Interest-free funds presumption defeats section 14A interest disallowance when reserves cover exempt-income investments

Where an assessee's own interest-free funds and free reserves exceed the investments yielding exempt income, a presumption arises that the investments were made from those funds and not from borrowed money. Applying that settled principle, the Bombay HC held that disallowance of interest expenditure under section 14A was not justified on the facts described, and the interest disallowance was deleted. The separate disallowance relating to other expenses under Rule 8D was not in dispute before the Court.

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Issues: Whether the disallowance of interest expenditure under section 14A of the Income-tax Act, 1961 was justified when the assessee's interest-free funds exceeded the investments yielding exempt income.

Analysis: The investment giving rise to exempt income was substantially lower than the assessee's own free reserves and share capital. In such a situation, the presumption applies that the investments were made out of interest-free funds and not borrowed funds. The Court followed the settled principle that where interest-free funds are sufficient to cover the investments, no disallowance of interest expenditure under section 14A is warranted. The separate disallowance relating to other expenses under Rule 8D was not in dispute before the Court.

Conclusion: The disallowance of interest expenditure was rightly deleted and the question was answered in favour of the assessee.

Ratio Decidendi: When an assessee has sufficient interest-free funds to meet the investment generating exempt income, a presumption arises that the investment was made from such funds and not from borrowed funds, defeating disallowance of interest under section 14A.

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