2022 (4) TMI 970 - AT - Income Tax

Disallowance u/s 14A - AO has computed the disallowance which constituted disallowance under Rule 8D in so far as the disallowance under Rule 8D(2)(iii) being 0.5% of the average value of investment is not in dispute - CIT (A) has restricted the disallowance under Section 14A of the Act to the extent of exempt income earned - HELD THAT - We have already incorporated the observations of the AO and the assessee s explanation as to why interest expenditure should not have been disallowed on the facts of the present case. Nowhere the AO has made any observation on these submissions that no interest can be disallowed or recorded his satisfaction as to why the claim of the assessee is not tenable having regard to the books of accounts and the nature of expenditure debited to the profit and loss account. He has mechanically proceeded to make the disallowance u/s 14A without rebutting to assessee s specific claim made before him. Here in this case as is evident from the order AO has nowhere records his satisfaction except for general remarks de-hors the facts of the case and explanation given by the assessee. He has not even examined that assessee had surplus funds which were interest free of more than 556.07 crores as against the exempt income earning investment of 63.66 crores. Thus interest expenditure could not have been disallowed. Now in the latest judgement of Hon ble Supreme Court in the case of South Indian Bank 2021 (9) TMI 566 - SUPREME COURT wherein it has been held that where assessee had interest free funds available which exceeds the investment made in tax free fund security then no interest expenditure can be disallowed and it has to be presumed that it is out of assessee s own fund and proportionate disallowance could not warrant under section 14A even where no separate accounts were maintained by the assessee and other expenditure made for earning tax free income. Disallowance could be legally impermissible for the investment made by the assessee in bonds/shares using interest free funds under Section 14A. Thus proportionate disallowance of interest is not warranted under section 14A for investments made in tax-free bonds/ securities which yielded tax free dividend and interest to assessee banks where interest free funds are available exceeded their investments. Thus no disallowance on account of section 14A can be made. The disallowance as made by the Assessing Officer under Rule 8D(2)(iii) is deleted. Consequently the appeal of the assessee is allowed and the appeal of the Revenue is dismissed.

Summary

Issues Involved:
1. Disallowance under Section 14A of the Income Tax Act, 1961.
2. Satisfaction recording by the Assessing Officer before invoking Rule 8D.
3. Allocation of interest expenditure for earning exempt income.

Issue-wise Detailed Analysis:

1. Disallowance under Section 14A of the Income Tax Act, 1961:
The primary issue revolves around the disallowance under Section 14A of the Income Tax Act, 1961. The assessee company, engaged in providing finance through hire purchase, lease, and loans, had earned dividend income of ?2,22,48,998/- and disclosed an investment of ?63,66,00,000/- in shares. The Assessing Officer (AO) disallowed ?3,24,31,758/-, which was contested by the assessee. The CIT (Appeals) restricted this disallowance to the extent of the exempt income earned, i.e., ?2,22,48,998/-. The Tribunal noted that the AO failed to provide specific reasons for rejecting the assessee's claim and mechanically applied Rule 8D without proper examination.

2. Satisfaction Recording by the Assessing Officer Before Invoking Rule 8D:
The Tribunal emphasized that the AO must record satisfaction regarding the incorrectness of the assessee's claim before invoking Rule 8D, as mandated by Section 14A(2) of the Act. The AO's general remarks without specific observations on the assessee's submissions were deemed insufficient. Citing the Supreme Court's judgment in Maxopp Investment Ltd. Vs. CIT, the Tribunal reiterated that the AO needs to record satisfaction that the suo motu disallowance by the assessee was incorrect before applying the apportionment theory.

3. Allocation of Interest Expenditure for Earning Exempt Income:
The Tribunal observed that the assessee had surplus interest-free funds exceeding the investments generating exempt income. It referenced the Supreme Court's judgment in South Indian Bank vs. CIT, which held that if interest-free funds exceed investments in tax-free securities, no interest expenditure disallowance is warranted under Section 14A. The Tribunal concluded that the AO did not examine the nature of the expenditure debited and the assessee's claim of surplus funds, leading to an unjustified disallowance of interest expenditure.

Conclusion:
The Tribunal deleted the disallowance of interest expenditure and upheld that no disallowance under Section 14A was warranted in the absence of the AO's satisfaction. The appeal of the assessee was allowed, and the Revenue's appeal was dismissed.

Order:
Order pronounced in the open court on: 19/04/2022.