2019 (11) TMI 1298 - AT - Income Tax

Disallowance u/s. 14A r.w.s. Rule 8D - HELD THAT - Admittedly, interest on borrowed funds used for business purposes cannot be computed for disallowance u/s. 14A of the I.T. Act r.w. Rule 8D(2)(ii) of the I.T. Rules. It is the duty of the assessee to prove that interest was incurred on borrowings are used for the specific business purpose and non-interest bearing funds were utilized for making investments which has given rise to exempted income. The assessee to prove that it is having its own funds to make investment which had yielded exempted income, necessarily has to furnish cash flow statement. The cash flow statement would disclose as on the date of making investments, which had given rise to the exempted income, that the assessee had interest free funds available with it. In the interest of justice and equity, we deed it fit to remand the case to the Assessing Officer for fresh consideration. the AO shall afford a reasonable opportunity of hearing to the assessee. The assessee shall prove its case that it is having interest free funds for making investments, by furnishing cash flow state for the respective assessment years. Disallowance u/s. 36(1)(iii) on account of funds having been diverted for non business purposes - disallowing the portion of interest paid by the assessee as huge amount had been lent by the assessee to its partners - HELD THAT - The contention of the assessee is that since the assessee was following the cash system of accounting, the interest receivable from partners on the amount lent to the partners cannot be offered to tax and it would be offered to tax only on receipt basis which was not actually received by the assessee in the year under consideration. Hence, it was not offered for tax. For this purpose, he relied on the judgment of the Jurisdictional High Court in the case of CIT vs. Muthoot Finance Corporation 2018 (10) TMI 1773 - ITAT COCHIN . In the present case, we observe that the Assessing Officer disallowed the portion of interest paid by the assessee as the interest bearing borrowings were diverted by the assessee by lending money to the partners without any interest and had not used for the purpose of the assessee s business. Assessing Officer had not brought to tax the notional interest receivable from the partners. As such, the judgment of the High Court in the case of CIT vs. Muthoot Finance Corporation cited supra cannot be applied to the assessee s case. More so, the High Court has not given any findings on this issue and it was remitted to the file of the Assessing Officer for fresh consideration and there is no ratio deceindi . Hence, we do not find any infirmity in the order of the CIT(A) and the same is confirmed. This ground of appeals of the assessee for both the assessment years is dismissed. Treatment of interest income earned from Banks - income from other sources OR income from business - HELD THAT - The assessee is engaged in the business of money lending and investments. The money is the stock in trade of the assessee and any income earned by the assessee by rotating that money, i.e. stock in trade is nothing but income from business only and it cannot be considered as income from other sources. Being so, we decide this issue in favour of the assessee and against the revenue. Hence, this ground of appeals of the assessee for both the assessment years is allowed.

Summary

Issues Involved:
1. Disallowance under Section 14A read with Rule 8D for expenditure incurred to earn exempted income.
2. Disallowance under Section 36(1)(iii) for funds diverted for non-business purposes.
3. Treatment of interest income earned from bank deposits as income from other sources instead of business income.

Issue-Wise Detailed Analysis:

1. Disallowance under Section 14A read with Rule 8D:
The assessee challenged the disallowance of ?18,36,878/- under Section 14A read with Rule 8D, arguing that no expenditure was incurred to earn the exempt dividend income of ?40,51,846.68/-. The Assessing Officer (AO) noted that the assessee did not segregate the expenditure related to dividend income and relied on a jurisdictional High Court judgment, applying Rule 8D to compute the disallowance. The CIT(A) upheld the AO's decision, stating that some active and passive expenditure is involved in earning income from investments, even if no specific expenditure was identifiable. The CIT(A) also referenced a CBDT Circular clarifying that disallowance under Section 14A is applicable even when no exempt income was earned. The Tribunal remitted the issue back to the AO for fresh consideration, directing the assessee to furnish a cash flow statement to prove that interest-free funds were used for investments yielding exempt income.

2. Disallowance under Section 36(1)(iii) for Funds Diverted for Non-Business Purposes:
The AO disallowed ?11,27,947/- under Section 36(1)(iii) for interest on funds diverted for non-business purposes. The AO observed that the assessee had taken secured loans and paid interest, but a partner had withdrawn funds for personal use. The CIT(A) upheld the disallowance, stating that interest paid on borrowed capital used for non-business purposes is not deductible. The assessee argued that it followed a cash system of accounting, and notional income could not be assessed. However, the Tribunal found no infirmity in the CIT(A)'s order, noting that the AO disallowed interest paid on borrowings diverted for non-business use, not the notional interest receivable from partners. The Tribunal dismissed the assessee's appeal on this issue.

3. Treatment of Interest Income Earned from Bank Deposits:
The AO treated the interest income from bank deposits as income from other sources, relying on the Supreme Court judgment in Bokaro Steel Ltd. The CIT(A) confirmed this treatment, referencing the Supreme Court judgment in Pandian Chemicals Ltd., which held that interest income from bank deposits is not derived from the business of the assessee. The assessee argued that the deposits were part of its business of money lending and investments, and the interest should be considered business income. The Tribunal agreed with the assessee, stating that money is the stock in trade of the assessee, and any income earned by rotating that money is business income. The Tribunal allowed the assessee's appeal on this issue.

Conclusion:
In conclusion, the Tribunal partly allowed the assessee's appeals for statistical purposes. The issue of disallowance under Section 14A was remitted back to the AO for fresh consideration, the disallowance under Section 36(1)(iii) was upheld, and the treatment of interest income from bank deposits as business income was allowed in favor of the assessee.