By TIOL News service

CHANDIGARH, SEP 12, 2016: THE issue is - Whether in the absence of any proximate nexus having been established by the lower authorities between the administrative and other expenses and the exempt income, no disallowance u/s 14A can be made. YES is the verdict.

Facts of the case

The assessee are engaged in various activities which they carry on through their different divisions, such as, the packaging, metallise, max foil, pharma, treasury and healthcare divisions. It had filed a return declaring a 'nil' total income with a brought forward loss and Rs. 6,80,27,490/- computed u/s 115JB. A revised return in the same terms was filed except to declare a short term capital gain arising from the sale of one of the divisions. The matter was taken up for scrutiny and a questionnaire was addressed to the assessee. Assessee earned exempted income by way of interest of which Rs.55 lakhs was interest on Maharashtra State Electricity Bonds and Rs. 2,91,97,852/- was earned by way of dividends. The aggregate amount was deducted by the assessee being exempted under the Act. The question was whether there was any expenditure relatable to the exempted income for, if there was, the provisions of Section 14A would apply. AO rejected the assessee's contention that it had not incurred any expenditure for the purpose of earning the exempt income observing that the possibility of the assessee having incurred expenditure relatable to such exempt income could not be ruled out. AO held that on identical facts for AY 2001-02, ad hoc disallowance relatable to such expenditure incurred for the purpose of earning exempt income was made and on the same basis he made a disallowance of Rs. 1.5 crores u/s 14A. The assessee contended that the investment had been made out of its own funds and not from the borrowed funds and, therefore, disallowance was not called for; that the dividend was received as long term investment during the relevant previous year and that no expenditure was attributable towards earning the same as the dividend received was only incidental to the holding of shares; that the dividend was received by single dividend warrants, and therefore, no expenditure was incurred to earn such dividend; that the assessee had not claimed any expenditure in relation to income which did not form part of the total income; that there was no nexus between the dividend expenditure and the expenses which were sought to be deducted and that the revenue had failed to establish any nexus between the expenditure and the exempt income.

On appeal, CIT (A) not only upheld the AO's order of disallowance but enhanced the same. It had noted as had the AO that the assessee had failed to produce the bank statements though called upon to do so. The assessee expressed its inability to produce the bank statements in respect of the utilization of the borrowed funds or to show the sources of funds for the investment made on the ground that the bank statements related to an 'old period' and that it was difficult, therefore, to produce the same. The assessment order u/s 143(3) was passed. Assessee further contended that the positive cash flow and surplus interest free funds available with the assessee during the relevant previous year were sufficient to cover the said interest free investment. The presumption, it was contended, was that the said investments were made from the assesses interest free reserves and, therefore, it was for the department to rebut the presumption by establishing the nexus between the funds borrowed on investment and the said investment. CIT(A) drew an adverse inference which was one of the main reasons for the order passed by CIT(A). The assessee also relied upon the agreements it had entered into with various lenders to establish that the funds borrowed on interest were utilized for purposes other than the said investment. CIT(A) analysed each of the documents. It was observed that in the absence of the bank books and bank statements it was not possible to determine whether the assessee had received free funds available at the time when the relevant investment was made or whether the said investment was made out of interest bearing funds and that as the finding about the utilization of funds can be made from a direct study of the books of accounts and the relevant bank statement, a presumption was liable to be drawn against the assessee in this regard. The assessee's contention that the bank statements were not readily available was not accepted. It was observed that assessee was otherwise able to produce and submit details of all matters relating to the proceedings in respect of other grounds but had not produced the bank statements or the bank books. It was further observed that the bank statements alongwith bank books were in the exclusive custody of the assessee and could lead to a finding that the assessee utilized borrowed funds for the purpose of making investments. The documents being in the custody of the assessee and the assessee having failed to produce the same though asked to do so, when a show cause notice was served upon him for enhancement, CIT(A) drew an adverse inference against the assessee. CIT(A) also analyzed the balance sheet and the cash flow statement submitted by the assessee for the relevant period.

On further appeal, Tribunal, however, set-aside the order of CIT (A) in so far as it disallowed the deduction of Rs. 4,52,94,905/- u/s 14A on account of interest expenditure. The Tribunal, however, sustained the order in so far as it estimated Rs. 20 lacs towards administrative expenditure relating to the investment from which exempt income was earned. The Tribunal rightly noted that the main thrust of the orders impugned before it was that the assessee had failed to furnish the bank statements and that, therefore, an adverse inference ought to be drawn against it. The Tribunal, however, also observed that the authorities indicated that the presumption as regards the utilization of interest free funds and borrowed funds in a mixed pool ought to be in favour of the assessee. The Tribunal noted that the assessee is a listed company and was required to publish its accounts and submit the same before various statutory authorities such as SEBI, Stock Exchanges as well as to the share holders and financial institutions. Thus, the Tribunal did not accepted the department's contention that the funds flow statements submitted by the assessee which in turn were prepared on the basis of the audited accounts for the year under consideration were not authentic. The Tribunal was certainly entitled to draw such an inference. It was a reasonable inference. The Tribunal addressed itself to the correct question, namely, to determine if there was any nexus between the additional investments with the interest free borrowed funds. The following findings of fact of the Tribunal were of vital importance: the assessee had during the relevant time invested an aggregate amount of Rs. 152.05 crores out of which an amount of Rs. 28.18 crores was made in shares of foreign companies. The dividend from the foreign companies was taxable. This, therefore, left an amount of Rs. 123.87 crores which yielded dividends which were exempt from income tax. The assessee realized 117.97 crores from the sale of its investments in the earlier years; Rs. 46 crores was generated from the assessee's operating activities; Rs. 6.87 crores was received from sale of fixed assets and there was an opening cash balance of Rs. 8.90 crores. The aggregate of surplus funds on which there was no interest burden was Rs. 179.74 crores. This amount was available during the relevant previous year. Thus such funds were in excess of the investment of Rs. 123.87 crores. In addition thereto the assessee had generated cash from its financing activities of an aggregate amount of Rs. 24.24 crores. It had purchased fixed assets aggregating only to Rs. 54.62 crores during the relevant period. The findings, therefore, that the assessee had sufficient interest free funds to make the investment yielding tax free returns cannot be faulted. The absence of bank books in these circumstances would not justify an adverse inference being drawn for whichever way the matter is viewed, the assessee had sufficient funds available to it on which no interest was payable.

Held that,

++ in the case of CIT v. Reliance Utilities and Power Ltd.2009-TIOL-27-HC-MUM-IT, it was held that if there be interest-free funds available to an assessee sufficient to meet its investments and at the same time the assessee had raised a loan it can be presumed that the investments were from the interestfree funds available. In our opinion, the Supreme Court in East India Pharmaceutical Works Ltd. v. CIT 2002-TIOL-152-SC-IT had the occasion to consider the decision of the Calcutta High Court in Woolcombers of India Ltd., [1982] 134 ITR 219 where a similar issue had arisen. Before the Supreme Court it was argued that it should have been presumed that in essence and true character the taxes were paid out of the profits of the relevant year and not out of the overdraft account for the running of the business and in these circumstances the appellant was entitled to claim the deductions. The Supreme Court noted that the argument had considerable force, but considering the fact that the contention had not been advanced earlier it did not require to be answered. It then noted that in Woolcombers of India Ltd.'s case, [1982] 134 ITR 219 the Calcutta High Court had come to the conclusion that the profits were sufficient to meet the advance tax liability and the profits were deposited in the over draft account of the assessee and in such a case it should be presumed that the taxes were paid out of the profits of the year and not out of the overdraft account for the running of the business. It noted that to raise the presumption, there was sufficient material and the assessee had urged the contention before the High Court. The principle, therefore, would be that if there are funds available both interest-free and over draft and/or loans taken, then a presumption would arise that investments would be out of the interest-free fund generated or available with the company, if the interest-free funds were sufficient to meet the investments. In this case this presumption is established considering the finding of fact both by the Commissioner of Income-tax (Appeals) and the Income-tax Appellate Tribunal. We are in respectful agreement with these observations. There is no reason to restrict the presumption to cases where the funds from different sources are mixed in a common pool. The rational for the presumption is that an assessee would utilize its funds prudently ensuring that it derives the greatest financial advantage. If that be the rational we see no reason for the presumption to be restricted to cases where the different funds are mixed in a common pool. It is, however, only a presumption;

++ in HDFC Bank Ltd. v. Deputy CIT and others, 2016-TIOL-408-HC-MUM-IT, the petitioner filed its return of income for the assessment year 2008-09 in which it declared an income of Rs. 5.81 crores from the investment and securities which were exempt from tax. It treated these investments as stock in trade. The petitioner had during that year paid interest on borrowed funds and claimed the same as expenditure. The petitioner claimed that the investment in tax free securities was made out of its own tax free funds and therefore no disallowance could be made under section 14A. The petitioner contended that it was possessed of sufficient interest free funds of Rs. 2153 crores as against the investment in tax free securities of Rs. 52.02 crores and that there was a presumption that the investment which had been made in the tax-free securities had come out of the interest-free funds available with the petitioner. We respectfully agree with these observations. While it is only a presumption, it is one which is in the assessee's favour. The Department could have rebutted this presumption by calling for the records from the bank itself. It chose not do so at though the assessee stated that it was not in possession of the records. There was no application either before the Tribunal or before us for an opportunity to lead further evidence in this regard. A Division Bench of this Court in Bright Enterprises Pvt. Ltd. v. CIT 2015-TIOL-1714-HC-P&H-IT , to which one of us (S.J.Vazifdar, C.J.) was a party, followed the judgment in CIT v. Reliance Utilities and Power Ltd.2009-TIOL-27-HC-MUM-IT . It was held that if the funds/reserves of the appellant were sufficient to cover the interest free advances made by it of Rs.10.29 crores to its sister company. We are entirely in agreement with the judgment of the Bombay High Court in Commissioner of Income Tax v. Reliance Utilities & Power Ltd., 2009-TIOL-27-HC-MUM-IT, para-10, that if there are interest free funds available a presumption would arise that investment would be out of the interest free funds generated or available with the company if the interest free funds were sufficient to meet the investment. In the circumstances, question No.(i) is answered in favour of assessee. The appeal is, accordingly, dismissed.

(See 2016-TIOL-2065-HC-P&H-IT)