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Facts
The assessee appealed against the CIT(A)'s order which confirmed disallowances made by the AO under Section 36(1)(iii) for interest expenses and under Section 14A for expenses related to exempt income for AY 2012-13. The core disputes involved the AO/CIT(A)'s treatment of capitalized interest, interest received on loans, bank and loan processing charges, and the methodology used for calculating disallowance under Section 14A and Rule 8D.
Held
The Tribunal partly allowed the first ground, restricting the disallowance under Section 36(1)(iii) to 15% of net interest expenses (Rs.51,427/-), aligning with a previous ITAT order for AY 2011-12. For the second ground concerning Section 14A, the Tribunal directed the AO to re-compute the disallowance under Rule 8D(2)(ii) based on net interest expenses and under Rule 8D(2)(iii) considering only investments that yielded exempt income, restoring the issue for fresh quantification. The CIT(A)'s enhancement of disallowances without providing an opportunity to the assessee was also noted.
Key Issues
1. Whether the disallowance of interest expenses under Section 36(1)(iii) was justified, particularly concerning the treatment of capitalized interest, interest earned, and bank/loan processing charges. 2. Whether the disallowance under Section 14A for expenses related to exempt income was correctly calculated by the AO/CIT(A), specifically regarding the inclusion of non-dividend yielding investments and the use of gross interest expenses.
Sections Cited
Section 143(3), Section 36(1)(iii), Section 250, Section 14A, Rule 8D, Rule 8D(2)(ii), Rule 8D(2)(iii)
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Income Tax Appellate Tribunal, DELHI BENCH “B” DELHI
Before: SHRI KUL BHARAT & SHRI PRADIP KUMAR KEDIA
The captioned appeal has been filed by the assessee against the order of the Commissioner of Income Tax (Appeals)-II, New Delhi (‘CIT(A)’ in short) dated 08.01.2018 arising from the assessment order dated 18.03.2015 passed by the Assessing Officer (AO) under Section 143(3) of the Income Tax Act, 1961 (the Act) concerning AY 2012-13.
The grounds of appeal raised by the assessee read as under: “(A) That on the facts & circumstances of the case the learned CIT (A)-2 while passing the order u/s 250 erred in: i) Confirming the disallowance to the extent of Rs.12,41,95,805/- u/s 36(1)(iii) of the Income Tax Act, 1961 without appreciating the factual matrix and law of land in given matter. ii) Not observing the nexus between the interest bearing funds
borrowed and advanced the same to sister concerns for earning interest income. iii) Understanding that borrowed funds has been utilized wholly and exclusively for the purpose of the business. (iv) Confirming the disallowance to the extent of Rs.2,35,88,495/- u/s. 14A of the Income Tax Act, 1961 without appreciating the factual matrix and law of land in given matter. (v) Confirming the mechanical action of AO in regard to disallowance made u/s. 14A of the Income Tax Act, 1961. (B) Without prejudice above, the addition made u/s. 14A is invalid as AO failed to record any type of dissatisfaction regarding the correctness of the claim of the Assessee "that all the expenses relating to investment and exempt income has already been capitalized."
The first ground concerns disallowance of interest under Section 36(1)(iii) of the Act.
In this regard, the ld. counsel submits that the AO while framing the assessment, made a disallowance of Rs.37,30,16,638/- towards interest expenses under Section 36(1)(iii) by reducing the interest received on loan of Rs.8,35,80,705/- from Rs. 45,65,97,343/-. In the process, the AO omitted to take note of interest capitalized by the assessee amounting to Rs.37,26,73,788/-. The ld. counsel submits that the amount of Rs.37.26 crore was capitalized by the assessee and thus never claimed as Revenue expenses. Therefore, the AO has failed to realize that net interest debited to P&L account stands at Rs.3,42,850/- only and excessive disallowance has been made without appreciating the facts in correct perspective and ground realities. 4.1 Adverting to first appellate order, the ld. counsel pointed out that the CIT(A) has proceeded on an altogether different tangent. The CIT(A) has adopted the interest cost at Rs.49,68,69,594/- as a base figure for the purposes of computing disallowance instead of Rs.45,65,97,343/-. Thus, in effect, the CIT(A) has also disallowed bank charges and loan processing charges amounting to Rs.17,000/- and Rs.4,02,55,251/- respectively for the purposes of disallowances. The CIT(A) however accepted the plea of the assessee towards incorrect disallowance on account of capitalization of interest amounting to Rs.37,26,73,788/-. At this stage, the ld. counsel pointed out that while appreciating the issue, the CIT(A) has denied the reduction on account of interest earned on loans advances amounting to Rs.8,35,80,705/-. The ld. counsel thus submits that the CIT(A) has denied the reduction of interest on loans earned which was duly accepted by the AO without any notice to the assessee. Likewise, the disallowance on account of bank charges and loan processing charges have also been carried out by the CIT(A) without confronting such approach either by way of enhancement notice or otherwise in the course of the appellate proceedings. The ld. counsel thereafter referred to the order of the Co-ordinate Bench in its own case for the Assessment Year 2011-12 in order dated 23.10.2020 concerning Assessment Year 2011-12 and pointed out that in similar facts, the ITAT in its wisdom has retained the disallowance @15% of the net interest cost incurred by the assessee. The ld. counsel thus submits that in accord with the earlier order of the ITAT in its own case, the disallowance @ 15% on net interest cost of Rs.3,42,850/- at best, is plausible in the facts of the present case. 4. The ld. DR, on the other hand, refers to and relies upon the first appellate order and submits that the assessee has failed to prove any nexus between the interest expenditure incurred and corresponding income earned and therefore set off of interest income against interest expenses was rightly held to be unjustified by the Revenue Authorities.
As pointed out on behalf of the assessee in detail that the Assessing Officer has overlooked the factum of interest capitalization while quantifying the disallowance at Rs.37.30 crore, the CIT(A) has agreed with the contention of the assessee in this regard and accepted the plea for exclusion of interest capitalized and not claimed as expenses but however the CIT(A) has adopted a different figure of Rs.49.68 crore including bank charges, loan processing charges and interest paid etc. as interest cost as against interest charges of Rs.45.65 crore adopted by the AO for the purposes of disallowance. Hence, in the process, the CIT(A) disallowed the bank charges and loan processing charges aggregating to Rs.4,02,00,000/-. No opportunity was given to the assessee while doing so, which has the effect of enhancement of disallowance. Consequently, the CIT(A) has also denied deduction of interest earned on loan at Rs.8.35 crore which was originally allowed by the Assessing Officer. The CIT(A) once again has not given any opportunity which has the effect of enhancement of disallowance.
On facts, it is submitted on behalf of the assessee that bank charges and loan processing charges are business expenditure in ordinary course and are not covered within the ambit of Section 36(1)(iii) of the Act. The disallowance towards loan processing charges and bank charges is not justified as rightly pleaded on behalf of the assessee.
We further take note of the plea of the assessee that the comparative financial statement placed on record would show that the assessee has obtained substantial long term borrowings and other liabilities and likewise given long term advances which has yielded interest income. In the identical factual matrix, the Co- ordinate Bench of Tribunal in Assessment Year 2011-12 has accepted the plea of the assessee that borrowed funds have been utilized for advancing money and consequently interest income arising from advancing of money is liable to be adjusted against interest expenses. The Co-ordinate Bench in the Assessment Year 2011-12 limited the disallowance to 15% of net interest expenses on similar footing. The disallowance under Section 36(1)(iii) is restricted to 15% of net interest expenses which is quantified at Rs.3,42,850/- after reduction of interest capitalized and interest received. The disallowance thereon thus works out to Rs.51,427/- in tune with the decision rendered by the Co-ordinate Bench in Assessment Year 2011-12. The assessee thus gets partial relief.
The first ground is thus partly allowed.
Second ground concerns disallowance under Section 14A of the Act.
At the time of hearing, the ld. counsel submits that the assessee has earned exempt income by way of dividend to the tune of Rs.7,85,42,616/- and the assessee has not incurred any expenses for earning dividend income. The dividend has been received to the credit of the bank account of the assessee automatically and that too, from only one company, i.e., namely, Tulip Shares. The ld. counsel submits that for the purposes of disallowance under Section 14A, only the investment which has yielded exempt income is required to be considered. The only investment which has given rise to exempt income is investment in equity shares of Tulip Telecom Ltd.
The ld. counsel thereafter adverted to paragraph 5.5 of the assessment order showing disallowance under Section 14A worked out by the Assessing Officer. The ld. counsel pointed out that the interest expenses disallowed under Rule 8D(2)(ii) has been calculated with reference to gross interest expenses of Rs.45.65 crore including interest capitalized and not claimed as expense to the tune of Rs.37.26 crore and also the reduction of interest correspondingly received has not been given. The ld. counsel submits that the interest to the tune of Rs.37.26 crore has not been charged to Profit and Loss Account and therefore it was palpably wrong on the part of the AO to take in account such not existent revenue expenses for the purposes of disallowance. Likewise, the interest received is offshoot of interest expenses on borrowings utilized for advancing money. The interest income therefore is directly relatable to the interest expense and the only net interest of Rs.3,42,850/- requires to be considered for the purposes of calculation of disallowance as per the statutory formula. The ld. counsel next submits that the Assessing Officer has taken average value of gross investment under Rule 8D(2)(iii) for the purposes of disallowance instead of taking only value of those investments which has yielded dividend income. Once, the interest expense and average value of investment are suitable modified, the disallowance should be in the vicinity of Rs.55,364/- under Rule 8D(2)(ii) of the Act.
We find that such plea on behalf of the assessee is in consonance with the facts on record and the judicial view governing field. The Hon’ble Delhi High Court in PCIT v. Caraf Builders and Constructions Pvt. Ltd. (2019) 414 ITR 122; Special Bench in ACIT vs. Vireet Investment (P.) Ltd., 165 ITD 27 (SB) have stated that investments which have not yielded any exempt income cannot be taken into account for the purposes of calculating disallowance under Section 14A r.w. Rule 8D of the Income Tax Rules, 1963.
12. In the light of submissions made, the AO is directed to re- compute the disallowance of interest under Rule 8D(2)(ii) with reference to net interest lost incurred and administrative expenses under Rule 8D(2)(iii) with reference to average investments which yielded exempt income. The issue is thus restored to AO for fresh quantification of disallowance under Section 14A of the Act.
The second ground is thus partly allowed.
In the result, the appeal of the assessee is partly allowed. Order was pronounced in the open Court on 18/01/2024