ITAT Mumbai remands interest deduction issue under Section 36(1)(iii); upholds cap on Section 14A disallowance

Background

The Mumbai ‘G’ Bench of the Income Tax Appellate Tribunal has partly allowed the Revenue’s appeal in the case of DCIT v. Sahyadri Agencies Limited for Assessment Year 2018–19, remanding the issue of interest deduction under Section 36(1)(iii) for fresh examination, while affirming the restriction of disallowance under Section 14A to the extent of exempt income. The assessee, a public limited company engaged in wholesale trading and distribution of FMCG products, had claimed interest expenditure of ₹27.58 crore on borrowings, primarily used for investment in shares of Jyothy Laboratories Ltd. (JLL). The assessee had also earned ₹9 crore as exempt dividend income and had made a suo motu disallowance of ₹9 crore under Section 14A.

The Assessing Officer disallowed interest of ₹18.05 crore under Section 36(1)(iii), alleging absence of business nexus, and made a further disallowance of ₹54.28 lakh under Section 14A over and above the voluntary disallowance. The CIT(A) deleted the interest disallowance, holding that the borrowings were for strategic business investment, and restricted Section 14A disallowance to the amount already offered by the assessee. On appeal, the Tribunal held that while interest on borrowed capital may be allowable on grounds of commercial expediency, the subsequent borrowings raised to refinance earlier loans require an independent examination of purpose, utilisation and nexus with business activity. Observing that the CIT(A) had not examined these aspects in sufficient detail, the Bench remanded the issue of interest deduction to the Assessing Officer for limited and focused verification, placing the burden on the assessee to establish business nexus.

However, on Section 14A, the Tribunal dismissed the Revenue’s ground, reiterating the settled position that disallowance cannot exceed exempt income, particularly where the assessee had already disallowed ₹9 crore. Accordingly, the Revenue’s appeal was partly allowed for statistical purposes.