Whether provisions of Section 14A are attracted when investment is made by assessee in foreign subsidiary and dividend received on such investment is not tax free as per Section 10 - YES: ITAT

THE issue before the Bench is - Whether provisions of Section 14A are attracted when investment is made by assessee in foreign subsidiary and dividend received on such investment is not tax free as per Section 10. And the answer goes against the assessee.

Facts of the case

The assessee had claimed certain amount as exempt income under section 10 but no

disallowance was made under section 14A in the computation of income. During the assessment proceedings the Assessing Officer asked the assessee to give the working of disallowance under section 14A read with rule 8D. The assessee submitted written submissions and contended that in respect of tax exempt dividend income no borrowed fund was utilized for investing and further no expenditure was incurred in relation to the exempt income. However, without prejudice to the contentions the assessee, gave the working of disallowance under section 14A read with rule 8D. The Assessing Officer did not accept the contention of the assessee as no expenditure was incurred for earning the tax free income and made disallowance under section 14A by applying rule 8D.

In appeal, CIT(A) confirmed the action of the Assessing Officer in making the disallowance under section 14A.

Assessee submitted that the assessee's own fund was more than sufficient for investment which generated the tax free income. It was submitted that no disallowance in respect of interest expenditure was called for under section 14A when the assessee's own fund was more than sufficient for the investment during the year. It was further contended that for the assessment year 2007-08 and earlier years the Tribunal had remanded the matter to the record of the Assessing Officer for disallowance under section 14A in the light of decision of Jurisdictional High Court in the case of "Godrej & Boyce Manufacturing Co. Ltd. Vs. DCIT" 2010-TIOL-564-HC-MUM-IT and the Assessing Officer while passing the giving effect order of the Tribunal's direction had disallowed the administrative expenses at 0.25% of the investment and no disallowance was made in respect of interest expenditure. Therefore when no disallowance was made on account of interest expenditure under section 14A in the earlier year and the assessee's own fund was many times more than the investment made during the year then the action of the authorities below was unjustified. As regards the disallowance on account of administrative expenses, it was submitted that when the assessee had claimed that no expense had been incurred for earning the dividend income in question then in the absence of any satisfaction recorded by the Assessing Officer the disallowance made by the Assessing Officer was not sustainable. It was submitted that the majority of the investment during the year was in the subsidiary of the assessee and therefore to the extent of the investment in the subsidiary no disallowance of amount of administrative expenses could be made under section 14A. It was submitted that when the Assessing Officer has not established any nexus or connection of the expenditure with the exempt income then no disallowance can be made under section 14A.

Revenue contended that as per the provisions of section 14A read with rule 8D if the investment is made from the common pool fund then the interest expenditure has to be apportioned as per the formula given in the rule 8D. As regards the administrative expenses, when the assessee had made investment during the year then it could not be said that the assessee had not incurred any expenditure for earning the exempt income. It was submitted that the investment requires a decision making process and therefore in the absence of any services of portfolio manager the decision taken by the assessee clearly engaged its management as well as employees in the process. Therefore the disallowance under section 14A read with rule 8D was attracted.

Having heard the parties, the tribunal held that,

++ out of total investment of Rs.59.22 crore during the year the investment to the extent of Rs.33.80 crore is in the subsidiaries of the assessee. Further, even in the subsidiaries of the assessee the investment of Rs.32.80 crore has been made in CG International BV which is a foreign company and the dividend on such investment is not tax free as per the provisions of section 10. Therefore the provisions of section 14A are not attracted to the extent of the investment in the foreign company. Accordingly, we direct the Assessing Officer to exclude the investment made in the foreign company for the purpose of disallowance under section 14A. Now we will examine the fact whether the assessee had sufficient funds for the investment which generates the tax free income. As we have already noted that out of the total investment of Rs.59.22 crore during the year an investment of Rs.32.80 crore is in the foreign company and therefore after excluding the said investment the investment during the year generating the tax free income comes to Rs.26.42 crore only. From the analysis of the statement of source and application of fund as well as the balance sheet of the assessee, we find that there is an increase in the assessee's own fund to the tune of Rs.300 crore and at the same time there is a decrease in the loan funds during the year to the tune of Rs.228 crore. Therefore, even if its presumed that out of the Rs.300 crore increase in the assessee's own fund a sum of Rs.228 crore is used for repayment of the loan during the year, still the assessee would have a sum of Rs.72 crore available for investment. Since the investment in the domestic companies is only to the extent of Rs.26.42 crore during the year, therefore the assessee's own fund is more than sufficient to meet the investment during the year. Accordingly, we are of the view that no disallowance under section 14A is called for on account of interest expenditure when the assessee's own fund is more than sufficient for the investment generating tax free income;

++ as regards the disallowance of administrative expenses, we do not accept the contention of the assessee that no expenditure has been incurred by the assessee for earning the dividend income. For taking an investment decision a high level thought process is required and therefore when the assessee has made investment during the year the provisions of section 14A are applicable on account of administrative expenses. However, as we have noted that out of the total investment of Rs.59.22 crore a sum of Rs.33.80 crore has been invested in the subsidiary companies, therefore for the purpose of disallowance under section 14A by applying rule 8D the investment made in the subsidiaries and in the foreign company shall be excluded. The apportionment of the administrative expenses can be made only by considering the investment in the domestic companies other than the subsidiary company. Therefore, we direct the Assessing Officer to recompute the disallowance under section 14A in respect of the administrative expenses by excluding the investment in the subsidiaries and in the foreign companies.