2017 (9) TMI 485 - HC - Income Tax

Disallallowance of expenditure u/s 14A - Assessee failed to prove that the investments was made out of interest free funds only - AO disallowed interest expense on basis substantial borrowings taken for investments - CIT(A) confirmed deicison of AO - Formula for calculating interest to be disallowed for the purpose of section 14A given under clause(ii) of subrule( 2) of Rule 8D- Held that - Amount of interest expenditure would be the interest paid by the assessee on the borrowings minus the taxable interest earned during the FY for purpose of disallowance u/s14A.- Decided in favor of assessee.

Summary

Issues Involved:
1. Whether the Appellate Tribunal is right in law and on facts in deleting the disallowance of ?1,06,56,837 for A.Y. 2008-09 made by the Assessing Officer under section 14A of the Income Tax Act?

Issue-wise Detailed Analysis:

1. Deletion of Disallowance under Section 14A of the Income Tax Act:
The core issue in the tax appeals revolves around the disallowance of ?1,06,56,837 made by the Assessing Officer under section 14A of the Income Tax Act for the assessment year 2008-09. The respondent assessee, a company, had declared a loss of ?5.63 crores in its return of income. During scrutiny, the Assessing Officer noted that the assessee had shown dividend income of ?25.26 lacs from investments in shares and securities, which was claimed as exempt income. The Assessing Officer questioned the source of these investments, suspecting that they were not made from interest-free funds but from substantial borrowings, and thus, invoked Rule 8D of the Income Tax Rules to compute the disallowance.

2. Computation of Disallowance:
The Assessing Officer computed the disallowance by considering the full interest expenditure of ?7.01 crores incurred on borrowings, without accounting for the taxable interest income of ?6.83 crores earned by the assessee. This resulted in a disallowance of ?99.41 lakhs under Rule 8D(2)(ii), plus an additional half percent of the average value of investments, totaling ?1.06 crores.

3. Tribunal's Judgment:
The assessee appealed to the Tribunal, which upheld the applicability of section 14A and Rule 8D but clarified that for computing disallowance under Rule 8D, the net interest payment (interest paid minus interest earned) should be considered, not the gross interest payment. The Revenue challenged this interpretation, leading to the present appeal.

4. Revenue's Argument:
The Revenue argued that Rule 8D provides a complete formula for computing disallowance under section 14A, and any adjustment or tinkering with the formula would distort its application. They referenced the Supreme Court's judgment in the case of Indian Molasses Co. Private Ltd. v. Commissioner of Income-tax, West Bengal, to emphasize that 'expenditure' should be understood as money spent irretrievably.

5. Assessee's Argument:
The assessee contended that 'interest expenditure' should be interpreted as the net interest (interest paid minus interest earned). They cited the Supreme Court's decision in ACG Associated Capsules Pvt. Ltd. v. Commissioner of Income-tax, which held that for deductions under section 80HHC, it is the net interest or net rent that should be considered. Similar interpretations were upheld in other cases like Commissioner of Income-tax v. Nirma Ltd. and Commissioner of Income-tax v. Hero Cycles Ltd.

6. Court's Analysis:
The Court analyzed section 14A and Rule 8D, emphasizing that the term 'expenditure by way of interest' must be interpreted reasonably to reflect the legislative intent. The Court found that considering only the gross interest paid, without accounting for the taxable interest earned, would distort the computation and lead to an unintended disallowance. The Court referred to the statutory provisions and relevant case laws, concluding that for the purpose of Rule 8D, 'interest expenditure' should be the net interest (interest paid minus taxable interest earned).

7. Conclusion:
The Court held that for applying the formula under Rule 8D(2)(ii), the amount of interest expenditure should be the net interest paid by the assessee during the financial year. Consequently, the Court answered the question in favor of the assessee and dismissed the tax appeals.

Judgment:
The tax appeals were dismissed, affirming that the net interest expenditure (interest paid minus taxable interest earned) should be considered for disallowance computation under section 14A and Rule 8D.