2015 (9) TMI 238 - HC - Income Tax

Disallowance under Section 14A - whether disallowance 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 the factual position that has not been disputed is that the investment by the Assessee in the shares of Max India Ltd. is in the form of a strategic investment. Since the business of the Assessee is of holding investments the interest expenditure must be held to have been incurred for holding and maintaining such investment. The interest expenditure incurred by the Assessee is in relation to such investments which gives rise to income which does not form part of total income. In light of the clear exposition of the law in Holcim India (P) Ltd. (2014 (9) TMI 434 - DELHI HIGH COURT) and in view of the admitted factual position in this case that the Assessee has made strategic investment in shares of Max India Ltd.; that no exempted income was earned by the Assessee in the relevant AY and since the genuineness of the expenditure incurred by the Assessee is not in doubt the question framed is required to be answered in favour of the Assessee and against the Revenue. The Court answers the question framed by holding that the expression does not form part of the total income in Section 14A of the envisages that there should be an actual receipt of income which is not includible in the total income during the relevant previous year for the purpose of disallowing any expenditure incurred in relation to the said income. In other words Section 14A will not apply if no exempt income is received or receivable during the relevant previous year. Consequently the impugned order of the ITAT is set aside and the appeal is allowed in the above terms - Decided in favour of assessee.

Summary

Issues Involved:
1. Applicability of Section 14A of the Income Tax Act, 1961, when no exempt income is earned or received.
2. Treatment of interest expenditure on borrowed funds for investment in shares as business expenditure.

Issue-wise Detailed Analysis:

1. Applicability of Section 14A of the Income Tax Act, 1961, when no exempt income is earned or received:

The central question for determination was whether disallowance under Section 14A of the Income Tax Act can be made in a year where no exempt income has been earned or received by the Assessee. The Assessee, engaged in investment in shares and loans, incurred an interest expenditure of Rs. 1,21,03,367/- on borrowed funds but did not earn any dividend income in the relevant assessment year (AY 2004-05). The Assessing Officer (AO) disallowed Rs. 97,87,570/- under Section 14A, attributing this to interest paid on borrowed funds used for purchasing shares to earn exempt dividend income.

The Special Bench of the ITAT upheld the disallowance, referencing the Supreme Court's decision in CIT v. Rajendra Prasad Moody, stating that the disallowance under Section 14A applies even if no income is earned. However, the High Court found that this interpretation was incorrect. The Court referred to its own decision in CIT v. Holcim India (P) Ltd., which held that Section 14A does not apply if no exempt income is received or receivable during the relevant previous year. The Court highlighted that the expression "does not form part of the total income" in Section 14A envisages actual receipt of income not includible in the total income during the relevant year. Thus, the Court concluded that Section 14A will not apply if no exempt income is earned in the year in question.

2. Treatment of interest expenditure on borrowed funds for investment in shares as business expenditure:

The Court also addressed whether the interest paid on borrowings for investment could be treated as business expenditure. The Assessee argued that the investment in shares of Max India Ltd. was a strategic investment and that the interest expenditure should be considered as incurred for holding and maintaining such investment. The Court noted that the Assessee's business involved holding investments, and the interest expenditure was related to such investments, which could give rise to income not forming part of the total income.

The Court referred to several decisions, including Eicher Goodearth Ltd. v. Commissioner of Income-tax and CIT v. Chugandas & Co., which supported the view that where shares are held as business investment, the related expenditure retains its character as business expenditure. However, the Court did not express any opinion on whether the interest expenditure for the relevant AY would be allowable as business expenditure under Section 36(1)(iii) of the Act.

Conclusion:

The High Court set aside the ITAT's order and allowed the appeal, holding that Section 14A of the Act does not apply if no exempt income is received or receivable during the relevant previous year. The Court clarified that the decision in Rajendra Prasad Moody, which dealt with Section 57(iii), could not be used to support disallowance under Section 14A when no exempt income is earned. The Court's decision was based on the factual position that the Assessee had made strategic investments and incurred genuine interest expenditure for holding and maintaining such investments.