2012 (7) TMI 591 - HC - Income Tax

Disallowance u/s 14A - Revenue contented that once deduction stands allowed, the income in view of the deduction ceases to be a part of the total income - Section 14A applicable in respect of deduction allowed under chapter VI-A? - Held that - Section 14A states that for the purpose of computing total income under Chapter IV, no deduction shall be allowed in respect of expenditure incurred in relation to the income which does not form part of the total income under this Act. It does not state that income which is entitled to deduction under Chapter VIA has to be excluded for the purpose of the said Section. The words do not form part of the total income under this Act is significant and important - Before allowing deduction under Chapter VIA we have to compute the income and include the same in the total income. In this manner, the income which qualifies for deductions under Sections 80C to 80U has to be first included in the total income of the assessee. It, therefore, becomes part of the income, which is subjected to tax. Thereafter, deduction is to be allowed in accordance with and subject to the fulfillment of the conditions of the respective provisions. This is also subject to Section 80AB and 80A(1) and (2). Chapter VIA does not postulate or state that the incomes which qualify for the said deduction will be excluded and not form part of the total income. They form part of the total income but are allowed as a deduction and reduced. Incomes in Chapter III are not chargeable to tax and, therefore, fall outside the ambit of Sections 4 and 5 but while computing the taxable income, deductions are allowed to the extent stipulated in Sections 80C to 80U. The distinction between the two, has been accepted and recognized by the Supreme Court in Second Income Tax Officer and Another v. Stumpp Schuele and Somappa Private Limited 1990 (9) TMI 69 - SUPREME COURT - deduction if allowed does not mean that the said income ceases to be part of the total income - the income on which the deduction is allowed forms a part of the total income, though not included in the amount or quantum on which tax is paid - in favour of assessee.

Summary

Issues Involved:
1. Disallowance under Section 14A of the Income Tax Act, 1961.
2. Distinguishing between deduction and exemption under the Income Tax Act.
3. Applicability of Section 14A to deductions under Chapter VIA.

Detailed Analysis:

Issue 1: Disallowance under Section 14A of the Income Tax Act, 1961
The Revenue appealed against the Income Tax Appellate Tribunal's (ITAT) decision concerning disallowance under Section 14A for the Assessment Year 2006-07. The Assessing Officer had disallowed expenditures under the head "interest" and a portion of employee benefits, asserting these were incurred for earning income under Section 80P(2)(d) and thus should be disallowed under Section 14A. However, the assessee succeeded in the first appeal and before the tribunal, which held that no disallowance could be made against income not specifically exempt under the Act.

Issue 2: Distinguishing between Deduction and Exemption
The ITAT distinguished between deductions under Chapter VIA and exemptions under Chapter III of the Act. The Revenue contended that deductions under Chapter VIA should result in the exclusion of the said income from the total income, thus making the related expenditure disallowable under Section 14A. However, the court found merit in the assessee's argument that Section 14A applies only to income not included in the total income as per Chapter III, not to deductions under Chapter VIA.

Issue 3: Applicability of Section 14A to Deductions under Chapter VIA
The court examined various provisions, including Sections 2(45), 14A, 80A(1) & (2), 80AB, and 80B(5), to determine the applicability of Section 14A to deductions under Chapter VIA. It concluded that deductions under Chapter VIA do not exclude the income from the total income. Instead, these deductions reduce the total income computed in accordance with the Act. The court emphasized that deductions allowed under Chapter VIA do not mean that the income ceases to be part of the total income. This distinction was supported by the Supreme Court's rulings in cases like Second Income Tax Officer v. Stumpp Schuele and Somappa Private Limited and Cambay Electric Supply Industrial Co. Ltd. v. CIT.

The court further clarified that Section 14A states that no deduction shall be allowed in respect of expenditure incurred in relation to income not forming part of the total income under the Act. It does not apply to income entitled to deductions under Chapter VIA, which must first be included in the total income before deductions are allowed.

Conclusion:
The court answered the questions of law in the affirmative, ruling against the appellant-Revenue and in favor of the respondent-assessee. It held that deductions under Chapter VIA do not result in the exclusion of the income from the total income and that Section 14A does not apply to such deductions. The court maintained that deductions allowed under Chapter VIA do not mean that the income ceases to be part of the total income, reaffirming the distinction between deductions and exemptions under the Income Tax Act.