Disallowance under s 14A —GujHC in CIT v Gujarat Power Corporation Ltd; Tax Ap

Disallowance under s 14A — The AO was not justified in making disallowance under s 14A of interest on borrowings on the ground that assessee ought not to have used its funds for tax-free investments as the assessee has shown that their was no nexus between borrowed funds and tax-free investment — as held by GujHC in CIT v Gujarat Power Corporation Ltd; Tax Appeal No. 1587 of 2009, 13 April 2011

Decided on: 28 March 2011 — In favour of: The Assessee.

The assessee took a loan amounting to Rs.3,83,44,651/- from Power Finance Corporation and paid interest of Rs.17,31,926/-. The assessee had made investments, earning tax-free returns, but the AO held that the entire interest paid on the borrowings had to be disallowed under s 14A on the basis that the assessee had arranged its affairs so as to reduce the tax liability. The AO was also of view that if the assessee had not invested its own fund for earning tax-free income, it would not have been required to borrow interest bearing funds for its business and there was a nexus between the borrowed funds and the tax-free income. In an appeal, the CIT(A) held that the assessee had utilised its own funds for making investments in shares, debentures, etc. The loan availed from the Power Finance Corporation was entirely utilised for business purpose and the interest paid was eligible for deduction under s 36(1)(iii), 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 under s14A was not justified. The Tribunal upheld the findings of the CIT(A) and held that 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. Being aggrieved, the revenue has filed the present appeal.

The issue is whether the AO was justified in making disallowance under s 14A of interest on borrowings on the ground that assessee ought not to have used its funds for tax-free investments.

The assessee has sufficiently explained its investment for borrowed funds, pointing out that a loan was obtained in assessment year 1997–1998 and its majority of the investments for tax-free security were made before the said period. Only a small portion of investment was made subsequently. The assessee had demonstrated that it had other sources of investment and that therefore, according to the assessee, no part of the borrowed fund could be stated to have been diverted to earn tax-free income. Both the CIT(A) and the Tribunal found that the borrowed funds were not used for earning tax-free income. The AO was not justified in applying the provision of s 14A.