2008 (10) TMI 390 - AT - Income Tax

Revision u/s 263 - Expenditure incurred on earning the tax free income - Disallowance of proportionate expenditure u/s 14A - order of the AO is erroneous and prejudicial to the interest of the revenue - Whether CIT has invoking the provisions of section 263 and thereby directing the AO to consider issue of disallowance of proportionate expenditure u/s 14A allegedly relating to the dividend income earned - HELD THAT - As per the record, AO has categorically asked the assessee the break up of interest and dividend income. The assessee has also filed various details and also demonstrated before us the fact that dividend income was received through a single cheque and no extra expenditure was incurred for earning the same with regard to deployment of funds. Investment in shares was made in earlier years, sufficient own capital reserve was shown in the balance sheet out of which investment was made in the subsidiary company and it was submitted that no interest bearing funds were utilized for the same. A bare reading of provisions of section 263 makes it clear that the prerequisite to exercise of jurisdiction by the CIT suo motu under it, is that the order of the ITO is erroneous insofar as it is prejudicial to the interests of the Revenue. Not only the incurring of expenditure but also its relationship with the exempted income must be clear and must be capable of being ascertained. There was no specific finding by the CIT to the effect that any particular expenses has been incurred for earning the exempted income, he only asked the AO to make inquiry and find out the proportionate expenses which can be disallowed u/s 14A. While applying section 14A, there is no authority conferred by the section upon the AO to deem or assume certain expenditure to have been incurred in relation to the tax free income. Accordingly, common expenditure incurred cannot be broken artificially to attribute for apportioning a part thereof to the earning of the tax free income on the assumption that such part of the common expenditure was incurred in relation to the tax free income. Therefore, we do not find any merit in the order passed by CIT u/s 263. Appeal filed by the assessee is allowed.

Issues Involved:
1. Invocation of Section 263 of the Income-tax Act, 1961.
2. Application of Section 14A of the Income-tax Act, 1961.
3. Identification and confrontation of the amount related to dividend income.
4. Validity and clarity of the directions issued by the CIT.
5. Legality of setting aside the assessment by the CIT.

Issue-wise Detailed Analysis:

1. Invocation of Section 263 of the Income-tax Act, 1961:
The assessee contended that the CIT erred in invoking Section 263, arguing that the original assessment was neither erroneous nor prejudicial to the revenue. The CIT had issued a notice under Section 263, observing that the Assessing Officer (AO) did not examine whether any expenditure was incurred to earn the dividend income, which was claimed as exempt. The CIT set aside the assessment order, directing the AO to reconsider the issue. The tribunal noted that the AO had made inquiries and was satisfied that no expenditure was incurred for earning the dividend income, which was received through a single cheque from a wholly-owned subsidiary. The tribunal emphasized that the CIT cannot invoke Section 263 merely for further inquiry without pointing out specific errors in the AO's order.

2. Application of Section 14A of the Income-tax Act, 1961:
The assessee argued that Section 14A was not applicable as no expenditure was incurred for earning the dividend income. The tribunal observed that the AO had inquired about the interest and dividend income, and the assessee had demonstrated that no additional expenses were incurred for earning the dividend. The tribunal referred to case laws, emphasizing that Section 14A disallows only the expenditure identified as incurred for earning exempt income, and it cannot be extended to disallow assumed expenses.

3. Identification and confrontation of the amount related to dividend income:
The assessee contended that the CIT erred in identifying Rs. 1,21,95,140 as related to the dividend income without confronting the assessee with this amount during the proceedings. The tribunal noted that the AO had obtained details and was satisfied that no expenditure was incurred for earning the dividend income. The tribunal found that the CIT did not point out any specific error in the AO's order and merely directed further inquiry, which was not justified.

4. Validity and clarity of the directions issued by the CIT:
The assessee argued that the directions issued by the CIT were vague and untenable. The tribunal observed that the CIT's order lacked specific findings of error and merely directed the AO to make further inquiries. The tribunal emphasized that an order under Section 263 must be based on specific errors that are prejudicial to the revenue, and it cannot be used for roving inquiries.

5. Legality of setting aside the assessment by the CIT:
The assessee contended that the CIT erred in setting aside the assessment, arguing that the original order was not erroneous or prejudicial to the revenue. The tribunal noted that the AO had made inquiries and was satisfied that no expenditure was incurred for earning the dividend income. The tribunal emphasized that the CIT cannot set aside an assessment order for further inquiry without pointing out specific errors. The tribunal concluded that the CIT's order under Section 263 was not justified and allowed the assessee's appeal.

Conclusion:
The tribunal found that the CIT's invocation of Section 263 was not justified as the AO had made inquiries and was satisfied that no expenditure was incurred for earning the dividend income. The tribunal emphasized that Section 14A disallows only identified expenses incurred for earning exempt income, and the CIT cannot use Section 263 for further inquiry without specific findings of error. The tribunal allowed the assessee's appeal, setting aside the CIT's order under Section 263.

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