2006 (11) TMI 362 - AT - Income Tax

Quantification of the disallowance - Expenditure incurred in relation to income not includible in total income - HELD THAT - Section 14A clearly makes a distinction between exempt income and taxable income. It treats both of them as separate classes for computation of income after allocation of expenditure relating thereto and mandates that no deduction in respect of any expenditure shall be allowed against taxable income which is incurred in relation to exempt income. The underlying object is to compute both the exempt income and taxable income correctly which is possible only after the expenditure incurred in relation thereto is allocated to them. In other words section 14A bars the deduction of expenditure incurred in relation to exempt income out of taxable income as this would have the effect of artificially inflating the exempt income and thereby deflating the taxable income. The procedure for computation of disallowance has now been provided in sub-sections (2) and (3) of section 14A of the Income-tax Act. It is no longer open to the Assessing Officer to apply his discretion in computing the disallowance or make ad hoc disallowance under section 14A. Substantive provisions are contained in sub-section (1) of section 14A prohibiting deduction in respect of expenditure incurred in relation to exempt income while procedural provisions regarding computation of the aforesaid disallowance are contained in sub-sections (2) and (3) thereof. Sub-sections (2) and (3) seek to achieve the underlying object of section 14A(1) that any expenditure incurred in relation to exempt income should not be allowed deduction. It is fairly well-settled by a catena of decisions that procedural provisions apply to all pending matters and that the rule against retrospectivity does not hit them. Thus we hold that the provisions for quantification of disallowance as contained in sub-sections (2) and (3) of section 14A are procedural and therefore apply to all pending matters. It is no longer open to the Assessing Officer to make disallowance according to his own discretion or on ad hoc basis. He is statutorily required to compute the disallowance in the manner provided by sub-sections (2) and (3) of section 14A. We therefore set aside the orders passed by the CIT(A) and the Assessing Officer in this behalf and restore the matter to the Assessing Officer for a fresh examination and decision in the light of the provisions of section 14A including sub-sections (2) and (3) thereof in accordance with law. Hence the appeal filed by the Department is treated as allowed for statistical purposes.

Issues Involved:
1. Deduction of Rs. 1,94,96,945 on account of provisions for accrued expenses.
2. Exemption under section 10(33) in respect of dividend income of Rs. 4,85,24,362.

Detailed Analysis:

1. Deduction of Rs. 1,94,96,945 on account of provisions for accrued expenses:
The department contended that the CIT(A) erred in allowing the deduction of Rs. 1,94,96,945 for accrued expenses, which the Assessing Officer (AO) had correctly disallowed. The Tribunal did not specifically address this issue in the provided text, focusing instead on the dividend income exemption under section 10(33) and the application of section 14A.

2. Exemption under section 10(33) in respect of dividend income of Rs. 4,85,24,362:
The assessee-company, engaged in financial services, had earned a dividend income of Rs. 4,85,24,362, which was exempt from tax. The AO, invoking section 14A of the Income-tax Act, allocated a portion of the total expenditure incurred by the assessee to the earning of the dividend income. The AO disallowed Rs. 3,68,02,411, being 4.06% of the total expenditure, while computing non-exempt income.

On appeal, the CIT(A) directed the AO to allow the deduction on the gross amount of dividend without allocating any expenditure. The department appealed against this decision, arguing that the disallowance was in conformity with section 14A.

The Tribunal examined the provisions of section 14A, which prohibits the deduction of expenditure incurred in relation to exempt income. The Tribunal noted that section 14A was inserted with retrospective effect from 1-4-1962 and had been amended subsequently to include sub-sections (2) and (3), which provide the mechanism for computing the disallowance.

The Tribunal emphasized that section 14A mandates that no deduction shall be allowed in respect of expenditure incurred in relation to exempt income, to avoid artificially inflating exempt income and deflating taxable income. The Tribunal cited various judicial precedents supporting the allocation of expenses related to exempt income.

The Tribunal concluded that all expenses connected with exempt income, whether direct or indirect, fixed or variable, managerial or financial, must be disallowed under section 14A. The Tribunal held that the procedural provisions of sub-sections (2) and (3) of section 14A, inserted by the Finance Act, 2006, apply to all pending matters, and the AO must compute the disallowance in the manner prescribed by these sub-sections.

The Tribunal set aside the orders of the CIT(A) and the AO and restored the matter to the AO for a fresh examination and decision in light of the provisions of section 14A, including sub-sections (2) and (3), in accordance with law.

Conclusion:
The appeal filed by the department was treated as allowed for statistical purposes, with the matter remanded to the AO for a fresh determination of the disallowance under section 14A, following the procedural provisions of sub-sections (2) and (3).

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