2003 (5) TMI 198 - AT - Income Tax

Summary

Issues Involved:
1. Allowability of expenses related to exempted dividend income u/s 14A and subsection (5) of section 115-O of the Act.

Summary:

Issue 1: Allowability of Expenses Related to Exempted Dividend Income u/s 14A and Subsection (5) of Section 115-O of the Act

The revenue appealed against the CIT(A)'s order allowing expenses related to exempted dividend income, arguing it violated section 14A and subsection (5) of section 115-O of the I.T. Act, 1961. The Assessing Officer (AO) noted that the assessee, an investment company, had significant borrowings and interest expenses, and had claimed dividend income as exempt under section 10(33). The AO disallowed a proportionate amount of interest expenses as related to earning exempt dividend income.

The CIT(A) deleted the disallowance, referencing various court decisions that allowed interest expenditure under section 36(1)(iii) if borrowed money was used for business purposes, even if the resultant income was exempt. The revenue contended that the AO was justified in disallowing the proportionate interest, citing sections 14A and 115-O.

The Tribunal examined the provisions of section 14A, inserted by the Finance Act, 2001, with retrospective effect from 1-4-1962, which disallows deductions for expenses related to exempt income. The Tribunal also considered section 115-O, which imposes tax on distributed profits and disallows deductions for such taxed amounts.

The Tribunal noted that prior to sections 10(33) and 115-O, interest on borrowed funds for acquiring shares could be deducted under section 57(iii). However, with the new provisions, such deductions are restricted. The Tribunal emphasized that section 14A aims to prevent deductions for expenses related to exempt income, ensuring that only net income is taxed.

The Tribunal concluded that the interest on borrowed funds used for acquiring shares, whether held as investment or stock-in-trade, should be apportioned against exempt dividend income. The Tribunal upheld the AO's disallowance of proportionate interest expenses, reversing the CIT(A)'s order.

Conclusion:
The Tribunal allowed the revenue's appeal, holding that the AO's disallowance of proportionate interest expenses related to earning exempt dividend income was justified and in accordance with sections 14A and 115-O of the Act. The AO's assessment order was restored.