Gujarat H.C : Whether the Appellate Tribunal was justified in upholding the order of the CIT(A) in deleting the addition of Rs.17,31,926/ on account of interest on borrowed funds u/s. 14A of the I.T. Act?

High Court Of Gujarat

CIT vs. Gujarat Power Corporation Ltd.

Section 14A, 115B

Akil Kureshi & Sonia Gokani, JJ.

TAX APPEAL No. 1587 of 2009

28th March, 2011

Counsel appeared

Mauna M Bhatt for the Appellant(s).: Sn Soparkar, Sr Advocate With Monaal Davawala And Swati Soparkar for the Respondent


1. Revenue is in appeal against judgement of the tribunal dated 30.1.2009 raising following questions of law for our consideration :

“(A) Whether the Appellate Tribunal was justified in upholding the order of the CIT(A) in deleting the addition of Rs.17,31,926/ on account of interest on borrowed funds u/s. 14A of the I.T. Act?

(B) Whether the Appellate Tribunal was deleted the addition on account of provision of wealth tax while computing profit u/s. 115B of the Act in view of para No.4 of Instruction No.5 of 2008?”

First question arises in following factual background. For assessment year in question, the assessee’s return was processed under scrutiny assessment. The Assessing Officer found that the assessee had taken loans on various dates totaling to Rs.3,83,44,651/ from Power Finance Corporation and paid interest of Rs.17,31,926/. The Assessing officer also found that during the year, the assessee had made investment earning tax free returns. The Assessing Officer therefore, desired to disallow the claim of deduction of interest on the borrowed funds in view of provisions contained in Section 14A of the Income Tax Act, 1961. Assessee’s explanation in this regard was called for. Assessee explained that : “In this connection we would like to state that during the year we have paid interest of Rs.17,31,926/ on loan taken from Power Finance Corp. (PFC). We have obtained the loan of Rs.3.83 crores from PFC in F.Y.97 98. We would like to state that majority of our investments made in tax free securities are made before F.Y.9798. The only investments made after the F.Y.9798 is in the shares of GIPCL for Rs.10 crores(in F.Y.9899) which is also not from loan obtained from PFC. Details of the investments made in tax free securities are as under :

From the above details your goodself can ascertain that amount invested in tax free securities are not from loan obtained from PFC and therefore, no portion of interest paid during the year can be allocated to the tax fee income received. It is submitted that as the loan was not obtained for investments in tax free securities provisions of Section 14A is not applicable at all and no disallowance is required to be made.”

The Assessing Officer disallowed the deduction of interest of Rs.17,31,926/ paid on the borrowed funds under Section 14A of the Act and added it back to the total income of the assessee. This issue was carried in appeal by the assessee. CIT(Appeals) accepted the assessee’s explanation deleted the addition making following observations :

“4. The facts of the case and arguments of the appellant have been considered. The appellant had utilized own funds for making investments in shares, debentures, etc. The loan availed from the Power Finance Corporation was entirely utilized for business purpose and the interest paid was eligible for deduction u/s.36(1) (iii) of the I.T. Act. There was no finding that any expenditure by way of interest was incurred in respect of the investments in securities and shares and accordingly the disallowance u/s.14A is not justified. The Assessing Officer is directed to delete the allowance.” Revenue carried the issue in appeal before the tribunal. Tribunal by impugned judgement confirmed view of the CIT(Appeals) holding as under :

“6. We have heard the rival submissions and perused the orders of the lower authorities and the material available on record. In the instant case, the assessee paid interest of Rs.17.31 lakhs to Power Finance Corporation on the sum of Rs.3.83 crores borrowed from them during the year under appeal. The assessee has also made investment of Rs.30.79 crores in shares, debentures and bonds and shown tax free income of Rs.5.68 crores earned on the investment made. The A.O. was of the view that the assessee has made huge investment of Rs.30.79 crores for earning tax free income and for this reason, the assessee has to resort to borrow funds for his other business purposes. Thus, the borrowing has a nexus with the tax free investment and, therefore, he disallowed the interest paid by the assessee. In appeal, the Ld. CIT(A) after considering the submissions of the assessee, held that the entire borrowed funds was utilized by the assessee for its business purposes and, therefore, the A.O. was not justified in disallowing the claim for deduction of interest for Rs.17.31 lakhs to the assessee. We find that in the instant case it is not in dispute that the assessee has utilized its own funds for the purpose of making investment in shares, etc. from which tax free income were earned. It is also not in dispute that the interest bearing borrowed funds were utilized for its own business purposes from which taxable income were earned by the assessee. The only grievance of the A.O. is that, the assessee has arranged the above affairs in such a manner so as to reduce its tax liability. The A.O. was of the view that as the assessee has not invested its own fund for earning tax free income, it would not have required to borrow interest bearing funds for its own business. In this view of the matter, the A.O. Observed that interest bearing funds had a nexus with the tax free income of the assessees. In this regard, the Ld/D.R. also placed reliance on the decision of the Hon’ble Delhi Special Bench of the Tribunal in the case of Aquarius Travels Pvt. Ltd. Vs ITO, 111 ITD 53(SB) (Del.) wherein it is held that where tax free income was earned by the assessee by making investment out of borrowed funds, then the proportionate amount of interest on funds utilized for earning tax free income by the assessee was to be disallowed. It is thus, observed that the above decision is not applicable to the facts of the instant case as in the instant case it is not in dispute that the borrowed funds were utilized for its own business purposes and the investment in earning tax free income were made out of own interest free funds. In our considered opinion, the assessee is fully justified in arranging its affairs in such a manner where his tax liability is reduced provided the assessee does not resort to any illegal means or enter into a sham transaction for the said purpose. It is the prerogative of the assessee to use its own fund in the manner in which it considers proper. The Revenue cannot dictate the assessee that how the assessee should use its own fund. Thus in our considered opinion the A.O.’s approach in the instant case was not justified. The nexus between the interest bearing fund ant interest free investment as claimed by the A.O. was not correct when it is not in dispute that the own funds were utilized for making tax free investment. Under these circumstances, we do not find any infirmity in the order of the Ld. CIT(A) which is confirmed and the ground of appeal of the Revenue is dismissed.”

We have heard learned counsel for the parties. Learned counsel Shri Manish Bhatt for the Revenue submitted that there was no demarcation in investment made by the assessee in earning tax free income, whether same was made from out of its own fund or from borrowed fund. In that view of the matter, Assessing Officer was justified in disallowing interest paid on borrowed fund since assessee had made investment in earning income which was tax exempted.

On the other hand, counsel for the assessee submitted that such borrowings were made even before investment were made for earning tax free income. Such borrowings were in assessee’s business expediency and was part of normal business transaction. CIT(Appeals) as well as tribunal on facts found that assessee has its own funds and that borrowed funds were not diverted in earning tax free income.

Having thus heard learned counsel for both sides and having perused the orders on record, we find that in the present case assessee had sufficiently explained its investment for borrowed funds pointing out that loan was obtained in assessment year 19971998 and its majority of the investment for tax free security were made before the said period. Only a small portion of investment was made subsequently. Assessee had demonstrated that it had other sources of investment and that therefore, according to assessee no part of the borrowed fund could be stated to have been diverted to earn tax free income. When CIT(Appeals) and tribunal both on facts in the present case found that the assessee did not invest borrowed fund for earning interest free income, we are of the view that not applying provision of Section 14A of the Act for taxing such interest was justified. No question of law therefore, is arising for our consideration.

With respect to second question, we find that total impact on revenue is Rs.10,700/. Only on this ground, we are not inclined to consider the question raised. Tax Appeal is therefore, dismissed.

[Citation : 352 ITR 583]