The Mumbai bench of the Income Tax Appellate Tribunal, has recently observed that while disallowing interest expenditure under section 14A of the Income Tax Act, 1961, the Assessing Officer shall record a sufficient reason for such disallowance. The Appellate Tribunal further opined that this is a mandatory requirement and the condition is applicable even in respect of assessment years before 2007.
The assessee-company had made an investment in shares of another company by raising a loan from its Directors and shareholders. While filing return of income for the relevant assessment year, the Assessee claimed deduction in respect of interest expenditure under section u/s 40A(2)(b) of the Income Tax Act. However, the Assessing Officer disallowed the claim by holding that the amount of loan raised from the Directors and shareholders were utilized to purchase the shares of a Company in which the Directors had substantial interest.
On appeal, the Commissioner of Income Tax(Appeals) confirmed the said order by finding that the assessee had borrowed funds from the banks on security of stocks and debtors @ 13.5%. It had borrowed Rs. 55,00,000/- from its Directors and paid interest thereon@ 16%. The borrowings made from the Directors were utilized for making investment in shares of Bharat Bijlee Ltd. wherein the assessee’s Directors had substantial interest. Therefore, the disallowance is justifiable. The CIT(A) further opined that interest of Rs. 8,54,836/- was otherwise disallowable u/s 14A.
The Tribunal, on second appeal preferred by the assessee noticed that in S.A. Builders vs. CIT, the Supreme Court has held that, “that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the armchair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize his profit. The IT authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own viewpoint but that of a prudent businessman.”
The Tribunal found that the present case is duly covered by the above decision since the assessee is in the business of manufacturing and trading in electrical and industrial chemicals. Further, the “Articles of Agreement”clearly specifies that “the assessee shall manufacture and sell to Bharat Bijlee Ltd. electrical/electronic and industrial products for distribution in India.” The Tribunal opined that “one has to see the transfer of the borrowed funds to a sister concern from the point of view of commercial expediency”.
Regarding the finding of the learned CIT(A) for A.Y. 2004-05 that interest of Rs. 8,54,836/- was otherwise disallowable u/s 14A, the Tribunal observed that “ We have gone through the assessment for the above year and find that the AO has not mentioned anything about disallowance of interest under section 14A. Before applying the provisions of sec.14A of the Act, the AO has to record a satisfaction that having regard to the accounts of the assessee, the claim is not correct. Though the aforesaid conditions enshrined in sec. 14A(2) was brought into the statute by Finance Act, 2006 w.e.f. 1st April 2007, however , it has been held in judicial precedents, such condition will apply even in respect of earlier assessment years. Thus, recording of satisfaction by the AO is a mandatory requirement. This is absent in present case. Therefore the issue of disallowance u/s 14A in A.Y. 2004-05 does not arise”.
Read the full text of the order below.
