2025 (6) TMI 389 - AT - Income Tax

Assessee wins on Section 14A Rule 8D disallowance and Section 36(1)(iii) interest disallowance issues

The ITAT Chandigarh ruled in favor of the assessee on two key issues. First, regarding disallowance under Section 14A read with Rule 8D, the Tribunal ... Disallowance u/s 14A r/w Rule 8D - credit of suo-moto disallowance - HELD THAT:- This issue is squarely covered by the Coordinate Bench in favour of the Assesee for A.Y. 2013-14 dt. 20/12/2018 assessee had himself suo-motu made disallowance of this expenditure. Therefore, this finding of the AO is totally irrelevant. Further, the AO has stated that in the absence of any direct evidence of expenses incurred to earn exempt income, disallowance u/s 14A is to be computed as per Rule 8D and has further stated that since the assessee had mixed funds, Rule 8D was applicable. This finding of the AO also, we find, does not dislodge the explanation of the assessee regarding the disallowance computed by it. Therefore, clearly there is no satisfaction of the AO regarding the incorrectness of the claim of expenditure by the assessee incurred in relation to earning exempt income. In view of the same, the disallowance computed by the AO is bad in law and is, therefore, directed to be deleted. Disallowance of interest u/s 36(1)(iii) - investments made by the assessee holding the same to be for non business purposes - AO disallowed the proportionate interest - CIT(A) has rightly deleted the disallowance of interest u/s 36(1)(iii) of the Act on finding that sufficient own interest free funds were available with the assessee for making the impugned investments and following the decision in the case of Bright Enterprises [2015 (11) TMI 342 - PUNJAB & HARYANA HIGH COURT] In view of the same, the ground of appeal raised by the Revenue is dismissed. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Tribunal in this appeal pertain to the following issues:(a) Whether the disallowance made under Section 14A of the Income Tax Act, 1961 read with Rule 8D, in respect of expenses related to exempt income, was justified and whether the Assessing Officer (AO) had recorded requisite satisfaction before invoking Rule 8D.(b) Whether the disallowance under Section 14A can be imported into the scheme of calculation of book profits under Section 115JB of the Act for Minimum Alternate Tax (MAT) purposes.(c) Whether the disallowance of interest expenditure on investments under Section 36(1)(iii) of the Act was warranted, considering the availability of own funds versus borrowed funds for making such investments.(d) Whether, alternatively, the disallowed interest expenditure could be allowed as a deduction under Section 57 of the Act against income from other sources.(e) General challenge to the order of the National Faceless Appeal Centre / Ld. CIT(A) for alleged non-appreciation of facts and erroneous legal conclusions.2. ISSUE-WISE DETAILED ANALYSISIssue (a): Validity of Disallowance under Section 14A read with Rule 8DLegal Framework and Precedents: Section 14A prohibits deduction of expenditure incurred in relation to income which does not form part of total income (exempt income). Sub-section (2) mandates that the AO shall determine the amount of such expenditure using prescribed methods only if he is 'not satisfied' with the assessee's claim. Rule 8D prescribes a formulaic method for such determination. The Supreme Court and various High Courts have held that before invoking Rule 8D, the AO must record objective satisfaction based on cogent reasons that the assessee's claim is incorrect. The onus lies on the AO to disprove the correctness of the claim. Relevant precedents include CIT vs. Deepak Mittal and CIT vs. Abhishek Industries Ltd., which emphasize strict and objective satisfaction before disallowance.Court's Interpretation and Reasoning: The Tribunal noted that the AO invoked Rule 8D mechanically without recording any specific satisfaction or cogent reasons dislodging the assessee's methodology. The assessee had made a suo-motu disallowance of Rs. 556/- based on allocation of expenses proportionate to exempt income earned through Portfolio Management Services (PMS) and Alternative Investment Funds (AIF). The AO simply disregarded this and applied Rule 8D formula on the entire investment value, resulting in a disallowance of Rs. 1,78,314/- after crediting the suo-motu disallowance.The Tribunal relied on a Coordinate Bench decision in the assessee's own case for AY 2013-14, which held that invoking Rule 8D without recording satisfaction on the incorrectness of the assessee's claim is impermissible. The AO's failure to provide any reasoned satisfaction rendered the disallowance invalid. The Tribunal also referred to judicial pronouncements where similar proportional allocation methods by the assessee were upheld.Key Evidence and Findings: The assessee's detailed calculations of expenses allocated to exempt income, the absence of AO's satisfaction, and the consistent judicial support for the assessee's method were critical. The AO's reliance on Rule 8D as mandatory, without examining the facts or the correctness of the claim, was found to be flawed.Application of Law to Facts: The Tribunal applied the principle that Rule 8D is applicable only upon AO's satisfaction of incorrectness, which was absent. Since the assessee had already made a proportional disallowance, and no evidence was brought to disprove it, the AO's disallowance was quashed.Treatment of Competing Arguments: The Revenue argued that Rule 8D is mandatory and that the assessee failed to prove correctness of its claim. The Tribunal rejected this, emphasizing that the AO must first record satisfaction based on evidence, which was not done.Conclusions: The disallowance under Section 14A read with Rule 8D was held to be illegal and was deleted.Issue (b): Incorporation of Section 14A Disallowance into Book Profits under Section 115JBLegal Framework and Precedents: Section 115JB provides a self-contained code for computation of book profits for MAT purposes. The Special Bench of the Tribunal in ACIT vs. Vireet Investment P. Ltd. held that disallowances under Section 14A cannot be imported into book profits under Section 115JB.Court's Interpretation and Reasoning: The Tribunal agreed with the assessee that Section 115JB operates independently and disallowances under Section 14A should not affect book profits. The Tribunal relied on the Coordinate Bench decision in the assessee's associate company's case, which supported this view.Application of Law to Facts: The AO's adjustment of book profits by adding back Section 14A disallowance was found to be contrary to the statutory scheme.Conclusions: The disallowance under Section 14A cannot be embedded into the book profits under Section 115JB, and such adjustment was disallowed.Issue (c): Disallowance of Interest Expenditure under Section 36(1)(iii)Legal Framework and Precedents: Section 36(1)(iii) disallows interest expenditure unless it is incurred for the purpose of the business or profession. The Supreme Court in South Indian Bank Ltd. vs. CIT held that where an assessee has mixed funds (interest-bearing and interest-free), the presumption is that investments are made out of interest-free own funds, and interest disallowance is not warranted if sufficient own funds are available.Various High Court and Tribunal decisions, including Bright Enterprises Pvt. Ltd. vs. CIT and CIT vs. Kapsons Associates Investment Pvt. Ltd., have held that no disallowance arises if adequate own funds or reserves are available.Court's Interpretation and Reasoning: The Tribunal noted the assessee's substantial own funds and reserves (Rs. 339.31 crores) compared to investments (Rs. 8.16 crores). The AO disallowed interest expenditure of Rs. 8,16,010/- on a notional basis, alleging investments were non-business related and funded by borrowed money. The Tribunal relied on the Coordinate Bench decision in the assessee's own case for AY 2013-14, which deleted such disallowance on similar facts.Key Evidence and Findings: The balance sheet and profit and loss account showed sufficient own funds. The AO did not dispute the availability of own funds. The Tribunal observed that the AO failed to establish that borrowed funds were used for investments.Application of Law to Facts: The presumption under the Supreme Court ruling was applied, favoring the assessee. The Tribunal found no reason to interfere with the CIT(A)'s deletion of the disallowance.Treatment of Competing Arguments: The Revenue relied on AO's order and argued investments were non-business and funded by borrowed money. The Tribunal found these arguments unsubstantiated.Conclusions: The disallowance of interest expenditure under Section 36(1)(iii) was deleted.Issue (d): Allowance of Disallowed Interest Expenditure under Section 57Legal Framework: Section 57 allows deduction of interest expenditure against income from other sources.Court's Interpretation and Reasoning: The assessee submitted that if the disallowance under Section 36(1)(iii) is upheld, the notional interest should be allowed under Section 57 against income from other sources. The Tribunal did not explicitly decide this issue as it deleted the disallowance under Section 36(1)(iii).Conclusions: The issue became infructuous due to deletion of disallowance under Section 36(1)(iii).Issue (e): General Grounds of AppealThe Tribunal dismissed the general ground as it was non-specific.3. SIGNIFICANT HOLDINGS'Undoubtedly as per the provision of Section 14A, the AO can determine the amount of expenditure incurred in accordance with the prescribed method only once he is satisfied with the incorrectness of the claim of the assessee in this regard.''The jurisdictional High Court has stated that the satisfaction should be an objective satisfaction.''The AO in his entire order has not given any finding as to why this basis of calculating the disallowance of expenses was incorrect.''The disallowance computed by the AO is bad in law and is, therefore, directed to be deleted.''Section 115JB is a self-contained code and disallowance made u/s 14A cannot be imported into book profits.''Where sufficient own interest free funds are available, the presumption is that the same have been used for the purpose of making investments and calling for no disallowance of interest u/s 36(1)(iii).''The finding of fact recorded by the CIT(A) that the assessee had sufficient own interest free funds for making the investments in relation to which interest expenditure had been disallowed by the AO has not been disputed by the Revenue.'Final determinations:- The disallowance under Section 14A read with Rule 8D was deleted due to lack of AO's satisfaction and incorrect application of Rule 8D.- The disallowance under Section 14A cannot be incorporated into book profits under Section 115JB.- The disallowance of interest expenditure under Section 36(1)(iii) was deleted on the basis of sufficient own funds and relevant judicial precedents.- The alternative relief under Section 57 was not adjudicated as disallowance under Section 36(1)(iii) was deleted.