2023 (9) TMI 430 - AT - Income Tax

ITAT Bangalore upholds CIT(A)'s decision on section 14A disallowance.

The Deputy Commissioner of Income Tax, Central Circle 1 (1), Bengaluru. Versus M/s. Khoday India Ltd.

The ITAT Bangalore upheld the CIT(A)'s decision to restrict the disallowance under section 14A r.w. Rule 8D to the amount of exempt income received by the ... Disallowance u/s. 14A r.w. Rule 8D - DR submitted that the disallowance made by the AO is correct and he has recorded satisfaction that the assessee has incurred interest/indirect expenditure, therefore it cannot be said that the loan funds have not been utilized by the assessee - scope of amendment made to section 14A - HELD THAT:- The assessee has incurred interest expenditure and made investments towards earning exempt income. The assessee itself disallowed a sum suomoto as expenses attributable to investments which has yielded exempt income during the year. The investments were made long back to the firm, M/s. Laxmi Estate and investment were made in other companies. We note from the submissions made before the CIT(Appeals) as well as AO that the assessee has not utilized borrowed funds during the impugned assessment year. Assessee has not incurred any expenditure in order to earn exempt income. Admittedly, there is no nexus between the investment in the firm of M/s Lakshmi Estates and the borrowed funds. The AO in the order of the earlier years has also given a categorical finding that the investment in M/s Lakshmi Estates has been made out of assessee's own interest free funds. Therefore, the interest paid on borrowed funds is not attributable to the investment the firm. We do not find any infirmity in the order of the CIT(Appeals), he has passed a good and reasoned order. Also in assessee’s own case for AY 2013-14 [2020 (2) TMI 1703 - ITAT BENGALURU] similar issue has been decided in favour of the assessee - We note that the amendment made to section 14A by Finance Act, 2022 has prospective effect which is settled in the case of PCIT v. Era Infrastructure (India) Ltd. [2022 (7) TMI 1093 - DELHI HIGH COURT] Therefore we dismiss the appeal of the revenue. ISSUES PRESENTED AND CONSIDERED 1. Whether the Assessing Officer recorded the mandatory satisfaction required to invoke disallowance under section 14A read with Rule 8D. 2. Whether disallowance under section 14A read with Rule 8D may be restricted to the amount of exempt income actually received. 3. Whether subsequent amendment to section 14A by Finance Act, 2022 or CBDT guidance (circular) affects the assessment year under consideration. ISSUE 1 - Whether the AO recorded the mandatory satisfaction required to invoke s.14A r.w. Rule 8D Legal framework: Section 14A permits disallowance of expenditure incurred in relation to exempt income; Rule 8D prescribes computation methodology. Judicial requirement in earlier decisions requires the AO to record satisfaction that expenditure was incurred in relation to exempt income before applying Rule 8D. Precedent Treatment: The Tribunal and higher judicial authorities in earlier adjudications (including coordinate bench decisions and a High Court ruling referenced by the adjudicating authority) have held that recording of satisfaction is mandatory before disallowance under section 14A/Rule 8D is made. Interpretation and reasoning: The Tribunal reviewed the assessment record and the CIT(A)'s findings that for the relevant year there was no nexus between borrowed funds and the investment yielding exempt income, and that earlier assessment orders had found investments were made out of own interest-free funds. The AO's order lacked an explicit, contemporaneous satisfaction that expenditures were incurred for earning exempt income in the impugned year. Ratio vs. Obiter: Ratio - disallowance under section 14A/Rule 8D cannot be sustained without recorded satisfaction by the AO that expenditure was incurred for earning exempt income; Obiter - related historical findings from earlier assessment years reinforced the absence of nexus but are supportive rather than independently dispositive for the impugned year. Conclusion: The requisite satisfaction was not recorded for the impugned assessment year; the AO could not validly disallow amounts under section 14A/Rule 8D on that basis. ISSUE 2 - Whether disallowance under s.14A r.w. Rule 8D may be restricted to the amount of exempt income actually received Legal framework: Section 14A targets expenditure attributable to exempt income; Rule 8D prescribes mechanistic computations (including allocation methods and a notional disallowance based on funds employed). Judicial practice has at times limited disallowance to the quantum of exempt income where nexus or factual basis for larger disallowance is absent. Precedent Treatment: Coordinate Tribunal decisions in the assessee's earlier matters applied the principle that disallowance should be restricted to the exempt income actually earned where there is no demonstrated nexus between borrowed funds and investments generating exempt receipts. The appellate authority relied on such precedent in limiting the disallowance. Interpretation and reasoning: The CIT(A) found - supported by earlier assessment findings - that investments yielding exempt income were funded from own interest-free funds and that borrowed funds were not utilized for those investments in the relevant year. The assessee itself made a nominal voluntary disallowance for attributable expenses. Given the absence of nexus and the trivial amount of exempt income (dividend of Rs. 31,231), the CIT(A) held that broader Rule 8D disallowance claimed by the AO (substantially larger) could not be justified and therefore limited disallowance to the exempt income actually received, following prior Tribunal decisions. Ratio vs. Obiter: Ratio - where no nexus between borrowed funds (or other expenses) and exempt-earning investments is established, disallowance under section 14A/Rule 8D may be confined to the amount of exempt income actually received; Obiter - reliance on historical assessment findings and voluntary small disallowance by the assessee are evidentiary supports rather than independent legal grounds. Conclusion: The restriction of disallowance to the amount of exempt income actually received (Rs. 31,231) was justified on the facts and in law for the impugned year; the AO's larger disallowance was unsustainable. ISSUE 3 - Effect of Finance Act, 2022 amendment to s.14A and CBDT Circular on the impugned assessment year Legal framework: The Finance Act, 2022 introduced an amendment to section 14A; administrative circulars may clarify application but cannot operate retrospectively unless expressly so stated and judicially sustained. Precedent Treatment: A higher court decision (referenced by the Tribunal) has held that the 2022 amendment is prospective in effect and does not affect assessment years prior to its effective date. Interpretation and reasoning: The Tribunal observed that the amendment has prospective operation and that the cited higher court decision supports non-applicability of the 2022 amendment to the assessment year under consideration. The Department's reliance on the amendment as clarificatory did not alter the conclusion that for the impugned year the pre-amendment jurisprudence and statutory regime govern. Ratio vs. Obiter: Ratio - the 2022 amendment to section 14A does not apply retrospectively to the assessment year in question; Obiter - comments on the content of the CBDT circular were not necessary to the disposal because the prospective nature of the statutory amendment controlled. Conclusion: The Finance Act, 2022 amendment and related circular do not alter the legal position for the impugned assessment year; reliance on the amendment by the revenue does not sustain reversal of the CIT(A)'s order. Overall Disposition and Key Legal Conclusions The Tribunal found no infirmity in the CIT(A)'s reasoned order: (a) the AO had not recorded the mandatory satisfaction required for invoking section 14A/Rule 8D for the year under appeal; (b) on the facts (absence of nexus and minimal exempt income) the disallowance could be restricted to the exempt income actually received; and (c) the 2022 amendment to section 14A is prospective and does not affect the assessment year under consideration. The revenue's appeal was dismissed.