2020 (10) TMI 938 - AT - Income Tax

Disallowance u/s. 14A r.w.r. 8D - interest on partners capital treated as exempt for the purpose of making disallowance or not? - assessee is claiming that there are no borrowed funds and no expenditure can be directly attributed to earn the exempt income and the AO has not recorded his satisfaction for not accepting the assessee s claim - HELD THAT - Respectfully following the decision of ITAT Pune in the case of Quality Industries 2016 (10) TMI 56 - ITAT PUNE we hold that payment of interest to the partners towards the use of the partner s capital as per the provisions of partnership deed is held not subject to disallowance under section 14A read with Rule 8D(ii). Interest is simultaneously be subjected to tax in the hands of its partners is merely in the nature of contract items in the hands of the firms-partners. Therefore, the investment in Mutual funds by the assessee generating tax free income bears the characteristic of and is attributable to its capital where, no disallowance u/s.14A r.w Rule 8D(ii) is warranted. Disallowance u/r 8D(iii) - no specific ground or plea has been taken by the ld A.R. on behalf of the assessee, therefore, we hold it sustainable in view of express mandate of law - Keeping in view the facts related to the remaining issue of mandatory disallowance u/s.14A r.w. Rule 8D(2)(iii), we are consistently following the view expressed in the case of NALCO 2019 (10) TMI 124 - ITAT CUTTACK wherein as held average of only such investments have to be taken into account, which yielded the income not forming part of the total income. AO was required to work out the average of such investment, the income from which did not form part of the total income instead of total value of investment. For this view, our stand is fortified by the decision of Special Bench in the case of ACIT vs. Vireet Investment (P) Ltd. 2017 (6) TMI 1124 - ITAT DELHI . We, therefore, restore the issue to the file of the AO for limited purpose i.e. for calculation of the disallowance u/s.14A r.w. Rule 8D(2)(iii) of the Rules, in the light of our conclusions recorded hereinabove.

Summary

Issues Involved:
1. Whether the interest on partners’ capital can be treated as exempt for the purpose of making disallowance under Section 14A of the Income Tax Act, 1961 by invoking Rule 8D of the Income Tax Rules, 1962.

Detailed Analysis:

Issue 1: Disallowance under Section 14A of the Income Tax Act, 1961

Facts and Background:
- The appeals pertain to the assessment years 2015-16 and 2016-17.
- The Assessing Officer (AO) noticed that the assessee firm had shown significant income from production of TV programs and other sources, and had claimed interest expenses on partners’ capital.
- The AO observed that the major portion of the partner’s capital was invested in mutual funds and other share transactions, which generated exempt income.
- Consequently, the AO disallowed a proportionate amount of expenditure towards interest in relation to the exempt income under Section 14A read with Rule 8D.

Assessee’s Arguments:
- The assessee, relying on various judicial precedents, argued that the AO can only apply Rule 8D if they are not satisfied with the correctness of the claim made by the assessee.
- It was contended that the AO did not record the required satisfaction for rejecting the self-assessed disallowances.
- The assessee also argued that there were sufficient own funds available, and no capital was introduced for investment purposes, thus no disallowance should be made.

Revenue’s Arguments:
- The Revenue supported the orders of the lower authorities, maintaining that the disallowance was justified.

Tribunal’s Observations and Decision:
- The Tribunal examined the rival submissions and the relevant materials.
- It was noted that the interest paid to partners by the partnership firm as per the provisions of the partnership deed is not an expenditure subject to disallowance under Section 14A.
- The Tribunal referred to the decision of ITAT Pune in the case of Quality Industries, which held that payment of interest to partners is not subject to disallowance under Section 14A read with Rule 8D(ii).
- The Tribunal also observed that the interest paid to partners is simultaneously subjected to tax in the hands of the partners, thus no revenue loss occurs due to the investment in mutual funds generating tax-free income.
- However, for disallowance under Rule 8D(iii), the Tribunal found no specific plea from the assessee and thus upheld it in view of the express mandate of law.
- The Tribunal restored the issue to the AO for re-computation of disallowance under Rule 8D r.w.s. 14A, specifically for calculating the disallowance under Rule 8D(2)(iii) afresh.

Conclusion:
- The Tribunal partly allowed the appeals for statistical purposes, directing the AO to re-compute the disallowance under Section 14A read with Rule 8D(2)(iii) in light of the Tribunal’s observations.
- The decision for the assessment year 2015-16 was applied mutatis mutandis to the assessment year 2016-17.

Final Order:
- The appeals of the assessee were partly allowed for statistical purposes.

Pronouncement:
- Order pronounced on 21/10/2020.