Wednesday, May 1, 2013

expenditure incurred on borrowed funds for financing purchase and sell of shares on behalf of others can be disallowed,

Whether expenditure incurred on borrowed funds for financing purchase and sell of shares on behalf of others can be disallowed, even if income earned from brokerage has been taxed: ITAT

THE issue before the Tribunal is - Whether the expenditure incurred by the assessee on borrowed funds for financing in respect to purchase and sell of shares on behalf of others cannot be allowed, although the income earned from brokerage has been taxed. And the answer goes against the Revenue.

Facts of the case

The assessee has borrowed huge funds from banks and also in the form of inter Corporate deposits etc. The AO has referred the matter to special audit u/s 142(2A), to study issue of utilization of the borrowed funds. The AO passed his order placing reliance on the findings of the Special Auditor, in which it was observed that the interest incurred by the assessee was in excess of the brokerage income. The Auditor also observed that the assessee had carried out huge volume of trade on which no brokerage has been charged, and thus he concluded that there was no commercial sense involved in the transactions of the assessee. The AO agreed with the observations of the Auditor that, there was no reason to allow the claim of interest incurred on financing the loan. Further, the AO relied on the fact that SEBI had debarred the assessee from trading in the stock market for two years for transactions against the public policy. He also came to a conclusion that the the borrowed capital was being utilized for financing the traders, which was not an active business of the assessee. The AO was of the strong opinion that any expense incurred in a business venture, which has no profit motive cannot be allowed as an expenditure

The CIT(A) allowed the appeal of the assesee by observing that on identical facts the issue has been decided in favour of the assessee for the assessment year 2001.

Aggrieved, the Revenue filed an appeal before the Tribunal.

The Departmental Representative strongly opposed the order of the CIT(A) and stated that the order of CIT(A) showed that he was allowing the contention of the assessee for the AY 2000-01 on the facts of that year and not on the facts of subsequent years's enquiry. The DR heavily relied on the order passed by the SEBI, in which an adverse finding was given against the assessee for involving in synchronized trade transactions with Ketan Parkeh group and facilitating circular trades and artificial volumes of the scrips in the markets. Finally, the DR argued that the transactions of the assessee were against public policy and hence expenditure incurred out of such transactions could not be allowed u/s 37(1) of the Act.

The counsel for the assessee contended that if the brokerage earned by the assessee from such illegal activities was taxed, the deduction of interest expenditure incurred to earn that brokerage has to be allowed. He argued that as per the subsequent amendments carried out to Section 37 empowered the AO only to disallow illegal expenditure incurred while carrying on legal business, and therefore even the activity of the assessee was treated as entirely illegal, still the expenditure has to be allowed. Further, he contended that the funds were borrowed for financing various traders from whom the assessee had earned brokerage which was more than the interest expenditure. He submitted that the AO had ignored the fact that brokerage of the assessee had increased substantially which was the basis for the CIT(A) to decide in favour of the assessee for the AY 2000-01

Disallowance u/s 14A

The AO disallowed the interest expenditure on the ground that the assessee had earned dividend income and, therefore, against exempted income, no expenditure on account of interest and other expenses were allowable. The CIT(A) relying upon the the identical facts of AY 2000-01, allowed the claim of expenditure.

Aggrieved, the Revenue filed an appeal before the Tribunal.

Discrepancy of brokerage amount in service tax return vis-a-vis P/L Account

The AO has the added the excess brokerage shown in service tax return as compared to brokerage income shown in profit and loss account. The CIT(A) relying upon previous AY order allow the appeal and deleted the addition.

Aggrieved, the Revenue filed an appeal before the Tribunal.

Allowability of prior period expenses

The AO disallowed certain expenses on the ground that they related to earlier years. On appeal, the CIT(A) deleted this addition following his earlier order.

Aggrieved, the Revenue filed an appeal before the Tribunal.

Interest accrued but not due

The AO had added the interest amount in the income of the assessee which had accrued but not due. On appeal before the CIT(A), that the interest became due on the coupon date of security. It was stated that where the coupon date fell beyond the last date on a particular financial year, the interest was merely taken into books of account of the said financial year in accordance with the periodicity concept of accounting. It was also stated that the interest in securities was receivable only after the last date of financial year, and there was no right of the assessee to receive the interest in the year under consideration. Thereafter, the CIT(A) deleted the addition.

Having heard the parties, the Tribunal held that,

Allowability of interest incurred on borrowed funds

++ it is recorded that during the year under consideration the assessee has earned brokerage of Rs.108,85,85,105/- against brokerage earned of Rs.67,44,07,631/- in earlier year. The assessee has incurred interest cost of Rs.17,48,70,004/- from the sale transaction and has earned brokerage of Rs.72,89,83,531/-. Similarly, against interest cost of Rs.4,43,98,516/-, it was for the purpose of transaction. The assessee company has earned brokerage of Rs.28,67,13,513/-, total of the brokerage comes to Rs.108,85,85,105/-. Therefore, the contention of the AO as well as DR that against huge interest expenditure the assessee has earned less brokerage, is factually incorrect;

+ it is further seen that in immediately preceding year, the assessee incurred interest expenditure about Rs.12 crore or odd against which the assessee has shown brokerage income of Rs.67,44,07,631/-. This fact has been noted by the CIT(A) while allowing the issue in favour of the assessee for assessment year 2000-01. The main contention of the department in denying the claim of the interest expenditure is that the SEBI has passed an order giving adverse report against the assessee. We have seen the report of the Special Auditor and in the note the Special Auditor has noted that the activity of the assessee indulging in financing activity may construe that the assessee is indulged in illegal activity. For a moment if it is accepted that the assessee is indulged in unauthorized activity of financing in respect to purchase and sell of shares on behalf of others, in that case, we are of the view that the interest expenditure has to be set off against brokerage earned by the assessee because the interest expenditure is incurred by the assessee on borrowed money for the purpose of buying shares or making purchases of shares on behalf of others. Huge brokerage is charged, which is much more as compared to interest expenditure. This is not expenditure, which is prohibited under Explanation of Section 37(1) as this expenditure does not belong to bribery nor on account of fine or penalty or hafta paid to someone as these expenditures are on account of borrowed money used for the purpose of business transaction. Even the Courts have held that if for a moment it is accepted that some activities are on account of unauthorized activity, then also unauthorized income has to be set off against unauthorized expenses;

+ in case of Bank of America (nt & sa), the Mumbai Bench of the Tribunal has held that loss incurred by the assessee in security transaction in violation of Section 15 of the Securities Contract Regulation Act, 1956, undisputedly borne out that it was set off against profit from comparable transaction. In this case, it was argued on behalf of the department that losses incurred by the assessee are not allowable on account of expenses as they are relating to illegal activities. Thereafter it was held by the Tribunal that if the expenses are on account of illegal transaction, then income part of the same transaction has to be treated on account of illegal transaction and both i.e. income as well as expenditure is to be set off against each other;

+ in the present case also facts are similar. If the department treats the activities of the assessee are illegal, then income earned by the assessee as well as expenditure incurred by the assessee has to be treated on the same transaction and they have to be netted against each other;

+ the department has also taken a plea that on certain transaction even no brokerage has been charged by the assessee. This is well known and settled position of law that this is business man, who knows how to run its business activities. If by any reason the assessee does not charge any brokerage from certain parties, that may be on account of commercial expediency and to earn brokerage in future. It is not the case of the department that the assessee has not charged brokerage from a particular party from whom heavy transaction has been made by the assessee and heavy interest expenditure have been incurred by the assessee. Figure of interest expenditure against brokerage income has been tabulated somewhere above in this order. Brokerage income is much more than the interest expenditure;

+ keeping in view of all these facts and circumstances of the case and the finding of the CIT(A) for earlier year, which has been followed by the CIT(A) for the year under consideration, we are of the view that the CIT(A) was correct in allowing the issue in favour of the assessee. Accordingly, we confirm the order of the CIT(A) on this issue.

Disallowance u/s 14A

++ we found no infirmity in the finding of the CIT(A). We noted that the CIT(A) has taken into consideration that the assessee is a trader and the entire shares purchases have been kept under the head stock-in-trade. This fact has been accepted by the AO. Dividend income is the consequential income. Any expenditure incurred during the regular course of business is allowable. There is a direct nexus between the trading activity and incurring expenditure either on account of interest or on account of other administrative expenses. Therefore, we are of the considered view that disallowance made by the AO was not justified and CIT(A) was justified in not deleting the same. Accordingly, we confirm the order of the CIT(A) in this respect;

Discrepancy of brokearge amount in service tax return vis-a-vis P/L Account

++ we found that CIT(A) was justified in deleting this addition also. The issue was examined by the CIT(A) for immediately preceding year i.e. assessment year 2000-01. It was seen by the CIT(A) that the assessee has been reflecting the service tax return, the brokerage on accrued basis but in profit and loss account the brokerage has been shown on actual basis on the basis of constant method adopted by the assessee. It was further noticed by the CIT(A) that sometime the assessee is required to reduce the brokerage at the request of the assessee during the final settlement of the bills and some time the assessee is also required to waive part of the brokerage disputed by the clients. Therefore, difference as per the service tax return and as per profit and loss account was found explainable. This is a minor difference, which has been reconciled by the assessee. Therefore, we see no reason to interfere in the finding of the CIT(A) in this respect also;

Allowability of prior period expenses

++ CIT(A) examined the issue in earlier year and found that no such expenses were claimed in earlier year and in the year under consideration the final settlement was arrived at and, therefore, they were booked in the year when the final settlement was made. Similar issue is involved in the year under consideration. These expenses were not claimed in earlier year as they were claimed on the basis of final settlement during the year under consideration. Any claim of expenditure settled in a particular year is allowable in that year if the same is not claimed in earlier year. Undisputedly, these expenses were not booked in earlier year, therefore, in our view, lCIT(A) was justified in deleting the disallowance made by the AO on account of prior period expenses;

Interest accrued but not due

++ after considering the submission and taking into the consideration the case laws relied upon, CIT(A) found that the interest on Government securities is not received on day to day basis, but only on the specified coupon dates. It was found that the Tribunal has held that this is the correct legal position on the basis of which income should be computed and it was held that when the interest was received then only can be taxable. In view of these facts, CIT(A) deleted the addition also.

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