2025 (5) TMI 805 - AT - Income Tax

Disallowance of expenses claimed u/s 57(iii) - assessee has stated in his letter many times that the Institution is covered u/s 10(23C)(iiiab) however no documents to substantiate its claim has been provided - HELD THAT - Assessee has furnished the relevant documentary evidence in support of its claim of exemption u/s 10(23C)/57 of the Act to substantiate receipt of grant from the Government and also to establish the nexus between the Income and Expenditure specifically related to salary grant and salary expenditure but these documentary evidences seems to have not been considered by the CIT(A)/AO or else not found satisfactory by them. We deem it fit and proper and in the interest of justice and fair play to restore the matter to the file of Ld. AO with a direction to verify the claim of the assessee afresh after due verification of the documents/evidence already available on record before him as well as such other documents / evidence that may be called upon and filed by the assessee during fresh proceedings before him and decide the matter afresh on merits as per facts and law. Thus ground Nos. 1 to 5 raised by the assessee are allowed for statistical purposes.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal are:

a) Whether the assessee trust is eligible for exemption under section 10(23C)(iiiab) of the Income Tax Act, 1961, given that it is an educational trust substantially financed by the Government but had filed its return in an incorrect form (ITR-5 instead of ITR-7) and had not obtained registration under section 12AA.

b) Whether the expenses amounting to Rs. 6,69,44,047/- claimed as deduction under section 57(iii) of the Act, primarily salary and incidental expenses funded by government grants, are allowable deductions against income from other sources under section 56.

c) Whether the procedural irregularity of filing the return in the wrong ITR form (ITR-5 instead of ITR-7) affects the validity of the return and the assessee's entitlement to exemption and deductions.

d) Whether the Assessing Officer (AO) and Commissioner of Income Tax (Appeals) [CIT(A)] were justified in disallowing the deduction claimed under section 57(iii) on grounds of lack of documentary evidence and nexus between income and expenditure.

e) Whether the assessee's failure to obtain registration under section 12AA and the rejection of its application for condonation of delay under section 119(2)(b) precludes it from claiming exemption under section 10(23C)(iiiab).

2. ISSUE-WISE DETAILED ANALYSIS

a) Eligibility for exemption under section 10(23C)(iiiab)

Legal framework and precedents: Section 10(23C)(iiiab) exempts income of educational institutions substantially financed by the Government, subject to conditions including registration under section 12AA unless exempted otherwise. The assessee trust claimed exemption on this basis.

Court's interpretation and reasoning: The AO and CIT(A) rejected the exemption claim primarily because the assessee had not obtained registration under section 12AA and had filed the return in an incorrect form (ITR-5 instead of ITR-7). The AO also noted that the gross receipts exceeded Rs. 5 crores, which, according to CIT(A), disqualified the trust from exemption under section 10(23C)(iiiab).

Key evidence and findings: The assessee submitted extensive documentary evidence including sanction letters, certificates from the School Education Department, audited income and expenditure accounts showing that 99.68% of its receipts were government grants, and that the expenditure was incurred wholly and exclusively for educational purposes. The assessee also filed an affidavit of its tax consultant admitting the mistake in filing the wrong ITR form and submitted an application under section 119(2)(b) for condonation of delay in filing the correct form.

Application of law to facts: The Tribunal observed that the trust was registered under the Bombay Public Trust Act and running government-approved schools. The documentary evidence clearly established that the trust was substantially financed by the Government (over 99%) and that the income was applied exclusively for educational purposes. The Tribunal found that the procedural mistake in filing ITR-5 instead of ITR-7 was inadvertent and technical, causing no revenue loss or undue benefit.

Treatment of competing arguments: The Revenue contended that the absence of registration under section 12AA and the incorrect ITR form filing invalidated the exemption claim. The Tribunal noted the rejection of condonation under section 119(2)(b) but emphasized that the return filed was valid and processed under section 143(1). The Tribunal relied on judicial precedents holding that returns filed with procedural errors but containing correct information should not be treated as invalid or non-existent.

Conclusions: The Tribunal held that the assessee trust is eligible for exemption under section 10(23C)(iiiab) as it satisfies the substantive conditions of being an educational institution substantially financed by the Government. The procedural irregularity of filing the wrong ITR form was a bona fide technical mistake and should not deprive the trust of exemption.

b) Allowability of expenses claimed under section 57(iii)

Legal framework and precedents: Section 57(iii) allows deduction of expenditure incurred wholly and exclusively for earning income chargeable under the head "Income from other sources" under section 56. The expenditure must not be capital or personal in nature and must relate to the relevant previous year.

Judicial precedents such as Eastern Investment Ltd. v. CIT and CIT v. Rajendra Prasad Moody were cited, establishing that expenses incurred for earning income from other sources are allowable even if the income is exempt or the purpose is not necessarily profitable, provided the expenditure satisfies the statutory conditions.

Court's interpretation and reasoning: The AO disallowed the deduction of Rs. 6,69,44,047/- claiming lack of nexus between income and expenditure and absence of supporting documents. CIT(A) upheld the disallowance, observing that the assessee failed to substantiate the claim with proper evidence.

Key evidence and findings: The assessee produced detailed pay sheets, sanction letters from the Education Department, bank passbooks showing direct credit of salary grants to schools and subsequent payment to staff, audited income and expenditure statements, and other supporting documents. The expenditure mainly comprised salaries to teaching and non-teaching staff (96%), audit fees, depreciation, and incidental expenses like building rent.

Application of law to facts: The Tribunal found that the expenditure was incurred wholly and exclusively for educational purposes and to earn income from government grants credited under section 56. The detailed documentary evidence established a direct nexus between the income and expenses claimed. The Tribunal noted that none of the expenditure was capital or personal in nature and was incurred in the relevant financial year.

Treatment of competing arguments: The Revenue's argument focused on the alleged absence of documentary proof and nexus. The Tribunal observed that the AO and CIT(A) had not adequately considered the extensive evidence submitted by the assessee. The Tribunal relied on judicial pronouncements affirming allowance of expenditure wholly and exclusively incurred for earning income from other sources.

Conclusions: The Tribunal concluded that the expenses claimed under section 57(iii) are allowable deductions against income from other sources under section 56, given the direct nexus and supporting evidence.

c) Effect of procedural irregularity in filing incorrect ITR form

Legal framework and precedents: Filing of returns in the correct form is a procedural requirement. Section 119(2)(b) allows the Commissioner to condone delay or rectify procedural defects. Judicial precedents have held that returns filed with technical errors but containing correct and complete information cannot be treated as invalid or non-existent.

Court's interpretation and reasoning: The assessee filed ITR-5 instead of ITR-7 due to a bona fide mistake by its tax consultant. The application for condonation under section 119(2)(b) was rejected by the CIT(Exemption) on the ground that the original return was valid and processed. The Tribunal found this rejection reasonable but emphasized that the original return was valid and processed under section 143(1).

Key evidence and findings: The affidavit of the tax consultant admitting the mistake, the processed return under section 143(1), and the absence of any loss to revenue or undue benefit to the assessee were significant factors.

Application of law to facts: The Tribunal applied judicial precedents holding that procedural mistakes in filing returns should be rectified and should not prejudice the assessee if the substantive information is correct and no revenue loss occurs.

Treatment of competing arguments: The Revenue argued that the incorrect form filing invalidated the return and exemption claim. The Tribunal rejected this, emphasizing fairness and the principle that procedural errors should not defeat substantive rights.

Conclusions: The Tribunal held that the procedural irregularity was a technical mistake that did not invalidate the return or the assessee's entitlement to exemption and deductions.

d) Validity of disallowance of deduction for lack of documentary evidence and nexus

Legal framework and precedents: The burden of proof lies on the assessee to substantiate claims with proper evidence. However, once evidence is furnished, the AO must consider it fairly and provide reasons if disallowing deductions.

Court's interpretation and reasoning: The AO and CIT(A) disallowed the deduction primarily on grounds of incomplete or insufficient evidence and lack of nexus. The Tribunal found that the assessee had furnished extensive documentary evidence which was either not considered or found unsatisfactory without adequate reasoning.

Key evidence and findings: The pay sheets, sanction letters, bank passbooks, audited accounts, affidavits, and other documents were on record and supported the claim.

Application of law to facts: The Tribunal noted that the AO/CIT(A) had not conducted a detailed verification or given cogent reasons for rejecting the evidence. The Tribunal directed a fresh verification and adjudication by the AO with opportunity to the assessee to present its case.

Treatment of competing arguments: The Revenue maintained that the evidence was insufficient. The Tribunal emphasized the principle of natural justice and fair play, requiring proper consideration of evidence and opportunity to the assessee.

Conclusions: The Tribunal set aside the disallowance and remanded the matter for fresh verification and decision on merits.

e) Effect of non-registration under section 12AA and rejection of condonation application

Legal framework and precedents: Registration under section 12AA is generally required for claiming exemption under section 10(23C). However, educational institutions substantially financed by the Government under clause (iiiab) may be exempt without registration. Procedural non-compliance should not defeat substantive rights if conditions are met.

Court's interpretation and reasoning: The assessee had applied for registration under section 12AA but the application was rejected due to pandemic-related delays. The AO and CIT(A) viewed this as non-compliance affecting exemption.

Key evidence and findings: The Tribunal noted the assessee's bona fide attempt to obtain registration, the pandemic-related difficulties, and the substantial government financing.

Application of law to facts: The Tribunal relied on CBDT Circular No. 14 (XL-35) dated 11/04/1955, which directs the Department not to take advantage of an assessee's ignorance or procedural mistakes to collect more tax than legitimately due. The Tribunal held that the absence of registration due to procedural reasons should not defeat exemption where substantive conditions are fulfilled.

Treatment of competing arguments: The Revenue emphasized the statutory requirement of registration. The Tribunal balanced this against the principle of equity and the assessee's compliance with substantive conditions.

Conclusions: The Tribunal held that non-registration under section 12AA due to procedural reasons does not preclude exemption under section 10(23C)(iiiab) where the trust is substantially financed by the Government and satisfies substantive conditions.

3. SIGNIFICANT HOLDINGS

"The Tribunal observed that the trust was registered under the Bombay Public Trust Act and running government-approved schools. The documentary evidence clearly established that the trust was substantially financed by the Government (over 99%) and that the income was applied exclusively for educational purposes."

"The procedural mistake in filing ITR-5 instead of ITR-7 was inadvertent and technical, causing no revenue loss or undue benefit. Such a bona fide procedural mistake should not deprive the trust of exemption."

"The expenditure claimed under section 57(iii) is allowable deduction against income from other sources under section 56, given the direct nexus and supporting evidence."

"The Tribunal relied on CBDT Circular No. 14 (XL-35) dated 11/04/1955 which directs the Department not to take advantage of an assessee's ignorance or procedural mistakes to collect more tax than legitimately due."

"The Tribunal directed a fresh verification and adjudication by the AO with opportunity to the assessee to present its case, emphasizing the principles of natural justice and fair play."

"The Tribunal set aside the disallowance and remanded the matter for fresh verification and decision on merits."

"The Tribunal held that non-registration under section 12AA due to procedural reasons does not preclude exemption under section 10(23C)(iiiab) where the trust is substantially financed by the Government and satisfies substantive conditions."

"The Tribunal held that returns filed with procedural errors but containing correct information should not be treated as invalid or non-existent."