2017 (5) TMI 839 - AT - Income Tax

Disallowance under Rule 8D(ii) on account of interest expenses - addition u/s 14A - primary onus/burden to prove - Held that - As observed from the perusal of the audited financial statement of the assessee that the investments of ₹ 45.83 crores are held as investment and not as stock in trade and hence the issue of applicability of section 14A of the Act to stock in trade do not need require adjudication by us. As per section 14A of the Act where any expenditure is incurred by the assessee in relation to the income which is not includible in total income of the assessee such expenses shall not be allowed as expenditure. Thus, disallowance of such expenditure incurred in relation to earning of income which does not form part of total income under provisions of this Act shall be computed having regard to accounts of the assessee as provided in section 14A(2) of the Act. The matter needs to be set aside and restored to the file of AO for re-computing the disallowance u/s. 14A of the 1961 Act of the expenditure incurred in relation to the earning of income which does not form part of the total income having regards to the accounts of the assessee in accordance with our above directions. The assessee is directed to produce working of disallowance of expenditure incurred in relation to the earning of income which does not form part of the total income having regards to the accounts of assessee as is contemplated u/s 14A of the 1961 Act. The primary onus/burden is on the assessee to produce such working as the said facts are especially in the knowledge of the assessee. If the AO is not satisfied with the working as is submitted by the assessee as such disallowance cannot be worked out keeping in view accounts of the assessee, the AO will be justified in invoking Rule 8D of the 1962 Rules - Decided partly in favour of assessee for statistical purposes.

Summary

Issues Involved:
1. Disallowance of ?20,27,472/- under Rule 8D(ii) on account of interest expenses.
2. Disallowance of ?11,45,953/- on account of expenses under Rule 8D(iii) being 0.5% of the average investments.

Issue-Wise Detailed Analysis:

1. Disallowance of ?20,27,472/- under Rule 8D(ii) on account of interest expenses:
The assessee contended that no interest-bearing funds were utilized to earn exempt income and that the disallowance was unwarranted. The assessee also argued that no interest expenses were claimed during the year as they were capitalized to the work-in-progress account. Additionally, the assessee submitted that any interest considered for disallowance should be net of the interest income earned during the year and offered to tax.

The Assessing Officer (AO) rejected these contentions and made a disallowance under Section 14A of the Income-tax Act, 1961, read with Rule 8D of the Income-tax Rules, 1962, amounting to ?31,73,425/- (including the disallowance under Rule 8D(ii)).

Upon appeal, the Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO's decision, observing that the assessee could not establish a direct nexus between the capital invested in securities and the funds claimed to be used for business purposes. The CIT(A) noted that the assessee had raised interest-bearing loans in earlier years and investments in shares and securities were made in the current financial year. The CIT(A) concluded that the assessee's claim that no interest expenditure could be disallowed was unsubstantiated.

The Income Tax Appellate Tribunal (ITAT) agreed with the CIT(A) that the assessee's claim needed further verification. The ITAT observed that the assessee had significant own funds and interest-free advances from flat bookings, which were claimed to be invested in shares and securities. The ITAT directed the AO to re-examine the claim that these advances were interest-free and verify the nexus between the funds used for investments and the interest-bearing loans. The ITAT also instructed the AO to consider the assessee's claim that the premium on redemption of debentures should not be disallowed under Section 14A.

2. Disallowance of ?11,45,953/- on account of expenses under Rule 8D(iii) being 0.5% of the average investments:
The assessee argued that no expenses were incurred for earning exempt income and that the disallowance was unwarranted. The assessee claimed that most of the expenses were transferred to the work-in-progress account and only a small portion was claimed as business expenditure. The assessee also contended that investments in debentures, which yield taxable income, should not be included in the calculation for disallowance under Rule 8D(iii).

The AO made a disallowance for administrative expenses under Rule 8D(iii), which was upheld by the CIT(A). The CIT(A) noted that the assessee had invested a substantial amount in shares and securities and could not provide details to establish that no expenses were incurred for earning exempt income.

The ITAT observed that the assessee's investments included debentures, which yield taxable income, and should not be considered for disallowance under Section 14A. The ITAT directed the AO to exclude investments in debentures from the calculation and re-compute the disallowance for administrative expenses. The ITAT also noted that the assessee's claim that administrative expenses were debited to the work-in-progress account needed verification. The ITAT emphasized that even if these expenses were debited to the work-in-progress account, disallowance under Section 14A was still required as these expenses were part of the closing work-in-progress valuation, which would affect the subsequent year's profit and loss account.

Conclusion:
The ITAT set aside the matter and directed the AO to re-compute the disallowance under Section 14A, considering the assessee's claims and verifying the details provided. The AO was instructed to exclude investments in debentures from the disallowance calculation and verify the nexus between the funds used for investments and interest-bearing loans. The ITAT emphasized the need for proper verification and adherence to the principles of natural justice.

Result:
The appeal filed by the assessee was partly allowed for statistical purposes. The order was pronounced in the open court on 17th May, 2017.