2016 (12) TMI 1412 - HC - Income Tax

Revenue's Appeal Dismissed on Section 14A Disallowance

Principal Commissioner Of Income-Tax (Central) – I Versus M/s. U.K. Paints (India) Pvt. Ltd.

The High Court dismissed the revenue's appeal regarding the disallowance under Section 14A read with Rule 8D, emphasizing the requirement for the ... Disallowance made under Section 14A of the Act read with Rule 8D cancelled - Held that:- Section 14A(2) prescribes the mode or methodology for the disallowance and the steps for its calculation. Unlike the other part of the statute which decree or enjoin the actual methodology and are substantive, Parliament deemed it appropriate to leave it to the rule making authority to prescribe the methodology, i.e. computation. The question of applying the statutorily prescribed method would arise only and only if the AO expresses an opinion rejecting the assessee’s methodology and the figure offered at the time of assessment. This is material because the jurisdiction to go into the method prescribed in the Rules arise only if the amounts the assessee offers does not have any realistic correlation with the tax exempt income. For instance, in a given case, if a tax exempt income is to the tune of ₹ 5 crores and the assessee is able to satisfy that expenditure relatable to that income or the reasonable nexus to such income is ₹ 25 lakhs, there has to be strong reasons why the said amount of ₹ 25 lakhs are to be rejected. The opinion of the assessing officer in the latter part [of Section 14A(2)] is to be based upon an appraisal of objective material relating to the assessee’s voluntary disallowance of amount/amounts. Not only that, if in the course of assessment, the AO enquires from the assessee about the amounts spent, which are to be disallowed, and the assessee in fact discloses a larger amount (than the one given in the return), it is still incumbent upon the AO to enquire into such larger amounts and determine whether it has nexus with expenditure relatable to exempt income to attract Section 14A(1). Sans this procedure, Section 14A would be reduced to a mere formality which it appears to have become in the circumstances of the case. Consequently, we are of the opinion that there is no infirmity in the reasoning and conclusions of the ITAT. - Decided against revenue Issues Involved:1. Cancellation of disallowance under Section 14A of the Income Tax Act, 1961 read with Rule 8D of the Income Tax Rules.2. Treatment of loans as deemed dividends under Section 2(22)(e) of the Income Tax Act, 1961.Issue-Wise Detailed Analysis:1. Cancellation of Disallowance under Section 14A read with Rule 8D:Assessment and Disallowance by AO:- The assessee reported tax-exempt income exceeding Rs. 25 crores for AY 2006-07.- The AO disallowed Rs. 2,55,02,142/- under Section 14A, rejecting the assessee’s voluntary disallowance of Rs. 7.5 lakhs.- The AO noted a direct nexus between the increase in exempt income and the increase in expenses, justifying the disallowance.CIT’s Observations:- The CIT upheld the disallowance but directed the AO to use Rule 8D for computation.- CIT emphasized that both direct and indirect expenditures related to exempt income are disallowable.- CIT referred to precedents and stated Rule 8D, being procedural, has retrospective effect.ITAT’s Decision:- ITAT relied on the Delhi High Court’s decision in CIT-VI v. Taikisha Engineering India Ltd., emphasizing the need for the AO to record satisfaction about the correctness of the assessee’s claim before making disallowances under Rule 8D.- ITAT found that the AO did not record such satisfaction, making the disallowance invalid.High Court’s Analysis:- The High Court reiterated that the AO’s satisfaction about the correctness of the assessee’s claim is crucial before invoking Rule 8D.- The court noted that the AO failed to record reasons for rejecting the assessee’s voluntary disallowance.- The court emphasized that the jurisdiction to apply Rule 8D arises only if the AO rejects the assessee’s methodology with objective material.- The court dismissed the revenue’s appeal, finding no infirmity in ITAT’s reasoning and conclusions.2. Treatment of Loans as Deemed Dividends under Section 2(22)(e):Assessment by AO:- The AO treated loans received by the assessee from M/s Citiland Commercial Credits Ltd. and M/s Bigg Investment as deemed dividends, adding Rs. 12,25,055/- and Rs. 7,40,988/- respectively to the assessee’s income.- The AO rejected the assessee’s explanation that these companies were in the lending business and thus, Section 2(22)(e) was not applicable.CIT’s Observations:- The CIT did not specifically address the issue of deemed dividends in the provided text.ITAT’s Decision:- The provided text does not detail ITAT’s decision on the deemed dividend issue.High Court’s Analysis:- The provided text does not detail the High Court’s analysis on the deemed dividend issue.Conclusion:The High Court dismissed the revenue’s appeal concerning the disallowance under Section 14A read with Rule 8D, emphasizing the necessity for the AO to record satisfaction about the correctness of the assessee’s claim before making such disallowances. The court upheld ITAT’s decision, finding no infirmity in its reasoning. The issue of deemed dividends under Section 2(22)(e) was not elaborated upon in the provided text.