2014 (4) TMI 104 - AT - Income Tax

Disallowance u/s 14A r.w. Rule 8D - Relief to assessee on issue of disallowance u/s 14A r.w. Rule 8D - Held that - order of AO as well as CIT(A) shows that none of them have given any specific findings with regard to source of funds from which investments which are likely to yield tax free income were made - Loans were for specific purpose and were not capable for being used for making investments - None of authorities have gone into any of aspects which are necessary for invoking provisions of section 14A of Act - Order of CIT(Appeals) is set aside and matter is remanded to Assessing Officer for fresh consideration - Decided in favor of Revenue.

Issues Involved:
1. Disallowance under Section 14A read with Rule 8D.
2. Attribution of interest expenses to exempt income.
3. Burden of proof regarding the use of borrowed funds.

Issue-wise Detailed Analysis:

1. Disallowance under Section 14A read with Rule 8D:
The primary issue revolves around the disallowance made under Section 14A of the Income Tax Act, which deals with the expenses incurred in relation to income that does not form part of the total income. The Assessing Officer (AO) invoked Rule 8D to compute the disallowance, resulting in a total disallowance of Rs. 2,14,24,898. The AO's rationale was that the investments made by the assessee would yield tax-free dividend income, and thus, the expenses incurred in earning such income should be disallowed.

2. Attribution of Interest Expenses to Exempt Income:
The AO contended that the assessee had utilized borrowed funds for making the investments, which would yield tax-free income. Consequently, a portion of the interest expenses amounting to Rs. 1,96,40,264 was disallowed under Rule 8D(2)(ii). However, the assessee argued that it had sufficient interest-free funds (Rs. 382.41 crores) to make the investments (Rs. 37.79 crores) and that the borrowed funds were used solely for business purposes. The CIT(A) accepted the assessee's argument, stating that there was no material evidence proving the nexus between borrowed funds and investments, and thus deleted the disallowance of interest expenses.

3. Burden of Proof Regarding the Use of Borrowed Funds:
The revenue argued that the CIT(A) had incorrectly placed the burden of proving the nexus between borrowed funds and exempt investments on the revenue. The revenue contended that it was the assessee's responsibility to demonstrate that the borrowed funds on which interest was paid were not used for making investments that would yield tax-free income. The Tribunal observed that neither the AO nor the CIT(A) provided specific findings regarding the source of funds used for the investments. The Tribunal emphasized that the assessee must establish one of the following: (i) investments were made from own funds, (ii) surplus funds were available at the time of investments, or (iii) borrowed funds were used solely for their intended purpose.

Conclusion:
The Tribunal set aside the order of the CIT(A) and remanded the matter to the AO for fresh consideration. The AO was instructed to provide a reasonable opportunity for the assessee to present evidence and establish the source of funds used for the investments. The appeal of the revenue was treated as allowed for statistical purposes, emphasizing the need for a detailed examination of the use of funds in relation to Section 14A disallowance.

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