Proportionate interest disallowance under section 14A upheld where exempt investments were funded by borrowed funds and book profit adjusted.

Where an assessee's net worth was negative throughout the year and its capital was wiped off, exempt investments were treated as financed from borrowed funds, making proportionate interest allocation under rule 8D(2)(ii) the appropriate basis for disallowance under section 14A(1). The contrary claim that past funding should control was rejected. Because the same expenditure was sustained as relatable to exempt income, it was also required to be adjusted while computing book profit under clause (f) of Explanation 1 to section 115JB. The disallowance and corresponding book profit adjustment were both upheld.

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Issues: Whether interest expenditure was liable to disallowance under section 14A(1) read with rule 8D(2)(ii) in relation to exempt dividend income; and whether the corresponding expenditure was to be added back while computing book profit under section 115JB.

Issue (i): Whether interest expenditure was liable to disallowance under section 14A(1) read with rule 8D(2)(ii) in relation to exempt dividend income.

Analysis: The fund position of the assessee had to be examined for the relevant year, since past funding of investments was not ative where the assessee's financial position had changed. The assessee's net worth was negative throughout the year and its capital stood wiped off, so the assets including tax-exempt investments were financed from borrowed funds. The method of proportionate allocation under rule 8D(2)(ii) was therefore held to be the appropriate method on the facts, and the assessee's contrary computation was rejected.

Conclusion: The disallowance under section 14A(1) was upheld against the assessee.

Issue (ii): Whether the corresponding expenditure was to be added back while computing book profit under section 115JB.

Analysis: Disallowance under section 14A concerns expenditure actually incurred in relation to exempt income, and rule 8D provides a uniform basis for determining such relatable expenditure. The same expenditure, once sustained under section 14A, was held to be liable for adjustment in book profit computation under clause (f) of Explanation 1 to section 115JB.

Conclusion: The adjustment in computing book profit under section 115JB was upheld against the assessee.

Final Conclusion: The assessee failed on both issues, and the additions sustained by the Revenue authorities were maintained in full.

Ratio Decidendi: For section 14A disallowance, the relevant inquiry is the assessee's fund position during the relevant year, and where borrowed funds finance exempt investments, proportionate interest allocation under rule 8D is warranted; the same relatable expenditure is also adjustible in book profit computation under section 115JB.

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