Section 14A disallows interest on borrowings linked to exempt dividend income, even in a composite investment business.

Interest on common borrowings used partly for share investment was held disallowable to the extent it related to exempt dividend income under section 14A of the Income-tax Act, 1961. The earlier contention that the assessee carried on an indivisible composite business did not override the statutory bar, because expenditure with a proximate connection to income not forming part of total income cannot be deducted against taxable income. The plea that the shares were acquired for controlling interest was rejected for lack of factual foundation at the appellate stage. The fact that tax may have been paid in the payer company's hands was also irrelevant, since section 14A turns on the tax character of income in the recipient's hands.

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Issues: Whether interest paid on borrowed funds used partly for investment in shares yielding exempt dividend income could be disallowed under section 14A of the Income-tax Act, 1961, and whether the assessee could claim full deduction by treating the borrowing as part of an indivisible business or by asserting that the shares were acquired for controlling interest.

Analysis: The assessee was engaged in investment and finance and had borrowed common funds, part of which was used for share investment and part for lending activity. The dividend received on the shares was exempt under section 10(33) of the Income-tax Act, 1961, and section 14A, inserted retrospectively from 1 April 1962, bars deduction of expenditure incurred in relation to income not forming part of total income. The earlier line of authority allowing full deduction in cases of indivisible business was held inapplicable in view of the statutory mandate of section 14A. The plea that the shares were acquired to obtain controlling interest was not raised before the lower authorities and was rejected at the appellate stage for want of factual foundation. The argument that dividend had suffered tax in the hands of the company declaring it was also rejected, because for section 14A the character of income in the hands of the recipient is ative, not the tax treatment in the hands of the payer.

Conclusion: The pro rata interest relatable to investment in shares yielding exempt dividend income was not allowable as a deduction, and the disallowance under section 14A was upheld in favour of the Revenue.

Ratio Decidendi: Expenditure incurred from common borrowings that has a proximate connection with exempt income cannot be deducted against taxable income under section 14A, even if the assessee carries on a composite business.

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