Modi Builders,, Pune vs Assessee

These are cross appeals. The first one is filed by the

assessee and the second one filed by the Revenue and are

directed against the order dated 19-10-2012 of the CIT(A)-III,

Pune relating to Assessment Year 2009-10. For the sake of

convenience, these were heard together and are being disposed

of by this common order.

2 ITA No.1693/PN/2013 :

2. Ground of appeal No.1 by the assessee reads as under :

"1. On the facts and in the circumstances of the case the CIT(A) has erred in disallowing the expenditure of Rs. 6,60,000/- paid by the appellant to Pune Municipal Corporation(PMC) for regularizing the excess area constructed for a building called "MODI MALL" by invoking the Explanation to sec 37(1).

3. Facts of the case, in brief, are that the assessee is a

partnership firm engaged in the business of land developers and

builders, leasing out commercial and residential property. It

filed its return of income on 31-10-2009 declaring total income

of Rs.12,26,71,670/-. During the course of assessment

proceedings the Assessing Officer noted that assessee firm has

debited an amount of Rs.6,60,000/- under the head direct

expenses towards penalty charges for completion certificate to

the profit and loss account. On being questioned by the

Assessing Officer it was submitted that the same has been paid

to PMC for regularising the excess area that had been

constructed than it was sanctioned. It was argued that the

impugned payment represented Tadjod fee paid to PMC and was

not in the nature of penalty or fine.

4. However, the Assessing Officer was not satisfied with the

explanation given by the assessee. He observed that the

assessee has violated the norms levied by the Municipal

authorities while constructing the MODI MALL due to which the

PMC has levied penalty of Rs.6,60,000/-. According to the

Assessing Officer as per Explanation to section 37(1) any

expenditure incurred by an assessee for a purpose which is an

offence or which is prohibited by law will not be deemed to have 3

been incurred for the purpose of business or profession and no

deduction or allowance will be made in respect of such

expenditure. He accordingly disallowed the amount of

Rs.6,60,000/- claimed by the assessee and added back the same

to the total income of the assessee.

5. In appeal the Ld.CIT(A) following the decision of Hon'ble

Karnataka High Court in the case of CIT Vs. Mamta Enterprises

reported in 266 ITR 356 which is directly on this issue held that

the compounding fees paid by the assessee to the Municipal

Corporation for violation of building construction norms notified

by PMC is in the nature of fine or penalty for infraction of law

and therefore provisions of Explanation to section 37(1) of the

I.T. Act are clearly attracted to such expenditure. He accordingly

upheld the action of the Assessing Officer.

6. Aggrieved with such order of the CIT(A) the assessee is in

appeal before us.

7. The Ld. Counsel for the assessee strongly challenged the

order of the CIT(A). He submitted that this compounding fees

cannot be treated as an expenditure incurred for a purpose

which is an offence or which is prohibited by law. According to

him the term offence connotes an illegal act which is against the

public policy. Such offence is not pardonable or compoundable.

He submitted that the explanation comes into play only when it

is proved that the expenditure though incurred for business

purpose but the same is coupled with the purpose which is an

offence or prohibited by law. As long as compounding fees are

paid for the business purpose and which is not an offence or

prohibited by law and otherwise allowable u/s.37(1) no 4

disallowance could be made. He further submitted that

Explanation to section 37(1) is in the nature of deeming

provision. It is a legal fiction and it is commonly called as fiction

whose mandate does not exist but for such a provision. The

scope of deeming provision has to be restricted to what is

expressly stated in such a provision.

8. So far as the decision of Hon'ble Karnataka High Court in

the case of Mamta Enterprises (Supra) is concerned he

submitted that the Hon'ble Karnataka High Court has not

considered the decision of Hon'ble Supreme Court in the case of

CIT Vs. Ahmedabad Cotton Manufacturing Company Ltd. and

others reported in 205 ITR 163. Referring to the above decision

of the Hon'ble Supreme Court he submitted that the Hon'ble

Supreme Court in the said decision has held that payments,

though referred to as penalty, but in fact made in exercise of

option available under statutory scheme, in the course of

assessee's business is an allowable expenditure. He submitted

that in that case the assessee being a manufacturer of cotton

textiles had to comply with the directions issued from time to

time by the Textile Commissioner under the provisions of Cotton

Textiles (Control order), 1948. The assessee instead of

producing and packing the minimum quantity of specified type

as required by the aforesaid directions of the Textile

Commissioner paid to the Textile Commissioner to

Rs.1,70,766/- in exercise of the option available to it under

clause 21C(1)(b) of the Control order. The assessee claimed the

amounts as deduction from its profit which was disallowed by

the Assessing Officer on the ground that the said amounts paid

by the assessee to the Textile Commissioner were not deductions 5

which can be allowed as items of business expenditure. The

AAC allowed the claim. The appeal filed by the Revenue before

the Tribunal was dismissed. A Division Bench of the Hon'ble

Gujarat High Court decided the issue against the Revenue and

in favour of the assessee. On further appeal by the Revenue the

Hon'ble Supreme Court held that payment though referred to as

penalty, but in fact made in exercise of option available under

statutory scheme in the course of assessee's business is an

allowable business expenditure.

8.1 He submitted that in the instant case also it is known as

compounding fees. However, it is for commercial expediency.

He submitted that assessee is in the business of land developers

and builders, leasing of commercial and residential properties

etc. as per clause 4 of the partnership deed. It constructed the

building called 'Modi Mall'. The PMC found that excess area had

been constructed by the assessee than the sanctioned area. On

payment of compounding fees the PMC regularised the excess

construction as per the office Circular dated 16-06-2011. He

submitted that had it been for an infraction of law the PMC

would not have accepted the compounding fees and regularised

the excess construction. Therefore, the amount paid to the PMC

though called compounding fee is an allowable expenditure.

8.2 Referring to the decision of Hon'ble Delhi High Court in

the case of CIT Vs. Lokenath and Co. (Construction) reported in

147 ITR 624 he submitted that the Hon'ble High Court in the

said decision has upheld the decision of the Tribunal wherein

the amount paid to municipality as compensation for condoning

deviations from original sanction and accepting revised plan of

construction was allowed as deductible business expenditure by 6

holding that it is not penalty for infraction of law. He also relied

on the decision of the Mumbai Bench of the Tribunal in the case

of DCIT Vs. Bharat C. Gandhi reported in 46 SOT 258 and the

decision of the Hon'ble Andhra Pradesh High Court in the case of

CIT Vs. Transport Corporation of India reported in 368 ITR 728.

He accordingly submitted that the amount should be allowed as

deduction u/s.371(1).

9. The Ld. Departmental Representative on the other hand

heavily relied on the order of the CIT(A). He submitted that the

Explanation to provisions of section 37(1) was not before the

Hon'ble Supreme Court in the case of Ahmedabad Cotton Mfg.

Co. Ltd. (Supra). He submitted that the Hon'ble Karnataka High

Court in the case of Mamta Enterprises (Supra) had decided the

issue which is directly on this issue. He submitted that there is

no commercial expediency in violating municipality law and the

assessee cannot be rewarded for an illegal act. 9.1 So far as the decision of Hon'ble Delhi High Court in the

case of Lokenath and Co. (Supra) is concerned he submitted that

the order is dated 13-01-1984 and the Explanation to section

37(1) was incorporated by Finance No.2 Act, 1998 with

retrospective effect from 01-04-1962. Therefore, the Explanation

to section 37(1) was not before the Hon'ble Delhi High Court.

Therefore, the same cannot be followed. As regards various other

decisions relied on by Ld. Counsel for the assessee are

concerned, he submitted that they are on different issues and

are distinguishable. He accordingly submitted that the order of

the CIT(A) should be upheld and the ground raised by the

assessee should be dismissed.

7

10. We have considered the rival arguments made by both the

sides, perused the orders of the Assessing Officer and the CIT(A)

and the Paper Book filed on behalf of the assessee. We have also

considered the various decisions cited before us. The only

dispute to be adjudicated in the impugned ground is regarding

allowability of compounding fees of Rs.6,60,000/- paid by the

assessee to PMC for regularising the excess area constructed as

deductible expenditure. We find the Assessing Officer disallowed

the claim of expenditure on the ground that the penalty paid to

the PMC was for violation of the norms levied by the municipal

authorities, therefore, Explanation to section 37(1) is clearly

applicable. We find the Ld.CIT(A) also upheld the action of the

Assessing Officer by holding that the compounding fees paid by

the assessee to Municipal Corporation for violation of building

construction norms notified by the PMC is in the nature of fine

or penalty for infraction of law and therefore provisions of

Explanation to section 37(1) of the I.T. Act are clearly attracted.

While doing so, he followed the decision of the Hon'ble

Karnataka High Court in the case of Mamta Enterprises (Supra). 10.1 It is the submission of the Ld. Counsel for the assessee

that the Hon'ble Karnataka High Court has not considered the

decision of the Hon'ble Supreme Court in the case of Ahmedabad

Cotton Mfg. Co. Ltd. and others (Supra). Further, according to

him the payment though referred to as penalty but in fact made

in exercise of option available under statutory scheme in the

course of assessee's business and therefore is an allowable

business expenditure.

8

10.2 We find the Finance (No.2) Act, 1998 had inserted

Explanation to Section 37(1) of the Act with retrospective effect

from 1.4.1962. The Explanation reads thus:--

"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."

According to the explanation, expenditure incurred for any

purpose which is an offence or which is prohibited by law, is not

entitled for deduction. Thus, the amount paid on account of

compounding fee as compensation for condoning deviations

from original sanctioned plan in view of the Explanation to

Section 37(1) of the Act in our opinion would not be an

admissible deduction.

10.3 We find the Hon'ble Karnataka High Court in the case of

Mamta Enterprises (Supra) has held that compounding fee paid

by the assessee to regularise the construction of the building

made in violation of the building regulations could not be

allowed as deduction in view of specific prohibition in

Explanation to section 37(1) as compounding of such an offence

by paying compounding fine did not wipe out the offence or

infraction of law committed by the assessee under the relevant

Corporation Act.

10.4 The decision of the Hon'ble Supreme Court in the case of

Ahmedabad Cotton Mfg. Co. Ltd. and others (Supra) and the

decision of Hon'ble Delhi High Court in the case of Lokenath and

Co. (Supra) were prior to the insertion of Explanation to section

37(1) of the I.T. Act. Therefore, the above decisions in our

opinion are not applicable to the facts of the present case. 9

10.5 So far as the decision of Mumbai Bench of the Tribunal in

the case of Bharat C. Gandhi (Supra) is concerned we find, the

issue in that case is regarding settlement fees paid under Motor

Vehicle Act. The issue in the case of Transport Corporation of

India (Supra) was secret commission paid to promote its

business. Therefore, the decisions relied on by the Ld. Counsel

for the assessee are not applicable to the facts of the present

case.

10.6 We find the Hon'ble Karnataka High Court in the case of

Mamta Enterprises (Supra) distinguishing the decision of

Hon'ble Delhi High Court in the case of Lokenath and Co.

(Supra) and following the decisions of Hon'ble Supreme Court in

the case of Haji Aziz & Abdul Shakoor Bros.reported in 41 ITR

350 and in the case of Maddi Venkataraman & Co. Pvt. Ltd. Vs.

CIT reported in 229 ITR 534 has observed as under :

"8. In our view, the above observation made by the Delhi High Court cannot be of any assistance to learned counsel for the respondent to support his case as the said decision was rendered prior to the amendment to section 37 of the Act by incorporating the Explanation referred to above by means of the Finance (No. 2) Act, 1998, which is made retrospective effect with effect from April 1, 1962. When the section itself declares the 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, it is not possible to take the view that the expenditure incurred for compounding of the offence should be allowed. When the section is clear and unambiguous, it is not permissible for the courts to stretch the meaning attached to the provision of law to extend the benefit to a person who violates the law or the regulations/rules made by the corporation or the municipal authorities with impunity. Under these circumstances, the expenditure incurred to pay the penalty cannot be treated as loss in business to get the benefit. In our view, the penalty paid has enured to the benefit of the assessee to save the additional construction put up in violation of the provisions of the Act and bye-laws framed there under and also the consequences of penal provision provided under the Corporation or the municipal law. The view we have taken above is fully supported by the decision of the hon'ble Supreme Court in the case of Haji Aziz and Abdul Shakoor Bros. [1961] 41 ITR 350, wherein the Supreme Court has observed as follows (page 359) :

10 "If a sum is paid by an assessee conducting his business, because in conducting it he has acted in a manner which has rendered him liable to penalty, it cannot be claimed as a deductible expense. It must be a commercial loss and in its nature must be contemplable as such. Such penalties which are incurred by an assessee in proceedings launched against him for an infraction of the law cannot be called commercial losses incurred by an assessee in carrying on his business. Infraction of the law is not a normal incident of business and, therefore, only such disbursements can be deducted as are really incidental to the business itself. They cannot be deducted if they fall on the assessee in some character other than that of a trader. Therefore, where a penalty is incurred for the contravention of any specific statutory provision, it cannot be said to be a commercial loss falling on the assessee as a trader the test being that the expenses which are for the purpose of enabling a person to carry on trade for making profits in the business are permitted but not if they are merely connected with the business. . . .

In our opinion, no expense which is paid by way of penalty for a breach of the law can be said to be an amount wholly and exclusively laid out for the purpose of the business. The distinction sought to be drawn between a personal liability and a liability of the kind now before us is not sustainable because anything done which is an infraction of the law and is visited with a penalty cannot on grounds of public policy be said to be a commercial expense for the purpose of a business or a disbursement made for the purposes of earning the profits of such business."

Further, a similar view is taken by the Supreme Court in the case of Maddi Venkataraman and Co. (P.) Ltd. [1998] 229 ITR 534. At page 545 of the judgment, the Supreme Court has observed thus :

"In the instant case, the assessee had indulged in transactions in violation of the provisions of the Foreign Exchange (Regulation) Act. The assessee's plea is that unless it entered into such a transaction, it would have been unable to dispose of the unsold stock of inferior quality of tobacco. In other words, the assessee would have incurred a loss. Spur of loss cannot be a justification for contravention of law. The assessee was engaged in tobacco business. The assessee was expected to carry on the business in accordance with law. If the assessee contravenes the provisions of the FERA to cut down its losses or to make larger profits while carrying on the business, it was only to be expected that proceedings will be taken against the assessee for violation of the Act. The expenditure incurred for evading the provisions of the Act and also the penalty levied for such evasion cannot be allowed as deduction. As was laid down by Lord Sterndale in the case of Alexander von Glehn and Co. Ltd. (1920) 12 TC 232 (CA), it was not enough that the disbursement was made in the course of trade. It must be for the purpose of the trade. The purpose must be a lawful purpose."

9. Therefore, we are clearly of the opinion that deduction permitted by the Commissioner as well as the Tribunal is totally unsustainable in law. Therefore, in the light of the above conclusion reached by us, the question referred to us by the Tribunal is required to be answered against the assessee and in favour of the Revenue. Accordingly, it is answered and this reference case is disposed of. However, no order is made as to costs." 11

10.7 In view of the above, we are of the considered opinion that

compounding fee paid by the assessee to the Municipal

Corporation on account of deviations from original sanctioned

plan is in the nature of penalty and therefore would not be

allowable as deduction in view of provisions of Explanation to

section 37(1) of the I.T. Act. The above view of ours also finds

support from the decision of the Hon'ble Punjab & Haryana High

Court in the case of Nahar Spinning Mills Vs. CIT reported in

(2014) 49 taxmann.com 565 and the decision of Hon'ble

Karnataka High Court in the case of Millennia Developers Pvt.

Ltd. Vs. DCIT reported in 188 Taxmann 388 (Kar.) In view of

the above discussion Ground of appeal No.1 by the assessee is

dismissed.

11. Ground of appeal No.2 by the assessee reads as under :

"2. On the facts and in the circumstances of the case, the CIT(A) has erred in sustaining the disallowance of payment of interest of Rs 55,85,717/- by invoking the provisions of sec 40(a) (ia) overlooking the fact that the interest is payable to the NBFC's which are granted exemption for no IDS u/s 194A(3)(iii)(f) and also overlooking the fact that the entire interest has been paid in the previous year."

12. Facts of the case, in brief, are that the AO during the

course of assessment proceedings noted that assessee has not

deducted TDS from the following payments :

a. City Financial Rs.7,31,374/- b. City Finance (Eduljee) Rs.26,83,156/- c. India Bulls Rs.21,71,187/- ------------------- TOTAL Rs.55,85,717/- ------------------- 12

He therefore disallowed the above amount u/s.40(a)(ia) of the I.T.

Act.

13. Before CIT(A) it was argued that no amount is outstanding

and provisions of section 40(a)(ia) are applicable only if the

interest amount is payable and outstanding as on 31st of March

of the relevant year. Rejecting the various submissions made by

the assessee and distinguishing the various decisions cited

before him the Ld.CIT(A) upheld the action of the AO.

14 Aggrieved with such order of the CIT(A) the assessee is in

appeal before us.

15. The Ld. Counsel for the assessee made two fold

arguments. He submitted that since no amount is payable at

the end of the financial year, therefore, provisions of section

40(a)(ia) are not applicable. Referring to the decision of the

Mumbai Bench of the Tribunal in the case of M/s. Arcadia Share

and Stock Brokers Pvt. Ltd., Vs. DCIT vide ITA

No.1871/Mum/2013 order dated 22-12-2014 for A.Y. 2006-07

he submitted that the Tribunal in the said decision after

considering the dismissal of the SLP filed by the Revenue in the

case of Vector Shipping Services Pvt. Ltd. has held that

provisions of section 40(a)(ia) are not applicable to a case where

no amount is payable at the end of the year and which has

already been paid. He accordingly submitted that although the

Pune Benches of the Tribunal are taking the view which is

against the assessee, however, in view of the latest decision of

the Mumbai Bench of the Tribunal no disallowance u/s.40(a)(ia)

is called for when admittedly no amount is payable on account of

such interest to NBFCs.

13

15.1 In his alternate argument the Ld. Counsel for the assessee

referring to the decision of the Pune Bench of the Tribunal in the

case of ITO Vs. Gaurimal Mahajan and Sons vide ITA

No.1852/PN/2012 order dated 06-11-2014 for A.Y. 2008-09

submitted that the Tribunal in the said decision has held that

disallowance u/s.40(a)(ia) of the I.T. Act could not be made if the

assessee is not deemed to be an assessee in default under the

first proviso to section 201(1) of the I.T. Act if the payers have

filed the return of income showing the interest receipt. He

submitted that although this argument was not advanced before

the lower authorities, however, in view of the decision of the

Tribunal, this argument of the assessee should be accepted and

he has no objection if the issue is restored to the file of the AO

for fresh adjudication.

16. The Ld. Departmental Representative on the other hand

heavily relied on the order of the CIT(A). He submitted that the

Pune Bench of the Tribunal are constantly taking the view

following the decision of the Hon'ble Gujarat High Court and

Hon'ble Calcutta High Court that provisions of section 40(a)(ia)

are applicable even if no amount is payable at the year end

where TDS has not been deducted from such payments.

Therefore, the issue has to be decided against the assessee. So

far as the alternate argument of the assessee is concerned, the

Ld. Departmental Representative submitted that such argument

was never taken before the lower authorities. However, he left it

to the Bench.

17. We have considered the rival arguments made by both the

sides. So far as the argument of the Ld. Counsel for the

assessee that no disallowance u/s.40(a)(ia) is required since no 14

amount is payable at the end of the year, we find the Pune

Benches of the Tribunal following the decisions of Hon'ble

Gujarat High Court and Hon'ble Calcutta High Court are taking

the consistent view that provisions of section 40(a)(ia) are

applicable for TDS default even if no amount is payable at the

end of the year. The above view of the Tribunal also finds

support from the decision of the Hon'ble Punjab & Haryana High

Court in the case of PMS Diesels Vs. CIT reported in TS-346-HC-

2015 (P&H). The Hon'ble High Court after considering the

decision of Hon'ble Allahabad High Court in the case of Vector

Shipping Services (P) Ltd. reported in 262 CTR 545 and the

dismissal of the SLP before Hon'ble Supreme Court has held that

provisions of section 40(a)(ia) are applicable even if no amount is

payable at the end of the year. Therefore, the first limb of

argument of the Ld. Counsel has to be rejected.

17.1 So far as the alternate argument of the Ld. Counsel for the

assessee that disallowance u/s.40(a)(ia) could not be made if the

assessee is not deemed to be an assessee in default under the

first proviso to section 201(1) of the Act whereof the payees have

filed the return showing such income in the return of income, we

find the same is acceptable. We find the Pune Bench of the

Tribunal in the case of Gaurimal Mahajan and Sons (Supra)

while deciding an identical issue has observed as under :

"8. We have considered the rival arguments made by both the sides, perused the orders of the Assessing Officer and the CIT(A) and the Paper Book filed on behalf of the assessee. We have also considered the various decisions brought to our notice by both the sides. There is no dispute to the fact that the assessee has not deducted TDS on an amount of Rs.58,81,847/- for which the Assessing Officer applying the provisions of section 40(a)(ia) made addition of the above amount. We find the Ld.CIT(A) deleted the addition made by the Assessing Officer on the ground that provisions of section 40(a)(ia) are not applicable since no amount is payable at the end of the year. While doing so, he relied upon the 15

decision of the Special Bench of the Tribunal in the case of Merilyn Shipping and Transport (Supra). The Coordinate Bench in the case of Vinay Ashwinikumar Joneja (Supra) has already taken a view that provisions of section 40(a)(ia) are applicable even if no amount is payable at the end of the year. Therefore, the order of the CIT(A) has to be reversed.

8.1 However, the assessee has made a new legal argument that the Finance Act, 2010 has amended the first proviso to section 40(a)(ia) w.e.f. 01-04-2010 and it has been held by various judicial authorities that such amendment is retrospective in nature. It is the submission of the Ld. Counsel for the assessee that the second proviso to section 40(a)(ia) was inserted by the Finance Act, 2012 w.e.f. 01-04-2013 wherein it is stated that disallowance u/s.40(a)(ia) of the Act need not be made if the assessee is not deemed to be an assessee in default under the first proviso to section 201(1) of the I.T. Act., therefore, this should also be held as retrospective since it has been introduced to eliminate unintended consequences which may cause undue hardship to the tax payers.

8.2 We find some force in the above argument of the Ld. Counsel for the assessee. We find the Cochin Bench of the Tribunal in the case of Antony D. Mundackal (Supra) relied on by Ld. Counsel for the assessee, had an occasion to decide an issue in the light of the above argument and has restored the issue to the file of the Assessing Officer with certain directions. The relevant observation of the Tribunal at Para 7 of the order read as under:

"7. We have heard the rival contentions and carefully perused the record. According to the assessee, there is no written contract between him and the persons doing polishing works. Accordingly, the assessee has contended before us that the provisions of sec. 194C shall not apply to the polishing charges. However, we notice that the assessing officer has given a clear finding that essential ingredients of a contract are very much available in the polishing works entrusted by the assessee. Further we notice that the CBDT, vide circular No.433 dated 25-09-1985 (1986)(157 ITR St. 27) has clarified that the provisions of sec. 194C are wide enough to cover oral contracts also. A contract is normally reduced in writing in order to make clear the terms and conditions, obligations of the parties to the contract etc. If the conditions of contract are otherwise understood by the parties, in view of the repeated transactions, in our view, the absence of a written contract would not make any difference. In the instant case, the assessee is repeatedly given works to the polishing people and hence the terms and conditions of the work would be clearly understood by both the parties. Accordingly, we reject this contention of the assessee and hold that the provisions of sec. 194C shall apply to the polishing works given by the assessee.

7.1 According to Ld A.R, the assessee has acted as a conduit pipe in connection with the polishing works between the customers and the person doing polishing job. Accordingly, it was submitted that there is no profit element in the said transactions. The Ld A.R further submitted that the assessee has included the cost of polishing works in the sale value of aluminium extrusions, without knowing tax implications. However, we notice that the assessee did 16

not furnish any proof to substantiate the above said claims. The assessee, being a dealer in aluminium extrusions, has only supplied the products after carrying out the polishing works according to the taste and requirement of customers. It is only one of the many business techniques normally adopted by a business man to improve his sales, since it will be very difficult for customers to identify the polishing people and get the work done by themselves. Hence, we are of the view that it may not be correct to argue that the contract existed between the customers and the polishing people. In fact, the customer may not have any contact with the polishing people in this type of transactions. Hence, it is hard to believe the claim of the assessee that he has acted as mere conduit pipe between the customers and polishing people, Accordingly, the claim that the assessee stands in a fiduciary capacity is also liable to be rejected. In this kind of factual situation, in our view, the existence or absence of profit element in the polishing works does not make any difference.

7.2 The Ld Counsel, by placing reliance on the decision of special bench in the case of Meryline Shipping and transports (supra) contended that the provisions of sec. 40(a)(ia) shall apply only to amount payable and not to the amount paid. However, the Hon'ble Gujarat High Court in the case of CIT Vs. Sikandar Khan N Tunvar (357 ITR 312) and the Hon'ble Calcutta High Court in the case of CIT Vs. Crescent Export Syndicate (ITAT 20 of 2013) have held that the decision rendered by the Special Bench in the case of Meryline Shipping & Transports is not a good law. The Ld A.R, however, placed reliance on the decision of Hon'ble Allahabad High Court in the case of Vector Shipping Services (357 ITR 642). On a careful perusal of the decision given by Hon'ble Allahabad High Court, we notice that the High Court has decided the issue referred to it on a different footing and has made a passing comment about the decision rendered by the Special Bench. Thus, the ratio of the said decision is different from that rendered in the case of Meryline Shipping and Transports by the Special bench. Hence, we are inclined to reject the contentions of the assessee on this point also.

7.3 The assessee placed reliance on the decision of Hon'ble Supreme Court in the case of Hindustan Coco-Cola beverages Ltd (supra) in order to contend that the revenue is not entitled to recover taxes, if the recipient has declared the payments in his return of income. We notice that the above said decision was rendered in the context of the provisions of sec. 201(1) and hence, we are of the view that the ratio of the said decision cannot be applied to the disallowance made u/s 40(a)(ia) of the Act,

7.4 The last contention of the assessee is that the second proviso to sec, 40(a)(ia) of the Act, inserted by the Finance Act, 2012 with effect from 1.4.2013 is clarificatory in nature and hence the benefit of the same should be applied retrospectively. However, the correctness of this contention has not been examined by the tax authorities. Hence, in the interest of natural justice, we are of the view that this contention of the assessee requires examination at the end of the assessing officer. Accordingly, we modify the order of the Ld.CIT(A) and set aside this ground to the file of the Assessing Officer with the direction to examine the above said contention of the assessee and decide the same in accordance with law, after affording necessary opportunity of being heard. We 17

make it clear that we have, in effect, rejected all the contentions of the assessee except the ground relating to applicability of the second proviso to sec.40(a)(ia) of the Act to the year under consideration".

8.3 Since the above arguments are being advanced before the Tribunal for the first time and the correctness of the contention has not been examined by the tax authorities, therefore, respectfully following the decision of the Cochin Bench of the Tribunal cited (Supra) and in the interest of justice, we restore this issue to the file of the Assessing Officer with a direction to examine the above contention of the assessee and decide the issue afresh and in accordance with law. Needless to say, the Assessing Officer shall give due opportunity of being heard to the assessee. We hold and direct accordingly."

17.2 Following the above decision we deem it proper to restore

the issue to the file of the AO with a direction to decide the issue

afresh in the light of the above decision of the Tribunal. Ground

No.2 by the assessee is accordingly allowed for statistical

purposes.

18. Ground of appeal No.3 by the assessee reads as under :

"3. On the facts and in the circumstances of the case, the C1T(A) has erred in sustaining the disallowance of interest of Rs. 5,85,000/- paid on unsecured loans by invoking the provision of section 40(a)(ia) overlooking the fact that the appellant has duly deducted the tax at source and deposited in time."

19. After hearing both the sides, we find invoking the

provisions of section 40(a)(ia) the Assessing Officer disallowed an

amount of Rs.5,85,000/- being interest paid to unsecured loan

creditors which has been upheld by the CIT(A). Both the sides

agreed that this issue is identical to ground of appeal No.2

above. Therefore, following the ratio laid down in Ground of

appeal No.2, we restore this issue to the file of the Assessing

Officer for deciding the issue afresh in the light of the

observations given while adjudicating ground of appeal No.2. 18

This ground by the assessee is accordingly allowed for statistical

purposes.

20. The assessee has also taken two additional grounds which

are as under :

"1. On the facts and in the circumstances of the case CIT(A) erred in confirming the disallowance of interest of Rs.2,02,91,840/- claimed as deduction from "Income from House Property".

2. On the facts and in the circumstances of the case CIT(A) has also erred in not allowing the alternate submission that the entire interest is allowable u/s.36(1)(iii) of the Act and has further erred in holding that this interest is to be capitalised to the qualifying assets by relying on proviso to sec. 36(1)(iii) overlooking the fact that the said proviso is applicable to the capital assets and to the current assets".

21. The Ld. Counsel for the assessee did not press the

Additional ground No.1. So far as the additional Ground No.2 is

concerned he submitted that the above ground arises from the

order of the CIT(A) and goes to the root of the issue involved in

the appeal. Relying on various decisions he submitted that this

additional ground No.2 should be admitted.

22. After hearing both the sides and considering that the facts

are already on record the additional ground No.2 by the assessee

is admitted.

23. We find the Revenue has also filed the following grounds

which are on the same issue. Grounds raised by the Revenue

are as under :

"1. The order of the Ld. Commissioner of Income Tax (Appeals) is contrary to the law and facts and circumstances of the case.

2. The Ld. Commissioner of Income-tax (Appeals) has not appreciate the efforts of Assessing Officer to put: forth the facts that the loans were taken against the property and rent receivable, not for acquiring or construction of the property or any others. Hence, the interest paid is not allowable for partly acquiring or construction of the property.

19 3. The Ld. Commissioner of Income-tax (Appeals) erred on facts and in law that under the proviso to section 36(1)(iii), the interest paid shall riot be allowed as deduction till the asset is first put to use but the assessee has partly utilized for purchased of plot, construction of mall and purchase of other stock, hence, all the interest amount is not allowable u/s 36(1)(iii) of the I. T, Act, 1961.

4. For these and such above other grounds as may be urged at the time of the hearing, the order of the learned CIT(Appeals) may be vacated and that of the Assessing Officer be restored.

5. The appellant craves, leave to add, amend, alter or delete any of the above ground of appeal during the course of the appellant proceedings before the ITAT."

Therefore, additional ground No.2 by the assessee and the

grounds raised by the Revenue are being adjudicated together.

24. Facts of the case, in brief, are that the Assessing Officer

during the course of assessment proceedings noted that

assessee has claimed loss of Rs.45,56,360/- under the head

income from house property after claiming deduction u/s.24

being interest on loan to the extent of Rs.2,02,91,840/-. The

interest was claimed against rent received from Krishna

Sahakari Bank Rs.18,75,284/- and LNB Textiles Pvt. Ltd.,

Rs.1,84,05,556/. According to the Assessing Officer the said

deduction is allowable where the property has been acquired,

constructed, repaired, renewed or reconstructed with borrowed

capital. He therefore asked the assessee to explain the

allowability of the same. It was submitted that loan has been

utilised partly for purchase of plot, construction of mall,

purchase of other stock. It was argued that the interest paid on

the above loan if not allowed as a deduction under the head

income from house property u/s.24 should be allowed as

deduction under the head income from business or profession

u/s.36(1)(iii) since such interest paid on loans were raised for

business purposes. It was submitted that the interest paid on 20

the entire loan has been debited to the P&L account in the

audited profit and loss account. It was submitted that the gross

total income of the firm will not be affected by allowing the

interest either u/s.24 or u/s.36(i)(iii). The decision of the

Hon'ble Bombay High Court in the case of CIT Vs. Lokandwala

Construction Industries Ltd. was also brought to the notice of

the Assessing Officer.

25. However, the Assessing Officer was not satisfied with the

explanation given by the assessee. According to him, the

assessee has taken the loan against the property and rent

receivable. The interest is not paid on capital borrowed for

acquiring or construction of the property within the meaning of

section 24(b). As regards the claim of deduction u/s.36(a)(iii) is

concerned the Assessing Officer noted that during the impugned

assessment year the assessee has declared loss under the head

house property, business income from sale of Kharadi plot at

Kharadi and interest received from fixed deposits. The assessee

made investment of Rs.20,75,93,364/- in land, shops and work-

in-progress and Rs.15,22,42,987/- towards advance for land

and other advances. The advances include Rs.25,05,000/- to

Modi Land Developers, Rs.10,51,98,692/- to Modi Milk and Agro

Products, Rs.44,17,480/- to Modi Properties, Rs.45 lakhs to

Refrigeration Electrical Appliances Pvt. Ltd., Rs.41,51,000/- to

R.S Developers, Rs.1.10 crores to Sanjay N. Jalan (HUF),

Rs.11 lakhs to Shanta Ram Kadu, Rs.30 lakhs to Vijay

Associates. No interest has been offered from the loans and

advances and also the land/plots have not been put to use for

the purpose of business. He therefore asked the assessee to

explain as to why the interest should not be disallowed. 21

According to the Assessing Officer operating costs that are

directly attributable to the acquisition, construction or

production of a "qualifying asset" should be capitalised as part of

the cost of the asset. Therefore, financial costs identifiable with

a particular project have to be added to the cost of the project as

any other method is going to distort the profits or sale of Kharadi

plot. He observed from the accounts that interest paid to Citi

Financial, Citi Finance and India bills and unsecured loans

amounting to Rs.61,70,717/- has been utilised for acquisition of

lands amounting to Rs.20.76 crores shown as closing stock and

also advance for purchase of land at Rs.15.22 crores. Since only

profit from sale of Kharadi plot has been declared during the

year the deduction claimed for interest paid against the profit

has to be disallowed as per Accounting Standard-16. He also

brought to the notice of the assessee the provisions of AS-16.

Rejecting the various explanations given by the assessee and

relying on various decisions the Assessing Officer held that

interest amounting to Rs.2,64,62,557/- has to be disallowed.

While doing so, he also observed that an amount of

Rs.55,85,717/- out of the above amount of Rs.2,64,62,557/-

paid to NBFCs is also liable to be disallowed u/s.40(a)(ia) as no

tax has been deducted at source.

26. Before CIT(A) it was submitted that the bank loans were

undisputedly utilised for construction of the building, lay out as

well as for their on-going business of trading in lands etc. It was

argued that most of the loans have been used for acquisition and

construction of the properties which are rented out and therefore

interest to the extent of Rs.2,02,91,840/- has been claimed as

deduction u/s.24(b) under the head income from house property 22

and the balance has been claimed as deduction from business

profits. Referring to the land sanction letter from India Bulls

Financial Services Ltd it was argued that as per the sanction

letter an amount of Rs.1,97,20,828/- and Rs.2,19,720/-

respectively were directly paid to Kanishka Properties for the

purchase of the property situated at 610, Sadashiv Peth, Pune.

27. As regards the reliance of Accounting Standard-16 by the

Assessing Officer is concerned it was submitted that the

Assessing Officer disallowed the interest expenditure on the

ground that they were utilised towards the qualifying assets.

However, the assessee deals in land and these are not the

projects and therefore they cannot be termed as qualifying

assets so as to attract AS-16. It was argued that the loans are

taken as working capital for purchasing the lands and the

interest paid thereon is an indirect expenditure and it is not

directly going to the purchase cost of the lands. It was

accordingly argued that the basic approach adopted by the

Assessing Officer is incorrect both on facts and in law.

28. As regards the alternate view expressed by the Assessing

Officer that interest paid to NBFCs to the extent of

Rs.55,85,717/- was also otherwise not admissible as deduction

in the light of the provisions of section 40(a)(ia) for failure to

deduct tax at source it was argued that no disallowance could

have been made since the entire interest has been paid to these

NBFCs. It was argued that disallowance u/s.40(a)(ia) can be

made only if such interest was payable as on 31-03-2009.

However, since the entire interest has been paid and no amount

is outstanding as at the year end, therefore, in view of the

decision of the Special Bench of the Tribunal in the case of 23

Merilyn Shipping and Transports reported in 136 ITD 23 no

disallowance u/s.40(a)(ia) can be made.

29. However, the CIT(A) was also not satisfied with the

explanation given by the assessee. So far as the claim of

deduction u/s.24(b) is concerned he disallowed the claim on the

ground that there is no direct nexus between the borrowed funds

and the acquisition or construction of properties. Therefore, he

held that the Assessing Officer was justified in disallowing the

interest of Rs.2,29,90,881/- claimed u/s.24 against income from

house property.

30. So far as the argument of the assessee that the interest

can be allowed as deduction u/s.36(1)(iii) is concerned the

Ld.CIT(A) observed at para 3.3.2.8 as under :

"3.3.2.8 To sum up the interest on the capital borrowed generally, which was also used for the purpose of incomplete on- going ventures and development of new ventures projects shall be hit by the proviso to sec.36(1)(iii) and interest, beginning from the date on which the capital was borrowed for the acquisition of these assets till the date on which such assets were ready for its intended use or sale, i.e. first put to use, cannot be allowed as deduction. In other words, the finance cost relatable to these ventures/projects cannot be allowed as deduction under sec.36(1)(iii) in this year. This position is also in line with the Accounting Standard-16, which is extracted hereinabove, and the projects of this nature fall within the definition of qualifying assets. As per the definition, a qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. The borrowing cost relatable to qualifying asset, i.e. land development projects are required to be capitalised and added to the cost or WIP of such projects. Capitalisation of borrowing costs should cease when substantially all the activities necessary to prepare the qualifying asset for its intended or sale are complete and that stage has not reached yet in the year under consideration in case of several ventures undertaken by the appellant. Thus, the Assessing Officer is justified in principle in holding that the land development ventures, the income from which is not yet recognized as on 31-03- 2009, are qualifying assets for the purpose of capitalisation of interest relatable to these projects.

24 31. He accordingly directed the Assessing Officer to compute

the allowability of deduction u/s.36(1)(iii) by observing as under:

"1. The Assessing Officer shall first identify the actual qualifying assets from the ventures undertaken by the appellant during the year and the earlier years, i.e. the projects which were in execution stage and not ready for intended sale as on 31-03-2009.

2. Thereafter, the Assessing Officer shall compute the interest attributable to such qualifying assets in terms of paragraph 12 of the Accounting Standard-16, which provides that the amount of borrowing costs eligible for capitalization should be determined by applying a capitalisation rate to the expenditure on that asset. The capitalisation rate should be the weighted average of the borrowing costs applicable to the borrowings of the enterprise that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. The amount of borrowing costs capitalised during a period should not exceed the amount of borrowing costs incurred during that period.

3. The interest so computed as per AS-16 and attributable to qualifying assets shall be capitalised for form part of the cost or WIP of the qualifying assets. The interest so capitalised is not an allowable deduction u/s.36(i)(iii) in the year under consideration.

Subject to the above directions, the grounds raised by the appellant relating to disallowance of interest stand disposed of."

32. Aggrieved with such order of the CIT(A) the assessee as

well as the revenue are in appeal before us.

33. The Ld. Counsel for the assessee referring to the copy of

the partnership deed drew the attention of the Bench to clause 4

of the partnership deed which reads as under :

"4. NATURE OF PARTNERSHIP BUSINESS :

A] The business of the partnership shall be purchase, sale, lease/rent, development, investment in Land, Real estate, Commercial and Residential plot and act as commission agent and all other allied activities.

B] The partners may vary the nature of business and do any additional type of business with their mutual consents from time to time."

34. He accordingly submitted that the assessee is engaged in

the business of land trading. These lands are held as stock in

trade and current assets and as such the interest is certainly 25

allowable as deduction u/s.36(1)(iii) of the I.T. Act. Referring to

the copy of the order giving effect to the order of the CIT(A) the

Ld. Counsel for the assessee submitted that there are no

qualifying assets. Therefore, the question of capitalising the

interest to those qualifying assets does not arise. Therefore, the

entire interest of Rs.2,64,62,557/- claimed by the assessee has

to be allowed u/s.36(1)(iii) of the I.T. Act. He submitted that the

fact that loans are taken for trading stands proved as per the

copies of the final accounts wherein the lands are shown as

trading assets and not held for any construction thereon. He

submitted that after the order of the CIT(A) directing the

assessee to furnish the list of qualifying assets and the cost

incurred thereon the assessee filed the requisite details before

the Assessing Officer vide letter dated 05-08-2013 providing

details of all such assets. After due verification the Assessing

Officer on being satisfied passed the order u/s.250 of the Act on

19-08-2013 and allowed the relief stating categorically that the

same is allowed following the direction by the CIT(A). He

submitted that although the assessee has got requisite relief

after the order of the CIT(A), still took this additional ground as

the interest is allowable u/s.36(1)(iii) of the Act since the

assessee is a trader in land and the borrowed funds have been

utilised for such trading assets which are shown as stock in

trade.

35. The Ld. Departmental Representative on the other hand

heavily relied on the order of the Assessing Officer.

36. We have considered the rival arguments made by both the

sides, perused the orders of the Assessing Officer and the CIT(A)

and the Paper Book filed on behalf of the assessee. We have also 26

considered the various decisions cited before us. There is no

dispute to the fact that the nature of business of the partnership

is to purchase, sale, lease/rent, development, investment in

land, real estate, commercial and residential plots and act as

commissioning agent and other allied activities. We find the

assessee claimed deduction of interest expenditure of

Rs.2,02,91,840/- as deduction towards income from house

property being rent received from Krishna Sahakari Bank at

Rs.18,26,284/- and LNB Textiles Pvt. Ltd. Rs.1.85 crores. The

Assessing Officer disallowed the interest claimed u/s.24(b) on

the ground that such interest has not been used for construction

of the property on which rent is received. The alternate

contention of the assessee that such interest has been utilised

for business and therefore allowable u/s.36(1)(iii) was also

rejected by the Assessing Officer by referring to the Accounting

Standard-16. According to the Assessing Officer operating costs

that are directly attributable to the acquisition, construction or

production of a qualifying asset should be capitalised as part of

the cast of that asset. He also disallowed the balance amount of

Rs.61,70,717/- being interest of Rs.7,31,374/- paid to City

Financial, Rs.26,83,156/- paid to City Finance,Rs.21,71,187/-

paid to India Bulls and interest on unsecured loans at

Rs.5,85,000/- on the ground that such interest should have also

been capitalised to the closing stock of land. Thus, in effect, the

Assessing Officer disallowed interest of Rs.2,64,62,557/- on the

ground that such interest needs to be capitalised and added to

the cost of the asset and cannot be claimed as Revenue

expenditure.

27

37. The Assessing Officer further held that the amount of

Rs.61,70,717/- mentioned above includes interest of

Rs.55,85,717/- paid to NBFCs on which no tax has been

deducted, therefore, the same is otherwise also not allowable

u/s.40(a)(ia).

38. We find in appeal the Ld.CIT(A) upheld the action of the

Assessing Officer so far as the disallowance u/s.24(b) is

concerned. As regards the alternate claim that such interest

should be allowed u/s.36(1)(iii) he gave certain directions to the

Assessing Officer to find out the qualifying assets and compute

the interest attributable to such qualifying assets in terms of

paragraphs 12 of the Accounting Standard-16 according to

which the interest so computed as per Accounting Standard-16

attributable to qualifying asset shall be capitalised to form part

of the cost of the work-in-progress. Only the interest not so

capitalised is allowable deduction u/s.36(1)(iii). We find after

such direction of the CIT(A) the Assessing Officer called for the

details from the assessee and after due verification held that

there is no qualifying asset as per Accounting Standard-16 and

the entire interest is allowable. A copy of the order of the

Assessing Officer giving effect to such direction of the CIT(A) is

placed at page 23 of the paper book. We find the Assessing

Officer has allowed relief of Rs.2,02,91,840/- being interest

which was earlier claimed as deduction from house property

income. Even otherwise also, the business of the assessee is

that of purchase and sale of land, investment in land, real

estate, commercial and residential plot etc. The funds borrowed

have been utilised for such business activity, therefore, the

entire interest paid has to be allowed as deduction u/s.36(1)(iii) 28

of the I.T. Act. The same is also borne out from the record after

the order of the Assessing Officer giving appeal effect to the order

of the CIT(A). In this view of the matter the grounds raised by

the Revenue are dismissed and the Additional Ground No.2 by

the assessee is allowed.

39. In the result, the appeal filed by the Revenue is dismissed

and the appeal filed by the assessee is partly allowed.

Pronounced in the open court on 26-06-2015.

Sd/- Sd/- (VIKAS AWASTHY) (R.K. PANDA) JUDICIAL MEMBER ACCOUNTANT MEMBER

satish Pune Dated: 26th June, 2015

Copy of the order forwarded to :

1. Assessee 2. Department 3. CIT(A)-III, Pune 4. CIT-III, Pune 5. The D.R, "B" Pune Bench 6. Guard File

By order

// True Copy // Senior Private Secretary ITAT, Pune Benches, Pune