2013 (12) TMI 189 - AT - Income Tax

Disallowance of Interest u/s 14A The assessee invested Rs. 10,99,00,000 in shares and also paid share application money of Rs. 47,51,00,000 of one M/s. Sringaravalli Consultants P. Ltd. - Held that - The assessee was doing investment as well as share trading as a part of its business - The assessee is a trader in share - Even if the shares were held as a part of its investment, such holding of shares could still be considered only as a part of its business The dividend earned by the assessee was a small amount of Rs. 10,11,449/- as compared to the amount of investment in shares It was not proved that this amount was earned on investment in the said company only Following CCI Ltd. 2012 (4) TMI 282 - KARNATAKA HIGH COURT - There could be no disallowance when shares were held not with an intention of earning dividend income - The acquisition of shares and placing share application money were in the course of business of the assessee - Decided in favour of assessee.

Issues Involved:
1. Disallowance of interest on borrowed funds used for investments.
2. Applicability of Section 14A of the Income-tax Act, 1961, on interest paid on borrowed funds utilized for purchasing equity shares.
3. Calculation and application of Rule 8D of the Income-tax Rules, 1962.
4. Determination of whether the investments were for business purposes or for earning exempt income.

Detailed Analysis:

Disallowance of Interest on Borrowed Funds Used for Investments:
The assessee, engaged in share dealing and investment counseling, declared a loss which was later revised. The Assessing Officer noted substantial unsecured loans and significant investments in shares and share application money. The AO disallowed a pro rata interest of Rs. 1,38,93,443, arguing that interest on borrowed funds used for acquiring shares and giving share application money could not be considered as business expenditure.

Applicability of Section 14A of the Income-tax Act, 1961:
The AO observed that the assessee received dividend income exempt from tax, prompting the application of Section 14A. The AO applied Rule 8D, disallowing Rs. 2,35,73,989 for interest and Rs. 15,93,169 under Rule 8D(2)(iii), totaling Rs. 2,51,67,158. The Commissioner of Income-tax (Appeals) upheld this, stating that the intention behind the expenditure was irrelevant, and the expenditure had a direct nexus with earning exempt income.

Calculation and Application of Rule 8D of the Income-tax Rules, 1962:
The AO applied Rule 8D for disallowance, adjusting the interest disallowance by subtracting the non-business expenditure. The Commissioner of Income-tax (Appeals) justified this application, emphasizing that expenditure not attributable to taxable income must be disallowed.

Determination of Whether the Investments Were for Business Purposes or for Earning Exempt Income:
The assessee argued that the investments were part of its business and not solely for earning dividend income. The Commissioner of Income-tax (Appeals) dismissed this, stating that the investments yielded dividend income, which was exempt, and thus Section 14A applied. The assessee contended that the investments were converted into stock-in-trade and were for business purposes, not for earning dividend income.

Tribunal's Findings:

1. Disallowance of Interest on Borrowed Funds Used for Investments:
The Tribunal found that the assessee was engaged in both investment and share trading as part of its business. The investments and share application money were part of the business, and thus, interest on loans for acquiring these assets was business expenditure. The Tribunal rejected the AO's and Commissioner of Income-tax (Appeals)' views that such interest was non-business or capital expenditure.

2. Applicability of Section 14A:
The Tribunal noted that Section 14A applies to expenditure incurred for earning exempt income. However, share application money does not yield any income until converted into shares. Therefore, no disallowance under Section 14A was warranted for the share application money. The Tribunal emphasized that the intention behind holding shares is relevant, especially when the assessee is a dealer in shares.

3. Calculation and Application of Rule 8D:
The Tribunal highlighted that the AO must record dissatisfaction with the correctness of the assessee's claim of expenditure before invoking Rule 8D. The Tribunal found that the disallowance under Rule 8D was not justified as the investments were part of the business, and the dividend income was incidental.

4. Determination of Business Purpose vs. Earning Exempt Income:
The Tribunal observed that the assessee's primary business was dealing in shares, and the investments were part of this business. The dividend income was incidental, and the intention was not to earn dividend income. The Tribunal relied on judgments from the Karnataka and Bombay High Courts, which supported the view that no disallowance under Section 14A is warranted when shares are held for business purposes and not primarily for earning dividend income.

Conclusion:
The Tribunal allowed the appeals, deleting the disallowances made under Section 14A and for interest on borrowed funds. The Tribunal found that the investments were part of the assessee's business, and the interest on loans was business expenditure. The disallowance under Rule 8D was not justified as the investments were not solely for earning exempt income. The appeals were allowed in favor of the assessee.

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