2025 (7) TMI 1494 - AT - Income Tax

Disallowance u/s 14A r.w.r. 8D - disallowance of 0.5% of the average value of investments - HELD THAT - Respectfully following the decision of Shalimar Pellet Feeds Ltd. 2022 (2) TMI 1209 - CALCUTTA HIGH COURT and Avantha Realty Ltd 2024 (6) TMI 987 - CALCUTTA HIGH COURT we reverse the finding of the Ld. CIT(A) in para 7.11 that the disallowance under Rule 8D(2)(iii) shall be @0.5% of average value of all equity investments irrespective of the fact whether these investments actually yielded any exempt income or not during the year and direct the Ld. AO to consider only the investments which yielded exempt income and delete the rest of the disallowance. The assessee shall file the relevant details before the Ld. AO in this regard. Disallowance of interest - as alleged that the assessee advanced interest-free loans to its associate/subsidiary companies without establishing commercial expediency - Advances Made Out of Own Funds - HELD THAT - The assessee has been able to demonstrate that the assessee had sufficient interest free funds of its own out of which advances were given for commercial expediency and the loans taken were not used for the advances made to the associates and the subsidiaries. Hence following the decision of Reliance Utilities Power Ltd 2009 (1) TMI 4 - BOMBAY HIGH COURT - Ground raised in the appeal is allowed and the disallowance made u/s 36(1)(iii) by the Ld. AO which has been confirmed by the CIT(A) is hereby directed to be deleted.

Summary

ISSUES:

Whether disallowance under section 14A of the Income Tax Act read with Rule 8D of the Income Tax Rules should be computed on the basis of all investments or only those investments which yielded exempt income during the relevant assessment year.Whether the amendment to section 14A of the Income Tax Act by the Finance Act, 2022, including the inserted non-obstante clause and explanation, applies retrospectively to assessment years prior to 01.04.2022.Whether disallowance of interest under section 36(1)(iii) of the Income Tax Act is justified on interest-free advances made to associate or subsidiary companies, particularly when the assessee had sufficient own funds and the borrowed funds were not utilized for such advances.

RULINGS / HOLDINGS:

The disallowance under section 14A read with Rule 8D shall be computed by considering only those investments which yielded exempt income during the year; the disallowance cannot be made on all investments indiscriminately. The Tribunal held that "the disallowance under Rule 8D(2)(iii) shall be @0.5% of average value of all equity investments irrespective of the fact whether these investments actually yielded any exempt income or not" is incorrect and directed the Assessing Officer to restrict disallowance accordingly.The amendment to section 14A by the Finance Act, 2022, including the inserted explanation and non-obstante clause, is prospective in operation and cannot be applied retrospectively to assessment years prior to 01.04.2022. The Tribunal followed the decision that "the amendment by the Finance Act, 2022 ... cannot be presumed to have retrospective effect."The disallowance of interest under section 36(1)(iii) on interest-free advances to associate/subsidiary companies is not sustainable where it is demonstrated that the advances were made out of own funds sufficient to cover such advances and the borrowed funds were specifically utilized for other business purposes. The Tribunal accepted the principle that "where both own funds and borrowed funds are available, a presumption arises that interest-free advances are made out of own funds" and that advances made for commercial expediency cannot be disallowed.

RATIONALE:

The Tribunal applied the legal framework under section 14A of the Income Tax Act and Rule 8D of the Income Tax Rules, relying on binding precedents from the jurisdictional High Court which held that disallowance under section 14A should be restricted to investments yielding exempt income. The Tribunal rejected the reliance on the Finance Act, 2022 amendment for prior years, following authoritative rulings that such amendments are prospective.Regarding the interest disallowance under section 36(1)(iii), the Tribunal applied settled legal principles affirmed by High Courts and Tribunals that a presumption arises favoring the assessee when own funds are sufficient to cover interest-free advances, and that borrowed funds earmarked for specific business purposes cannot be presumed diverted. The Tribunal also relied on the principle of commercial expediency, as established in Supreme Court precedents, that business-related advances are not liable to disallowance merely because they are interest-free.There was no dissent or doctrinal shift noted; the Tribunal adhered to established statutory interpretation and judicial precedents, ensuring consistency with jurisdictional High Court rulings.