2012 (10) TMI 199 - AT - Income Tax

Disallowance u/s 14A - investments in shares of companies and units of mutual funds - It is mentioned that the investments have been made with a view to earn dividend - investments have been made in this year from interest-free funds available with the assessee - no dividend had been received from various companies Held that - No evidence on record to suggest that any investment in shares or units has been made in this year out of borrowed funds on which interest is payable by the assessee - payment of interest is in respect of income other than dividend income. In such a situation the interest cannot be said to be a kind of general expenditure incurred for earning of various kinds of incomes. Therefore the provision contained in Rule 8D(2)(ii) is not applicable - AO has to examine the expenditure and its nexus with the earning of tax-free income as provided in sub-section (2) of section 14A. If there is no such nexus the disallowance cannot be made - no interest expenditure had been incurred for earning tax-free income - provision contained in Rule 8D(2)(ii) cannot be invoked Disallowance of misuse charges - assessee constructed commercial space in the basement which was not permissible as per master plan - misuse charges were paid in respect of the aforesaid space Held that - Misuse charges were also paid for illegally using the space for a period of time till the infraction was noticed by the DDA and it ordered the removal of the infraction - nature of interest on misuse charges is the same as misuse charges - Explanation-1 to section 37(1) provides inter-alia that any expenditure incurred for any purpose which is prohibited by law shall not be deemed to have been incurred for the purpose of business and no deduction or allowance shall be made in respect of such expenditure - this provision is clearly applicable to the case of the assessee in favor of revenue

Summary

Issues Involved:
1. Disallowance under Section 14A of the Income-tax Act, 1961.
2. Disallowance of misuse charges.

Detailed Analysis:

1. Disallowance under Section 14A of the Income-tax Act, 1961:

Assessment Officer's (AO) Findings:
The AO found that the assessee made significant investments in shares and mutual funds, which stood at Rs. 89,77,51,107 as of 31.03.2008, compared to Rs. 54,10,80,750 as of 31.03.2007. The AO invoked Section 14A of the Income-tax Act, 1961, read with Rule 8D of the Income-tax Rules, 1962, to disallow expenditure related to earning tax-free income. The AO calculated disallowance under Rule 8D(2)(ii) at Rs. 51,78,366 and under Rule 8D(2)(iii) at Rs. 35,97,079, totaling Rs. 87,75,445.

CIT (Appeals) Findings:
The CIT (Appeals) found that the investments were made from interest-free funds available with the assessee, and hence, no disallowance was warranted under Rule 8D(2)(ii). However, the CIT (Appeals) sustained the disallowance under Rule 8D(2)(iii), amounting to Rs. 35,97,079, stating that the potentiality of earning income in future years is relevant for disallowance under Section 14A.

Tribunal's Decision:
The Tribunal upheld the CIT (Appeals) decision, noting that there was no evidence of investments made from borrowed funds. The Tribunal emphasized that the interest expenditure was not directly related to receipts by way of dividends, thus Rule 8D(2)(ii) was not applicable. The Tribunal dismissed ground nos. 2 and 2.1 regarding this issue.

2. Disallowance of Misuse Charges:

Assessment Officer's (AO) Findings:
The AO disallowed a sum of Rs. 67,31,919 claimed by the assessee, which included misuse charges, interest on misuse charges, interest on conversion charges, and interest on ground rent. The AO held that the expenditure did not pertain to the current year and was related to unauthorized construction, thus not qualifying as revenue expenditure.

CIT (Appeals) Findings:
The CIT (Appeals) held that the demand notices from the Delhi Development Authority (DDA) dated 08.05.2007 and 18.12.2007 crystallized the liability in the current year. The CIT (Appeals) found the interest to be compensatory and deductible under Section 37(1). The misuse charges were also deemed deductible as they were incurred out of commercial expediency and did not involve violation of any statutory provision.

Tribunal's Decision:
The Tribunal analyzed the precedents and facts, concluding that the misuse charges and interest on misuse charges were not deductible. The Tribunal noted that the DDA acted as a sovereign authority enforcing the master plan, and the misuse charges were for violating the master plan. The Tribunal applied Explanation-1 to Section 37(1), which disallows any expenditure incurred for purposes prohibited by law. Thus, ground nos. 3 and 3.3 were allowed in favor of the revenue.

Conclusion:
The appeal was partly allowed. The Tribunal upheld the CIT (Appeals) decision on disallowance under Section 14A, dismissing the revenue's appeal on this issue. However, the Tribunal allowed the revenue's appeal regarding the disallowance of misuse charges and interest on misuse charges, concluding that these were not deductible under Section 37(1).