2016 (6) TMI 205 - AT - Income Tax

Disallowance u/s 14A - investment in shares/mutual funds/partnership firms, the income of which is tax free - disallowance of indirect expenditure for earning tax free dividend income - Held that - Since the assessee in the instant case has conclusively proved that it s own capital and free reserves is far more than the investment in shares/mutual funds/partnership firms, the income of which is tax free, therefore, respectfully following the decision of the Hon ble Bombay High Court in the case of HDFC Bank Ltd. 2016 (3) TMI 755 - BOMBAY HIGH COURT we hold that no disallowance u/s.14A r.w. Rule 8D(2) is called for on account of disallowance of interest. So far as the disallowance of indirect expenditure for earning tax free dividend income is concerned we find there is no objective satisfaction recorded by the AO which is one of the mandates of section 14A(2) of the I.T. Act. Neither there is any discussion by the AO nor any specific query raised by the AO to the assessee on this issue. At the same time, there is no suo moto disallowance made by the assessee on account of the expenditure attributable to earning of the exempt income other than the expenditure on account of IPO. Although the assessee has neither disallowed any expenditure on this account in the computation statement presumably on the ground that no expenditure has been incurred and although the AO has also not specifically discussed this issue in the body of the assessment order, however, it cannot be said that no expenditure has been incurred by the assessee for earning the tax free income. Considering the totality of the facts of the case, we are of the considered opinion that disallowance of ₹ 10 lakhs on adhoc basis on account of expenditure attributable for earning tax free income will meet the ends of justice - Decided partly in favour of assessee

Issues Involved:
1. Disallowance under Section 14A read with Rule 8D.
2. Utilization of borrowed funds for tax-free investments.
3. Recording of satisfaction by the Assessing Officer (AO).
4. Applicability of the decision in Reliance Utilities and Power Ltd.
5. Investments in mutual funds from IPO proceeds.
6. Indirect expenditure for earning tax-free income.

Issue-wise Detailed Analysis:

1. Disallowance under Section 14A read with Rule 8D:
The primary issue was whether the disallowance under Section 14A read with Rule 8D was justified. The AO disallowed ?2,70,46,829/- for A.Y. 2008-09 and ?2,62,33,383/- for A.Y. 2009-10, asserting that the assessee incurred expenditure for earning exempt income. The CIT(A) upheld this disallowance. The Tribunal, however, found that the assessee had sufficient own capital and free reserves exceeding the tax-free investments, and thus, no disallowance was warranted under Section 14A read with Rule 8D(2) for interest expenditure.

2. Utilization of Borrowed Funds for Tax-Free Investments:
The AO argued that the assessee used borrowed funds for tax-free investments, as the investments exceeded the interest-free funds available. The Tribunal noted that the assessee demonstrated that investments in mutual funds were from IPO proceeds kept in a separate bank account, and there was no diversion of borrowed funds for tax-free investments. The Tribunal held that the AO was not justified in including investments in debentures and NSC, whose income is taxable, in the category of tax-free investments.

3. Recording of Satisfaction by the AO:
The Tribunal emphasized that the AO must record specific, objective satisfaction as mandated by Section 14A(2). The AO had recorded satisfaction regarding interest disallowance but failed to do so for indirect expenses. The Tribunal cited the decision in Kalyani Steels Ltd., asserting that without such satisfaction, invoking Rule 8D is untenable.

4. Applicability of the Decision in Reliance Utilities and Power Ltd.:
The assessee relied on the decision in Reliance Utilities and Power Ltd., which presumes that if the assessee has sufficient own funds, investments are presumed to be made from such funds. The Tribunal upheld this principle, referencing the Bombay High Court's decision in HDFC Bank Ltd., which applied this presumption to Section 14A cases.

5. Investments in Mutual Funds from IPO Proceeds:
The assessee argued that investments in mutual funds were from IPO proceeds kept in a separate bank account, and no borrowed funds were used. The Tribunal accepted this argument, noting that the revenue did not contradict the assessee's submission. Hence, no disallowance under Section 14A was warranted for these investments.

6. Indirect Expenditure for Earning Tax-Free Income:
The Tribunal found no objective satisfaction recorded by the AO regarding indirect expenses for earning tax-free income. Although the assessee did not disallow any expenditure on this account, the Tribunal believed some expenditure must have been incurred. Therefore, it directed a disallowance of ?10 lakhs on an ad-hoc basis for indirect expenses attributable to earning tax-free income.

Conclusion:
The Tribunal partly allowed the appeals, directing a disallowance of ?10 lakhs on an ad-hoc basis for indirect expenses attributable to earning tax-free income, while holding that no disallowance under Section 14A read with Rule 8D(2) for interest expenditure was warranted due to sufficient own funds.

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