By TIOL News Service

NEW DELHI, SEPT 16, 2014: THE issue before the Bench is - Whether when the assessee makes investments in shares to pick up controlling stake in an Indian company after taking approval of FIPB, the entire expenditure related to such investment is to be attributed to investments made for earning dividend, and is to be disallowed u/s 14A. And the answer is NO.

Facts of the case

The assessee company is a subsidiary of Holderind Investments Ltd., Mauritius which was formed for making downstream investments in cement manufacturing ventures in India. While filing its return, the assessee had declared cumulative losses for both the A.Ys 2007-08 and 2008-09. The assessee had also declared revenue receipts, including interest from FDRs and profit from sale of fixed assets, and claimed administrative and miscellaneous expenses expenditure written off over such receipts. For A.Y 2008-09, the assessee had declared revenue receipts in the form of foreign currency fluctuation difference gain and other expenses including personal expenses, operating expenses, depreciation and financial expenses. The AO however held that the assessee had neither commenced business activities, nor made any downstream investments. The expenditure claimed by assessee for earning dividend income was also disallowed by holding that mere approval of Foreign Investment Promotion Board (FIPB) showing permission to acquire share capital, was not sufficient to indicate or hold that the assessee had started their business. He accordingly disallowed the entire expenditure u/s 14A.

On appeal, the CIT(A), by two separate orders, did not agree with the findings recorded by the Assessing Officer that the business of the assessee had not been set up or commenced. The CIT(A) observed that the assessee had been set up with the business objective of making investment in cement industry after due approval given by the Government of India. In fact, the assessee was not to undertake any manufacturing activity themselves. He referred to the FIPB approval permitting them to make investment in Ambuja Cement Ltd. by acquiring majority stake from the earlier shareholders. Thereupon, the assessee had purchased shares in the said company of Rs 1850.91 Crores. Reference was then made to the expenditure as per the financial statement. Section 3 of the Act was elucidated upon to observe that business would be established when the assessee was ready to commence. Revenue expenditure incurred after setting up business should be allowed under Section 37 of the Act but expenditure incurred prior to setting up of business cannot be allowed. The CIT (A) accordingly held that the provisions of Sec 14A were applicable in this case.

On appeal, the HC held that,

++ we note that the Revenue did not prefer any appeal or file cross-objection against the finding on the question whether the business had been set up. The Tribunal specifically noticed that the CIT(A) did not make disallowance on the ground that the assessee had invested in the shares for earning of the dividends but, on the ground that the assessee had acquired controlling interest in the respective companies and this was their line of business. Therefore, the Tribunal observed that there was a contradiction in the submissions made by the DR that the assessee had acquired shares for earning of dividends;

++ the question which needs to be answered is that whether section 14A can be invoked and disallowance of expenditure can be made, even if no dividend income is earned. The Punjab and Haryana High Court in case of CIT, Faridabad vs. Lakhani Marketing Inc., CIT Vs. Hero Cycles Ltd. and CIT Vs. Winsome Textile Industries Ltd. held that Section 14A cannot be invoked when no exempt income was earned. Income exempt u/s 10 in a particular A.Y may not have been exempt earlier, but can become taxable in future years. Further, whether income earned in a subsequent year would or would not be taxable, depend upon the nature of transaction entered into in the subsequent A.Y. it is an undisputed position that assessee is an investment company and had invested by purchasing a substantial number of shares and thereby securing right to management. Possibility of sale of shares by private placement cannot be ruled out and is not an improbability. Dividend is declared by the company and strictly in legal sense, a shareholder has no control and cannot insist on payment of dividend. However, upon declaration, such dividend is subjected to dividend distribution tax (DDT). What is noticeable is that the entire expenditure has been disallowed, which in turn will lead to an inference that there was no expenditure incurred by the assessee for conducting business, which is an impossibility. Since, the genuineness of the expenditure and the fact that it was incurred for business activities was neither doubted by the AO, nor CIT(A), we do not find any merit in appeal.

(See 2014-TIOL-1586-HC-DEL-IT)