Issue: Investment made through borrowed fund, interest on borrowed funds, whether claim in disallowed within the provisions of section 14A r.w. 37 (1)
Section 14A r.w. 37 (1) of Income Tax act, 1961
Appeal by Assessee before ITAT: (Relevant Extract)
4. That on the facts and in the circumstances of the case, the learned CIT (A) erred in upholding an ad-hoc disallowance u/s 14A of the Act amounting to Rs.2,92,000/- i.e. 5% of the gross dividend income: on account of management/administrative expenses and other costs alleged to be incurred in earning dividend income.
4.1 That the learned CIT (A) erred on facts and in law in partly confirming the disallowance on a pure estimate even though the AO had brought nothing on record to establish that the appellant had incurred any expenditure on earning dividend income.
Contentions of Department (As per AO’s Odrer):
“1. “On the facts and in the circumstances of the case and in law, the CIT(A) erred in deleting the disallowance of Rs.12,27,50,000/-made U/S 14A on account of interest paid on the borrowed funds utilized for making investment in shares on which the tax free dividend income of Rs.58,40,028/- has been earned, without appreciating the facts on record. (Interest disallowance was deleted by CIT (A) which has been challenged by Department before honorable ITAT)
2. On the facts and in the circumstances of the case and in law, the CIT(A) erred in restricting the disallowance of Rs.15,00,000/-made u/s 14A on account of proportionate administrative expenses incurred for earning the tax free dividend, to Rs.2,92,000/- i.e. 5% of the gross dividend, without appreciating the facts on record. (Disallowance for admin, management expense made by AO was restricted to Rs 292,000/- by CIT (A).
Observations by ITAT:
iii) Disallowance u/s 14A: Ground No.4 relates to upholding of a part of disallowance u/s 14A of the Act. The A.O. had disallowed an amount of Rs.12,27,50,000/- on account of expenditure of interest relatable to earning of dividend and further had disallowed an amount of Rs.15 lacs relating to administrative expense for earning of dividend income. Ld. CIT(A) has however, deleted the additions on account of interest expenses. In respect of expenses, he has partly allowed relief by holding 5% of gross dividend income as reasonable expenses for earning the income. The assessee is now in appeal for upholding of amount of Rs.2,92,500/- which Ld. CIT(A) has upheld for expenses and revenue is in appeal for deletion of addition of Rs.12,27,50,000/- on account of expenditure of interest Ld. A.R. submitted that the assessee had received an amount of dividend as Rs.58,40,028/-which was received from group companies namely Maruti Countrywide Auto Finance Services Ltd. and GE India Ltd. and investment in these companies were made way back in 1995-96 and 1996-97. Ld. A.R. submitted that the assessee was a cash rich company and investment was made out of internal accruals and the issue of disallowance of interest has already been considered in earlier Assessment Year 1998-99 by the Tribunal in I.T.A. No. 1523/ Del./2003 and our attention was invited to paper book page 35. Ld. A.R. further submitted that the assessee has not incurred any interest expenses in order to make investments in these investments as the assessee had invested out of cash accruals and that too in earlier years. He further argued that no notional deduction in terms of administrative expenses can be made in the absence of any finding of actual incurring of expenditure; the Ld. A.R. relied upon the following case laws:
In view of above facts, Ld. A.R. submitted that Ld. CIT(A) has passed reasonable and speaking order as far as interest expenditure is concerned and moreover, the issue of interest expenses is already covered in favour of assessee by the order of Tribunal in Assessment Year 1998-99. It was argued that as regards administrative expense, the issue is covered in favour of assessee by various judgements.
D.R. on the other hand submitted that for earning exempt income, expenditure has to be incurred and provisions of Rule 14A are mandatory in nature and, therefore, the A.O. has rightly disallowed the same u/s 14A of the Act.
We have heard rival parties and have gone through the material placed on record. We find that in the year under consideration, there is no investment in the shares and it is also undisputed fact that dividend was earned from two companies which are group companies of assessee and the assessee had made investments in these companies as strategic investment and dividend amount of R.58,40,028/- comes to 0.15% of total income of assessee which fact is apparent from the order of Ld. CIT(A) at page 11
Moreover, Ld. CIT(A) has clearly held that investment in shares was made out of internal accruals and own funds and no borrowed funds were used. Ld. CIT(A) has held that out of internal accruals of s.248 crores for the year ended 31.03.1996, and Rs.253 crores in the year ended 31.03.1997, the assessee had made investment of Rs.34.99 crores and Rs.46.93 crores in these two years, which means that the figures of internal accruals for two years was six times more than the figure of investments in these two years. Therefore, relying upon the decision of ACIT Vs Eicher Ltd. in 101 TTJ 369, Ld. CIT(A) has rightly held that disallowance on account of interest was not applicable to the assessee.
Ld. D.R. was not able to controvert any of the findings of Ld. CIT(A). In view of the above ground No.1 of Revenue’s appeal is dismissed.
As regards ground No.2 of Revenue’s appeal, and ground No.4 of assessee’s appeal, we find that the A.O. has made addition on a lump sum basis without noting down incurring of any expenditure @ 25% of dividend income whereas Ld. CIT(A) has restricted the disallowance to the extent of 5% of gross total income. Both the authorities have not made any finding of fact of incurring of any expenditure in this respect. Hon’ble Punjab & Haryana High Court in the case of Hero Cycles Ltd. 323 ITR 518 has held that disallowance u/s 14A requires finding of incurring of expenditure and where it is found that for earning exempt income, no expenditure has been incurred, disallowance u/s 14A cannot be made. Ld. A.R. has also invited our attention to para 28 of Maxopp Investments case decided by Hon’ble Delhi High Court and has argued that the Hon’ble High Court has held that the expenses incurred mentioned in Section 14A referred to accrual expenditure and not some imaginary expenditure and the accrual expenditure as contemplated u/s 14A is the actual expenditure in relation to earning of exempt income and, therefore, had held that if no expenditure is incurred in relation to exempt income no disallowance can be made u/s 14A of the Act. However, we find that the provisions of Section 14A are mandatory in nature and sub-section (3) of Section 14A applies to the cases where assessee claims that no expenditure has been incurred in relation to income which does not form part of total income under the said act. In other words, sub-section (2) deals with cases where the assessee specifies incurrence of some expenditure in relation to income which does not form part of total income whereas sub-section (3) applies to cases where the assessee asserts that no expenditure had been incurred in relation to exempt income. In both the cases, the A.O. should be satisfied with the contents of the claim of assessee in respect of which, expenditure or no expenditure as the case may be and without this satisfaction he cannot embark upon to determine the amount of expenditure in accordance with any prescribed method as mentioned in sub-section (2) to section 14A of the Act. It is only if the A.O. is not satisfied with the correctness of claim of assessee in both the cases that A.O. gets jurisdiction to determine the amount of expenditure incurred in relation to such income which does not form part of total income under the Act in accordance with the prescribed method. While rejecting the claim of assessee with regard to expenditure or no expenditure as the case may be, in respect of exempt income, the A.O. would have to indicate cogent reasons for the same which has not been done in the present case. Therefore, relying upon the ratio of Hero Cycles Ltd. 323 ITR 518, we hold that without recording of finding of fact as to the incurring of some expenditure, disallowance made by A.O. and partly confirmed by Ld. CIT(A) is not
justified. Moreover, we find hat dividends were received from the group companies wherein the investment was made as a strategic investment and not for the purpose of earning dividend and since these are strategic investments there is no chance of incurring of any expenditure on day to day basis. In view of above facts and circumstances, ground No. 4 of assessee’s appeal is allowed, whereas ground No.2 of Revenue’s appeal is dismissed
Decision by ITAT:
The honorable ITAT agreed with the decision of CIT (A) so far it related to Interest. ITAT has also deleted the disallowance of 5% of Exempt Income.
Anyalysis of the Case
Section 14A does not allow the expense which have been incurred for earning the exempt income. The contentions of the department was on the basis that the investments earning exmpt income was sourced from borrowed fund on which interest was claimed by assessee.
From the discussion above it follows that, if the investments are not made from borrowed funds, then there should not be any disallowance. Since in this case it was evidenced from the records and evidence s that the income accured was from internal accruals consequently addition deleted (by both the authorities i.e. CIT (A) and ITAT). As far as expenses of management of investment, which was considered @ 5 of expemt income was upheld by CIT (A). howver the same has been deleted by ITAT, since in Hero Cycle it was held “Disallowance u/s 14A requires a finding of incurring of expenditure. If it is found that for earning exempted income no expenditure has been incurred, disallowance u/s 14A cannot stand;”