2018 (1) TMI 586 - AT - Income Tax

Addition u/s 14A r.w.s. Rule 8D - investment in subsidiary company from which the dividend income was earned - Held that - No disallowance of interest expense claimed by the assessee can be made under the provision of Section 14A of the Act r.w.r 8D of IT Rules. Now coming to the disallowance made by the AO in respect of administrative expense we note that the investment which have given rise to the dividend income during the year can only be considered for the purpose of disallowance under Rule 8D(2)(iii) of IT Rules. In holding so we find guidance & support from the order of Coordinate Bench of this Tribunal in the case of REI Agro Ltd. v. Dy. CIT 2013 (9) TMI 156 - ITAT KOLKATA wherein it was held that the disallowance as per Rule 8D shall be made by taking into consideration only those shares, which have yielded dividend income in the year under consideration. Therefore we direct the AO to make the disallowance under rule 8D after considering the investments which have yielded the dividend income during the year. We also find that the assessee has made investment in subsidiary company from which the dividend income was earned by it during the year. In this regard, we observed that the assessee has made strategic investment in its subsidiary company to control the interest in the company and not with the object to earn dividend income. The dividend income is merely incidental from the subsidiary company. Therefore no disallowance of whatsoever can be made in respect of dividend income earned from the subsidiary company. In holding so, we find support and guidance from the order of the Hon ble Tribunal in the case of Electrosteel Casting Limited Vs. DCIT 2017 (2) TMI 685 - ITAT KOLKATA wherein it was held that no disallowance shall be made against the dividend income if it arises from the strategic investment.Thus, the strategic investments need to be excluded for the purpose of the disallowance under section 14A read with rule 8D The investments made in the non-subsidiary company which have yielded dividend income can only be considered for the purpose of the disallowance under section 14A r.w.r. 8D(2)(iii) of Income Tax Rules 1962. Thus the appeal filed by Revenue is partly allowed. Accordingly, AO is directed.

Summary

Issues Involved:
1. Disallowance under Section 14A read with Rule 8D of the Income Tax Rules, 1962.
2. Consideration of own funds versus borrowed funds for investments.
3. Exclusion of strategic investments in subsidiaries from disallowance calculations.

Detailed Analysis:

1. Disallowance under Section 14A read with Rule 8D of the Income Tax Rules, 1962:
The primary issue raised by the Revenue was the disallowance of ?78,94,597/- under Section 14A read with Rule 8D for expenses related to earning exempt dividend income. The assessee, a private limited company engaged in consultancy engineering, earned dividend income of ?33,73,356/- and suo motu disallowed ?3,37,335/- (10% of the dividend income) based on previous appellate orders. The AO, however, found this disallowance insufficient and applied Rule 8D, resulting in a higher disallowance of ?75,57,261/-. The CIT(A) deleted the AO’s addition, noting the lack of objective satisfaction and specific findings by the AO regarding the assessee's calculations. The Tribunal upheld the CIT(A)'s decision, emphasizing that disallowance under Rule 8D should consider only those investments which yielded dividend income during the year.

2. Consideration of Own Funds versus Borrowed Funds for Investments:
The assessee argued that no part of the borrowed funds was used for the investments generating exempt income, as the investments were made from its own funds, which exceeded the amount of the investments. The Tribunal supported this view, citing the Bombay High Court's rulings in Reliance Utilities and Power Ltd. and HDFC Bank Ltd., which established that if own funds exceed investments, it is presumed that investments were made from own funds. Consequently, no disallowance of interest expenses was warranted under Rule 8D(2)(ii).

3. Exclusion of Strategic Investments in Subsidiaries from Disallowance Calculations:
The assessee contended that investments in subsidiaries, made for strategic control and not for earning dividends, should be excluded from disallowance calculations. The Tribunal agreed, referencing the Chennai Tribunal's decision in EIH Associated Hotels Ltd. and the Kolkata Tribunal's decision in REI Agro Ltd., which held that strategic investments should not be considered for disallowance under Section 14A. The Tribunal also cited the Electrosteel Casting Limited case, affirming that strategic investments should be excluded from the disallowance calculations.

Conclusion:
The Tribunal concluded that:
- No disallowance of interest expenses should be made under Rule 8D(2)(ii) as the assessee's own funds exceeded the investments.
- Disallowance under Rule 8D(2)(iii) should only consider investments that yielded dividend income during the year.
- Strategic investments in subsidiaries should be excluded from disallowance calculations.

The Tribunal partly allowed the Revenue's appeal and fully allowed the assessee's cross-objection, directing the AO to make disallowances in line with these principles.