FAQs on Section 43CA of the Income-Tax Act

By Subash Agarwal, Advocate

1.   Introduction

      Section 50C was enacted a decade ago under Chapter IVof the Act, which deals with computation of capital gains arising from the sale of a capital asset. This provision was enacted to check the proliferation of black money in property transactions by deeming the value assessed or assessable by the Stamp Valuation Authority (in short, SVA) as the full value of consideration received / accrued on sale of a capital asset, being land or building or both. The provision applied to land or building or both held as a capital asset by the assessee and not to cases, where such assets were held as stock-in-trade.

2.   Enactment of section 43CA

      To extend the ambit of deeming fiction to such cases, where such assets are held as stock-in-trade, the Finance Act, 2013 has enacted section 43CA w.e.f. 1.4.2014, which falls in chapter-IV relating to the computation of Business Income.

3.   Salient features of Section 43CA

(a)  It applies to transfer of land or building or both held other than as a capital asset i.e., as a stock-in-trade.

(b)  In computing the business profit arising from the transfer of such asset, the value assessed or assessable by the SVA will be substituted in place of the actual consideration received.

(c)  Like as per the provision of section 50C, the assessee can claim before the A.O. that the value assessed / assessable by the SVA exceeds the FMV as on the date of transfer and ask him to refer the valuation of the property to the valuation officer.

(d)  Where the promoter or developer has entered into an agreement for sale with the buyer of the property but the sale is accounted for at the time of registration of deed at a subsequent date, the promoter-assessee has the option to take the value assessable by SVA on the date of agreement provided the consideration or a part of it has been received by him on or before the date of agreement in cheque.

4.   FAQs on section 43CA

      Attempt is being made hereunder to address various important issues that may arise from the enactment of this new provision.

5.   Fact Situation

      Suppose, one builder make an agreement for sale in a newly launched project at a price of Rs. 5,000/- PSF (Market price on that date is Rs. 7,000/- ). Subsequently, the investor cancels the deal and settles the deal at Rs. 7,000/- PSF and took the difference of Rs. 2,000/- PSF.

(a)  Query

      Whether the provisions of section 43CA will apply in the above example?

      Answer

      The provision of section 43CA is not applicable to the stated fact situation. The fact that the builder has entered into an agreement with an investor does not result into transfer of land or building. In the given fact situation, the builder has incurred a loss and the same is arising out of and in the course of business. As such, the builder can claim deduction of loss out of his business profits which is allowable u/s 28.

(b)  Query

      What would be the situation if in the above case, the investor instead of canceling the deal, nominate some other person at the market price of Rs. 7,000/-?

      Answer

      Where the investor nominates a person, he becomes the confirming party and the nominee becomes the buyer in the conveyance deed that is ultimately executed and registered.

      But the problem will arise when the conveyance deed is ultimately executed and registered. At that time, the sale will take place and in terms of section 43CA, deemed sale value will be the assessable value as per the State Stamp Valuation Authority (SVA) on the date of agreement with the investor, provided the investor has paid the booking amount by account payee cheque. Admittedly, the investor has booked the property at a price lower than the assessable value of the SVA and he has also pocketed the difference received from the nominee. Inspite of the fact that the difference does not go into the pockets of the builder, he has to face the brunt of the newly introduced section 43CA inasmuch as per the sub-section (3) thereof, the actual value of consideration will have to be substituted by the value assessable by the SVA on the date of agreement.

(c)  Query

      What would be the situation if the investor cancels the deal and settles for the same amount of Rs. 5,000/-?

      Answer

      If the investor cancels the deal and settles at the same price at which the property was booked (i.e., at the price less than the assessable value of the SVA), section 43CA does not come into play. It can be applied only when there is execution and registration of the conveyance deed.

6.   Query

      Suppose, a builder sells the right in Flat before the construction is  complete – Will the provision of above section be attracted as at that point of time, the building is not ready for use, so it cannot be termed as a building, nor does it come under the purview of Land?

      Answer

      As stated in response to Q no. 5(c), the provision of section 43CA cannot be applied where the builder merely sells the right in flat without entering into sale through the registered conveyance deed.

7.   Query

      Suppose, a buyer of a flat, who purchased the right in flat @ Rs. 5,000/-  PSF, sells the right in flat to another person at Rs. 6,000/- PSF before the construction is completed. Will the provisions of section 43CA be attracted, since there is no building or land which he is selling, although transfer includes extinguishment of rights u/s 2( 47)?

      Answer

      In the hands of the purchaser of right in a flat, the provision of section 43CA does not apply. The provision of section 43CA applies to an asset other than a capital asset, being land or building or both. This is specifically stated in sub section (1) of section 43CA. It is true that sale of a right in a capital asset results in extinguishment of right therein, but it is important to note that “extinguishment of right” is a form of transfer in relation to a capital asset in terms of section 2(47). Therefore, in the hands of the buyer of the right in flat, the differential sum on the sale of right is chargeable to tax as capital gains.

8.   Query

      What is the meaning of term “transfer” u/s 43CA, since in terms of section 2(47), “transfer” is used in relation to Capital Assets, whereas section 43 CA uses the term “transfer” in relation to  an asset (other than a capital asset)?

      Answer

      As stated in the preceding paragraphs, definition of “transfer” as per section 2(47) is confined to “capital assets”, gains arising out of which is chargeable to tax under the head “Income from Capital Gains”. Meaning of “transfer” u/s 43CA has not been defined. Therefore, the meaning as per the general law i.e., Transfer of Property Act will apply. “Transfer” u/s 5 of the Transfer of Property Act, 1882 implies conveyance of property “in present or in future” by a living person (including a company or AOP) to himself or to others. Conveyance is complete by registration of the document in respect of immovable properties.

9.   Query 

      Suppose a flat is booked in the year 2008-09 and a part consideration is also received in cheque. The flat is registered in the F.Y.: 2013-14, whether section 43CA of the Act is applicable?

      Answer

      In the given situation, section 43CA will be applicable. This is because, the provision is applicable from the A.Y.:2014-15 in regard to transfer of assets other than capital assets. Since the flat is registered in F.Y.: 2013-2014, transfer has also taken place in that year.

10. Query

      Suppose, a flat is booked in the year 2008-2009 or any date before 31.03.2012 and a part consideration is also received in cheque. The possession of the flat is given in F.Y.: 2011-2012 and maintenance charges are also received in that year. The flat is registered in the F.Y.: 2013-14, whether 43CA of the Act is applicable? Whether it makes any difference, if completion certificate is received after 31.03.13?

      Answer

      Date of registration is important for the purpose of applicability of section 43CA. Possession and other factors like completion certificate are irrelevant.

11. Query

      Suppose, the Buyer has shown the cost of flat in his Balance Sheet long back say, in F.Y.: 2005-06 and the developer has also shown the sale and booked profit in profit & loss account and his return of income in the said year. Now the flat is getting registered in F.Y.: 2013-14 and the stamp duty value is higher than the sale price even on the agreement date. I.T. return of either party is not reflecting any income/loss or any investment in AY 2014-15. Buyer has also taken benefit u/s 54 in the year of purchase/possession. Whether the assessing officer can reopen the case for earlier year for the developer (for considering sec. 43CA) and the buyer for sec. 56(2)(viib) or will do the assessment for the differential price in the year of registration? How far it is practically feasible and more so. when the section was inserted from the AY 2014-15?

      Answer

      The replies are as under –

(a)  It is to be clearly understood that the year of purchase in the hands of the buyer / investor and the year of sale in the hands of the builder / promoter / developer need not be the same.

(b)  A person who purchases a property as a capital asset is governed by the provisions relating to Capital Gains viz., chapter IV, E of the Act. He is also governed by the definition of the term “transfer” as per section 2(47), which has been conferred a very wider meaning. Thus, as per clause (v) thereof, even allowing of the possession of any immovable property to be taken in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act will amount to “transfer”.

(c)  The builder / promoter who is in the real estate business and is showing the income under the head business is not governed by the section 2(47) of the Act. In his hands, the sale / transfer will take place on the execution and registration of sale deed.

      In the context of 1922 Act, when the present day wider definition of ‘transfer’ as in section 2(47) was not on the statute book, the Hon’ble Supreme Court in CIT vs. Bhurangya Coal Co. 34 ITR 802 held that in the cases of an immovable property, transfer takes place only when the sale deed is concluded  and not when the agreement for sale is executed. It is only in case of movable property that the title passes by delivery. In the case of Alapati Venkataramiah vs. CIT 57 ITR 185 (SC), this view was once again reiterated. It was held in the context of section 12B (corresponding to section 45 of 1961 Act) as under –

      “Before section 12B of the 1922 Act, can be attracted, title must pass to the company by any of the modes mentioned in section 12B, of the 1922 Act i.e., sale, exchange or transfer. It is true that the word ‘transfer’ is used in addition to the word ‘sale’ but even so, in the context transfer must mean effective conveyance of the capital asset to the transferee. Delivery of possession of immovable property cannot by itself be treated as equivalent to conveyance of the immovable property.”

(d)  Thus, the wider definition of “transfer” u/s. 2(47) is confined to the “Capital Asset” and taxation under the head “Capital Gains”. The same cannot be extended to the determination of income under the head “Business”. It is pertinent to note here that the provision of section 43CA falls under chapter IV, D of Act, which relates to the determination of income under the head “Profit and Gains of Business or Profession”.

      Though word “transfer” has been used in section 43CA but the same has not been defined therein. Section 2(47) specifically states that “transfer” defined therein is in relation to “capital asset”.

      Therefore, for the purposes of section 43CA, “transfer” has to construed as per the general law which has been discussed in the preceding para.

(e)        If the builder / promoter / developer has already shown the sale on the basis of handing over of the possession and agreement in the preceding year(s) and the said return has been accepted by the department, the department cannot reopen those assessments as in those years provision of section 43CA cannot be applied. It may be noted that there cannot be two sales of the same transaction.

MERILYN SHIPPING REFUSES TO SINK

According to the ld. Advocates present in the court room no 6 of the Calcutta high court on 24 th june ,the present tax bench comprising of the hon’ble justice Indira banerjee and the hon’ble justice A. R Saraswati was not convinced with the reasoning of the earlier division bench’s  view in the case of  CIT vs. Crescent Export Syndicate, Order dated 03.04.2013 and also in the case of CIT vs. Md. Jakir Hossain Mondal, Order dated 4.4.2013 . In these two cases, the same High Court had taken a view contrary to the view taken by ITAT , Spl. Bench in Merilyn Shipping & Transports 146 TTJ 1 (Viz) (SB), where the Spl. Bench ITAT held  that the disallowance u/s 40(a)(ia) could be made only for the expenditure that is “payable” as on 31st March and not for the amounts that have already been “paid” during the year.

In keeping with the judicial discipline, the bench has referred the matter at hand, being ITAT 101/2013 in the case of CIT vs. Sk. Mahasin Ali to the hon’ble chief justice to constitute a larger bench for reconsidering the judgement rendered in the aforesaid two cases.

Deduction U/S. 54F On Investment In More Than One Flat - Case Studies

By Subash Agarwal,Advocate

Fact situation

An assessee has sold his Landed Property (Non-agricultural Land) and wants to purchase two nos. of House Property. Can he claim any exemption in the following situations-

Situation - 1, He already owns a residential house at the time of transfer of the above landed property and he wants to purchase two residential house.

Situation- 2, He does not have any residential house at the time of transfer of the above landed property and he wants to purchase two residential house.

Situation-3, His father & he jointly owned a residential house at the time of transfer of the above landed property and wants to purchase two residential house.

Analysis

Where long term capital gains arise from transfer of an asset other than a residential house, the assessee is entitled to the benefit of section 54F i.e., exemption from capital gains on purchase of a residential house within the specified period. As per the said provision, the benefit is not available if the assessee owns more than one residential house on the date of transfer of asset in question.

In the three situations narrated above, the assessee is not owning more than one residential house on the date of sale. So, there is no impediment in claiming exemption u/s. 54F. Now, the question arises – whether the assessee can claim exemption in respect of two residential houses.

The view of the courts in general is that where two or more flats are acquired in the same apartment/complex and they are contiguous (adjoining) to each other and used as single residential unit, the exemption can be allowed for the cost of all those flats. However, where the flats are situated in different locations, then the exemption will be allowed only for one of the flats at the option of the assessee.

Important case laws are as under –

(i)         CIT vs. D. Ananda Basappa 309 ITR 329 (Kar.)

This was a case of multiple flats in the same complex used as one unit and the exemption under section 54 was allowed. The SLP filed by the Department against this decision was rejected by the Supreme Court [ 320 ITR (St.) 19]

(ii)        CIT vs. K.G. Rukminiamma 331 ITR 211 (Kar.)

In this case, there were  four residential units, but all of them were in the same building acquired in pursuance of a development agreement. Held, the exemption was allowable.

 (iii)      CIT vs. Raman Kumar Suri 212 Taxman 411 (Bom)

In this case, the assessee purchased a duplex flat. The A.O. held that it was not one flat but two flats which have been joined into one flat. He restricted the exemption to half of the investment made. It was held that the assessee is entitled to exemption for the entire investment made.

(iv)       Hon’ble Punjab and Haryana High Court in the case of Pawan Arya vs. CIT 49 DTR 123 restricted the benefit to one house since in this case, two new houses were acquired  in different locations.

(v)        In the case of Smt. Myrtle D’Souza vs. ITO 53 SOT 236 (Mum) the exemption was restricted to the value of one of the flats since in that case, two flats in different floors of the complex were acquired.

However, recently in Gita Duggal’s case 257 CTR 208 (Del) liberal view has been taken in respect of purchase of residential units in the same building but at different floors. It was held that section 54/54F uses the expression “a residential house” and not “a residential unit”. It was held that there is nothing in these sections which require the residential house to be constructed in a particular manner. This judgement, however, is on different factual plane. In this case, the assessee had entered into a collaboration agreement with developer. The builder was to construct three floors at his cost and first two constructed floors were to be given to the assessee in lieu of land and third floor was to be retained by the builder. The assessee had claimed that if the cost of construction was to be treated as sale price, the same should also be correspondingly taken to have been invested in the residential house namely, the two floors that the assessee was entitled to. The case of the assessee was accepted by the ITAT and the High Court.

Whether Gifts From Nana / Nani fall Under Exempted Category U/s 56(2)?

By Subash Agarwal,Advocate

The issue is not free from doubt. As per section 56(2)(vii), r.w. Explanation thereto, any gift from, interalia, lineal ascendant / descendant is not taxable as IFOS. The term used has not been defined in the Act. Colloquially, the term is meant to indicate lineal movement of relationship on the paternal side upwards and downwards. However, a closer analysis indicates a wider movement on the maternal side as well.

As per Tomlin’s Law Dictionary, lineal descent is a term used to designate a descent from father to son or grandfather to grandson. Thus, lineal ascendant will move in reverse manner i.e., son to father or father to grandfather or son to grandfather . As per Black’s Law Dictionary Parents, grandparents and great grand parents are lineal ascendant.

As per “The Oxford Large Print Dictionary”, grandfather is the father of a person’s father or mother and grandmother is the mother of a person’s father or mother. As per Law Lexicon (General Editor: Justice Y.V. Chandrachud), the term “Lineal descendant” includes all the descendants and is not restricted to male descendants. Thus, in my view the relationship of “Nana”/ “Nani” is covered in the exempted category and gifts received from them are exempt from tax.

No Disallowance Can Be Made In Respect Of Shares On Which Dividend Income Has Not Been Received U/s 14A r.w Rule 8D

ITAT, Kolkata holds in a landmark judgement  that in computing disallowance u/s 14A r.w Rule 8D , only investment in those shares are to be considered which has yielded exempt income in the form of dividends. In other words, disallowance cannot be made in respect of shares on which dividend income has not been received. Read the full text:

IN THE INCOME TAX APPELLATE TRIBUNAL “A” BENCH: KOLKATA

[Before Shri K.K.Gupta, A.M. & Shri George Mathan, J.M.]

I.T.A. No. 1331/Kol/2011 : Assessment Year : 2008-09

REI Agro Ltd., Kolkata -Vs- DCIT, Central Circle-XXVII, Kol.

(PAN : AABCR 4929H)

(Appellant) (Respondent)

I.T.A. No. 1423/Kol/2011 : Assessment Year : 2008-09

DCIT, Central Circle-XXVII, Kol. –Vs- REI Agro Ltd., Kolkata

(Appellant) (Respondent)

Date of concluding the hearing : 22.05.2013

Date of pronouncing the Order : 19.06.2013

Appearances :

For the Department : Shri L.K.S. Dehiya, CIT(DR)

For the Assessees : Shri Ravi Tulsiyan, FCA

O R D E R

Per Shri George Mathan,J.M.

The ITA No.1331/Kol/2011 is an appeal filed by the Assessee and the ITA

No.1423/Kol/2011 is an appeal filed by the Revenue against the order of the CIT(A),

Central-I, Kolkata in Appeal No.03/CC-XXVII/CIT(A),C-II/10-11 dated 2nd August,

2011 for the assessment year 2008-09.

2. Shri L.K.S.Dehiya, CIT,D.R appeared on behalf of the Revenue and Shri Ravi

Tulsiyan. FCA appeared on behalf of the assessee.

3. In the assessee’s appeal, the assessee has raised the following grounds:

“1. The orders passed by the lower authorities are unwarranted, arbitrary,

without proper reasons, invalid and bad in law, in so far as they are against

the interest of the appellant company.

2. On the facts and in the circumstances of the case, the learned CIT(A)

erred in holding that proportionate management and administrative expenses are required to be deducted while computing exempt income or dealing with investment matter and in that view, in sustaining thedisallowance of Rs.26,09,386/- under Rule 8D(2)(iii) of the Income Tax Rules.

3. On the facts and in the circumstances of the case, the learned CIT(A)

erred in sustaining disallowance of Rs.26,09,386/- u/s 14A of the Incometax

Act, 1961, by applying the provisions of Rule 8D(2)(iii) of the Income

Tax Rules against meager Dividend income of Rs.1,32,638/- only.

4. The appellant craves leave to amend, alter, modify, add to, abridge

and/or rescind any or all the above grounds in future.”

3.1 In the Revenue’s appeal, the Revenue has raised the following grounds:

“01. That in the facts and circumstances of the case and in law, the Learned

CIT(A) has erred in law in deleting the disallowance of Rs.37727610/- in

respect of interest made u/s.14A of the Act read with Rule 8D of IT rules by

holding that the investment of shares was made out of own funds of the

assessee without considering that the linkage between the funds borrowed

and the investments, the income of which is exempt, was not established by

the assessee.

02. That in the facts and circumstances of the case, the Ld. CIT(A) has

erred in law in deleting the disallowance of Rs.3,77,27,610/- in respect of

interest made u/s.14A r/w Rule 8D of the Act, in view of the decision of the

Hon’ble Kolkata High Court in the case of Danukha & Sons –Vs- CIT

(Central)-I, Kolkata reported in 201 Taxman 105 (Kol) (Mag), wherein it

has been held that in the absence of any material disclosing the source of

acquisition of shares which is within the special knowledge of the assessee,

the assessing authority can make proportionate disallowance.

03. That the Department craves leave to add, modify or alter any of the

above ground(s) of appeal and/or adduce additional evidence at the time of

hearing of the case.”

4. At the time of hearing, it was submitted by the ld. D.R. that the assessee is a company which is doing the business of rice processing, power generation and Retail sale. It was a submission that during the year, the assessee had received dividend income of Rs.1,32,638/-, which was claimed as exempt. The assessee had not debited any expenses in respect of expenditure incurred for earning such exempt income. The AO has invoked the provisions of section 14A read with rule 8D of the Act and has made a disallowance of an amount of Rs.4,03,36,996/-. It was a submission that on appeal, the ld. CIT(A) had reduced the disallowance under section 14A to Rs.26,09,386/-. It was a submission that against the relief granted of Rs.4,03,36,996/-, the Revenue has filed the appeal in ITA No.1423/Kol/2011 and in respect of disallowance confirmed by the CIT(A) to the extent of Rs.26,09,386/-, the assessee has filed the appeal in ITA No.1331/Kol/2011. It was a submission that the ld. CIT(A) had considered the various case laws to come to the conclusion that no disallowance under section 14A would be made. It was a submission that the case laws relied on by the ld. CIT(A) related to the period prior to the assessment year 2008-09, being the assessment year from which the provisions of Rule 8D came into application. It was a submission that the assessee had invested Rs.103 crores in shares during the relevant assessment year. It was a further submission that there was no increase in

the share capital during the relevant assessment year. It was a submission that however, the assessee’s loan account had increased by Rs.122 crores. It was, thus, the submission by the ld. D.R. that the investment in the shares was out of interest bearing funds. It was a submission that the ld. CIT(A) had in his order in para 4.1 held that the assessee was having a common pool in respect of its own fund as also its loan fund. It was a submission that as the assessee had used interest-bearing fund for purchasing shares and the assessee had paid interest on the same, the disallowance as made by the AO by invoking the provisions of section 14A read with Rule 8D was liable to be upheld. It was a further submission that though the AO has in his assessment order specifically held that there is no disallowance liable to be made under rule 8D(i), disallowance under rule 8D(ii) had been made on the basis of the computation provided thereunder, as also under Rule 8D(iii). It was a submission that in view of the decision of the Hon’ble Jurisdictional High

Court in the case of Danukha & Sons –Vs- CIT (Central)-I, Kolkata reported in

201 Taxman 105 (Kol), it was for the assessee to show the source of acquisition of the shares by production of the materials that those were acquired from funds available in the hands of the assessee at the relevant point of time without taking benefit of any loan. The assessee having not shown such availability of funds, the disallowance was liable to be upheld.

4.1 He also relied upon the decision of the Hon’ble Kerala High Court in the

case of Leena Ramchandran reported in 339 ITR 296. It was a submission that the order of the ld. CIT(A) was liable to be reversed to the extent that he has reduced the disallowance.

5. In reply, the ld. A.R. submitted that as per the provisions of section 14A(2),

the AO was to determine the amount of expenditure incurred in relation to such income which does not form part of the total income, in accordance with such method as may be prescribed. It was a further submission that there was also supposed to be satisfaction to the correctness of the claim of the assessee. It was a submission that at the outset, the AO has not shown that the claim of the assessee that there is no amount disallowable was wrong nor is there any satisfaction recorded to such effect. On this point, the ld. D.R. submitted that the Coordinate Bench of this Tribunal has, in the case of Champion Commercial reported in 26 Taxman.com 342, held that it is only where the assessee offers a disallowance under section 14A, the AO is required to record satisfaction. When no expenditure is offered by the assessee, the AO need not record such satisfaction.

5.1    It was submitted by the ld. A.R. that as per the provisions of section 14A(3), the provisions of sub-section (2) also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to the income which does not form part of the total income under the Act. In the return filed by the assessee, there is no provision for making a claim that there is no expenditure. The fact that the assessee did not make any disallowance under section 14A, in the return filed itself was the claim that no expenditure has been incurred. The ld. A.R. further drew our attention to P&L a/c. of the assessee for the year ended on 31.03.2008 as also the balance-sheet, which were at pages 78 to 95 of the paper book. It was a submission that the shareholders’ funds in the balance-sheet showed that the share capital had increased by Rs.4 crores during the relevant assessment year and the Reserves and Surplus had gone up by Rs.112 crores. The loan fund had increased by Rs.122 crores. It was a submission that the loan funds were  used for the acquisition of assets as also towards working capital and in fact the fixed assets net block increased by Rs.116 crores, after considering a depreciation of 57 crores. It was, thus, a submission that the actual increase in the fixed assets when compared to the net block for the year ended on 31.03.2007 was 174 crores. It was a submission that the profits available to the assessee before taxation for the assessment year 2008-09 was Rs.130 crores and the profit, after taxation, was Rs.109 crores. The amount available for appropriation for the assessment year 2008-09 was Rs.128 crores. He further drew our attention to the investments during the year, which is shown at page 84, being the investment in Varrsana Ispat Limited at Rs.103 crores. It was a submission that the other investments, which were there as on the beginning of the assessment year was to an extent of Rs.58,27,282/-. It was a submission that it is out of the shares of this investment of Rs.58,27,282/-, the assessee had received the dividend income and not on the investment of Rs.103 crores. The ld. A.R. further drew our attention to page 362 of the paper book, which was the copy of the loan sanction document from the State Bank of Bikaner and Jaipur dated 22.12.2007 for letter of credit of Rs.175 crores.

It was a submission that this was on the security of the stock available with the

assessee. He further drew our attention to page 370 of the paper book, which was the letter from Allahabad Bank for reviewing and enhancing the limits for working capital from the existing Rs.250 crores to Rs.500 crores. It was a submission that this was also enhanced working capital limit, which was to be released only after the tie-up of the entire limit of Rs.1800 crores from the Consortium. This was also for the Letter of Credit purpose. He further drew our attention to pages 372, 374 and 381, which were all credit sanction advices given by the various banks, being United Bank of India, Indian Overseas Bank. It was a submission that all these were for L.C. only. It was a submission that all the loans were directly related to the business of the assessee. The ld. A.R. further drew our attention to the decision of the Coordinate Bench of this Tribunal in the case of Balarampur Chini Mills

Ltd. 140 TTJ (Kol) 73, wherein the Tribunal has held that section 14A and Rule 8D can be invoked only when the AO is not satisfied with regard to the account of the assessee that the claim of expenditure made by the assessee is not correct and the claim made by the assessee that no expenditure has been made in relation to income, which does not form part of total income under the Act. Where the assessee has explained that the share capital and reserves, that is its own funds, were utilized for the purpose of investment in shares for earning dividend income which has not been negated by lower authorities and there is no linkage or nexus between the funds borrowed by the assessee and the impugned investments, no interest expenditure can be disallowed by mechanically applying the provisions of rule 8D. It was a submission that the decision of the Hon’ble Jurisdictional High Court in the case of Danukha & Sons (supra) would not apply in so far as in that case the assessee was not able to show that the investment was made out of its own

independent non-interest bearing funds. It was a submission that no disallowance under section 14A could be made.

6. We have considered the rival submissions. A perusal of the provisions of

section 14A, more specifically sub-section (2), shows that if the AO is not satisfied with the correctness of the claim of the assessee, then the AO shall determine the amount of expenditure incurred in relation to such income, which does not form part of total income under the Act. For this the method is prescribed in rule 8D. The provision of section 14A, sub-section (3) specifies the provision of 14A(2) would also apply where the assessee makes a claim that there is no expenditure incurred. This is because if the assessee does not make a disallowance under section 14A in its computation of total income, when filing the return, then if subsection (3) was not available, the AO might not be able to make a disallowance under section 14A. Thus, where the assessee makes a claim that only a particular amount is to be disallowed under section 14A or where the assessee does not make a disallowance under section 14A, if the AO proposes to invoke the section 14A, he is to record a satisfaction on that issue. This satisfaction cannot be a plain satisfaction or a simple note. It is to be done with regard to accounts of the

assessee. In the present case, there is no satisfaction by the AO and consequently, in view of the decision of the Coordinate bench of this Tribunal in the case of Balarampur Chini Mills Ltd. referred to supra, no disallowance under section 14A can be made.

7. Now coming to the merits of the issue. A perusal of the provision of section

14A(1) clearly shows the wordings, “in relation to the income which does not form part of the total income under this Act”. In the present case, this income, which does not form part of the total income under the Act, is the dividend income of Rs.1,32,638/-. Therefore, if any disallowance is to be made in respect of expenditure incurred, it should be in relation to this dividend income of Rs.1,32,638/-. If an assessee has invested in shares, which could get dividend or there is investment which generates dividend income or exempt income as also investment which does not generate exempt income, it is only such investments in respect of which the dividend income or exempted income has been earned which can be considered when computing the disallowance under section 14A read with rule 8D. A perusal of the provisions of rule 8D also talks of satisfaction in sub-rule (1). Rule 8D(2) has three sub-parts. The first sub-part i.e. (i) deals with the amount of expenditure directly relating to the income which does not form part of the total income. That issue is not in dispute here and therefore, we do not go into it in this case. In second sub-part i.e.(ii), it is a computation provided in respect of expenditure incurred by the assessee by way of interest during the previous year which is not directly attributable to any particular income or receipt. This clearly means that if there is any interest expenditure, which is directly relatable to any particular income or receipt, such interest expenditure is not to be considered under rule 8D(2)(ii). In the assessee’s case here the interest has been paid by the assessee on the loans taken from the banks for its business purpose. There is no allegation from the banks nor the AO that the loan funds have been diverted for making the investment in shares or for non-business purposes. Further rule 8D(2)(ii) clearly is worded in the negative with the words “not directly attributable”. Thus for bringing any interest expenditure, claimed by the assessee, under the ambit of rule 8D(2)(ii) it will have to be shown by the AO that the said interest is not directly attributable to any particular income or receipt. Why we say here that it is to be shown by the AO is on account of the words in Rule 8D(1) being “where the Assessing Officer, …… is not satisfied with.

(a) ……..

(b) ……..

in relation to income……., he shall determine the amount of expenditure in

relation to such income in accordance with the provisions of sub-rule (2).

In the assessee’s case, admittedly, the assessee has substantial capital. The increase in the capital itself is to an extent of Rs.4 crores and in respect of reserves and surplus, the increase is Rs.112 crores. The loans taken during the year admittedly are for the letters of credit and the assessee is bound to provide the bank stock statement and other details to show the utilization of the loans. No bank would permit the loan given for one purpose to be used for making any investment in shares. The ld. CIT(A), it is noticed that after considering these facts that the assessee had not used any of its borrowings for purchasing the shares, has deleted the disallowance. On this ground itself, the deletion as made by the ld. CIT(A) is liable to be confirmed and we do so.

7.1 In any case, the working of the disallowance under sub-part (ii) of subclause (2) of rule 8D as made by the AO also suffers from a substantial error in so far as in the said rule in regard to the numerator B, the words used are the average value of the investment, income from which does not form or shall not form part of the total income as appearing in the balance-sheet as on the first day and in the last day of the previous year. Here the AO has taken into consideration the investment of Rs.103 crores made this year, which has not earned any dividend or exempt income. It is only the average of the value of the investment from which the income has been earned which is not falling within the part of the total income that is to be considered. This is why the question of satisfaction is provided in section 14A and rule 8D(1), that relates to the accounts of the assessee.

Thus, it is not the total investment at the beginning of the year and at the end of the year, which is to be considered but it is the average of the value of investments which has given rise to the income which does not form part of the total income which is to be considered. A question may arise as to why the term “average of the value of investment” is then used. The term average of the value of investment would be to take care of cases where there is the issue of dividend striping. In any case, as we have already held that the assessee has not incurred any expenditure by way of interest during the previous year, which is not directly attributable to any particular income, the findings of the ld. CIT(A) on the issue stand confirmed and consequently the appeal filed by the Revenue stands dismissed.

8. In respect of provisions of rule 8D(2)(iii), which is the subject-matter of the

appeal in the assessee’s hand, a perusal of the said provision shows that what is disallowable under rule 8D(2)(iii) is the amount equal to ½ percentage of the average value of investment the income from which does not or shall not form part of the total income. Thus, under sub-clause (iii), what is disallowed is ½ percentage of the numerator B in rule 8D(2)(ii). Again this is to be calculated in the same line as mentioned earlier in respect of Numerator B in rule 8D(2)(ii) of the Act.

8.1 Thus, not all investments become the subject-matter of consideration when computing disallowance under section 14A read with rule 8D. The disallowance under section 14A read with rule 8D is to be in relation to the income which does not form part of the total income and this can be done only by taking into  consideration the investment which has given rise to this income which does not form part of the total income. Under the circumstances, the computation of the disallowance under section 14A read with rule 8D(2)(iii), which is issue in the assessee’s appeal, is restored to the file of the AO for recomputation in line with the direction given above. No disallowance under section 14A read with rule 8D(2)(i) and (ii) can be made in this case.

9. In the result, the appeal filed by the Revenue stands dismissed and the

appeal filed by the assessee stands partly allowed for statistical purposes.

This Order is pronounced in the Court on 19th June, 2013.

Sd/- Sd/-

(K. K. Gupta) (George Mathan)

Accountant Member Judicial Member

Dated : 19th June, 2013

Order pronounced by:

Sd/- Sd/-

A.M. J.M.

(NSS) (GM)

 

Copy of the order forwarded to:

1. REI Agro Ltd., 46C, Chowringhee Road, Kolkata - 700 071

2 DCIT, Central Circle-XXVII, Kolkata

3. The CIT(A),

4. CIT,

5. DR, Kolkata Benches, Kolkata

True Copy, By order,

Asstt. Registrar, ITAT, Kolkata

Talukdar(Sr.P.S.)

Whether A Firm Is Liable To Capital Gains Tax On Reconstitution Of Partnership?

By Subash Agarwal, Advocate

According to section 45(4)  gains arising from deemed distribution of capital assets on the dissolution of a firm or otherwise is chargeable to capital gains tax and for the purpose of section 48, FMV of assets on the date of dissolution etc. is deemed to be the full value of the consideration received.

This provision was brought on the statue book to block a devise resorted to by the assessees to transfer capital assets through the medium of firms without paying any capital gains tax, particularly, by bringing in new partner(s) and after a while, dissolving the firm and handing over high valued assets at book value to the newly inducted partners, thereby, evading capital gains tax.

Though the term “dissolution of a firm” is vividly mentioned in the provision but at the same time, there is an omnibus term used i.e., “otherwise”. The purpose of this write-up is to examine whether the “reconstitution” of partnerships are also covered under the sweep of the general term “otherwise”.

Often, revenue’s contention is that “reconstitution” of a partnership is also a specie of transfer referred to in section 45(4) and the same is covered by the term “otherwise”. As such, FMV of the assets given to the retiring partners shall be taken as deemed sale consideration for the purpose of computation of capital gains in the firm’s hands.

The mischief of sec 45(4) is applied even where there is induction of new partners on the plea that a right on existing assets is created in favour of the incoming partners, which are appearing at the book value in the accounts but their market value is considerably higher. In this regard, Kerala High Court judgement in the case of CIT vs. Kunnamkulam Mill Board 257 ITR 544 is worth taking note of.

In this case, the  Hon’ble Court held that in a case of this nature what happens is that with the admission of new partners, the right of the existing partners were reduced and that a right was created in favour of the newly inducted partners. But the ownership of the property did not change even with the change in the constitution of the firm.

Likewise, if a partner retires, he does not transfer any right in the immovable property in favour of the surviving partner because he has no specific right with respect of the properties of the firm.

 More recently, in the case of Prashant S. Joshi vs. ITO 324 ITR 154 (Bom.), same view as in the case of Kunnamkulam Mill’s case was taken.

However, a contrary view has been taken by the Bombay High Court in the case of CIT vs. A.N. Naik Associates 265 ITR 346.  In this case, there was handing over of assets of the partnership to the retiring partners. In that context, it was held that section 45(4) will apply, where there is transfer of assets to the retiring partners (see para 21 of the judgement). In this case, even Kunnamkulam Mills’ case (supra) was also considered at para 15 and the same was distinguished and it was observed that in Kunaamkulam’s case, assets were not allotted to the partners.

Another interesting case was before the Hon’ble Karnataka High Court in the case of CIT vs. Gurunath Talkies 328 ITR 59 (Karn.) where there were four partners. There was reconstitution of partnership. Two new partners were inducted. There was again reconstitution of the firm. The Old partners retired leaving the assets of the firm with newly inducted partners. The Court held that there was transfer of assets of the firm after considering the objects of the introduction of section 45(4).

Thus, the application of mischief of sec 45(4) on reconstitution of firms depends on facts and circumstances of a case.