DHNALAXMI BANK LIMITED,TRICHUR vs. THE PR CIT, THRISSUR

This appeal is against the order of the PCIT, Kozhikode passed u/s. 263 of the Act dated 29.3.2021 for the AY 2016-17.

For the above and other grounds to be adduced at the time of hearing it is prayed that the order passed by the learned Principal Commissioner of Income tax may be cancelled.”

The assessee filed the return of income for the AY 2016-17 on 15.10.2016 declaring a net loss of Rs.2,07,65,15,808. The case was selected for scrutiny and the notice u/s. 143(2) was duly served on the assessee. During the course of assessment, the AO noticed that the assessee has claimed exemption u/s. 10(33) for an amount of Rs.17,18,870 being dividend from tax free investment. The AO proposed to invoke provisions of section 14A and in this regard issued a notice to the assessee. The assessee submitted before the AO that the various funds in the nature of capital funds, reserves, current account deposits are invested in earning dividend income. The assessee also submitted that the assessee being a bank, funds are generated from all activities which is common. There is no segregation of interest bearing and interest free funds. The assessee in this regard had relied on the decision of Bombay High Court in the case of CIT v. Walfort Share & Stock Brokers P. Ltd., 310 ITR 421 (Bom) where it was held that section 14A contemplates the real expenditure and not assumed on deemed expenditure. The AO did not accept the contentions of the assessee. The AO relying on the decision of Kerala High Court in the case of South Indian Bank, ITA 730/2009 dated 21.10.2010 wherein it was held that non-maintenance of separate accounts is no excuse for being unable to substantiate the claim of interest bearing funds being used to earn exempt income. Accordingly, the AO computed the disallowance u/s. 14A r.w. Rule 8D(2)(i)(ii) and (iii) at Rs.2,16,59,021. The AO restricted the disallowance to the amount of exempt income and thereby made a disallowance of Rs.17,80,870.

The PCIT invoked the provisions of section 263 and issued a notice as to why the entire amount computed as disallowance u/s. 14A r.w. Rule 8D cannot be disallowed. The assessee submitted that it is a well settled position in law as per the decision of Apex Court in the case of UCO Bank, 240 ITR 355 (SC) and the decision of the jurisdictional High Court in the case of Nedungadi Bank Ltd., 264 ITR 545 that the dividend income received from securities forming part of stock & trade held in the regular course of business is exempt u/s. 10(33). The assessee further submitted that in the case of Joint Investment P. Ltd., 372 ITR 694, the Delhi High Court has held that disallowance u/s. 14A cannot exceed the tax exempt income. The PCIT did not accept the submissions of the assessee and held that disallowance made u/s. 14A should be restricted to the extent of exempt income is not settled and therefore the contentions of the assessee cannot be accepted. Accordingly, to the extent of amount not disallowed by the AO, the PCIT held the order of assessment to be erroneous and prejudicial to the interest of the revenue.

The ld. DR supported the order of the PCIT.

We have heard the rival submissions and perused the material on record. We notice that during the year under consideration the assessee has earned income of Rs.17,80,870. The revisionary power invoked by the PCIT is contended on the following grounds:-

In view of the above settled position, the amount of disallowance u/s 14A of the I.T. Act needs to be restricted to the extent of exempted income earned during the relevant assessment year. As would be evident that in the facts and circumstances of the present case the amount of exempted income is Rs.10,80,870 and therefore the disallowance if at all should be restricted to the said amount.

The ld. AR during the course of hearing presented the below table with the details of total free funds available as per the statement of account of the assessee :-

It is also noticed that the value of investments made by the assessee as of 31.03.2016 is Rs.30,84,12,303 and therefore substantiates submissions of the ld AR that the interest free funds available are much more than the investments made and therefore we see merit in the argument of the ld. AR. We notice that the similar issue was considered by Hon’ble Karnataka High Court in the case of CIT Vs. Micro Labs Ltd. (2016) 383 ITR 490, where it was held that no disallowance out of interest expenditure is called for. The relevant extract of the observations made by Hon’ble Karnataka High Court in the above said case is as below “40. We have heard the rival submissions. A copy of the availability of funds and investments made was filed before us which is at pages 38 to 42 of the assessee's paper book and the same is enclosed as ANNEXURE-III to this order. It is clear from the said statement that the availability of profit, share capital and reserves & surplus was much more than investments made by the assessee which could yield tax free income.

The Hon'ble Bombay High Court in Reliance Utilities & Power Ltd. 313 ITR 340 (Bom) has held that where the interest free funds far exceed the value of investments, it should be considered that investments have been made out of interest free funds and no disallowance u/s. 14A towards any interest expenditure can be made. This view was again confirmed by the Hon'ble Bombay High Court in CIT v. HDFC Bank Ltd., of 2012, judgment dated 23.7.14, wherein it was held that when investments are made out of common pool of funds and non-interest bearing funds were more than the investments in tax free securities, no disallowance of interest expenditure u/s. 14A can be made.

In the light of above said decisions, we are of the view that disallowance of interest expenses in the present case of Rs.49,42,473 made under Rule 8D(2)(ii) of the I.T. Rules should be deleted. We order accordingly." Thereafter, it was held by Hon’ble Karnataka High Court as under:- “The aforesaid shows that the Tribunal has followed a decision of the Bombay High Court in the case of CIT v. HDFC Bank Ltd.

Therefore the issue of disallowance u/s. 14A with respect disallowance being restricted to the amount of exempt income and that no disallowance is warranted when own funds are available are settled by the judicial pronouncements herein above. Further the issue of the securities of the bank through classified as investment are in reality stock-in-trade and therefore the computation of disallowance under Rule 8D is not applicable has also been a subject matter of adjudication in the case of Nedungadi Bank Ltd., (supra) and United Commercial Bank (Supra).

From these discussions, it is clear that with respect to the impugned issue it is possible to take two views What is prejudicial to the interest of the Revenue is explained in the judgment of the Hon’ble Supreme Court in the case of Malabar Industries Co Ltd v. CIT [2000] 243 ITR 83 (SC) (head note):

Placing reliance on the decision of Hon’ble Supreme Court, we are of the considered view that the PCIT is not justified in setting aside the order of the AO for enhancing the disallowance u/s.14A. Further even on merits in our view there is no error prejudicial to the interest of the revenue. On these counts we quash the order of the PCIT passed u/s.263. Accordingly assessee’s appeal is allowed.

In result the appeal of the assessee is allowed.