Expenditure incurred in relation to exempt income earned only during that year to be considered u/s 14A – Hyd ITAT


Bellwether Microfinance Fund Pvt Ltd v ITO (ITA No. 1743/Hyd/2013 dated 27.06.2014)  Hyderabad ITAT 

Background:

Assessee is a non-banking financing company engaged in the business of investing in microfinance companies in India. Assessee entered into a fund management agreement with Caspian Advisors Pvt. Ltd. (‘CAPL’) on 27/05/2005 as per which the said company would render consultation services to the assessee in the matter of investment etc. as fund manager. CAPL was holding 18.7% shareholding in the assessee company. The fund manager was to be paid remuneration for the fund based services.

During the course of assessment proceedings, the AO noticed that while computing its income, assessee has disallowed expenditure of Rs. 35,65,860/- under section 14A read with Rule 8D. The assessee under clause (i) of Rule 8D(2) i.e. amount of expenditure directly relating to income which does not form part of total income had already disallowed an amount of Rs 25,20,080 towards fund management fees. However, on the basis of the agreement with fund manager, AO worked out the fees paid to the fund manager and arrived at an amount of Rs 2,47,49,044 as fees paid. The AO then reworked the disallowance  and  added Rs. 1,97,36,624/- to the income of the assessee. 

Assessee’s contentions:

  • As the assessee has not incurred any expenditure to earn exempt income disallowance u/s 14A is not warranted.
  • Fund management fees was not entirely towards exempt income.
  • The AO should have determined fund management fees relating to equity investments, which actually gave rise to exempt income. 
  • Dividend income received by the assessee cannot be considered to be exempt from tax as the companies have paid dividend distribution tax u/s 115-O. 
HELD:
  • The assessee itself is recognizing the fact that it has incurred expenditure towards earning of exempt income and has disallowed expenditure to the tune of Rs. 35,65,860/- u/s 14A read with Rule 8D(2) of the Act. Therefore, assessee’s challenge with regard to applicability of section 14A read with Rule 8D (2) cannot be sustained. 
  • The  AO while working out disallowance under rule 8D(2)(i) has taken the total investment irrespective of the fact whether they have yielded income or not during the assessment year under consideration.  
  • Rule 8D(2)(i) speaks of expenditure directly relating to income which does not form part of “total income”. The term total income has not been defined either u/s 14A or under Rule 8D. Therefore, one has to look to the definition of ‘total income’ as appearing in section 2(45) of the Act.
  • Definition of ‘total income u/s 2(45) refers to section 5 which envisages ‘scope of total income’. On a reading of section 5 of the IT Act, it would be evident that as per this section ‘total income’ is of any previous year.  Considered in aforesaid context, expression ‘total income’ referred to in rule 8D(2)(i) cannot be in abstract. It must relate to a previous year income of which is sought to be assessed. 
  • Rule 8D(2)(i) does not refer to the investment made by the assessee. On a conjoint reading of clause (i) and clause (iii) of Rule 8D(2), the difference between them is clearly discernible. Therefore, while disallowance of expenditure under clause (i) is related to income earned which does not form part of total income, clause (iii) relates to the average of the value of investment appearing in the balance sheet. 
  • On a plain reading of Rule 8D(2) as a whole the legislative intent becomes clear that the disallowance of expenditure contemplated under sub- rule(i) must relate to the income which does not form part of the total income of that year.
  • The use of the words “does not or shall not” in Rule 8D(2)(iii) connotes that income not only does not form part of total income during the year but it also shall not form part of total income at any time.
  • That being the case, AO cannot disallow expenditure relating to investment which has not yielded any exempt income during the previous year relevant to the assessment year under dispute.

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