2017 (9) TMI 1573 - HC - Income Tax

Addition u/s 14A - Rule 8D applicability - recording of satisfaction in the shape of reasons as to why voluntary disallowance made by the assessee was unreasonable and unsatisfactory - Held that - If the order of the Assessing Officer indicate that he is not satisfied with the correctness of the claim of the assessee or the claim of the assessee that no expenditure has been incurred, he has to proceed in the manner indicated in rule 8D(2) of the Rules, 1962. The court then examined the order of the Assessing Officer passed in that case which contained various reasons and details of disclosure made by the assessee and found that there was compliance of requirement of section 14A(2) of the Act, 1961 and order shows application of mind on the part of the Assessing Officer to the accounts of the assessee from the assessment order itself. Revenue when confronted with the 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 the Assessing Officer, the same has been rectified by the Commissioner of Income-tax (Appeals) in the appellate order, when it has discussed everything in detail justifying as to why exemption of expenditure claimed by the assessee was rightly disallowed by the Assessing Officer. In our view, jurisdiction to apply section 14A of the Act, 1961 contemplates satisfaction of condition precedent therein, on the part of the Assessing Officer. If he has illegally exercised jurisdiction, the same cannot be said to have been rectified by order passed by the appellate authority inasmuch as the order of the assessing authority itself being illegal as statutory mandatory condition was not satisfied, such illegality could not have been cured by order passed by the appellate authority.- Decided in favour of assessee.

Summary

Issues Involved:
1. Justification of ITAT in setting aside the CIT(A) order and deleting the addition made by the AO under Section 14A of the Income-tax Act, 1961.
2. Justification of ITAT in setting aside the CIT(A) order without considering the lack of explanation from the assessee regarding the expenditure.
3. Requirement for the AO to record satisfaction separately prior to applying Section 14A.

Issue-wise Detailed Analysis:

Issue 1: Justification of ITAT in setting aside the CIT(A) order and deleting the addition made by the AO under Section 14A of the Income-tax Act, 1961.
The assessee, a U.P. Government company, filed a return for AY 2009-10 declaring total income as nil and later revised it. The AO disallowed the assessee's claim of dividend income exemption under Section 14A, read with Rule 8D(2)(iii), and computed an addition of ?40,31,477. The CIT(A) confirmed the applicability of Section 14A but reduced the addition to ?39,83,913. The ITAT allowed the assessee's appeal, observing that the AO failed to record objective satisfaction regarding the correctness of the assessee's claim and that the addition was mechanical. The court upheld the ITAT's decision, emphasizing that Section 14A requires the AO to record non-satisfaction with the assessee's claim before making any disallowance.

Issue 2: Justification of ITAT in setting aside the CIT(A) order without considering the lack of explanation from the assessee regarding the expenditure.
The AO noted that the assessee claimed no expenditure was incurred for earning the exempt dividend income of ?7,52,120. However, the AO did not accept this and applied Section 14A read with Rule 8D(2)(iii) without providing detailed reasoning. The court highlighted that the AO must record reasons for non-satisfaction with the assessee's claim. The ITAT found that the AO's order lacked such satisfaction and thus set aside the addition. The court supported this view, stating that the AO's mere observation without detailed reasoning was insufficient to justify the disallowance under Section 14A.

Issue 3: Requirement for the AO to record satisfaction separately prior to applying Section 14A.
The court examined Section 14A and Rule 8D, noting that the AO must record objective satisfaction regarding the assessee's claim before disallowing any expenditure. The AO must follow a prescribed method only if not satisfied with the assessee's claim. The court referred to various judgments, including CIT v. Walfort Share and Stock Brokers P. Ltd. and Godrej and Boyce Mfg. Co. Ltd. v. Deputy CIT, which emphasized the necessity of recording satisfaction. The court concluded that the AO's failure to record such satisfaction rendered the disallowance invalid, and this procedural requirement could not be rectified by the appellate authority.

Conclusion:
The court dismissed the Revenue's appeal, affirming the ITAT's decision to delete the addition made by the AO under Section 14A. The court emphasized that the AO must record objective satisfaction regarding the assessee's claim before making any disallowance under Section 14A, and failure to do so invalidates the disallowance.