2018 (1) TMI 699 - AT - Income Tax

Disallowance of interest expense u/s 40A(2)(b) - Held that - Order of the AO suffers from factual errors. One such error would be that secured loans have been considered as having been diverted by the assessee for non business purposes. Secured loans were taken from the bank for specified business purposes and because of the rigid norm of the bank they cannot be diverted for any other purpose. This aspect has been over looked by the AO. Besides the above the AO has made disallowance on imaginary average rate of interest on borrowings and investments. CIT(A), in our view, rightly considered the action of the AO as not proper. - Decided against revenue Disallowance u/s 14A rule 8D(2)(iii) - CIT(A) restricted the disallowance to ₹ 15,500/- under Rule 8D(2)(iii) and deleted the disallowance on interest expenses on the basis of the finding that assessee had sufficient own funds which were more than the investments in shares which are likely to yield exempt income under Rule 8D(2)(iii)- Held that - In the submissions made by the assessee before CIT(A) the assessee has taken a stand that there cannot be any disallowance u/s 14A of the Act because the assesee had not earned any tax free income during the previous year. This submission is not being considered in this appeal by the revenue. We make it clear that the conclusion in this appeal are confined to the grounds raised by the revenue on the factual details given by CIT(A) which remained uncontroverted . We are of the view that the disallowance on interest expenses made by CIT(A) was just and proper and calls for no interference. Consequently ground no.2 raised by the revenue is also dismissed.

Summary

Issues Involved:
1. Disallowance of interest expense under Section 40A(2)(b) of the Income Tax Act, 1961.
2. Disallowance under Section 14A read with Rule 8D of the Income Tax Act, 1961.

Issue-wise Detailed Analysis:

1. Disallowance of Interest Expense under Section 40A(2)(b):

The Revenue appealed against the CIT(A)'s order which restricted the disallowance of interest expense to ?78,000 out of the total disallowance of ?43,24,193 made by the Assessing Officer (AO) under Section 40A(2)(b) of the Income Tax Act, 1961.

The AO disallowed the interest expense on the grounds that:
- The assessee received interest on deposits at an average rate of 8.16% while paying interest on borrowed loans at an average rate of 13%.
- The interest income was not commensurate with the expense made.
- The expense on borrowed funds used for investment was not a business expense and lacked business expediency.
- More than 50% of the unsecured loan was taken from a related party, indicating a self-imposed liability to reduce taxable income.

The CIT(A) accepted the assessee's contention that the investments were made out of commercial expediency. The investments were primarily in fixed deposits and recurring deposits for securing loans and maintaining working capital. The CIT(A) also noted that the AO failed to consider the availability of the assessee's own funds and had arbitrarily fixed the average rate of interest on borrowings.

The CIT(A) sustained the addition made by the AO to the extent of ?75,000 by invoking Section 40A(2)(b), restricting the allowable interest to 10% from the 12% paid to the related party.

The Tribunal agreed with the CIT(A) and noted that the AO's order suffered from factual errors, particularly the incorrect assumption that secured loans were diverted for non-business purposes. The Tribunal confirmed the CIT(A)'s order and dismissed the Revenue's ground.

2. Disallowance under Section 14A read with Rule 8D:

The AO made a disallowance of ?2,34,525 under Section 14A read with Rule 8D(2)(iii) of the Income Tax Act, 1961. The assessee had initially added back ?9,857 as disallowance under Section 14A. The AO recalculated the disallowance, including investments in the balance sheet of the assessee's proprietary firm, resulting in a higher disallowance.

On appeal, the CIT(A) restricted the disallowance to ?15,500 under Rule 8D(2)(iii), deleting the disallowance on interest expenses under Rule 8D(2)(ii) based on the finding that the assessee had sufficient own funds, which were more than the investments in shares likely to yield exempt income.

The Tribunal upheld the CIT(A)'s decision, noting that the disallowance on interest expenses was just and proper. The Tribunal clarified that the findings were confined to the grounds raised by the Revenue and did not consider the assessee's submission that no tax-free income was earned during the previous year.

Conclusion:

The Tribunal dismissed the Revenue's appeal, confirming the CIT(A)'s order on both issues. The disallowance of interest expense was restricted to ?78,000, and the disallowance under Section 14A was limited to ?15,500. The Tribunal's decision was based on the factual details provided and the proper application of the law.