2020 (11) TMI 339 - AT - Income Tax

Disallowances u/s.14A - Addition of interest expenditure on the ground that the assessee is having interest free funds being equity share capital and free reserves which is far less than the interest free funds available with the assessee and therefore no disallowance of interest expenditure is called for - HELD THAT - In this case, the assessee has made out a case with necessary evidence that it has interest income free funds being share capital and surplus reserve in excess of investments which yield exempt income. AO as well as CIT(A) have erred in disallowing interest expenditure under Rule 8D(2) of Income Tax Rules, 1962. Accordingly, we direct the AO to delete interest disallowances under rule 8D(2)(ii) of IT Rules 1962. Disallowance of expenditure @ 0.5% average value of investment under 3rd limb of Rule 8D(2)(iii) - AO has taken value of investments in partnership firm as on 31.03.2012 on the basis of amount disclosed in the financial statements, whereas the assessee claimed that original investment was at ₹ 1.5 crores only and remaining balance was out of accrued profit of the firm which needs to be excluded while computing average value of investments. This aspect needs verification from the AO because the facts are not clear as the Assessing Officer stated that investments in partnership firm is at ₹ 7.35 crores, whereas the assessee claimed investment in partnership firm is ₹ 1.5 crores. As regards investments in mutual funds we have given our thoughtful consideration to arguments of the assessee in light of provisions of section 14A - what is to be considered in exempt income in form of dividend received by an assessee, but not capital gain derived on transfer of such investments to decide applicability of disallowances of expenditure. If dividend from mutual fund is exempt from tax, then certainly expenditure relatable to such exempt income needs to be disallowed. In this case, there is no clarity whether any exempt income is received from such investments from mutual funds. Receipt of exempt income is a precondition for including investments in average value of investments, because investments which do not generate exempt income for the year cannot be included in average value of investments. In this case, the fact with regard to nature of investments and whether any exempt income was earned from investment is not clear from the orders of the lower authorities. Therefore, to ascertain correct facts with regard to nature of investments, the issue needs to be go back to the file of the Assessing Officer. Therefore, we remit issue relatable to computation of disallowances under 3rd limb of Rule 8D regarding 0.5% of average value of investments to the file of the AO to reconsider the issue. AO is therefore, directed to consider the investments made in partnership firm as well as mutual funds while computing average value of investments in accordance with law. - Appeal filed by the assessee is partly allowed for statistical purposes.

Issues:
1. Disallowance under section 14A of the Income Tax Act.
2. Interpretation of Rule 8D of the Income Tax Rules, 1962.
3. Disallowance of interest expenditure.
4. Disallowance of expenditure under Rule 8D(2)(iii).
5. Verification of investments in partnership firm and mutual funds.
6. Applicability of disallowances based on exempt income received.
7. Remittance of issue back to the Assessing Officer for reconsideration.

Analysis:

1. The appeal challenged the disallowance under section 14A of the Income Tax Act, pertaining to the assessment year 2012-13. The Assessing Officer invoked Rule 8D of the Income Tax Rules, 1962, to determine the disallowance of interest and other expenses related to exempt income.

2. The assessee contended that no part of the borrowed funds was utilized for investments, and investments in the firm were for strategic reasons, hence should not attract disallowance under section 14A. The Commissioner of Income Tax (Appeals) upheld the disallowance, citing the prescribed formula under Rule 8D for computation of disallowances.

3. The learned CIT(A) observed that disallowance under Rule 8D should be computed irrespective of interest-free funds available with the assessee. The assessee challenged the interest disallowance under Rule 8D(2)(ii) based on the availability of sufficient own funds, citing a precedent from the Bombay High Court.

4. The Appellate Tribunal found that the Assessing Officer and CIT(A) erred in disallowing interest expenditure when the assessee had adequate interest-free funds exceeding the value of investments. The Tribunal directed the Assessing Officer to delete the interest disallowances under Rule 8D(2)(ii) of the Income Tax Rules, 1962.

5. Regarding the disallowance under Rule 8D(2)(iii) for expenditure at 0.5% of the average value of investments, the Tribunal noted discrepancies in the computation of investments in partnership firms and mutual funds. The issue was remitted back to the Assessing Officer for verification and reconsideration.

6. The Tribunal emphasized the need to consider investments generating exempt income for the applicability of disallowances under section 14A. Clarity was sought on the nature of investments and receipt of exempt income from mutual funds to determine the correctness of disallowances.

7. The appeal was partly allowed for statistical purposes, with the issue related to the computation of disallowances under Rule 8D(2)(iii) sent back to the Assessing Officer for further examination in accordance with the law.

This detailed analysis provides insights into the legal judgment, focusing on the issues raised, arguments presented, and the Tribunal's decision on each matter.

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