2016 (3) TMI 233 - AT - Income Tax

Disallowance u/s 14A - Held that - Hon ble Jurisdictional High Court in the case of CIT v. HDFC Bank Ltd. 2014 (8) TMI 119 - BOMBAY HIGH COURT has laid down the proposition that, if the assessee s capital, profits, reserves and surplus and current account deposits are higher than the investments in tax free securities, then it would be presumed that the investments made by the assessee would be out of interest free funds available with the assessee. Respectfully following the decision of the Hon ble Bombay High Court in the case of HDFC Bank Ltd. (supra) we concur with the contention of the assessee that no disallowance of interest can be made u/s 14A r.w. Rule 8D of the Act. Otherwise also Ld. Counsel has specifically pointed out before us, the source of investments, which were from interest free funds. Thus, on these facts also, no disallowance of interest can be made. Coming to the indirect expenses, we find that assessee has debited sum of ₹ 8.92 crores on the employees costs which majorly constituted salary of the employees. As pointed out by the Ld. Senior Counsel, the only activity in relation to the investment carried out by the assessee was Switching of one HSBC Mutual Fund account to Reliance Mutual Fund account. Thus, if at all any indirect expenses is to be attributable, then same has to be estimated having regard to the accounts and nature of expenditure incurred by the assessee. The blanket application of Rule 8D(iii) that is 0.5% of the average investment may not be acquired to do so because it is not commensurate with the nature of activity of investment carried out and the expenses debited by the assessee which is mostly for its business activities. Looking to the fact that the assessee has earned dividend income of ₹ 38.19 lakhs, we estimate the indirect expenses at ₹ 5 lakhs which in our opinion, is still on a higher side, but it will take into account all other indirect expenses. Thus, the disallowance u/s 14A is restricted to ₹ 5 lakh and balance addition made by the AO and confirmed by the CIT(A) stands deleted - Decided partly in favour of assessee

Summary

Issues:
Disallowance made under section 14A r.w. Rule 8D for exempt income - Nexus between surplus funds and investments - Application of Rule 8D - Estimation of indirect expenses.

Analysis:

1. Disallowance under Section 14A r.w. Rule 8D for Exempt Income:
- The appeal was filed against the order passed by CIT(A) for the assessment year 2008-09, disallowing sums aggregating to Rs. 81,37,289 under section 14A r.w. Rule 8D for the quantum of assessment.
- The assessee, an Authorized Dealer of Cat-II, earned dividend income of Rs. 38,18,832 claimed as exempt in total income computation. The AO computed disallowance as per Rule 8D formula despite the assessee's claim of using interest-free funds for investments.
- Assessee reiterated before CIT(A) that investments were made from own interest-free funds, but the disallowance was confirmed citing lack of nexus between surplus funds and investments, and inapplicability of a specific court decision.

2. Nexus Between Surplus Funds and Investments:
- Assessee's senior counsel argued that investments were mostly from reserves and surplus, supported by a fund flow statement showing the availability of funds for investments.
- Tribunal noted that the assessee demonstrated a huge surplus for investments and the source of interest-free funds, aligning with a High Court proposition that investments from interest-free funds are presumed if capital and reserves exceed tax-free securities.
- Consequently, the Tribunal agreed that no disallowance of interest could be made under section 14A due to the availability of interest-free funds for investments.

3. Estimation of Indirect Expenses:
- Regarding indirect expenses, the Tribunal found that the only significant activity related to the investment was switching accounts, justifying an estimation of indirect expenses.
- The Tribunal disagreed with the blanket application of Rule 8D(iii) for indirect expenses, estimating the expenses at Rs. 5 lakhs, considering the nature of the activity and the expenses debited by the assessee.
- The disallowance under section 14A was restricted to Rs. 5 lakhs, overturning the balance addition confirmed by CIT(A) and allowing the appeal partly.

In conclusion, the Tribunal ruled in favor of the assessee, highlighting the availability of interest-free funds for investments and the estimation of indirect expenses for disallowance purposes. The disallowance under section 14A was restricted to Rs. 5 lakhs, and the balance addition was deleted. The appeal of the assessee was partly allowed, emphasizing the importance of demonstrating the source of funds for investments and justifying indirect expenses in line with the nature of activities.