By C. N. Vaze
Shailesh Kamdar
Jagdish T. Punjabi
Bhadresh Doshi
Chartered Accountants
Section 14A r.w.s 36(1)(iii), section 10(2A) and section 28(v) — Since there was direct/one-toone nexus between the funds borrowed on which interest was paid and the funds invested in the firm on which interest was received, such interest had to be deducted u/s.36(1)(iii) against the interest income assessable as business income u/s.28(v) and no disallowance of interest expenditure is called for u/s.14A.
Facts: For the relevant assessment year, the assessee earned interest of Rs.2.34 crores on capital invested in a partnership firm (SE) and also share of profit from the firm [exempt u/s.10 (2A)]. The assessee paid interest of Rs.1.82 crores on funds borrowed from R. Ltd. for investing in the partnership firm. The AO assessed the interest income under the head ‘Income from Other Sources’ as against ‘Business Income’ shown by the assessee. Further, he did not allow any deduction for the interest paid by the assessee.
The CIT(A) held in favour of the assessee on both counts. In further appeal, the Revenue also invoked the provisions of section 14A for proportionate disallowance of interest on borrowed funds invested in the partnership firm. The Departmental representative stated that the assessee company not only earned interest income of Rs.2.34 crores from the partnership firm in the shape of interest, but also received the share in the profits of the firm to the tune of Rs.8.54 crores, which is exempt u/s.10(2A) and, therefore, the proportionate interest on the amount borrowed and invested in the firm to the extent it related to the share in the profits of the firm, should have been disallowed u/s.14A. In other words, the contention was that the interest paid amounting to Rs.1.82 crores should be bifurcated into two parts, that is, as relatable to the earning of the share in the profits of the firm and earning of interest income in the capacity of partner in the partnership firm and, thereafter, the part as is relatable to share in the profits of the firm should be disallowed by invoking the provisions of section 14A.
Held: The Tribunal upheld the assessee’s claim on both issues. The Tribunal noted as under:
1. From the facts it is clearly noticed that the assessee borrowed funds from R. Ltd. and the same funds were invested in SE. One-toone nexus between the borrowed funds as invested in partnership firm was proved by the assessee.
2. Interest income from the firm always has a direct and immediate relation with the capital contribution. Interest is allowed on the capital contributed by a partner in firm irrespective of the profit-sharing ratio. If some funds are borrowed and invested in the firm as capital, it is only the relation between the interest paid on such borrowed funds and interest earned from the firm that exists.
3. The interest paid by the assessee at Rs.1.82 crore has direct and sole relation with the interest income of Rs.2.34 crores. When the interest income of Rs.2.34 crores is taxable u/s.28(v) as business income, it cannot be bifurcated into two parts viz., towards interest received and share of profit from firm.
4. Even though an amount is deductible under the regular provisions of the Act, including section 36(1)(iii), disallowance can be made u/s.14A if the expenditure is in relation to exempt income. Thus, it becomes obvious that the provisions of section 14A have an overriding effect. In such a situation the applicability of section14A on the otherwise deductible interest expenditure of Rs.1.82 crores u/s.36(1) (iii) has to be examined. The question is whether any part of interest expenditure of Rs.1.82 crores can be correlated to the share of the assessee in the profits of the firm, which is otherwise exempt u/s.10(2A). [Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT & Anr., (2010) 234 CTR (Bom.) 1, (2010) 43 DTR (Bom.) 177].
5. No part of interest expenditure, which is sought to be disallowed u/s.14A, relates to share in profits of partnership firm which is otherwise exempt u/s.10(2A).
6. As there is direct nexus between the funds borrowed on which interest is paid and the funds invested in the firm on which interest is received, such interest has to be deducted u/s.36(1)(iii) against the interest income in entirely. Therefore, no disallowance of interest expenditure is called for u/s.14A, as it does not relate to any exempt income.
