Tribunal rules in favor of assessee on interest disallowance under Section 36(1)(iii)

The Tribunal ruled in favor of the assessee, directing the Commissioner of Income Tax (Appeals) to delete the disallowance of interest under Section 36(1)(iii) as the borrowed funds were used for business purposes. The Tribunal emphasized that since no exempt income was earned, the disallowance under Section 14A was deleted, and introducing a new issue of interest disallowance under Section 36(1)(iii) was not permissible as it was not part of the appeal. The appeal was upheld, and the assessee's grounds were allowed.

---

---

Issues:
Whether the Commissioner of Income Tax (Appeals) was justified in substituting the disallowance of interest u/s. 36(1)(iii) of the Act for disallowance made u/s. 14A r.w. Rule 8D(2)(ii) of the Income Tax Rules.

Analysis:
The appeal in question arises from the order of the ld. Commissioner of Income Tax (Appeals) against the assessment order passed by the ld. Deputy Commissioner of Income Tax. The main issue to be decided was whether the disallowance of interest under Section 36(1)(iii) of the Act was justified in place of the disallowance made under Section 14A r.w. Rule 8D(2)(ii) of the Income Tax Rules. The assessee, a company engaged in HR consulting services, training, development, staffing services, and financial activities, filed its return for A.Y. 2014-15 showing a loss. The ld. AO observed the investments made by the assessee in shares and proceeded to examine the applicability of Section 14A of the Act. The assessee contended that no exempt income was earned from the investments during the year. However, the ld. AO made disallowances under Rule 8D(2)(ii) and (iii) of the Rules, which were challenged before the ld. CIT(A).

The ld. CIT(A) acknowledged that no exempt income was earned by the assessee and deleted the disallowance of administrative expenses. However, the ld. CIT(A) disallowed the interest paid on borrowed funds under Section 36(1)(iii) of the Act, stating that since investments were made from borrowed funds, the interest would be disallowed. The Tribunal noted that the investment was made in a group company for strategic purposes using borrowed funds, which the ld. AO had accepted. The Tribunal emphasized that the issue before the ld. CIT(A) was limited to the applicability of Section 14A to strategic investments. Since no exempt income was earned, the disallowance under Section 14A was deleted, and the ld. CIT(A) could not introduce a new issue of interest disallowance under Section 36(1)(iii) as it was not part of the appeal.

The Tribunal directed the ld. AO to delete the disallowance of interest under Section 36(1)(iii) in the given circumstances, as the borrowed funds were used for business purposes. It was clarified that once borrowed funds are utilized for business, the interest paid on them is allowable as a deduction under Section 36(1)(iii) of the Act. The Tribunal allowed the grounds raised by the assessee and upheld the appeal, ruling in favor of the assessee.

---