2015 (10) TMI 393 - AT - Income Tax

Disallowance of expenses incurred in earning tax-free income invoking provisions of section 14A - Held that - For the purpose of deciding the disallowance under section 14A r.w. Rule 8D(2)(ii), those details will be very material. We are of the view that if the stand taken by the assessee on the disallowance of interest expenses under Rule 8D(2)(ii) of the Rules is factually correct, then no disallowance of interest expenses can be made. We, however, find that the required details have not been filed by the assessee before us. In such circumstances, we are of the view that it would be just and fair to set aside the order of the CIT(Appeals) on this issue and remand the question of disallowance of interest expenses under Rule 8D(2)(ii) to the Assessing Officer for fresh consideration with a direction to the assessee to furnish the required details to substantiate its claim as made before the CIT(Appeals). As far as disallowance under Rule 8D(2)(iii) is concerned, the assessee has not shown as to what is the expenditure to be disallowed. The assessee s only plea before the CIT(A) was that weighted average based on time (no. of days) in which investments were made should be considered. As rightly contended by the ld. DR, the above stand of the assessee cannot be sustained in view of the clear mandate of Rule 8D(2)(iii) of the Rules, which refers to only the average value of investments as appearing in the Balance Sheet of the assessee as on the first and last day of the previous year. One cannot travel beyond the language of Rule 8D(2)(iii) of the Rules. In the absence of any other plea by the assessee in this regard, the disallowance has to be sustained. However, we find that the Hon ble Delhi High Court in Joint Investments Pvt. Ltd. (2015 (3) TMI 155 - DELHI HIGH COURT ) has held that disallowance u/s. 14A of the Act cannot be in excess of the tax exempt income. Following the aforesaid decision, we direct the AO to restrict the disallowance to income that is exempt in the set aside proceedings under Rule 8D(2)(iii) of the Rules, after complying with the directions with regard to disallowance of interest expenses under Rule 8D(2)(ii) of the Rules. - Decided partly in favour of assessee for statistical purposes.

Summary

Issues Involved:

1. Disallowance of expenses incurred in earning tax-free income under Section 14A of the Income-tax Act, 1961 r.w. Rule 8D(2) of the Income-tax Rules.

Detailed Analysis:

1. Disallowance of Interest Expenses Invoking Rule 8D(2)(ii):

The Assessing Officer (AO) disallowed Rs. 46,62,647 under Section 14A of the Income-tax Act, 1961, applying Rule 8D(2)(ii) and (iii) of the Income-tax Rules. The assessee claimed that no expenditure was incurred to earn the tax-free dividend income of Rs. 9,728. However, the AO disagreed, stating that earning income without incurring any expenditure was not plausible. The AO calculated the disallowance by considering interest expenses and average investments.

Before the Commissioner of Income Tax (Appeals) [CIT(A)], the assessee argued that the interest expenses debited were for credit facilities and lease obligations used for business purposes, not for investments yielding tax-free income. The assessee provided details of its own funds and the usage of borrowed funds, emphasizing that the investments were made from funds received through compulsorily convertible debentures, which did not carry any interest. The assessee also highlighted that the auditors' report did not indicate any misuse of interest-bearing borrowed funds.

The CIT(A) rejected the assessee's arguments, stating that the assessee failed to establish a clear nexus between borrowed funds and their business use. The CIT(A) mandated disallowance under Rule 8D from AY 2008-09 onwards, asserting that disallowance must be made irrespective of the quantum of expenditure.

Upon appeal to the Tribunal, the assessee reiterated its arguments, emphasizing that the disallowance exceeded the exempt income, citing the Delhi High Court's decision in Joint Investments Pvt. Ltd. v. CIT, which held that disallowance under Section 14A cannot exceed the tax-exempt income. The Tribunal noted the absence of detailed evidence showing that borrowed funds were not used for tax-free investments and remanded the issue back to the AO for fresh consideration, directing the assessee to provide the necessary details.

2. Disallowance Under Rule 8D(2)(iii):

The AO applied Rule 8D(2)(iii) to disallow 0.5% of the average value of investments. The assessee contended that using a simple average could lead to absurd results and suggested a weighted average based on time. The CIT(A) upheld the AO's method, and the Tribunal agreed, stating that the language of Rule 8D(2)(iii) mandates using the average value of investments as per the balance sheet.

However, the Tribunal, following the Delhi High Court's decision in Joint Investments Pvt. Ltd., directed the AO to limit the disallowance to the amount of tax-exempt income.

Conclusion:

The Tribunal partly allowed the appeal for statistical purposes, remanding the issue of disallowance of interest expenses under Rule 8D(2)(ii) to the AO for fresh consideration and directing the AO to restrict the disallowance under Rule 8D(2)(iii) to the amount of tax-exempt income.