If absence of exempt income disallowance u/s 14A not warranted

Brief case of the case:

In the case of M/s Chhaganlal Khimji & Co. Vs. ACIT Mumbai Bench of ITAT have held that that no disallowance can be made u/s.14A when there is no exempt income. ITAT relied upon the judgments of various courts in coming to the conclusion. ITAT also upheld the decision of CIT (A) on other grounds related to borrowed funds.

Facts of the case:

• Assessee Company is a group concern of Marathon Group and engaged in the business of construction of commercial & residential complexes and investments.
• The assessee company is authorized to lend advance money as per clause 42 of its object clause of its Memorandum and Article of Association.
• During the course of assessment proceedings AO treated the interest income earned by the assessee as income from other sources.
• AO also directed to treat the interest expenditure as direct cost and for taking the same to closing work-in-progress.
• AO also disallowed interest paid on borrowings against the interest income.
• During the year under consideration assessee had entered into a Joint Venture in the form of a Memorandum of Understating with its group concern wherein assessee would receive a tax free dividend of 11 % on the face value of the Preference Shares’ and a Return of 15% on the premium paid.
• AO held that interest income earned from interest free advances from customers and borrowed funds invested which resulted in interest income and must be assessed u/s. 56 as income from other sources.
• Interest received by the assessee to the tune of Rs.3,65,62,742/- was assessed as income from other sources as against profits and gains of business as returned by the assessee.
• During the year the appellant had borrowed Rs.110.02 crores from M/s Marathon Nextgen Realty Ltd.(MNRPL}.
• The borrowed funds were in turn invested with M/s.Parmeka Pvt. Ltd. (PPL) a Joint Venture Company in which appellant is one of the Joint Venture partner.
• Assessee would receive a tax free dividend of 1,1 % on the face value of the Preference Shares and a Return of 15% on the premium paid.
• On the borrowed fund for the investment in preferential shares Rs. 81.50 lakhs and on the balance premium Rs.109.21 crores appellant needs to pay interest @11 % to MNRPL.
• The assessee had worked out the disallowance of Rs.1,28,893/- u/s 14A which was not accepted by the AO, as the assessee did not take into consideration the interest paid towards the premium on purchase of 11 % preferential shares.
• AO observed that during the year under consideration assessee had considered both the direct as well as indirect cost incurred towards construction as a part of closing stock till AY 2009-10. However, during the AY under consideration only direct cost have been taken leaving the indirect cost as a part of closing WIP.
• No reply was submitted before AO regarding this issue.
• Since the assessee had consistently followed considering both direct as well as indirect expenses and hence, the AO had transferred Rs.58,55,328/- to closing stock and did not allow the same as expenses to be debited in the P&L account.

Contention of the revenue: