object of Sec.14A is to disallow the direct and indirect expenditure incurred in relation to income which does not form part of the total income (page 21).
4. The insertion of sec.14A was curative and declaratory of the intent of the Parliament. The basic principle of taxation is that only net income, namely, gross income minus expenditure that is taxable.
Expenses incurred can be allowed only to the extent that they are relatable to the earning of taxable income (pages 22-23). The test which has been enunciated in Wallfort for attracting the provisions of sec.14A is that there has to be a proximate cause for disallowance which has its relationship with the tax exempt income. Once the test of proximate cause, based on the relationship of the expenditure with tax exempt income is established, a disallowance would have to be effected under section 14A (page 28)
5. What merits emphasis is that the jurisdiction of the AO to determine the expenditure incurred in relation to such income which does not form part of the total income, in accordance with the prescribed method, arises if the AO is not satisfied with the correctness of the 23 ITA No. 72&85/PNJ/2012 claim of the assessee in respect of the expenditure which the assessee claims to have incurred in relation to income which does not form part of the total income. Moreover, the satisfaction of the AO has to be arrived at, having regard to the accounts of the assessee. Hence, sub-sec (2) does not ipso facto enable the AO to apply the method prescribed by the rules straightaway without considering whether the claim made by the assessee in respect of the expenditure incurred in relation to income which does not form part of the total income is correct. The AO must, in the first instance, determine whether the claim of the assessee in that regard is correct and the determination must be made having regard to the accounts of the assessee. The satisfaction of the AO must be arrived at on an objective basis. It is only when the AO is not satisfied with the claim of the assessee, that the legislature directs him to follow the method that may be prescribed. In a situation where the accounts of the assessee furnish an objective basis for the AO to arrive at a satisfaction in regard to the correctness of the claim of the assessee of the expenditure which has been incurred in relation to income which does not form part of the total income, there would be no warrant for taking recourse to the method prescribed by the rules. For, it is only in the event of the AO not being so satisfied that recourse to the prescribed method is mandated by law (pages 31-32).
6. In the event that the AO is not satisfied with the correctness of the claim made by the assessee, he must record reasons for his conclusion (page-79).
7. The effect of sec.14A is to widen the theory of the apportionment of expenditure (page 49).
8. The expression ‗expenditure incurred; in Sec.14A refers to expenditure on rent, taxes, salaries, interest, etc., in respect of which allowances are provided for (page-50).
9. Sub-sections (2) & (3) of Sec.14A are intended to enforce and implement the provisions of sub-sec (1) (pages 50).
10. Even in the absence of sub-section (2) of sec.14A the AO would have to apportion the expenditure and to disallow the expenditure incurred by the assessee in relation to income which does not form 24 ITA No. 72&85/PNJ/2012 part of the total income under the Act. The AO would have to follow a reasonable method of apportioning the expenditure consistent with what the circumstances of the case would warrant and having regard to all relevant facts and circumstances‖.
The said decision of the jurisdictional High Court is binding on us. While deciding this case, the decision of the Hon‟ble Supreme Court in the case of CIT Vs Wallfort Shares & Stock Brokers Ltd., 233 CTR (SC) 42 was referred to. In this decision, we noted that the Hon‟ble Supreme Court in that case upheld the view of the Hon‟ble Mumbai High Court in the case of Wallfort Shares & Stock Brokers Ltd. Vs ITO 310 ITR 421. The Hon‟ble Supreme Court in this decision, at page-31 of the order held as under;
―To attract Sec.14A there has to be proximate cause for disallowance which has its relationship with the tax exempt. Pay back or return of investment is not such proximate cause. Hence, Sec.14A is not applicable in the present case. Thus, in the absence of such proximate cause for disallowance, Sec.14A cannot be invoked‖.
16. The Hon‟ble Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd. Vs DCIT (supra) therefore at page-28 has clearly laid down that there must be proximate cause based on the relationship of the expenditure that tax exempt income is established, only then a disallowance would have to be effected u/s 14A of the IT Act. Therefore, in view of the decision of the jurisdictional High Court and the decision of the Hon‟ble Supreme Court, we are of the view that sec.14A cannot be applied unless there is a proximate cause for disallowance. The onus to establish that there is proximate cause based on the relationship of the expenditure with the exempt income in our opinion is on the Revenue. Thus, the application of the provisions of sec. (2) & (3) of Sec.14A and Rule 8D is not automatic in each and every case, where there is income not forming part of the total income. Sub-sec. (2) & (3) are intended to enforce and implement the provisions of sub-sec. (1). Therefore, it is necessary for the AO first to ascertain whether there is proximate connection between the expenditure incurred and the income not forming part of the total income. If such proximate connection is established with the exempt income, the AO would be justified in applying the provisions 25 ITA No. 72&85/PNJ/2012 of sub-sec (2) & (3) of sec.14A and Rule 8D of the IT Act, 1961. The expenditure incurred u/s 14A would include direct and indirect expenditure, but relationship with exempted income must be proximate. If there is material to establish that there is direct nexus between the expenditure incurred and the income not forming part of total income then disallowance would be justified even where there is no receipt of exempted income u/s 10 in the year under consideration in view of the decision of Special Bench in the case of Cheminvest Ltd. 124 TTJ 577 (Del)(SB).
17. The basic principle of taxation is to tax the net income. On the same analogy, the exemption is also to be allowed on net basis i.e. gross receipts minus related expenses. Therefore, if any expenditure is directly related to exempted income, it cannot be allowed to be set off against taxable profit. On the same analogy, in our opinion, if any expenditure is directly related to taxable income, it cannot be allowed to be set off against the exempted income merely because some incidental benefit has arisen towards exempted income. Before making any disallowance u/s 14A, the AO is required to record a satisfaction, having regard to the accounts of the assessee, that claim of assessee that expenditure incurred is not related to the income forming part of the total income is incorrect. Such satisfaction must be arrived at on the objective basis. He is also required to record the reasons for arriving at such satisfaction. The assessing officer in this case, we noted is not satisfied with the correctness of the disallowance made by the assessee even though he has accepted the explanation of the assessee that no interest is incurred with regard to exempt income. He rejected the explanation of the assessee that no administrative expenditure incurred on earning dividend income considering the magnitude of the investments and dividend income received and the disallowance according to him made by the assessee u/s 14A towards administrative expenditure is very less. The assessing officer nowhere pointed out the proximate connection of other expenses not apportioned by the assessee for the earning of the dividend income. He merely observed that the administrative expenses disallowed by the assessee is very less but how they are less and how the other expenses incurred by the assessee related to the dividend income has not been brought on record. Even the AO has not pointed out the expenses excluded by the assessee for 26 ITA No. 72&85/PNJ/2012 disallowance has proximate connection with dividend income. In our opinion, the assessing officer before rejecting the disallowance computed by the assessee must give a clear cut finding having regard to the accounts of the assessee how the other expenditure claimed by the assessee out of non exempt income is related with the exempt income. No discrepancy in the claim of the assessee was pointed out. The assessing officer in our opinion in view of the jurisdictional High Court decision is bound to record satisfaction as to how the expenses claimed by the assessee have been incurred on earning dividend income were not sufficient and correct. We have already held that the onus to prove in this regard lies on the assessing officer. Although the Ld. DR had vehemently contended and tried to build up his case by substituting the reasons given by the CIT(Appeal) in place of the AO, but failed to bring any cogent material or evidence in this regard which may prove that the other expenses claimed by the Revenue for apportionment had proximate connection with the earning of the dividend income. In our opinion until and unless this is proved or established by the revenue, the assessing officer does not have any power to reject the accounts of the assessee and take the shelter of Rule 8D for computing the disallowance out of the exempt income. We are not at all convinced with the submission of the Ld. DR relying on the decision of CIT(Appeal) in respect of Explanation bb to sec. 80HHC that 10% of the receipts under the sources mentioned therein are deemed to be the expenditure. This in our opinion will strengthen the case of the assessee as Explanation bb to sec. 80HHC does not recognize amount of the investment made in other receipt to be the basis of computing the expenditure being incurred for the earning of that income. Similar views have been taken by Hon‟ble Tribunal in the following decisions also.
In the case of DCIT Vs. Jindal Photo Ltd. held in I.T.A.T. Delhi bench dated 7.1.2011 it was held as follows:
"Now as per section 14A(2) of the Act, if the AO, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of expenditure incurred in relation to income which does not form part of the assessee's total income under the Act, the AO shall determine the amount incurred in relation to such income, in accordance with such method as may be prescribed, i.e., 27 ITA No. 72&85/PNJ/2012 under Rule 8D of the I.T. Rules. However, in the present case, the assessment order does not evince any such satisfaction of the AO regarding the correctness of the claim of the assessee. As such, Rule 8D of the Rules was not appropriately applied by the AO as correctly held by the CIT(A). It has not been done by the AO that any expenditure had been incurred by the assessee for earning its dividend income. Merely, an adhoc disallowance was made. The onus was on the AO to establish any such expenditure. This onus has not been discharged. In ―CIT Vs. Hero Cycles‖ (P&H) 323 ITR 518, under similar circumstances, it was held that the disallowance u/s 14A of the Act requires a clear finding of incurring of expenditure and that no disallowance can be made on the basis of presumptions. In ―ACIT Vs. Eicher Ltd.‖, 101 TTJ (Del.) 369, that it was held that the burden is on the AO to establish nexus of expenses incurred with the earning of exempt income, before making any disallowance u/s 14A of the Act. In ―Maruti Udyog Vs. DCIT, 92 ITD 119 (Del.), it has been held that before making any disallowance u/s 14A of the Act, the onus to establish the nexus of the same with the exempt income, is on the revenue. In ―Wimco Seedlings Limited Vs. DCIT‖, 107 ITD 267 (Del.) (TM), it has been held that there can be no presumption that the assessee must have incurred expenditure to earn tax free income. Similar are the decisions in:
1. Punjab National Bank Vs. DCIT, 103 TTJ 908 (Del.);
2. Vidyut Investment Ltd., 10 SOT 284 (Del.); and
3. D.J. Mehta Vs. Income Tax Officer, 290 ITR 238 (Mum.) (AT) In view of the above, finding no error with the order of the CIT(A) on the point at issue, the same is hereby confirmed. Ground no.3 is thus rejected.‖ In the case of Jindal Photo Ltd. Vs. DCIT held in I.T.A.T. Delhi bench dated 23.9.2011 it was held as follows:
"In the year under consideration, it is seen that it is not incorrect when the assessee contends that no satisfaction has been recorded by the 28 ITA No. 72&85/PNJ/2012 AO regarding the assessee's calculation being incorrect. Even so, Rule 8D of the Rules has been applied. This, in our opinion, is not correct. Such satisfaction of the Assessing Officer is a pre-requisite to invoke the provisions of Rule 8D of the Rules. The Learned CIT(A), therefore, erred in partially approving the action of the Assessing Officer.‖ In the case of Avshesh Mercantile P. Ltd. Vs. DCIT in I.T.A.T. Mumbai Bench (I.T. Act No.5779/Mum/2006 & 208/Mum/2009) it was held as follows:
―At the time of hearing, the contention raised by the learned DR in this regard is that the appeal of the Revenue on the issue having been dismissed by the Hon'ble Bombay High Court merely observing that no question arises, it cannot be treated as a decision rendered by the Hon'ble High Court on the merit of the issue which is binding on this Tribunal. We are unable to accept this contention of the learned DR.
It is well settled proposition of judicial precedents that is appeal the Hon'ble High Court considers facts pertaining to the issue and gives approval to the decision of the lower forum, the decision of lower forum gets merged with the judgment and order of the High Court and it becomes binding precedent even though approval to decision of lower forum/court is summarily recorded. Similar situation had arisen for consideration before the Hon'ble Gujarat High Court in the case of Nirma Industries Ltd. 283 ITR 402 wherein the effects of summary disposal of appeal by the High Court were analysed and explained by their Lordships. It was clarified that while hearing an appeal even for deciding whether substantial question of law arises or not from the order of the Tribunal, the High Court does not exercise either the original jurisdiction or the jurisdiction to issue writs and the only jurisdiction exercised by the High Court in the first instance decides whether or not substantial question of law arises from the order of the Tribunal, it cannot be said that the High Court does not exercise the appellate powers or that there is no decision on merit when the high court dismisses an appeal holding that no substantial question of law arises from the order of the Tribunal. It was held that whenever an order of the subordinate forum is carried in appeal before the higher 29 ITA No. 72&85/PNJ/2012 appellate forum/court, operative part thereof merges into the judgment, decision or order of the higher court after the confirmation, modification or reversal, as the case may be, and the decision of the lower court or forum has no independent existence thereafter in relation to the issue which was carried before the appellate court or forum. It was held that where the High Court comes to the conclusion that no substantial question of law arises on a particular issue, it cannot be stated that the subject matter of controversy between the parties has not been dealt with by the High Court. It was held that when the decision of the Tribunal is affirmed on the issue brought before the High Court, it is the decision of the High Court which becomes operative and which is capable of being given effect to for all intents and purposes. Keeping in view the decision of Hon'ble Gujarat High Court in the case of Nirma Industries Ltd. (supra), we have no hesitation to hold that the decision of the Hon'ble Bombay High Court in the case of Delite Enterprise Ltd.
(supra) is a decision on merit which is binding precedent on us. As the issue involved in the present cases as well as all the material facts relevant thereto are similar to that of the case of Delite Enterprise (supra), we respectfully follow the said decision of the jurisdictional High Court and delete the disallowance made by the AO and confirmed by the learned CIT(A) on account of premium paid by the assessees on redemption of premium notes (OCPN) by invoking the provisions of section 14A of the Act. As regards the case laws cited by the Learned DR, it is observed that in none of these cases, the facts involved were similar to the case of the present assessees in as much as the investment made therein was not found to be capable of earning taxable as well as exempt income which was actually not earned by the assessee in the relevant period as are the facts of the present case or that of the case of Delite Enterprise (supra) decided by the Hon'ble Bombay High Court. Accordingly, we decide the common issue involved in all these appeals in favour of the assessees following the decision of jurisdictional High Court in the case of Delite Enterprises (supra) and allow the appeals of all the assessees.‖ 30 ITA No. 72&85/PNJ/2012
18. We have also gone through the decision relied upon by the learned DR also. The decision of ACIT Vs CITICORP Finance (Ind.) Ltd., 108 ITD 457 (Bom.) is no more relevant, in view of the decision of the Hon‟ble Mumbai High Court in the case of Godrej Boyce Mfg Co. Ltd. (Supra). The decision of SPIC Vs DCIT 93 TTJ (Chennai) 161 is not applicable to the facts of the case. As in that case, the assessee was regularly investing in the shares. The assessee has not disallowed any expenditure with regard to the earning of the dividend income. Under these facts, the Hon‟ble Tribunal held that whether to invest or not to invest is a very strategic decision and top management involve in taking the decisions. This decision relate to assessment year 2000-01 much prior to the insertion of provision of sec.14A(2) of the IT Act,1961. The decision of ACIT Vs Premium Consolidated Capital Trust 83 TTJ (Bom.) relates to assessment year 1991-92 prior to insertion of 14A(2) hence will not assist the revenue. The other decision relied on are also not applicable to the facts of the case, except the decision of jurisdictional High Court in the case of Godrej & Boyce Mfg. Co. Ltd. Vs DC IT & Another 328 ITR 81(Bom.).
In view of our aforesaid discussion and respectively following the decision of the jurisdictional High Court in the case of Godrej & Boyce Mfg. co. Ltd. Vs. DCIT & another 328 ITR 81 (Bom), we delete the disallowance made u/s 14A r.w. Rule 8D and accordingly, the ground taken by the assessee in this regard is allowed.
19. Ground no. 2 relates to sustenance of the disallowance of Rs. 9,88,29,729/- towards the payment of the sales commission to the non- resident agents. The assessing officer disallowed the commission paid to the sales agents u/s 40(a)(i) of the Income-tax Act for the reason that the assessee had not deducted tax u/s 195 of the I.T. Act on such payment. When the matter went before the CIT(A), CIT(A) confirmed the disallowance u/s 37 of the Income-tax Act in the following manner:-
―6.3 I have carefully considered the submissions made by the assessee and the observations of the assessing officer. I have also perused the order of the Hon'ble ITAT in ITA. No. 113/PNJ/2010, dated 10.3.2011 in assessee's own case for the assessment year 31 ITA No. 72&85/PNJ/2012 2005-06, in which the similar issue was considered. With regard to the controversy whether the assessee is required to deduct tax at source for the commission paid to the non-resident agents, the Hon'ble tribunal has decided the issue in favour of the assessee in the above referred appeal. In this regard it is held that circular no. 7 of 2009 withdrawing the circular no. 23 of 1969, 163 of 1975 and 786 of 2000, will be operative only from 22/10/2009 and not prior to that date. It was accordingly held that the circular is not applicable for the year under consideration, i.e., 2005-06 and accordingly the appeal of the assessee was allowed. Following the ratio of this decision, circular no. 7 of 2009, which was held to be operative only from 22/10/2009, should have no application to the present case which relates to the financial year 2008-09 relevant to the assessment year 2009-10. Accordingly, following the decision of the Hon'ble ITAT, the assessee was not liable to deduct tax in respect of the commission payments made to the non-resident agents.
Therefore, as far as the issue of non deduction of tax is concerned, the assessing officer is not justified in disallowing the commission payment by invoking provisions of section 40(a)(i) of the Incomes Tax Act.
6.4 The assessing officer, while making the disallowance of commission payment, has also referred to the observations of the CIT(A) on the similar issue for the assessment year 2006-07 and stated as under.
―For the reasons elaborately discussed by the CIT (A) in the Appellate order ITA No.136/PNJ/2009-10 dt.
30.08.2011 for the A.Y. 2006-07 in the assessee's own case, the commission payments made by the assessee also needs to be disallowed as the issues during the year under consideration are also similar to the issues for the A.Y. 2006-07, apart from the ground of non-deduction of TDS u/s 40a(ia). In view of the aforesaid discussion, the amount of 32 ITA No. 72&85/PNJ/2012 Rs.9,88,29,729/- is added back to the total income of the assessee.‖ It is therefore, necessary to refer to the order of the CIT(Appeal) for the assessment year 2006-07 in connection with the allowability of commission payment. During the year 2005-06 (relevant for assessment year 2006-07) commission was paid to three concerns including, Rs.15,21,98,212/- to Mitsui & Co., Japan, Rs.2,71,86,975/- to Ahmed Jaffar & Co. Ltd., Karachi and Rs.66,86,324/- to Arimpeks Dis Ticaret Ve Mum Ltd. In this regard, in the order of the CIT (Appeal), it was held that since the assessee company is dealing with the purchasers of iron ore year after year, exports are made directly; payments are received directly without being routed through the commission agents. There is apparently no justified reason for payment of commission without substantiating the authenticity of the commission agents and without having furnished reasonable proof of correspondence and adequacy of services rendered by the commission agents. Therefore, for the assessment year 2006-07 the CIT (Appeal) had held that there was no necessity for engaging the commission agents and accordingly, the commission payment was not held to be allowable as business expenditure u/s 37 of the I.T. Act.
6.5 In the present case, it is observed that the facts are very much similar to that of the case for assessment year 2006-07. For the year under consideration, assessee has paid commission of Rs.8,26,79,634/- to M/s Mitsui & Co. Ltd., Japan and Rs.54,90,159/- to M/s Omega Pvt. Ltd., Karachi, Pakistan. The balance amount of the claim represents service tax. During the course of appeal proceedings, the assessee had furnished copy of agreement dated 26.07.2007 between Sesa Goa Ltd. and Omega Pvt. Ltd. and a copy of an Addendum agreement between Sesa Goa Ltd. and Mitsui Japan. The assessee has also relied on extracts of e-mails exchange between the appellant and the sales agents to 33 ITA No. 72&85/PNJ/2012 substantiate the nature of services rendered by the sales agents. However, it is important to note that the claim of payment of commission to the extent of Rs.9.88 crores cannot be justified merely by relying on copies of agreements or e-mail extracts. It is not disputed that M/s Mitsui & Co. or M/s Omega Pvt. Ltd. are known entities as far as the assessee is concerned. It is possible that the assessee may have some kind of business relationship with the above two companies. It is also possible that there may be some correspondence with the two companies with regard to sales of iron ore abroad. But this shall not be sufficient justification to prove that the companies abroad have rendered necessary services for effecting sales so as to justify the claim of commission. It is important to observe that although the agreement between the assessee and Omega Pvt. Ltd. is dated 26.7.2007, no commission was paid to Omega Ltd. during the F.Y. 2007-08 which implies that no services were rendered during that year, notwithstanding the agreement. This demonstrates that entering an agreement does not necessarily imply that services are rendered. Similarly, the assessee has not been able to counter the observations made by the CIT(Appeal) in respect of commission payment to M/s Mitsui & Co. for the assessment year 2006-07. It is established in law that mere existence of an agreement for payment of commission shall not justify the claim of deduction u/s 37 of the I.T. Act. In this regard, it is relevant to note the following observations of the Supreme Court in the case of Laxminarayan Madanlal Vs CIT (1972) 86 ITR 439 (SC).
―The question whether an amount claimed as an expenditure was laid out or expended wholly and exclusively for the purpose of the business has to be decided on the facts and in the light of the circumstances in each case. The mere existence of an agreement between the assessee and its selling agents or payment of certain amounts as commission, assuming there was such payment, does not bind the ITO to hold that payment was made exclusively and wholly for the purpose of the assessee's business. Although there 34 ITA No. 72&85/PNJ/2012 might be such an agreement in existence and the payments might have been made, it is still open to the ITO to consider the relevant factors and determine for himself whether commission said to have been paid to the selling agents or any part thereof is properly deductible u/s 37 of the IT Act.‖ 6.6 In the present case, it is significant to note that assessee is an established iron ore exporter and has been exporting iron ore to the same countries year after year for substantially long time. It is also observed that the assessee has been transacting with known business concerns and therefore, there was no real necessity for an agent to render any service for promoting sales with such concerns with whom the assessee has been transacting for long. As far as Mitusi & Co., Japan, is concerned, it is pertinent to note that assessee has been exporting iron to this concern for substantially long time, which should normally not require any sales promotion. Considering the facts of the case as discussed above, the assessee has not been able to substantiate the claim for payment of commission to non-resident agents by adducing specific and tangible evidence to demonstrate that services were rendered by the sales agents to justify commission payment as claimed by the assessee. Therefore, in view of the above, it is held that the commission payment of Rs.9,88,29,729/- which is claimed to have been paid to non-resident agents cannot be allowed as business expenditure u/s 37 of the I.T. Act, and therefore, the disallowance of Rs.9,88,29,729/- made by the Assessing Officer is accordingly confirmed. The ground of appeal is accordingly, dismissed.‖
20. The Learned. A.R. vehemently contended that the commissions to the non-residents are being paid from year to year. In this regard, he has drawn our attention towards page 413 of the paper book, which contains the details of the commission paid to various parties during the year as well as in the earlier years as follows:-
35ITA No. 72&85/PNJ/2012 Details of Commission paid to non-resident sales agents abroad Name & Address of AY AY AY AY AY AY Agent 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Amount (Rs.) Mitsui & Co. Ltd. 63920828 99823321 15219821 182307027 12792282 8267953 Head Office, CPO 2 6 4 Box 822, 100-91 apan Arimpeks Dis 2178584 6686324 6125101 3886760 Ticaret Ve Mum Ltd., Giz Plaza, Harman Sokak, No.5 Kat: 10, Daire :
19 34394 Levent Istanbul -
Turkey Nissho Iwai 25374360 5268486 Corporation 19th Floor, Tradepia Odaiba, 3-1, Daiba 2 Chome, Minato - Ku, Tokyo, Japan Ahmed Jaffer & Co. 21431717 28898391 27186975 32209631 27999688 113A, Sindhi Muslim Co-op Housing Society, PO Box 7482, Main Shahrah e-Faisal, Karachi 7400, Pakistan Omega Private 5490159 Limited, 68B, Sindhi Muslim Co- operative Housing 36 ITA No. 72&85/PNJ/2012 Society, Karachi, 74000, Pakistan Others 11072690 136168783 18607151 220641759 15980927 8816969 Difference in rate of 5 1 0 4 3 exchange Add 2639868 0 0 (Less) Previous years adjustments Service Tax -1764641 -257580 19160584 1091761 6 TOTAL 11336677 136168783 18607151 220641759 17720521 9882972 3 1 7 9
21. It was pointed out that during the year; commission has been paid only to two parties as is clear from the said chart i.e. Mitsui & Co. Ltd., Japan and Omega Private Limited, Karachi. In the earlier year, commission was paid to Ahmed Jaffer & Co. in Karachi. This party was reconstituted and became Private Limited Company at the same place and the same services are being rendered by Omega Private Ltd. None of the parties is related to the assessee. The assessee has entered into an agreement with both the parties for which attention was drawn to page 414 and 421 of the paper book.
21.1 The AO disallowed the said commission u/s 40(a)(i) for the first time in A.Y. 2005-06, on the pretext that no tax has been deducted at source on such commission paid. Though CIT (A) confirmed the disallowance, but the issue was decided in favor of the assessee by the Hon‟ble I.T.A.T., Panaji in ITA No. 113/PNJ/2010 vide order dt. 10/03/2011. It is understood that department has not filed appeal against the said order in the High Court of Bombay at Goa. The CIT (A) in his order for A.Y. 2005-06, had also raised a point regarding necessity of the payment of such commission. The I.T.A.T. did refute to make any comment on this issue since it was not a ground raised by AO for disallowance. The same disallowance is getting repeated in the AYs 37 ITA No. 72&85/PNJ/2012 2006-07, 2007-08, 2008-09 & 2009-10. However, the question of genuineness of commission has been raised in all these years. In AY 2006- 07, the said disallowance was confirmed by CIT (A) and the matter is lying under appeal before the Hon‟ble I.T.A.T. which has already been heard. For A.Y. 2007-08, the first appellate order is still pending for adjudication till date. For A.Y. 2008-09, in view of certain TP additions, the draft order was referred to DRP which refused to interfere with the AO‟s order and hence this matter is also before the Tribunal but adjourned on the request of Department.
21.2 The learned A.R submitted that so far the issue regarding disallowance of commission u/s 40(a)(i) due to non-deduction of tax at source is concerned, the same has been decided in favor of the assessee and thus there remains no dispute regarding the same. It was further argued that it must be appreciated that the sometimes commission is paid to the agent only in the first year for finding a buyer. However, mostly it is paid regularly year after year for smooth execution of the contracts with the said buyers. It always depends upon the terms and conditions of the contract with agent which mention about the service to be rendered by the agents. The agent may/may not assist in settling the terms of the transactions because that is the subject matter between the seller and the buyer. But the agents are entitled for commission for services rendered by them for smooth and perfect execution of contracts without hindrances. The services of the sale agents are utilized, besides getting the sales contracts, also in settling the problems arising to the buyers. These agents arrange meetings, prepare presentations, communicate shipping documents, nomination of vessel for export by the buyers, dealing with the difficulties arising on such nominations, assist in fixing shipment schedules, opening letter of credit by the buyers and any amendments whereon, various issues cropping in connection with letter of credit, follow-up with buyers for payments and settlement of invoices, prompt settlement of demurrage and dispatch matters. Our attention was drawn to Page No.131 of (Initial) PB Vol. I, wherein vide para nos. 2.3 & 2.4 services rendered by the commission agents are mentioned. The agents ensure that the goods would be supplied by the buyers on settled terms for which payment would be released by the buyer as settled between the two. The agents cannot be left out of the transactions. Sale of goods is not the only important aspect in 38 ITA No. 72&85/PNJ/2012 international business, that too of iron ore business, various business auxiliary services like shipping dispatching, documentation, letter of credit are other important aspects to be taken care of for proper dispatch of goods and receipt of money. If the goods are not shipped in time, the assessee may have to bear extra cost in form of demurrage, compensation, etc. If the letter of credit is not opened in time it will delay the dispatch and the entire process. Either the assessee has to employ staff overseas which can take care of such things but it will increase fixed cost to the assessee, or the assessee can get services of these agents who have been rendering services to it for years and know the intricacies of business. It is the prerogative of the businessman to decide as to whether commission has to be paid or not as per his business requirements. The commercial expediency should be adjudged from the point of view of the businessman. The AO cannot step into the shoes of the businessman to decide commercial expediency. The CIT (A) has accepted that there is some business relationship and correspondence between the assessee and the agents but held that is not sufficient justification to hold services were rendered by agents for commission to the extent of Rs. 9.88 crores. This shows that the CIT (A) agreed that evidences produced show the existence of business relationship which could be none other than agent as is clear from the agreement wherein services rendered are mentioned. Emails show that the said services were actually rendered. What more justification was required has not been brought on record by the authorities. The international business is being done through telephones, internet and emails and therefore only such type of evidences can be produced to prove the physical rendering of services by the agents. The CIT (A) held that mere existence of an agreement for payment of commission does not justify the expenditure. The assessee agrees to it but the agreements are supporting evidences to show the nature of services rendered by the agent. These agreements read with other supporting evidences like emails, etc. prove the rendering of services by the agents and are therefore an important piece of evidence. Reliance was placed by the Ld. AR on the judgement of CIT Vs Shriram Pistons & Rings Ltd. [2012-TIOL-187-HC-DEL-IT] wherein it has been held that when the assessee pays up commission based on agreements, any disallowance cannot be made of the same by disputing that the agents did not render any service. The assessee-company has been 39 ITA No. 72&85/PNJ/2012 paying commission to Mitsui & Co. in the preceding years which has been allowed to it even prior to AY 2006-07. The commission paid to Mitsui & Co. Ltd. Was considered by the Transfer Pricing Officer in AY 2004-05 and 2005- 06 and it was held by him that the transactions were at Arm‟s Length Prices. Photocopies of the TPO orders are enclosed at Page nos. 424-427 of (Initial) PB Vol. II. The said Mitsui & Co. Ltd. was an AE (Associated Enterprise) of the assessee till AY 2008-09 and till then, the transactions with the AE including payment of commission were subjected to TPO‟s audit and no adverse inference was drawn by TPO in view of arm‟s length principle followed for making such payment. A photocopy of the addendum agreement entered with Mitsui & Co. is placed at Page nos. 421-423 of (Initial) PB Vol. II. Further, Mitsui & Co. Ltd rendered services to the assessee during the year as can be seen from the photocopies of emails exchanged between buyer and Mitsui and seller and Mitsui placed at Page nos. 135-156 of (Initial) PB Vol. I. These evidences clearly show that the said agent has rendered services to the assessee and therefore commission paid to it should be allowed. A copy of agency contract entered into with M/s Omega Private Ltd is placed on record at Page nos. 414-420 of (Initial) PB Vol. II. Though the agreement was entered into on 26/07/2007, but since no services were rendered by the said party as per contract, no commission was paid to it in the preceding year. However, in the year under consideration, services were rendered by it, and therefore the commission was paid. The said amount was paid to the agent for smooth execution of contract with Pakistan steel. The said party is not related to the assessee in any manner. None of the recipients of commission was a related party but internationally known independent and reputed companies. All payments were made through proper banking channels notified to RBI as well. The assessee company had a turnover (iron ore only) of Rs. 4,586 crores during the financial year 2008- 09 (relevant to AY 2009-10). The claim of commission was Rs. 9.88 crore, which works out to 0.215% of the turnover which is reasonable. The assessee had declared an income of Rs. 2,007 crores and paid tax of Rs. 682 crores at the time of filing the return. In the facts and circumstances, the lower authorities are not justified in concluding that the commission of Rs. 9.88 cr (which would have a tax impact of Rs. 3.35 cr (approx.) or 0.5% of the tax paid by the assessee is not genuine.
40ITA No. 72&85/PNJ/2012
22. It was argued that the facts involved in this year are different from the assessment year 2006-07. The assessee has not submitted the various evidences while during this year the assessee has submitted brief evidences which are available at page 135 to 156 of the paper book. The various e- mails confirmed the services being rendered by the agent date-wise, summary of the e-mails with the agents are given in the following table available at page 135 of the paper book.
Page Email Date Contents
No. No.
1 1 23.12.08 The agent confirming vessel nomination from the
buyer
1 2 23.12.08 Our acceptance to the above nomination
1 3 24.12.08 Our request to the agent for opening of LC
2-6 4-11 09.12.08- Request for LC amendments and LC
24.12.08 acceptances
7 12 12.11.08 The Agent confirming vessel nomination from the
buyer
7 13 12.11.08 The Agent advising changes in the sale contract
with the buyer
8 14 11.11.08 Our acceptance to the above.
8 15 11.11.08 The agent confirming changes in the contract to
be conveyed to the buyer
10 16 20.11.08 We are suggesting amendments to the draft LC
12 17 21.11.08 The agent confirming/suggesting amendments to
the LC
13 18 17.11.08 The Agent confirms vessel nomination from the
buyer
13-14 19 17.11.08 Our Acceptance to the above.
15 21 17.11.08 The agent forwarding draft LC
15-16 20 19.11.08 Our suggestion towards the amendments to the
draft LC
17 22 24.02.09 The agent forwarding draft revised Final
Adjustment sheet
41
ITA No. 72&85/PNJ/2012
18 23 24.01.09 We are suggesting corrections to Final
adjustment sheets and requesting the agent to
forward the same to the buyer
18 24 27.01.09 Our request to the agent to correspond with the
buyer
18 25 03.02.09 We are asking the agent to convey our message
to the buyer
20-21 26 13.03.09 The agent conveying message from the buyer to
us
23. It was contended that it is on the principal as to how many or how much services he may require from an agent, the purpose of appointing an agent is to be introduced to a party. Once the agent has introduced a party, he may continue to get the commission as per the terms and conditions agreed between the agent and the principal. In the instant case, all payments were duly approved by the RBI and were sent through banking channel. Survey has taken place in the case of the assessee, but no contrary evidence was found which may prove that these parties were not the agents of the assessee. The disallowance was made merely on surmises and conjectures. It was pointed out that the main condition for deduction of the expenditure u/s 37 of the Act is that the expenditure should be incurred wholly and exclusively for the purpose of the business and that there is no condition to the fact that it need to have also been incurred necessarily. It is the assessee to decide whether any expenditure should be incurred or not. The assessing officer cannot enter into the shoes of the assessee and direct the assessee as to what expenditure the assessee should incur. Thus, it was contended that the assessee has duly proved the genuineness of the expenditure incurred and the deduction must be allowed. The Learned D.R. on the other hand contended that Mitsui & Company Ltd. is originally a purchaser from assessee. The claim of the assessee that during the current assessment year, Mitsui & Company Ltd. did not purchase any stock from the assessee but acted as an agent is not supported by any evidence. The assessee has not proved any nexus between the agents and the assessee with reference to the actual sale or export. The assessee has not produced any evidence to substantiate the payment of the commission that the 42 ITA No. 72&85/PNJ/2012 services were rendered by the sales agent. Mere agreement between the assessee and the foreign company is not sufficient to justify the payment of the commission. Reliance was placed on the decision of Hon'ble Supreme Court in the case of Laxminarayan Madanlal Vs. CIT 86 ITR 439 (Supreme Court).
24. We have carefully considered the rival submissions along with the order of the tax authorities below and also the material relied upon by both the parties. The only issue before us is whether the commission paid by the assessee has been incurred by the assessee wholly and exclusively for the purpose of the business of the assessee. Now, coming to the relevant provision in which the assessee claimed deduction is section 37(1) of the Income Tax Act, 1961. Section 37(1) reads as under:-
"Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purpose of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession.
Explanation: For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure"
From the aforesaid section, it is apparently clear that expenditure to be eligible for deduction u/s 37(1) must fulfill the following conditions:-
a) The expenditure should not be covered by the provision of section 30 to 36 as these sections provide its specific treatment to expenditure laid down in those sections.
43
ITA No. 72&85/PNJ/2012
b) Expenditure should not be capital in nature.
c) It is not to be personal expenditure of the assessee.
d) It should be incurred wholly and exclusively for the purpose of
business or profession.
e) It should be incurred during the previous year.
f) It should not be incurred for any purpose which is an offence or
which is prohibited by law.
24.1 In the case of the assessee, there is no doubt that the commission
paid by the assessee is not covered by the provision of section 30 to 36. There is also no dispute that the expenditure incurred by the assessee is of revenue nature and not of capital in nature. There is also no dispute about the fact that the expenditure has been incurred during the respective previous years. There is also no dispute that this expenditure has not been incurred for any purpose which is an offence or which is prohibited by law. The expenditure so incurred by the assessee company cannot be regarded to be the personal expenditure of the assessee. There is no evidence on record that these expenses were incurred to meet out the personal needs of the assessee company. The company is always incorporated for the purpose of carrying on the business as stipulated under its object clause laid down in the Memorandum of Association. The company so incorporated is not human being, which may have personal needs. The company is an artificial person incorporated under the legislature by having a separate entity. Although by having a separate entity; it may work as a human being in its own name but it does not require any expenditure to be incurred, as a human being requires for meeting out its personal needs. Therefore the expenditure incurred by the assessee company cannot be regarded to be the personal expenditure of the assessee. The personal expenditure of the management or the human beings who are controlling the company cannot be regarded to be the personal expenses of the assessee company. It may be remuneration or perquisite in the hands of the management or the human beings but it cannot regard to be the personal expenses of an incorporated body.
25. The only dispute in this case relates to the fact whether the commission paid can be regarded to have been incurred wholly and exclusively for the 44 ITA No. 72&85/PNJ/2012 purposes of the business or profession of the assessee company. Before 1939, the phrase used was „Expenditure incurred solely for the purpose of earning profit‟. The Omnibus provision of section 37 as amended by 1939 Act allows of „Expenditure incurred wholly and exclusively in connection with such business/profession‟ as long as no personal/capital element is involved. The scope of the term „For the purpose of business‟ is surely wider than the term „for the purpose of earning profit‟. In our opinion the Income Tax Department cannot prescribe what expenditure an assessee should incur and under what circumstances. Every businessman knows his interest best. The assessee may not be a prudent man and yet an expenditure incurred voluntarily for the purpose of the business would be allowable u/s 37(1).
The Hon‟ble Apex Court in the case of Eastern Investment Ltd. Vs. CIT, 20 ITR 14 (SC), laid down the following principles for evaluation of „wholly and exclusively for the purpose of business‟: -
(i) Even if the question must be decided on the facts of each case, the concluding decision will be one of law.
(ii) It is not necessary that the expenditure be incurred for earning profit.
(iii) It is enough that the money was expended "not of necessity and with a view to directing and immediate benefit to the trade, but voluntarily on the ground of commercial expediency, and in order, indirectly, to facilitate the carrying on of the business."
(iv) No hard and fast rule can be laid down to explain what the word "solely" is meant for.
The expression "wholly and exclusively" used in section 37(1) does not mean "necessarily". Ordinarily, it is for the assessee to decide whether any expenditure should be incurred in the course of its or his business. Such expenditure may be incurred voluntarily and without any necessity, and if is incurred for promoting the business and to earn profits, the assessee can claim deduction therefore under section 37(1) even though there was no compelling necessity to incur such expenditure. The Supreme Court, in the case of CIT Vs Malayalam Plantation (1964) 53 ITR 140 (SC), held that it is 45 ITA No. 72&85/PNJ/2012 not only expenditure which directly results in benefit or advantage to the assessee‟s business that is entitled to deduction, but also any expenditure which is incurred with a view to facilitating the carrying on of the business.
26. We do agree with the submissions of the Ld. AR that it is not open to the department to prescribe what expenditure the assessee should incur and in what circumstances he should incur that expenditure. Every businessman knows his interest best as this has been clearly laid down by the Hon‟ble Apex Court in 91 ITR 544 in the case of CIT Vs Dhanrajgiri Raja Narsinghgiri. No doubt every businessman is the best judge of his business expediency but the Assessing Officer in our opinion has the right to know whether the expenditure has been incurred for business purposes or not or whether it has been incurred for other extraneous consideration. Similar view has been taken by the Hon‟ble Rajasthan High Court in the case of Jaipur Electro Pvt. Ltd. Vs CIT, 134 CTR 237 (Raj). The Hon‟ble Bombay High Court has also taken the similar view in the case of Ramanand Sagar Vs DCIT, 255 ITR 134 (Bom) in which it was held that the mere fact that the payment has been made under a contract is not conclusive of expenditure being laid down wholly and exclusively for the purpose of the business. Once doubt arise about the bonafide nature of the payment, it is necessary to look into the necessary circumstances such as relationship of the payee to the assessee, the general standard of similar expenditure in comparable business, the true worth of the services or goods in question and so forth. It is also open to the A.O. to question the reality of the expenditure i.e., the true nature of the payment, the true consideration for it and so forth. Once the A.O. considers the payment and the purpose to be bonafide, it is not open for him to substitute his own judgment what is the reasonable quantum of expenditure for the assessee. The A.O. can only decide whether the expenditure is real, whether it relates to the business and is wholly spent for that purpose. In applying the test of commercial expediency, for determining whether the expenditure was wholly and exclusively laid out for the purpose of the business the reasonableness of the expenditure has to be judged from the point of view of the businessman and not the Revenue, as held in CIT Vs Walchand and Co. (P) Ltd. (1967) 65 ITR 381 (SC). The similar view has been taken in the cases of JK Woollen Manufacturers Vs CIT (1969) 72 ITR 46 ITA No. 72&85/PNJ/2012 612 (SC); Aluminum Corporation of India Ltd. Vs CIT (1972) 86 ITR 11 (SC) and CIT Vs Panipat Woollen and General Mills Co. Ltd. (1976) 103 ITR 66 (SC). Considering the true import of the expression "wholly and exclusively" it was observed by the apex court in Sassoon J Davit and Co. Pvt. Ltd. Vs CIT (1979) 118 ITR 261, that the same does not mean "necessarily". Ordinarily, it is for the assessee to decide whether any expenditure should be incurred in the course of its business. Such expenditure may be incurred voluntarily and without any necessity and if it is incurred for promoting the business and to earn profits, the assessee can claim deduction under the relevant provision even though there was no compelling necessity to incur such expenditure. The fact that somebody other than the assessee is also benefited by the expenditure should not come in the way of an expenditure being allowed by way of deduction u/s 37 of the Act if it otherwise satisfies the tests laid down by law. The bill read "any expenditure laid out or expended wholly, necessarily and exclusively for the purposes of the business or profession shall be allowed". In view of the protests raised by the taxpayers the word "necessarily" came to be dropped. It will be also noticed that in CIT Vs Chandulal Keshavlal and Co. (1960) 38 ITR 601, 610, it was observed as follows:-
"Another fact that emerges from these cases is that if the expense is incurred for fostering the business of another only or was made by way of distribution of profits or was wholly gratuitous or for some improper or oblique purpose outside the course of business then the expense is not deductible. In deciding whether a payment of money is a deductible expenditure one has to take into consideration questions of commercial expediency and the principles of ordinary commercial trading. If the payment or expenditure is incurred for the purpose of the trade of the assessee it does not matter that the payment may incur to the benefit of a third party (Usher‟s Wiltshire Brewery Limited v Bruce (1914) 6 Tax cases 399 (HL). Another test is whether the transaction is properly entered into as a part of the assessee‟s legitimate commercial undertaking in order to facilitate the carrying on of its business; and it is immaterial that a third party 47 ITA No. 72&85/PNJ/2012 also benefits thereby. But in every case it is a question of fact whether the expenditure was expended wholly and exclusively for the purpose of trade or business of the assessee."
27. If we apply the principles of the law as enunciated in the various judgments, we are of the opinion that once the A.O. finds that the assessee has bonafidely incurred the expenditure for the business, the A.O. cannot decide the quantum of the expenditure to be incurred by the assessee. In this case before us the assessing officer has disputed the fact that commission has been paid for the purpose of the business and also disallowed the said expenditure by applying the provisions of sec. 40(a)(i) as well as on the basis of the genuineness of the expenditure incurred. The CIT (A) while holding that the assessee was not liable to deduct tax in respect of the commission payment made to the non-resident agents took the view that the assessing officer was not justified in disallowing the commission payment by invoking the provision of sec. 40(a)(i). The CIT(A), however, disallowed the commission paid by the assessee to the foreign non-resident agents by applying the provisions of sec. 37 as according to him the assessee had not able to substantiate the claim for payment of commission to non-resident agents by adducing specific and tangible evidence to demonstrate that the services were rendered by the sales agents to justify the commission payment as claimed by the assessee. He, thus, confirmed the order of the assessing officer for the said disallowance. Now the only issue before us is whether the assessee had discharged its onus of proving the genuineness of the expenditure incurred by the assessee or not.
27.1 The documentary evidences by way of agreements with the non- resident agents and emails exchanged with them in this regard, which were placed on record of the authorities below and also furnished at page nos. 135 to 156 of the paper book before us, clearly exhibit the nature and extent of services rendered by those non-resident agents; and the genuineness of the same cannot be doubted merely on surmises without bringing anything contrary on record. CIT (A) while rejecting this vital piece of evidence has merely stated vide para 6.5 of his appellate order that "it is possible that the assessee may have some kind of business relationship with the above two 48 ITA No. 72&85/PNJ/2012 companies. It is also possible that there may be some correspondence with the two companies with regard to sales of iron ore abroad. But this shall not be sufficient justification to prove that the companies abroad have rendered necessary services for effecting sales so as to justify the claim of commission." Whereas in our considered view, the contents of the emails furnished by the assessee, which have been summarized herein above, clearly show that those were being exchanged with the said two non-resident agents in actual performance of their services for which they had been engaged by the assessee as per the respective agreements entered into with them and for which commission had been paid to them. It is not the case of the Revenue that the impugned emails were fabricated or forged one. In fact, the CIT (A) has admitted in his appellate order that „it is possible that there may some correspondence with the two companies with regard to sale of iron ore abroad‟, but without going into the merits of the emails exchanged and without controverting how the same did not exhibit that actual services had not been rendered by those agents, he merely rejected the claim of the assessee as if the assessee has not incurred these expenses genuinely for the purpose of the business. It is cardinal principle of law that a disallowance cannot be made on mere surmises and conjectures. Where the explanation of the assessee is bonafide and evidences produced by it further corroborate its explanation, there is no reason for Revenue to disregard the same on whims without bringing forth any tangible and cogent material to the contrary.
27.2 The said two non-resident agents had been engaged by the asseseee in the past and they have been paid commission on sales abroad since last so many years. There is no law which mandates that a middleman is entitled to his commission only for the first time when he introduces both the parties to each other. We agree with the ld. AR that in fact, it is a normal business practice all over the world that after the parties are introduced the actual work of a commission agent starts. Here in the instant case of the assessee, the buyers had been introduced by the said agents in the past. The emails exhibit that the agents were deeply involved with the buyers vis-à-vis the assessee in actual transportation of goods and securing payments to the assessee. Emails show that the agent was confirming vessel nomination from the buyer, which was later accepted by the assessee. Other emails 49 ITA No. 72&85/PNJ/2012 show the assessee‟s request to the agent for opening of LC and subsequently requesting the agent for LC amendments and LC acceptances. In other such set of emails, the assessee is found suggesting amendments to the draft LC and the agent confirming / suggesting amendments to the LC. Similarly, another set of emails show the Agent advising changes in the sale contract with the buyer and the assessee accepting the same. Yet another exchange of emails shows the agent is forwarding draft revised Final Adjustment Sheet and the assessee is suggesting corrections to Final Adjustment Sheets and requesting the agent to forward the same to the buyer. More so, in one such set of emails, the assessee is seen asking the agent to convey its message to the buyer and the agent can be seen conveying message from the buyer to the assessee. Thus, there remains no doubt in our mind that the non-resident agents were actually rendering the services as middlemen in terms of their respective agreements with the assessee and, accordingly, commission was genuinely paid by the assessee for those services only, i.e., wholly and exclusively for the purpose of the business of the assessee.
The decision in Laxminarayan Madanlal Vs CIT (1972) 86 ITR 439 (SC), relied upon by the Revenue is totally distinguishable on facts. In that case the assessee had only produced the agreements and the Hon‟ble apex court decided that the mere existence of an agreement between the assessee and its selling agents or payment of certain amounts as commission, assuming there were such payments, does not bind the ITO to hold that payment was made exclusively and wholly for the purpose of the assessee‟s business. Whereas in the instant case, the assessee has placed other documentary evidences on record besides the agreements, which clearly demonstrate that the requisite services under those agreements for which commission was paid to them, had actually been rendered by them. Thus, in the case of the assessee commercial expediency has clearly been proved. Therefore, the disallowance of Rs. 9,88,29,729/- for commission paid to non- resident agents is deleted by allowing this ground of appeal of the assessee.
28. The ground nos. 3 & 4 relate to the common issue about the disallowance of the demurrage charges paid amounting to Rs.36,05,767/- to the buyers as reimbursement and Rs.1,19,70,782/- paid to the Shipping 50 ITA No. 72&85/PNJ/2012 Companies/Ship owners u/s 40(a)(i) of the Income-tax Act. The brief facts of the case are that the assessee has noted that the assessee has paid an amount of Rs. 36,05,767/- to its buyer in Pakistan without deduction of tax at source and therefore he disallowed the same u/s 40(a)(i). In respect of sum of Rs. 119,70,782/-, the AO noted that the assessee deposited the taxes deducted on behalf of the shipping companies of the countries with whom India has no DTAA. The taxes were paid on its PAN on behalf of those shipping companies but were not paid within the due dates and therefore said amount was disallowed u/s 40(a)(i). When the matter went before the CIT(A), CIT(A) confirmed both the disallowances by merging both the grounds observing as under:
―7.2 I have considered the facts of the case and the submissions made by the assessee. The claim of the assessee that the demurrage amount remitted to the nonresident buyers of iron ore was actually payable by the said buyers to the ship owners and therefore liable to tax u/s. 172 of the Act, is without any merit. It has been clearly established that the payments were made by the assessee to the buyers of iron ore abroad and no tax was either deducted or deducted belatedly in respect of such payments. The claim that such payments were ultimately payable to the ship owners will not change the nature of payments in the hands of the assessee. As far as the assessee is concerned, it has paid the amounts as demurrage and the same has been claimed as expenditure. The payments made by the assessee are clearly covered by the residual limb of section 40 (i) of the Income tax Act, which refers to ‗Other sum chargeable under this Act'. The payments made by the assessee are clearly in the nature of payments chargeable to tax. The assessee has not substantiated its claim that these payments would have been subsequently paid to the ship owners by the buyers of iron ore or why such payments are not chargeable to tax. It is established law that the onus of substantiating the claim lies on the assessee who makes the claim. Therefore, considering the facts of the case and the observations made by the assessing officer and considering the fact that the assessee has completely failed to substantiate its claim as mentioned above, I find no merit in the claim of the assessee. Accordingly, I confirm the disallowance of Rs.36,05,767/- and Rs. 1,19,70,782/- made by the Assessing Officer. This ground of appeal is accordingly, dismissed.
51ITA No. 72&85/PNJ/2012
29. Before us, the Learned. A.R. contended that the demurrage amount remitted to the buyers of iron ore in Pakistan amounting to Rs.36,05,767/- was in respect of amount payable by the said buyers to the ship owners of the vessels by which relevant iron ore was exported. The assessee has exported to Pakistani buyer on FOB basis. The foreign buyer engages a ship for taking delivery of the goods from India. Ship comes to Indian port for a limited period and when the assessee enables to load the goods on to the ship within the limited period. In such situations the foreign buyer has to pay demurrage to the ship owner. The assessee has to compensate the buyer for the same. The assessee has remitted the said sum to Pakistan buyers which they said buyer had paid to ship owners in addition to the Freight Charges due to delay in loading of the ships at the India Port. The said sum was paid as per the export contract. Tax is to be deducted at source only when income is chargeable to tax under this Act. So it is necessary to determine whether this income is taxable or not. Such payment is not in the nature of any income since this is merely offsetting the additional cost incurred by the said buyer due to the lack of operational efficiency and non-adherence to the stipulated timelines (terms of performance) by the seller. In fact this amount must be considered as an additional discount by the assessee to the buyer. It was akin to price reduction due to fault in product/service and is equivalent to discount/rebate which can be adjusted against the sale price. It goes to reduce the sale price rather than to be considered as an expense in the hands of the assessee. Further, even if for the sake of argument, it is assumed that there is an incidence of income in the hands of non-resident buyers, the same would not attract any tax in India in view of Explanation 1(b) to section 9(1)(i) of IT Act, 1961 which provides that in case of non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of export. It is an admitted fact that the non-resident buyer got the demurrage through the operation which are confined to purchase of goods, i.e., in relation to the ship which it had arranged for taking the delivery of the goods from the assessee/seller from India. Thus, the said income will not be deemed to accrue or arise in India and therefore the said amount is not taxable in India and is not liable to the tax deduction at source. Presuming 52 ITA No. 72&85/PNJ/2012 without admitting, if the said amount is considered as demurrage payment instead of compensation, in that case demurrage charges are liable to tax u/s 172(8) of the Act in the hands of ship owners. In this regard, it is stated that section 172(8) states that the amount mentioned in 172(2) includes demurrage charges. Section 172(2) provides that where a ship carries passengers, goods, etc., then 7.5% of the amount paid or payable on account of such carriage to the owner or character on this behalf shall be deemed to be income accruing in India to the owner or charterer. Thus, as per section 172(8), the amount of demurrage will also be considered for this purpose, i.e., for computing its taxable income. Thus, the demurrage stands considered as part of Freight, i.e., the payment made u/s 172(2) of the Act. Reliance is placed on CBDT Circular No. 723 of 1995 which explains that section 194C and 195 to tax deduction at source are not applicable to the section 172. Clauses 5 of the Circular states that even the payment to the agent of the non-resident ship owners will also not attract TDS. The demurrage paid by the assessee to the non-resident buyer would in turn have been paid by the buyer to the ship-owners. The Freight including demurrage was taxable in the hands of ship owner u/s 172 of the Act. Thus, the amount can be treated as paid to the agent of the ship owner. Even in that case the assessee was not liable to deduct TDS as mentioned in clause 5 of Circular No. 723 (supra). Thus, when the amount covered under section 172 is not liable to TDS u/s 195, then no disallowance u/s 40(a)(ia) can be made.
29.1 For the sum of Rs. 1,19,70,782/-, it was contended that the assessee has export sales contract with the buyer on CIF basis. The assessee engages a ship on its own and paid the Freight directly to ship owners which are also non-residents. Sometimes there is delay in loading the ship within the pre agreed time line which results into payment of demurrage by the assessee to such ship owners. The CIT (A) did not deal with this amount separately but got it merged with payment made to Pakistani buyer without appreciating the defect of these payments were entirely different from demurrage reimbursed to Pakistani buyer. The said amount was paid to foreign shipping companies. U/s 172 demurrage is to receive the same treatment as Freight payment the assessee has not deducted any tax on these payments but in some cases the assessee assisted ship owners in discharging their legal obligation by making 53 ITA No. 72&85/PNJ/2012 payment to the department for and on behalf of such ship owners and not as TDS. Assessing Authority misunderstood that the assessee has deducted the tax and deposited it. In the earlier year also similar payments were made without TDS and were allowed as deduction. Circular No. 723 of 1995 is very clear that section 194C and 195 are not applicable to section 172 which is a self contained code. Thus it was contended that since the provision of 195 is not applicable and the payments are not covered under section 40(a)(i) and therefore the disallowance be deleted.
30. The Ld. DR on the other hand contended that demurrage charges are liable to tax in India u/s 172(8) of the Act. The assessee when making the payment to the non-resident is bound to deduct tax at source u/s 195 of the Income-tax Act. Having failed so, the disallowance has rightly been sustained by the CIT(A) u/s 40(a)(i) of the Income-tax Act.
31. We have carefully considered the rival submissions and perused the material on record. This is a fact that the assessee has paid the demurrage charges to the non-resident in respect of delay in loading the ship. We find that the sum of Rs. 36,05,767/- was reimbursed by the assessee to the foreign buyer to compensate the foreign buyer for paying demurrage to the ship owner when ship came to Indian port and the assessee could not load the goods on to the ship within the limited time period. The export sales were made to the foreign Pakistani buyer on FOB basis. In view of the contract with the Pakistani buyer specifically clause 11(d), in our opinion, the assessee is bound to compensate the Pakistani buyer in respect of demurrage paid by the Pakistani buyer to the ship owner. This payment in our opinion can be regarded to be the expenditure incurred by the assessee for the sales of the goods. We do not agree with the Ld. AR that this payment was akin to price deduction due to fault in product/service and is equivalent to discount/rebate which can be adjusted against the sale price.
32. We have gone through explanation 1(b) to section 9(1)(i) of the Income-tax Act, 1961. We noted that this section provides that in the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of the goods in 54 ITA No. 72&85/PNJ/2012 India for the purpose of export. The non-resident buyer got the compensation towards the demurrage incurred through the operation which are confined to the purchase of the goods, i.e. in relation to the ship which it had arrange for taking the delivery of the goods from the assessee/seller from India. In our opinion this income cannot be deemed to accrue or arise in India in the hands of the foreign buyer and therefore it cannot be taxable in India and is not liable to tax deduction at source. On this basis, no disallowance can be made u/s 40(a)(ia) and accordingly we delete the disallowance of Rs. 36,05,767/-.
32.1 Now coming to the submission of the Ld. DR that these charges are the demurrage liable to tax in India u/s 172(8) of the I.T. Act and have been incurred by the assessee for making payment to the shipping company through foreign buyer. We have gone through the circular no.723 dated 19/9/1995 which deals with the provisions of section 172, 194C & 195 of the Income-tax Act. It reads as under:
"Section 172 deals with shipping business of non-residents. Section 172(1) provides the mode of the levy and recovery of tax in the case of any ship, belonging to or chartered by a non-resident, which carries passengers, live-stock, mail or goods shipped at a port in India. An analysis of the provisions of section 172 would show that these provisions have to be applied to every journey a ship, belonging to or chartered by a non-resident, undertakes from any port in India. Section 172 is a self-contained code for the levy and recovery of the tax, ship wise and journey wise, and requires the filing of the return within a maximum time of thirty days from the date of departure of the ship.
The provisions of section 172 are to apply, notwithstanding anything contained in other provisions of the Act. Therefore, in such cases, the provisions of section 194C and 195 relating to tax deduction at source are not applicable. The recovery of tax is to be regulated, for a voyage undertaken from any port in India by a ship under the provisions of section 172.55
ITA No. 72&85/PNJ/2012 Section 194C deals with work contract including carriage of goods and passengers by any mode of transport other than railways. This section applies to payments made by a person referred to in clauses (a) to (j) of sub-section (1) to any ―resident‖ (termed as contractor). It is clear from the section that the area of operation of TDS is confined to payments made to any ―resident‖. On the other hand, section 172 operates in the area of computation of profits from shipping business of non-residents. Thus, there is no overlapping in the areas of operation of these sections.
There would, however, be cases where payments are made to shipping agents of non-resident ship owners or charterers for carriage of passengers, etc., shipped at a port in India. Since, the agent acts on behalf of the non-resident ship-owner or charterer, he steps into the shoes of the principal. Accordingly, provisions of section 172 shall apply and those of sections 194C and 195 will not apply.‖
33. From the perusal of this circular, it is apparently clear that the provisions of section 194C and 195 relating to tax deduction at source are not applicable where the provisions of section 172 are applicable. The circular issued by the CBDT is binding on the department. In view of the circular in our opinion the assessee is not obliged to deduct TDS on the payment made as demurrage charges and the demurrage charges are also liable to be taxed u/s 172 of the Income-tax Act. The assessee, since is not liable to deduct tax at source, no question arise for making any disallowance u/s 40(a)(i).
33.1 Coming to the disallowance of Rs. 1,19,70,782/-, we noted that this is not a case where the assessee had deducted tax at source but the assessee had assisted the shipping owner in discharging their legal obligation by making payment of their income tax to the revenue for which they were liable u/s 172 of the I.T. Act. This is not a case where assessee has deducted TDS as the assessee was not liable to deduct any TDS in respect of payment made to the ship owner for the demurrage. There is no dispute that the income of the foreign shipping companies were chargeable to tax u/s 172 of the I.T. Act. The demurrage paid to these shipping companies were also to be 56 ITA No. 72&85/PNJ/2012 treated as freight in view of specific provision of section 172(8). We have already held in the preceding paragraph that in view of circular number 723 dt. 19/09/1995, the provision of section 194C and 195 relating to tax deduction at source are not applicable to the income which is chargeable to tax u/s 172. In view of this circular the assessee was not obliged to deduct tax at source on the demurrage paid to the shipping owners during the year. Since the provision of TDS were not applicable, therefore no disallowance can be sustained u/s 40(a)(ia). We therefore, set aside the order of the CIT(A) on these issues and delete the disallowance of Rs.36,05,767/- and Rs. 1,19,70,782/-. Thus the ground nos. 3 & 4 are allowed.
33.2. The ground no. 5 relates to the disallowance of education and higher education cess amounting to Rs.19,72,00,814/-. The assessee claimed this cess paid by him as deduction as business expenditure. The assessing officer hold that this cess is collected by the revenue as part of income-tax and in view of section 40(ic)&(i), this amount cannot be allowed as an expenditure. When the matter went before the CIT(A), CIT(A) confirmed the disallowance by holding as under: