2011 (9) TMI 730 - HC - Income Tax

Expense on exempt Income - held that - Though purchase of tax free bonds is for meeting the SLR requirements, interest and other expenditures incurred on the borrowals for investment in tax free bonds is to be disallowed.

Summary

Issues:
1. Disallowance of expenditure incurred by the assessee on interest paid on funds borrowed for making investments generating tax-free income.

Analysis:
The main issue in this judgment revolves around the disallowance of expenditure incurred by the assessee on interest paid on funds borrowed for making investments that generate tax-free income. The Tribunal's decision to cancel this disallowance is challenged by the Revenue. The Tribunal primarily focused on the applicability of Section 14A of the Income Tax Act concerning free bonds purchased to meet the Statutory Liquidity Ratio (SLR) by the respondent Bank. However, the disallowance in question pertains not only to investments in tax-free bonds but also to funds raised for purchasing shares of companies, the income from which is exempt from tax under Section 10(23G) of the Income Tax Act.

The High Court's judgment refers to a previous decision in CIT v. Catholic Syrian Bank Ltd. where a similar issue was addressed. The respondent/assessee argues that the current case involving investment in tax-free bonds to meet SLR requirements is distinguishable from the previous judgment. The Court, however, rejects this argument, stating that the purpose or object of the investment does not impact the operation of Section 14A of the Income Tax Act. The Court emphasizes that any expenditure incurred for earning tax-free income is not an allowable deduction under this section. Therefore, the Court holds that even though tax-free bonds were purchased to meet SLR requirements, the interest and other expenditures incurred on borrowings for such investments must be disallowed.

Consequently, the High Court allows the appeal filed by the Revenue by overturning the Tribunal's decision and that of the First Appellate Authority. The disallowance under Section 14A of the Income Tax Act for expenditure incurred on borrowings for investments in tax-free bonds and other investments generating non-taxable income is reinstated.