Avshesh Mercantile P. Ltd. vs. DCIT (ITAT Mumbai)

No s. 14A disallowance if tax-free investments capable of taxable income

The assessee, an investment company, issued optionally convertible premium notes which entitled the holder thereof to a premium on redemption. The proceeds of the issue was invested by the assessee in acquiring the shares of Reliance Utilities and Power Ltd (“RUPL”), the income whereof was exempt u/s 10(23G). The assessee claimed a deduction of the premium paid to the holders of the notes which was rejected by the AO & CIT (A) on the ground the expenditure was incurred in respect of tax-free income and so deduction could not be allowed u/s 14A. Before the Tribunal, the assessee argued that s. 14A could not apply because (a) though the dividends and LTCG on the shares of RUPL were exempt u/s 10(23G), the STCG & stock-lending income were not exempt and (b) the assessee had in fact not received any tax-free income on the shares. HELD upholding the assessee’s plea:

(i) Though the proceeds of the premium notes on which the redemption premium was paid had been invested in the shares/debentures of RUPL and although the dividend income and LTCG from the said investment was exempt u/s 10(23G), the premium cannot be regarded as expenditure incurred exclusively in relation to earning of exempt income so as to invoke s. 14A because the said investment had the potential of generating taxable income in the form of STCG etc;

(ii) Further, as no taxable income was actually earned by the assessee, disallowance u/s 14A was not sustainable. (Delite Enterprises followed). The fact that in Delite Enterprises, the appeal was dismissed on the ground that no Q of law arises does not mean that it is not a decision on merits. Even a dismissal of an appeal on the ground that no Q of law arises results in a merger (Nirma Industries 283 ITR 402 (Guj) followed)