2016 (1) TMI 979 - AT - Income Tax

Disallowance u/s 14A - satisfaction formed by the Assessing Officer before working out the disallowance - Held that - Working of disallowance as per Rule 8D of the Rules was furnished along with letter dated 09.10.2011. In view of the above said findings of the Assessing Officer, wherein the Assessing Officer had noted that the assessee had declared Nil amount as the amount to be disallowed in terms of section 14A of the Act and thereafter, issued show cause notice to the assessee to explain as to why no disallowance should be made under section 14A of the Act establishes the case of the Department that the Assessing Officer had recorded implicit satisfaction before working out the disallowance under section 14A of the Act. In terms of section 14A(2), we find merit in the claim of the Revenue in this regard and dismiss the contention of the assessee that no satisfaction was formed by the Assessing Officer before working out the disallowance under section 14A of the Act. In view of the business funds available with the assessee and the business assets created by the assessee, we find no merit in the claim of assessee that the amount due to the Sundry Creditors was the interest free funds available with the assessee for making the investments and hence, no disallowance could be made out of interest expenditure. Admittedly, the funds available with the assessee were out of common pool i.e. on account of capital investment by the partners, on which the assessee firm was paying interest and other business funds in the form of Sundry Creditors and advances from customers since the investment was made out of common pool of investments, then the provisions of section 14A of the Act were clearly attracted and the disallowance made under Rule 8D(2)(ii) of the Rules is to be upheld. The said disallowance is to be made in line with the formula provided under the said sub-rule. However, claim of the assessee before us that in view of the ratio laid down by the Hon ble High Court of Karnataka in Canara Bank Vs. ACIT (2014 (6) TMI 929 - KARNATAKA HIGH COURT), where the assessee has not incurred any expenditure since the dividend was re-invested in the mutual funds itself, no expenditure was attributable to earn the said income. Admittedly, the assessee has not incurred any direct expenses for making the aforesaid investments. However, some part of the administrative expenses is attributable for making the aforesaid investments in funds, income from which is not includable in the total income of the assessee. The dividend earned by the assessee may have been reinvested by the fund manager itself. However, the expenditure relatable to making the investment and taking steps for its redemption and reinvestment involved an element of expenditure and in view of the provisions of Rule 8D(2)(iii) of the Rules, such expenditure is disallowable in the hands of the assessee. - Decided against assessee.

Summary

Issues Involved:
1. Disallowance under Section 14A of the Income-Tax Act, 1961.
2. Applicability of Rule 8D of the Income Tax Rules, 1962.
3. Recording of satisfaction by the Assessing Officer under Section 14A(2).
4. Mixed funds and the nexus between interest-bearing funds and investments.

Issue-wise Detailed Analysis:

1. Disallowance under Section 14A of the Income-Tax Act, 1961:
The primary issue in this case is the disallowance made by the Assessing Officer (AO) under Section 14A of the Income-Tax Act, 1961, amounting to Rs. 11,40,553/-. The assessee, a partnership firm engaged in manufacturing and supply, had earned exempt income from dividends on mutual funds. The AO noted that the assessee had declared NIL amount as inadmissible under Section 14A in the audit report. The AO issued a questionnaire requiring the assessee to furnish details of expenditure incurred for earning tax-free income. The assessee contended that no direct expenses were incurred for earning the exempt income and that only direct expenses should be covered under Section 14A. However, the AO found that the major chunk of interest debited was related to the partner's capital and concluded that there was a direct nexus between the funds employed for earning tax-free income and the interest liability. Consequently, the AO computed the disallowance under Section 14A read with Rule 8D.

2. Applicability of Rule 8D of the Income Tax Rules, 1962:
The CIT(A) upheld the AO's disallowance, stating that the investment in mutual funds was made from a common pool of funds, both interest-bearing and interest-free. The CIT(A) relied on the decision of the Chennai Bench of the Tribunal in M/s Lakshmi Ring Travellers vs. ACIT and distinguished the assessee's reliance on other case laws, including CIT vs. Reliance Utilities and Power Ltd., on the grounds that they were not applicable to the context of disallowance under Section 14A. The CIT(A) concluded that the provisions of Rule 8D were applicable as the funds were mixed and the assessee had not established that no interest-bearing funds were utilized for the investment in mutual funds.

3. Recording of satisfaction by the Assessing Officer under Section 14A(2):
The assessee argued that the AO had not recorded satisfaction as required under Section 14A(2) before making the disallowance. However, the Tribunal found that the AO had implicitly recorded satisfaction by noting that the assessee had declared NIL expenditure relatable to earning exempt income and had issued a show cause notice to the assessee. The Tribunal held that the AO had recorded implicit satisfaction before working out the disallowance under Section 14A, thus dismissing the assessee's contention.

4. Mixed funds and the nexus between interest-bearing funds and investments:
The Tribunal examined the assessee's claim that sufficient non-interest bearing funds were available to make the investment in mutual funds. The assessee argued that the investment was made from non-interest bearing funds, including Sundry Creditors and advances from customers. However, the Tribunal found that the funds available with the assessee were a common pool of both interest-bearing and interest-free funds. The Tribunal held that the business funds, such as Sundry Creditors, could not be considered interest-free funds available for making investments in mutual funds. The Tribunal concluded that the provisions of Section 14A were applicable as the investment was made from a common pool of funds and the assessee had not established the source of the investment as being from independent, non-interest bearing funds.

Conclusion:
The Tribunal upheld the disallowance made by the AO and CIT(A) under Section 14A read with Rule 8D, dismissing the appeal of the assessee. The Tribunal found that the AO had recorded implicit satisfaction, the investment was made from a common pool of funds, and the provisions of Section 14A and Rule 8D were squarely applicable. The Tribunal also dismissed the reliance placed by the assessee on various case laws, distinguishing them based on the facts and context of the present case.