2024 (10) TMI 1707 - AT - Income Tax

Deletion of disallowance under u/s 14A read with r.8D where no exempt dividend and investments funded by own interest-free funds

M/s. Sapphire Foods India Limited, Versus   DCIT, Circle 3 (3) (1), Mumbai

M/s. Sapphire Foods India Limited, Versus   DCIT, Circle 3 (3) (1), Mumbai - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether disallowance under section 14A of the Act read with rule 8D of the Rules can be made where no exempt income (dividend) is earned or receivable in the relevant assessment year. 2. Whether investments made out of the assessee's own non-interest-bearing (interest-free) funds, when such funds exceed the invested amount, permit drawing a presumption that borrowed funds were not used and therefore preclude disallowance under section 14A read with rule 8D. 3. Whether the amendment to section 14A by the Finance Act, 2022 (and the related CBDT circular) applies retrospectively to assessment year 2021-22 so as to permit disallowance even in absence of exempt income. ISSUE-WISE DETAILED ANALYSIS - Issue 1: Applicability of section 14A / rule 8D where no exempt income is earned Legal framework: Section 14A disallows expenditure attributable to income exempt under the Act; rule 8D prescribes a formulaic computation for such disallowance. CBDT circulars have previously guided application. Amendment by Finance Act, 2022 altered the statutory text and included an explanation. Precedent Treatment: Earlier decisions of several High Courts and tribunals have held that section 14A does not operate in cases where no exempt income is earned or receivable in the relevant year; notable decisions applied this principle to deny disallowance in absence of exempt income. Interpretation and reasoning: The Tribunal examined the factual matrix - no dividend income was earned in the assessment year - and relied on precedent holding that section 14A is not attracted where no exempt income arises. The Court observed that, on facts, exempt income was absent and therefore rule 8D-based disallowance lacks foundational basis in that year. Ratio vs. Obiter: Ratio: In factual situations where no exempt income is earned or receivable in the relevant year, section 14A/rule 8D disallowance is not warranted. Obiter: Observations on policy and CBDT circulars are ancillary to the factual ratio. Conclusion: No disallowance under section 14A/rule 8D is sustainable for the assessment year in question because no exempt income was earned or receivable in that year. ISSUE-WISE DETAILED ANALYSIS - Issue 2: Presumption of use of interest-free funds where such funds exceed investments Legal framework: Principle of allocation of sources when an assessee has both interest-bearing borrowed funds and interest-free own funds; tax law permits inference regarding source of investment where facts establish sufficiency of interest-free funds. Precedent Treatment: Jurisdictional High Court and appellate authorities have held that where interest-free funds available to the assessee are sufficient to meet investments in tax-exempt shares/advances, a presumption arises that investments were made from such interest-free funds and not from borrowed funds, leading to deletion of section 14A disallowance. Interpretation and reasoning: The Tribunal accepted the assessee's fund-flow evidence showing initial and cumulative investments funded by non-interest-bearing funds substantially exceeding the specific investment in the relevant year. Applying the precedent, the Tribunal drew the permissible presumption that investments were out of interest-free funds, removing the factual basis for attributing interest expense to exempt income. Ratio vs. Obiter: Ratio: Where admissible material establishes that interest-free own funds exceed the investment amount, the presumption that investments were financed by such funds is available and precludes section 14A disallowance. Obiter: Commentary on the correctness of alternative allocation methodologies is not essential to the ratio. Conclusion: The assessee's undisputed evidence of sufficient interest-free funds establishes that the impugned investment was funded from non-interest-bearing sources; accordingly, section 14A disallowance cannot be sustained on this ground. ISSUE-WISE DETAILED ANALYSIS - Issue 3: Effect of Finance Act, 2022 amendment to section 14A on assessment year 2021-22 Legal framework: Finance Act, 2022 amended section 14A (including insertion of a non-obstante clause and an explanation) and the CBDT had issued circular guidance earlier; question arises whether amendment operates retrospectively to affect assessments prior to its enactment. Precedent Treatment: Conflicting judicial views noted: some High Courts held the amendment retrospective; others held the amendment applies prospectively from assessment year 2022-23. Authorities have differed on whether the 2022 amendment validates disallowances in years where no exempt income arose. Interpretation and reasoning: The Tribunal examined the text and intent of the amendment but, on the facts, concluded the amendment does not assist the revenue because the assessee neither earned exempt income nor used borrowed funds for the relevant investment. The Tribunal relied on jurisdictional precedents that, in analogous fact patterns where interest-free funds suffice, section 14A disallowance was deleted despite subsequent statutory amendments. The Tribunal treated the 2022 amendment as not altering outcomes where factual sufficiency of interest-free funds exists and where the assessment year predates the amendment's operative effect as applied in comparable decisions. Ratio vs. Obiter: Ratio: The amendment to section 14A does not justify sustaining a disallowance in an assessment year where (a) no exempt income was earned/receivable and (b) admissible material establishes that interest-free funds exceeded the investment; thus the amended provision does not alter the result. Obiter: Express views on retrospective/declaratory character of the amendment beyond this factual matrix are explanatory. Conclusion: The 2022 amendment to section 14A does not operate to sustain the disputed disallowance for the assessment year under consideration given absence of exempt income and demonstrable sufficiency of interest-free funds; the addition under section 14A/rule 8D is therefore deleted. Cross-reference The conclusions on Issues 1-3 are interdependent: absence of exempt income (Issue 1) combined with evidentiary demonstration that interest-free funds exceeded the investment (Issue 2) renders inapplicable any disallowance under section 14A notwithstanding the amendment debates considered under Issue 3.