Whether interest expenditure attributable to a taxable business can be disallowed u/s. 14A/ Rule 8D and whether expenditure on creating assets which do not belong to the assessee is revenue expenditure?

ALLAHABAD HIGH COURT

AFR

Chief Justice's Court

Case:- INCOME TAX APPEAL No. - 220 of 2014

Appellant:- Additional Commissioner Of Income Tax Bareilly

Respondent:- M/S Dhampur Sugar Mill Pvt. Ltd.

Counsel for Appellant - Dhananjay Awasthi

Counsel for Respondent:-Suyash Agrawal

BEFORE

Hon'ble Dr. Dhananjaya Yeshwant Chandrachud, Chief Justice

Hon'ble Pradeep Kumar Singh Baghel, J.

This appeal by the revenue has arisen from a decision of the Income Tax Appellate Tribunal dated 31 January 2014. The assessment year to which the appeal relates is AY 2008-09. The following questions of law have been formulated on behalf of the revenue:

(1) Whether the Tribunal erred in law in deleting the addition made on account of disallowance under Section 14A of the Income Tax Act, 1961read with Rule 8D of the Income Tax Rules, 1962, without appreciating the language and provision of these Sections, more so when the expenditure was with respect to amount of interest expenses which was directly attributable to dividend income and which did not form part of total income;

(2) Whether the Tribunal erred in law in deleting the addition made under Section 36(1)(iii) ignoring the fact that the assessee was not charging interest on funds given as loans and advances to its sister concerns/subsidiaries when there was no specific business purpose for which these interest free loans and advances were given;

(3) Whether the Tribunal erred in law and fact in deleting the disallowance made by the Assessing Officer on account of expenses incurred on transmission lines and contribution paid to the Uttar Pradesh Power Corporation Limited4, without appreciating the fact that, these expenses were in the nature of capital expenditure as they were for providing enduring benefits to the assessee and would remain an asset with the assessee for indefinite period, hence these were not deductible as per the provisions of Section 37 (1) of the Act; and

(4) Whether the ITAT erred in law and facts in allowing appeal with respect to computation of bookprofit under Section 115JB of the Act made by theAssessing Officer as a result of disallowance of interestand other expenses under Section 14A of the Act amounting to Rs 66,79,000/- in computation of bookprofit under Section 115 JB.

Re Question No 1

The assessee is engaged in the business, inter-alia, of the manufacture and sale of sugar, chemicals and power, and has a distillery. The return of income was initially processed under Section 143 (1). The case was selected for scrutiny and resulted in an order under Section 143(3) of the Assessing Officer dated 27 December 2010. The Assessing Officer held that the assessee had invested some of its funds in shares and the dividend income which had been or was receivable on these investments did not form part of the total income. Holding that certain expenses, such as on account of interest, were directly attributable to the exempt income, the Assessing Officer came to the conclusion that such expenditure could not have been debited to the profit and loss account in view of the provisions of Section 14A of the Act. The Assessing Officer made a disallowance of Rs 67.75 lacs. In appeal, the Commissioner(Appeals) deleted the disallowance. The Commissioner (Appeals)observed that certain shares of Kashipur Sugar Mills Ltd were acquired in1993 out of the own funds of the assessee. The term loans on which interest was paid during the year under consideration were received for specific purposes and the cash credit account was used for the working capital of the business. Hence, it was held that a disallowance under Section 14A read with Rule 8D of the Rules could not be justified. In regard to the investment which was made by the assessee in Dhampur Distillery Pvt Ltd, the Commissioner (Appeals) held that there was no material which would establish that the investment in shares was made out of interest bearing funds but that it was made from fresh share capital raised in the period under consideration. The finding of the Commissioner(Appeals) can conveniently be extracted herein below:

“The facts reveal that the investment in Dhampur Distillery Pvt Ltd was not a direct investment in the form of liquid capital. The assets including land, plant and machinery in the business premises etc were acquired out of share capital raised during the year. This fact was submitted by the assessee along with evidence for the source of investment made by its promoters before the AO. Therefore, the finding of the AO that the assessee invested certain amount of fund in shares of the above company and any income received or receivable on these investments in the form of dividend would not form part of total income and the expenses in the form of interest paid which were directly attributable to the exempt income would not be eligible for deduction by virtue of Section 14A of the Act, was factually not correct. The AO did not dispute the source of investment by the appellant in Dhampur DistilleryPvt Ltd. The appellant furnished evidence of raising fresh share capital during the year for the purpose of funding its Ethanol Unit. There is nothing on the record which could establish that the AO gathered any evidence to substantiate his funding that the appellant made investment in the share capital of DhampurPvtLtd out of interest bearing funds. As a matter of fact, the AO applied the provisions of Section 14A without establishing the requirement of law. The provisions of Section 14A(2) lay down that, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act, then he shall not allow deduction in respect of such expenditure incurred by the assessee. The source of investment in the shares of Dhampur Distillery Pvt Ltd was clearly proved by the assesse with the explanation that it was invested from the fresh share capital raised in the period under consideration. This explanation of the assessee was not disputed by the AO. In view of such facts and circumstances of the case and position of law, denial of claim of deduction of expenses in the form of interest on the ground that they were attributable to exempt income, was not sustainable.”

In the appeal, the Tribunal has confirmed the finding. The Tribunal has observed that the findings of the Commissioner (Appeals) were not controverted on behalf of the revenue. Once it was duly established that no borrowed funds on which interest was paid had been invested for earning tax free income, no disallowance was permissible under Section14A. The Tribunal has observed that under Rule 8D(2)(ii), a proportionate disallowance out of interest expenditure would be made in respect of interest expenditure which is not directly attributable to any particular income or receipt. Since the entire interest expenditure, in the present case, was attributable to business in which the resultant income was assessable to tax, a disallowance could not be made. The Tribunal, consequently, deleted a disallowance to the extent of Rs 66.79 lacs out of a total disallowance of Rs 67.75 lacs made by the Assessing Officer under Section 14A, sustaining the balance of Rs 0.96 lacs on account of other expenditure to the extent of 0.5 percent of the average value of investment. The order of the Tribunal in regard to the disallowance of Rs0.96 lacs has been confirmed by this Court by a judgment dated 1September 2014 in an appeal5 filed by the assessee.

To read the full judgment, please find the attached file:

Attached file:

http://elegalix.allahabadhighcourt.in/elegalix/WebDownloadJudgmentDocument.do