2023 (11) TMI 31 - AT - Income Tax

Tribunal Upholds Deletion of Disallowance u/s 14A, Citing Sufficient Own Funds and Lack of AO Satisfaction.

ACIT, Central Circle-26, New Delhi. Versus Punj Lloyd Ltd.

The Tribunal dismissed the Revenue's appeal, upholding the Ld. CIT(A)'s decision to delete the disallowance of Rs. 10,47,30,878/- under section 14A r.w. ... Disallowance u/s 14A r.w Rule 8D - mandation of recording satisfaction - addition made as assessee did not establish the nexus between interest free funds and investment yielding exempt income - CIT(A) deleted the addition - HELD THAT:- It is not in dispute that the assessee on its own made disallowance u/s 14A - as observed that the AO has not recorded his satisfaction regarding correctness of self disallowance made by the assessee under section 14A as is mandatory in terms of sub-section (2) of section 14A to invoke and take recourse to Rule 8D. In such a scenario as held in Pr. CIT vs. Keshav Power Ltd.[2019 (8) TMI 811 - SC ORDER] that disallowance is not sustainable. The Revenue filed SLP before the Hon’ble Supreme Court against the order (supra) of the Hon’ble Delhi High Court which stands dismissed reported. [2018 (11) TMI 645 - DELHI HIGH COURT]. Similar is the view expressed in Pr. CIT vs. Reliance Capital Asset Management Ltd. [2018 (9) TMI 883 - SC ORDER] - Moreover, CIT(A) recorded the finding that sufficient own funds were available with the assessee to make investment in shares on which no interest was being paid and that interest bearing funds were utilised only for purposes of business. The above finding could not be controverted by bringing on record any material by the Ld. DR. If that be so, the decision of South Indian Bank Ltd. [2021 (9) TMI 566 - SUPREME COURT] squarely applies to the facts of the assessee’s case wherein it is held that if interest free funds available with the assessee exceeded their investment in tax free securities, investments would be presumed to be made out of assessee’s own funds and no disallowance is warranted. It may be stated that there is no requirement of law either under section 14A or Rule 8D that the assessee should establish nexus between interest free funds and investment which yields exempt income. Decided in favour of assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether disallowance under section 14A read with Rule 8D is sustainable where the Assessing Officer has not recorded satisfaction under section 14A(2) as to correctness of the assessee's self-disallowance. 2. Whether Rule 8D operates mandatorily to compute disallowance irrespective of (a) existence of actual exempt income in the year and (b) the assessee's demonstration that investments were made out of interest-free own funds (i.e., whether a nexus between interest-bearing borrowings and tax-exempt investments must be established by the revenue). ISSUE-WISE DETAILED ANALYSIS Issue 1: Requirement of AO's satisfaction under section 14A(2) before invoking Rule 8D Legal framework: Section 14A(2) requires that where a deduction or allowance is claimed in respect of expenditure otherwise allowable, which is attributable to income not includible in the total income, the Assessing Officer shall make such disallowance as he may consider proper having regard to the accounts and materials on record; Rule 8D provides a method for computation of expenditure in relation to income not includible in total income. Precedent treatment: Higher courts have examined the interplay between section 14A(2) and Rule 8D, holding that Rule 8D can be applied only after the statutory condition (satisfaction under s.14A(2)) is met; authorities have set aside disallowances where AO failed to record requisite satisfaction before mechanically applying Rule 8D. Interpretation and reasoning: The Tribunal notes that the AO did not record any satisfaction regarding the correctness of the assessee's self-disallowance before applying Rule 8D. In absence of such satisfaction, the mechanical application of Rule 8D to compute and add back interest expense was procedurally flawed. The Tribunal relies on the principle that statutory safeguards embodied in s.14A(2) cannot be bypassed by invoking Rule 8D as an automatic tool; procedural preconditions must be fulfilled by the AO. Ratio vs. Obiter: Ratio - The requirement of AO's satisfaction under s.14A(2) is mandatory prior to application of Rule 8D; mechanical application without such satisfaction renders the disallowance unsustainable. Obiter - Observations on ancillary facts related to self-disallowance quantum are incidental. Conclusion: The disallowance computed under Rule 8D is not sustainable where the AO failed to record the mandatory satisfaction under section 14A(2); therefore such disallowance was rightly deleted by the appellate authority. Issue 2: Whether Rule 8D is mandatory irrespective of actual exempt income and whether nexus between interest-free funds and exempt investments must be established Legal framework: Rule 8D prescribes formulas for computing expenditure in relation to exempt income (including apportioned interest expense) and contains clauses addressing interest attributable to investments and proportionate expenses; section 14A governs disallowance for expenditure in relation to income not includible in total income. Precedent treatment: Supreme Court jurisprudence and High Court precedents hold that where interest-free (own) funds available to the assessee exceed the amount invested in tax-exempt securities, investments are to be presumed to have been made out of own funds and no disallowance under s.14A/Rule 8D is required. Further, jurisprudence indicates that Rule 8D is not to be applied in a vacuum where there is no actual exempt income or where the assessee's records show absence of expenditure incurred for earning exempt income. Interpretation and reasoning: The Tribunal accepted the appellate authority's factual finding that sufficient own funds were available to the assessee to make the investments and that interest-bearing funds were utilized only for business purposes. In such factual matrix, it is reasonable to presume investments were made from interest-free funds. The Tribunal further observed there is no statutory requirement either under section 14A or Rule 8D that the assessee must independently establish a direct transactional nexus between specific interest-bearing borrowings and particular exempt investments when the available own funds exceed the investments. The Tribunal emphasized that Rule 8D does not operate as an automatic, mandatory addition every time there are investments yielding exempt income; the context of available funds and actual expenditure incurred for earning exempt income matters. Ratio vs. Obiter: Ratio - Where available interest-free own funds exceed investments in tax-exempt securities, such investments are to be presumed to be out of own funds, and no disallowance under s.14A/Rule 8D is warranted; there is no legal requirement for the assessee to demonstrate an explicit nexus in such circumstances. Obiter - Remarks on the absence of any claimed expenses for earning exempt income in the profit & loss account are incidental to the primary conclusion. Conclusion: Given the finding of sufficient own funds and absence of expenditure incurred specifically for earning exempt income, Rule 8D could not be invoked to make a disallowance; therefore the deletion of the AO's addition was upheld. Cross-references and Interaction of Issues The two issues are interlinked: procedural compliance (Issue 1) is a precondition to substantive application of Rule 8D (Issue 2). Even if procedural requirements had been satisfied, the substantive facts-sufficiency of own funds and absence of expenditure attributable to exempt income-would have precluded disallowance under Rule 8D. The Tribunal thus affirmed both the procedural and substantive bases for deleting the disallowance.