2019 (11) TMI 926 - AT - Income Tax

Disallowance of interest - CIT(A) restricted the disallowance proportionately to the exempt income as well as taxable income for which the unsecured loans were contributed as investment - AR submitted that the entire expenditure cannot not be allocated proportionately to the income earned on two different streams since, the income earned not only on account of capital contribution, but also on account of various services rendered by the firm therefore, requested to make the reasonable disallowance for capital contribution and also for other activities of earning the income - HELD THAT - We have carefully considered the submissions of the Ld.AR and unable to convince with the argument of the Ld.AR, since, the share of profit is directly related to the capital contribution made by the assessee. For other services mentioned by the Ld.AR, the assessee is free to draw salary or remuneration as provided in the partnership deed. The Hon ble Special Bench also confirmed the disallowance of expenditure in the ratio of income earned that is exempt and the taxable income. Therefore, we hold that the Ld.CIT(A) has fairly restricted the disallowance proportionately on the basis of income earned by the assessee with regard to exempt income as well as the taxable, thus, we do not find any reason to interfere with the order of the Ld.CIT(A) and the same is upheld. - Decided against assessee

Issues Involved:
1. Sustaining the addition of ?12,71,348/- out of the total addition of ?16,41,509/- made by the Assessing Officer (AO) towards the disallowance of interest.
2. Nexus between earning of interest and interest payment.
3. Application of Section 14A of the Income Tax Act and Rule 8D of the Income Tax Rules.
4. Proportionate disallowance of interest expenditure.
5. Admission of additional evidence by CIT(A).
6. Proper opportunity of being heard before finalization of the assessment order.

Issue-wise Detailed Analysis:

1. Sustaining the Addition of ?12,71,348/-:
The appeal concerns the sustaining of an addition of ?12,71,348/- out of a total addition of ?16,41,509/- made by the AO towards the disallowance of interest. The AO disallowed the entire interest claimed by the assessee due to a lack of clear nexus between the earning of interest and the interest payment.

2. Nexus Between Earning of Interest and Interest Payment:
The AO found that the assessee was not maintaining books of accounts and had made investments in a company and given loans and advances to various persons. The AO held that there was no clear nexus between the earning of interest and the interest payment, leading to the disallowance of the entire interest of ?16,41,509/-. However, the CIT(A) found a nexus between the loans borrowed and the investment made in the partnership firm, thus allowing partial relief.

3. Application of Section 14A and Rule 8D:
The CIT(A) applied Section 14A of the Income Tax Act read with Rule 8D of the Income Tax Rules, which disallows expenditure incurred in relation to income not includible in total income. The CIT(A) proportionately disallowed the interest expenditure attributable to the tax-exempt share of profit from the partnership firm.

4. Proportionate Disallowance of Interest Expenditure:
The CIT(A) restricted the disallowance to ?12,71,348/- against the actual disallowance of ?16,41,509/-. The CIT(A) apportioned the interest expenditure based on the ratio of tax-exempt income (share of profit) to taxable income (interest on capital). The proportionate interest expenditure attributable to tax-exempt income was calculated as ?12,71,348/-, and the allowable interest expenditure against taxable income was ?3,70,160/-.

5. Admission of Additional Evidence by CIT(A):
The assessee submitted additional evidence before the CIT(A), including details of loans availed and investments made in the partnership firm. The CIT(A) admitted the additional evidence under Rule 46A(1)(d) of the Income Tax Rules, noting that the AO had not provided proper opportunity to the assessee before finalizing the assessment order.

6. Proper Opportunity of Being Heard:
The CIT(A) observed that the AO had completed the assessment without providing the assessee proper opportunity of being heard. The AO failed to demonstrate that the issue of disallowance of interest expenditure was discussed with the assessee before finalizing the assessment order. This led to the admission of additional evidence by the CIT(A).

Conclusion:
The Tribunal upheld the order of the CIT(A), agreeing with the proportionate disallowance of interest expenditure based on the ratio of tax-exempt income to taxable income. The Tribunal found no reason to interfere with the CIT(A)'s order and dismissed the appeal of the assessee. The appeal was partly allowed, providing relief of ?3,70,160/- to the assessee. The order was pronounced in the open court on 15th November 2019.

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