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2021 (11) TMI 495 - AT - Income TaxDisallowance of interest u/s 14A - Treatment of interest expenditure with the exempt income from the firm - Identification of how the own funds were utilized by the assessee - Whether assessee has not utilized the borrowed funds for the purpose of investment in shares? - disallowance of interest paid to the assessee s minor children whose income is already clubbed with the income of the assessee u/s 64 - HELD THAT - Assessee has borrowed certain funds and utilized the same in the firm. In our considered view, the assessee has duly earned the interest income from the firm and also incurred interest expenditure on the funds utilized for the purpose of the business. Therefore, the assessee is eligible to claim the above expenditure independently against the income earned by the assessee. It is important to note that the earning of interest income is restricted by the provision of section 40(b) whereas assessee has to incur interest expenditure as per agreement with the lenders. The source of interest income from the firm is not exempt. Therefore, it is not proper on the part of Assessing Officer to add the difference of interest over and above paid by assessee as expenditure directly related to exempt income. The AO cannot penalize the assessee simply for the reason that assessee cannot claim more than the restricted interest as per section 40(b) of the Act. Otherwise, assessee would have claimed the same interest paid by him to the lenders. Therefore, the interest paid to the firm is not exempt and chargeable to tax. The interest expenses incurred by the assessee is adjustable against the interest income as a separate source of income. It is not proper on the part of AO to treat the interest expenditure with the exempt income from the firm. Therefore, the ground No. 1 raised by the assessee is allowed.
Issues Involved:
1. Disallowance of interest expenditure under Section 14A of the Income Tax Act. 2. Disallowance of interest paid to the assessee's minor children whose income is clubbed with the assessee's income under Section 64. 3. Applicability of the decision in Vishnu Mahajan regarding disallowance proportional to exempted income. Issue-wise Detailed Analysis: 1. Disallowance of Interest Expenditure under Section 14A: The assessee filed a return declaring an income of ?2,05,68,430, which was processed under Section 143(1) and later scrutinized under CASS. The Assessing Officer (AO) noted that the assessee had adjusted interest paid on loans against income from the firm. The AO contended that only business-related expenditures are deductible and observed that the borrowed funds were not used in the trading of shares but advanced to the firm. Therefore, the AO disallowed the interest paid on these borrowed funds and added ?13,12,037 to the total income, treating it as an expenditure related to exempt income under Section 14A read with Rule 8D(2)(i). The assessee argued that the borrowed funds were transferred to the firm due to exhausted bank limits and that interest should be allowed as per Section 40(b), which restricts the interest payment to 12%. The AO, however, added ?99,198 for the differential interest rate (14% paid vs. 12% received). The AO further applied Section 14A, arguing that the interest expenditure was claimed against exempt income (profit from the firm), which should be disallowed. The assessee contended that the borrowed funds were used for the firm, and no borrowed funds were used for share investments, citing the Bombay High Court decision in CIT v. HDFC Bank Ltd. 2. Disallowance of Interest Paid to Minor Children: The AO disallowed the interest paid to the assessee's minor children, whose income was already clubbed with the assessee's income under Section 64. The assessee argued that since the borrowed funds were lent to the firm, the interest paid should not be disallowed. 3. Applicability of Vishnu Mahajan Decision: The assessee referred to the Special Bench decision in Vishnu Mahajan, which held that expenditure proportionate to exempted income should be disallowed. The AO, however, relied on this case to support the disallowance under Section 14A. Tribunal’s Findings: The Tribunal noted that the assessee had borrowed funds for business purposes and transferred them to the firm. The assessee’s capital was ?9.52 crores, and the investment in the firm was ?8.14 crores. The Tribunal observed that the assessee earned taxable remuneration and interest income from the firm and had not utilized borrowed funds for trading in shares. The Tribunal concluded that the interest expenditure was an allowable deduction as it was incurred for business purposes. The Tribunal found that the AO incorrectly treated the interest expenditure as related to exempt income. The Tribunal allowed the interest expenditure as a deduction against the interest income earned from the firm. Conclusion: - The Tribunal allowed the appeal regarding the disallowance of interest expenditure under Section 14A, finding that the interest paid was an allowable business expenditure. - The Tribunal did not adjudicate the grounds related to the interest paid to minor children and the applicability of the Vishnu Mahajan decision, as they were consequential in nature. Order: The appeal filed by the assessee was partly allowed. The order was pronounced in the open Court on 05/10/2021.
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