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TMI Blog2012 (12) TMI 1036X X X X Extracts X X X X X X X X Extracts X X X X ..... of Rs. 4,51,931/- u/s 14A of Income-tax Act, 1961 without considering the reply filed by the appellant. Therefore, addition of Rs. 4,51,931/- is uncalled for unwarranted and may be deleted." 3. ITA No. 36/Chd/2012 - In this appeal the Revenue has raised the following grounds:- "1(a) That the ld. CIT(A)-II, Ludhiana on facts as well as in law, has erred in partly deleting the interest disallowed u/s 36(i)(iii) of Income-tax Act, 1961 on account of interest free advance given to M/s Balwindra Tools Pvt Ltd. (b) That the ld. CIT(A)-II, Ludhiana has erred in law by accepting additional evidence, which was not filed before the Assessing Officer without confronting the same to him, thus violating the provisions of Rule 46A of the I.T. Rules. 2(a) That the ld. CIT(A)-II, Ludhiana on facts as well as in law, has erred in deleting disallowance of Rs. 20,19,490/- out of total disallowance of Rs. 24,71,119/- mad;e u/s 14A of the Income-tax Act, 1961 r.w.r. 8D of I.T. Rules. (b) That the ld. CIT(A)-II, Ludhiana has failed to appreciate that once it is held that, disallowance u/s 14A is called for, it has to be computed as per Rule 8D of the Income-tax Rules and not in any other manne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... opportunity to the AO. 7. Before us, the ld. Counsel for the assessee submitted that a sum of 20 Lakhs was given to M/s Devbhumi Spinning & Weaving Mills on account of advances for arranging suitable property to be purchased by them. Therefore, the same was for a business purpose. However, the property could not be purchased and advance was returned in Fy 2010-11 by the said party. In this regard he referred to the copies of account of the party filed at page 19 to 22 of paper book. He also submitted that this party was not related to the assessee and therefore, interest could not have been disallowed at all. As far as disallowance on account of M/s Balwindra Tools Pvt Ltd is concerned, he agreed that since the first appellate authority has not given an opportunity to the Assessing Officer, the matter may be set aside. 8. On the other hand, the ld. D.R. for the Revenue submitted that no evidence was filed for justification of advance to M/s Devbhumi Spinning & Weaving Mills before the Assessing Officer or the ld. CIT(A) and therefore, the ld. Counsel for the assessee now cannot argue that the same was for the purpose of business and accordingly disallowance was justified. In resp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xempt in the hands of the assessee. Therefore, the expenditure in relation to theseinvestment was required to be added back to the income of the assessee as per Sec 14A of the Act. In response to the show cause notice, it was submitted vide letter dated 10.12.2010 as under: "That the assessee-company is a partner in M/s Chadha Motors, Transport Nagar, Ludhiana and introduced capital in M/s Chadha Motors at the time of start of the business of M/s Chadha Motors and also introduced sum capital during the year under consideration as this capital was required by the Chadha Motors for doing the business. The assessee-company receiving the profit from the above said firm which is exempt under the Income-tax Act, 1961. This profit is exempt because of the fact the M/s Chadha Motors paid the tax on this profit. So in order to avoid the double taxation the profit received by the company is exempt from tax under the provision of Income-tax Act, 1961. The section 14A can only contemplates the expenditure actually incurred for earning tax free income and not assumed expenditure or deemed expenditure as held by Hon'ble Bombay High Court in the case of CIT V. Wallfort Share and Stock Broker ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rongly observed that investment of Rs. 2,09,74,356/- is made to earn exempt income and the same was done for the business purpose with an emphasis to expand the business by floating the sister concern, M/s Chadha Motors has shown income from year to year and paying tax at the higher rate applicable, therefore, it cannot be said that investment made in the firm as working capital was to earn exempt income. The share of profit, resultant off-shoot of the partner, remaining in the firm after paying the income-tax which ultimately become the part of capital of a partner in the partnership firm. It was stressed that Sec 14A is applicable only when the investment is made to earn exempt income and the assessee had not earned any exempt income in the year. Therefore, provisions of Section 14A were not applicable. It was also contended that significant part of the investment was made out of the paid up capital available with the appellant company and therefore, that part of the capital cannot be considered for calculating disallowance u/s 14A. In this regard reliance was placed on the decision of Hon'ble Punjab & Haryana High Court in case of CIT V. Winsom Textile, 319 ITR 204. The cal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... icer has extracted the Memorandum explaining the provisions and Circular No. 14 issued by the CBDT wherein it has been observed that expenses relating to the exempt income cannot be allowed because the same is against the basic principle of taxation because only net income that is gross income minus expenditure only can be taxed. It was further stated in this Memorandum that "same analogy exemption is also in respect of net income". The expenditure against income can be allowed only to the extent they are relatable to the taxable income. Since investment in partnership firm is clearly taxable, expenditure so incurred against the same cannot be disallowed. 15 He also submitted that in any case the assessee has made investment out of share capital and reserves available with the assessee and not out of borrowed funds and therefore, the provisions of Section 14A were not applicable. For this he relied on the decision of Hon'ble Punjab & Haryana High Court in case of Hero Cycles (Supra) and CIT V. Winsome Textile Inds Ltd, (supra). He also referred to the calculation of surplus funds which was given before the ld. CIT(A). However, on a specific query by the Bench it was admitted t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ferently, the concept of partnership firm, being a compendium of its partners is subject to the modifying such concept of partnership law which means that if there exist no provision in the tax laws for a particular situation, then, the provisions of partnership law would be the guiding factor for adjudication of that issue. The current judicial thought is leaning towards the concept of separate legal entity of partnership firm than that of its partners for the purposes of IT Act, 1961. "here was a judicial opinion that on distribution or division or allotment of assets to partners by the on dissolution or otherwise there resulted no gain exigible to tax, however, by incorporating s. -45(2), 45(3) and 45(4), the legislature has declared its intention in clear terms that partners and the firm are two independent entities not only for the purposes of assessment but also for the purpose of determining the charge of income-tax on the transactions entered into between them. Similarly, from asst. yr. 1993-94 partnership firms have been given a corporate personality in a limited sense by making necessary amendments in the provisions of ss. 10(2A), 28(v), 40(b) and relevant procedural sect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ade in a firm is to be treated as investment for earning exempt income. 18 Coming to the second aspect of the issue that whether in any nexus is required between the investment and the disallowance to be made u/s 14A, we shall first refer to the decision relied on by the ld. counsel of the assessee in case of CIT V. Winsom Textile, 319 ITR 204. In that case following question of law was considered: "Whether, in the facts and circumstances of the case and in law, the Hon'ble Income-tax Appellate Tribunal was justified in holding that the order of the jurisdictional High Court in the case of CIT V. Abhishek Industries Ltd. reported in (2006) 286 ITR 1 (PH); 156 Taxman 257 (PH) are not applicable in this case and the disallowance made by the Assessing Officer u/s 14A of the Income-tax Act is not as per law." The assessee was engaged in the manufacturing and sale of cotton yarn and had made certain investments. The Assessing Officer disallowed interest on investment in shares u/s 14A because dividend income was exempt. The ld. CIT(A) deleted the disallowance by observing that the assessee had made investment using its own funds and no interest was incurred. The Tribunal confir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nterest and the investment in the share and funds were out of the dividend proceeds. In view of this finding of fact, disallowance u/s 14A was no sustainable. Whether, in a given situation, any expenditure was incurred which was to be disallowed, is a question of fact. The contention of the Revenue that directly or indirectly some expenditure is always incurred which must be disallowed under section 14A and the impact of expenditure so incurred cannot be allowed to be set off against the business income which may nullify the mandate of section 14A, cannot be accepted. Disallowance under section 14A requires finding of incurring of expenditure where it is found that for earning exempted income no expenditure has been incurred, disallowance under section 14A cannot stand. In the present case, finding on this aspect, against the Revenue, is not shown to be perverse. Consequently, disallowance is not permissible. We have taken this view earlier ^so in I. T. A. No. 504 of 2008 in CIT v. Winsome Textile Industries Ltd. 1)09] 319 ITR 204 (P&H), (decided on August 25, 2009), wherein it was observed as under (page 207) : "The contention raised on behalf of the Revenue is that even if th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l Development Cooperative Ltd. has made observations which we will also like to discuss little later. 23 Hon'ble Bombay High Court considered the issues arising out of Section 14A as well as implications of Rule 8D. Hon'ble High Court reached the following conclusion at para 88 which reads as under: "88 Our conclusion in t his judgment are as follows : (i) Dividend income and income from mutual funds falling within the ambit of section 10(33) of the Income-tax Act, 1961, as was applicable for the assessment year 2002-03 is not includible in computing the total income of the assessee. Consequently, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to such income which does not form part of the total income under the Act, by virtue of the provisions of section 14A(1) ; (ii) The payment by a domestic company under section 115O(1) of additional income-tax on profits declared, distributed or paid is a charge on a component of the profits of the company. The company is chargeable to tax on its profits as a distinct taxable entity and it pays tax in discharge of its own liability and not on behalf of or as an agent for its shareholder ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... only from Assessment year 2008-09. In this decision the theory of apportionment of expenditure which was confirmed by the Hon'ble Supreme Court in case of CIT V. Walfort Share and Stock Brokers P Ltd (2010) 326 ITR 1 (S.C), was followed. In fact before introduction of Section 14A, the assessee had a right to claim all the expenses if such expenses could not be bi-furcated against normal taxable income as well as exempted income in view of the decision of Hon'ble Supreme Court in case of Rajasthan Warehousing Cooperation V CIT, 242 ITR 450. This position got changed after the introduction of Section 14A by Finance Act, 2001. The Memorandum explaining the provisions of Finance Bill reads as under: "Certain income are not includible while computating the total income as these are exempt under various provisions of the Act. There have been cases where deductions have been claimed in respect of such exempt income. This in effect means that the tax incentive given by way of exemptions to certain categories of income is being used to reduce also the tax payable on the non-exempt income by debiting the expenses incurred to earn the exempt income against taxable income. This is a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expenditure between taxable income and exempted income. 25 As observed earlier, almost similar observations have been made by the Hon'ble Punjab & Haryana High Court in a recent judgment in case of CIT V. Punjab State Industrial Development Cooperation Ltd. in ITA No. 565 of 2006 vide order dated 18.7.2011. "11. Adverting to question No.(ii), learned counsel for the revenue submitted that while determining the quantum of deduction admissible to the assessee under Section 80M of the Act, the expenditure incurred relating to the earning of dividend income has to be excluded there-from. According to the learned counsel, the expenditure which was to be deducted was required to be deducted on proportional basis for incurring of such expenditure. Reliance was placed on Section 14A of the Act which was incorporated by Finance Act 2001 retrospectively .w.e.f. 1.4,1962. Support was gathered from the decision of the Rajasthan High Court in Shekhavati General Traders Ltd. vs. Commissioner of Income Tax (1987) 167 ITR116 and the judgment of this Court in Income Tax Appeal No. 530 of 2006 (The Punjab State Cooperative Milk Producer's Federation Ltd, vs. Commissioner of Income Tax-if ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eing claimed against taxable income. The mandate of Section 14A is clear. It desires to curb the practice to claim deduction of expenses incurred in relation to exempt income against taxable income and at the same time avail the tax incentive by way of exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income. The basic reason for insertion of Section 14A is that certain Incomes are not includibie while computing total income as these are exempt under certain provisions of the Act. In the past, there have bean in which deduction has been sought In respect of such incomes which in effect would mean that tax incentives to certain incomes was being used to reduce the tax payable on the non-exempt Income by debiting the expenses, incurred to earn the exempt income, against taxable income. The basic principle of taxation is to tax the net income, i.e., gross income minus the expenditure. Oh the same analogy the exemption is also in respect of net income. Expenses allowed can only be in respect of earning of taxable income. This is the purport of Section 14A. In Section 14A, the first phrase is "for the purposes of computing the total i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Tax Appeal Nos. 565, 567 and 569 stand disposed of accordingly." 26 Thus theory of apportionment as approved by the Hon'ble Supreme Court in case of CIT V. Walfort Share and Stock Brokers P Ltd (2010) 326 ITR 1 (S.C) followed by Hon'ble Bombay High Court in case of Godrej and Boycee (supra) has also been approved by Hon'ble Punjab & Haryana High Court in case of CIT V. Punjab State Industrial Development Coop Ltd. (supra). 27 Now the question is how such expenditure can be apportioned. There may be a situation whether the expenses or interest cannot be identified against the particular item of income to meet these difficulties rule 8D was introduced which has been held to be constitutionally valid by Hon'ble Bombay High Court in case of Godrej and Boycee (supra). Rule 8D reads as under: "Rule 8D reads as under: "(1) Where the Assessing Officer having regard to the account of the assessee of a previous year, is not satisfied with - (a) the correctness of the claim of expenditure made by the assessee; or (b) the claim made by the assessee that no expenditure has been incurred in relation to income which does not form part of the total inco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 82 Amount invested in excess of loan 198.51 Amount invested in Chadha Motors 255.96 Consequently by simply saying that the funds invested in fixed assets and current assets are more than the borrowed funds, would not show that specific funds have been borrowed for specific purpose. For example it can be very easily said that the assessee supported its business with own funds and borrowed loans have been used for making investment in assets as well as in investments which generate exempted income. Once the funds are mixed, there is no way to find out actual usage of the funds. To meet this situation only Rule 8D was inserted to remove the difficulties. In fact this aspect was also examined by Hon'ble Bombay High Court in case of Godrej & Boycee (supra). Many observations were made under the head "parameters of judicial review at para 62 to 72 of the order". Without unnecessarily burdening this order with these observations we will quote para 73 which deals with justification of Rule 8D: "In the affidavit in reply that has been filed on behalf of the Revenue an explanation has been provided of the rationale underlying rule 8D. In the written submissions which have been filed by ..... X X X X Extracts X X X X X X X X Extracts X X X X
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