2024 (6) TMI 1534 - AT - Income Tax

Borrowed funds and equity investments: interest disallowance u/s36(1)(iii) rejected; s.14A limited to exempt dividends

Disallowance of interest under s.36(1)(iii) turned on whether borrowed funds were diverted to non-business investments. The Tribunal held the AO made no ... Disallowance of interest expenditure u/s 36(1)(iii) and section 14A r.w. Rule 8D of the Rules - HELD THAT:- As there is no finding from the AO with regard to the diversion of loan borrowed for the purpose of business for non-business purpose. Although the AO refers to increase in equity instruments and corresponding increase in long term and short term borrowings, but failed to make out a case that increase in investments in equity instruments is out of borrowed funds. Assessee has filed all the evidences and proved that investment in equity instruments of various companies is for strategic business purpose and said investments gave business advantage to the assessee. We find that the assessee has made investments in various companies as directly or indirectly connected with business carried on by the assessee. If the amounts so invested is purely a strategic investment and for the purpose of commercial expediency, then the AO cannot held that the said investments are for non-business purpose. Further, by investing in various companies linked with Tata Group concern, the company got several advantages in its automobile dealership business, since the appellant is only a sole and exclusive authorised dealer of Tata Motors for the entire state of Telangana and in the three districts of Andhra Pradesh for commercial vehicles. Further, the said investment has given various business advantages to the assessee. Therefore, AO is erred in treating the investment in equity instruments is not for the purpose of business of the assessee. CIT(A) after considering the relevant submissions, has rightly held that the AO failed to make out a case of diversion of interest bearing funds for non-business purpose and consequently, provisions of section 36(1)(iii) of the Act, cannot be invoked. Thus, we are inclined to uphold the findings of the Ld. CIT(A), and reject the grounds raised by the Revenue. Addition u/s 14A r.w. Rule 8D - As there is no error in the reasons given by the Ld. CIT(A) to restrict the disallowance interest expenditure u/s. 14A r.w. Rule 8D of the Rules to the extent of dividend income earned for the assessment year, because this issue is fully covered by the decisions in the case of CIT vs. Chettinad Logistics Pvt. Ltd [2018 (7) TMI 567 - SC ORDER] - A similar view was also taken in the case of Cheminvest Ltd., [2015 (9) TMI 238 - DELHI HIGH COURT] wherein it was clearly held that if no exempt income, then, no disallowance u/s. 14A r.w. Rule 8D of the Rules. disallowance u/s. 14A r.w. Rule 8D of the Rules does not exceed the exempt income earned for the relevant assessment year. In the present case, CIT(A) restricted the disallowance u/s. 14A r.w. Rule 8D of the Rules to the extent of exempt income earned by the assessee. Therefore, we are inclined to uphold the findings of the Ld. CIT(A) and reject the grounds raised by the assessee. Disallowance of adhoc addition made towards un-proved sundry creditors -AO has disallowed 20% of un-proved sundry creditors on the ground that the assessee did not file the verifiable details with regard to sundry creditors - HELD THAT:- The assessee has filed confirmation letters to the extent of 90% of sundry creditors shown in the books of account of assessee for the relevant assessment year. For some cases although the assessee has requested the parties to file confirmations, but for various reasons, few parties have not responded. AO disallowed 20% of remaining creditors, where there was no confirmation from the parties. However, the AO has not given any plausible reasons for making adhoc disallowance of un-proved sundry creditors. In our considered view, there cannot be any adhoc disallowance, without giving proper reasons for such disallowance. Ld. CIT(A) after considering the relevant facts has rightly deleted the addition made by the AO. Thus, we are inclined to uphold the findings of the CIT(A) and reject the ground raised by the Revenue. Disallowance of ROC fees for increase in authorised share capital - Assessee at the time of arguments submitted that the assessee does not want to press the said ground, since the same has been decided against the assessee in the case of Brook band India Ltd [1997 (2) TMI 11 - SUPREME COURT] -Therefore, there is no error in the reasons given by the Ld. CIT(A) to sustain the addition made towards disallowance of ROC paid for increase in authorised share capital. 1. ISSUES PRESENTED AND CONSIDERED (i) Whether proportionate interest was disallowable under section 36(1)(iii) on the basis that interest-bearing borrowings were diverted to make investments in equity instruments allegedly for non-business purposes. (ii) Whether a disallowance under section 14A read with Rule 8D was warranted and, if so, whether it had to be restricted to the extent of exempt dividend income earned during the relevant year. (iii) Whether an ad hoc disallowance of a portion of sundry creditors merely for want of confirmations was sustainable when the underlying purchases/expenses were not doubted. (iv) Whether fees paid for increase in authorised share capital were capital expenditure and therefore not allowable as revenue deduction. 2. ISSUE-WISE DETAILED ANALYSIS (i) Disallowance of interest under section 36(1)(iii) for alleged diversion of borrowed funds Legal framework: The Court noted that section 36(1)(iii) allows deduction of interest on borrowed capital used for business; where borrowed funds are diverted for non-business purposes, interest relatable to such non-business use is not allowable. Interpretation and reasoning: The disallowance was premised mainly on an increase in investments alongside an increase in borrowings. The Court held that a mere correlation between increased investments and increased borrowings is insufficient. It found a crucial factual gap: there was no finding establishing that the increased investments were made out of borrowed funds or that loans taken for business were actually diverted to non-business purposes. The Court also accepted that the investments were shown, on evidence, to be strategic and connected with the assessee's business interests, and therefore could not be treated as inherently non-business. Conclusion: The Court upheld the appellate finding that the necessary factual foundation for invoking section 36(1)(iii) was absent; consequently, the interest disallowance under section 36(1)(iii) was not sustainable. (ii) Disallowance under section 14A read with Rule 8D and its ceiling by exempt income Legal framework: The Court examined section 14A read with Rule 8D as the mechanism to disallow expenditure relatable to exempt income. It addressed the permissible extent of such disallowance with reference to the exempt income earned in the year. Interpretation and reasoning: While section 36(1)(iii) disallowance failed for lack of proof of diversion, the Court agreed with applying section 14A in principle because exempt dividend income was earned. It further agreed with the restriction imposed by the appellate authority that the disallowance under section 14A should not exceed the exempt income of the year. The Court treated this restriction as consistent with the governing judicial principle applied in the reasoning that section 14A disallowance cannot surpass the exempt income earned for that assessment year. Conclusion: The Court upheld the direction to compute disallowance under section 14A read with Rule 8D, restricted to the amount of exempt dividend income earned during the relevant year. (iii) Ad hoc disallowance relating to sundry creditors for non-furnishing of confirmations Interpretation and reasoning: The Court noted that confirmations were produced for a substantial portion of creditors and that non-receipt of some confirmations, by itself, did not justify an estimated disallowance. It emphasized that the assessing authority did not provide plausible reasons for disallowing a fixed percentage of remaining creditors and did not demonstrate defects warranting such estimation, particularly when the underlying purchases/expenses were not doubted. Conclusion: The Court upheld deletion of the ad hoc disallowance; a percentage-based disallowance without cogent reasons was held unsustainable on the facts recorded. (iv) Fees paid for increase in authorised share capital Interpretation and reasoning: The Court affirmed the treatment of the expenditure as capital in nature where it was incurred towards increase in authorised share capital. It sustained the disallowance on that basis. Conclusion: The disallowance of the fees paid for increase in authorised share capital was upheld as capital expenditure.