2010 (10) TMI 407 - AT - Income Tax

Disallowance - Income from other sources vs Business income - It has been clearly noticed that the assessee borrowed funds from M/s Reliance Capital Limited and the same funds were invested in M/s Sreenath Enterprises. One to one nexus between the borrowed funds as invested in partnership firm was proved by the assessees - interest income of Rs.2.34 crores received from M/s Sreenath Enterprises, a firm in which the assessee is partner, is taxable under the head Profits and gains of the business or profession and interest expenditure of Rs.1.82 crores is deductible u/s.36(1)(iii) - Although the provisions of section 14A cannot be invoked for the first time before the Tribunal, still on the facts and circumstances of the present case, no disallowance is called for u/s.14A on proportionate basis - the appeal is dismissed

Issues Involved:

1. Taxability of interest earned from a partnership firm.
2. Allowability of interest expenditure under section 36(1)(iii).
3. Applicability of section 14A.
4. Amount disallowable under section 14A, if any.

Issue-wise Detailed Analysis:

A. Interest Earned from Firm is Taxable Under Which Head of Income

The Assessing Officer (AO) contended that the interest of Rs.2.34 crores received from the partnership firm should be taxable under "Income from other sources" since the assessee was engaged in the business of "Trade". The assessee, however, argued that it was engaged in the business of entering into partnerships, giving loans, and making investments, supported by the Object clause of its Memorandum of Association (MoA). The Tribunal held that the actual carrying on of the business is determinative, not merely the mention in the MoA. The assessee failed to provide evidence of engaging in the business of entering into partnerships. However, as per section 28(v), any interest, salary, bonus, commission, or remuneration received by a partner from a firm is chargeable to tax under "Profits and gains of business or profession". Thus, the interest income of Rs.2.34 crores received from the partnership firm is taxable under "Profits and gains of business or profession".

B. Whether the Interest Expenditure is Allowable Under Section 36(1)(iii)

The AO disallowed the interest expenditure of Rs.1.82 crores on the grounds that it was not incurred for business purposes. The Tribunal found that the borrowed funds from Reliance Capital Limited were invested in the partnership firm M/s Sreenath Enterprises, from which the interest income was earned. The conditions of section 36(1)(iii) were met: payment of interest, capital borrowed, and utilization of borrowed funds for business purposes. Therefore, the interest expenditure of Rs.1.82 crores is allowable under section 36(1)(iii).

C. Attractability of Provisions of Section 14A

The Revenue invoked section 14A, arguing that the proportionate interest on the amount borrowed and invested in the firm should have been disallowed. However, the AO did not reference section 14A in the assessment order, and the CIT(A) did not consider its application. The Tribunal, citing the Hon'ble jurisdictional High Court's judgment in Topstar Mercantile Pvt. Ltd., held that section 14A cannot be invoked for the first time before the Tribunal.

D. Amount Disallowable Under Section 14A, If Any

Despite the conclusion on point C, the Tribunal examined the applicability of section 14A. The Special Bench in Daga Capital Management Pvt. Ltd. held that section 14A applies to all heads of income and aims at disallowing expenditure related to exempt income. The Tribunal found that the interest paid by the assessee had a direct and sole relation with the interest income received from the firm. No part of the interest expenditure related to the share in profits of the partnership firm, which is exempt under section 10(2A). Therefore, no disallowance of interest expenditure is warranted under section 14A.

Conclusion:

The Tribunal upheld the CIT(A)'s order, holding that the interest income of Rs.2.34 crores is taxable under "Profits and gains of business or profession" and the interest expenditure of Rs.1.82 crores is deductible under section 36(1)(iii). The provisions of section 14A cannot be invoked for the first time before the Tribunal, and no disallowance under section 14A is warranted on the facts of the case. The appeal was dismissed.

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