2017 (1) TMI 1758 - AT - Income Tax

Disallowing interest paid on borrowed funds by assessee to the extent interest free loan given for the purpose of business - HELD THAT - We are of the view that the observation of the AO that the assessee had advanced loans even before assessee had became a major share-holder is factually incorrect. The submission of the assessee that to diversify into new business, Sentosa Resorts Pvt Ltd was formed and the assessee has advanced loans to it on account of commercial expediency has not been controverted by Revenue by placing any material on record. In the case of S.A. Builders Limited 2006 (12) TMI 82 - SUPREME COURT has held that the expression commercial expediency is of one wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. It further held that the expenditure may not have been incurred under any legal obligation but yet it is an allowable business expenditure if it was incurred on grounds of commercial expediency. It held that the true test is whether the amount advanced to subsidiary or associated company or any other party was advanced as a measure of commercial expediency. If so, interest was deductible - no disallowance of interest could have been made by AO. We therefore set aside the order of AO and thus, the ground of assessee is allowed. Disallowing expenditure u/s 14A Rule 8D - there is no tax free income claimed in the return filed to appreciate various case laws brought to their notice during the assessment proceedings - HELD THAT - Presumption of investments to be out of interest free funds is established and therefore no disallowance on account of interest could be made by invoking the provisions of Sec.14A r/w Rule 8D of IT Rules 1962. As far as the disallowance of other expenses under Rule 8D is concerned, it is assessee s submission that the investments on which the disallowance u/s 14A has been made has not yielded any tax free income The aforesaid submission of the assessee has not been controverted by the Revenue. We find that ld. CIT(A) has relied upon CBDT Circular No.5/2014 dated 11.02.2014 to hold that even when assessee has not earned any tax free income, provisions of Sec.14A are applicable. At the same time we find that the Hon ble Delhi High in the case of Cheminvest Ltd. Vs. CIT reported in 2015 (9) TMI 238 - DELHI HIGH COURT has held that provisions of Sec.14A will not apply if no exempt income is received or receivable during the relevant previous year. We are of the view that no disallowance of u/s 14A could be made in the present case. Thus, this ground of the assessee is allowed.

Summary

Issues Involved:
1. Disallowance of interest on borrowed funds.
2. Disallowance of expenditure under Section 14A and Rule 8D.

Issue-wise Detailed Analysis:

1. Disallowance of Interest on Borrowed Funds:
The first issue pertains to the disallowance of interest on borrowed funds by the Assessing Officer (AO). The assessee, a company engaged in the wholesale trading of country liquor, had advanced interest-free funds to Sentosa Resort Pvt. Ltd. (a sister concern) while incurring significant interest costs on borrowed funds. The AO disallowed a portion of the interest expense, arguing that the advances were made before the assessee became a major shareholder and without receiving any dividend income from Sentosa Resort Pvt. Ltd. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO's decision, stating that the assessee failed to demonstrate that the advances were given on account of commercial expediency.

Upon appeal, it was found that the assessee was indeed a major shareholder of Sentosa Resorts Pvt. Ltd. since 2008, contradicting the AO's observation. The assessee argued the advances were made for business diversification and commercial expediency. The Tribunal referred to the Supreme Court's decision in S.A. Builders vs. CIT, which held that the expression "commercial expediency" includes expenditures incurred by a prudent businessman for business purposes. The Tribunal concluded that the advances were made on grounds of commercial expediency and therefore, no disallowance of interest was warranted. The Tribunal set aside the AO's order, allowing the assessee's appeal on this ground.

2. Disallowance of Expenditure under Section 14A and Rule 8D:
The second issue concerns the disallowance of expenditure under Section 14A read with Rule 8D of the Income Tax Act. The AO noticed the assessee had made investments and incurred interest expenses on borrowed funds. As the assessee did not provide a detailed movement of funds, the AO applied Rule 8D and disallowed a portion of the expenditure. The CIT(A) upheld this disallowance, relying on CBDT Circular No. 5/2014, which stated that disallowance under Section 14A applies even if no exempt income is earned during the financial year.

The assessee argued that the investments were made from interest-free funds and no tax-free income was earned from these investments. The Tribunal referred to the Bombay High Court's decision in CIT vs. HDFC Bank Limited, which held that if interest-free funds are available, it is presumed that investments are made from such funds. The Tribunal also referred to the Delhi High Court's decision in Cheminvest Ltd. vs. CIT, which held that Section 14A does not apply if no exempt income is received or receivable during the relevant year. Considering these precedents, the Tribunal concluded that no disallowance under Section 14A was warranted in the absence of exempt income. The Tribunal allowed the assessee's appeal on this ground as well.

Conclusion:
The Tribunal allowed the appeal of the assessee on both grounds, setting aside the orders of the AO and CIT(A). The disallowance of interest on borrowed funds and the disallowance of expenditure under Section 14A were both overturned. The Tribunal emphasized the principles of commercial expediency and the necessity of actual receipt of exempt income for disallowance under Section 14A.