IN THE INCOME TAX APPELLATE TRIBUNAL
BENCH ‘A’ MUMBAI
Assessment Year: 2011-12
DEPUTY COMMISSIONER OF INCOME TAX
WARD 1(2)-1, R NO 535, 5TH FLOOR
AAYAKAR BHAVAN, M K ROAD
LIC NOMURA MUTUAL FUND ASSET MANAGEMENT COMPANY LTD
4TH FLOOR, INDUSTRIAL ASSURANCE BLDG
PAN NO: AAACJ1166H
Mahavir Singh, JM & Rajesh Kumar, AM
Date of Hearing: March 22, 2019
Date of Decision: June 12, 2019
Appellant Rep by: Mrs Nilu Jaggi, DR
Respondent Rep by: Shri Vijay Mehta, AR
Income Tax – Explanation 1 to Section 37(1)
Keywords – Mutual fund scheme – Repurchase of units
THE assessee company had filed its return for the relevant AY. During the course of the assessment proceedings, the AO noted that the assessee company has debited an amount of Rs 4.62 cr in the P & L Account on account of scheme related expenses under the head of administrative and other expenses. The assessee was required by the AO to explain as to why the expenses are not be disallowed. In response the assessee filed particulars of expenses. Rejecting the submissions of the assessee Finally, the AO held that these expenses are not incurred wholly and exclusively for the purpose of business. Therefore, they are disallowed and accordingly an amount of Rs 1.20 cr added back to the total income of the assessee and moreover these are penal in nature. On appeal, the CIT(A) allowed the claim of the assessee.
On appeal, the Tribunal held that,
Whether expense incurred by a bank towards repurchase of units can be allowed where though it promised 12.5% returns to investors in respect of a mutual funds scheme, it lacked adequate funds to honor its commitments upon redemption – NO: ITAT
++ it is also a fact the loss is supposed to be booked in the books of the assessee as a matter of commercial expediency and to maintain the net asset value of the scheme and not to effect the source of income. This fact is not doubted by the AO in his assessment order but admitted this. But the AO disallowed the claim of expenses/loss only on the basis that the assessee has treated it as to have goodwill among the investors and therefore, he treated this expense as capital in nature. It is noted that this issue is squarely covered by the decision of Supreme Court in the case of Empire Jute Co. Ltd. Vs. CIT, L.H Sugar Factory & Oil Mills Pvt. Ltd. vs. CIT, CIT vs. Malayalam Plantations Ltd., Sassoon J. David & Co. Pvt. Ltd. Vs. CIT. In Malayalam Plantations Ltd.wherein Court was concerned whether Estate Duty paid by the company on the death of shareholders can be said to be, “…laid out or expended wholly or exclusively for the purpose of business…”;
++ it is also noted from decision of Karnataka High court in the case of CIT v. Canara Bank Ltd. that the bank had set up in Mutual fund which had floated a scheme under which an assured return of income @ 12.5% was granted to the investors. But, at the time of redemption, the scheme did not have adequate assets nor funds to honor its commitment and consequently, in order to maintain the banks goodwill and reputation, the bank decided to repurchase of units of the scheme at a price at which mutual fund had committed to the investors. The bank claimed the amount paid towards repurchase of the units as an expenditure. The AO disallowed and finally, Karnataka High Court allowed the claim of the assessee. Hence, the CIT(A) has rightly allowed the claim of the assessee after discussion in detail. Hence the order of the CIT(A) on this issue is affirmed.
Revenue’s appeal dismissed
Per: Mahavir Singh:
This appeal by the Revenue is arising out of the order of Commissioner of Income Tax (Appeals)-2, Mumbai [in short CIT(A)], in appeal No. CIT(A)-2/IT-84/2014-15 vide order dated 28.02.2017. The Assessment was framed by the Dy. Commissioner of Income Tax, Circle-1(2), Mumbai (in short ‘DCIT/ITO/AO’) for the A.Y. 2011-12 vide order dated 27.03.2014 under section 143(3) of the Income Tax Act, 1961 (hereinafter ‘the Act’).
2. The first issue in this appeal of Revenue is against the order of CIT(A) deleting the addition made by AO by holding that the expenses of contribution for scheme deficiencies as capital in nature as against the claim of Revenue, the assessee contended that these are revenue in nature. For this Revenue has raised ground No. 1: –
“1. Whether on the facts and in the circumstances of the case the ld. CIT(A) was justified in deleting the addition of Rs.1,12,79,19,622/- made by the AO without considering the fact that the expenses is not related to the business activity and the assessing officer had not correctly disallowed and treating them capital in nature?”
3. Briefly stated facts are that the assessee during the year under consideration debited a sum of Rs.112,79,19,622/- in the profit and loss account on account of contribution for scheme deficiencies under the head of administrative and other expenses. The assessee claimed the same as allowable deduction. The AO required the assessee to explain or show cause as to why this amount should not be treated as provision for future expenses/loss and the same should not be disallowed. The assessee vide letter dated 22.01.2014 replied vide detailed query. The AO noted that the assessee’s income during the year under consideration has come down to Rs.10061.44 lakhs from Rs.19567.68 lakhs comparing last year due to contribution towards deficiency arising out of sale of securities to meet redemption application and violation deficiency arising out of revision in the violation policy of debt securities. The AO noted that the assessee company manages the following open ended scheme of mutual funds i.e. a) LIC MF Liquid Fund, b) LIC MF Income Fund, c) LIC MF savings Plus Fund, d) LIC MF Floating Rate Fund. The AO admitted that these funds created by assessee were performing really well and investors were having confidence in these funds. He also noted that over the times, due to very tight liquidity and high interest rates, the above funds faced heavy redemption pressure and in such situation the schemes have to be sold at a loss and the investors started loose confidence in their schemes. It was observed by the AO that to maintain the sustainability of the schemes and to bring back the confidence of the investors in the schemes paid a sum of Rs.112,79,19,622/- to the mutual fund schemes during the relevant assessment year. But AO finally noted that the claim of assessee is not acceptable as Revenue in nature as the assessee company has paid this sum to the scheme to maintain wholly all the scheme in the market so that investor do not switch their funds from their scheme to some other mutual funds. Finally, the AO noted that “by making the payment to the scheme, the assessee company has gained the NAV of the schemes. Higher the NAV on particular date will attract more and more investors to the schemes and it will grow higher and higher when the investors kept their existing fund in the scheme and bring more funds in these schemes. Here, the assessee company made the payment of Rs.112,79,19,622/- only to lure the investors at the scheme by maintaining the NAV of the as per its reputation in the market in past years. So, here the assessee company raises the goodwill of the schemes and as well as the company. Henc,e the contribution made by the assessee company for scheme deficiencies is not a revenue expenditure, instead a capital expenditure which needs to be capitalized in the books of accounts. Therefore, total disallowance of Rs.112,79,19,622/- is made treating it as capital expenditure.” Aggrieved, assessee preferred the appeal before CIT(A).
4. The CIT(A) considered the issue in Para 5.3 as under: –
“5.3 I have gone through the assessment order dtd. 27.03.2014 in para 5, the AO discussed about the disallowance of Rs. 112,79,19,622/- of the scheme expenses claimed by the appellant company treated it as capital expenditure rather than the revenue expenditure as claimed by the appellant company. The appellant company has given enough reason for claiming such mutual fund scheme expenditure and given justification that more of loss booked into scheme will adversely affect reputation of the scheme and institution and moreover the commission received from mutual fund will get affect and therefore the AR pleads that the expenditure booked of Rs. 112,79,19,622 to be allowed as revenue expenditure.
The AR also has explained that following schemes can be withdrawn in the specified time –
1. LIC Mutual Fund Liquified found [can be withdrawn within 2 days]
2. LIC Mutual fund Income fund [can be withdrawn in short time]
3. LIC Mutual fund Saving Plus Fund [can be withdrawn in 72 hours]
4. LIC Mutual Fund Floating Rate Fund [can be withdrawn in short time]
Further in July, 2010, schemes faced redemption pressure from the investors on account of tight liquidity condition and higher interest rates available in the market. Accordingly, securities were sold at loss which resulted in aggregate loss of Rs. 60,82,36,469.82 and further Securities Exchange Board of India circulars dated 02.02.2010 and 21.06.2010 stipulated though money market securities with a residual maturity exceeding 91 days that were held by above schemes were directed to be marked to market (MTM) with effect from 1st August 2010 and thus process also scheme incurred loss of Rs. 51,96,83,152.38 and put together the total loss come to Rs. 112,79,19,622/-.
I have also gone through management fees received from LIC Mutual fund for the following AYs as asset management company by the appellant. The details are as under:
Management fees from LIC Mutual Fund as a % of total income
|Management fees from Mutual fund||337,642,393||878,864,965||1,831,764,079||728,330,531|
|% of total income||91.95%||87.33%||73.61%||92.86%|
|2007-08 *||2006-07 *||2006-07 *|
From the above table, it is understood that the major revenue comes from management fees of mutual fund is about 90%.
The core issue is loss of Rs. 112,78,19,6227- pertains to the mutual funds schemes will be an allowable expenditure in the hands of the appellant company i.e. being the asset management. The AO has discussed very elaborately the submission given by the appellant company in para 5. The loss is supposed to be booked in the books of the appellant company as a matter of commercial expediency and to maintain the net asset value of the scheme and not effect the sources of income etc but finally the AO not accepting the submission of the appellant has treated it as to have a goodwill among the investors and therefore he treated it as capital expenditure. In principal, the AO has agreed that this expenditure can be booked in the books of accounts of the appellant though this expenditure is not directly attributable to the appellant company.
In support of the claim of the loss booked in the appellant books of account, the AR relies on the following judicial decisions as under:
Considering the above fact on records, and also consider SEBI circulars, market conditions in June and July, 2010 and various judicial citations cited above and specifically in the case of Sassoon J David & Co. Pvt. Ltd. vs. CIT (118 ITR 261) = 2002-TIOL-2001-SC-IT, Karnataka High Court decision in CIT vs. Canara Bank Ltd. (ITA No. 1397 of 2006), Supreme Court decision in the case of CIT v. Delhi Safe Deposit Co. Ltd. (133 ITR 756) = 2002-TIOL-899-SC-IT and Chandulal Keshavlal & Co. (38 ITR 601); I am of the considered opinion that expenditure was incurred by company in order to preserve the income generating machinery since about90% of income derives from mutual fund by the appellant company being the asset manager and to instill confidence among the investors of the scheme and hence, this expenditure could be allowed as revenue expenditure and not capital expenditure as held by the Learned AO. The AO is directed to delete the addition of Rs.1,12,79,19,622/- Appeal on this ground is allowed.”
Aggrieved, now Revenue is in appeal before Tribunal.
5. Before us, the learned Sr. Departmental Representative relied on the assessment order and the learned Counsel for the assessee relied on the order of CIT(A).
6. We have heard the rival contentions and gone through the facts and circumstances of the case. We noted that the facts narrated by CIT(A) in its order regarding the claim of expenditure being contribution of deficiencies of the mutual fund scheme managed by the assessee at Rs.112,79,19,922/- are not disputed. It is also a fact the loss is supposed to be booked in the books of the assessee as a matter of commercial expediency and to maintain the net asset value of the scheme and not to effect the source of income etc. This fact is not doubted by the AO in his assessment order but admitted this. But the AO disallowed the claim of expenses/loss only on the basis that the assessee has treated it as to have goodwill among the investors and therefore, he treated this expense as capital in nature. We noted that this issue is squarely covered by the decision of Hon’ble Supreme Court in the case of Empire Jute Co. Ltd. Vs. CIT (124 ITR 1) =2002-TIOL-238-SC-IT-LB, L.H Sugar Factory & Oil Mills Pvt. Ltd. vs. CIT (125 ITR 293) = 2002-TIOL-791-SC-IT-LB, CIT vs. Malayalam Plantations Ltd. (53 ITR 140) = 2002-TIOL-1683-SC-IT-LB, Sassoon J. David & Co. Pvt. Ltd. Vs. CIT (118 ITR 261) = 2002-TIOL-2001-SC-IT. From the above judgments of Hon’ble Supreme Court, we will reproduce the findings of one of the judgments of Hon’ble Supreme Court in the case of Malayalam Plantations Ltd. (supra), wherein Hon’ble Court was concerned whether Estate Duty paid by the company on the death of shareholders can be said to be, “laid out or expended wholly or exclusively for the purpose of business.” Hon’ble Supreme Court while disallowing the claim, laid down certain principles as under:-
” ………………The aforesaid discussion leads to the following result: The expression “for the purpose of the business” is wider in scope than the expression “for the purpose of earning profits”. Its range is wide : it may take in not only the day to day running of a business but also the rationalization of its administration and modernization of its machinery; it may include measures for the preservation of the business and for the protection of its assets and property from expropriation, coercive process or assertion of hostile title ; it may also comprehend payment of statutory dues and taxes imposed as a pre-condition to commence or for carrying on of a business ; it may comprehend many other acts incidental to the carrying on of a business. However wide the meaning of the expression may be, its limits are implicit in it. The purpose shall be for the purpose of the business, that is to say, the expenditure incurred shall be for the carrying on of the business and the assessee shall incur it in his capacity as a person carrying on the business. …………”.
7. Further, Hon’ble Supreme Court in the case of Sassoon J. David & Co. Pvt. Ltd. (supra) has laid down the following tests for treating an expenditure as wholly and exclusively for the business purposes: –
“It has to be observed here that the expression “wholly and exclusively” used in section 10(2)(xv) of the Act does not mean “necessarily”. Ordinarily it is for the assessee to decide whether any expenditure should be incurred in the course of his or its business. Such expenditure may be incurred voluntarily and without any necessity and if it is incurred for promoting the business and to earn profits, the assessee can claim deduction under section 10(2)(xv) of the Act even though there was no compelling necessity to incur such expenditure. It is relevant to refer at this stage to the legislative history of section 37 of the Income-tax Act, 1961 which corresponds to section 10(2)(xv) of the Act. An attempt was made in the Income-tax Bill of 1961 to lay down the “necessity” of the expenditure as a condition for claiming deduction under section 37. Section 37(1) in the Bill read “any expenditure. . . . laid out or expended wholly, necessarily and exclusively for the purposes of the business or profession shall be allowed” The introduction of the word “necessarily” in the above section resulted in public protest. Consequently when section 37 was finally enacted into law, the word “necessarily” came to be dropped. The fact that somebody other than the assessee is also benefited by the expenditure should not come in the way of an expenditure being allowed by way of deduction under section 10(2)(xv) of the Act if it satisfies otherwise the tests laid down by law.”
8. We also noted from the arguments of the learned Counsel relied on by him of Hon’ble Karnataka High court in the case of CIT v. Canara Bank Ltd. in ITA No. 1397/Mum/2006, wherein identical set of facts were considered. The facts were that the bank had set up in Mutual fund which had floated a scheme under which an assured return of income @ 12.5% was granted to the investors. But, at the time of redemption, the scheme did not have adequate assets nor funds to honor its commitment and consequently, in order to maintain the banks goodwill and reputation, the bank decided to repurchase of units of the scheme at a price at which mutual fund had committed to the investors. The bank claimed the said amount paid towards repurchase of the units as an expenditure. The AO disallowed and finally, Hon’ble Karnataka High Court allowed the claim of the assessee. Hence, we are of the view that the CIT(A) has rightly allowed the claim of the assessee after discussion in detail as reproduced above. We, accordingly, affirmed the order of the CIT(A) on this issue.
9. The second issue in this appeal of Revenue is against the order of CIT(A) deleting the disallowance of related expenses holding the same as penal in nature and also not incurred for the purpose of the business. For this Revenue has raised the following ground No. 2 : –
“2. Whether on the facts and in the circumstances of the case the Id. CIT(A) erred in deleting the disallowance of scheme elated expenses of Rs. 91,15,800/- without appreciating that the expenses are made on behalf of the mutual fund which is a distinct entity from the assessee and are penal in nature.”
10. Briefly stated facts are that the AO during the course of assessment proceedings noted that the assessee company has debited an amount of Rs.4,62,20,860/- in the P & L Account on account of scheme related expenses under the head of administrative and other expenses. The assessee was required by the AO to explain as to why the expenses are not be disallowed. The assessee vide letter dated 06.05.2014 filed particulars of expenses which reads as under: –
|1.||Difference in Unit creation||2,19,305|
|2.||Double interest on security due to improper accounting||1,64,365|
|3.||Incorrect accounting for security||13,46,129|
|4.||Shortfall in Systematic Withdrawal plan in bond fund||2,11,392|
|5.||Write off of long outstanding balance appearing in ULLS as per audit observation||4,65,800|
|6.||Write off of long outstanding balance appearing in ULIS as per audit observation||86,50,000|
|7.||Provision made on account of fraudulent encashment of warrant||10,00,000|
11. Finally, the AO held that these expenses are not incurred wholly and exclusively for the purpose of business and moreover these are penal in nature. For this he observed in Para 7.3 as under: –
“7.3 From the above table, it is clear that the assessee expenses on account of many alleged errors committed by the Mutual Fund and claimed such expenditure as revenue expenditure and deducted the same as well from the taxable profit. Since, these expenses are penal in nature and are no way connected with the business of the assessee company, the contention of the assessee company is totally wrong that the expenses have been incurred wholly and exclusively for the purpose of the business. Therefore, the same are disallowed as not having been incurred for the purpose of the business of the assessee company and accordingly an amount of Rs. 1,20,57,921/- as per the table above is hereby disallowed and added back to the total income of the assessee.”
12. Aggrieved, assessee preferred the appeal before CIT(A). The CIT(A) allowed the claim of the assessee by observing as under: –
“I have gone through the modified agreement entered between LIC Mutual fund Trust Co. Ltd. and Jeevan Bima Sahyog Asst Management Company Ltd. dtd. 06.10.2003 wherein as per clause no. 3 investments are supposed to be invested in approved investments only such as –
Laws means the laws of India including any rules, regulations or directives and orders made thereunder whether generally or otherwise and shall be deemed also to include the Securities and exchange Board of India Ct, 1992 (15 of 1992), the Securities and Exchange Board of India, Rules, 1992 and Securities and Exchange Board of India (Mutual Fund) Regulations, 1996, the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and the Depositories Act, 1996 (22 of 1996) and such other laws as may be enacted from time to time and other rules or regulations or guidelines issued or made thereunder and any modifications thereto or substitutions thereof.
Sponsor means Life Insurance Corporation of India, who has established the LIC Mutual Fund.
Appointment of AMC
LIC Mutual fund has appointed the AMC as Manager of the rust Fund subject to the terms contained and in accordance with the Trust Deed, this Agreement and with the laws until its appointment is terminated as hereinafter provided and the AMC has accepted its appointment and agreed to assume the obligations contained herein.
4(ii) The Unit holders are informed about the proposed change in the controlling interest of AMC by sending individual communication and an advertisement shall be given in one English daily newspaper having nationwide circulation and in a newspaper published in the language of the region where the head office of the mutual fund has been situated.
Duties of AMC
(6) be solely responsible for selection of investments of the Trust fund and in the event of an investment other than in an Approved investment or in a manner that infringes any restriction or limit imposed in that behalf by the……………
(10) take all necessary steps to ensure that investment of the Trust are duly protected and that all the documents and evidences of title relating to the Approved investments, shall be deposited with the Custodian to be appointed by the Trustee Company.
(11) issue and administer instructions to the custodian, the Stock brokers and agents bankers, registrars and advertising and other agencies of the LCI Mutual Fund.
(12) be responsible for the acts of commission or omissions by its employees or the persons whose serviced have been procured by the AMC.
(13) disclose the basis of calculating the repurchase price and Net Asset Value of the various schemes of the fund in the scheme particulars and disclose the same to the Unit Holders at such intervals as may be specified byte LI Mutual Fund and SEBI.
I have gone also gone through the original agreement entered between LIC and Jeevan Bima Sahayog Asset Management Co. Ltd. and further I have gone through modified agreement dtd. 25.10.1999. As per agreement cited above, the AR pleads that the above scheme related to expenditure of Rs. 120,56,991 has to be allowed as expenditure as per clause 3(v). AMC has to maintain all the records and over all supervision and administration and also to advice them to invest in the right scheme. However, on close reading of expenditure claimed by the appellant company of Rs. 1000000/-made on fraudulent encashment of warrant found to be not connected to the definitions and duties of the AMC. The encashment of warrant is not found to be in the agreement. I am of the considered opinion that this provision made on account of fraudulent encashment of warranted to Rs. 10 lakhs is not allowable expenditure in the hands of the appellant as, management company.
With regard to right of long outstanding balances of Rs.86,50,000 and 4,65,800 it is mentioned that this has been written off gs per audit objection made to be allowable expenditure even otherwise under section 36(l)(vii)
“subject to the provisions of sub-section (2), the amount of [any bad debt or part thereof which is written off as irrecoverable in the accounts of the assessee for the previous year]”
I agree with the AR of the appellant that having written off outstanding balance in the books of accounts, it is an allowable expenditure.
With regard to shortfall in Systematic withdrawal plan of Rs.2,11,392/- incorrect accounting was made for a security of Rs.13,46,129/-, double interest was booked at Rs.1,64,365/- and difference in unit creation of Rs.2,19,305/-,the AR pleads that these are all due to wrong journal entries or otherwise excess credit and therefore this is also allowable expenditure.
I have gone through the submissions of the AR of the appellant on the careful perusal of claims made by the appellant company what I understood is that the money went out of the scheme to the investors by excess allowances or otherwise excess withdrawal by investors carried out by concerned scheme therefore I am of the considered opinion that this is also not an allowable expenditure. Accordingly, the appellant gets relief for Rs.91,15,800/- and balance of Rs.29,41,191/- is confirmed.”
Aggrieved Revenue came in appeal before Tribunal.
13. Before us, the learned counsel for the assessee relied on the order of CIT(A). On the other hand, the learned CIT DR relied on the order of the AO.
14. After hearing both the sides and going through the facts, we noted that the money went out of scheme to the investors by excess allowance or otherwise by excess withdrawals by the investors carried out by concerned scheme. The above narrated expenses/deductions in no way can be said that these are in the nature of penal expenses as described in explanation 1 to section 37(1) of the Act. We have gone through the agreement entered into between LIC Mutual Fund Trust Co. Ltd. and Jeevan Bima Sahyog Asst. Management Company Ltd. dtd 06.10.2003 and as per clause 3, the investments are supposed to be made in approved investment only and for this purpose AMC has been appointed by LIC Mutual Fund as manager for the same and duties of AMC are also prescribed. It is noted that AMC is maintained all the records and overall supervision and administration and also advising the assessee to invest in the right scheme. We noted that the expenditure claimed by assessee of Rs.10 lakhs on account of fraudulent encashment of warrant Rs.13,46,129 on account of incorrect accounting made for security, shortfall in systematic withdrawal of plan of Rs.2,11,392/-, double interest booked at Rs.1,64,365/- and difference in unit creation of Rs.2,19,305/- has already been disallowed by CIT(A) and for this assessee is not in appeal. We noted that for the balance amount of Rs.91,15,800/- there is no application of explanation 1 to section 37(1) of the Act. Hence, we find no infirmity in the order of CIT(A) and we confirm the same.
15. In the result, the appeal of Revenue is dismissed.
(Order pronounced in the open court on 12.06.2019)