The Ahmedabad bench of the Income Tax Appellate Tribunal (ITAT) quashed invocation of section 14 of the Income Tax Act 1961 (ITA) noting that it was not applicable in the assessee’s case as no nexus between borrowed fund and tax-exempt investments could be found, which is a prerequisite for attracting this particular section.
The case consists of cross-appeals filed by both the Revenue and the Assessee concerning the disallowance of expenses under Section 14A of the Income Tax Legislature. These appeals arose from an order passed by the Commissioner of Income Tax (Appeals) [CIT(A)] in Vadodara for the assessment year (A.Y.) 2011-12.
The assessee in this case is Gujarat State Fertilizers and Chemicals Ltd.
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Initially, the Assessing Officer (AO) invoked Section 14A of the tax statute and Rule 8D of the Income Tax Rules to disallow interest and administrative expenses claimed by the Assessee, with the total disallowance amounting to Rs. 3,95,40,410/-. The AO disallowed Rs. 1,82,91,360/- as interest expenses and Rs. 2,12,49,050/- as administrative expenses. The Assessee, however, had already made a suo-moto disallowance of Rs. 60,276/- for administrative expenses related to exempt income. Dissatisfied with the AO’s approach, the Assessee appealed before the CIT(A).
The CIT(A) ruled in favor of the Assessee regarding the interest expenses, deleting the disallowance of Rs. 1,82,91,360/-. However, the CIT(A) upheld the disallowance of administrative expenses amounting to Rs. 2,12,49,050/-, with a specific direction that certain investments—such as those in the National Savings Certificate and TIFERT—be excluded from the calculation of disallowance. Dissatisfied with this partial relief, both the Assessee and the Revenue approached the ITAT.
The Tribunal, after reviewing the case, remanded it back to the AO for further examination, particularly on the question of whether current liabilities and provisions should be deducted from the opening and closing stock of current assets when calculating the disallowance under Rule 8D. The Tribunal stressed that the AO needed to examine the disallowance more carefully, especially with regard to whether the Assessee’s own funds, rather than borrowed funds, were used for investments generating tax-exempt income. The AO was instructed to record satisfaction in this regard before making any disallowance under Section 14A of the tax statute.
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The Assessee, dissatisfied with the Tribunal’s order, filed appeals before the Gujarat High Court.
The High Court noted that the Tribunal had failed to consider the rulings from prior assessment years in the Assessee’s own case, where similar disallowances were dealt with differently. The High Court found this to be a significant oversight and remanded the case back to the Tribunal for a fresh hearing on the specific grounds related to Section 14A disallowance.
Now, before the tribunal the Assessee presented its case, highlighting that it had substantial own funds—comprising share capital and reserves—amounting to Rs. 2,82,865.47 lakhs as of March 31, 2011. These funds far exceeded the borrowed funds of Rs. 68,758.26 lakhs. The Assessee argued that it had not made any new investments in tax-free securities during the relevant financial year and that its existing investments had been funded through its own surplus funds, not borrowed money. The Assessee’s representative also cited decisions from prior assessment years (A.Y. 2008-09 to A.Y. 2010-11), where similar disallowances were either reduced or eliminated by the Tribunal and the Gujarat High Court.
The Revenue, on the other hand, argued that the CIT(A) erred in deleting the disallowance of interest expenses, as the Assessee had failed to provide conclusive evidence that borrowed funds were not used for investments generating tax-exempt income. According to the Revenue, the burden was on the Assessee to prove that its own surplus funds, rather than borrowed money, were used for these investments.
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Upon review, the division bench of Ms Suchitra Kamble and Mr Makarand V Mahadeokar observed that the Assessee had indeed demonstrated that its own funds were sufficient to cover the investments in tax-exempt securities. The Tribunal noted that the AO had failed to establish a clear link between borrowed funds and the investments yielding exempt income, a crucial requirement for making a valid disallowance under Section 14A of ITA. Additionally, the Tribunal referenced the Gujarat High Court’s rulings in the Assessee’s previous assessment years, which held that no disallowance could be made if the Assessee’s interest-free funds exceeded the investments.
Furthermore, the Tribunal considered the Supreme Court’s decision in Excel Industries Ltd., which stressed the need for consistency in the application of legal principles across assessment years unless there were substantial reasons to deviate. Given that the Assessee’s own funds far exceeded the investments and the AO had not provided adequate reasoning for invoking Rule 8D, the Tribunal upheld the CIT(A)’s decision to delete the disallowance of interest expenses.
In light of this, the Tribunal dismissed the Revenue’s appeal regarding the interest disallowance and deemed the Assessee’s cross-objections to be infructuous. The Tribunal also instructed the AO to carefully reconsider the Assessee’s claims regarding administrative expenses and to ensure that dissatisfaction is properly recorded before any future disallowances are made.
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