2006 (10) TMI 250 - AT - Income Tax

Expenditure incurred in relation to income not includible in total income - section 14A are not applicable to the expenditure incurred in relation to earning of dividend income? - disallowance of the interest paid - investment in shares dividend - exempt u/s 10(33) - HELD THAT - It is an admitted position that part of the borrowed money was utilized for the purpose of investment in shares, from which dividend income is received, which is exempt from tax. In view of the decision of Ahmedabad Bench in the case of Harish Krishnakant Bhatt 2004 (8) TMI 342 - ITAT AHMEDABAD the expenditure being the interest on borrowed capital for the purpose of investment in shares dividend from which is exempt u/s 10( 33 ) of the I.T. Act is not to be allowed as an expenditure in view of the provisions of section 14A of the I.T. Act. The interest on borrowings attributable to investments made in foreign companies is to be considered for allowance u/s 57(iii) of the I.T. Act and the same shall be considered by the Assessing Officer as per the provisions of the Act. The assessee has also utilized part of the borrowings raised during the year for investment made in units of growth fund. The claim being of investment in growth plan, no income from which is received from year-to-year and the annual accretions are added to the NAV of the growth fund without any distribution of income which is taxable in the hands of the assessee-company for the year under consideration. In view of the facts that the income from such investments is not amenable to tax, the interest on such borrowings utilized for making investments in the units of the growth fund is not allowable as an expenditure in view of the provisions of section 14A of the I.T. Act. The issue at length was also considered by Co-ordinate Bench of Mumbai Tribunal in Macintosh Finance Estate Ltd. s case 2006 (2) TMI 578 - ITAT MUMBAI and it was held that interest expenses cannot allowed to be added to the cost of investment. Therefore, this ground of appeal raised by the assessee is partly allowed for statistical purpose. Disallowance on total administrative and other expenses - HELD THAT - We find from the perusal of the administrative expenses that no expenditure is directly relatable to the earning of dividend income and there is no merit in making ad hoc disallowance of portion of the expenditure being attributable to earning of dividend income. Accordingly, we direct the Assessing Officer not to disallow any expenditure towards earning of dividend income. In the result, the appeal filed by the assessee is partly allowed.

Summary

Issues Involved:
1. Disallowance of interest paid under section 14A of the Income-tax Act, 1961.
2. Disallowance of administrative and other expenses under section 14A of the Income-tax Act, 1961.

Detailed Analysis:

1. Disallowance of Interest Paid Under Section 14A:

The primary issue is the disallowance of Rs. 4,12,57,221/- as interest paid by the assessee-company, which the CIT(A) upheld. The assessee argued that section 14A should not apply to dividend income because, although the dividend is exempt in the hands of the shareholder, it is taxed under section 115-O at the company level. The assessee also contended that interest on borrowings for investments in foreign companies and growth funds should not be disallowed as these do not yield exempt income.

The Tribunal noted that the original return filed by the assessee disallowed the net interest, but the revised return claimed it as a deduction under section 36(1)(iii). The Assessing Officer (AO) disallowed the interest under section 14A, stating that the borrowed funds were used for investments yielding exempt dividend income. The CIT(A) upheld this disallowance.

The Tribunal examined the provisions of section 14A, which disallows expenditure related to exempt income, and noted that section 14A was introduced with retrospective effect from 1-4-1962. It considered precedents, including the Ahmedabad Bench's decision in Harish Krishnakant Bhatt v. ITO, which held that expenses related to exempt income cannot be deducted.

The Tribunal concluded that the interest on borrowings for investments yielding exempt dividend income is not allowable under section 14A. However, it remanded the case to the AO to quantify the interest attributable to investments in foreign companies, which are not exempt under section 10(33), and to consider this interest under section 57(iii).

2. Disallowance of Administrative and Other Expenses Under Section 14A:

The second issue concerns the disallowance of Rs. 60,220/- as administrative and other expenses. The AO made an ad hoc disallowance of 10% of the total administrative expenses, attributing them to earning exempt dividend income. The CIT(A) reduced this disallowance to Rs. 60,220/-.

The Tribunal reviewed the records and found no direct link between the administrative expenses and the earning of dividend income. It noted that ad hoc disallowances without direct correlation to earning exempt income lack merit. The Tribunal directed the AO not to disallow any administrative expenses towards earning dividend income, thus overturning the disallowance.

Conclusion:

The appeal was partly allowed. The Tribunal upheld the disallowance of interest related to exempt dividend income but remanded the case for quantifying interest on investments in foreign companies. It overturned the ad hoc disallowance of administrative expenses, directing no disallowance for these expenses.