Even under Rule 8D of S.14A, disallowance can be made only if there is actual nexus between tax-free income and expenditure

SUMMARY OF THE CASE LAW

The assessee earned dividend income on shares which was exempt from tax. The AO took the view that the investment in shares was made out of borrowed funds on which interest expenditure was incurred and consequently made a disallowance u/s 14A. This was partly upheld by the CIT (A). On further appeal by the assessee, the Tribunal deleted the disallowance by noting that the assessee had proved that the investment in shares was made out of non-interest bearing funds.

It held that unless there was evidence to show that the interest – bearing funds had been invested in the tax – free investments and the nexus was established by the Revenue, s. 14A could not be applied on mere presumption.

The Revenue appealed to the High Court and claimed that in view of s. 14A (2) and Rule 8D (1) (b), a disallowance could be made even if the assessee claimed that no expenditure had been incurred in respect of the tax – free income. HELD, dismissing the appeal:

(i) If the investment in the shares is out of the non-interest bearing funds, disallowance u/s 14A is not sustainable;

Please become a Premium member. If you are already a Premium member, login here to access the full content.