Section 14A disallowance cannot be made if no expenditure found to be incurred to earn exempt income

Facts of the Case-
The assessee is engaged in manufacturing of cycles and parts of two-wheelers in multiple units. It earned dividend income, which is exempted under Section 10 (34) and (35). The Assessing Officer made an inquiry whether any expenditure was incurred for earning this income and as a result of the said inquiry addition was made by way of disallowance under Section 14A (3), which was partly upheld by the CIT (A). The Tribunal held that there was no nexus with the expenditure incurred and the income generated.

Held BY ITAT

We have perused the same and find that the plea of the assessee that the entire investments have been made out of the dividend proceeds, sale proceeds, debenture redemption etc., is borne out of record. In fact the CIT (Appeals) has also come to a categorical finding that in so far as other units are concerned, none of their funds have been utilized to make the investments in question.

One aspect which is evident that the interest income earned by the main unit, Ludhiana, exceeds the expenditure by way of interest incurred by it, thus obviating the application of Section 14A of the Act. Even with regard to the funds of the main unit, Ludhiana the funds flow position explained shows that only the non-interest bearing funds have been utilized for making the investments. At pages 3 to 6 of the paper book are placed the details of the Bank accounts, wherein the amount of dividend, sale proceeds of shares, debenture redemption etc. have been received and later on invested in the investments in question. Such funds are ostensibly without any burden of interest expenditure. Thus, on facts we do not find any evidence to show that the assessee has incurred interest expenditure in relation to earning to the tax exempt income in question. We find that all the details in question were produced before the Assessing Officer and the CIT (Appeals) also. The entire evidence in this regard, which is submitted before the lower authorities have been compiled in the paper book, to which we have already adverted to in the earlier part of the order. Therefore, merely because the assessee has incurred interest expenditure on funds borrowed in the main unit, Ludhiana, it would not ipso-facto invite the disallowance under Section 14A, unless there is evidence to show that such interest bearing funds have been invested in the investments which have generated the ‘tax exempt dividend income.’

As noted earlier, there is no nexus established by the Revenue in this regard and therefore, on a mere presumption, the provisions of Section 14A cannot be applied. Thus, we find that the CIT (Appeals) erred in part sustaining the addition. In fact, in the absence of such nexus, the entire addition made was required to be deleted.

Held by High Court

In view of finding reproduced above, it is clear that the expenditure on interest was set off against the income from interest and the investment in the share and funds were out of the dividend proceeds. In view of this finding of fact, disallowance under Section 14A was not sustainable.

Disallowance under Section 14A requires finding of incurring of expenditure where it is found that for earning exempted income no expenditure has been incurred, disallowance under Section 14A cannot stand.

In the present case finding on this aspect, against the revenue, is not shown to be perverse. Consequently, disallowance is not permissible.