Insertion of Section 14A (of Income Tax Act, 1961) with respective effect reflected serious attempt on part of Parliament not to allow deduction in respect of any expenditure incurred by Assessee in relation to income which did not form part of total income under Act, 1961 against taxable income thus where order of A.O. indicate that he is not satisfied with correctness of claim of Assessee or claim of Assessee that no expenditure had been incurred, he had to proceed in manner indicated in Rule 8D(2) (of Income Tax Rules, 1962).

1. Heard Sri Manish Misra, learned counsel for appellant and Mr. D.D. Chopra, learned counsel for respondent.

2. This is an appeal at the instance of Commissioner of Income Tax II, Lucknow (hereinafter referred to as “Revenue”) under Section 260 (of Income Tax Act, 1961)­A of Income Tax Act, 1961 (hereinafter referred to as the “Act, 1961”) arisen from judgment and order dated 23.01.2015 passed by Income Tax Appellate Tribunal, Lucknow Bench “A”, Lucknow (hereinafter referred to as “Tribunal”) in ITA No. 538/LKW/2012, relating to Assessment Year (hereinafter referred to as “A.Y.”) 2009­ 10, whereby it has allowed Assessee's appeal partly and has set aside order of Assessing Officer (hereinafter referred to as “A.O.”) as confirmed by Commissioner of Income Tax (Appeal) (hereinafter referred to as “CIT(A)”) in relation to additions made by disallowing exemption under Section 14A(2) (of Income Tax Act, 1961) read with Rule 8D (of Income Tax Rules, 1962) (hereinafter referred to as “Rules, 1962”).

3. The expenditure computed as income by A.O. disputed in this appeal are to the extent of Rs. 40,31,477/­. This appeal was admitted on 03.07.2015 on the following substantial questions of law:­

“i) Whether the Income Tax Appellate Tribunal is justified under the facts and circumstances of case in setting aside order of CIT(A) and deleting the addition made by Assessing Officer under section 14A (of Income Tax Act, 1961) of Rs. 40,31,477/­; when the assessee made investments in subsidiary companies and not submitted any detail of expenditure before the authorities.

ii) Whether the Income Tax Appellate Tribunal is justified under the facts and circumstances of the case in setting aside the order of CIT(A) without considering that when no explanation submitted by assessee regarding expenditure Assessing Officer rightly applied the provision of Rule 8D (of Income Tax Rules, 1962) for making disallowance under Section 14A (of Income Tax Act, 1961).

iii) Whether the Income Tax Appellate Tribunal is justified under the facts and circumstances of the case in setting aside the order of CIT(A) and deleting the addition made by Assessing Officer without appreciating that Rule 8D(2) (of Income Tax Rules, 1962) does not require Assessing Officer to record the satisfaction separately prior to applying the provision of Section 14A (of Income Tax Act, 1961).”

4. M/s U.P. Electronics Corporation Ltd. (hereinafter referred to as “Assessee”) is a Company registered under Companies Act, 1956 (hereinafter referred to as “Act, 1956”) owned by State of U.P. and therefore is a U.P. Govt. Company. It is engaged in promotion of Electronics Industry and imparting Computer Training in State of U.P. It's activity also included Trading Activity, Computer Hardware and other peripherals. This is also registered as Non­banking Finance Company (Investment Company). Assessee e­filed Original Return for A.Y. 2009­10 on 30.09.2009 declaring total income as NIL, income for calculation of tax under Section 115JB (of Income Tax Act, 1961) at Rs. 47,23,798/­. It revised Return on 31.03.2011 showing book profit at Rs. 55,72,210/­ through CASS. The Return was selected for scrutiny. Consequently, notices under Section 143(2) (of Income Tax Act, 1961) and 142(1) of Act, 1961 were issued on 19.04.2011 and 01.06.2011, respectively.

5. Assessee claimed dividend income of Rs. 7,52,120/­ stating that no expenditure was incurred on the said record. A.O. did not accept Assessee's version and applied Section 14A (of Income Tax Act, 1961) read with Rule 8D(2)(iii) (of Income Tax Rules, 1962), disallowed dividend income and worked out addition is as under:­

“A. Opening balance of investment as on 01.04.2008 Rs. 79,09,45,416/­

B. Closing balance of investment as on 31.03.2009 Rs. 82,16,45,416/­

C. Average of investment Rs. 1,61,25,90,832/­ = Rs. 80,62,95,416/­ One half % of C = Rs. 40,31,477/­ (Addition : Rs. 40,31,477/­)”

6. Consequently, vide assessment order dated 28.12.2011, total income of Assessee was computed at Rs. 59,32,539/­.

7. Being aggrieved, Assessee preferred appeal before CIT(A). Vide order dated 17.01.2012, CIT(A) confirmed applicability of Section 14A (of Income Tax Act, 1961) for disallowing expenditure but giving a relief of Rs. 47,564/­, it reduced additions to Rs. 39,83,913/­.

8. Assessee preferred further appeal before Tribunal. It has allowed appeal of Assessee with regard to addition applying Section 14A (of Income Tax Act, 1961) by observing that A.O. has failed to record its objective satisfaction with regard to correctness of claim of Assessee and addition is mechanical without satisfying the conditions precedent for applying Section 14A(2) (of Income Tax Act, 1961). It has set aside said addition made by CIT(A) and deleted the same.

9. Now Revenue, being aggrieved by this order, has preferred this appeal.

10. Section 14A (of Income Tax Act, 1961) as it stood during the relevant period of A.Y., reads as under:­

“14A. Expenditure incurred in relation to income not includible in total income­

(1) For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.

(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.

(3) The provisions of sub­section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act: Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 (of Income Tax Act, 1961) or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154 (of Income Tax Act, 1961), for any assessment year beginning on or before the 1st day of April, 2001.” (emphasis added)

11. Section 14A (of Income Tax Act, 1961) was inserted by Finance Act, 2001, w.e.f. 1.4.1962. Proviso thereto was inserted by Finance Act, 2002 w.e.f. 11.05.2001.

12. Fundamental principal underlying Section 14A (of Income Tax Act, 1961) is that income which is not taxable or exempt, falls in a separate stream, distinct from income taxable under Act, 1961. That expenditure which is incurred in relation to income subject to tax, would be admissible under Section 32 (of Income Tax Act, 1961) to 43B of Act, 1961, whereas expenditure incurred to earn exempt income would be extraneous in the computation of taxable income under Act, 1961. Thus, only that expenditure is deductible, which is incurred in relation to business or profession.

13. In CIT, Mumbai Versus Walfort Share & Stock Brokers Private Limited, 2010 (8) SCC 137, Court held that: “....expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income. In many cases the nature of expenses incurred by the Assessee may be relatable partly to the exempt income and partly to the taxable income. In absence of Section 14A (of Income Tax Act, 1961), the expenditure incurred in respect of exempt income was being claimed against taxable income. The mandate of Section 14A (of Income Tax Act, 1961) is clear. It desires to curb the practice to claim deduction of expenses incurred in relation to exempt income against taxable income and at the same time avail the tax incentive by way of exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income."

14. Section 14A(1) (of Income Tax Act, 1961) is substantive in nature and provides that for the purpose of computation of total income under Chapter IV, no deduction can be allowed in respect of expenditure in relation to income which does not form part of total income under Act, 1961. In other words, a deduction of an expenditure incurred by Assessee which relates to income forming part of total income is only allowable for computing total income under Chapter IV and not otherwise.

15. Sub­section (2) of Section 14A (of Income Tax Act, 1961) is procedural in nature. It provides as to what A.O. has to do for determining amount of expenditure incurred in relation to such income which does not form part of total income under Act, 1961. For this purpose, he has to follow procedure prescribed, i.e., under the Rules. However, there is a mandate under Sub­section (2) that determination by A.O. is subject to condition precedent that having regard to accounts of Assessee, he must not be satisfied with the correctness of claim of Assessee in respect of such expenditure in relation to income which does not form part of total income under Act, 1961.

16. Sub­section (3) incorporates the mandate of Sub­section (2) in the cases where an Assessee claims that no expenditure has been incurred by him in relation to income which does not form part of total income under Act, 1961.

17. So far as proviso to Sub­section (2) of Section 14A (of Income Tax Act, 1961) is concerned, it is not at all attracted to answer questions under consideration in this appeal.

18. It is evident from order of A.O. itself that Assessee produced books of accounts, bills and vouchers which were checked and tested. The manner in which Assessee disclosed its incomes from interest, etc. has been referred to in para 3 of order passed by A.O. and it is not the case of A.O. that there was any discrepancy.

19. With regard to exemption, dividend income of Rs. 7,52,120/­, it is only para 4 of order of A.O. which reads as under:­

“4. The assessee has shown exempt dividend income of Rs. 7,52,120/­. The assessee was show caused regarding the applicability of Section 14A (of Income Tax Act, 1961). The assessee submitted that no expenditure has been incurred on this account. The contention of the assessee is not acceptable. The provisions of Section 14A (of Income Tax Act, 1961) r.w. Rule 8D(2)(iii) (of Income Tax Rules, 1962) is applicable to the assessee.”

(emphasis added)

20. Thus, it is evident from order passed by A.O. that he has simply observed that Section 14A (of Income Tax Act, 1961) was applicable and Assessee's contention that no expenditure has been incurred is not acceptable. Nothing further has been said by A.O. Can it be said that to disallow claim of Assessee and to apply Section 14A (of Income Tax Act, 1961) read with Rule 8D(2)(iii) (of Income Tax Rules, 1962), A.O. was justified in simply observing that contention of Assessee is not acceptable.

21. Learned counsel for Revenue claimed that it was Assessee's responsibility to give details of investments made in Subsidiary Companies and details of expenditure, etc., which it failed. He placed before us Rule 8D (of Income Tax Rules, 1962) which came to be inserted in Rules, 1962 by Income Tax (Fifth Amendment) Rules, 2008 w.e.f. 24.03.2008 and as it stood during the relevant A.Y., reads as under:­

“8D. Method for determining amount of expenditure in relation to income not includible in total income.

(1) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with­

(a) the correctness of the claim of expenditure made by the assessee; or

(b) the claim made by the assesee that no expenditure has been incurred, in relation to income which does not form part of the total income under the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub­rule (2).

(2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely:­

(i) the amount of expenditure directly relating to income which does not form part of total income;

(ii) in a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely:­

A X B/C

Where A = amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year;

B = the average of value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year;

C = the average of total assets as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year;

(iii) an amount equal to one­half per cent of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year.

(3) For the purpose of this rule, the “total assets” shall mean, total assets as appearing in the balance sheet excluding the increase on account of revaluation of assets but including the decrease on account of revaluation of assets.”

(emphasis added)

22. Rule 8D(1)(b) (of Income Tax Rules, 1962) will come into the picture only when A.O. recorded his non­satisfaction with regard to claim of Assessee that no expenditure has been incurred or about the correctness of claim of expenditure by Assessee. Therefore, to attract Section 14A(1)(b) (of Income Tax Act, 1961) & (2) of Act, 1961 read with Rule 8D (of Income Tax Rules, 1962), A.O. has to show his non­satisfaction about the claim set up by Assessee.

23. The law as it was prior to insertion of Section 14A (of Income Tax Act, 1961) was summarized by Supreme Court in Rajasthan State Warehousing Corporation Vs. CITA [2000] 242 ITR 450 (SC) as under:­

“(i) if income of an assessee is derived from various heads of income, he is entitled to claim deduction permissible under the respective head whether or not computation under each head results in taxable Income;

(ii) if income of an assessee arises under any of the heads of income but from different items, e.g., different house properties or different securities etc., and income from one or more items alone is taxable whereas income from the other item is exempt under the Act, the entire permissible expenditure in earning the income from that head is deductible: and

(iii) in computing 'profits and gains of business or profession' when an assessee is carrying on business in various ventures and some among them yield taxable income and the others do not, the question of allowability of the expenditure under Section 37 (of Income Tax Act, 1961) will depend on:

(a) fulfillment of requirements of that provision noted above; and

(b) on the fact whether all the ventures carried on by him constituted one indivisible business or not; if they do, the entire expenditure will be a permissible deduction but if they do not, the principle of apportionment of the expenditure will apply because there will be no nexus between the expenditure attributable to the venture not forming an integral part of the business and the expenditure sought to be deducted as the business expenditure of the assessee.”

24. This exposition of law prior to introduction of Section 14A (of Income Tax Act, 1961) was when an Assessee had a composite and indivisible business which had elements of both taxable and non­taxable income, entire expenditure in the said business was deductible and in such case, principle of apportionment of expenditure relating to non- taxable income did not apply. However, where business was divisible, principle of apportionment of expenditure was applicable and expenditure apportioned to “exempt” income or income not exigible to tax was not allowable as a deduction.

25. Section 14A (of Income Tax Act, 1961) after its insertion came to be considered at length in CIT Vs. Walfort Share and Stock Brokers Private Ltd. [2010] 326 ITR 1 (SC). It held that insertion of Section 14A (of Income Tax Act, 1961) with respective effect reflects serious attempt on the part of Parliament not to allow deduction in respect of any expenditure incurred by Assessee in relation to income which does not form part of total income under Act, 1961 against taxable income.

26. Sub­section (2) of Section 14A (of Income Tax Act, 1961) was considered by a Division Bench of Bombay High Court in Godrej and Boyce Mfg. Company Ltd. Vs. Deputy Commissioner of Income Tax and another [2010] 328 ITR 81 (Bombay). Therein even validity of Section 14A (of Income Tax Act, 1961) and Rule 8D (of Income Tax Rules, 1962) was challenged. The constitutional validity was upheld. While summing up conclusion on the interpretation of aforesaid provision, Court in para 55(viii) and (ix) of judgment observed as under:­

“55(viii) Sub­section (2) of Section 14A (of Income Tax Act, 1961) does not enable the Assessing Officer to apply the method prescribed by Rule 8D (of Income Tax Rules, 1962) without determining in the first instance the correctness of the claim of the assessee, having regard to the accounts of the assessee. Sub­section (2) of Section 14A (of Income Tax Act, 1961) mandates that it is only when having regard to the accounts of the assessee, the Assessing Officer is not satisfied with the correctness of the claim of the assessee in respect of expenditure incurred in relation to income which does not form part of the total income under the Act, that he can proceed to make a determination under the Rules;

(ix) The satisfaction envisaged by sub­section (2) of Section 14A (of Income Tax Act, 1961) is an objective satisfaction that has to be arrived at by the Assessing Officer having regard to the accounts of the assessee. The safeguard introduced by sub­section (2) of Section 14A (of Income Tax Act, 1961) for a fair and reasonable exercise of power by the Assessing Officer, conditioned as it is by the requirement of an objective satisfaction, must, therefore, be scrupulously observed. An objective satisfaction contemplates a notice to the assessee, an opportunity to the assessee to place on record all the relevant facts including his accounts and recording of reasons by the Assessing Officer in the event that he comes to the conclusion that he is not satisfied with the claim of the assessee;” (emphasis added)

27. A Division Bench of Delhi High Court considered Section 14A(2) (of Income Tax Act, 1961) and (3) of Act, 1961 and Rule 8D (of Income Tax Rules, 1962) in Maxopp Investment Ltd. Vs. Commissioner of Income Tax [2012] 347 ITR 272 (Delhi) and in para 30 of judgment, Court said:­ “However, if we examine the provision carefully, we would find that the Assessing Officer is required to determine the amount of such expenditure only if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under the said Act. In other words, the requirement of the Assessing Officer embarking upon a determination of the amount of expenditure incurred in relation to exempt income would be triggered only if the Assessing Officer returns a finding that he is not satisfied with the correctness of the claim of the assessee in respect of such expenditure. Therefore, the condition precedent for the Assessing Officer entering upon a determination of the amount of the expenditure incurred in relation to exempt income is that the Assessing Officer must record that he is not satisfied with the correctness of the claim of the assessee in respect of such expenditure. Sub­section (3) is nothing but an offshoot of sub­section (2) of Section 14A (of Income Tax Act, 1961). Sub­section (3) applies to cases where the assessee claims that no expenditure has been incurred in relation to income which does not form part of the total income under the said Act. In other words, sub­section (2) deals with cases where the assessee specifies a positive amount of expenditure in relation to income which does not form part of the total income under the said Act and sub­section (3) applies to cases where the assessee asserts that no expenditure had been incurred in relation to exempt income. In both cases, the Assessing Officer, if satisfied with the correctness of the claim of the assessee in respect of such expenditure or no expenditure, as the case may be, cannot embark upon a determination of the amount of expenditure in accordance with any prescribed method, as mentioned in sub- section (2) of Section 14A (of Income Tax Act, 1961) of the said Act. It is only if the Assessing Officer is not satisfied with the correctness of the claim of the assessee, in both cases, that the Assessing Officer gets jurisdiction to determine the amount of expenditure incurred in relation to such income which does not form part of the total income under the said Act in accordance with the prescribed method. The prescribed method being the method stipulated in Rule 8D of the said Rules. While rejecting the claim of the assessee with regard to the expenditure or no expenditure, as the case may be, in relation to exempt income, the Assessing Officer would have to indicate cogent reasons for the same.”

(emphasis added)

28. Same view has been reiterated by other Division Benches of Delhi High Court in Commissioner of Income Tax Vs. I.P. Support India (P) Ltd. [2015] 378 ITR 240 (Delhi); Commissioner of Income Tax­VI Vs. Taikisha Engineering India Ltd. [2015] 370 ITR 338 (Delhi); and Joint Investments (P.) Ltd. Vs. Commissioner of Income Tax [2015] 372 ITR 694 (Delhi). In all these judgments, Court disapproved order of A.O. invoking Section 14A (of Income Tax Act, 1961) and Rule 8D(2) (of Income Tax Rules, 1962) where A.O. has disallowed exemption without recording his satisfaction. Court said that recording of satisfaction in the shape of reasons as to why voluntary disallowance made by Assessee was unreasonable and unsatisfactory and it is a mandatory requirement of law.

29. The view of this Court is also similar. In Dhampur Sugar Mills Vs. Commissioner of Income Tax [2015] 370 ITR 187, a Division Bench of this Court, presided by Hon'ble Dr. Justice D.Y. Chandrachud (Chief Justice) (as His Lordship then was), after referring to Section 14A(2) (of Income Tax Act, 1961) and Rule 8D (of Income Tax Rules, 1962) observed that to determine the amount of expenditure incurred in relation to such income which does not form part of total income under Act, 1961 by applying the method which is prescribed in Rule 8D (of Income Tax Rules, 1962), A.O. must not be satisfied with the correctness of claim of Assessee having regard to accounts of Assessee. Having said so, Court observed that for the purpose of looking into the fact whether order passed by A.O. has applied to the aforesaid requirement or not, one has to go through the order itself since there cannot be any straitjacket formula requiring A.O. to use any particular language or form. If the order of A.O. indicate that he is not satisfied with the correctness of claim of Assessee or the claim of Assessee that no expenditure has been incurred, he has to proceed in the manner indicated in Rule 8D(2) (of Income Tax Rules, 1962). Court then examined the order of A.O. passed in that case which contained various reasons and details of disclosure made by Assessee and found that there was compliance of requirement of Section 14A(2) (of Income Tax Act, 1961) and order shows application of mind on the part of A.O. to the accounts of Assessee from the assessment order itself.

30. Learned counsel for Revenue when confronted with aforesaid expositions of law could not place anything otherwise before this Court so as to persuade us to take a different view. He, however, submitted that whatever has been omitted by A.O., same has been rectified by CIT(A) in the appellate order, when it has discussed everything in detail justifying as to why exemption of expenditure claimed by Assessee was rightly disallowed by A.O.

31. In our view, jurisdiction to apply Section 14A (of Income Tax Act, 1961) contemplates satisfaction of condition precedent therein, on the part of A.O. If he has illegally exercised jurisdiction, same cannot be said to have been rectified by order passed by Appellate Authority inasmuch as order of Assessing Authority itself being illegal as statutory mandatory condition was not satisfied, such illegality could not have been cured by order passed by Appellate Authority.

32. In the circumstances, we answer aforesaid questions against Revenue and in favour of Assessee.

33. Appeal in question is accordingly dismissed.

Order Date :­ 15.2.2017

Shubham