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.”