2016 (11) TMI 256 - AT - Income Tax

Disallowance u/s 14A - whether section 10B is a deduction or an exemption provision? - Held that - The language of the heading of Chapter III, it is clear that income as contemplated under section 10B is outside the scope of total income and has no relevance with the gross total income. It is, therefore, a section which provides for exemption of income and not for deduction. It is further important to note that provisions of section 14A are applicable in relation to income which does not form part of total income . This very phrase is the heading for Chapter III under which the section 10B and also section 10(33) lies. This makes it very apparent and conclusive that the provisions of section 14A are clearly applicable to the investment made in a EOU covered under the provisions of section 10B. The claim of the appellant that section 14A is not applicable to investment made in an EOU covered under the provisions of section 10B is, therefore, not accepted. This ground of appeal is, therefore, dismissed Disallowance under Rule 8D(2)(ii) in respect of shares and mutual funds - Held that - The assessee has demonstrated that the interest paid was to the specific loans utilized towards purchase of car, purchase of machinery, working capital etc. The Assessing Officer has not been able to establish that the interest was towards loans for non-specific purpose, which could be attributed to the investment in shares on proportionate basis. No investment in shares/mutual funds have been made out of the borrowed funds and, therefore, no disallowance under Rule 8D2(ii) of the Rules could be made for interest on proportionate basis towards investment in shares/mutual funds which could earn exempted income. Inclusion of amount of capital of EOU for the purpose of disallowance under section 14A - Held that - no borrowed funds were utilized for the purpose of EOU. The profits earned by the EOU contributed to the reserves & surplus. Thus, the entire amount of ₹ 15,45,31,633/- as on 31.03.2009 is out of capital and profit earned over the year. The Assessing Officer has in the assessment order not provided any basis to show that the investment in the EOU has been made out of borrowed funds. The Unit has on its own taken some loans on which interst is being paid and is being debited to its Profit & Loss Account for the purpose of computing its profit. The Assessing Officer has not brought anything on record to show that the head office has taken loans for the purpose of investment in the EOU. The Assessing Officer has taken the opening investment in the EOU at ₹ 16,04,07,523/- and the closing investment at ₹ 15,45,31,633/-. The disallowance under Section 14A on the average of this investment is deleted as the funds are out of appellant s own sources

Issues Involved:
1. Legality and factual correctness of the CIT(A)'s order.
2. Applicability of Section 14A disallowance.
3. Nature of Section 10B - Deduction vs. Exemption.
4. Validity of disallowance under Rule 8D read with Section 14A.
5. Computation of administrative expenses related to investments.
6. Deletion of disallowance under Rule 8D(2)(ii) for investment in EOU.

Issue-wise Detailed Analysis:

1. Legality and Factual Correctness of the CIT(A)'s Order:
The assessee contended that the CIT(A)'s order was flawed both legally and factually. However, this was a general ground and was not specifically adjudicated upon.

2. Applicability of Section 14A Disallowance:
The assessee challenged the applicability of Section 14A, arguing that it did not apply to investments in Export Oriented Units (EOUs) covered under Section 10B. The CIT(A) disagreed, referencing the Delhi High Court's decision in CIT vs. TEI Technologies Pvt. Ltd., which held that Section 10A (similar to Section 10B) is essentially an exemption provision. Thus, Section 14A was applicable to investments in EOUs.

3. Nature of Section 10B - Deduction vs. Exemption:
The assessee argued that Section 10B provided for a deduction, not an exemption, and thus Section 14A should not apply. They cited various judgments supporting this view. However, the Tribunal upheld the CIT(A)'s reliance on the Delhi High Court's decision, which treated Section 10B as an exemption provision. Consequently, the Tribunal dismissed the assessee’s ground, affirming that Section 14A applies to investments in EOUs.

4. Validity of Disallowance under Rule 8D read with Section 14A:
The assessee contended that the computation of disallowance under Rule 8D was incorrect, especially since investments were made in subsidiaries and there was no significant change during the year. They also argued that borrowed funds were used for specific purposes with a direct nexus to their utilization. The Tribunal found merit in the assessee's arguments, noting that no borrowed funds were used for investments in shares/mutual funds. Consequently, the disallowance under Rule 8D(2)(ii) for interest on borrowed funds was deemed unjustified and was deleted.

5. Computation of Administrative Expenses Related to Investments:
The assessee argued that no administrative expenses were required for managing mutual funds, and the disallowance was unsustainable without specific linkage to any expenditure. However, this ground was not pressed before the Tribunal and was dismissed as infructuous.

6. Deletion of Disallowance under Rule 8D(2)(ii) for Investment in EOU:
The Revenue appealed against the deletion of the disallowance corresponding to investments in the EOU. The Tribunal upheld the CIT(A)'s order, noting that the capital for the EOU came from the assessee's own funds and profits, not borrowed funds. The Tribunal found that the Assessing Officer had not demonstrated any borrowed funds being used for the EOU investment, thus confirming the deletion of the disallowance.

Conclusion:
The Tribunal partly allowed the assessee's appeal, deleting the disallowance under Rule 8D(2)(ii) for interest on borrowed funds used for investments in shares/mutual funds. It dismissed the Revenue's appeal, upholding the deletion of the disallowance for investments in the EOU. The decision was pronounced in open court on 21st October 2016.

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