SHRI PREM NANDKUMAR KALATI ,MUMBAI vs. DCIT, CIRCLE -17(1), MUMBAI

The sole grievance raised by the assessee in the present appeal relates to the disallowance of ₹6,23,736 made under section 14A read with Rule 8D of the Income Tax Rules, 1962 and sustained by the learned CIT(A).

Briefly stated, the facts borne out from the assessment records are that the assessee is an individual engaged in business activities through two proprietary concerns, namely M/s. Chic Baby and M/s. Duru Realty. The return of income was originally filed on 29.07.2014 declaring total income of ₹4,90,000. Subsequently, a revised return was filed declaring income of ₹54,55,448. During the course of scrutiny assessment proceedings, the Assessing Officer observed that the assessee had earned exempt income comprising dividend income of ₹1,85,455 and long-term capital gains amounting to ₹6,86,351. The Assessing Officer further noted that the assessee was holding substantial investments and was availing certain financial and administrative infrastructure. According to him, expenditure attributable to earning exempt income was liable to be disallowed under section 14A. Accordingly, invoking the provisions of section 14A read with Rule 8D, he computed and disallowed a sum of ₹6,23,736.

Before the learned CIT(A), the assessee specifically contended that no expenditure whatsoever had been claimed

The assessee had further submitted that the investments generating exempt income were old investments carried forward from earlier years and no fresh investment activity involving deployment of borrowed funds had been undertaken during the relevant previous year. It was also contended that the Assessing Officer had mechanically invoked Rule 8D without recording the mandatory satisfaction contemplated under section 14A(2) and without demonstrating any nexus between the alleged expenditure and the exempt income

Before us, the learned counsel reiterated the submissions advanced before the lower authorities and drew our attention to the statement of accounts and the written submissions placed in the paper book. He submitted that the assessee had not claimed any expenditure which could remotely be said to be incurred for earning dividend income or long-term capital gains. Insofar as M/s. Chic Baby is concerned, income had been declared under section 44AD and therefore no deduction of any expenditure had been claimed separately. Insofar as M/s. Duru Realty is concerned, all expenditures including interest expenditure and administrative expenses stood capitalized to work-in-progress and none had been debited as revenue expenditure. He thus submitted that once no expenditure has been claimed as a deduction while computing taxable income, no disallowance under section 14A could be made. Reliance was also placed on various judicial precedents for the proposition that where no expenditure is claimed, there can be no occasion for making a disallowance under section 14A.

We have heard the rival submissions and perused the material placed on record. The short controversy before us is whether a disallowance under section 14A can be sustained in a situation where the assessee has not claimed any expenditure which can be regarded as having been incurred in relation to earning exempt income.

A careful perusal of the material available on record reveals that the assessee has earned exempt income by way of dividend income of ₹1,85,455 and long-term capital gains of ₹6,86,351. However, the crucial fact emerging from the records is that the assessee has consistently maintained that no expenditure relatable to such exempt income has been claimed as a deduction. In respect of M/s. Chic Baby, income has been offered under the presumptive taxation scheme prescribed under section 44AD. Once income is computed under section 44AD, the statute itself deems all allowable business expenditures to have been considered while arriving at the presumptive income and no separate claim of expenditure survives for examination. Thus, there is no identifiable expenditure claimed by the assessee which can be subjected to disallowance under section 14A.

Equally significant is the position emerging from the accounts of M/s. Duru Realty. The records indicate that although substantial expenditure was incurred in connection with the real estate project, the same was not claimed as a revenue deduction. The entire expenditure stood capitalized to work-in-progress. Even the interest expenditure incurred during the year was either voluntarily disallowed or capitalized to the project. Likewise, administrative expenses were also capitalized and not claimed while computing taxable income. Thus, from a plain reading of the accounts, it becomes evident that there was no claim of expenditure against taxable income which could form the subject matter of disallowance under section 14A.

Section 14A operates to disallow expenditure incurred in relation to income which does not form part of the total income. The provision presupposes the existence of expenditure which has been claimed by the assessee and which bears a nexus with exempt income. The provision cannot be interpreted in a manner so as to create a hypothetical disallowance in the absence of any actual claim of expenditure. The disallowance mechanism under Rule 8D is only a machinery provision and can come into operation only when the foundational requirement of section 14A,

In the present case, neither the assessment order nor the appellate order identifies any specific expenditure claimed by the assessee which can be said to have been incurred for earning the exempt income. The entire disallowance has been made merely on the assumption that because the assessee held investments and earned exempt income, some expenditure must necessarily have been incurred. Such an approach, in our considered opinion, is contrary to the scheme of section 14A. The existence of exempt income by itself cannot automatically justify a disallowance unless there is material to establish that expenditure has actually been incurred and claimed in relation thereto.

We further find merit in the assessee’s contention that the investments were old investments and there is nothing brought on record by the Assessing Officer to demonstrate that borrowed funds were utilized for making investments yielding exempt income. On the contrary, the material placed before us indicates that the borrowings were utilized in the real estate business and the corresponding interest cost was capitalized to work-in-progress. Once such interest expenditure has not been claimed as a deduction, there remains no occasion to invoke Rule 8D(2)(ii). Similarly, when

Another significant infirmity in the assessment order is that the Assessing Officer has failed to record any objective satisfaction as required under section 14A(2). The statute mandates that before resorting to the computation mechanism prescribed under Rule 8D, the Assessing Officer must record dissatisfaction regarding the correctness of the assessee’s claim having regard to the accounts. In the present case, no such exercise is discernible from the assessment order. The application of Rule 8D appears to be mechanical and based solely on the existence of exempt income and investments, which is impermissible in law.

Considering the entirety of facts and circumstances of the case, we are of the considered opinion that the very foundation for invoking section 14A is absent. The assessee has successfully demonstrated that no expenditure relatable to exempt income was claimed as a deduction while computing taxable income. The interest expenditure stood capitalized or voluntarily disallowed; administrative expenses were also capitalized; and business income from one of the proprietary concerns was declared under the presumptive provisions of section 44AD. Thus, there was no expenditure

Accordingly, we direct the Assessing Officer to delete the disallowance of ₹6,23,736 made under section 14A read with Rule 8D. The grounds raised by the assessee are allowed.

In the result, the appeal of the assessee is allowed.