2018 (2) TMI 1588 - AT - Income Tax

Interest claimed as expenditure disallowed u/s. 36(1)(iii) - Held that - No reason to interfere with the findings of Ld.CIT(A) holding that the investments are for business purposes and no amount of interest can be disallowed u/s. 36(1)(iii). The order of Ld. CIT(A) is as per the finding of facts by AO in consequential proceedings and in tune with the orders of ITAT in earlier years. Disallowance u/s 14A r.w.r. 8D - Held that - Rule 8D(ii) envisages only the interest which is not directly attributable. Having given a finding that the interest paid is for the purpose of investment in business and allowing the same u/s. 36(1)(iii), the same cannot be considered as directly not attributable interest . When there is direct nexus with business, the same cannot be considered again u/r 8D(ii). Therefore, the disallowance of interest under Rule 8D(ii) does not arise. To that extent, the order of CIT(A) is not correct factually as well as legally. While examining the fresh investment of ₹ 2,82,67,573/- in KRAEL during the year, if any interest allowable to that investment out of borrowed funds, the corresponding interest is directly disallowable u/s. 36(1)(ii). But, he gave a finding that the investment is for the purpose of business, consequent to finding of AO in later year. While invoking rule 8D(ii), he should have at best considered that amount of investment for proportionate disallowance, but directly he took entire average of entire investment and disallowed, even the interest allowable under the head business . The order of CIT(A) is thus based on misconceptions and wrong appreciation of facts and law thus, not sustainable. Hence, his order and findings from paras 6.13 to 6.17 are thus, set aside. Neither the AO nor the CIT(A) has considered any amount for disallowance under Rule 8D(iii). Therefore, this forum cannot invoke the said rule. Disallowance u/s. 14A cannot be made/restricted, by this forum as there is nothing to disallow under Rule 8D(ii) and AO or CIT(A) has not disallowed any amount under Rule 8D(iii). The grounds are accordingly considered allowed.

Summary

Issues Involved:
1. Disallowance of interest and finance charges under Section 36(1)(iii) of the Income Tax Act.
2. Application of Section 14A and Rule 8D for disallowance of interest.

Issue-wise Detailed Analysis:

1. Disallowance of Interest and Finance Charges under Section 36(1)(iii):

The assessee-company, engaged in the manufacture and sale of ferro alloys, filed its return of income declaring a net taxable income at nil and later revised it to declare a net loss. During the scrutiny, the Assessing Officer (AO) disallowed the claim of interest and finance charges amounting to ?5,69,37,061/- under Section 36(1)(iii) of the Income Tax Act. The AO observed that the assessee had made substantial investments in other companies, including Konaseema Gas Power Ltd. (KGPL), and concluded that if the assessee had not invested its funds in KGPL, it would not have needed to borrow money, thus incurring huge interest burdens. The AO relied on judicial precedents and disallowed the entire claim of interest and finance charges.

Upon appeal, the Commissioner of Income Tax (Appeals) [CIT(A)] followed the orders of the ITAT in the assessee’s own case for earlier years and allowed the assessee’s contentions. The CIT(A) concluded that the investments were made for business purposes, specifically to draw power at cheaper rates for the manufacture of ferro alloys, and therefore, no disallowance of interest under Section 36(1) could be made.

2. Application of Section 14A and Rule 8D for Disallowance of Interest:

The CIT(A), however, invoked the provisions of Section 14A without giving the assessee an opportunity to explain its case. The CIT(A) applied Rule 8D(ii) and computed the disallowance of interest at ?3,91,90,153/-. The CIT(A) directed the AO to disallow this amount instead of the entire ?5,69,37,061/-.

The Revenue appealed against the relief given by the CIT(A), arguing that no disallowance of interest under Section 36(1) should be made in respect of the investments in KGPL and other companies. The assessee also appealed against the partial disallowance under Section 14A, contending that the investments were made out of its own funds for business purposes and no borrowed funds were utilized.

The ITAT upheld the CIT(A)’s finding that the investments were for business purposes and confirmed that no amount of interest could be disallowed under Section 36(1)(iii). The ITAT noted that the CIT(A)’s order was consistent with the findings of the AO in consequential proceedings and previous ITAT orders. However, the ITAT disagreed with the CIT(A)’s partial disallowance under Section 14A, stating that the CIT(A) did not provide the assessee an opportunity to explain and that the disallowance under Rule 8D(ii) was not justified since the investments were for business purposes.

The ITAT concluded that the disallowance of interest under Rule 8D(ii) did not arise and set aside the CIT(A)’s order and findings from paras 6.13 to 6.17. The ITAT also noted that neither the AO nor the CIT(A) had considered any amount for disallowance under Rule 8D(iii), and therefore, this forum could not invoke the said rule.

Conclusion:

The ITAT dismissed the Revenue’s appeal and allowed the assessee’s appeal, confirming that the investments were for business purposes and no interest could be disallowed under Section 36(1)(iii). The ITAT also set aside the partial disallowance under Section 14A, concluding that the disallowance under Rule 8D(ii) was not warranted. The order was pronounced in the open court on 21st February 2018.