s.14A disallows expenses apportioned to exempt firm income, but depreciation under s.32 is not disallowable for assessee

ITAT, Ahmedabad - AT held that where share of firm income is exempt, s.14A applies and expenditures (other than depreciation) apportioned to exempt income must be disallowed; this aspect was decided against the assessee. However, depreciation being a statutory allowance u/s 32 is not an "expenditure" for purposes of s.14A and therefore cannot be disallowed under s.14A; this point was decided in favour of the assessee.

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Issues Involved:
1. Applicability of Section 14A to disallow 76% of depreciation and other related expenses.
2. Whether depreciation allowance qualifies as "expenditure" under Section 14A.

Issue-wise Detailed Analysis:

1. Applicability of Section 14A to disallow 76% of depreciation and other related expenses:

The central question referred to the Special Bench was whether the CIT(A) was justified in disallowing 76% of the depreciation and other related expenses by apportioning them in the ratio of exempt to taxable income under Section 14A of the Income Tax Act on the share income from the firm, which is exempt from tax under Section 10(2A).

The assessee, an individual deriving income from various sources including a share of profit from a partnership firm, had his expenses and depreciation allowance scrutinized by the AO and CIT(A). The CIT(A) interpreted that expenses and depreciation allowance pertain to the partnership firm and not to the individual. Since the share income from the firm is exempt under Section 10(2A), the provision of Section 14A, which deals with "expenditure incurred in relation to income not included in total income," becomes applicable.

The Tribunal considered various precedents and legal interpretations. It was argued that the firm and its partners should be seen as a single entity under the Partnership Act, but the Income Tax Act treats them as separate entities. The income taxed in the hands of the firm is not taxed again in the hands of the partners due to Sections 10(2A) and 28(v). Therefore, the share income is excluded from the total income of the partner, invoking Section 14A for any expenditure incurred in earning such income.

The Tribunal agreed with the CIT(A) that the provision contained in Section 14A is applicable in this case. The CIT(A) had disallowed the expenditure in the ratio of income not included in the total income to the income received from the firm, and this method was upheld in the absence of any argument regarding its correctness.

2. Whether depreciation allowance qualifies as "expenditure" under Section 14A:

The Tribunal examined whether depreciation allowance could be considered as "expenditure" under Section 14A. It was noted that Section 14A uses the term "expenditure incurred by the assessee in relation to income." However, a statutory allowance under Section 32, such as depreciation, is not considered an expenditure.

The Tribunal referred to the decision in the case of Hoshang D. Nanavati, which held that Section 14A deals only with the expenditure and not any statutory allowance admissible to the assessee. This decision was based on the precedent set by Nectar Beverages Pvt. Ltd. vs. DCIT. The CIT-DR could not displace the ratio of these cases, leading the Tribunal to agree that a statutory allowance like depreciation does not fall under the purview of "expenditure" as contemplated by Section 14A.

Conclusion:

The Tribunal concluded that Section 14A is applicable for disallowing expenses related to exempt income but does not extend to statutory allowances like depreciation. The Division Bench was directed to dispose of the appeal in conformity with this decision.

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