Business expenditure : Disallowance u/s. 14A of Income-tax Act, 1961 : In the absence of nexus between exempt income and expenditure in question established by Revenue, the provisions of S. 14A cannot be applied.

[CIT v. M/s. Hero Cycles Ltd. (P&H), ITA No. 331 of 2009 dated 4-11-2009]

The assesse is engaged in manufacturing of cycles and parts of two-wheelers in multiple units. It earned dividend income, which is exempted u/s. 10(34) and u/s.(35) of the Income-tax Act, 1961. The AO made an inquiry whether any expenditure was incurred for earning this income and as a result of the said inquiry, addition of Rs.3,48,04,375 was made by way of disallowance u/s.14A(3) of the Act. The Tribunal deleted the addition and observed as under :

“(i) We find that the plea of the assessee that the entire investments have been made out of the dividend proceeds, sale proceeds, debenture redemption, etc., is borne out of record. One aspect which is evident is that the interest income earned by the main unit exceeds the expenditure by way of interest incurred by it, thus obviating the application of S. 14A of the Act. Even with regard to the funds of the main unit, the fund flow position explained shows that only the non-interest bearing funds have been utilised for making the investment.

(ii) Thus, on facts we do not find any evidence to show that the assessee has incurred interest expenditure in relation to earning the tax exempt income in question. Therefore, merely because the assessee has incurred interest expenditure on funds borrowed in the main unit, it would not ipso-facto invite the disallowance u/s.14A, unless there is evidence to show that such interest-bearing funds have been invested in the investments which have generated the ‘tax exempt dividend income’.

(iii) As noted earlier, there is no nexus established by the Revenue in this regard and therefore, on a mere presumption, the provisions of S. 14A cannot be applied. In fact, in the absence of such nexus, the entire addition made is required to be deleted. We accordingly hold so.”

On appeal by the Revenue, the Punjab and Haryana High Court upheld the decision of the Tribunal and held as under :

“(i) Learned counsel for the appellant relies upon S. 14A(2) and Rule 8D(1)(b) to submit that even where the assessee claimed that no expenditure had been incurred, the correctness of such claim could be gone into by the AO and in the present case, the claim of the assessee that no expenditure was incurred was found to be not acceptable by the AO and thus disallowance was justified. We are unable to accept the submission.

(ii) In view of the finding reproduced above, it is clear that the expenditure on interest was set off against the income from interest and the investment in shares and funds were out of the dividend proceeds. In view of this finding of fact, disallowance u/s.14A was not sustainable.

(iii) Whether, in a given situation, any expenditure was incurred which was to be disallowed, is a question of fact. The contention of the Revenue that directly or indirectly some expenditure is always incurred which must be disallowed u/s.14A and the impact of expenditure so incurred cannot be allowed to be set off against the business income which may nullify the mandate of S. 14A, cannot be accepted.

(iv) Disallowance u/s.14A requires finding of incurring of expenditure. Where it is found that for earning exempt income, no expenditure has been incurred, disallowance u/s.14A cannot stand. In the present case finding on this aspect, against the Revenue, is not shown to be perverse. Consequently, disallowance is not permissible.”