S. 14A disallowance of interest on borrowings on ground that assessee ought to have repaid borrowings instead of investing in tax-free investments invalid
The assessee earned tax-free dividends of Rs. 21.73 crores from shares & units and claimed that the investment in the shares & units having been made out of own funds, no part of the interest on the borrowed funds could be disallowed u/s 14A. The AO, relying on Abhishek Industries 286 ITR 1 (P&H) held that the assessee ought to have utilized the own funds for repaying the borrowing instead of investing in shares and that it was a case of indirect diversion of borrowed funds into the shares and units to earn tax-free income. Interest of Rs. 9.91 crores was disallowed on a pro-rata basis. This was upheld by the CIT (A). On appeal by the assessee, HELD:
(i) The facts showed that the borrowed funds were utilized for business purposes and the investment in shares & units was made out of own funds. As per the fund flow statement for the year, Rs. 46 crores were generated from operations while the net investment made in the year was only Rs. 40.60 crores. While the aggregate investment was Rs. 316.46 crores, the own funds in the form of capital & reserves were Rs. 335.36;
(ii) The AO’s argument that the assessee could have utilized its surplus funds for repaying the borrowings instead of investing in shares and by not doing so, there was diversion of borrowed funds towards investment in shares to earn dividend income is not acceptable in view of CIT vs. Hero Cycles Ltd 323 ITR 518 (P&H) where Abhishek Industries was distinguished and it was held disallowance u/s 14A of interest on borrowed funds was not permissible if the investment in shares was made out of own funds.