No Section 14A Interest Disallowance When Own Funds Exceed Investments: SC

South Indian Bank Ltd. Vs CIT (Supreme Court of India)

Summary: The Supreme Court considered whether proportionate disallowance of interest expenditure under Section 14A of the Income Tax Act could be made against scheduled banks in respect of investments in tax-free bonds, securities and shares where the assessees had sufficient interest-free own funds exceeding the investments. The assessee banks did not maintain separate accounts identifying the funds utilised for investments yielding tax-free income. The Assessing Officer therefore made proportionate disallowance by reference to the average cost of deposits, and the CIT(A) concurred. The ITAT, however, found that the banks carried on an indivisible banking business, that the investments were in the nature of stock-in-trade and that surplus funds and reserves were available. It consequently held that Section 14A disallowance was not warranted in the absence of clear identification of borrowed funds with the investments. The High Court reversed the Tribunal.

The Supreme Court held that where an assessee has a mixed fund consisting partly of interest-free funds and partly of interest-bearing funds, and the interest-free funds are sufficient to meet the investments, the investment must be presumed to have been made from the interest-free funds. Referring to CIT v. Reliance Industries Ltd., HDFC Bank Ltd. v. DCIT and other authorities, the Court held that proportionate interest disallowance is legally impermissible where non-interest-bearing funds exceed investments in tax-free securities. The Court also distinguished SA Builders v. CIT and the pending larger Bench proceedings in Tulip Star Hotels Ltd., since those matters concerned loans to sister concerns rather than investments by banks in bonds and securities.