2023 (11) TMI 1375 - AT - Income Tax

Disallowance of notional Interest u/s 36(1)(iii) on Loan given to subsidiary - HELD THAT - As decided in own case 2021 (9) TMI 882 - ITAT MUMBAI view taken by the lower authorities is absolutely misconceived and in fact misplaced. In our considered view if there be interest-free funds available with an assessee which are sufficient to meet its interest free investments; and at the same time the assessee had raised interest bearing loans then the presumption would be that the investments in question were made by the assessee from the interest-free funds so available with it. Our aforesaid view is fortified by the judgment of Reliance Utilities Power Ltd. 2009 (1) TMI 4 - BOMBAY HIGH COURT . In its aforesaid order the Hon ble High Court had observed that in case if the assessee had advanced interest-free amounts out of its mixed funds i.e interest free and interest bearing funds lying in common pool then the presumption would be that the amount so advanced was from the interest-free funds available with the assessee company. As we follow the judicial precedence and set- aside the order of the CIT(A) on this disputed issue of charging notional interest and direct the AO to delete the addition and allow these grounds of appeal in favour of the assessee. Disallowance U/sec 14A r.w.r 8D(2)(ii) (iii) - AO has not recorded satisfaction on the incorrectness of claim - HELD THAT - In Vireet Investment Pvt. Ltd. 2017 (6) TMI 1124 - ITAT DELHI has held inter-alia that (i) computation under clause (f) of Explanation 1 to section 115JB(2) is to be made without resorting to computation as contemplated u/s 14A read with rule 8D; (ii) only those investments are to be considered for computing average value of investment which yielded exempt income during year. As mentioned earlier in Maxopp. Investment Ltd. 2018 (3) TMI 805 - SUPREME COURT has held interalia that (i) only expenses proportionate to earning exempt income could be disallowed u/s 14A; (ii) the dominant purpose for which investment into shares is made by assessee may not be relevant as section 14A applies irrespective of whether shares are held to gain control or as stock-in-trade. Thus we set aside the order of the Ld. CIT(A) and restore the matter to the file of the AO to recomputed the disallowance u/s 14A r.w. Rule 8D for the normal computation.Grounds of appeal of the assessee for statistical purposes. Disallowance in computing the book profits U/sec 115JB on disallowance u/s 14A - In the assessee appeal on the issue of computation of disallowance U/sec 14A r.w.r 8D(2)(ii) (iii) of the I T Rules relying on the decision in the own case for A.Y.2009-10 and also considering the facts that only investments which yield exempt income should be considered for computing the disallowance under sec14A r.w.r 8D(2)(ii) (iii) of the I T Rules the matter was restored with the directions to the file of the AO. Since the issue of computation of disallowance u/sec14A r.w.r 8D(2)(ii) (iii) of IT Rules is restored to the file of the Assessing Officer with specific directions as discussed above paragraph. We considered it appropriate to restore this disputed issue in the revenue appeal also to the file of the Assessing Officer to re compute the disallowance u/sec 14A of the Act and exclude the disallowance in computing the book profits U/sec 115JB of the Act. Accordingly the grounds of appeal are allowed for statistical purposes.

Summary

The core legal issues considered by the Tribunal in this appeal and cross-appeal include:

1. Whether notional interest on interest-free loan advanced to a subsidiary company is disallowable under section 36(1)(iii) of the Income Tax Act, 1961, especially when the loan is given out of the assessee's own surplus funds and for commercial expediency.

2. Whether disallowance under section 14A of the Act read with Rule 8D of the Income Tax Rules, 1962, in respect of expenditure related to exempt dividend income under section 10(34) of the Act, is justified, including the quantum and basis of such disallowance.

3. Whether interest under section 234B of the Act was rightly levied.

4. Whether penalty proceedings under section 271(1)(c) of the Act were rightly initiated.

5. Additional grounds concerning the computation of disallowance under section 14A, specifically whether only investments yielding exempt income should be considered, and whether the disallowance should be capped by the amount of exempt income or by 1% of administrative expenditure.

Issue-wise Detailed Analysis:

1. Disallowance of Notional Interest under Section 36(1)(iii) on Interest-Free Loan to Subsidiary

The legal framework under section 36(1)(iii) disallows interest expenditure incurred on borrowed funds if such funds are used for purposes other than business or for earning exempt income. The Assessing Officer (AO) disallowed notional interest of Rs. 48,84,000/- on an interest-free loan of Rs. 4.07 crores advanced to the subsidiary company, applying a market interest rate of 12%. The AO's rationale was that the loan was funded by interest-bearing borrowed funds, and no interest was charged to the subsidiary, thus the interest expense was not allowable.

The assessee contended that the loan was given out of its own surplus funds, not borrowed funds, and was for commercial expediency and business purposes, being a project financing company. The assessee relied on its own prior year ITAT decision for AY 2009-10 where similar disallowance was deleted, and on judicial precedents establishing that if sufficient own funds are available, interest-free loans given out of such funds do not attract disallowance under section 36(1)(iii).

The Tribunal examined the factual matrix and judicial precedents, including the Bombay High Court's ruling in CIT vs. Reliance Utilities & Power Ltd. and Supreme Court affirmations, which held that when both interest-bearing and interest-free funds are available, a presumption arises that interest-free investments are made out of own funds, and no disallowance is warranted. The Tribunal also noted that the assessee had substantial owned funds exceeding the loan amount.

Accordingly, the Tribunal set aside the AO and CIT(A) orders sustaining disallowance and directed deletion of the addition, following the principle that disallowance under section 36(1)(iii) is not justified when loans are advanced out of own surplus funds for bona fide business purposes.

2. Disallowance under Section 14A read with Rule 8D of the Income Tax Rules on Exempt Dividend Income

Section 14A disallows expenditure incurred in relation to income exempt under the Act, such as dividend income under section 10(34). Rule 8D prescribes the methodology for computing such disallowance. The AO disallowed Rs. 15.94 crores (including interest and administrative expenses) after invoking Rule 8D, despite the assessee's suo-motu disallowance of Rs. 0.87 crore. The AO recorded satisfaction that the assessee's claim was incorrect and applied the prescribed formula.

The assessee challenged the disallowance on multiple grounds: (i) no borrowed funds were used for earning exempt income; (ii) prior years' decisions in the assessee's own case and judicial precedents held that interest expense disallowance under section 14A is not warranted if no borrowed funds were used; (iii) only investments yielding exempt income should be considered for disallowance computation; (iv) disallowance should not exceed exempt income or 1% of administrative expenses; and (v) the AO failed to record satisfaction as mandated by law.

The CIT(A) upheld the disallowance relying on the statutory provisions, amendments to section 14A by the Finance Act 2022 (including the non-obstante clause and explanatory notes clarifying applicability even when exempt income is not accrued or received in the same year), and judicial decisions such as H.T. Media Ltd. and Tamilnad Mercantile Bank Ltd., which supported the AO's application of Rule 8D and disallowance computation.

However, the Tribunal noted that the issue requires factual verification regarding which investments yielded exempt income and the correctness of the AO's satisfaction. It also observed that judicial precedents, including the assessee's own case for AY 2009-10 and decisions of the Bombay High Court and Supreme Court, support the proposition that disallowance under section 14A should be limited to expenditure related to investments yielding exempt income and should not exceed exempt income or prescribed percentages.

Accordingly, the Tribunal set aside the CIT(A) order on this issue and restored the matter to the AO for fresh adjudication in accordance with judicial precedents and statutory provisions, directing the AO to record satisfaction and recompute disallowance considering only relevant investments and limiting disallowance as per law.

3. Addition to Book Profits under Section 115JB on Account of Disallowance under Section 14A

The AO added back the disallowance under section 14A while computing book profits under section 115JB. The CIT(A) deleted this addition relying on the Supreme Court decision in PCIT vs. Atria Power Corporation Ltd. and other judicial precedents which held that provisions of section 14A and Rule 8D do not apply for computation of book profits under section 115JB unless specifically provided.

The revenue challenged this deletion. The Tribunal upheld the CIT(A)'s deletion of addition to book profits, holding that the Supreme Court's decision is binding and no addition under section 115JB is warranted for amounts disallowed under section 14A. However, since the disallowance under section 14A itself was restored to the AO for fresh computation, the Tribunal also restored the issue of disallowance in book profits to the AO for recomputation consistent with the fresh assessment.

4. Other Grounds

The Tribunal briefly noted that the issues relating to levy of interest under section 234B and initiation of penalty proceedings under section 271(1)(c) were raised but no detailed submissions or findings were recorded in the impugned order, indicating these were not pressed or were disposed of in line with the main issues.

Significant Holdings and Core Principles Established:

On the notional interest disallowance under section 36(1)(iii), the Tribunal held:

"If there be interest-free funds available to an assessee sufficient to meet its investments and at the same time the assessee had raised a loan it can be presumed that the investments were from the interest-free funds available... Accordingly, the presumption would be that the amount so advanced was from the interest-free funds available with the assessee company."

This principle was applied to set aside the disallowance on notional interest on interest-free loans advanced to subsidiaries when funded by own surplus funds for business purposes.

Regarding disallowance under section 14A, the Tribunal emphasized the need for the AO to record satisfaction as to the incorrectness of the assessee's claim before invoking Rule 8D and computing disallowance. It also held that only investments yielding exempt income should be considered for disallowance computation, and the disallowance should be limited by the amount of exempt income or reasonable percentages of administrative expenditure, consistent with judicial precedents.

On addition to book profits under section 115JB, the Tribunal reaffirmed the binding Supreme Court ruling that disallowance under section 14A cannot be imported into the computation of book profits unless expressly provided.

Finally, the Tribunal restored the issues related to section 14A disallowance computation to the AO for fresh adjudication in line with the principles laid down in the Tribunal's and higher courts' decisions, ensuring adherence to procedural requirements and factual verification.