2016 (4) TMI 662 - AT - Income Tax

Disallowance u/s 14A - Held that - It should be presumed that the assessee used own funds for making investments where assessee had both own funds as well as borrowed funds. The ld.CIT(A), on the same parity of reasoning, directed the AO to delete the addition under rule 8D(2)(ii). Therefore, we do not find any reason to interfere with the order of the ld.CIT(A) Once exempt income is earned, it means that some expenditure being incurred in relation to the exempt income which should be disallowed by applying formula laid down in rule 8D(2)(iii). Therefore, action of the AO is correct in applying rule 8D(2)(iii) but the amount of disallowance should be restricted to the dividend income.

Summary

Issues:
1. Disallowance of expenses under section 14A r.w.s. 8D of the Income Tax rules.
2. Restriction of disallowance of expenses based on investments made out of interest-free funds.
3. Disallowance of expenditure incurred to earn dividend income.
4. Applicability of rule 8D(2)(iii) in disallowing expenditure to earn dividend income.

Issue 1: Disallowance of expenses under section 14A r.w.s. 8D:
The case involved cross-appeals by both the revenue and the assessee against the order of the CIT(A) concerning the disallowance of 0.5% of tax-exempted investment under section 14A r.w.s. 8D. The AO disallowed a total of &8377; 80,93,286 under sec.14A, based on the assessee's dividend income of &8377; 29,000 and interest expenditure of &8377; 22.08 crores. The CIT(A) deleted &8377; 75,67,905 of the disallowance, considering the free funds utilized for investments. The Tribunal upheld the CIT(A)'s decision, citing precedents where it was presumed that own funds were used for investments when both own and borrowed funds were available.

Issue 2: Restriction of disallowance based on investments from interest-free funds:
The assessee contended that no new investments were made during the relevant year and that all investments were from free reserves. The Tribunal agreed with the assessee, emphasizing that no disallowance should be made under rule 8D(2)(ii) as the reserves and surplus exceeded investments, indicating the use of free funds for investments.

Issue 3: Disallowance of expenditure to earn dividend income:
The AO disallowed &8377; 5,25,381 under rule 8D(2)(ii) for expenditure incurred to earn dividend income of &8377; 29,000. The CIT(A) confirmed this disallowance, rejecting the assessee's claim that no expenditure was incurred to earn the dividend income. The Tribunal upheld the disallowance, stating that once exempt income is earned, some expenditure is deemed to be incurred, as per the formula in rule 8D(2)(iii).

Issue 4: Applicability of rule 8D(2)(iii) in disallowing expenditure to earn dividend income:
The Tribunal held that while the purpose of expenditure is not relevant, once exempt income is earned, some expenditure is deemed to be incurred. The AO's application of rule 8D(2)(iii) was deemed correct, but the disallowance amount should be restricted to the dividend income of &8377; 29,000.

In conclusion, the Tribunal dismissed the revenue's appeal regarding the disallowance under rule 8D(2)(ii) and partly allowed the assessee's appeal for statistical purposes, restricting the disallowance amount to the dividend income.