ITA No.5069/Mum/2003 order Pronounced On: 19^th November, 2010. DCIT VERSUS M/s Reliance consolidated Enterprises Ltd.

Brief facts of the case 

The assessee company was engaged in dealing in shares and securities. It had shown income from sale of shares, dividend income, interest on debentures and miscellaneous income etc. The Assessing Officer, during the course of assessment proceedings noted that the assessee company has received dividend income of ` 1,01,21,075/- out of which it has claimed an amount of ` 1,01,11,259 as exempt. On being questioned by the Assessing Officer as to why the administrative expenses should be allowed, the assessee submitted that the administrative expenses and the interest on borrowing have not been incurred by the assessee company in relation to income which does not form part of the total income.  

The Assessing Officer further noted that the assessee has debited interest of ` 69.71 lakhs. He asked the assessee to explain the allowability of these expenses. It was explained by the assessee that the company has received dividend of ` 1,01,21,075/- on shares of Reliance Industries Ltd, Reliance Capital Ltd and UTI units 1964. All these shares were purchased during the earlier years. The company has not invested any amount during the relevant previous year in any of the shares mentioned above on which dividend income was received.  

Contentions of the AO

The Assessing Officer was not convinced with the explanation given by the assessee. He noted that the funds were borrowed during the course of carrying on the business of the assessee and interest has been paid on those funds which are utilized for investment in business. Since investment in shares results into dividend income, the interest paid on borrowings is held to be having been incurred in respect of earning of exempt income. He, accordingly disallowed the entire amount of ` 69.71 lakhs as has been incurred wholly and exclusively for the purpose of earning the income which has been claimed as exempt.           

Before CIT(A)

In appeal, the CIT(A) upheld the action of the Assessing Officer in disallowing the administrative expenses of ` 1 lakh on ad-hoc basis as attributable to earning of dividend income. However, as regards the disallowance of interest income of `. 69.71 lakhs, he directed the Assessing Officer to restrict the disallowance to ` 6.99 lakhs which, according to him should be calculated on the basis of the following formula: 

Upon cross appeals to ITAT by assessee and revenue: -

Held , while confirming the action of the lower authorities for adhoc disallowance of Rs. 1 Lakhs, that  Since admittedly, all the shares on which dividend income was earned and claimed as exempt were purchased much prior to the amounts borrowed by the assessee; therefore, ……, no part of the interest in our opinion can be disallowed u/s 14A of the I T Act. Accordingly, we set aside the order of the CIT(A) and direct the Assessing Officer to delete the disallowance of interest expenditure u/s 14A of the I T Act (para 7)