Disallowance under Section 14A of Income TAx Act, 1961
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Whether on the facts and in the circumstance of the case and in law the Hon’ble Tribunal was right in deleting the disallowance made by the Assessing Officer of interest paid by the Assessee Company on borrowed funds amounting to Rs.241.10 lakhs overlooking the fact that the borrowed funds were used by the Assessee Company to invest in the Capital of another Partnership Firm and since profits derived by the Assessee Company from a Partnership firm were exempt from tax u/s.10(2A) of the Income-tax Act, the interest expense related to such tax free profits is to be disallowed u/s.14A of the Income Tax Act?
During the year under consideration the appellant received dividend income on surplus funds invested with various mutual funds through Citibank who acted as investment adviser with no cost to the appellant company. The dividends were directly credited to the bank account of the appellant electronically by ECS. No interest was paid by the appellant during the year. As such, the appellant did not incur any expenditure on earning dividend income and section 14A and the I.T. Act, 1961 did not apply.
The appellant had raised interest bearing loan from Reliance Capital Ltd. The said Loan had been utilized by the appellant for the purchase of shares and also for making capital contribution to M/s Shreenath Enterprises in which the appellant was a partner. Thus, to the extent the interest bearing loan has been used for making contribution, there is a direct nexus between the loan obtained from Reliance Capital Ltd. and contribution made to the partnership firm.
The taxpayer adjusted the interest expenditure against the interest income earned. After such adjustment no interest expenditure remained to be disallowed. The taxpayer offered expenditure other than interest of Rs. 111,521 for disallowance under Section 14A of the Act on the estimated basis. The Kolkata Tribunal held that there was no interest expenditure remaining after adjusting the interest credited to the Profit and Loss Account. Therefore, no part of interest paid can be disallowed for earning tax free dividend. Further, expenditure other than interest had been offered for disallowance by the taxpayer under Section 14A of the Act. Therefore, no further disallowance shall be made.
Disallowance u/s 14A required a finding of incurring of expenditure and where it was found that for earning exempted income, no expenditure had been incurred, disallowance u/s 14A could not stand. In the present case, as seen, the AO has not established any nexus whatsoever between the borrowed funds and the investment made. Therefore, Hero Cycles (supra), is applicable.
The correct sequence, in our considered opinion, for making any disallowance u/s. 14A is to, firstly, examine the assessee’s claim of having incurred some expenditure or no expenditure in relation to exempt income. If the AO gets satisfied with the same, then there is no need to compute disallowance as per Rule 8D. It is only when the AO is not satisfied with the correctness of the claim of the assessee in respect of such expenditure or no expenditure having been incurred in relation to exempt income, that the mandate of Rule 8D will operate.
Disallowance under section 14A has to be made in accordance with the principle laid down by the Hon’ble Bombay High Court in the case of Godrej & Boyce Mfg.Co.Ltd. Mumbai. Vs. Dy. Commissioner of Income . Rule 8D should not be applied and the AO has to adopt a reasonable basis or method consistent with all relevant facts and circumstances and after affording reasonable opportunity to the assessee to place all germane material on the record.
Assessing Officer has disallowed the interest of Rs. 72,83,21,913/- on the ground of borrowed funds were used by the assessee for making investment in shares. The contention of the assessee is that in the earlier Assessment Year 2006-07 where no dividend income was received by the assessee, the Tribunal has held that no disallowance of expenditure can be made u/s. 14A of the Act and therefore, the disallowance made in the year under appeal may also be deleted as in this year also the assessee has not received any dividend income on the shares,
The provisions of rule 8D of the Income-tax Rules which have been notified with effect from March 24, 2008, shall apply with effect from the assessment year 2008-09; Even prior to the assessment year 2008-09, when rule 8D was not applicable, the Assessing Officer has to enforce the provisions of sub-section (1) of Section 14A. For that purpose, the Assessing Officer is duty bound to determine the expenditure which has been incurred in relation to income which does not form part of the total income under the Act.
Provisions of rule 8D of the Rules which have been notified with effect from March 24, 2008, would apply with effect from assessment year 2008-09. Even prior to assessment year 2008-09, when rule 8D was not applicable, the AO had to enforce the provisions of sub-section (1) of section 14A. For that purpose, the AO is duty bound to determine the expenditure which has been incurred in relation to income which does not form part of the total income under the Act.