2006 (10) TMI 253 - AT - Income Tax

Ad hoc disallowance u/s 14A - Expenditure incurred in relation to income not includible in total income - HELD THAT - Section 14A clearly makes a distinction between exempt income and taxable income. It treats both of them as separate classes for computation of income after allocation of expenditure relating thereto and mandates that no deduction in respect of any expenditure shall be allowed against taxable income which is incurred in relation to exempt income. The underlying object is to compute both the exempt income and taxable income correctly, which is possible only after the expenditure incurred in relation thereto is allocated to them. Hence, we hold that all expenses connected with the exempt income have to be disallowed u/s 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 Income-tax 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. Thus, 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. We therefore 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. Capital gain on sale of shares - sell to subsidiary company - HELD THAT - It cannot be laid down as inflexible rule that subsequent events can never be considered for deciding a matter under dispute. It is the duty of the assessee to pay correct amount of tax on its income chargeable to tax. It is the right of the department to realize tax from the assessees on their income chargeable to tax. Subsequent events in the case before us would relate back to the assessment year under consideration. In our view, the matter should go back to the Assessing Officer with the direction to consider and decide the matter afresh in accordance with law after giving reasonable opportunity of hearing to the assessee. Ground No. 3 is treated as allowed for statistical purposes. Thus, Appeal filed by the assessee is partly allowed.

Issues Involved:
1. Ad hoc disallowance out of administrative expenses of Rs. 2,00,000.
2. Disallowance out of interest paid Rs. 19,78,127.
3. Capital gain on sale of shares of Rs. 25,00,000.
4. Disallowance of share issue expenses of Rs. 1,26,524.

Issue-wise Detailed Analysis:

1. Ad hoc Disallowance out of Administrative Expenses of Rs. 2,00,000:
The primary issue was whether the provisions of section 14A empower the Assessing Officer to make a proportionate allocation of expenditure incurred in relation to exempt income. The assessee argued that the rule of proportionality of expenses was not applicable under section 14A and relied on several judicial decisions to support this claim. However, the Departmental Representative contended that section 14A barred deduction of any expenditure incurred in relation to exempt income, emphasizing that it was improbable to earn substantial dividend income without incurring any expenditure. The Tribunal held that section 14A mandates the allocation of expenses related to exempt income, barring their deduction from taxable income to avoid distortion in income computation. The Tribunal further noted that the procedural provisions in sub-sections (2) and (3) of section 14A, inserted by the Finance Act, 2006, apply to all pending matters, thus requiring the Assessing Officer to compute the disallowance as per the prescribed method rather than on an ad hoc basis. Consequently, the Tribunal set aside the orders of the CIT(A) and the Assessing Officer, directing a fresh decision in light of section 14A's provisions.

2. Disallowance out of Interest Paid Rs. 19,78,127:
The assessee acknowledged that this issue was covered against them by the Tribunal's order in their own case for previous assessment years (1994-95 to 1997-98). Therefore, Ground No. 2 was dismissed by the Tribunal.

3. Capital Gain on Sale of Shares of Rs. 25,00,000:
The assessee contested the assessment of sales consideration of investment sold at Rs. 1.25 crores, arguing that the actual consideration received was Rs. 1 crore due to adjustments for unrealized/unrealizable current assets and liabilities. The Assessing Officer, however, treated the consideration as Rs. 1.25 crores. The CIT(A) upheld this view, stating that subsequent events could not be considered for earlier years. The Tribunal disagreed, stating that subsequent events could be relevant and directed the Assessing Officer to reconsider the matter afresh, taking into account the actual consideration received, thereby treating Ground No. 3 as allowed for statistical purposes.

4. Disallowance of Share Issue Expenses of Rs. 1,26,524:
The assessee's counsel conceded that this issue was covered against them by the Supreme Court's decision in Brooke Bond (I) Ltd. v. CIT. Consequently, Ground No. 4 was dismissed by the Tribunal.

Conclusion:
The appeal filed by the assessee was partly allowed. The Tribunal directed a fresh assessment for the administrative expenses disallowance under section 14A, upheld the disallowance of interest paid and share issue expenses, and remanded the capital gain issue for reconsideration based on actual consideration received.

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