No s. 14A disallowance if there is no tax-free income
The assessee, a partner in a firm, borrowed funds and advanced it to the firm on terms that the firm would pay interest if it made a profit. For one year, the firm paid interest which was offered as income by the assessee while for the second year it did not pay interest as it made a loss. The assessee claimed the interest paid on the borrowing as a deduction u/s 36(1)(iii). The AO disallowed the claim on the ground that as the borrowings had been invested in the firm and the income from the firm was exempt u/s 10(2A), the interest expenditure was not allowable u/s 14A. This was reversed by the CIT (A). On appeal, the Tribunal upheld the CIT (A) on the ground that as there was no exemption claimed u/s 10(2A) by the assessee and there was no tax-free income, s. 14A could not apply. The department filed an appeal in the High Court in which it argued that as the profits derived by the assessee from the firm was exempt u/s 10(2A), the interest on the borrowed funds used to invest in the firm was disallowable u/s 14A. HELD by the High Court dismissing the appeal:
In so far as Question (A) is concerned, on facts we find that there is no (tax-free) profit for the relevant assessment year. Hence the question as framed would not arise.