CIT vs. Gujarat Power Corporation Ltd (Gujarat High Court)

S. 14A disallowance of interest on borrowings on ground that assessee ought not to have used own funds for tax-free investments invalid

The assessee borrowed Rs. 3.83 crores on which it paid interest of Rs. 17.31 lakhs. As the assessee had made investments in tax-free bonds, the AO held that the entire interest paid on the borrowings had to be disallowed u/s 14A on the basis that the assessee had arranged its affairs so as to reduce the tax liability. If the assessee had not invested its own fund for earning tax-free income, it would not have required to borrow interest bearing funds for its business and so there was a nexus between the borrowed funds and the tax free income. This was reversed by the CIT (A) and Tribunal on the basis that the assessee was justified in arranging its affairs so as to reduce the tax liability and that it was the prerogative of the assessee to use its own fund in the manner in which it considers proper and the Revenue cannot dictate how the funds should be used. On appeal by the department to the High Court, HELD dismissing the appeal:

The assessee has sufficiently explained that a majority of the investment in the tax-free security was made before the borrowing. The assessee had demonstrated that it had other sources of investment and that no part of the borrowed fund could be stated to have been diverted to earn tax free income. As borrowed funds were not used for earning tax-free income, applying s. 14A was not justified.