If absence of exempt income disallowance u/s 14A not warranted
Case Law Citation:– M/s Chhaganlal Khimji & Co. Vs. ACIT (ITAT MUMBAI), ITA No. 7629/Mum/2013, Date of Decision: 23.09.2015
Brief case of the case:
In the case of M/s Chhaganlal Khimji & Co. Vs. ACIT Mumbai Bench of ITAT have held that that no disallowance can be made u/s.14A when there is no exempt income. ITAT relied upon the judgments of various courts in coming to the conclusion. ITAT also upheld the decision of CIT (A) on other grounds related to borrowed funds.
Facts of the case:
Assessee Company is a group concern of Marathon Group and engaged in the business of construction of commercial & residential complexes and investments.
The assessee company is authorized to lend advance money as per clause 42 of its object clause of its Memorandum and Article of Association.
During the course of assessment proceedings AO treated the interest income earned by the assessee as income from other sources.
AO also directed to treat the interest expenditure as direct cost and for taking the same to closing work-in-progress.
AO also disallowed interest paid on borrowings against the interest income.
During the year under consideration assessee had entered into a Joint Venture in the form of a Memorandum of Understating with its group concern wherein assessee would receive a tax free dividend of 11 % on the face value of the Preference Shares’ and a Return of 15% on the premium paid.
AO held that interest income earned from interest free advances from customers and borrowed funds invested which resulted in interest income and must be assessed u/s. 56 as income from other sources.
Interest received by the assessee to the tune of Rs.3,65,62,742/- was assessed as income from other sources as against profits and gains of business as returned by the assessee.
During the year the appellant had borrowed Rs.110.02 crores from M/s Marathon Nextgen Realty Ltd.(MNRPL}.
The borrowed funds were in turn invested with M/s.Parmeka Pvt. Ltd. (PPL) a Joint Venture Company in which appellant is one of the Joint Venture partner.
Assessee would receive a tax free dividend of 1,1 % on the face value of the Preference Shares and a Return of 15% on the premium paid.
On the borrowed fund for the investment in preferential shares Rs. 81.50 lakhs and on the balance premium Rs.109.21 crores appellant needs to pay interest @11 % to MNRPL.
The assessee had worked out the disallowance of Rs.1,28,893/- u/s 14A which was not accepted by the AO, as the assessee did not take into consideration the interest paid towards the premium on purchase of 11 % preferential shares.
AO observed that during the year under consideration assessee had considered both the direct as well as indirect cost incurred towards construction as a part of closing stock till AY 2009-10. However, during the AY under consideration only direct cost have been taken leaving the indirect cost as a part of closing WIP.
No reply was submitted before AO regarding this issue.
Since the assessee had consistently followed considering both direct as well as indirect expenses and hence, the AO had transferred Rs.58,55,328/- to closing stock and did not allow the same as expenses to be debited in the P&L account.
Contention of the revenue:
On the investment of Rs.110 Crores towards acquisition of 11 % preference shares in M/s. PPL, the dividend income earned from the shares are exempt therefore, provisions of Sec.14A applies to the facts of the assessee’s case.
Assessee has used the borrowed funds towards making investment in the preference shares and the Interest expenditure on the borrowing needs to be disallowed u/s.14A.
Contention of the assessee:
Regarding disallowance u/s 14A it was contended that only interest attributable to face value of preference shares amounting to Rs.81.50 lakhs is liable to be disallowed and not the interest on the amount borrowed and utilized as a premium on preference shares amounting to Rs.1,09,21,00,000/-.
Since the assessee was not in receipt of any exempt income during the year, therefore, no disallowance is warranted u/s.14A.
Reliance was placed on the decision of Hon’ble High Court in the case of M/s Shivam Motors Pvt. Ltd., 2014-TIOL-754-HC-ALL-IT, wherein the Hon’ble High Court held as under:
Section 14A of the Act provides that for the purposes of computing the total income under the Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act. Hence, what Section 14A provides is that if there is any income which does not form part of the income under the Act, the expenditure which is incurred for earning the income is not an allowable deduction.
Further reliance was placed on the decision of Hon’ble Gujarat High Court in the case of Corrtech Energy (P) Ltd., 45 taxmann.com 116 – 372 ITR 97, wherein it was held that where the assessee did not make any claim for exemption of any income from payment of tax, disallowance under Section 14A could not be made.
Held by CIT (A):
Advances received from the customers, borrowed funds and surplus business funds only were lent to the group concerns which have earned the interest income and hence it constitute the business activity of the appellant.
The borrowed funds were taken from one group concern and invested in another group concern being partner in joint venture.
Both construction as well as lending constitutes the business activities of the assessee and hence, the claim of the appellant that the interest income earned is from business is in order.
The interest on monies borrowed for investment in shares which had not yielded any dividend was admissible as a deduction under section 57(iii) of the Income-tax Act, 1961, in computing its income from dividend under the head “Income from other sources”.
The interest expenditure incurred Rs.2,31,96,641/- needs to be allowed either as business expenditure u/s.36(1)(iii) or u/s.57(iii), it is not correct on the part of the AO to carry into the work-in-progress.
According to the directions issued by the ICAI, the administrative and selling expenditure needs to be debited to the P&L account and not to the closing stock of WIP.
Held BY ITAT:
From the record it is found that the investment and lending activity was a separate stream of business apart from the business activity in real estate. Also assessee was authorized to carry business of money lending as per its memorandum.
The detailed finding to this effect has not been controverted by DR by brining any positive material on record.
Hence order of CIT (A) has confirmed on all three issued related to borrowed funds.
CIT(A) has correctly held that interest expenditure was incurred for the purpose of business, therefore, same is deductible u/s.36(1)(iiii) of the Act or u/s.57 of the Act.
CIT (A) has correctly held that the assessee has already credited interest element of Rs.10,89,78,431/- to the work-in-progress out of total interest ITA No.7629&7674/13 17 of Rs.11.63 crores paid on the loans taken, therefore, there is no need to further apportion interest to the work-in-progress.
As the assessee had already credited interest of Rs.10.89 crores to work in progress out of total interest of Rs.11.63 crores, no further interest is required to be credited to work-in-progress.
No direct expenses incurred for the investment in the preference shares as per the joint venture agreement except that the amount borrowed for making investment in the shares from Marathon Nextgen Realty Pvt. Ltd. to the extent of face value of preference shares of Rs.81,50,000/- on which dividend is going to receive is direct expenditure as per clause (i) of Rule 8D(2) and that comes to Rs.1,08,518/-.
Assessee was in receipt of 15% by way of internal rate of return on premium on preference shares of Rs.109.21 crores which is liable to be taxed, therefore, there is no justification for disallowance of interest attributable to such funds utilized for payments of premium on the preference shares.
During the year under consideration the assessee company was not in receipt of any exempt income, therefore, no disallowance u/s.14A is warranted. Reliance was placed on M/s Shivam Motors Pvt. Ltd. (Supra) and Corrtech Energy (P) Ltd. (Supra).