THE DCIT 2(3), MUMBAI V. M/S. HDFC BANK LTD, MUMBAI

CO 75/MUM/2006

• Counselvise Citation: [2011] 122 COUNSELVISE.COM (IT) 6237 (ITAT-MUMBAI)
• Duration Of Justice: 5 year(s) 3 month(s) 27 day(s)
• Appeal Type: Cross Objection
• Pronouncement Date: 29-06-2011
• Appeal Filed By: Department
• Order Result: Dismissed
• Bench Allotted: H
• Next Hearing Date: 31-05-2011
• Assessment Year: 2001-2002
• Appeal Filed On: 03-03-2006
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Assessee Lawyers: MRUDAL INAMDAR
• Keywords: Business income; Depreciation; Earning of tax free income; Retrospective amendment; Bad and doubtful debts; Revenue expenditure; Capital expenditure
• Section: 43B; 14A

Judgement Text

1 M/S HDFC BANK LTD IN THE INCOME TAX APPELLATE TRIBUNAL IN THE INCOME TAX APPELLATE TRIBUNAL IN THE INCOME TAX APPELLATE TRIBUNAL IN THE INCOME TAX APPELLATE TRIBUNAL MUMBAI MUMBAI MUMBAI MUMBAI H HH H BENCH BENCH BENCH BENCH MUMBAI BENCHES, MUMBAI MUMBAI BENCHES, MUMBAI MUMBAI BENCHES, MUMBAI MUMBAI BENCHES, MUMBAI BEFORE SHRI BEFORE SHRI BEFORE SHRI BEFORE SHRI J SUDHAKAR REDDY, J SUDHAKAR REDDY, J SUDHAKAR REDDY, J SUDHAKAR REDDY, AM & AM & AM & AM & SHRI SHRI SHRI SHRI VIJAY PAL RAO, JM VIJAY PAL RAO, JM VIJAY PAL RAO, JM VIJAY PAL RAO, JM ITA NO ITA NO ITA NO ITA NOS SS S. .. .4529/MUM/2005 4529/MUM/2005 4529/MUM/2005 4529/MUM/2005 (ASST YEAR (ASST YEAR (ASST YEAR (ASST YEAR 2001 2001 2001 2001- -- -02) 02) 02) 02) ITA NO ITA NO ITA NO ITA NOS SS S. .. .3650 3650 3650 3650/MUM/2006 /MUM/2006 /MUM/2006 /MUM/2006 (ASST YEAR (ASST YEAR (ASST YEAR (ASST YEAR 2002 2002 2002 2002- -- -03) 03) 03) 03) ITA NO ITA NO ITA NO ITA NOS SS S. .. .3651/MUM/2006 3651/MUM/2006 3651/MUM/2006 3651/MUM/2006 (ASST YEAR (ASST YEAR (ASST YEAR (ASST YEAR 2003 2003 2003 2003- -- -04) 04) 04) 04) ITA NO ITA NO ITA NO ITA NOS SS S. .. .4039/MUM/2007 4039/MUM/2007 4039/MUM/2007 4039/MUM/2007 (ASST YEAR (ASST YEAR (ASST YEAR (ASST YEAR 2004 2004 2004 2004- -- -05) 05) 05) 05) ITA NO ITA NO ITA NO ITA NOS SS S. .. .991/MUM/2008 991/MUM/2008 991/MUM/2008 991/MUM/2008 (ASST YEAR (ASST YEAR (ASST YEAR (ASST YEAR 2005 2005 2005 2005- -- -06) 06) 06) 06) THE DY COMMR OF INCOME TAX 2(3), MUMBAI VS M/S HDFC BANK LTD SANDOZ HOUSE DR ANNIE BASANT ROAD WORLI - MUMBAI 400 018 ( (( (APPELLANT APPELLANT APPELLANT APPELLANT) )) ) (RESPONDENT) (RESPONDENT) (RESPONDENT) (RESPONDENT) P PP PAN NO. AN NO. AN NO. AN NO.AAACH2702H AAACH2702H AAACH2702H AAACH2702H ITA NO. 217/MUM/2008(ASST YEAR 2005 ITA NO. 217/MUM/2008(ASST YEAR 2005 ITA NO. 217/MUM/2008(ASST YEAR 2005 ITA NO. 217/MUM/2008(ASST YEAR 2005- -- -06) 06) 06) 06) & && & CROSS OBJECTION NO.75/MUM/06 (ASST YEAR 2001 CROSS OBJECTION NO.75/MUM/06 (ASST YEAR 2001 CROSS OBJECTION NO.75/MUM/06 (ASST YEAR 2001 CROSS OBJECTION NO.75/MUM/06 (ASST YEAR 2001- -- -02) 02) 02) 02) CROSS OBJECTION NO.342/MUM/06 (ASST YEAR 2002 CROSS OBJECTION NO.342/MUM/06 (ASST YEAR 2002 CROSS OBJECTION NO.342/MUM/06 (ASST YEAR 2002 CROSS OBJECTION NO.342/MUM/06 (ASST YEAR 2002- -- -03) 03) 03) 03) CROSS OBJECTION NO.343/MUM/06 (ASST YEAR 2003 CROSS OBJECTION NO.343/MUM/06 (ASST YEAR 2003 CROSS OBJECTION NO.343/MUM/06 (ASST YEAR 2003 CROSS OBJECTION NO.343/MUM/06 (ASST YEAR 2003- -- -04) 04) 04) 04) CROSS OBJECTION NO.225/MUM/07 (ASST YEAR 200 CROSS OBJECTION NO.225/MUM/07 (ASST YEAR 200 CROSS OBJECTION NO.225/MUM/07 (ASST YEAR 200 CROSS OBJECTION NO.225/MUM/07 (ASST YEAR 2004 44 4- -- -05 0505 05) )) ) M/S HDFC BANK LTD SANDOZ HOUSE DR ANNIE BASANT ROAD WORLI - MUMBAI 400 018 VS THE DY COMMR OF INCOME TAX 2(3), MUMBAI (APPELLANT (APPELLANT (APPELLANT (APPELLANT/CROSS OBJECTOR /CROSS OBJECTOR /CROSS OBJECTOR /CROSS OBJECTOR) )) ) (RESPONDENT) (RESPONDENT) (RESPONDENT) (RESPONDENT) A SSESSEE BY SHRI MRUDAL INAMDAR REVENUE BY SHRI GOLI SRINIWAS RAO PER PER PER PER VIJAY PAL RAO VIJAY PAL RAO VIJAY PAL RAO VIJAY PAL RAO, , , , JM JMJM JM THESE APPEALS ARE FILED BY THE REVENUE AND CROSS OB JECTIONS ARE FILED BY THE ASSESSEE, EXCEPT FOR AY 2005-06 FOR WHICH THE C ROSS APPEALS ARE FILED AGAINST THE ORDER OF THE CIT(A) FOR THE RESPECTIVE ASSESSMENT YEARS FROM 2000-01 TO 2005-06. 2 M/S HDFC BANK LTD 2 FIRST COMMON GROUND IN ALL THE APPEALS OF THE REV ENUE IS WHETHER IN THE FACTS AND CIRCUMSTANCES OF THE CASE, THE CIT(A) IS JUSTIFIED IN HOLDING THAT NO DISALLOWANCE U/S 14A SHOULD BE MADE IN RESPECT OF I NTEREST ON BORROWED FUNDS TO THE EXTENT OF THE AVAILABILITY OF SHARE CAPITAL AND PROFIT RESERVES. 3 THE LD DR HAS SUBMITTED THAT THE ASSESSEE HAS CLA IMED THE DEDUCTION OF INTEREST EARNED ON TAX FREE BONDS/DIVIDEND INCOME A S EXEMPT FROM TAX. HE HAS FURTHER SUBMITTED THAT THE ASSESSEE HAS PAID INTERE ST ON THE BORROWED FUNDS AND THE BORROWED FUNDS AND ASSESSEES OWN FUNDS ARE NOT SEPARATELY IDENTIFIED. THE INVESTMENTS IN THE GOVERNMENT SECURITIES HAS BEEN MADE BY THE ASSESSEE BANK FROM THE COMMON POOL OF FUNDS. AS PER THE PROVISION S OF SEC. 14A, NO DEDUCTION SHALL BE ALLOWED IN RESPECT OF THE EXPENDITURE INCU RRED BY THE ASSESSEE AGAINST THE INCOME CLAIMED AS EXEMPT FROM THE TAX. APPORTI ONMENT OF THE EXPENDITURE IS INHERENT PART OF SEC. 14A. IN THE ABSENCE OF D IRECT NEXUS BETWEEN THE ASSESSEES OWN FUNDS AND INVESTMENT, THE INVESTMENT WILL BE TREATED FROM COMMON POOL OF ACCOUNT HAVING BOTH BORROWED AS WELL AS OWN FUNDS OF THE ASSESSEE. THEREFORE, PROPORTIONATE DISALLOWANCE OF INTEREST IS JUSTIFIED. HE RELIED ON THE ORDER OF THE ASSESSING OFFICER . 3.1 THE LD AR OF THE ASSESSEE HAS SUBMITTED THAT TH E ASSESSEES CAPITAL, PROFIT RESERVES AND SURPLUS AND CURRENT ACCOUNT DEPOSIT IS HIGHER THAN THE INVESTMENT IN THE TAX FREE DEPOSITS; THEREFORE, THE INVESTMENT IN TAX FREE SECURITIES SHOULD BE REGARDED TO BE MADE FROM ITS OWN FUNDS. HE HAS REF ERRED THE BALANCE SHEETS OF THE RESPECTIVE YEARS AND SUBMITTED THAT THE ASSESSE ES OWN FUNDS AND CURRENT ACCOUNT BALANCE ARE MUCH MORE THAN THE INVESTMENT I N TAX FREE SECURITIES. THUS, THE LD AR HAS SUBMITTED THAT THE DISALLOWANCE OF IN TEREST EXPENDITURE IS NOT CALLED FOR AS THE ASSESSEE WAS HAVING ITS OWN SUFFI CIENT FUNDS AS WELL AS INTEREST 3 M/S HDFC BANK LTD FREE BALANCE IN THE CURRENT ACCOUNT. HE RELIED UPON THE ORDER OF THE TRIBUNAL IN THE CASE OF YATISH TRADING CO LTD VS ACIT REPORTED IN 129 ITD 237, CIT VS RELIANCE UTILITIES AND POWER LTD REPORTED IN 313 ITR 340(MUM ) AND IN THE CASE OF CIT VS HERO CYCLES LTD REPORTED IN 323 ITR 158(P&H). 4 WE HAVE CONSIDERED THE RIVAL CONTENTIONS AND PERU SED THE RELEVANT MATERIAL ON RECORD. THERE IS NO DISPUTE ON THE POIN T THAT THE ASSESSEES SHARE CAPITAL, PROFIT RESERVES AND SURPLUS AS WELL AS TH E BALANCE IN THE CURRENT ACCOUNT IS MORE THAN THE INVESTMENT IN THE TAX FREE SECURIT IES. IT IS ALSO AN ACCEPTED NORMS AND BUSINESS PRACTICE THAT A PRUDENT BUSINESS MAN WOULD MAKE THE INVESTMENT OUT OF HIS OWN FUNDS INSTEAD OF BORROWED FUNDS AND THE BORROWED FUNDS ARE UTILIZED FOR BUSINESS/TRADING PURPOSES; H OWEVER, EXCEPTION MAY BE THERE TO THIS GENERAL PRACTICE. AS PER THE PROVISI ONS OF SEC. 14A, THE EXPENDITURE INCURRED TO EARN EXEMPT INCOME CANNOT BE ALLOWED AN D THE EXPENDITURE SHALL BE ALLOWED ONLY TO THE EXTENT THAT THEY ARE RELATABLE TO THE EARNING OF TAXABLE INCOME. IN OTHER WORDS, ONLY NET INCOME IS SUBJECT ED TAX AND SIMILARLY EXEMPTION IS ALSO ALLOWED ON THE NET EXEMPTED INCOM E. IF AN EXPENDITURE IS DIRECTLY OR INDIRECTLY INCURRED FOR EARNING THE EXE MPT INCOME, THEN THE SAME CANNOT BE CLAIMED AS AGAINST THE INCOME, WHICH IS T AXABLE. 4.1 IN ORDER TO DISALLOW THE PROPORTIONATE EXPENDIT URE U/S 14A, THERE SHOULD BE SOME PROXIMATE COURSE AND THE NEXUS OF THE SAID EXP ENDITURE WITH THE TAX EXEMPT INCOME. WHEN IT HAS BEEN BROUGHT ON RECORD T HAT NO EXPENDITURE ACTUALLY INCURRED FOR EARNING THE EXEMPT INCOME, TH EN THE PROVISIONS OF SEC. 14A CANNOT BE INVOKED. 4 M/S HDFC BANK LTD 4.2 IN THE CASE IN HAND, UNDISPUTEDLY, THE ASSESSEE S OWN FUNDS AND NON- INTEREST BEARING FUNDS ARE MORE THAN THE INVESTMENT IN THE TAX FREE SECURITIES THEN THERE IS NO BASIS FOR DEEMING THAT THE ASSESSE E HAS USED THE BORROWED FUNDS FOR INVESTMENT IN TAX FREE SECURITIES. ACCOR DINGLY, ON THIS FACTUAL ASPECT, WE DO NOT FIND ANY MERIT IN THE CONTENTION OF THE L D DR. FURTHER, IT IS TO BE NOTED THAT IT IS NOT THE CASE OF INVESTMENT IN TAX FREE S ECURITIES EVERY YEAR; BUT THE INVESTMENT IN THE EARLIER YEARS HAS BEEN CARRIED FO RWARD AS IT IS EVIDENT FROM THE PARTICULARS WHERE THE BALANCE AT THE END OF THE YEA R SHOWS THAT THE INVESTMENT IS APPEARING IN ALL THE EARLIER YEARS. THEREFORE , WE DO NOT FIND ANY ERROR OR ILLEGIBILITY IN THE ORDER OF THE CIT(A), QUA, THE ISSUE OF DISALLOWANCE OF INTEREST U/S 14A. 5 THE SECOND COMMON ISSUE IN THE APPEALS OF THE REV ENUE FOR THE ASSESSMENT YEAR 2001-02, 04-05 AND 05-06 IS WHETHER IN THE FACTS AND CIRCUMSTANCES OF THE CASE, THE CIT(A) IS JUSTIFIED IN RESTRICTING DISALLOWANCE OF ADMINISTRATIVE EXPENSES U/S 14A TO 1% AS AGAINST 2% DISALLOWED BY THE AO. 5.1 THE ASSESSEE HAS ALSO RAISED A GROUND OF DISALL OWANCE OF ADMINISTRATIVE EXPENSES IN THE CROSS APPEAL AND APPEAL FOR AY 2005 -06. THEREFORE, THIS COMMON ISSUE HAS BEEN TAKEN UP TOGETHER FOR ADJUDIC ATION. 6 WE HAVE HEARD THE LD DR AS WELL AS THE LD AR OF T HE ASSESSEE AND CONSIDERED THE RELEVANT MATERIAL ON RECORD. THE AS SESSING OFFICER DISALLOWED OPERATING/ADMINISTRATIVE EXPENSES U/S 14A TO THE EX TENT OF 2% OF THE TOTAL TAX FREE INCOME AND ACCORDINGLY WORKED OUT THE EXPENDIT URE RELATED TO THE EARNING OF TAX FREE INCOME AT RS. 1,26,78,080/-. THE ESTIM ATION OF 2% BY THE ASSESSING OFFICER IS ON THE GROUND THAT THE ASSESSEE HAS NOT FILED THE EXACT DETAILS OF THE OPERATING EXPENSES. 5 M/S HDFC BANK LTD 6.1 ON APPEAL, THE CIT(A) RESTRICTED THE DISALLOWAN CE TO 1% OF THE TOTAL TAX FREE INCOME. 7 IT IS SETTLED PROPOSITION OF LAW THAT SEC 14A HAS IMPLICIT WITHIN IT A NOTION OF APPORTIONMENT IN CASE WHERE THE EXPENSES WERE INCUR RED FOR COMPOSITE INDIVISIBLE BUSINESS WHICH RECEIVED TAXABLE AND NON -TAXABLE INCOME. THE PRINCIPLES OF APPORTIONMENT IS APPLIED IN CASE WHER E IT IS NOT POSSIBLE TO DETERMINE THE ACTUAL EXPENSE INCURRED IN RELATION T O THE INCOME CLAIMED AS EXEMPT FROM TAX. 7.1 IN THE CASE IN HAND, THE CIT(A) CONSIDERED THE FACTS AND POINTED OUT THAT THE ASSESSEE IS MAINTAINING THE TREASURY DEPARTMENT WHICH LOOKS AFTER THE DAY TO DAY INVESTMENT PORTFOLIO OF THE BANK INCLUDING TAX FREE INVESTMENTS. HAVING REGARD TO THE SAID FACTUAL PROPOSITION, THE ADMINIS TRATIVE EXPENSES RELATABLE TO THE INCOME NOT FORMING PART OF THE TOTAL INCOME CAN BE ATTRIBUTABLE TO THE EXPENDITURE OF SPECIAL TREASURY DEPARTMENT MAINTAIN ED BY THE ASSESSEE; BUT IT SEEMS THE ASSESSEE HAS NOT FILED THE EXACT DETAIL O F THE OPERATING EXPENSES AND THEREFORE, NO OPTION WAS LEFT BUT TO ESTIMATE THE DISALLOWANCE. 7.2 EVEN OTHERWISE, THE OVERALL ADMINISTRATION OF T HE BANK LOOKS AFTER ALL THE DEPARTMENT INCLUDING THE TREASURY DEPARTMENT; THERE FORE, IN THE ABSENCE OF THE EXACT EXPENDITURE INCURRED IN RELATION TO THE ACTIV ITY RELATING TO TAX FREE INVESTMENT AND EARNING THE INCOME NOT FORMING PART OF THE TOTAL INCOME, IN OUR CONSIDERED OPINION, THE CIT(A) IS JUSTIFIED IN REST RICTING THE SAID DISALLOWANCE TO 1%. ACCORDINGLY, WE DO NOT FIND ANY REASON TO INTER FERE WITH THE ORDER OF THE LD CIT(A) ON THIS ISSUE OF DISALLOWANCE OF ADMINISTRA TIVE EXPENDITURE U/S 14A. ACCORDINGLY, THE GROUND RAISED BY THE REVENUE AS WE LL AS THE ASSESSEE IN THE RESPECTIVE APPEAL AND CROSS OBJECTION ARE LIABLE TO BE DISMISSED. 6 M/S HDFC BANK LTD 8 NEXT ISSUE RAISED BY THE REVENUE IN THE APPEAL FO R AY 2001-02 IS WHETHER IN THE FACTS AND CIRCUMSTANCES OF THE CASE, THE CIT (A) IS JUSTIFIED IN DELETING THE DISALLOWANCE OF THE CLAIM FOR PAYMENT OF BROKEN PER IOD INTEREST OF RS. 1,55,98,062/-. 9 WE HAVE HEARD THE LD DR AS WELL AS LD AR OF THE A SSESSEE AND CONSIDERED THE RELEVANT MATERIAL ON RECORD. AT THE OUTSET, TH E LD AR HAS POINTED OUT THAT THIS ISSUE IS COVERED IN FAVOUR OF THE ASSESSEE AND AGAINST THE REVENUE BY THE DECISION OF THE JURISDICTION HIGH COURT IN THE CA SE OF AMERICAN EXPRESS INTERNATIONAL BANKING CORPN LTD VS CIT REPORTED IN 258 ITR 601 (BOM). 9.1 THE LD DR, ON THE OTHER HAND, RELIED UPON THE D ECISION OF THE HONBLE RAJASTHAN HIGH COURT IN THE CASE OF CIT VS THE BANK OF RAJASTHAN LTD, REPORTED IN 316 ITR 391. 10 THOUGH, THE HONBLE RAJASTHAN HIGH COURT HAS DEC IDED THE ISSUE AGAINST THE ASSESSEE AFTER CONSIDERING THE DECISION OF THE JURISDICTIONAL HIGH COURT IN THE CASE OF AMERICAN EXPRESS INTERNATIONAL BANKING COR PN LTD VS CIT REPORTED IN 258 ITR 601 (BOM); HOWEVER, WE ARE BOUND BY THE DECISIO N OF THE JURISDICTIONAL HIGH COURT. THE CIT(A) HAS DECIDED THE ISSUE BY FOLLOWI NG THE DECISION OF THE JURISDICTIONAL HIGH COURT IN THE CASE OF AMERICAN E XPRESS INTERNATIONAL BANKING CORPN LTD (SUPRA) AS UNDER: 6. I HAVE CONSIDERED THE RIVAL SUBMISSIONS AND THE FINDINGS OF THE ASSESSING OFFICER. RESPECTFULLY FOLLOWING THE JUDGM ENT OF THE HONBLE BOMBAY HIGH COURT IN THE CASE OF AMERICAN EXPRESS I NTERNATIONAL BANKING CORPORATION (SUPRA), IN PRINCIPLE I AGREE WITH THE CONTENTION OF THE APPELLANT. THE HONBLE COURT AFFIRMING THE DECISION OF THE APPELLATE TRIBUNAL HELD THAT ONCE THE DEPARTMENT SOUGHT TO AS SESS TO ASSES TO TAX THE INTEREST RECEIVED BY THE ASSESSEE FROM THE TRAN SFEREES FROM THE BROKEN PERIOD UNDER THE HEAD BUSINESS, THE DEPARTM ENT COULD NOT HAVE 7 M/S HDFC BANK LTD REJECTED THE ADJUSTMENT OF THE AMOUNTS PAID BY THE ASSESSEE TO THE TRANSFERORS FOR THE BROKEN PERIOD UNLESS THE DEPART MENT PROVES THAT THE METHOD ADOPTED BY THE ASSESSEE DID NOT DISCLOSE THE TRUE AND PROPER INCOME. HOWEVER, SINCE THE INTEREST INCOME OF THE A PPELLANTS BANK HAS BEEN TAXED BY THE DEPARTMENT ON ACCRUAL BASIS; INTE REST EXPENDITURE RELATABLE TO THE SAID INCOME IS ONLY TO BE ALLOWED. THE ASSESSING OFFICER IS THEREFORE DIRECTED TO ALLOW BROKEN PERIOD INTEREST EXPENDITURE ONLY RELATABLE TO INTEREST INCOME TAXED ON ACCRUAL BASIS FOR THE YEAR UNDER CONSIDERATION. THE ASSESSING OFFICER IS, THEREFORE, DIRECTED TO VERIFY AND ALLOW THE SAME ACCORDINGLY. APPELLANTS APPEAL ON T HIS GROUND IS ALLOWED SUBJECT TO VERIFICATION. 10.1 SINCE THE JURISDICTIONAL HIGH COURT HAS DECIDE D THE ISSUE IN FAVOUR OF THE ASSESSEE; THEREFORE, WE DO NOT FIND ANY ERROR OR IL LEGALITY IN THE ORDER OF THE LD CIT(A), QUA , THIS ISSUE. 11 NEXT ISSUE IN THE APPEAL OF THE REVENUE FOR AY 2 001-02 IS WHETHER IN THE FACTS AND CIRCUMSTANCES OF THE CASE, THE CIT(A) IS JUSTIFIED IN DELETING THE DISALLOWANCE OF LOSS DUE TO DIMINUTION IN THE VALU E OF THE CURRENT INVESTMENT AND AMORTIZATION OF PREMIUM ON INVESTMENTS HELD TO MATURITY. 11 WE HAVE HEARD THE LD DR AS WELL AS THE LD AR OF THE ASSESSEE AND CONSIDERED THE RELEVANT MATERIAL ON RECORD. THE LD AR HAS POINTED OUT THAT THIS ISSUE HAS BEEN CONSIDERED AND DECIDED BY THE TRIBU NAL IN THE CASE OF M/S LORD KRISHNA BANK LTD IN ITA NO.118/COCH/2007 FOR AY 199 9-00 VIDE ORDER DATED 27.4.2011. THE CIT(A) HAS DECIDED THE ISSUE IN PAR A 10 AS UNDER: 10. RESPECTFULLY FOLLOWING THE HONBL BOMBAY HIGH COURT DECISION IN THE CASE OF CIT VS BANK OF BARODA (262 ITR 334) WHEREIN THE HONBLE COURT HELD THAT LOSS DEBITED TO PROFIT & LOSS ACCOUNT DUE TO DECREASE IN VALUE OF SECURITIES IS ALLOWABLE AS DEDUCTION AND THE HONBL E SUPREME COURT IN THE CASE OF UNITED COMMERCIAL BANK VS VIT 240 ITR 355 WHERE THE HONBLE COURT REVERSING THE DECISION OF THE HIGH COURT HELD THAT NATIONALISED BANK GOVERNED BY BANKING REGULATION ACT. BANK IS FOLLOWI NG MERCANTILE SYSTEM OF ACCOUNTING BOTH FOR BOOK KEEPING AS WELL AS TAX PURPOSES. BANK IS VALUING STOCK IN TRADE (INVESTMENTS) AT COST IN B ALANCE SHEET IN ACCORDANCE WITH BANKING REGULATION ACT AND VALUING VERY SAME INVESTMENTS AT COST OR MARKET VALUE WHICHEVER W AS LOWER FOR INCOME TAX PURPOSES. METHOD FOLLOWED CONSISTENTLY WAS VAL ID AND COULD NOT BE 8 M/S HDFC BANK LTD REJECTED. IN THE PRESENT CASE THE FACTS BEING SIMIL AR TO THE FACTS REPORTED IN UCO BANK, THE ASSESSING OFFICER IS DIRECTED TO A LLOW THE REVALUATION OF SECURITIES. HOWEVER, FOR THE COMPUTATION OF DEPRECI ATION ALLOWABLE, THE ASSESSING OFFICER IS ALSO DIRECTED TO REVALUE THE S ECURITIES IN THE SAME MANNER IN THE BEGINNING OF THE YEAR ALSO. 11.1 WE FIND THE TRIBUNAL IN THE CASE OF LORD KRISH NA BANK LTD (SUPRA) HAS CONSIDERED AND ADJUDICATED THE ISSUE IN PARA 3 & 4 AS UNDER: 3. WE HAVE HEARD THE RIVAL SUBMISSIONS AND PERUSED THE RELEVANT MATERIAL ON RECORD. THE LEARNED A.R. HAS RELIED ON CIRCULAR DBOD.NO.BP.BC.29/21.04.048/98 DATED 11 TH APRIL, 1998 ISSUED BY THE RESERVE BANK OF INDIA PRESCRIBING THE METHOD TO BE FOLLOWED FOR VALUATION OF GOVERNMENT AND OTHER SECURITIES. THE LEARNED A.R . INVITED OUR ATTENTION TOWARDS PAGE 4 OF THE PAPER BOOK, WHICH IS THE MET HOD SUGGESTED BY THE RBI TO BE ADOPTED BY THE BANKS IN RESPECT OF PERMAN ENT INVESTMENTS. CLAUSE (II) OF POINT NO.1 OF THIS, BEING VALUATION OF PERMANENT INVESTMENTS, WHICH HAS BEEN PRESSED INTO SERVICE BY THE LD. AR, READS AS UNDER:- `PERMANENT INVESTMENTS SHOULD BE VALUED AT COST A ND IN CASE COST PRICE IS HIGHER THAN THE FACE VALUE, THE PREMIUM SHOULD BE AMORTISED OVER THE REMAINING PERIOD OF MA TURITY OF THE SECURITY. ON THE OTHER HAND, WHERE THE COST PRICE IS LESS THAN THE FACE VALUE, THE DIFFERENCE SHOULD BE IGNORED AND SHOULD NOT BE AMORTISED OR TAKEN TO INCOME ACCO UNT SINCE THE AMOUNT REPRESENTS UNREALIZED GAIN. 4. WHEN WE VIEW THE ABOVE METHOD OF VALUATION , IT COMES TO NOTICE THAT THE PERMANENT INVESTMENT SHOULD BE VALUED AT C OST AND WHERE SUCH COST PRICE IS HIGHER THAN THE FACE VALUE, THE PREM IUM SHOULD BE AMORTIZED FOR THE REMAINING PERIOD OF MATURITY OF T HE SECURITY. FROM THE ABOVE IT IS CLEAR THAT THE PREMIUM HAS TO BE AMORTI ZED FOR THE REMAINING PERIOD OF MATURITY OF THE SECURITY. THE LEARNED A.R . FAIRLY CONCEDED THAT DETAILS OF SUCH PREMIUM SPLITTING OVER THE REMAINI NG PERIOD OF THE MATURITY WAS NOT READILY AVAILABLE AND HENCE THE MA TTER BE REMITTED TO THE FILE OF A.O. FOR DECIDING IT AS PER THE ABOVE P ART OF THE CIRCULAR. NO SERIOUS OBJECTION WAS TAKEN BY THE LEARNED DEPARTME NTAL REPRESENTATIVE. IN VIEW OF THESE FACTS WE SET ASIDE THE IMPUGNED OR DER AND RESTORE THE MATTER TO THE FILE OF A.O. FOR DECIDING THIS POINT IN ACCORDANCE WITH THE ABOVE NOTED METHOD. 11.2 THEREFORE, RESPECTFULLY FOLLOWING THE ORDER OF THE TRIBUNAL WE DECIDE THE ISSUE IN FAVOUR OF THE ASSESSEE AND AGAINST THE REV ENUE AND CONFIRM THE ORDER OF THE CIT(A) ON THIS ISSUE. 9 M/S HDFC BANK LTD 12 THE NEXT COMMON ISSUE RAISED BY THE REVENUE IN T HE APPEALS FOR ASSESSMENT YEAR 2001-02,02-03 AND 03-04 IS WHETHER IN THE FACTS AND CIRCUMSTANCES OF THE CASE, THE CIT(A) IS JUSTIFIED IN DELETING DISALLOWANCE U/S 43B BEING THE PAYMENT OF EMPLOYERS CONTRIBUTION TO PF BEYOND THE DUE DATE. 13 WE HAVE HEARD THE LD DR AS WELL AS THE LD AR OF THE ASSESSEE AND CONSIDERED THE RELEVANT MATERIAL ON RECORD. THE LD AR OF THE ASSESSEE HAS SUBMITTED THAT THIS ISSUE IS COVERED BY THE DECISIO N OF THE HONBLE SUPREME COURT IN THE CASE OF CIT V ALOM EXCLUSIONS LTD REP ORTED IN 319 ITR 306. AT THE OUTSET WE NOTE THAT THE PAYMENTS WERE MADE BEFORE THE DUE DATE OF FILING OF THE RETURN; THEREFORE, IN VIEW OF THE DECISION OF THE H ONBLE SUPREME COURT IN THE CASE ALOM EXTRUSIONS LTD (SUPRA), NO DISALLOWANCE I S CALLED FOR. ACCORDINGLY, WE DO NOT FIND ANY ERROR OR ILLEGALITY IN THE ORDER OF THE CIT(A), QUA THIS ISSUE. 14 NEXT ISSUE RAISED BY THE REVENUE FOR THE AY 2005 -06 WHETHER IN THE FACTS AND CIRCUMSTANCES OF THE CASE, THE CIT(A) IS JUSTIF IED IN DELETING THE DISALLOWANCE OF CLAIM OF THE ASSESSEE FOR DEDUCTION OF LOSS OF R EVALUATION OF THE CURRENT INVESTMENTS. 15 WE HAVE HEARD THE LD DR AS WELL AS THE LD AR OF THE ASSESSEE AND CONSIDERED THE RELEVANT MATERIAL ON RECORD. THE C IT(A) HAS RECORDED IN THE IMPUGNED ORDER THAT THIS ISSUE HAS BEEN CONSISTENTL Y DECIDING IN FAVOUR OF THE ASSESSEE FOR THE AYS 2001-02 TO 2004-05 AND ACCORDI NGLY, DECIDED THE ISSUE IN FAVOUR OF THE ASSESSEE. THE RELEVANT PORTION OF THE ORDER OF THE LD CIT(A) READS AS UNDER: 8 I HAVE CAREFULLY CONSIDERED THE SUBMISSIONS, GON E THROUGH THE MATERIAL PLACED ON RECORD AND ALSO PERUSED THE ORDE R OF THE AO. I FIND THAT THE ISSUE RELATING TO THIS GROUND OF APPEAL HAD CON SISTENTLY BEEN DECIDED BY MY LEARNED PREDECESSORS IN THE APPELLANTS OWN C ASE OF THE ASSESSMENT YEARS 2001-02 TO 2004-5 IN FAVOUR OF THE APPELLANT. FOR 10 M/S HDFC BANK LTD ASSESSMENT YEAR 2004-05, MY LD PREDECESSOR BY REPRO DUCING THE RELEVANT PORTION OF THE FINDINGS OF THE APPELLATE ORDER FOR THE ASSESSMENT YEAR 203- 04 HAD ALLOWED THIS GROUND. I ALSO FIND IT APPROPRI ATE TO REPRODUCE THE SAME FINDING FOR THE SAKE OF CLARIFY AND CONSISTE4N CY HERE BELOW: 6. THIS ISSUE HAD ARISEN FOR MY CONSIDERATION IN A SSESSMENT YEAR 2001-02 ALSO. IN MAY APPELLATE ORDER NO.CIT(A)-XXX/ RG.2(3)/IT/8- H/03-04 DATED 28/3/2005 FOR ASSESSMENT YEAR 2001-02 ASSESSING OFFICER WAS DIRECTED TO ALLOW THE REVALUATION OF S ECURITIES. HOWEVER, FOR THE COMPUTATION OF DEPRECIATION ALLOWABLE, ASSE SSING OFFICER WAS DIRECTED TO REVALUE THE SECURITIES IN THE SAME MANN ER IN THE BEGINNING OF THE YEAR ALSO. 6.1 FOLLOWING MY OWN ORDER FOR AY 2001-02 AND THE H ONBLE BOMBAY HIGH COURT DECISION IN THE CASE OF CIT VS BANK OF B ARODA (262 ITR 334) WHEREIN THE HONBLE COURT HELD THAT LOSS DEBIT ED TO P&L ACCOUNT DUE TO DECREASE IN VALUE OF SECURITIES IS A LLOWABLE AS DEDUCTION AND THE HONBLE SUPREME COURT IN THE CASE OF UNITED COMMERCIAL BANK VS CIT 240 ITR 355 THE H HONBLE CO URT REVERSING THE DECISION OF THE HIGH COURT HELD THAT NATIONALIZ ED BANK GOVERNED BY BANKING REGULATION ACT. BANK IS FOLLOWING MERCAN TILE SYSTEM OF ACCOUNT BOTH FOR BOOK KEEPING AS WELL AS TAX PURPOS ES. OF ACCOUNTING BOTH FOR BOOK KEEPING AS WELL AS TAX PUR POSES. BANK IS VALUING STOCK IN TRADE (INVESTMENTS) AT COST IN B ALANCE SHEET IN ACCORDANCE WITH BANKING REGULATION ACT AND VALUING VERY SAME INVESTMENTS AT COST OR MARKET VALUE WHICHEVER W AS LOWER FOR INCOME TAX PURPOSES. METHOD FOLLOWED CONSISTENTLY WAS VALID AND COULD NOT BE REJECTED. IN THE PRESENT CASE THE FACT S BEING SIMILAR TO THE FACTS REPORTED IN UCO BANK, THE ASSESSING OFFIC ER IS DIRECTED TO ALLOW THE REVALUATION OF SECURITIES. HOWEVER, FOR T HE COMPUTATION OF DEPRECIATION ALLOWABLE, THE ASSESSING OFFICER IS AL SO DIRECTED TO REVALUE THE SECURITIES IN THE SAME MANNER IN THE BE GINNING OF THE YEAR ALSO. SINCE THERE BEING NO DEVIATION EITHER OF FACTS OR L AW RELATING TO THIS GROUND OF APPEAL, I AM INCLINED TO AGREE WITH THE FINDINGS OF MY LD PREDECESSORS. BY FOLLOWING THE DECISIONS OF MY LD PREDECESSORS, W HICH ARE SUPPORTED BY THE DECISION OF HONBLE JURISDICTIONAL HIGH COURT A ND ALSO FOR THE SAKE OF CONSISTENCY, THE ASSESSING OFFICER IS DIRECTED TO A LLOW THE LOSS ON REVALUATION OF SECURITIES. HOWEVER, FOR THE COMPUTA TION OF DEPRECIATION ALLOWABLE, THE ASSESSING OFFICER IS DIRECTED TO REV ALUE THE SECURITIES IN THE SAME MANNER AS IN THE BEGINNING OF THE YEAR ALSO. 15.1 FURTHER, WE FIND THAT THIS ISSUE IS IDENTICAL TO THE ISSUE RAISED BY THE REVENUE FOR AY 2001-02. IN THE SUBSEQUENT YEAR, TH E REVENUE HAS NOT CHALLENGED THE ORDER OF THE CIT(A) ON THIS ISSUE. THEREFORE, W E DO NOT FIND ANY MERIT IN THE 11 M/S HDFC BANK LTD GROUND RAISED BY THE REVENUE ON THIS ISSUE. ACCORD INGLY, THE GROUND OF THE REVENUE IS DISMISSED. CROSS OBJECTIONS ( CROSS OBJECTIONS ( CROSS OBJECTIONS ( CROSS OBJECTIONS (BY THE ASSSSEE) BY THE ASSSSEE) BY THE ASSSSEE) BY THE ASSSSEE) 16 THE COMMON ISSUE RAISED BY THE ASSESSEE IN ITS C O FOR THE ASSESSMENT YEAR 2001-02 AND 2002-03 WHETHER IN THE FACTS AND CIRCUMSTANCES OF THE CASE, THE CIT(A) IS JUSTIFIED IN UPHOLDING THE DISALLOWAN CE OF DEDUCTION CLAIMED U/S 36(1)(VIIA) OF THE I T ACT. 16.1 THE ASSESSING OFFICER DISALLOWED THE DEDUCTION CLAIMED BY THE ASSESSEE U/S 36(1)(VIIA) ON THE GROUND THAT DEDUCTION UNDER THE PROVISO TO THIS SECTION IS OPTIONAL AND IN LIEU OF DEDUCTION AVAILABLE UNDER SUB. CLAUSE (A) OF CLAUSE (VIIA) OF SEC. 36(1) OF THE I T ACT. THE CIT(A) CONFIRMED THE ACTION OF THE ASSESSING OFFICER AND ALSO NOTED THAT IDENTICAL DISALLOWANCE WAS MADE FOR THE ASSESSMENT YEAR 2000-01. 17 WE HAVE CONSIDERED THE RIVAL CONTENTIONS AND REL EVANT MATERIAL ON RECORD. CLAUSE (VII)(A) OF SUB-SECTION (1) OF SECTION 36 PR OVIDES FOR A DEDUCTION IN RESPECT OF ANY PROVISION FOR BAD AND DOUBTFUL DEBTS MADE BY A SCHEDULED BANK WITHIN THE LIMIT AS PROVIDED IN THE SAID CLAUSE. IT IS IMPERA TIVE TO REPRODUCE THE RELEVANT PART OF CLAUSE (VIIA) OF SUB-SECTION (1) OF SECTION 36 AS UNDER:- (VIIA) IN RESPECT OF ANY PROVISION FOR BAD AND DO UBTFUL DEBTS MADE BY (A) A SCHEDULED BANK NOT BEING A BANK INCORPORATED BY OR UNDER THE LAWS OF A COUNTRY OUTSIDE INDIA OR A NON-SCHEDULED BANK, OR A CO-OPERATIVE BANK OTHER THAN A PRIMARY AGRICULTURAL CREDIT SOCIE TY OR A PRIMARY CO- OPERATIVE AGRICULTURAL AND RURAL DEVELOPMENT BANK, AN AMOUNT NOT EXCEEDING SEVEN AND ONE-HALF PER CENT OF THE TOTAL INCOME (COMPUTED BEFORE MAKING ANY DEDUCTION UNDER THIS CLAUSE AND C HAPTER VIA) AND AN AMOUNT NOT EXCEEDING TEN PER CENT OF THE AGGREGA TE AVERAGE ADVANCES MADE BY THE RURAL BRANCHES OF SUCH BANK CO MPUTED IN THE PRESCRIBED MANNER. PROVIDED THAT A SCHEDULED BANK OR A NON-SCHEDULED BANK REFERRED TO IN THIS SUB-CLAUSE SHALL, AT ITS OPTION, BE ALLOWED IN ANY OF THE 12 M/S HDFC BANK LTD RELEVANT ASSESSMENT YEARS, DEDUCTION IN RESPECT OF ANY PROVISION MADE BY IT FOR ANY ASSETS CLASSIFIED BY THE RESERVE BANK OF INDIA AS DOUBTFUL ASSETS OR LOSS ASSETS IN ACCORDANCE WITH T HE GUIDELINES ISSUED BY IT IN THIS BEHALF, FOR AN AMOUNT NOT EXCE EDING FIVE PER CENT OF THE AMOUNT OF SUCH ASSETS SHOWN IN THE BOOKS OF ACCOUNT OF THE BANK ON THE LAST DAY OF THE PREVIOUS YEAR: PROVIDED FURTHER THAT FOR THE RELEVANT ASSESSMENT YEARS COMMENCING ON OR AFTER THE 1ST DAY OF APRIL, 2003 AND ENDING B EFORE THE 1ST DAY OF APRIL, 2005, THE PROVISIONS OF THE FIRST PROVISO SHALL HAVE EFFECT AS IF FOR THE WORDS FIVE PER CENT, THE WORDS TEN PER C ENT HAD BEEN SUBSTITUTED: PROVIDED ALSO THAT A SCHEDULED BANK OR A NON-SCHEDULED BANK REFERRED TO IN THIS SUB-CLAUSE SHALL, AT ITS OPTION , BE ALLOWED A FURTHER DEDUCTION IN EXCESS OF THE LIMITS SPECIFIED IN THE FOREGOING PROVISIONS, FOR AN AMOUNT NOT EXCEEDING THE INCOME DERIVED FROM REDEMPTION OF SECURITIES IN ACCORDANCE WITH A SCHEM E FRAMED BY THE CENTRAL GOVERNMENT: PROVIDED ALSO THAT NO DEDUCTION SHALL BE ALLOWED UNDER THE THIRD PROVISO UNLESS SUCH INCOME HAS BEEN DISCLOSED IN TH E RETURN OF INCOME UNDER THE HEAD PROFITS AND GAINS OF BUSINES S OR PROFESSION. 17.1 FROM THE SUB-CLAUSE (A) OF CLAUSE (VIIA) OF SU B-SECTION (1) OF SECTION 36 AND PROVISO TO SAID CLAUSE, IT IS CLEAR THAT UNDER SUB- CLAUSE (A), WHILE COMPUTING THE BUSINESS INCOME OF A SCHEDULED BANK (NOT BEING A FO REIGN BANK) OR A NON SCHEDULED BANK, DEDUCTION IS ALLOWABLE IN RESPECT O F ANY PROVISION FOR BAD AND DOUBTFUL DEBTS TO THE EXTENT OF AN AGGREGATE AMOUNT NOT EXCEEDING 7.5% OF THE TOTAL INCOME AND 10% OF THE AGGREGATE AVERAGE ADVAN CES MADE BY ITS RURAL BRANCHES. IN ORDER TO PROVIDE FLEXIBILITY IN THE F ISCAL INCENTIVE, AN OPTION IS GIVEN TO SUCH BANKS BY INSERTING THE FIRST PROVISO FOR CL AIMING DEDUCTION, FOR A PERIOD OF 5 YEARS FOR ANY PROVISIONS MADE BY IT IN RESPECT OF DOUBTFUL OR LOSS ASSETS, IN ACCORDANCE WITH THE GUIDELINES ISSUED BY THE RESERV E BANK OF INDIA NOT EXCEEDING 5% OF SUCH LOSS OR DOUBTFUL ASSET. THUS, THE PROVISO PROVIDES ONLY AN OPTION TO THE BANK TO EXERCISE AN ALTERNATIVE TO TH E DEDUCTION FOR PROVISION FOR BAD AND DOUBTFUL DEBTS NOT EXCEEDING 5% OF TOTAL I NCOME AND 10% OF AGGREGATE AVERAGE OF ADVANCES BY THE RURAL BRANCHES. THUS, TH E OPTION UNDER THE PROVISO IS 13 M/S HDFC BANK LTD ONLY AN ALTERNATIVE TO SUB-CLAUSE (A). THEREFORE, THE PROVISO DOES NOT PROVIDE A DEDUCTION IN ADDITION TO DEDUCTION ALLOWABLE UNDER SUB-CLAUSE (A) OF CLAUSE (VIIA). 18 IN VIEW OF THE ABOVE, WE CONFIRM THE ORDER OF THE CIT(A) ON THIS ISSUE. 19 NEXT ISSUE RAISED BY THE ASSESSEE IN ITS CO FOR AY 2001-02 IS WHETHER IN THE FACTS AND CIRCUMSTANCES OF THE CASE, THE CIT(A) IS JUSTIFIED IN UPHOLDING THE DISALLOWANCE OF PROPORTIONATE DEDUCTION U/S 35D(1) (II) BEING 10% OF THE EXPENSES INCURRED FOR INCREASING THE AUTHORIZED SH ARE CAPITAL. 20 WE HAVE HEARD THE LD DR AS WELL AS THE LD AR OF THE ASSESSEE AND CONSIDERED THE RELEVANT MATERIAL ON RECORD. WE F IND BEFORE THE CIT(A), THIS ISSUE WAS NOT PRESSED AND ACCORDINGLY, THE SAME WAS DISMISSED BY THE CIT(A) AS NOT PRESSED. EVEN OTHERWISE, THIS EXPENSE IS ADMIT TEDLY INCURRED AND RELATED TO ENHANCEMENT OF SHARE CAPITAL; THEREFORE, IN VIEW OF THE DECISION OF THE HONBLE SUPREME COURT IN THE CASE OF BROOK BOND INDIA LTD REPORTED IN 225 ITR 798 AS WELL AS PUNJAB INDUSTRIAL DEVELOPMENT CORPN VS CIT REPORTED IN 225 ITR 792, WE DO NOT FIND ANY MERIT IN THE GROUND RAISED BY THE A SSESSEE IN ITS CROSS OBJECTION AND THE SAME IS DISMISSED. 21 THE ASSESSEE HAS RAISED THE FOLLOWING GROUNDS AY 2005-06: GROUND NO.I GROUND NO.I GROUND NO.I GROUND NO.I 1. ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE LD CIT(A) ERRED IN CONFIRMING THE DISALLOWANCE MADE BY THE AS SESSING OFFICER OF A SUM OF RS. 152.34 CRORES U/S 14A OF THE I T ACT BE ING THE ALLEGED COST OF INTEREST ATTRIBUTED FOR EARNING TAX FREE INCOME. 2. HE FURTHER ERRED IN MAKING CERTAIN IRRELEVANT AN D/OR IMMATERIAL OBSERVATIONS AND IN PARTICULAR THE FOLLOWING: A) CASH FLOW STATEMENT FILED BY THE APPELLANT DOES NOT HELP IN ANY WAY TO ESTABLISH A NEXUS BETWEEN THE INVESTMENTS AN D ITS OWN FUNDS. B) THE APPELLANT HAS MENTIONED THAT ITS OWN FUNDS A ND BORROWINGS HAVE BEEN MIXED SO THE APPELLANTS CLAIM THAT THE I NVESTMENTS IN 14 M/S HDFC BANK LTD TAX FREE BONDS ARE OUT OF ITS OWN FUNDS AND INTERNA L CASH ACCRUAL IS NOT ACCEPTABLE. 3. HE FAILED TO APPRECIATE AND OUGHT TO HAVE HELD T HAT; A) THE APPELLANT HAD NET WORTH, WHICH WAS MORE THAN THE INVESTMENTS IN TAX FREE SECURITIES. ACCORDINGLY, IN VESTMENTS IN TAX FREE INCOME EARNING SECURITIES MADE SHOULD BE PRESU MED TO BE MADE OUT OF OWN FUNDS AND NOT OUT OF BORROWED FUNDS . B) THE INVESTMENTS WERE OUT OF ITS OWN FUNDS AND IN TERNAL CASH ACCRUALS C) ALL THE RECEIPTS, INCLUDING SALE PROCEEDS OF INV ESTMENTS AND BORROWINGS, BOTH FOR CAPITAL EXPENDITURE AND FOR WO RKING CAPITAL WERE DEPOSITED IN THE SAME ACCOUNT AND FROM THIS AC COUNT THE PAYMENTS, BOTH FOR WORKING CAPITAL EXPENDITURE AND REVENUE EXPENDITURE HAS BEEN AFFECTED. 4. THE APPELLANT PRAYS THAT THE DISALLOWANCE OF RS. 152.34 CRORES BE DELETED. GROUND NO.2 GROUND NO.2 GROUND NO.2 GROUND NO.2 1 IN THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE CIT(A) ERRED IN RESTRICTING THE DISALLOWANCE U/S 14A AT 1% OF THE GROSS EXEMPT INCOME INSTEAD OF DELETING THE ENTIRE DISALLOWANCE BEING ALLEGED EXPENSES ATTRIBUTED FOR EARNING TAX FREE INCOME. 2 HE FAILED TO APPRECIATE AND OUGHT TO HAVE HELD TH AT WHERE NO EXPENDITURE HAS BEEN ACTUALLY INCURRED, NO ESTIMATI ON CAN BE MADE TO DISALLOW EXPENDITURE FOR EARNING EXEMPT INCOME. 3 THE APPELLANT THEREFORE PRAYS THAT THE DISALLOWAN CE OF ALLEGED EXPANSES ATTRIBUTED AT 1% OF THE GROSS EXEMPT INCOM E BE DELETED. GROUND NO.III GROUND NO.III GROUND NO.III GROUND NO.III 1. IN THE FACTS AND CIRCUMSTANCES OF THE CASE AND I N LAW, THE CIT(A) ERRED IN UPHOLDING A DISALLOWANCE OF RS. 28,153/- U/S 40( A) (IA) BEING INTEREST PAID IN THE STATE OF SIKKIM ON WHICH NO TDS HAS TO BE DEDUCTED. 2. HE FAILED TO APPRECIATE AND OUGHT TO HAVE HELD T HAT AFORESAID SUM SHOULD NOT BE DISALLOWED IN VIEW OF THE CLARIFICATI ONS ISSUED FROM THE MINISTRY OF FINANCE STATE OF SIKKIM. 3 THE APPELLANT PRAYS THAT THE AFORESAID DISALLOWAN CE BE DELETED. 22 GROUND NO.1 REGARDING DISALLOWANCE OF INTEREST E XPENSES U/S 14A. 23 IN VIEW OF OUR FINDINGS IN REVENUES APPEAL FOR ASSESSMENT YEAR 2001-02, WE DECIDE THIS ISSUE IN FAVOUR OF THE ASSESSEE. 15 M/S HDFC BANK LTD 24 GROUND NO.2 IS COMMON IN REVENUES APPEAL AS WEL L AS IN THE CO OF THE ASSESSEE FOR THE OTHER ASSESSMENT YEARS AND WE HAVE ALREADY DECIDED THIS ISSUE AND UPHELD THE ORDER OF THE LD CIT(A) ON THIS ISSUE . ACCORDINGLY, THIS GROUND OF THE ASSESSEE IS DISMISSED. 25 THE REMAINING GROUND IS REGARDING DISALLOWANCE O F RS.28,153/- U/S 40(A)(IA) OF THE ACT BEING THE INTEREST PAID TO THE STATE OF SIKKIM ON WHICH NO TDS HAS BEEN DEDUCTED. 26 WE HAVE HEARD THE LD DR AS WELL AS THE LD AR OF THE ASSESSEE AND CONSIDERED THE RELEVANT MATERIAL ON RECORD. THE L D AR REFERRED SECTION 10(26AAA) AND SUBMITTED THAT WHEN AN INCOME ACCRUES OR ARISES TO AN INDIVIDUAL, BEING SKKIMESE FROM ANY SOURCE IN THE S TATE OR BY WAY OF DIVIDEND OR INTEREST ON SECURITIES , THE SAME IS EXEMPTED FROM TAX. ACCORDINGLY, THE LD AR OF THE ASSESSEE HAS SUBMITTED THAT WHEN THE INTEREST P AYMENT WAS EXEMPTED IN THE HANDS OF THE RECIPIENT THEN NO DEDUCTION OF TDS WAS REQUIRED TO BE MADE. THE LD DR ON THE OTHER HAND RELIED ON THE ORDERS OF THE AUTHORITIES BELOW. 27 THE SUB.SEC. 26(AAA) OF SEC. 10 HAS BEEN INSERT ED BY THE FINANCE ACT 2008 WITH RETROSPECTIVE EFFECT FROM 1.4.1990, WHICH IS REPRODUCED HEREUNDER: 26(AAA): 26(AAA): 26(AAA): 26(AAA):- -- - IN CASE OF AN INDIVIDUAL, BEING A SIKKIMESE, ANY INCOME WHICH ACCRUES OR ARISES TO HIM A) FROM ANY SOURCE IN THE STATE OF SIKKIM; OR B) BY WAY OF IN DIVIDEND OR INTEREST ON SECURITI ES; PROVIDED THAT NOTHING CONTAINED IN THIS CLAUSE SHAL L APPLY TO A SIKKIMESE WOMAN WHO, ON OR AFTER THE 1 ST DAY OF APRIL 2008 MARRIES AN INDIVIDUAL WHO IS NOT A SIKKIMESE. 27.1 FROM THE ABOVE, IT IS CLEAR THAT THE INCOME RE CEIVED OR ACCRUED TO AN INDIVIDUAL BEING A SIKKIMESE ON ACCOUNT OF DIVIDEND OR INTEREST IS EXEMPTED THEN 16 M/S HDFC BANK LTD NO DISALLOWANCE CAN BE MADE U/S 40(A)(IA) OF THE AC T FOR NON DEDUCTION OF TDS. WE FURTHER FIND THAT FOR INVOKING THE PROVISIONS OF SEC. 40(A)(IA), IT IS NECESSARY PRECONDITION THAT TAX IS DEDUCTIBLE AT SOURCE UNDER CHAPTER XIIB IN RELATION TO THE PAYMENT OF INTEREST, COMMISSION OR BROKERAGE AND SU CH TAX HAS NOT BEEN DEDUCTED OR AFTER DEDUCTION HAS NOT BEEN PAID BEFOR E THE DUE DATE. THEREFORE, WHEN THE INCOME OF INTEREST IN THE HANDS OF THE REC IPIENT IS EXEMPTED THEN NO TAX IS DEDUCTIBLE UNDER CHAPTER XVII-B AND CONSEQUE NTLY NO DISALLOWANCE IS CALLED FOR U/S 40(A)(IA) OF THE ACT. 28 IN THE RESULT, THE APPEAL OF THE ASSESSEE IS PAR TLY ALLOWED. 29 TO SUM UP, THE APPEALS OF THE REVENUE AND CROSS OBJECTIONS OF THE ASSESSEE ARE DISMISSED WHEREAS THE APPEAL OF THE AS SESSEE FOR AY 2005-06 IS PARTLY ALLOWED. ORDER PRONOUNCED ON THE 29 TH , DAY OF JUNE 2011. SD/- SD/- ( (( ( J SUDHAKAR REDDY J SUDHAKAR REDDY J SUDHAKAR REDDY J SUDHAKAR REDDY ) )) ) ACCOUNTANT MEMBER ( (( ( VIJAY PAL RAO VIJAY PAL RAO VIJAY PAL RAO VIJAY PAL RAO ) )) ) JUDICIAL MEMBER PLACE: MUMBAI : DATED: 29 TH , JUNE 2011 RAJ* COPY FORWARDED TO: 1 APPELLANT 2 RESPONDENT 3 CIT 4 CIT(A) 5 DR /TRUE COPY/ BY ORDER DY /AR, ITAT, MUMBAI