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2014 (11) TMI 229 - AT - Income TaxAddition u/s 14A r.w. Rule 8D - Exempt income towards dividend earned on investments made in mutual funds Held that - If at all there is any investment made by assessee out of borrowed funds in the mutual funds, then, it can possibly be in the month of March 09 only - the investments made in mutual funds could have been made out of the own funds available with assessee without utilizing the borrowed funds - when assessee was having sufficient surplus funds to make investment in mutual funds no disallowance can be made towards interest expenditure unless nexus is established between the borrowed funds and the investments made relying upon Commissioner of Income Tax-2, Mumbai Versus HDFC Bank Ltd. 2014 (8) TMI 119 - BOMBAY HIGH COURT - there was no reason to sustain the addition towards interest expenditure under rule 8D(2)(iii) - so far as disallowance @ 0.5% on the average value of investment under rule 8D(2)(III) is concerned, even where the assessee claims that he has not incurred any expenditure for earning exempt income, disallowance of expenditure deemed to have been incurred has to be worked out @ 0.5% on the average value of investments - As the AO has correctly computed disallowance in terms with rule 8D(2)(iii), it is upheld Decided partly in favour of assessee.
Issues Involved:
1. Disallowance under Section 14A read with Rule 8D of the Income Tax Rules. 2. Nexus between borrowed funds and investments in mutual funds. 3. Calculation of disallowance amount. Issue-wise Detailed Analysis: 1. Disallowance under Section 14A read with Rule 8D of the Income Tax Rules: The primary issue revolves around the disallowance of Rs. 14,23,29,696 under Section 14A read with Rule 8D. The assessee, a company engaged in microfinance, declared a total income of Rs. 153,31,02,225 for AY 2009-10. During the assessment, the AO observed that the assessee earned exempt income from dividends on mutual fund investments. The investments in mutual funds increased significantly from Rs. 1,42,45,685 to Rs. 295,05,66,475. The AO, invoking Section 14A and Rule 8D, issued a show-cause notice proposing disallowance, which the assessee contested, claiming the investments were made from internal accruals and not borrowed funds. However, the AO, relying on the Bombay High Court's decision in Godrej and Boyce Manufacturing Co. Ltd., proceeded with the disallowance, adding Rs. 13,49,17,666 towards interest expenditure and Rs. 74,12,030 towards administrative expenditure, totaling Rs. 14,23,29,696. The CIT(A) upheld this disallowance, stating that the investments, even if temporarily made from borrowed funds, attracted Section 14A provisions. 2. Nexus between Borrowed Funds and Investments in Mutual Funds: The assessee argued that except for March 2009, the investments were made from internal accruals, and no borrowed funds were utilized. They provided month-wise details showing that borrowed funds were temporarily invested in mutual funds in March 2009 due to banks disbursing maximum amounts to meet priority sector lending targets. The assessee contended that there was no direct nexus between borrowed funds and investments, and thus, no presumptive disallowance under Section 14A should be made. The AO, however, was not convinced and maintained the disallowance, asserting that the assessee earned exempt income and the related expenditure must be disallowed as per Rule 8D. 3. Calculation of Disallowance Amount: The Tribunal examined whether the disallowance of Rs. 13,49,17,666 towards interest expenditure was justified. The assessee's balance sheet indicated sufficient own funds from reserves and surplus, exceeding the investments in mutual funds, except in March 2009. The Tribunal noted that the assessee's own funds and current liabilities were Rs. 314,82,01,550 against total investments of Rs. 295,05,66,474, suggesting that investments could have been made without utilizing borrowed funds. The Tribunal cited the Bombay High Court's decision in CIT Vs. HDFC Bank Ltd., emphasizing that no disallowance should be made unless there is a clear nexus between borrowed funds and investments. The Tribunal also referred to the ITAT Ahmedabad Bench's decision in ITO Vs. Karnavati Petrochem Pvt. Ltd., which held that no disallowance should be made when there is a net positive interest income. Consequently, the Tribunal found no reason to sustain the addition of Rs. 13,49,17,666 towards interest expenditure. However, it upheld the disallowance of Rs. 74,12,030 at 0.5% of the average value of investments under Rule 8D(2)(iii), as mandated by Section 14A(3). Conclusion: The Tribunal partly allowed the assessee's appeal, deleting the disallowance of Rs. 13,49,17,666 towards interest expenditure, but sustaining the disallowance of Rs. 74,12,030 towards administrative expenses. The judgment emphasized the need for a clear nexus between borrowed funds and investments for disallowance under Section 14A and upheld the statutory requirement of disallowing administrative expenses at 0.5% of the average value of investments. The final pronouncement was made in the open court on 10/10/2014.
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