Cheminvest Ltd vs. ITO (ITAT Delhi Special Bench)

S. 14A disallowance has to be made even if assessee has no tax-free income

The assessee had borrowed funds for the purpose of investing in shares. The shares were held for capital purposes as well as for investment purposes. In AY 2004-2005, the assessee did not receive any dividend on the said shares and so there was no exempt income. The Special Bench had to consider whether the interest expenditure incurred by the assessee on the said borrowings used for purposes of investment in shares could be disallowed u/s 14A even though the assessee had not received any tax-free income in respect of the said shares. HELD, deciding against the assessee:

(i) In Rajendra Prasad Moody 115 ITR 522 the Supreme Court held that interest on monies borrowed for purchase of shares was allowable as a deduction u/s 57 (iii) irrespective of whether or not there is any yield of dividend to the assessee. It was held that the words “expenditure incurred for making or earning the income” in s. 57 (iii) did not mean that income actually had to be earned for the allowability of the expenditure. The converse of this principle is now applicable. i.e. s. 14A disallows expenditure “in relation to income which does not form part of total income” and in order for the expenditure to be disallowed, actual income need not be earned;

(ii) The fact that the expenditure is allowable u/ss 36 (1) (iii) / 57 is irrelevant because s. 14A has overriding effect and supercedes all other provisions;

(iii) The disallowance has to be of the entire amount of the expenditure so related and cannot be reduced by the receipt of interest which has no relation to such expenditure.