2006 (3) TMI 226 - AT - Income Tax

Disallowance u/s 14A - expenditure incurred by the assessee in relation to income - HELD THAT - In our opinion, the said expenditure incurred on running the branches of the assessee-bank cannot be considered as incurred in relation to the tax-free income earned by it and it is only the expenditure directly attributable for making the corresponding investments that alone can be considered as in relation to the said income for the purpose of making a disallowance on pro rata basis for the purpose of s. 14A Before the authorities below as well as before us, the assessee has quantified such expenditure at Rs. 5.76 lakhs, which quantum, however, appears to have not been verified by the AO. We, therefore, direct the AO to verify the same and accordingly recompute the disallowance to be made u/s 14A of the Act. In the result, the appeal of the assessee is treated as partly allowed.

Summary

Issues:
1. Disallowance of expenses under section 14A of the Income Tax Act.
2. Interpretation of statutory liquidity ratio (SLR) requirements for a nationalized bank.
3. Expenditure allocation for tax-free income earned by the bank.
4. Disallowance of expenditure on a pro rata basis for tax-free investments.

Detailed Analysis:
Issue 1: The appeal concerned the disallowance of expenses under section 14A of the Income Tax Act. The Assessing Officer (AO) disallowed expenses attributable to tax-free income earned by the assessee. The CIT(A) upheld a reduced disallowance, which the assessee contested before the Tribunal. The Tribunal held that as per section 14A, if income does not form part of the total income, expenses related to that income must be disallowed. The Tribunal rejected the assessee's argument that tax-free investments were made to comply with statutory requirements, stating that the legislative intent of section 14A is clear.

Issue 2: The assessee, a nationalized bank, argued that investments in approved securities were made to maintain the statutory liquidity ratio (SLR) as required by the Banking Regulation Act. The bank contended that expenses related to these investments should be fully deductible against business income. The Tribunal acknowledged the bank's compliance with SLR requirements but maintained that section 14A mandates disallowance of expenses linked to tax-free income.

Issue 3: The bank asserted that the expenses incurred for tax-free investments were solely for banking business purposes and should not be subject to disallowance under section 14A. The CIT(A) partially accepted this argument, reducing the disallowance amount. However, the Tribunal held that all expenses related to tax-free income must be disallowed as per the clear language of section 14A.

Issue 4: The Tribunal agreed with the bank's contention that only expenses directly attributable to making tax-free investments should be considered for disallowance under section 14A. The Tribunal directed the AO to verify the specific expenditure related to these investments and recompute the disallowance accordingly. The appeal was treated as partly allowed, recognizing the need for a more precise allocation of expenses for tax-free income.

In conclusion, the Tribunal's decision emphasized the strict application of section 14A in disallowing expenses related to tax-free income, despite the bank's arguments regarding statutory compliance and business purposes. The judgment highlighted the importance of accurately identifying and allocating expenses for tax-free investments to ensure compliance with the Income Tax Act.