Disallowance u/s 14A gets attracted even if a mix of interest bearing & non-bearing funds used to make investments earning exempt income
Case Law Citation: –M/s Thermotech Engineering vs. ACIT, Pune (ITAT Pune), ITA No.- 533/PN/2013, Date of Pronouncement – 30.10.2015, Assessment Year-2009-10
Brief of the case:
The ITAT bench of Pune in the case of M/s Thermotech Engineering held that where the assessee has earned exempt income and incurred expenditure by way of interest
which is not directly attributable to any particular income, the assessee is liable to fact the disallowance to be worked as per Rule 8D(2)(ii) unless it is
established that investment in mutual funds were from independent sources on which no interest expenditure was incurred.
Facts of the case:
The assessee firm was engaged in designing, manufacturing and supply of reactors, pressure vessels, agitators, tanks, etc. During the course of assessment proceedings,
the Assessing Officer noted that the assessee had earned exempt income of Rs.24,18,535/- i.e. the dividend on mutual fund.
The Assessing Officer also noted that in Form No.3CD of audit report in para 17(1), the assessee had declared NIL amount as amount inadmissible as a deduction in terms
of section 14A of the Act.
AO issued a questionnaire in which inter alia assessee was required to furnish the details of expenditure incurred for earning tax-free income and also to explain as
to why disallowance should not be made under provisions of section 14A of the Act.
Assessee in its reply stated that provisions of section 14A and Rule 8D of the Income Tax Rules, 1962 were not applicable, since there was no direct cost to earn
The Assessing Officer computed the disallowance under section 14A of the Act read along with Rule 8D of the Rules by taking the average of value of investment and
average of total assets and also made the disallowance both under Rule 8D(ii) and 8D(iii) of the Rules. The Assessing Officer computed the disallowance under section
14A of the Act at Rs.11,40,553/-
On appeal to CIT(A) he also agreed and upheld the disallowance made by AO and stated that the investment in mutual fund had been made from the common pool of funds
available with the assessee both were interest bearing as well as interest-free. Therefore, the assessee’s claim that no interest bearing funds were utilized for
investment in mutual funds was not accepted by the CIT(A).
Aggrieved assessee is in appeal before ITAT.
Contention of the Assessee:
The learned counsel for the assessee submitted that dividend income of Rs.24,18,535/- on an investment made in mutual fund units, which in turn was in Automatic
Dividend Reinvested Plan. As such no cash income received in hands and no expenditure was incurred in earning the aforesaid dividend income, no disallowance was to be
made under section 14A of the Act.
A working also shown and it was claimed that that non-interest bearing funds available with the assessee firm were to the extent of Rs.10.30 crores, whereas the
investment in the mutual fund was only Rs.4.55 crores.
The mixed funds theory pointed out by CIT(A) was also challenged by arguing that theory of mixed funds has been overruled by the Hon’ble High Court of Karnataka in
Canara Bank Vs. ACIT (2014) 99 DTR 36. Thus, even if the investment was made by a mixture of interest bearing and non-bearing funds, disallowance u/s 14A is not
Contention of the Revenue:
The departmental representative contended that even if there may not be any direct expenditure incurred by assessee to earn dividend income still the assessee to face
disallowance as long as it fails to prove that investment was wholly out of non-interest bearing funds.
The Revenue pointed out that theory of non-interest bearing funds available with the assessee on account of sundry creditors, outstanding liabilities and advance from
customers had no basis and in the absence of assessee establishing because assessee failed to explain how such funds could have used to made investment in mutual fund.
Further Rule 8D make its very clear that the expenditure of interest which is not directly attributable to any particular of income is to be considered for working out
Held by ITAT:
Section 14A of the Act provides that the expenditure incurred in relation to income, which is exempt from tax (i.e. not includable in the total income) shall be
disallowed while computing the total income.
Under section 14A(2) of the Act, the Assessing Officer shall determine the amount of expenditure incurred in relation to such income, which does not form part of total
income under the Act, in accordance with the method prescribed in Rule 8D of the IT Rules, 1962 where the Assessing Officer is not satisfied with the correctness of
the claim of the assessee in respect of such expenditure relating to the income.
The Assessing Officer issued a questionnaire to the assessee and required it to furnish the details of expenditure for earning tax free income and also to explain as
to why disallowance should not be made as per the provisions of section 14A of the Act. Further, after receipt of assessee’s reply AO furnished the working of
disallowance u/Rule 8D to it. This all prove that the Assessing Officer had recorded implicit satisfaction before working out the disallowance under section 14A of the
Act in terms of Sec 14A(2).
The case of the assessee was that no direct expenditure was incurred, hence, the provisions of Rule 8D of the Rules were not applicable. The balance sheet presented
before the bench shows that the funds available with the assessee were a common pool of funds, which included both the interest bearing and interest free funds because
the investment in mutual funds are slightly lesser than that of partner’s capital account , it implies that both investment in mutual funds consist of both interest
free funds and interest bearing funds(partner’s capital).
Further, assessee also failed to establish that it had made the investment in the mutual funds from independent sources on which for no interest expenditure was
incurred. And since investment was out of common pool the method prescribed under Rule 8D squarely applies as there was some interest expenses not attributable
exclusively in earning tax free income.
In result the disallowance made by AO was upheld and appeal of assessee was dismissed.