2024 (6) TMI 983 - AT - Income Tax

Section 14A disallowance invalid without actual exempt income in assessment year

ITAT Mumbai held that disallowance under Section 14A read with Rule 8D cannot be made in the absence of exempt income for the relevant assessment year. ... Disallowance u/s 14A r.w.r. 8D in the absence of exempt income for the relevant A.Y - Retrospective/Prospective application of the explanation to Section 14A inserted by Finance Act, 2022 - CIT(A) has based his finding while upholding the disallowance made by the Ld. AO on the ground that the Finance Act, 2020 has amended Section 14A by adding explanation to section 14A of “the Act” to clarify that notwithstanding anything to contrary contained in this Act, the provisions of this Section shall apply and shall be deemed to have always applied in a case where the exempt income has not accrued or arisen or has not been received during the previous year relevant to an A.Y. and the expenditure has been incurred during the said previous year in relation to such exempt income - Whether disallowance can be made under Rule 8D without satisfaction of the Ld. AO u/s. 14A or whether the explanation to section 14A inserted by Finance Act, 2022 can be made applicable retrospectively? HELD THAT:- Hon’ble Supreme Court in the case of Reliance Industries Ltd. [2019 (1) TMI 757 - SUPREME COURT] was pleased to hold that the Hon’ble High Court had noted the finding of the Tribunal that the interest free funds available to the assessee were sufficient to makes its investment. Hence, it could be presumed that the investments were made from the interest free funds available with the assessee. Hon’ble Supreme Court in GVK Project and Technical Services Ltd. [2019 (5) TMI 725 - SUPREME COURT] was pleased to hold that in the absence of any exempt income, disallowances were impermissible because for the relevant A.Y. 2013-14, concededly, the assessee did not report any exempt income. AO has proceeded for disallowance made in this case on the basis of presumptions that the investment was made from the borrowed funds bearing interest expenditure which may earn dividend income in future and further that such disallowances and additions are permissible u/s. 14A r.w.r. 8D of the I. T. Rules, 1962. In view of the discussions made and the relevant law laid down by the Hon’ble Supreme Court as well as Hon’ble High Court, the said finding and observation of the Ld. AO are neither tenable nor legally sustainable in the eyes of law. While upholding the finding of the Ld. AO and permitting the disallowances made therein in the Assessment Order, the Ld. CIT(A) has committed illegality and perversity by relying the explanation to Section 14A brought into existence by the Finance Amendment Act, 2022 while giving retrospective effect to the said amendment which as has been held by the Hon’ble High Court of Delhi in M/s. Era Infrastructure (India) Ltd. [2022 (7) TMI 1093 - DELHI HIGH COURT] to be not permissible. The amendment in Section 14A is not applicable retrospectively to the previous A.Y. 2016-17. For the above reasons, the finding recorded by the Ld. CIT(A) while upholding the assessment order of Ld. AO are found to be perverse, not legally sustainable in the eyes of law and accordingly set aside. Since the satisfaction of the Ld. AO for making disallowance u/s. 14A r.w.r. 8D was based on presumptions of earning dividend income in future, therefore, cannot be said to be based on the legally sustainable satisfaction. We therefore conclude that both the question no. 1 and 2 enumerated for consideration before this Tribunal are decided against the revenue and in favour of the assessee/appellant. Issues Involved:1. Disallowance under Section 14A read with Rule 8D in the absence of exempt income for A.Y. 2016-17.2. Retrospective application of the explanation to Section 14A inserted by Finance Act, 2022.Detailed Analysis:Issue 1: Disallowance under Section 14A read with Rule 8D in the absence of exempt income for A.Y. 2016-17The appellant filed a return for A.Y. 2016-17 declaring a total income of Rs. 20,94,130/-. During the assessment, the AO observed that the appellant had significant non-current investments in equity shares and short-term borrowings, leading to a disallowance of Rs. 50,81,159/- under Section 14A read with Rule 8D. This disallowance was based on the presumption that interest-bearing funds were used for these investments, which could generate exempt income in the form of dividends.The appellant argued that no exempt income was earned during the relevant financial year, making Section 14A inapplicable. The appellant cited case laws to support this contention, emphasizing that the investments were made to acquire a controlling interest in a subsidiary, not to earn dividends. The AO, however, maintained that the disallowance was justified under Rule 8D, supported by the CBDT Circular No. 5/2014 and the case of ITO vs. Daga Capital.In appellate proceedings, the CIT(A) upheld the AO's order, referencing the Finance Act 2022 amendment to Section 14A, which clarified that the section applies even if no exempt income is earned.The Tribunal examined various case laws, including:- Godrej & Brave Manufacturing Company Limited vs. Dy. Commissioner of Income Tax: The Supreme Court emphasized the necessity of actual expenditure incurred in earning dividend income for Section 14A to apply.- Commissioner of Income Tax vs. Reliance Industries Ltd.: The Supreme Court held that if interest-free funds are sufficient to cover investments, it is presumed that the investments were made from these funds.- Principal Commissioner of Income Tax vs. GVK Project and Technical Services Ltd.: The Supreme Court ruled that disallowance under Section 14A is impermissible in the absence of exempt income.The Tribunal concluded that the disallowance under Section 14A was based on presumptions and not legally sustainable, especially when no exempt income was earned. Thus, the disallowance was deleted.Issue 2: Retrospective application of the explanation to Section 14A inserted by Finance Act, 2022The CIT(A) relied on the Finance Act 2022 amendment to Section 14A, which included an explanation stating that the section applies even if no exempt income is earned. The CIT(A) treated this amendment as having retrospective effect.The appellant argued that this amendment could not be applied retrospectively. The Tribunal considered the case of Principal Commissioner of Income Tax (Central)-2 vs. M/s. Era Infrastructure (India) Ltd., where the Delhi High Court ruled that a retrospective provision in a tax act, even if stated to be for the removal of doubts, cannot be presumed to be retrospective if it changes the law as it stood.The Tribunal agreed with this interpretation, concluding that the Finance Act 2022 amendment to Section 14A does not apply retrospectively to A.Y. 2016-17. Therefore, the CIT(A)'s reliance on this amendment was legally unsustainable.Conclusion:The Tribunal decided both issues in favor of the appellant. The disallowance under Section 14A read with Rule 8D was deleted, and the retrospective application of the Finance Act 2022 amendment to Section 14A was rejected. The appeal was allowed, and the order of the CIT(A) was set aside.