2024 (8) TMI 1579 - AT - Income Tax

Disallowance u/s 14A in respect of expenditure attributable earning exempt income - suo moto addition made by assessee - CIT(A) has restricted the disallowance comprising disallowance under rule 8D(ii) and as per rule 8D(iii) of the Act - HELD THAT - We have perused the decision of ITAT Mumbai in the case of the assessee itself for the A.Y. 2008-09 2024 (5) TMI 1586 - ITAT MUMBAI CIT(A) has rightly deleted the addition made on account of interest expenditure as the assessee had sufficient interest free surplus fund to make the investment and the ITAT has rightly deleted the disallowance made by the AO u/s 14A r.w Rule 8D. Consequently we hold that the interest expenditure cannot be disallowed u/s 14A r.w. Rule 8D(2)(ii) under any circumstances. AO before rejecting the suo-moto disallowance has not given any specific error in the computation of suo-moto disallowance but has made a general observation that certain indirect expenses ought to have been incurred by the assessee. AO has not brought anything on record to factually state that the computation of disallowance made by the assessee is not correct. Therefore the enhanced disallowance made without recording satisfaction cannot be sustained - we hold that the disallowance made u/s 14A should be restricted to the suo-moto disallowance. Incentive in the form of reimbursement/exemption and the exemption from collection and deposit from payment of Value Added Tax (VAT) and Central Sales Tax (CST) - assessee has claimed it as capital receipt under New Sugar Industry Promotion Policy 2004 announced by the state government of Uttar Pradesh not eligible to Income Tax - HELD THAT - We have perused the decision of ITAT 2023 (1) TMI 1482 - ITAT MUMBAI as held various incentives were granted under the New Sugar Industry Promotion Policy 2004 for the purpose of development and growth of sugar industry in the state and same has to be considered as capital in nature. Claim of deduction of expenditure u/s 115JB - reserves of construction of molasses storage tanks - CIT(A) held that deduction of reserve for molasses tank will not be allowable after referring the decision of CIT(A) for A.Y. 2007-08 in assessee s case relying upon the decision of Ambur Cooperative Sugar Mills Ltd. 2001 (8) TMI 1329 - SC ORDER - HELD THAT - Identical fact has been decided by the ITAT Mumbai in favour of the assessee for A.Y. 2007-08 2023 (1) TMI 1482 - ITAT MUMBAI we find the decision of ld. CIT(A) in not allowing the claim of the assessee in respect of amount diverted to the statutory reserve for construction of molasses is not justified therefore we direct the Assessing Officer to exclude the aforesaid amount while computing book profit u/s 115JB. Addition of disallowance u/s 14A while computing the book profit u/s 115JB - HELD THAT - We find that in the case of ACIT vs Vireet Investment Pvt. Ltd. 2017 (6) TMI 1124 - ITAT DELHI held that disallowance made u/s 14A is not to be added while computing book profit u/s 115JB of the Act. Therefore this ground of appeal is allowed. Incentive received under the New Sugar Industry Promotion Policy to be reduced while computing book profit u/s 115JB because of being nature of capital receipt - We have adjudicated the ground no. 2 of the assessee holding that incentive received under the New Sugar Industry Promotion Policy 2004 of Uttar Pradesh Government are of the nature of capital receipt therefore we direct the assessing officer to reduce the same while computing the book profit u/s 115JB of the Act. Disallowance of club entrance fees treating the same as not revenue in nature - HELD THAT - As in the case of Swiss Re Services India (P) Ltd. 2023 (10) TMI 979 - BOMBAY HIGH COURT on the proposition that club entrance fees would be a revenue expenditure because it had been incurred wholly and exclusively for the purpose of business and not toward capital account but for the smooth running of business. Nature of receipt - gain on revaluation of FCCB and ECB - Revenue or capital receipt - HELD THAT - We find that similar issue on identical fact has been restored to the file of assessing officer by the ITAT Mumbai in the appeal of the assessee for A.Y. 2007-08 2023 (1) TMI 1482 - ITAT MUMBAI Similarly we restore this issue to the file of assessing office for deciding the same after verification/examination of the material as directed by the ITAT for A.Y. 2007-08. Therefore this ground of appeal is allowed for statistical purposes.

Summary

1. ISSUES PRESENTED and CONSIDERED

- Whether disallowance under section 14A of the Income Tax Act, 1961 (the Act), in respect of expenditure attributable to exempt income, was correctly computed and applied, particularly in light of Rule 8D of the Income Tax Rules, 1962.

- Whether incentives and subsidies received under the New Sugar Industry Promotion Policy, 2004 (the Policy) of the Uttar Pradesh Government are capital receipts or revenue receipts for income tax purposes.

- Whether the deduction claimed under section 115JB of the Act in respect of reserves created for construction of molasses storage tanks is allowable in computing book profit.

- Whether disallowance under section 14A should be added while computing book profit under section 115JB of the Act.

- Whether incentives received under the New Sugar Industry Promotion Policy should be reduced while computing book profit under section 115JB.

- Whether club entrance fees paid by the assessee are allowable as revenue expenditure under section 37(1) of the Act.

- Whether gains on revaluation of Foreign Currency Convertible Bonds (FCCB) and External Commercial Borrowings (ECB) are capital or revenue in nature.

- Whether provisions relating to foreign exchange gains should be considered in computing book profit under section 115JB.

2. ISSUE-WISE DETAILED ANALYSIS

Disallowance under section 14A of the Act (Expenditure attributable to exempt income)

The Assessing Officer (AO) disallowed Rs. 29,34,72,987/- under section 14A read with Rule 8D, on account of expenditure attributable to exempt income comprising dividend income and long-term capital gains exempt under section 10(38). The AO applied Rule 8D without recording specific satisfaction regarding the correctness of the assessee's claim of expenditure attributable to exempt income.

The Commissioner of Income Tax (Appeals) [CIT(A)] restricted the disallowance to Rs. 10,74,43,886/-. The assessee relied on a prior ITAT Mumbai decision for the assessment year 2008-09, which held that the AO must record reasons and examine the correctness of the claim before applying Rule 8D. The AO's failure to do so rendered the disallowance unsustainable.

The Tribunal reiterated that the AO cannot apply Rule 8D mechanically without examining the correctness of the expenditure claimed by the assessee. The Tribunal cited the Bombay High Court decision which held that interest expenditure cannot be disallowed under section 14A read with Rule 8D(2)(ii) if the assessee had sufficient interest-free funds for investment. The AO's general observations without specific findings or recorded satisfaction were insufficient to enhance the disallowance beyond the suo-moto disallowance of Rs. 10 lakhs claimed by the assessee.

The Tribunal concluded that the disallowance under section 14A should be restricted to the suo-moto disallowance of Rs. 10 lakhs and deleted the enhanced disallowance.

Incentives under New Sugar Industry Promotion Policy - Capital or Revenue Receipt

The AO treated incentives and reimbursements amounting to Rs. 32,28,38,755/- and exemptions aggregating Rs. 10,03,27,783/- under the Policy as revenue receipts, adding them to the total income. The CIT(A) upheld the AO's view.

The assessee contended that these incentives are capital receipts, not liable to tax, and should not be reduced from the cost of assets under section 43(1) of the Act. The assessee relied on ITAT decisions for earlier years and various judicial precedents including Supreme Court and High Court rulings which established the "purpose test" for characterizing subsidies or incentives. The test requires determining the nature of the receipt by the purpose for which the subsidy is granted rather than its form or timing.

The Tribunal examined the Policy's background, objectives, and the nature of benefits granted, which aimed at promoting private investment, industrial development, increased sugar production, rural development, and employment generation. The incentives included capital subsidies, exemptions from registration and stamp duty, and reimbursements related to operations.

The Tribunal observed that the incentives were granted to encourage capital investment in new sugar mills and were not linked to acquisition of specific assets. It relied on judicial precedents holding that similar subsidies and incentives granted for industrial promotion are capital receipts. The Tribunal held that the incentives under the Policy are capital receipts and not taxable as revenue income. Consequently, these receipts should be excluded from total income and reduced while computing book profit under section 115JB.

Deduction under section 115JB for reserves for construction of molasses storage tanks

The assessee claimed deduction for reserves created for construction of molasses storage tanks while computing book profit under section 115JB. The CIT(A) disallowed this claim relying on a prior decision of the Supreme Court in CIT vs Ambur Cooperative Sugar Mills Ltd.

The assessee referred to ITAT decisions for earlier years and various High Court rulings which held that amounts set apart for molasses storage fund are allowable deductions under the normal provisions and should be allowed for computing book profit under section 115JB. The rationale is that such reserves are statutory requirements and related to business operations.

The Tribunal found merit in the assessee's submissions and held that the deduction for reserves for molasses storage tanks should be allowed while computing book profit under section 115JB. The AO was directed to exclude such amounts from book profit computation.

Addition of disallowance under section 14A in computing book profit under section 115JB

The CIT(A) directed the AO to add the disallowance under section 14A while computing book profit under section 115JB. The Tribunal referred to the ITAT Special Bench decision in ACIT vs Vireet Investment Pvt. Ltd., which held that disallowance under section 14A is not to be added while computing book profit.

Following this binding precedent, the Tribunal allowed the assessee's ground and held that disallowance under section 14A should not be added in computing book profit under section 115JB.

Club entrance fees as revenue expenditure

The AO disallowed club entrance fees of Rs. 13,23,600/- paid to Mumbai Cricket Association treating it as capital expenditure. The CIT(A) allowed the claim treating it as business expenditure under section 37(1) relying on judicial precedents including decisions of Bombay High Court and other tribunals.

The Tribunal found no reason to interfere with the CIT(A)'s decision and upheld the allowance of club entrance fees as revenue expenditure incurred wholly and exclusively for business purposes.

Gains on revaluation of FCCB and ECB - capital or revenue in nature

The CIT(A) held that foreign exchange gains written back aggregating Rs. 79,11,26,251/- on revaluation of FCCB and ECB were capital in nature and excluded them from total income. The Tribunal noted that a similar issue for an earlier year was restored to the AO for fresh examination.

Accordingly, the Tribunal restored this issue to the AO for fresh verification and examination of relevant material, allowing the appeal for statistical purposes.

Provision relating to foreign exchange gains in computation of book profit under section 115JB

Since the issue of foreign exchange gains was restored to the AO for fresh adjudication, the Tribunal held that the ground relating to provisions for foreign exchange gains in book profit computation became infructuous and dismissed the ground.

3. SIGNIFICANT HOLDINGS

"For the purpose of application of section 14A read with Rule 8D(2)(iii), the AO has to record reasons as to why he is not satisfied with the correctness of the claim of expenditure by the assessee. The AO cannot apply Rule 8D straightaway without considering the correctness of the assessee's claim in respect of expenditure incurred in relation to the exempt income. The disallowance made by applying Rule 8D without such satisfaction is against the statutory mandate and legal principles."

"The incentives granted under the New Sugar Industry Promotion Policy, 2004 are capital receipts. The character of receipt has to be determined with respect to the purpose for which the subsidy is given. The form or timing of subsidy is immaterial. The incentives are granted to promote capital investment and industrial development and hence are not taxable as revenue income."

"Amounts set apart towards reserves for construction of molasses storage tanks are allowable deductions under normal provisions and must be allowed while computing book profit under section 115JB."

"Disallowance under section 14A is not to be added while computing book profit under section 115JB."

"Club entrance fees paid wholly and exclusively for business purposes are revenue expenditure and allowable under section 37(1)."

"Issues relating to foreign exchange gains on revaluation of FCCB and ECB require fresh examination by the AO and are restored accordingly."