ENVIRO CONTROL PRIVATE LIMITED,SURAT vs. PRINCIPAL COMMISSIONER OF INCOME- 1, SURAT

The grievances raised by the assessee are as follows: “1. That on facts and circumstances of the case the learned PCIT has erred in passing order u/s 263 setting aside order as passed by the AO u/s 143(3) and ordering fresh assessment for considering the proposed disallowance of Rs.3,84,086 u/s 14A without appreciating the fact that question related to disallowance u/s 14A was asked during the course of assessment proceedings and on being satisfied with the reply of the appellant, no disallowance u/s 14A was made and accordingly order u/s 263 is bad-in-law. 2. That on facts and circumstances of the case the learned PCIT has erred in passing order u/s 263 for considering the proposed disallowance u/s 14A without appreciating written submissions along with directly applicable judicial pronouncements relied on having reference to the Circular No.5/2016 which is heavily relied on by the PCIT while passing order u/s 263.

Succinct facts qua the issue are that assessee is a Private Limited Company and filed its return of income for assessment year 2017-18 on 31.10.2017, declaring total income of Rs.43,58,80,060/-. Thereafter, the case was selected for scrutiny under CASS and assessment under section 143(3) of the Act was finalized on 21.12.2019 by determining total assessed income of Rs.67,28,34,760/- after making addition of Rs.23,69,54,700/-.

Later on, Ld. PCIT exercised his jurisdiction and after going through the assessment records, it has been observed by Ld.PCIT that assessee-company has made following investment in unquoted shares, which can earn exempt income: Sr. Nature of investment Amount of investment as Amount of investment No on 01.04.2016 (Rs) as on 31.03.2017 (Rs) 1 Shares of Mahalaxmi Rubtech 5,55,19,521/- 80,11,385/- Ltd. 2 Shares of Gandhinagar Hotel 49,71,303/- 1,90,000/- Ltd. Shares of raj Packaging Ltd 3 58,73,052/- 11,52,000/- 4 Investment in mutual fund 5,50,000/- 5,50,000/- Total 6,69,13,876/- 99,03,385/-

The CBDT in its Circular No.05/2014 dated 11.02.2014 has clarified that Rule 8D read with section 14A of the Act provides for disallowance of the expenditure even where taxpayer in a particular year has not earned any exempt income. Accordingly, it can be concluded that disallowance u/s14A is applicable to the case of assessee, the amount of disallowance as per Rule 8D r.w.s.14A is worked out as under: As per rule 8D(2)(i) Direct expenditure relating to NI: income which does not form part of total income. As per rule 8D(2)(ii) Indirect expenditure interest not directly attributable to any particular income receipt Total investment which can earn exempt income Rs.6,69,13,876/- Page | 2

Thus, Ld.PCIT noted that while finalizing the assessment proceedings, an amount of Rs.3,84,086/- should have been disallowed u/s 14A and required to be added to the total income of the assessee. The ld PCIT noted that no inquiry in this regard has been made by the assessing officer in the course of assessment proceedings and order was passed without application of his mind. Therefore, ld PCIT noted that this makes the assessment order erroneous in so far as it is prejudicial to the interest of the Revenue and requiring revision of the order u/s 263 of the Act for A.Y 2017-18. Accordingly, proceedings for revision of order u/s 263 of the Act were initiated by issuing show cause notice bearing DIN No.ITBA/REV/F/REV1/2021-22/040734126(1) dated 15.03.2022 and duly served through e-proceedings.

In response to the notice, the assessee-company submitted its reply through e- proceedings.

However, Ld.PCIT rejected the contention of the assessee and noted that as per Balance-Sheet as on 31.03.2016, the assessee has made investment in equity shares of Mahalaxmi Rubtech Ltd to the tune of Rs.5,55,19,521/-, and in shares of Gandhinagar Hotel Ltd to the tune of Rs.49,71,303/- and in shares of Raj Packaging Ltd of Rs.58,73,052/-. As on 31.03.2017, Mahalaxmi Rubtech Ltd to the tune of Rs.80,11,382/- in shares of Gandhinagar Hotel Ltd to tune of Rs.1,90,000/- and in share of Raj Packaging Ltd of Rs.11,52,000/-. Besides, as on Page | 3

Aggrieved by the order of Ld. PCIT, the assessee is in appeal before us.

Shri Ankur A Shah, Ld. Counsel for the assessee, pleads that Ld. PCIT has exercised his jurisdictional power without any error in the assessment order. The Ld. Counsel for the assessee submitted that section 14A disallowance is not applicable to the assessee under consideration, as there is no exempt income during the year. Since there was no exempt income during the year under consideration, therefore no disallowance is attracted in assessee’s case under consideration. The Ld. Counsel took us through paper book page-5, wherein the Assessing Officer asked the question during the assessment proceedings by issuing notice u/s 142(1) of the Act and in response to notice, the assessee has submitted its reply during the assessment proceedings which is placed at paper book page- 7.Therefore Ld. Counsel contended that during the assessment stage, assessing officer questioned the assessee and assessee has submitted its reply, thus assessing officer has applied his mind and frame the assessment order, therefore the order passed by the Assessing Officer is neither erroneous nor prejudicial to the interest of Revenue.

On the other hand, Shri Ashok B Koli, Ld. CIT-DR for the Revenue, supported the order of Ld.PCIT and requested the Bench to uphold the same.

We have heard both the parties and perused the materials available on record. The Ld. Counsel took us through paper book page no.5, wherein the Assessing Officer asked the question during the assessment proceedings by issuing notice u/s 142(1) which is reproduced below: “Please furnish the details of expenditure incurred in relation to income not includible in total income and covered u/s 14A of the I.T. Act, 1961.Details of head-wise interest expenses. Also specify the interest incurred for any exempted income along with supporting evidences. Please submit the copy of JV entered, ITR filed for the JV along with the copy of the annual audit report and annexures from which exempted income is earned.”

The Ld. Counsel submitted that in response to notice, the assessee has submitted its reply during the assessment proceedings, which is placed at paper book page no.7, which is reproduced below:

Therefore Ld. Counsel contended that during the assessment stage, Assessing Officer questioned the assessee and assessee has submitted its reply. After getting the reply from the assessee, the assessing officer examined the issue and applied his mind, therefore the order passed by the Assessing Officer is neither erroneous nor prejudicial to the interest of Revenue. We note that assessee has replied to the assessing officer stating that income claimed as exempt pertains to the share of Joint Venture entered into by the company, and the share from JV is exempted u/s 86 of the Income-Tax Act, 1961, and accordingly, provisions of section 14A of the Act, is not applicable in relation to this income. We note that submitted its reply during the assessment stage, stating that share from Joint Venture is exempted u/s 86 of the Income-Tax Act, 1961. Therefore, at this juncture, it is appropriate to quote the provisions of section 86 of the Act, which reads as follows:

From the above provisions of the Act, it is vivid that Income-Tax shall not be payable by the assessee in respect of his share in the income of the association or body computed in the manner provided in section 67A. Thus, if the joint venture has paid the taxes on its income, then in that circumstances, share received by the members from such joint venture is exempt from tax. Therefore, it is clear that assessee has received exempt income from Joint venture. However, assessee submitted that to earn such income the Joint Venture has incurred relevant expenses, and after deducting such relevant expenditure the Joint Venture has paid the taxes. After paying the taxes, the net income was distributed among members of joint venture, which is tax free in the hand of the members of joint venture. Thus, the income distributed among the members have already been suffered tax, hence, ld Counsel stated that order passed by the assessing officer is neither erroneous nor prejudicial to the interest of Revenue, therefore order of ld PCIT may be quashed.

We note that during the assessment stage, the Assessing Officer asked the assessee to submit the details regarding the exempt income u/s 14A, which is placed at paper book page no.5 and in response thereto, the assessee submitted its reply during the assessment stage, which is placed at page no. 7 of the paper book. Hence, we note that during the assessment stage the assessing officer has examined the issue. However, just because assessing officer has called the details relating to issue of section 14A does not mean that order passed by the assessing officer is correct. In assessee`s case under consideration, the assessing officer, after getting the relevant documents and details from assessee about exempt income, has reached on wrong conclusion. The assessee has himself submitted before the assessing officer that share from Joint Venture (JV) is exempt u/s 86 of the Income-tax Act, 1961. It means the assessee has received the exempt income from the Joint venture and assessee himself submitted such information before the

Therefore, from the above facts, it is abundantly clear that there are no two possible views are available before the Assessing Officer. In the assessee`s case, there is only one view available before the Assessing Officer, which is that if the assessee has received exempt income from Joint venture then there should be disallowance under section 14A of the Act and Assessing Officer has failed to make such disallowance under section 14A of the Act, therefore order passed by the assessing officer is not sustainable in the eye of law. For that, let us take the guidance of judicial precedents laid down by the Hon’ble Apex Court in Malabar Industries Ltd. vs. CIT [2000] 243 ITR 83(SC) wherein their Lordship have held that twin conditions needs to be satisfied before exercising revisional jurisdiction u/s 263 of the Act by the CIT. The twin conditions are that the order of the Assessing Officer must be erroneous and so far as prejudicial to the interest of the Revenue. In the following circumstances, the order of the AO can be held to be erroneous order, that is (i) if the Assessing Officer’s order was passed on incorrect assumption of fact; or (ii) incorrect application of law; or (iii)Assessing Officer’s order is in violation of the principle of natural justice; or (iv) if the order is passed by the Assessing Officer without application of mind; (v) if the AO has not investigated the issue before him; then the order passed by the Assessing Officer can be termed as erroneous order. Coming next to the second limb, which is required to be examined as to whether the actions of the AO can be termed as prejudicial to the interest of Revenue. When this aspect is examined one has to understand what is prejudicial to the interest of the revenue. The Hon’ble Supreme Court in the case of Malabar Industries (supra) held that this phrase i.e. “prejudicial to the interest of the revenue’’ has to be read in conjunction with an erroneous order passed by the Assessing Officer. Their Lordship held that it has to be remembered that every loss of revenue as a consequence of an order of Assessing Officer cannot be treated as prejudicial to the interest of the revenue.

We note that Co-ordinate Bench of ITAT Pune in the case of Paras Bhomraj Oswal,[2017] 88 taxmann.com 41 (Pune - Trib.) held that profit share from the partnership firm is exempt income, which is liable for disallowance under section 14A of the Act. The findings of the CO-Ordinate Bench is reproduced below:

Reference in this regard can be usefully made to the decision of CO-Ordinate Bench of ITAT Mumbai, in the case of Hoshang D. Nanavati, 25 taxmann.com141( Mumbai-Trib), wherein it was held as follows: “5………Coming to the question as to the basis on which remaining expenses are to be apportioned between the expenditure incurred for the purpose of profit share and expenditure incurred for the purpose of earning remuneration from partnership firm, we are unable to see much guidance from section 16(1) as it is stood at the relevant point of time. In our considered view the purpose of standard deduction under section 16(1) was to grant deduction in respect of incidental expenditure incurred in connection with earning the salary income, which involved attending office or place of employment. However, in the present case, since the assessee earns remuneration income as also profit share from the same activity of attending office, it would not be fair to treat all such incidental expenditure only for the purpose of earning remuneration income. In our considered view and particularly having regard to the smallness of the amount involved it would be justified to allocate these expenses in the same ratio in which these expenses were allocated by the Assessing Officer……” 21. From the above judgments, it is vivid that share received from Joint Venture is exempt income therefore disallowance under section 14A of the Act would attract. After getting the details and information from the assessee, the assessing officer has failed to compute the disallowance under section 14A of the Act, therefore jurisdiction exercised by ld PCIT under section 263 of the Act is valid in law. 22. Apart from this, during the revision proceedings under section 263 of the Act, it has been observed by Ld.PCIT that assessee-company has made following investment in unquoted shares, which can earn exempt income: Sr. Nature of investment Amount of investment as Amount of investment No on 01.04.2016 (Rs) as on 31.03.2017 (Rs) 1 Shares of Mahalaxmi Rubtech 5,55,19,521/- 80,11,385/- Ltd. 2 Shares of Gandhinagar Hotel 49,71,303/- 1,90,000/- Ltd. 3 Shares of raj Packaging Ltd 58,73,052/- 11,52,000/- 4 Investment in mutual fund 5,50,000/- 5,50,000/- Total 6,69,13,876/- 99,03,385/-