PR. COMMISSIONER OF INCOME TAX-04 vs. M/S IL & FS ENERGY DEVELOPMENT COMPANY LTD.

This appeal by the Revenue under Section 260 A of the Income Tax Act, 1961 ('Act') is directed against the order dated 7th November 2016 passed by the Income Tax Appellate Tribunal (‘ITAT’) in ITA No. 2895/Del/2015 for the Assessment Year (‘AY’) 2011 – 2012.

The question of law sought to be urged by the Revenue is whether the ITAT erred in deleting the disallowance made by the Assessing Officer (‘AO’) of the sum of Rs. 4,00,78,074/- from the returned income of the Assessee under Section 14A of the Act read with Rule 8D of the Income

The facts are that the Respondent-Assessee is a company engaged in provision of consultancy services. On 26th September 2011, the Assessee filed its return at a loss of Rs. 2,42,63,176/-. The Assessee was asked to explain why disallowance should not be made under Section l4A of the Act read with Rule 8D of the Rules for the purpose of normal computation of book profit for the purpose of Minimum Alternative Tax (‘MAT’) under Section 115JB of the Act.

The response of the Assessee was that it had made investment in mutual funds and that no interest bearing funds were invested to earn tax free income. It accordingly pleaded that no disallowance under Section 14A of the Act was called for.

However, this plea was rejected by the AO who relied on the decision of the Special Bench of the ITAT Delhi in Cheminvest Ltd. v. ITO [2009] 121 ITD 318 (Del) (SB) wherein it was held that Section 14A would apply even if during the AY in question, the investment has not actually yielded any exempt income. The AO, by the assessment order dated 20th February 2014, made an addition of Rs.15,44,43,369/- to the income of the Assessee. The AO held that the Assessee had made investments in shares to the tune of Rs.5,29,38,26,780/- for the purposes of earning dividend income not chargeable to the tax. The AO noted that, even in the tax audit report, the auditors had calculated disallowance under Section 14A read with Rule 8D in the sum of Rs. 5,89,22,873/-, which included direct expenses of Rs. 1,12,025/-.

The appeal filed by the Assessee was disposed of by the Commissioner of Income (Appeal) [‘CIT (A)’] by an order dated 20th March 2015 observing as under: (i) The opening balance in the investment of the appellant company, as on 31st March 2010 was Rs.44.98 lakh. The bulk of the investment was made during the year in the equity shares of ONGC Tripura Power Company Limited in the sum of Rs. 402,32,17,980/-, Himachal Sorang Power Limited in the sum of Rs.35,70,40,000/- and, SE Power Private Ltd in the sum of Rs. 28,99,60,000/-.

The ITAT, by the impugned order dated 7th November 2016, allowed the Assessee’s appeal and held as under: (i) The Assessee had made investments in various companies amounting to Rs. 5,29,38,26,780/-. Out of said investments, an amount of Rs. 35,70,40,000/- was invested in fully convertible debentures which could yield no tax-free income. (ii) When the Assessee did not earn any exempt income, there could not be any disallowance. Further, when the Assessee had made investments in shares of subsidiary companies and joint ventures for the purposes of business and not for earning exempted dividend income, there could not be any disallowance. This Court, in Cheminvest Ltd. v. Commissioner of Income Tax (2015) 378 ITR 33 (Del), reversed the decision of the Special Bench of the ITAT and held that Section 14A of the Income Tax Act would not apply if the Assessee had not received any exempt income in the year in question. The Gujarat High Court had, in CIT v. Corrtech Energy Pvt. Ltd. [2015] 372 ITR 97 (Guj) held likewise. The Assessee held interest free funds in the form of share capital, share application money and reserve paid surplus, which exceeded the amount invested by the Assessee. Consequently, the question of disallowance of any expenditure incurred to earn exempt income during the AY in

Mr. Zoheb Hossain, learned Senior Standing Counsel for the Revenue, submitted that, in Cheminvest Ltd. (supra), this Court had no occasion to consider the CBDT Circular No. 5/2014 dated 11th February 2014 which clarified that Section 14A would apply even when exempt income was not earned in a particular AY. According to him, the other decisions of this Court in CIT-IV v. Taikisha Engineering India Pvt. Ltd. [2015] 370 ITR 338 (Del) and CIT-IV v. Holcim India Pvt. Ltd. (2014) 272 CTR (Del) 282 did not actually discuss the above Circular of the CBDT and, therefore, would be distinguishable.

Mr. Hossain further submitted that there was nothing in Section 14A of the Act which suggested that exempt income had to necessarily be earned in the AY in question for the applicability of the said provision. He submitted that if the interpretation placed on Section 14 A of the Act by the above CBDT Circular was not accepted, the very purpose of Section 14A would be defeated. He referred to the decisions of the ITAT in ACIT v. Ratan Housing Development Ltd. (order dated 23rd May 2008 of ITAT Lucknow) Relaxo Footwear Ltd. v. Addl. CIT [2012] 50 SOT 102 (Del).

At the outset, it requires to be noticed that we are concerned with the AY 2011-12 and, therefore, the question of the applicability of Rule 8D, which was inserted with effect from 24th March 2008, is not in doubt.

Section 14A of the Act, which was inserted with retrospective effect from 1st April 1962, provides for disallowance of the expenditure incurred in

In the above background, the key question in the present case is whether the disallowance of the expenditure will be made even where the investment has not resulted in any exempt income during the AY in question but where potential exists for exempt income being earned in later AYs.

In the Explanatory Memorandum to the Finance Act 2001, by which Section 14A was inserted with effect from 1st April 1962, it was clarified that “expenses incurred can be allowed only to the extent they are relatable to the earned income of taxable income”. The object behind Section 14A was to provide that “no deduction shall be made in respect of any expenditure incurred by the Assessee in relation to income which does not form part of the total income under the Income Tax Act”.

What is taxable under Section 5 of the Act is the “total income" which is neither notional nor speculative. It has to be ‘real income’. The subsequent amendment to Section 14A does not particularly clarify whether the disallowance of the expenditure would apply even where no exempt income is earned in the AY in question from investments made, not in that AY, but earlier AYs.

Rule 8D (1) of the Rules is helpful, to some extent, in understanding the above issue. It reads as under: “8D. (1) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with—

The words “in relation to income which does not form part of the total income under the Act for such previous year” in the above Rule 8 D (1) indicates a correlation between the exempt income earned in the AY and the expenditure incurred to earn it. In other words, the expenditure as claimed by the Assessee has to be in relation to the income earned in ‘such previous year’. This implies that if there is no exempt income earned in the AY in question, the question of disallowance of the expenditure incurred to earn

The CBDT Circular upon which extensive reliance is placed by Mr. Hossain does not refer to Rule 8D (1) of the Rules at all but only refers to the word “includible” occurring in the title to Rule 8D as well as the title to Section 14A. The Circular concludes that it is not necessary that exempt income should necessarily be included in a particular year’s income for the disallowance to be triggered.

In the considered view of the Court, this will be a truncated reading of Section 14 A and Rule 8D particularly when Rule 8D (1) uses the expression ‘such previous year’. Further, it does not account for the concept of ‘real income’. It does not note that under Section 5 of the Act, the question of taxation of ‘notional income’ does not arise. As explained in Commissioner of Income Tax v. Walfort Share and Stock Brokers Pvt. Ltd [2010] 326 ITR 1 (SC), the mandate of Section 14A of the Act is to curb the practice of claiming deduction of expenses incurred in relation to exempt income being taxable income and at the same time avail of the tax incentives by way of exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income. Consequently, the Court is not persuaded that in view of the Circular of the CBDT dated 11th May 2014, the decision of this Court in Cheminvest Ltd. (supra) requires reconsideration.

In M/s. Redington (India) Ltd. v. The Additional Commissioner of Income Tax, Company Range – V, Chennai (order dated 23rd December, 2016 of the High Court of Madras in TCA No. 520 of 2016), a similar

The decisions in CIT v. M/s Lakhani Marketing Inc. 2014 SCC Online P&H 20357, CIT v. Winsome Textile Industries Limited [2009] 319 ITR 204 (P&H), CIT v. Shivam Motors (P) Ltd. (2014) 272 CTR (All) 277 have all taken a similar view. The decision in Taikisha Engineering India Pvt. Ltd. (supra) does not specifically deal with this issue.

It was suggested by Mr. Hossain that, in the context of Section 57(iii), the Supreme Court in Commissioner Of Income Tax, West v. Rajendra Prasad Moody [1978] 115 ITR 519 (SC) explained that deduction is allowable even where income was not actually earned in the AY in question. This aspect of the matter was dealt with by this Court in M/s Cheminvest Ltd. (supra) where it reversed the decision of the Special Bench of the ITAT by observing as under: “20. Since the Special Bench has relied upon the decision of the Supreme Court in Rajendra Prasad Moody (supra), it is considered necessary to discuss the true purport of the said decision. It is noticed to begin with that the issue before the Supreme Court in the said case was whether the expenditure under Section 57 (iii) of the Act could be allowed as a deduction against dividend income assessable under the

There is merit in the contention of Mr. Vohra that the decision of the Supreme Court in Rajendra Prasad Moody (supra) was rendered in the context of allowability of deduction under Section 57(iii) of the Act, where the expression used is "for the purpose of making or earning such income." Section 14A of the Act on the other hand contains the expression "in relation to income which does not form part of the total income." The decision in Rajendra Prasad Moody (supra) cannot be used in the reverse to contend that even if no income has been received, the expenditure incurred can be disallowed under Section 14A of the Act.”

The decisions of the ITAT in ACIT v. Ratan Housing Development Ltd. (supra) and Relaxo Footwear Ltd. v. Addl. CIT (supra), to the extent that

For all of the aforementioned reasons, this Court is of the view that the CBDT Circular dated 11th May 2014 cannot override the expressed provisions of Section 14A read with Rule 8D.

No substantial question of law arises from the impugned order of the ITAT. The appeal is accordingly dismissed.