2024 (3) TMI 254 - HC - Income Tax

Allowable deduction of interest paid on the borrowings - Application of Section 14A and Section 36(1)(iii) - AO disallowed the interest holding that no deduction is to be allowed in respect of expenditure incurred in relation to income which does not form part of the total income under the Income Tax Act - Assessee argued that the expenditure claimed was not hit by Section 14A of the Act, on the ground that although borrowed funds were partly utilised for investment in shares held as trading assets, such investment was made with the intention to acquire and retain a controlling interest in the company and that the receipt of dividend thereon was merely incidental - Tribunal held that the interest paid on the borrowings was not allowable as deduction HELD THAT - The fact remains that such dividend income is non taxable and in that scenario, if expenditure is incurred on earning the dividend income, that much of the expenditure which is attributable to the dividend income has to be disallowed and cannot be treated as business expenditure. As the dividend income from the two companies is not taxable and in that scenario the expenditure incurred on interest paid on funds borrowed in respect of investment in shares of two operating companies is hit by Section 14A of the Act inasmuch as the dividend received on such shares does not form part of the total income. We do not find any infirmity in the findings arrived at by the ITAT, the question of law is answered in affirmative.

Summary

Issues Involved:
1. Allowability of interest paid on borrowed amounts invested in shares.
2. Applicability of Section 14A of the Income Tax Act, 1961.
3. Interpretation of "commercial expediency" in relation to business expenditure.

Summary:

1. Allowability of Interest Paid on Borrowed Amounts:
The appellant, a Chartered Accountant turned stock broker, invested borrowed capital primarily in shares of his two companies. The Assessing Officer disallowed the interest of Rs. 36,88,866/- paid on these borrowings, stating that no deduction is allowed for expenditure related to income not forming part of the total income under the Income Tax Act, 1961. The CIT(A) upheld this decision, emphasizing that dividend income is not includable in the total income by virtue of Section 10(33) and thus, the related expenditure is not allowable under Section 14A.

2. Applicability of Section 14A of the Income Tax Act, 1961:
The ITAT dismissed the appellant's appeal, noting that the borrowed capital was used to acquire controlling interest in the two companies and did not generate any income. The ITAT held that the appellant failed to demonstrate how the borrowed funds were used for business purposes. The present appeal raised the question of whether the interest paid on borrowings was allowable as a deduction. The court referred to the Apex Court's judgment in Maxopp Investment Ltd. v. Commissioner of Income Tax, which clarified that expenditure related to income not forming part of the total income must be disallowed under Section 14A.

3. Interpretation of "Commercial Expediency":
The appellant argued that the interest should be allowed as a deduction based on the principle of "commercial expediency" as established in S.A. Builders Ltd. v. Commissioner of Income Tax. However, the court found that this principle was not applicable in this case. The court reiterated that the dominant purpose test is not relevant for interpreting Section 14A. The expenditure incurred on earning non-taxable dividend income must be disallowed, irrespective of the purpose behind the investment.

Conclusion:
The court found no infirmity in the ITAT's findings and upheld the disallowance of the interest expenditure. The appeal was dismissed, and the question of law was answered in the affirmative, confirming that the interest paid on borrowings for investment in shares of the appellant's companies is not allowable as a deduction under Section 14A.