High Court dismisses Revenue’s appeal on Section 14A (of Income Tax Act, 1961) disallowance limits

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Case Name

Principal Commissioner of Income Tax vs M/s. EWS Finance & Investments Pvt Ltd. (High Court of Madras)

Tax Case Appeal Nos.140 & 141 of 2021 and C.M.P.No.2625 of 2021 in T.C.A.No.141 of 2021

Date: 15th February 2021

Key Takeaways

• Disallowance under Section 14A (of Income Tax Act, 1961) cannot exceed the exempt income earned - this is a significant protection for taxpayers
• The court followed its own precedent from Commissioner of Income Tax Vs. M/s.Tidel Park Limited, showing consistency in judicial decisions
• CBDT circulars don’t override judicial interpretations when they conflict with established legal principles
• The Assessing Officer must first examine the taxpayer’s claim before mechanically applying Rule 8D (of Income Tax Rules, 1962)

Issue

The central legal questions were:

1. Can disallowance under Section 14A (of Income Tax Act, 1961) exceed the exempt income earned?
2. Should CBDT Circular No. 5/2014 override the principle that disallowance cannot exceed exempt income?

Facts

• This case covers assessment years 2008-09 and 2009-10
• The Income Tax Appellate Tribunal had ruled in favor of the assessee (EWS Finance) on December 21, 2017
• The Revenue (tax department) wasn’t happy with this decision and filed appeals raising two substantial questions of law
• The main dispute was about how much expense disallowance could be made under Section 14A (of Income Tax Act, 1961)

Arguments

Revenue’s Arguments:

• They argued that disallowances under Section 14A (of Income Tax Act, 1961) should not be capped at the exempt income amount
• They relied on CBDT Circular No. 5/2014, claiming it clarified that disallowance under Section 14A (of Income Tax Act, 1961) read with Rule 8D (of Income Tax Rules, 1962) must be made even if no exempt income was earned in a particular year
• They believed the tribunal was wrong in limiting the disallowance

Assessee’s Arguments:

• The assessee’s position (though not explicitly detailed in this judgment) would have been that disallowance cannot logically exceed the exempt income earned
• They likely argued that the tribunal’s decision was correct and legally sound

Key Legal Precedents

The court relied heavily on several important cases:

1. Commissioner of Income Tax Vs. M/s.Tidel Park Limited (T.C.A.Nos.732 and 733 of 2018 dated 07.07.2020) - This was the key precedent where the same High Court had already decided identical issues
2. Joint Investments Private Limited Vs. CIT (2015) 372 ITR 0694 (Del) - The Delhi High Court decision that supported limiting disallowances
3. Commissioner of Income Tax VI Vs. Taikisha Engineering India Limited [ITA No.115/2014 decided on 25.11.2014] - Referenced by the Delhi High Court
4. Godrej & Boyce Manufacturing Company Limited, Mumbai Vs. Deputy Commissioner of Income Tax (2010) 328 ITR 0081 (Bombay High Court) - This case laid down detailed principles for Section 14A (of Income Tax Act, 1961) application

The Bombay High Court in Godrej & Boyce established crucial principles, including that the AO must first determine whether the assessee’s claim is correct before applying prescribed methods, and that the AO’s satisfaction must be arrived at on an objective basis.

1. CIT Vs. Elnet Technologies Limited (2013) 30 Taxmann.com 63 (Mad) - Used for determining business income classification
2. CIT Vs. Chennai Properties and Investments Limited (2005) 274 ITR 117 - Referenced for income classification principles

Judgement

The High Court dismissed the Revenue’s appeals and ruled in favor of the assessee. Here’s their reasoning:

1. On the disallowance issue: The court noted that identical substantial questions had already been decided against the Revenue in the Tidel Park Limited case
2. Legal consistency: The court applied the well-established principle from the Godrej & Boyce case that emphasized proper procedure must be followed under Section 14A (of Income Tax Act, 1961)
3. Final order: “The Tax Case Appeals are dismissed and the substantial questions of law are answered against the Revenue and in favour of the assessee”

FAQs

Q1: What does this mean for taxpayers facing Section 14A (of Income Tax Act, 1961) disallowances?

A: This is good news for taxpayers. It confirms that the tax department cannot disallow expenses under Section 14A (of Income Tax Act, 1961) that exceed the actual exempt income you’ve earned. It’s a reasonable limitation that prevents excessive disallowances.

Q2: Can the tax department ignore this decision and continue making excessive disallowances?

A: No, this High Court decision creates a binding precedent for lower authorities in that jurisdiction. However, the department could potentially appeal to the Supreme Court.

Q3: What about CBDT Circular No. 5/2014 that the Revenue relied on?

A: The court essentially said that CBDT circulars cannot override established judicial principles. When there’s a conflict between a circular and court decisions, the court decisions prevail.

Q4: Does this apply only to this specific taxpayer?

A: No, this creates a precedent that can be used by other taxpayers facing similar Section 14A (of Income Tax Act, 1961) disallowance issues, especially in the same High Court’s jurisdiction.

Q5: What should taxpayers do if they face excessive Section 14A (of Income Tax Act, 1961) disallowances?

A: They can cite this judgment and the Tidel Park Limited case to argue that disallowances cannot exceed exempt income earned. However, each case depends on its specific facts, so professional advice is recommended.

These appeals, filed by the Revenue, are directed against the order

dated 21.12.2017 made in ITA.No.2461/Mds/2017 for the assessment year

2008-09 and ITA.No.2462/Mds/2017 for the assessment year 2009-10 on

the file of the Income Tax Appellate Tribunal, Madras 'B' Bench (for

brevity, the Tribunal).

2. The appellant-Revenue in both the appeals has raised the

following substantial questions of law for consideration:

"1.Whether on the facts and circumstances of

the case and in law, the Hon'ble ITAT is right in

deleting the addition made u/s 14A (of Income Tax Act, 1961) by

holding that disallowances made u/s 14A (of Income Tax Act, 1961) cannot

exceed the exempt income, when the provisions of

the said section as well as Rule 8D (of Income Tax Rules, 1962) does not

provide for any such exceptions?

2.Whether on the facts and circumstances of

the case and in law, the Hon'ble ITAT is right in

not appreciating the CBDT Circular No. 5/2014

wherein it's clarified that, disallowance u/s 14A (of Income Tax Act, 1961)

r.w.r 8D has to be made even if the tax payer in a

particular year not earned any exempt income?"

3. We have heard Mr.R.Karthik Ranganathan, learned Senior

Standing Counsel for the appellant-Revenue and Mr.N.Devanathan, learned

counsel for the respondent-assessee.

5. It is not disputed before us that the substantial questions of law

raised by the Revenue in these appeals have been decided against the

Revenue in T.C.A.Nos.732 and 733 of 2018 dated 07.07.2020 in the case

of Commissioner of Income Tax Vs. M/s.Tidel Park Limited. The

operative portion of the judgment reads as follows:

"4. We take up for consideration the

substantial question of law no.2 referred above. The

tribunal in paragraph No.8.1, held that the Assessing

Officer is not justified in making excessive

disallowance and that the CIT(A) rightly restricted

the disallowance to the extent the dividend income

declared by the assessee. In fact the tribunal records

that the revenue could not controvert the findings

rendered by the High Court of Delhi in the case of

Joint Investments Private Limited Vs. CIT, reported

in (2015) 372 ITR 0694 (Del).

5. It is relevant to point out that in the said

decision the Division Bench of the Delhi High Court

referred the decision in the case of Commissioner of

Income Tax VI Vs. Taikisha Engineering India

Limited [ITA No.115/2014 decided on 25.11.2014].

6. Further, the Bombay High Court in the

case of Godrej & Boyce Manufacturing Company

Limited, Mumbai Vs. Deputy Commissioner of

Income Tax, reported in (2010) 328 ITR 0081, has

elaborated the procedure to be followed by the

Assessing Officer under Section 14A (of Income Tax Act, 1961) in the following

terms.

“The following principles would emerge from s.

14A : (a) the mandate of s. 14A is to prevent

claims for deduction of expenditure in relation

to income which does not form part of the total

income of the assessee; (b) sec. 14A(1) (of Income Tax Act, 1961) is

enacted to ensure that only expenses incurred

in respect of earning taxable income are

allowed; (c) the principle of apportionment of

expenses is widened by s. 14A to include even

the apportionment of expenditure between

taxable and non-taxable income of an

indivisible business; (d) the basic principle of

taxation is to tax net income. This principle

applies even for the purposes of s. 14A and

expenses towards non-taxable income must be

excluded; (e) once a proximate cause for

disallowance is established —which is the

relationship of the expenditure with income

which does not form part of the total income—a

disallowance has to be effected. All expenditure

incurred in relation to income which does not

form part of the total income under the

provisions of the Act has to be disallowed under

s. 14A. Income which does not form part of the

total income is broadly adverted to as exempt

income as an abbreviated appellation. Under

sub-s. (2), the AO is required to determine the

amount of expenditure incurred by an assessee

in relation to such income which does not form

part of the total income under the Act in

accordance with such method as may be

prescribed. The method, having regard to the

meaning of the expression 'prescribed' in s.

2(33), must be prescribed by rules made under

the Act. What merits emphasis is that the

jurisdiction of the AO to determine the

expenditure incurred in relation to such income

which does not form part of the total income, in

accordance with the prescribed method, arises

if the AO is not satisfied with the correctness of

the claim of the assessee in respect of the

expenditure which the assessee claims to have

incurred in relation to income which does not

form part of the total income. Moreover, the

satisfaction of the AO has to be arrived at,

having regard to the accounts of the assessee.

Hence, sub-s. (2) does not ipso facto enable the

AO to apply the method prescribed by the rules

straightaway without considering whether the

claim made by the assessee in respect of the

expenditure incurred in relation to income

which does not form part of the total income is

correct. The AO must, in the first instance,

determine whether the claim of the assessee in

that regard is correct and the determination

must be made having regard to the accounts of

the assessee. The satisfaction of the AO must be

arrived at on an objective basis. It is only when

the AO is not satisfied with the claim of the

assessee, that the legislature directs him to

follow the method that may be prescribed. Sub-

s. (3) of s. 14A provides for the application of

sub-s. (2) also to a situation where the assessee

claims that no expenditure has been incurred by

him in relation to income which does not form

part of the total income under the Act."

7. The above legal position has been rightly

followed by the tribunal while deciding the assessee's

case and therefore, rightly dismissed the appeal filed

by the revenue. Thus, we find that the Substantial

Question of Law No.2 has to be answered against the

revenue and in favour of the assessee.

8. So far as Substantial Question of Law

No.1 is concerned, it has to be seen as to whether the

income derived from letting out of the property in an

industrial park/SEZ including the amenities and the

income received by the owners for such property and

the amenities therein would be business income in the

hands of the owner of the property.

9. We need not labour much on this issue,

on account of the circular No.16 of 2017 issued by the

CBDT dated 25.04.2017. The CBDT after taking note

of the two decisions of the Karnataka High Court held

that it is now a settled position that in the case of an

undertaking which develops, develops and operates or

maintains and operates an industrial park/SEZ

notified in accordance with the scheme framed and

notified by the Government, the income from letting

out the premises/developed space along with other

facilities in an industrial park/SEZ is to be charged to

tax under the head 'Profits and Gains of Business'.

10. As rightly pointed out by Mr.R.Vijaya

Raghavan, the emphasis is on not only letting out of

the premises/ developed space but along with other

facilities in an industrial park/SEZ. The tribunal in

this regard followed a decision of the Division Bench

of this Court in the case of CIT Vs. Elnet

Technologies Limited, reported in (2013) 30

Taxmann.com 63 (Mad). In the said decision, at

paragraph No.11, the Division Bench, has held as

follows:

"11. In considering whether the income arising

on the leasing of the property was business of the

assessee, one has to get into the nature of the

business of the assessee, to find out the receipts

are assessable under the head of income from

house property or as business income and if

receipts does not fall in any of those classified

heads, would fall consideration under the

residuary head of income as income from other

sources."

11. After referring to the decision in the

case of CIT Vs. Chennai Properties and Investments

Limited, reported in (2005) 274 ITR 117, it was

pointed out that income derived from letting out of the

property with all amenities and facilities would be

income from business and cannot be assessed either

as income from house property or as income from

other sources. The said decision of the Hon'ble

Division Bench was appealed against by the revenue

before the Hon'ble Supreme Court in SLP No.11638

of 2013 and we are informed that the appeal was

dismissed on 27.01.2020 on the ground of Low Tax

Effect.

12. Considering all those facts as wells as

the circular issued by CBDT, substantial question of

law No.1, has to be answered against the revenue and

in favour of the assessee. The Tax Case Appeals are

dismissed and the Substantial Questions of Law are

answered against the revenue. No Costs."

6. Thus, by applying the law laid down in the above case, the

present Tax Case Appeals are dismissed and the substantial questions of law

are answered against the Revenue and in favour of the assessee.

Consequently, connected miscellaneous petition is closed. No costs.