2021 (6) TMI 1191 - HC - Income Tax

No disallowance under s.14A where taxpayer earned no exempt income during the relevant year, relief to assessee

PRINCIPAL COMMISSIONER OF INCOME TAX-5, ASSISTANT COMMISSIONER INCOME TAX, CIRCLE-5 (1) (1), BENGALURU Versus M/s. NADATHUR ESTATES PVT. LTD.

HC held that no disallowance under section 14A is warranted where the taxpayer did not earn any exempt income during the relevant year. The court ... Disallowance u/s 14A - investments which yielded exempt income during the said year - HELD THAT:- This Court in [2021 (4) TMI 652 - KARNATAKA HIGH COURT] has already answered the aforesaid question of law in favour of the assessee and against the revenue No disallowance u/s 14A has to be made when taxpayer has not earned any exempt income. The object of Section 14A is to curb the practice to claim deduction of expenses incurred in relation to exempt income against taxable income and at the same time avail of the tax incentive by way of exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income. Decided in favour of assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether disallowance under Section 14A read with Rule 8D(2)(iii) is justified where the Assessing Officer recalculates disallowance by taking into account only those investments which yielded exempt income during the relevant year. 2. Whether Section 14A applies and a disallowance can be made in a year when no exempt income has actually accrued to the assessee. ISSUE-WISE DETAILED ANALYSIS Issue 1: Validity of directing recalculation of disallowance under Section 14A r.w. Rule 8D(2)(iii) by reference only to investments which yielded exempt income Legal framework: Section 14A prohibits deduction of expenses incurred in relation to exempt income; Rule 8D prescribes methodology for computing such disallowance, with Rule 8D(2)(iii) addressing apportionment based on investments yielding exempt income. Precedent treatment: The Court considered prior High Court and Supreme Court pronouncements interpreting Section 14A and Rule 8D(2)(iii), including authorities that emphasize apportionment only to the extent of actual exempt income earned and other decisions that took a broader approach. Interpretation and reasoning: The Court held that Rule 8D(2)(iii) and the scheme of Section 14A require linkage to actual exempt income; hence, when applying Rule 8D(2)(iii) the appropriate comparator is investments which in fact yielded exempt income in the relevant year. The Tribunal's direction to remit the issue to the Assessing Officer to recalculate by reference to only those investments which produced exempt income accords with the statutory scheme and the correct interpretive approach that limits disallowance to expenses proportionate to earning of exempt income. Ratio vs. Obiter: Ratio - the proper application of Rule 8D(2)(iii) requires consideration of investments that yielded exempt income for apportioning expenses under Section 14A. Conclusions: Restoring the issue to the Assessing Officer with directions to recalculate the disallowance by reference to investments that yielded exempt income is justified when the conditions of Rule 8D(2)(iii) are satisfied. Issue 2: Applicability of Section 14A where no exempt income accrued in the year Legal framework: Section 14A targets expenses incurred in relation to exempt income; the statutory object is to prevent deduction of expenses against taxable income where those expenses relate to earning exempt income. Precedent treatment: The Court analysed higher court authority which held that Section 14A disallowance is relatable to the earning of actual exempt income and that only expenses proportionate to earning of exempt income could be disallowed. Conflicting High Court decisions that supported making disallowance even in years with no exempt income were examined and found to have misread the controlling higher authority. Interpretation and reasoning: The Court observed that the legislative aim of Section 14A is to deny deduction of expense allocated to exempt income actually earned, not to impose a notional or anticipatory disallowance when no exempt income has accrued. The correct approach is to link disallowance to actual exempt receipts (or to investments that yielded exempt income in that year for purposes of Rule 8D). Therefore, in a factual matrix where no exempt income has accrued in the relevant assessment year, Section 14A does not apply to generate a disallowance. Ratio vs. Obiter: Ratio - Section 14A is applicable only to expenses proportionate to actual exempt income; where no exempt income has accrued, no disallowance under Section 14A is warranted. Conclusions: The question whether disallowance under Section 14A can be made in a year with no exempt income is answered negatively; the provision does not apply in such factual situations and appellate intervention confirming this view is warranted. Cross-references and Interaction of Issues Where the Assessing Officer invokes Rule 8D(2)(iii), the computation must be consistent with the principle that only expenses relating to actual exempt income are disallowable - thus the two issues converge: (a) if exempt income was actually earned, disallowance must be apportioned by reference to investments yielding that exempt income; (b) if no exempt income was earned, Section 14A/Rule 8D does not justify any disallowance. Final Conclusion The substantial question of law is answered in favour of the assessee: Section 14A read with Rule 8D(2)(iii) requires disallowance to be linked to actual exempt income (or investments yielding such income in the year); where no exempt income accrued, Section 14A does not apply to create a disallowance. Accordingly, the appellate outcome dismissed the revenue's contention and affirmed the position favourable to the assessee.