Income Tax Disallowance Based On Presumptions Of Earning Dividend Income In Future Is Not Sustainable: Mumbai ITAT

The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has held that income tax disallowance based on presumptions of earning dividend income in the future is not sustainable.

The bench of Raj Kumar Chauhan (Judicial Member) and Padmavathy S (Accountant Member) has observed that the AO has proceeded for disallowance made on the basis of presumptions that the investment was made from borrowed funds bearing interest expenditure, which may earn dividend income in the future, and the disallowances and additions are permissible under Section 14A read with Rule 8D of the Income Tax Rules, 1962.

As per Section 14A, the expenditure incurred by a taxpayer in relation to income that is not included in the total income as per the provisions of the Act should not be considered a deduction while computing the total income of the taxpayer.

Rule 8D relates to the method of determining expenditure incurred towards exempt income. As per the present income tax laws post-amendment in June 2016, expenditure incurred in relation to earning exempt income is the aggregate of any amount of expenditure that is directly related to exempt income and an amount equal to 1 percent of the annual average of the monthly average of the opening and closing balances of the value of the investment, income from which does not or shall not form part of total income.

The appellant/assessee is in the business of real estate, architectural services, and estate agents. The appellant acquired 520000 shares, equivalent to 50.98% of the total capital of Zodiac Developers Private Ltd., thereby making it a subsidiary. It was submitted that it purchased shares of Zodiac Developers Pvt. Ltd. to acquire controlling interest therein. The investment was made with a view to carrying on the business of the subsidiary and not earning a dividend.

The appellant/assessee filed the return of income for the assessment year 2016–17 on September 10, 2016, declaring a total income of Rs 20,94,130/-. The case of the appellant was selected for limited scrutiny under Computer-Assisted Scrutiny Selection (CASS).

During the course of assessment proceedings, on a perusal of the balance sheet of the appellant, the AO observed that the appellant had a non-current investment in the equity shares, out of the total of the assets of Rs. 15,94,58,744 as of 31.3.2016 and Rs. 15,72,01,787 as of 31.03.2015. The appellant had short-term borrowing of Rs. 3,06,01,355/- as of March 31, 2016 and Rs. 3,31,20,033 as of March 31, 2015. The appellant had debited a finance cost of Rs. 43,65,629/- to the profit and loss account and other expenses of Rs. 27,82,092/-. The revenue of the appellant for FY 2015-16 consisted of the sale of services (the architect and liaison fee) and interest income.

The AO observed that the interest-bearing funds were used to make investments in equity shares. Therefore, not satisfied with the reply of the appellant, the AO calculated Rs 50,81,159 as disallowance under 14A and added back the same to the income of the appellant. The assessee appealed before the CIT (A), and the CIT (A) upheld the AO's order and dismissed the appeal filed by the assessee.

The appellant/assessee has challenged the order passed by the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC), Delhi, under Section 250 of the Income Tax Act, 1961, for the A.Y. 2016–17.

The appellant contended that it had not received any dividend, and therefore there was no question of application of Section 14A. When no exempt income was earned in the financial year 2016, the addition u/s. 14A was not permissible. The explanation inserted by the Finance Act, 2022, in Section 14A cannot be applied retrospectively. The AO has not specified any income; therefore, anticipated income cannot be called taxable income.

The tribunal noted that the amendment in Section 14A is not applicable retrospectively and further that the assessee has sufficient funds apart from the borrowed amount carrying interest for investment in shares, and as such, the disallowances under Section 14A were not warranted because no exempt income was earned in the previous year relevant for the concerned A.Y. 2016–17.

The tribunal held that the findings recorded by the CIT (A) while upholding the assessment order of the AO were found to be perverse, not legally sustainable in the eyes of law, and is set aside.

Counsel For Appellant: S. C. Tiwari

Counsel For Respondent: Mahesh Parwani

Case Title: Zodiac Ventures Ltd. Versus ITO

Case No.: ITA NO. 4754/MUM/2023(A.Y: 2016-17)

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