2022 (7) TMI 451 - AT - Income Tax

Disallowance u/s 14A - CIT-A restricted the addition - when no exempt income is earned or disallowance u/s 14A upto the the exempt income only - Scope of legislative history of section 14A - what is the effect of the insertion of the explanation to section 14A vide Finance Act of 2022 and whether the same shall operate prospectively or with retrospective effect ? - HELD THAT - The first and foremost condition for allowance of an expenditure is of fulfilment of the requirements of that provision i.e. unless otherwise provided, it must be incurred wholly and exclusively for business as per the provisions of section 37 or else it must be incurred for earning of taxable income under the head Income from other sources. The intent, purpose and consequences thereof of the insertion of section 14A vide Finance Act of 2001 with retrospective effect came into consideration of the hon ble Supreme court in the case of CIT vs M/s Walfort Share Stock Brokers Pvt. Ltd. 2010 (7) TMI 15 - SUPREME COURT as stated Section 14A clarifies that expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income.The basic principle of taxation is to tax the net income, i.e., gross income minus the expenditure.On the same analogy the exemption is also in respect of net income.The expenses towards non-taxable income must be excluded.If any of the expenses incurred for earning of taxable income are relatable to exempt income also or common expenses have been used for taxable as well as exempt income, the expenses relatable to exempt income have to be apportioned and disallowed. For the purpose of calculation of disallowance under this rule, the value of investments not only income from which does not but also shall not part of the total income are to be considered. Similarly in Rule 8(2) (iii) the words does not and shall not have been used in respect of exempt income for calculating the disallowance @0.5 % of the value of investments. In our view, the words does not and shall not have their own significance. The words does not refer to the income which has already been received and the words shall not refers to the income which may be received. Only the expenditure relatable to earning of taxable income has to be allowed. If the expenditure has not been incurred for the purpose of earning of taxable income, that cannot be allowed irrespective of the fact that any exempt income has been earned or not by incurring such expenditure. However, in a situation where there is a hotchpotch of the expenditure attributable to both earning of taxable and exempt income, the theory of apportionment applies and the expenditure relatable to earning of exempt income has to be disallowed irrespective of the fact that such an expenditure is otherwise allowable under the respective head. However lately, despite the aforesaid legal position and CBDT Circular No.5 of 2014, the different Hon'ble High Courts of the country ruled that no disallowance is attracted u/s 14A, in case, the assessee has not earned any income not forming part of the total income and that the disallowance u/s 14A cannot exceed the total tax exempt income earned by the assesse during the year. However, in our view, the above interpretation cannot be widened/extended to hold that disallowance of expenditure relatable to exempt income cannot be made if no exempt income is earned or that the disallowance u/s 14A cannot exceed the exempt income received irrespective of the fact that the expenditure claimed is not relatable to earning of chargeable income of the assessee under the relevant provisions of the Act. That, in our view, would be against the respective provisions governing the allowance of deduction out of income chargeable under different heads as provided under the Income Tax Act. Explanation will be applicable retrospectively or prospectively? - As from various decisions of the Hon ble Supreme Court it has been settled that in determining as to whether an amendment is to take effect prospectively or with retrospective effect, the date from which the amendment is made operative does not conclusively decide the question. The Court has to examine the scheme of the statute prior to the amendment and subsequent to the amendment to determine whether an amendment is clarificatory or substantive. Further that an amendment which is clarificatory is regarded as being retrospective in nature and would date back to the original statutory provision which it seeks to amend. A clarificatory amendment is an expression of intent which the Legislature has always intended to hold the field. A clarificatory amendment may be introduced in certain cases to set at rest divergent views expressed in decided cases on the true effect of a statutory provision. Where the Legislature clarifies its intent, it is regarded as being declaratory of the law as it always stood and is therefore, construed to be retrospective. Coming to the facts of the present case assessee has made suo moto disallowance by not following any systematic or specific method of calculation but only on estimation on the basis of disallowance made in assessment orders in earlier assessment years. Since the assessee could not show to the AO as on the basis of what methodology the suomo to disallowance was made by the assessee, therefore, the AO proceeded to compute the disallowance by applying Rule 8D. A perusal of the assessment order reveals that the same is a detailed and speaking order recording the reasons on the basis of which the AO was not satisfied with the suo moto disallowance made by the assessee. In appeal before the CIT(A), the assessee took the plea that he had made strategic investment in group companies for business purposes. However, the ld. CIT(A) relied upon the decision of the Hon ble Supreme Court in the case of Maxopp Investment Ltd. 2018 (3) TMI 805 - SUPREME COURT and rightly held that dominant purpose theory was not applicable for the purpose of apportionment of expenditure relatable to exempt income. CIT(A) accepted the contention of the assessee that the disallowance u/s 14A cannot exceed the exempt income earned during the year relying upon the decision of the Delhi High Court in the case of PCIT vs. Moderate Leasing and Capital Services Pvt. Ltd. 2018 (1) TMI 1401 - DELHI HIGH COURT In view of our discussion made above and in view of the fact that we have held that the explanation to section 14A inserted by Finance Act 2022 being clarificatory in nature has retrospective effect, the impugned order of the CIT(A) is not sustainable in the eyes of law and the same is accordingly set aside. The order of the Assessing Officer is hereby restored. The appeal of the Revenue stands allowed.

Summary

Issues Involved:
1. Justification of CIT(A) in restricting disallowance under Section 14A of the Income Tax Act, 1961.
2. Applicability and retrospective effect of the newly inserted explanation to Section 14A.

Detailed Analysis:

Issue 1: Justification of CIT(A) in Restricting Disallowance
- The revenue argued that the CIT(A) was not justified in restricting the disallowance under Section 14A to the extent of income claimed exempt for the assessment year under consideration.
- During assessment, the Assessing Officer (AO) noted that the assessee earned tax-exempt dividend income and had insufficient own funds for the investments. The AO applied Section 14A read with Rule 8D and computed the expenditure relatable to the tax-exempt dividend income.
- The assessee had suo moto disallowed an amount, but the AO disallowed the balance amount and added it back to the income.
- The CIT(A), relying on the Delhi High Court decision in PCIT vs. Moderate Leasing and Capital Services Private Limited, held that the disallowance under Section 14A cannot exceed the total tax-exempt income earned during the year.
- The revenue contended that the CIT(A)'s action was not in line with the legislative intent and referred to the newly inserted explanation to Section 14A, which clarifies that disallowance is applicable even if no exempt income is earned during the year.

Issue 2: Applicability and Retrospective Effect of the Newly Inserted Explanation to Section 14A
- The revenue argued that the explanation to Section 14A inserted by the Finance Act, 2022, is clarificatory and should apply retrospectively.
- The explanation clarifies that the provisions of Section 14A shall apply even if the income not forming part of the total income has not accrued, arisen, or been received during the year.
- The assessee argued that the explanation is prospective and cannot be applied to pending appeals, and that disallowance under Section 14A cannot exceed the tax-exempt income earned during the year.
- The Tribunal examined the legislative history and judicial interpretations of Section 14A, noting that the section was introduced to clarify that no deduction shall be allowed for expenditure incurred in relation to income that does not form part of the total income.
- The Tribunal referred to the Supreme Court decisions in Walfort Share & Stock Brokers Pvt. Ltd. and Godrej & Boyce Manufacturing Company Ltd., which clarified that only expenses incurred to earn taxable income are allowable, and expenses related to exempt income must be disallowed.
- The Tribunal concluded that the explanation to Section 14A is clarificatory and operates retrospectively, as it aims to remove doubts and clarify the legislative intent.
- The Tribunal held that the disallowance of expenditure under Section 14A is not dependent on the actual earning of exempt income, and the explanation inserted by the Finance Act, 2022, applies retrospectively.

Conclusion:
- The Tribunal set aside the order of the CIT(A) and restored the order of the Assessing Officer, holding that the disallowance under Section 14A can exceed the exempt income earned during the year.
- The Tribunal's findings apply to all the captioned appeals, and all the appeals of the revenue were allowed.