2021 (12) TMI 928 - AT - Income Tax

Disallowance u/s.14A in respect of strategic investments made by the assessee - CIT(A) applied the provisions of Section 36(1)(iii) of the Act and held that since investments were made out of borrowed funds by the assessee company, the interest paid on borrowings would be disallowed u/s.36(1)(iii) - HELD THAT - CIT(A) is bound to adjudicate only that issue which is before him and not consider a new source of income which is disallowance of interest u/s.36(1)(iii) of the Act as it is not the subject matter of the appeal before him. In any case, in the absence of exempt income derived by the assessee during the year, the disallowance made by the ld. AO u/s.14A of the Act has been deleted by the ld. CIT(A). The matter ends there. CIT(A) could not have looked into a new source of income i.e. disallowance of interest u/s.36(1)(iii) of the Act. We also find that from the perusal of the entire CIT(A) s order, there is not even a whisper about proposal to enhance the assessment by issuing proper enhancement notice to the assessee in terms of Section 251 of the Act. In any case, the undisputed fact is that the borrowed funds has been utilized by the assessee for making investment in the group company which is made in the ordinary course of business and hence, once the borrowed funds are utilized for the purpose of business, the interest paid thereon would be squarely allowable as deduction u/s.36(1)(iii) of the Act. The law is very well settled on this issue by series of judicial pronouncements including various decisions of the Hon ble Supreme Court - we direct the ld. AO to delete the disallowance of interest u/s.36(1)(iii) - Appeal of the assessee is allowed.

Summary

Issues:
Whether the Commissioner of Income Tax (Appeals) was justified in substituting the disallowance of interest u/s. 36(1)(iii) of the Act for disallowance made u/s. 14A r.w. Rule 8D(2)(ii) of the Income Tax Rules.

Analysis:
The appeal in question arises from the order of the ld. Commissioner of Income Tax (Appeals) against the assessment order passed by the ld. Deputy Commissioner of Income Tax. The main issue to be decided was whether the disallowance of interest under Section 36(1)(iii) of the Act was justified in place of the disallowance made under Section 14A r.w. Rule 8D(2)(ii) of the Income Tax Rules. The assessee, a company engaged in HR consulting services, training, development, staffing services, and financial activities, filed its return for A.Y. 2014-15 showing a loss. The ld. AO observed the investments made by the assessee in shares and proceeded to examine the applicability of Section 14A of the Act. The assessee contended that no exempt income was earned from the investments during the year. However, the ld. AO made disallowances under Rule 8D(2)(ii) and (iii) of the Rules, which were challenged before the ld. CIT(A).

The ld. CIT(A) acknowledged that no exempt income was earned by the assessee and deleted the disallowance of administrative expenses. However, the ld. CIT(A) disallowed the interest paid on borrowed funds under Section 36(1)(iii) of the Act, stating that since investments were made from borrowed funds, the interest would be disallowed. The Tribunal noted that the investment was made in a group company for strategic purposes using borrowed funds, which the ld. AO had accepted. The Tribunal emphasized that the issue before the ld. CIT(A) was limited to the applicability of Section 14A to strategic investments. Since no exempt income was earned, the disallowance under Section 14A was deleted, and the ld. CIT(A) could not introduce a new issue of interest disallowance under Section 36(1)(iii) as it was not part of the appeal.

The Tribunal directed the ld. AO to delete the disallowance of interest under Section 36(1)(iii) in the given circumstances, as the borrowed funds were used for business purposes. It was clarified that once borrowed funds are utilized for business, the interest paid on them is allowable as a deduction under Section 36(1)(iii) of the Act. The Tribunal allowed the grounds raised by the assessee and upheld the appeal, ruling in favor of the assessee.