Pr. Commissioner of Income-tax-4 v. IL & FS Energy Development Company Ltd
[Citation -2017-LL-0816-4]

Citation 2017-LL-0816-4
Appellant Name Pr. Commissioner of Income-tax-4
Respondent Name IL & FS Energy Development Company Ltd.
Court HIGH COURT OF DELHI AT NEW DELHI
Relevant Act Income-tax
Date of Order 16/08/2017
Assessment Year 2011-12
Judgment View Judgment
Keyword Tags share application money • concept of real income • method of computation • condition precedent • tax audit report • notional income • returned income • question of law • monthly average • share capital • total income • exempted income • expenditure incurred in relation to income not includible in total income • dividend income
Bot Summary: 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. 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 indicates a correlation between the exempt income earned in the AY and the expenditure incurred to earn it. The CBDT Circular upon which extensive reliance is placed by Mr. Hossain does not refer to Rule 8D 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. As explained in Commissioner of Income Tax v. Walfort Share and Stock Brokers Pvt. Ltd 2010 326 ITR 1, 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. The Court there declined to apply the CBDT Circular by explaining that Section 14A is clearly relatable to the earning of the actual income and not notional income or anticipated 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.


IN HIGH COURT OF DELHI AT NEW DELHI 2 ITA No. 520/2017 PR. COMMISSIONER OF INCOME TAX-04 ..... Appellant Through: Mr. Zoheb Hossain, Senior Standing Counsel with Mr. Rajender Dangwal, Advocate versus IL & FS ENERGY DEVELOPMENT COMPANY LTD .... Respondent Through: None. CORAM: JUSTICE S. MURALIDHAR JUSTICE PRATHIBA M. SINGH ORDER 16.08.2017 Dr. S. Muralidhar, J.: 1. matter is taken up for hearing today as 14th August 2017 was declared holiday on account of Janmashtami. 2. This appeal by Revenue under Section 260 of Income Tax Act, 1961 ('Act') is directed against order dated 7th November 2016 passed by Income Tax Appellate Tribunal ( ITAT ) in ITA No. 2895/Del/2015 for Assessment Year ( AY ) 2011 2012. 3. question of law sought to be urged by Revenue is whether ITAT erred in deleting disallowance made by Assessing Officer ( AO ) of sum of Rs. 4,00,78,074/- from returned income of Assessee under Section 14A of Act read with Rule 8D of Income ITA No. 520/2017 Page 1 of 11 Tax Rules, 1962 ( Rules ). 4. facts are that Respondent-Assessee is company engaged in provision of consultancy services. On 26th September 2011, Assessee filed its return at loss of Rs. 2,42,63,176/-. Assessee was asked to explain why disallowance should not be made under Section l4A of Act read with Rule 8D of Rules for purpose of normal computation of book profit for purpose of Minimum Alternative Tax ( MAT ) under Section 115JB of Act. 5. response of 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 Act was called for. 6. However, this plea was rejected by AO who relied on decision of Special Bench of 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 AY in question, investment has not actually yielded any exempt income. AO, by assessment order dated 20th February 2014, made addition of Rs.15,44,43,369/- to income of Assessee. AO held that Assessee had made investments in shares to tune of Rs.5,29,38,26,780/- for purposes of earning dividend income not chargeable to tax. AO noted that, even in tax audit report, auditors had calculated disallowance under Section 14A read with Rule 8D in sum of Rs. 5,89,22,873/-, which included direct expenses of Rs. 1,12,025/-. ITA No. 520/2017 Page 2 of 11 7. appeal filed by Assessee was disposed of by Commissioner of Income (Appeal) [ CIT (A) ] by order dated 20th March 2015 observing as under: (i) opening balance in investment of appellant company, as on 31st March 2010 was Rs.44.98 lakh. bulk of investment was made during year in equity shares of ONGC Tripura Power Company Limited in sum of Rs. 402,32,17,980/-, Himachal Sorang Power Limited in sum of Rs.35,70,40,000/- and, SE Power Private Ltd in sum of Rs. 28,99,60,000/-. (ii) In terms of decision of ITAT Delhi (Special Bench) in Cheminvest Ltd. (supra), Section 14A would apply even where investments do not give rise to exempt income pertaining to AY in question. Further, Central Board of Direct Taxes ( CBDT ) by Circular No. 5/2014 dated 11th February 2014 clarified above position. (iii) On facts, it could not be held categorically that Assessee used significant amount of its own funds only towards investments while borrowed funds were used only towards fixed assets and loans and advances given by Assessee. Some amount of borrowed funds would have gone towards making investments. Even Assessee admitted that balance amount of loans of Rs. 175 crores could have been utilized for making investments. Consequently, application of Rule 8D (2)(ii) of Rules by AO could not be said to be erroneous. ITA No. 520/2017 Page 3 of 11 (iv) CIT (A) reduced disallowance to Rs. 4,00,78,074/-. CIT (A) also reduced interest disallowed from Rs. 29,03,54,953/- to Rs. 6,11,80,756/-. 8. ITAT, by impugned order dated 7th November 2016, allowed Assessee s appeal and held as under: (i) Assessee had made investments in various companies amounting to Rs. 5,29,38,26,780/-. Out of said investments, amount of Rs. 35,70,40,000/- was invested in fully convertible debentures which could yield no tax-free income. (ii) When Assessee did not earn any exempt income, there could not be any disallowance. Further, when Assessee had made investments in shares of subsidiary companies and joint ventures for 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 decision of Special Bench of ITAT and held that Section 14A of Income Tax Act would not apply if Assessee had not received any exempt income in year in question. Gujarat High Court had, in CIT v. Corrtech Energy Pvt. Ltd. [2015] 372 ITR 97 (Guj) held likewise. Assessee held interest free funds in form of share capital, share application money and reserve paid surplus, which exceeded amount invested by Assessee. Consequently, question of disallowance of any expenditure incurred to earn exempt income during AY in ITA No. 520/2017 Page 4 of 11 question did not arise. 9. Mr. Zoheb Hossain, learned Senior Standing Counsel for Revenue, submitted that, in Cheminvest Ltd. (supra), this Court had no occasion to consider CBDT Circular No. 5/2014 dated 11th February 2014 which clarified that Section 14A would apply even when exempt income was not earned in particular AY. According to him, 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 above Circular of CBDT and, therefore, would be distinguishable. 10. Mr. Hossain further submitted that there was nothing in Section 14A of Act which suggested that exempt income had to necessarily be earned in AY in question for applicability of said provision. He submitted that if interpretation placed on Section 14 of Act by above CBDT Circular was not accepted, very purpose of Section 14A would be defeated. He referred to decisions of 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). 11. At outset, it requires to be noticed that we are concerned with AY 2011-12 and, therefore, question of applicability of Rule 8D, which was inserted with effect from 24th March 2008, is not in doubt. 12. Section 14A of Act, which was inserted with retrospective effect from 1st April 1962, provides for disallowance of expenditure incurred in ITA No. 520/2017 Page 5 of 11 relation to income exempted from tax. From 11th May 2001, proviso was inserted in Section 14A to clarify that it could not be used to reopen or rectify completed assessment. Sub-sections (2) and (3) of Section 14A were inserted with effect from 1st April, 2007 to provide for methodology for computing of disallowance under Section 14A. However, actual methodology was provided in terms of Rule 8D only from 24 th March 2008. There was further amendment to Rule 8D with effect from 2nd June 2016 limiting disallowance aggregate of amount of expenditure directly relating to income which does not form part of total income and amount equal to one per cent of annual average of monthly average of opening and closing balances of value of investment, income from which does not form part of total income. It is also provided that amount shall not exceed total expenditure claimed by Assessee. 13. In above background, key question in present case is whether disallowance of expenditure will be made even where investment has not resulted in any exempt income during AY in question but where potential exists for exempt income being earned in later AYs. 14. In Explanatory Memorandum to 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 extent they are relatable to earned income of taxable income . object behind Section 14A was to provide that no deduction shall be made in respect of any expenditure incurred by Assessee in relation to income which does not form part of total income under Income Tax Act . ITA No. 520/2017 Page 6 of 11 15. What is taxable under Section 5 of Act is total income" which is neither notional nor speculative. It has to be real income . subsequent amendment to Section 14A does not particularly clarify whether disallowance of expenditure would apply even where no exempt income is earned in AY in question from investments made, not in that AY, but earlier AYs. 16. Rule 8D (1) of Rules is helpful, to some extent, in understanding above issue. It reads as under: 8D. (1) Where Assessing Officer, having regard to accounts of assessee of previous year, is not satisfied with (a) correctness of claim of expenditure made by assessee; or (b) claim made by assessee that no expenditure has been incurred, in relation to income which does not form part of total income under Act for such previous year, he shall determine amount of expenditure in relation to such income in accordance with provisions of sub-rule (2). 17. words in relation to income which does not form part of total income under Act for such previous year in above Rule 8 D (1) indicates correlation between exempt income earned in AY and expenditure incurred to earn it. In other words, expenditure as claimed by Assessee has to be in relation to income earned in such previous year . This implies that if there is no exempt income earned in AY in question, question of disallowance of expenditure incurred to earn ITA No. 520/2017 Page 7 of 11 exempt income in terms of Section 14A read with Rule 8D would not arise. 18. CBDT Circular upon which extensive reliance is placed by Mr. Hossain does not refer to Rule 8D (1) of Rules at all but only refers to word includible occurring in title to Rule 8D as well as title to Section 14A. Circular concludes that it is not necessary that exempt income should necessarily be included in particular year s income for disallowance to be triggered. 19. In considered view of Court, this will be truncated reading of Section 14 and Rule 8D particularly when Rule 8D (1) uses expression such previous year . Further, it does not account for concept of real income . It does not note that under Section 5 of Act, 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), mandate of Section 14A of Act is to curb practice of claiming deduction of expenses incurred in relation to exempt income being taxable income and at same time avail of tax incentives by way of exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income. Consequently, Court is not persuaded that in view of Circular of CBDT dated 11th May 2014, decision of this Court in Cheminvest Ltd. (supra) requires reconsideration. 20. In M/s. Redington (India) Ltd. v. Additional Commissioner of Income Tax, Company Range V, Chennai (order dated 23rd December, 2016 of High Court of Madras in TCA No. 520 of 2016), similar ITA No. 520/2017 Page 8 of 11 contention of Revenue was negated. Court there declined to apply CBDT Circular by explaining that Section 14A is clearly relatable to earning of actual income and not notional income or anticipated income. It was further explained that, computation of total income in terms of Rule 8D is by way of determination involving direct as well as indirect attribution. Thus, accepting submission of Revenue would result in imposition of artificial method of computation on notional and assumed income. We believe thus would be carrying artifice too far. 21. 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 similar view. decision in Taikisha Engineering India Pvt. Ltd. (supra) does not specifically deal with this issue. 22. It was suggested by Mr. Hossain that, in context of Section 57(iii), 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 AY in question. This aspect of matter was dealt with by this Court in M/s Cheminvest Ltd. (supra) where it reversed decision of Special Bench of ITAT by observing as under: 20. Since Special Bench has relied upon decision of Supreme Court in Rajendra Prasad Moody (supra), it is considered necessary to discuss true purport of said decision. It is noticed to begin with that issue before Supreme Court in said case was whether expenditure under Section 57 (iii) of Act could be allowed as deduction against dividend income assessable under ITA No. 520/2017 Page 9 of 11 head income from other sources . Under Section 57 (iii) of Act deduction is allowed in respect of any expenditure laid out or expended wholly or exclusively for purpose of making or earning such income. Supreme Court explained that expression "incurred for making or earning such income , did not mean that any income should in fact have been earned as condition precedent for claiming expenditure. Court explained: What s. 57(iii) requires is that expenditure must be laid out or expended wholly and exclusively for purpose of making or earning income. It is purpose of expenditure that is relevant in determining applicability of s. 57(iii) and that purpose must be making or earning of income. s. 57(iii) does not require that this purpose must be fulfilled in order to qualify expenditure for deduction. It does not say that expenditure shall be deductible only if any income is made or earned. There is in fact nothing in language of s. 57(iii) to suggest that purpose for which expenditure is made should fructify into any benefit by way of return in shape of income. plain natural construction of language of s. 57(iii) irresistibly leads to conclusion that to bring case within section, it is not necessary that any income should in fact have been earned as result of expenditure." 21. There is merit in contention of Mr. Vohra that decision of Supreme Court in Rajendra Prasad Moody (supra) was rendered in context of allowability of deduction under Section 57(iii) of Act, where expression used is "for purpose of making or earning such income." Section 14A of Act on other hand contains expression "in relation to income which does not form part of total income." decision in Rajendra Prasad Moody (supra) cannot be used in reverse to contend that even if no income has been received, expenditure incurred can be disallowed under Section 14A of Act. 23. decisions of ITAT in ACIT v. Ratan Housing Development Ltd. (supra) and Relaxo Footwear Ltd. v. Addl. CIT (supra), to extent that ITA No. 520/2017 Page 10 of 11 they are inconsistent with what has been held hereinbefore do not merit acceptance. Further, mere fact that in audit report for AY in question, auditors may have suggested that there should be disallowance cannot be determinative of legal position. That would not preclude Assessee from taking stand that no disallowance under Section 14 of Act was called for in AY in question because no exempt income was earned. 24. For all of aforementioned reasons, this Court is of view that CBDT Circular dated 11th May 2014 cannot override expressed provisions of Section 14A read with Rule 8D. 25. No substantial question of law arises from impugned order of ITAT. appeal is accordingly dismissed. S. MURALIDHAR, J. PRATHIBA M. SINGH, J. AUGUST 16, 2017 rd ITA No. 520/2017 Page 11 of 11 Pr. Commissioner of Income-tax-4 v. IL & FS Energy Development Company Ltd
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