2007 (1) TMI 284 - AT - Income Tax

Expenditure incurred in relation to income not includible in total income - Disallowance of interest being the expenditure related to earn dividend income and claimed exempt u/s 10(3) of the Act within the meaning of section 14A - HELD THAT - Keeping in view of provisions of section 14A as also the aforesaid decisions of the co-ordinate Benches of this Tribunal, we hold that all expenses connected with the exempt income have to be disallowed under section 14A regardless of whether they are direct or indirect, fixed or variable and managerial or financial in accordance with law. In this connection, the provisions of sub-section (2)/(3) of section 14A inserted by the Finance Act, 2006 deserve to be noted. The procedure for computation of disallowance has now been provided in sub-sections (2) and (3) of section 14A of the IT Act. It is no longer open to the Assessing Officer to apply his discretion in computing the disallowance or make ad hoc disallowance u/s 14A. Substantive provisions are contained in sub-section (1) of section 14A prohibiting deduction in respect of expenditure incurred in relation to exempt income while procedural provisions regarding computation of the aforesaid disallowance are contained in sub-sections (2) and (3) thereof. Sub-sections (2) and (3) seek to achieve the underlying object of section 14A(1) that any expenditure incurred in relation to exempt income should not be allowed deduction. It is fairly well-settled by a catena of decisions that procedural provisions apply to all pending matters and that the rule against retrospectivity does not hit them. We hold that the provisions for quantification of disallowance as contained in sub-sections (2) and (3) of section 14A are procedural and therefore apply to all pending matters. It is no longer open to the Assessing Officer to make disallowance according to his own discretion or on ad hoc basis. He is statutorily required to compute the disallowance in the manner provided by sub-sections (2) and (3) of section 14A. All these aspects have neither been considered by the Assessing Officer nor the CIT(A) while making the impugned disallowance. Thus, we consider it appropriate to set aside the orders passed by the CIT(A) and the Assessing Officer in this behalf and restore the matter to the Assessing Officer for a fresh decision in the light of the provisions of section 14A including sub-sections (2) and (3) thereof. Ground No. 2 is treated as allowed for statistical purposes. In the result, this appeal of the Department is partly allowed.

Summary

Issues Involved:
1. Whether the differential amount of Rs. 4,42,65,747/- against additional sugar quota is a capital receipt or revenue receipt.
2. The disallowance of Rs. 10,34,730/- on account of interest expenditure related to earning exempt dividend income under section 14A of the IT Act.

Issue-wise Detailed Analysis:

1. Differential Amount Against Additional Sugar Quota:
The primary issue is whether the sum of Rs. 4,42,65,747/-, representing the difference between the free sale price of additional sugar quota allotted as an incentive and the levy price of sugar, should be classified as a capital receipt or a revenue receipt. The assessee, engaged in the manufacture and sale of sugar, argued that this amount should be treated as a capital receipt. The CIT(A) referred to several previous orders by the Tribunal in the assessee's own case for various assessment years (1991-92 to 1999-2000), where it was consistently held that such amounts were capital receipts. Following these precedents, the CIT(A) ruled in favor of the assessee. The Tribunal, upon review, found no reason to deviate from its earlier decisions and dismissed the department's ground, thereby affirming that the amount in question is a capital receipt.

2. Disallowance of Interest Expenditure Related to Dividend Income:
The second issue concerns the disallowance of Rs. 10,34,730/- by the Assessing Officer (AO) on the grounds that it was an interest expenditure related to earning dividend income, which is exempt under section 10(33) of the IT Act. The AO noted that the assessee had substantial borrowed funds and attributed a proportionate amount of interest expenditure to the investment in shares, thereby disallowing the same under section 14A. However, the CIT(A) allowed the assessee's claim, observing that the investments in mutual funds were made from surplus funds and not from borrowed funds, as evidenced by the bank statements.

The Tribunal analyzed section 14A, which prohibits the deduction of any expenditure incurred in relation to income that does not form part of the total income under the IT Act. The Tribunal emphasized that all forms of expenses connected with exempt income, whether direct or indirect, must be disallowed under section 14A. This principle is supported by various judicial precedents, including the matching principle of accountancy as explained in Taparia Tools Ltd. v. Joint CIT and other relevant cases.

The Tribunal noted that the procedural provisions for computing disallowance under section 14A, as contained in sub-sections (2) and (3), are applicable to all pending matters. These provisions require the AO to determine the amount of expenditure in relation to exempt income using a prescribed method, rather than applying discretion or making ad hoc disallowances.

Given that the AO and CIT(A) did not consider these procedural aspects while making the disallowance, the Tribunal set aside their orders and remanded the matter back to the AO for a fresh decision in accordance with the provisions of section 14A, including sub-sections (2) and (3). Consequently, this ground was treated as allowed for statistical purposes.

Conclusion:
The appeal by the department is partly allowed. The Tribunal upheld the CIT(A)'s decision regarding the classification of the differential amount against the additional sugar quota as a capital receipt. However, the disallowance of interest expenditure related to dividend income was remanded back to the AO for reconsideration in light of the procedural provisions of section 14A.