Disallowance u/s 14 A of Income Tax Act Cannot Exceed Exempt Income: Delhi HC [Read Order}

The Delhi High Court has held that disallowance under section 14 A of the Income Tax Act cannot exceed exempt income.                                The appellant/revenue challenged the order passed by the Income Tax Appellate Tribunal [“Tribunal”]. The Assessing Officer (AO) made an addition amounting to Rs.5,06,73,874/- under Section 14A of the Income Tax Act, 1961 [“Act”] read with Rule 8D of the Income Tax Rules, 1962 [“Rules”]. The Commissioner of Income Tax (Appeals) [“CIT(A)”], confirmed the addition made by the AO. In an appeal preferred by the respondent/assessee, Devata Tradelink Ltd with the Tribunal, the addition was deleted. The respondent/assessee in the period in issue i.e., Financial Year (FY) 2007-08 [AY 2008-09] had earned exempt income amounting to Rs.35,347/-.

The respondent/assessee had made a suo motu disallowance amounting to Rs.87,442/-.  The AO, however, added to the respondent’s/assessee’s income, as indicated above, Rs.5,06,73,874/- based on the following rationale contained in the order. On going through the simple and plain language, it is abundantly clear that the relation has to be seen between the exempt income and the expenditure incurred to it and not vice versa. What is relevant is to work out the expenditure to the exempt income and the expenditure incurred about it and not vice versa.

From the three clauses of rule 8D, it emerged that the stipulation of the section is to compute the amount of expenditure which is not allowable under section 14A as is relatable to the exempt income and not in considering all the expenses one by one for ascertaining if either of them has resulted into exempt income and thereafter considering such amount as disallowable under section 14A. Mr Jain contended that although the AO was right in holding that in the balance sheet for FY in issue i.e., FY 2007-08, a part of the shares bought concerning Reliance Industries Ltd. (RIL) was shown as a long-term investment, they were sold and the profit earned therefrom was offered for imposition of tax.  Mr Jain, thus, went on to state that the profit on the sale of all the shares mentioned in Table- II above, which included shares of RIL (except Reliance Liquid Fund) was Rs.7,10,34,493/-, which as indicated above, was offered for levy of tax.  Once the appellant/revenue has accepted the transaction as one concerning the sale of shares held as stock-in-trade, neither the CIT(A) nor the AO could have made an additional qua interest paid on the loan availed by the respondent/assessee.

The shared bought from borrowed funds were sold and this profit earned was offered for levy of tax, which was accepted by the appellant/revenue. The question, as proposed, is confined to the disallowance of Rs.5,06,73,874/- made under Section 14A of the Act read with Rule 8D of the Rules. In any event, the well-established principle is that the manner of treatment of an item concerning expenditure and income in the books of accounts or financial statements does not determine its liability under the Act. Since, as noticed above, the exempt income was only Rs.35,347/-, the disallowance ordered by the AO amounting to Rs.5,06,73,874/- could not have been made in view of the position in law enunciated in the judgment referred to hereinabove.

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