2009 (8) TMI 126 - AT - Income Tax

Business Expenditure - Whether disallowance u/s. 14A can be made in a year in which no exempt income has been earned or received by the assessee - HELD THAT - In the present case we find that the borrowed money has been utilized in purchase of shares held both as investment as well as stock-in-trade. As the monies borrowed have been utilized in purchase of shares held the interest paid on so borrowed monies is allowable against the income from dividend income either as incurred for making or earning dividend income on such shares or as incurred wholly and exclusively for the purposes of business carried on by the assessee if he deals in such shares. It is in both the situations irrespective of whether or not there is any yield of dividend on the shares purchased. In other words the interest incurred is to be relatable to earning of dividend on the shares purchased. The dividend income is now exempted from tax by virtue of s. 10(34) and therefore as a consequence thereof the interest paid on borrowed capital utilized in purchase of shares being the expenditure incurred in relation to dividend income not forming part of assessee s total income cannot be allowed as a deduction. There is no chargeable income against which it can be allowed as a deduction. It cannot also be allowed against any other taxable income inasmuch as the interest so paid is not relatable to the earning of taxable income. This is what is provided by the legislature in the scheme of the IT Act even without the existence of s. 14A with retrospective effect from1st April 1962. If the answer is in affirmative then that expenditure cannot be allowed irrespective of the fact that it was allowable under different provisions of the Act where a different phraseology is used in allowing that expenditure as the focus has to be on disallowance within parameters of s. 14A an overriding provision over allowance provisions. It would result in disallowance even if no income has resulted or made or earned by the assessee in the year under consideration. We also make it clear that the disallowance has to be of the entire amount of the expenditure so related and as claimed in Revenue s appeal cannot be reduced by the receipt of interest which has no relation to such expenditure. Delhi Bench of the Tribunal in the case of Insaallah Investments Ltd. vs. ITO 2008 (2) TMI 652 - ITAT DELHI held that the receipt Of dividend in the relevant year is irrelevant which is by following the decision of the Special Bench of the Tribunal in the case of Aquarius Travels (P) Ltd 2008 (2) TMI 455 - ITAT DELHI-D . In this case of Aquarius Travels (P) Ltd. the issue whether the provisions of s. 14A can be invoked in the appellate proceedings for the first time or not was held in affirmative. The intervener has exempted income and therefore would not fall within the scope of the issue for which (the Special Bench) is constituted to dispose of the case of disallowance in cases where no exempted income is earned or received. We are therefore excluding this case from our consideration. Therefore answered affirmatively against the assessee and in favour of the Revenue.

Summary

Issues Involved:
1. Disallowance of interest under Section 14A of the Income Tax Act.
2. Applicability of Section 14A when no exempt income is earned or received.

Issue-wise Detailed Analysis:

1. Disallowance of Interest under Section 14A:
The core issue in the cross-appeals pertains to the disallowance of interest by invoking the provisions of Section 14A of the Income Tax Act. The Assessing Officer (AO) noted that the assessee had invested substantial amounts in shares and had borrowed funds, incurring significant interest expenses. The AO disallowed a proportionate amount of interest attributable to investments made for earning exempt income, even though no exempt income was earned during the year. The CIT(A) upheld the AO's decision but directed the AO to work out the disallowable interest on a pro-rata basis of net interest payment.

2. Applicability of Section 14A When No Exempt Income is Earned or Received:
The primary question referred to the Special Bench was whether disallowance under Section 14A can be made in a year when no exempt income has been earned or received by the assessee. The learned counsel for the assessee argued that disallowance under Section 14A should not apply if no exempt income is earned during the relevant previous year. The counsel emphasized that the term "does not" in Section 14A signifies the present tense, implying that exempt income must be earned during the relevant year for the disallowance to apply.

The Special Bench, however, disagreed with this contention, stating that the disallowance under Section 14A applies irrespective of whether any exempt income is earned or received during the year. The Bench noted that Section 14A does not contain any such exception and emphasized that the provision aims to disallow expenditure incurred in relation to income that does not form part of the total income, regardless of the actual receipt of such income.

The Bench referred to various precedents, including the Supreme Court's decision in CIT vs. Rajendra Prasad Moody, which held that expenditure incurred for earning income is allowable even if no income is actually earned. Applying this principle conversely, the Bench concluded that disallowance under Section 14A can be made even if no exempt income is earned or received during the year.

The Bench also addressed the argument regarding the language of Section 14A, clarifying that the term "in relation to income" is broad enough to encompass expenditure incurred for earning income, regardless of whether the income is actually earned or not. The Bench emphasized that the legislative intent behind Section 14A is to prevent taxpayers from reducing their taxable income by claiming deductions for expenses incurred to earn exempt income.

In conclusion, the Special Bench held that disallowance under Section 14A can be made in a year in which no exempt income has been earned or received by the assessee. The Bench ruled in favor of the Revenue and against the assessee, affirming the applicability of Section 14A even in the absence of exempt income during the relevant year.