2010 (11) TMI 1027 - AT - Income Tax

Tribunal directs AO to re-examine disallowance issue for unestablished nexus between borrowed funds and investments.

Aditya Medisales Limited Versus Dy. CIT Central Circle-1 Baroda

The Tribunal found that the Assessing Officer (AO) failed to establish the nexus between borrowed funds and investments, contrary to past practices. ... - Issues Involved:1. Disallowance u/s 14A.Summary:1. Disallowance u/s 14A:1.1. The CIT(A) erred in confirming the disallowance of interest u/s 14A.1.2. The CIT(A) ought to have considered that the shares are held as stock-in-trade and not as investment.1.3. The CIT(A) ought to have considered that the entire borrowings made by the Appellant were for the purpose of business.1.4. The CIT(A) erred in not appreciating the fact there is no provision for proportionate distribution of expenses between taxable income and tax-free income.Facts and Observations:- The assessee-company is in the business of trading pharmaceutical products.- The assessee earned dividend income of Rs. 13,39,322/-, which was exempted income.- The Assessing Officer (AO) disallowed expenses attributable to the exempted income by invoking the provisions of section 14A of the Act.- The AO observed that the shares were recorded as investments and not as stock-in-trade.- The AO calculated the disallowance using a specific formula: Interest expenses on borrowed capital X (Total investment in shares / Current assets, loans, and advances including investment in shares).First Appellate Authority:- The CIT(A) confirmed the addition based on the orders of his predecessors in the assessee's own case, noting no change in facts or law.Tribunal's Analysis:- The Tribunal noted that the AO had not followed the past method of calculation and failed to establish the nexus of utilization of borrowed interest-bearing funds towards investment in debentures.- The Tribunal referred to the Hon'ble Bombay High Court's decision in the case of Godrej & Boyce Mfg. Co. Ltd. vs. Dy. CIT, which upheld the constitutional validity of section 14A and directed the AO to determine if the assessee incurred any expenditure in relation to exempt income.- The Tribunal emphasized the need for the AO to provide a reasonable opportunity to the assessee to produce relevant material.- The Tribunal also referred to other case laws, including Daga Capital Management Pvt. Ltd. and Wal Fort Shares and Stock Brokers Ltd., which discussed the applicability of section 14A and the necessity of establishing a proximate cause for disallowance.Conclusion:- The Tribunal found that the AO had not enquired into the issue in light of the legal pronouncements and guidelines.- The Tribunal restored the appeals for re-adjudication, directing the AO to compute the correct disallowance after providing an adequate opportunity of hearing to the assessee.Result:- Both appeals for Assessment Years 2001-02 and 2002-03 were restored for re-adjudication and treated as allowed for statistical purposes.