2025 (5) TMI 1486 - AT - Income Tax

Disallowance of expenses u/s 14A - investments made by the assessee company in foreign entity - HELD THAT - Since there is no exempt income derived by the assessee during the year under consideration the application of provisions of Section 14A of the Act cannot be pressed into service. See M/S.ERA INFRASTRUCTURE (INDIA) LTD. 2022 (7) TMI 1093 - DELHI HIGH COURT Disallowance of interest u/s 36(1)(iii) - AO observed that assessee had suffered interest on its borrowings on one hand but on the other hand had advanced interest-free loans and advances to its subsidiary companies which amount to diversion of interest for non-business purposes - HELD THAT - As workings are captured from the audited financial statements which are already part of the income tax return. We find that the assessee is having sufficient interest free funds of Rs 165.48 crores as on 31.3.2018 as against the loans and advances given to subsidiaries of Rs 102.40 crores. Hence it could be reasonably presumed that interest free loans to subsidiaries were advanced out of own funds of the assessee company and not out of borrowed funds in view of the decision of Reliance Industries Limited 2019 (1) TMI 757 - SUPREME COURT . Hence there cannot be any disallowance of interest u/s 36(1)(iii). Levy of penalty u/s 270A - as argued inappropriate portion in the penalty notice had not been struck off by the AO in the show cause notice issued for penalty proceedings - HELD THAT - Non-striking off of the irrelevant portion in the penalty notice by not specifically mentioning the offence committed by the assessee would become fatal to the penalty proceedings as decided in Mohd. Farhan A Shaikh 2021 (3) TMI 608 - BOMBAY HIGH COURT (LB) treats omnibus show-cause notices as betraying non-application of mind and disapproves of the practice to be particular of issuing notices in printed form without deleting or striking off the inapplicable parts of that generic notice. Thus we direct the ld. AO to delete the penalty levied u/s 270A. Assessee appeals allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

- Whether disallowance of expenses under Section 14A of the Income-tax Act, 1961 is justified when no exempt income has accrued to the assessee during the relevant assessment year.

- Whether disallowance of interest under Section 36(1)(iii) of the Act is warranted on the ground of interest-free loans advanced to subsidiaries, considering the availability of own funds of the assessee.

- Whether penalty under Section 270A of the Act can be sustained when the penalty show cause notice does not specifically strike off the irrelevant portion and fails to clearly specify the offence (under-reporting or misreporting of income) committed by the assessee.

- Ancillary issues raised in general grounds not requiring specific adjudication.

2. ISSUE-WISE DETAILED ANALYSIS

Disallowance under Section 14A of the Act (Grounds 2 and 3)

The legal framework involves Section 14A of the Income-tax Act, which empowers disallowance of expenditure incurred in relation to exempt income. Rule 8D(2) of the Income Tax Rules provides a mechanism for computation of such disallowance.

The Court noted that the assessee had made investments in foreign entities from which no exempt income was derived during the year under consideration. This fact was undisputed. The Assessing Officer (AO) applied Rule 8D(2) to disallow expenses amounting to Rs. 39,79,299/-, and the Commissioner of Income Tax (Appeals) upheld this disallowance.

The Tribunal referred to the authoritative precedent from the Jurisdictional High Court which held that Section 14A cannot be invoked where no exempt income is earned. The Court emphasized that the mere presence of investments in foreign entities not yielding exempt income does not trigger disallowance under Section 14A.

Applying this principle, the Tribunal concluded that the disallowance under Section 14A was not justified in the present facts. The competing argument of the Revenue that Rule 8D(2) computation warranted disallowance was rejected on the ground that the foundational condition-existence of exempt income-was absent.

Accordingly, Grounds 2 and 3 were allowed in favour of the assessee.

Disallowance of Interest under Section 36(1)(iii) of the Act (Ground 4)

Section 36(1)(iii) permits disallowance of interest expenses where borrowed funds are used for non-business purposes, including loans or advances to subsidiaries.

The AO disallowed Rs. 12 crores of interest on the basis that the assessee had interest-bearing borrowings but had advanced interest-free loans to subsidiaries, amounting to diversion of borrowed funds for non-business purposes. This disallowance was upheld by the Commissioner of Income Tax (Appeals).

The assessee contended that it had sufficient own funds to cover the interest-free loans, supported by audited financial statements showing own funds of Rs. 165.48 crores against loans of Rs. 102.40 crores to subsidiaries.

The Tribunal relied on the Supreme Court decision in Reliance Industries Limited, which established that if own funds are sufficient to cover interest-free advances, no disallowance under Section 36(1)(iii) is warranted.

Applying this precedent, the Tribunal held that it could reasonably be presumed that the interest-free loans were advanced out of own funds and not borrowed funds, thus negating the basis for disallowance.

The Tribunal rejected the Revenue's contention and allowed Ground 4 in favour of the assessee.

Penalty under Section 270A of the Act (ITA No. 3688)

The preliminary issue was whether a penalty under Section 270A can be levied when the show cause notice does not specify the offence committed by the assessee by failing to strike off the irrelevant portion, i.e., whether the penalty is for under-reporting or misreporting of income.

The Tribunal examined the show cause notice and found that the AO had not deleted the irrelevant parts, resulting in ambiguity as to the specific offence alleged.

The Tribunal referred extensively to the Full Bench decision of the Bombay High Court in Mohd. Farhan A Shaikh vs DCIT, which held that omnibus show cause notices without striking off irrelevant portions betray non-application of mind and are liable to be quashed. The Court emphasized the requirement of precision and clarity in penalty notices to comply with principles of natural justice.

Further reliance was placed on the Jurisdictional High Court's decision in PCIT vs Sahara India Life Insurance Co. Ltd, which held that penalty notices must specify the limb of Section 271(1)(c) under which proceedings are initiated, and failure to do so renders the notice bad in law.

Though these precedents arose under Section 271(1)(c), the Tribunal held that the ratio applies equally to penalty proceedings under Section 270A.

The Tribunal directed the AO to delete the penalty levied under Section 270A on this preliminary technical ground, thereby allowing the penalty appeal without adjudicating the other substantive grounds raised by the assessee.

General Grounds (Grounds 1 and 5)

These grounds were general in nature and did not require specific adjudication as per the Tribunal's observations.

3. SIGNIFICANT HOLDINGS

"Since there is no exempt income derived by the assessee during the year under consideration, the application of provisions of Section 14A of the Act cannot be pressed into service."

"It could be reasonably presumed that interest free loans to subsidiaries were advanced out of own funds of the assessee company and not out of borrowed funds in view of the decision of Hon'ble Supreme Court in the case of Reliance Industries Limited."

"Omnibus show-cause notices without deleting or striking off the inapplicable parts betray non-application of mind and are liable to be quashed."

"The ratio laid down in the context of penalty under Section 271(1)(c) squarely applies to penalty proceedings under Section 270A."

The Tribunal conclusively held that disallowance under Section 14A is not sustainable without exempt income; disallowance under Section 36(1)(iii) is not justified where own funds cover interest-free advances; and penalty under Section 270A must be quashed if the penalty notice lacks clarity on the specific offence alleged.