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* IN THE HIGH COURT OF DELHI AT NEW DELHI
2
+ ITA No. 520/2017
PR. COMMISSIONER OF INCOME TAX-04 ..... Appellant
Through: Mr. Zoheb Hossain, Senior Standing
Counsel with Mr. Rajender Dangwal, Advocate
versus
IL & FS ENERGY DEVELOPMENT COMPANY LTD .... Respondent
Through: None.
CORAM:
JUSTICE S. MURALIDHAR
JUSTICE PRATHIBA M. SINGH
ORDER
% 16.08.2017
Dr. S. Muralidhar, J.:
1. The matter is taken up for hearing today as 14th August 2017 was declared
a holiday on account of Janmashtami.
2. This appeal by the Revenue under Section 260 A of the Income Tax Act,
1961 ('Act') is directed against the order dated 7th November 2016 passed by
the Income Tax Appellate Tribunal (`ITAT') in ITA No. 2895/Del/2015 for
the Assessment Year (`AY') 2011 2012.
3. The question of law sought to be urged by the Revenue is whether the
ITAT erred in deleting the disallowance made by the Assessing Officer
(`AO') of the sum of Rs. 4,00,78,074/- from the returned income of the
Assessee under Section 14A of the Act read with Rule 8D of the Income
ITA No. 520/2017 Page 1 of 11
Tax Rules, 1962 (`Rules').
4. The facts are that the Respondent-Assessee is a company engaged in
provision of consultancy services. On 26th September 2011, the Assessee
filed its return at a loss of Rs. 2,42,63,176/-. The Assessee was asked to
explain why disallowance should not be made under Section l4A of the Act
read with Rule 8D of the Rules for the purpose of normal computation of
book profit for the purpose of Minimum Alternative Tax (`MAT') under
Section 115JB of the Act.
5. The response of the Assessee was that it had made investment in mutual
funds and that no interest bearing funds were invested to earn tax free
income. It accordingly pleaded that no disallowance under Section 14A of
the Act was called for.
6. However, this plea was rejected by the AO who relied on the decision of
the Special Bench of the ITAT Delhi in Cheminvest Ltd. v. ITO [2009] 121
ITD 318 (Del) (SB) wherein it was held that Section 14A would apply even
if during the AY in question, the investment has not actually yielded any
exempt income. The AO, by the assessment order dated 20th February 2014,
made an addition of Rs.15,44,43,369/- to the income of the Assessee. The
AO held that the Assessee had made investments in shares to the tune of
Rs.5,29,38,26,780/- for the purposes of earning dividend income not
chargeable to the tax. The AO noted that, even in the tax audit report, the
auditors had calculated disallowance under Section 14A read with Rule 8D
in the sum of Rs. 5,89,22,873/-, which included direct expenses of Rs.
1,12,025/-.
ITA No. 520/2017 Page 2 of 11
7. The appeal filed by the Assessee was disposed of by the Commissioner of
Income (Appeal) [`CIT (A)'] by an order dated 20th March 2015 observing
as under:
(i) The opening balance in the investment of the appellant company, as
on 31st March 2010 was Rs.44.98 lakh. The bulk of the investment
was made during the year in the equity shares of ONGC Tripura
Power Company Limited in the sum of Rs. 402,32,17,980/-, Himachal
Sorang Power Limited in the sum of Rs.35,70,40,000/- and, SE Power
Private Ltd in the sum of Rs. 28,99,60,000/-.
(ii) In terms of the decision of ITAT Delhi (Special Bench) in
Cheminvest Ltd. (supra), Section 14A would apply even where the
investments do not give rise to exempt income pertaining to the AY in
question. Further, the Central Board of Direct Taxes (`CBDT') by
Circular No. 5/2014 dated 11th February 2014 clarified the above
position.
(iii) On facts, it could not be held categorically that the Assessee used
significant amount of its own funds only towards investments while
the borrowed funds were used only towards fixed assets and loans and
advances given by the Assessee. Some amount of the borrowed funds
would have gone towards making investments. Even the Assessee
admitted that the balance amount of loans of Rs. 175 crores could
have been utilized for making investments. Consequently, the
application of Rule 8D (2)(ii) of the Rules by the AO could not be
said to be erroneous.
ITA No. 520/2017 Page 3 of 11
(iv) The CIT (A) reduced the disallowance to Rs. 4,00,78,074/-. The CIT
(A) also reduced the interest disallowed from Rs. 29,03,54,953/- to
Rs. 6,11,80,756/-.
8. The ITAT, by the impugned order dated 7th November 2016, allowed the
Assessee's appeal and held as under:
(i) The Assessee had made investments in various companies amounting
to Rs. 5,29,38,26,780/-. Out of said investments, an amount of Rs.
35,70,40,000/- was invested in fully convertible debentures which
could yield no tax-free income.
(ii) When the Assessee did not earn any exempt income, there could not
be any disallowance. Further, when the Assessee had made
investments in shares of subsidiary companies and joint ventures for
the purposes of business and not for earning exempted dividend
income, there could not be any disallowance. This Court, in
Cheminvest Ltd. v. Commissioner of Income Tax (2015) 378 ITR 33
(Del), reversed the decision of the Special Bench of the ITAT and
held that Section 14A of the Income Tax Act would not apply if the
Assessee had not received any exempt income in the year in question.
The Gujarat High Court had, in CIT v. Corrtech Energy Pvt. Ltd.
[2015] 372 ITR 97 (Guj) held likewise. The Assessee held interest
free funds in the form of share capital, share application money and
reserve paid surplus, which exceeded the amount invested by the
Assessee. Consequently, the question of disallowance of any
expenditure incurred to earn exempt income during the AY in
ITA No. 520/2017 Page 4 of 11
question did not arise.
9. Mr. Zoheb Hossain, learned Senior Standing Counsel for the Revenue,
submitted that, in Cheminvest Ltd. (supra), this Court had no occasion to
consider the CBDT Circular No. 5/2014 dated 11th February 2014 which
clarified that Section 14A would apply even when exempt income was not
earned in a particular AY. According to him, the other decisions of this
Court in CIT-IV v. Taikisha Engineering India Pvt. Ltd. [2015] 370 ITR
338 (Del) and CIT-IV v. Holcim India Pvt. Ltd. (2014) 272 CTR (Del) 282
did not actually discuss the above Circular of the CBDT and, therefore,
would be distinguishable.
10. Mr. Hossain further submitted that there was nothing in Section 14A of
the Act which suggested that exempt income had to necessarily be earned in
the AY in question for the applicability of the said provision. He submitted
that if the interpretation placed on Section 14 A of the Act by the above
CBDT Circular was not accepted, the very purpose of Section 14A would be
defeated. He referred to the decisions of the ITAT in ACIT v. Ratan
Housing Development Ltd. (order dated 23rd May 2008 of ITAT Lucknow)
Relaxo Footwear Ltd. v. Addl. CIT [2012] 50 SOT 102 (Del).
11. At the outset, it requires to be noticed that we are concerned with the AY
2011-12 and, therefore, the question of the applicability of Rule 8D, which
was inserted with effect from 24th March 2008, is not in doubt.
12. Section 14A of the Act, which was inserted with retrospective effect
from 1st April 1962, provides for disallowance of the expenditure incurred in
ITA No. 520/2017 Page 5 of 11
relation to income exempted from tax. From 11th May 2001, a proviso was
inserted in Section 14A to clarify that it could not be used to reopen or
rectify a completed assessment. Sub-sections (2) and (3) of Section 14A
were inserted with effect from 1st April, 2007 to provide for methodology
for computing of disallowance under Section 14A. However, the actual
methodology was provided in terms of Rule 8D only from 24 th March 2008.
There was a further amendment to Rule 8D with effect from 2nd June 2016
limiting the disallowance the aggregate of the amount of expenditure
directly relating to income which does not form part of total income and an
amount equal to one per cent of the annual average of the monthly average
of the opening and closing balances of the value of investment, income from
which does not form part of the total income. It is also provided that the
amount shall not exceed the total expenditure claimed by the Assessee.
13. In the above background, the key question in the present case is whether
the disallowance of the expenditure will be made even where the investment
has not resulted in any exempt income during the AY in question but where
potential exists for exempt income being earned in later AYs.
14. In the Explanatory Memorandum to the Finance Act 2001, by which
Section 14A was inserted with effect from 1st April 1962, it was clarified
that "expenses incurred can be allowed only to the extent they are relatable
to the earned income of taxable income". The object behind Section 14A
was to provide that "no deduction shall be made in respect of any
expenditure incurred by the Assessee in relation to income which does not
form part of the total income under the Income Tax Act".
ITA No. 520/2017 Page 6 of 11
15. What is taxable under Section 5 of the Act is the "total income" which is
neither notional nor speculative. It has to be `real income'. The subsequent
amendment to Section 14A does not particularly clarify whether the
disallowance of the expenditure would apply even where no exempt income
is earned in the AY in question from investments made, not in that AY, but
earlier AYs.
16. Rule 8D (1) of the Rules is helpful, to some extent, in understanding the
above issue. It reads as under:
"8D. (1) Where the Assessing Officer, having regard to the accounts
of the assessee of a previous year, is not satisfied with--
(a) the correctness of the claim of expenditure made by the assessee;
or
(b) the claim made by the assessee that no expenditure has been
incurred, in relation to income which does not form part of the total
income under the Act for such previous year,
he shall determine the amount of expenditure in relation to such
income in accordance with the provisions of sub-rule (2)."
17. The words "in relation to income which does not form part of the total
income under the Act for such previous year" in the above Rule 8 D (1)
indicates a correlation between the exempt income earned in the AY and the
expenditure incurred to earn it. In other words, the expenditure as claimed
by the Assessee has to be in relation to the income earned in `such previous
year'. This implies that if there is no exempt income earned in the AY in
question, the question of disallowance of the expenditure incurred to earn
ITA No. 520/2017 Page 7 of 11
exempt income in terms of Section 14A read with Rule 8D would not arise.
18. The CBDT Circular upon which extensive reliance is placed by Mr.
Hossain does not refer to Rule 8D (1) of the Rules at all but only refers to
the word "includible" occurring in the title to Rule 8D as well as the title to
Section 14A. The Circular concludes that it is not necessary that exempt
income should necessarily be included in a particular year's income for the
disallowance to be triggered.
19. In the considered view of the Court, this will be a truncated reading of
Section 14 A and Rule 8D particularly when Rule 8D (1) uses the expression
`such previous year'. Further, it does not account for the concept of `real
income'. It does not note that under Section 5 of the Act, the question of
taxation of `notional income' does not arise. As explained in Commissioner
of Income Tax v. Walfort Share and Stock Brokers Pvt. Ltd [2010] 326
ITR 1 (SC), the mandate of Section 14A of the Act is to curb the practice of
claiming deduction of expenses incurred in relation to exempt income being
taxable income and at the same time avail of the tax incentives by way of
exemption of exempt income without making any apportionment of
expenses incurred in relation to exempt income. Consequently, the Court is
not persuaded that in view of the Circular of the CBDT dated
11th May 2014, the decision of this Court in Cheminvest Ltd. (supra)
requires reconsideration.
20. In M/s. Redington (India) Ltd. v. The Additional Commissioner of
Income Tax, Company Range V, Chennai (order dated 23rd December,
2016 of the High Court of Madras in TCA No. 520 of 2016), a similar
ITA No. 520/2017 Page 8 of 11
contention of the Revenue was negated. The Court there declined to apply
the CBDT Circular by explaining that Section 14A is "clearly relatable to
the earning of the actual income and not notional income or anticipated
income." It was further explained that,
"The computation of total income in terms of Rule 8D is by way of a
determination involving direct as well as indirect attribution. Thus,
accepting the submission of the Revenue would result in the
imposition of an artificial method of computation on notional and
assumed income. We believe thus would be carrying the artifice too
far."
21. The decisions in CIT v. M/s Lakhani Marketing Inc. 2014 SCC Online
P&H 20357, CIT v. Winsome Textile Industries Limited [2009] 319 ITR
204 (P&H), CIT v. Shivam Motors (P) Ltd. (2014) 272 CTR (All) 277 have
all taken a similar view. The decision in Taikisha Engineering India Pvt.
Ltd. (supra) does not specifically deal with this issue.
22. It was suggested by Mr. Hossain that, in the context of Section 57(iii),
the Supreme Court in Commissioner Of Income Tax, West v. Rajendra
Prasad Moody [1978] 115 ITR 519 (SC) explained that deduction is
allowable even where income was not actually earned in the AY in question.
This aspect of the matter was dealt with by this Court in M/s Cheminvest
Ltd. (supra) where it reversed the decision of the Special Bench of the ITAT
by observing as under:
"20. Since the Special Bench has relied upon the decision of the
Supreme Court in Rajendra Prasad Moody (supra), it is considered
necessary to discuss the true purport of the said decision. It is noticed
to begin with that the issue before the Supreme Court in the said case
was whether the expenditure under Section 57 (iii) of the Act could be
allowed as a deduction against dividend income assessable under the
ITA No. 520/2017 Page 9 of 11
head "income from other sources". Under Section 57 (iii) of the Act
deduction is allowed in respect of any expenditure laid out or
expended wholly or exclusively for the purpose of making or earning
such income. The Supreme Court explained that the expression
"incurred for making or earning such income, did not mean that any
income should in fact have been earned as a condition precedent for
claiming the expenditure. The Court explained:
"What s. 57(iii) requires is that the expenditure must be lai d out
or expended wholly and exclusively for the purpose of making
or earning income. It is the purpose of the expenditure that is
relevant in determining the applicability of s. 57(iii) and that
purpose must be making or earning of income. s. 57(iii) does
not require that this purpose must be fulfilled in order to qualify
the expenditure for deduction. It does not say that the
expenditure shall be deductible only if any income is made or
earned. There is in fact nothing in the language of s. 57(iii) to
suggest that the purpose for which the expenditure is made
should fructify into any benefit by way of return in the shape of
income. The plain natural construction of the language of s.
57(iii) irresistibly leads to the conclusion that to bring a case
within the section, it is not necessary that any income should in
fact have been earned as a result of the expenditure."
21. There is merit in the contention of Mr. Vohra that the decision of
the Supreme Court in Rajendra Prasad Moody (supra) was rendered
in the context of allowability of deduction under Section 57(iii) of the
Act, where the expression used is "for the purpose of making or
earning such income." Section 14A of the Act on the other hand
contains the expression "in relation to income which does not form
part of the total income." The decision in Rajendra Prasad Moody
(supra) cannot be used in the reverse to contend that even if no
income has been received, the expenditure incurred can be disallowed
under Section 14A of the Act."
23. The decisions of the ITAT in ACIT v. Ratan Housing Development Ltd.
(supra) and Relaxo Footwear Ltd. v. Addl. CIT (supra), to the extent that
ITA No. 520/2017 Page 10 of 11
they are inconsistent with what has been held hereinbefore do not merit
acceptance. Further, the mere fact that in the audit report for the AY in
question, the auditors may have suggested that there should be a
disallowance cannot be determinative of the legal position. That would not
preclude the Assessee from taking a stand that no disallowance under
Section 14 A of the Act was called for in the AY in question because no
exempt income was earned.
24. For all of the aforementioned reasons, this Court is of the view that the
CBDT Circular dated 11th May 2014 cannot override the expressed
provisions of Section 14A read with Rule 8D.
25. No substantial question of law arises from the impugned order of the
ITAT. The appeal is accordingly dismissed.
S. MURALIDHAR, J.
PRATHIBA M. SINGH, J.
AUGUST 16, 2017
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