2015 (12) TMI 972 - HC - Income Tax

Disallowance under section 14A - ITAT held no disallowance can be made under section 14A unless a clear cut nexus is established between the expenses disallowed and income earned ignoring the fact that both direct and indirect expenses are attributable to such investment - Held that - The Tribunal after considering the matter held that no part of interest expenditure could be considered for the purpose of computing disallowance under Section 14A of the Act. Further, in the absence of any proximate nexus having been established by the lower authorities between the administrative and other expenses and the exempt income, no disallowance under section 14A of the Act could have been made for the assessment year under consideration. Learned counsel for the appellant-revenue has not been able to show any illegality or perversity in the approach of the Tribunal or that the findings recorded by it are erroneous. Adverting to the judgment relied upon by the learned counsel for the appellant-revenue, it may be noticed that in Walfort Share and Stock Brokers P. Limited s case (2010 (7) TMI 15 - SUPREME COURT ), it held that the assessee was entitled to set off loss from transactions against its other Income chargeable to tax. The said view was affirmed by the High Court. The question before the Apex Court was whether loss arising in the course of dividend stripping transaction taking place prior to 1.4.2002 was disallowable on the ground that such loss was artificial as the dividend stripping transaction was not a business transaction. After examining the legal and factual position therein, it was held that in cases arising before 1.4.2002, losses pertaining to exempted income could not be disallowed. Such is not the position in the present case. - Decided against the revenue

Summary

Issues Involved:
1. Disallowance of expenses under Section 14A of the Income Tax Act, 1961.
2. Establishment of a clear nexus between expenses disallowed and income earned.

Detailed Analysis:

1. Disallowance of Expenses under Section 14A:
The primary issue in this case was whether disallowance of expenses under Section 14A of the Income Tax Act, 1961 was justified. The assessee company, engaged in the manufacturing of pharmaceuticals and health care services, declared a loss in its return and the Assessing Officer (AO) disallowed Rs. 1.50 crores as expenses apportioned for exempt income. The AO's rationale was that a significant portion of the assessee's capital was invested in securities, and expenses related to these investments should be disallowed under Section 14A. The AO's assessment was based on the assumption that a large part of the company's expenses, including salaries, conveyance, and other incidental expenses, were related to earning exempt income.

The Commissioner of Income Tax (Appeals) [CIT(A)] partially allowed the appeal, reducing the disallowance to Rs. 10 lacs. The CIT(A) noted that the AO had not provided a clear basis for the Rs. 1.50 crores disallowance and emphasized that the assessee was involved in various other business activities requiring significant corporate office resources.

The Income Tax Appellate Tribunal (ITAT) further examined the matter and concluded that no disallowance under Section 14A could be made without establishing a proximate nexus between the expenditure incurred and the exempt income earned. The Tribunal emphasized that the AO's disallowance was made on an ad hoc basis without concrete evidence of the expenses incurred specifically for earning the exempt income.

2. Establishment of Clear Nexus:
The Tribunal's analysis highlighted that for any disallowance under Section 14A, there must be a reasonable basis and clear evidence linking the expenses to the exempt income. The Tribunal observed that the assessee had sufficient surplus funds for making investments, and no part of the interest expenditure could be attributed to earning exempt income. The Tribunal also noted that the lower authorities failed to establish a proximate nexus between the administrative and other expenses and the exempt income.

The Tribunal's findings were supported by various judicial precedents, including the cases of CIT vs. Metalman Auto P. Limited and CIT vs. Hero Cycles Limited, which held that disallowance under Section 14A requires a finding of actual expenditure incurred for earning exempt income. In the absence of such a finding, no disallowance is justified.

The High Court upheld the Tribunal's decision, stating that the revenue had not demonstrated any illegality or perversity in the Tribunal's approach. The court reiterated that disallowance under Section 14A requires concrete evidence of expenditure incurred specifically for earning exempt income, and there cannot be a presumption that certain expenses are bound to be incurred for such income.

Conclusion:
The High Court dismissed the appeal, affirming that no disallowance under Section 14A can be made without establishing a clear and proximate nexus between the expenses incurred and the exempt income earned. The substantial question of law was answered against the revenue, emphasizing the necessity of concrete evidence for any disallowance under Section 14A.