AO has to record his satisfaction before proceeding to make addition u/s 14A

Brief of the Case-

Delhi High Court Held In the case of I.P. Support Services India (P) Ltd vs CIT that   AO cannot invoke Section 14A read with Rule 8D (2) without recording his satisfaction and noted that the recording of satisfaction as to why “the voluntary disallowance made by the assessee was unreasonable and unsatisfactory” is a mandatory requirement of the law. Court followed the judgment by the same court  in the case of  Maxopp Investment (P) Ltd. v. CIT & CIT v. Taikisha Engineering India Ltd.

Facts of the Case

The assessee is a company doing business of providing legal support and other support services to law firms, specifically related to search of trade mark, patent and design out of the unique data base created and owned by the assessee.

Question of Law (Not substantial question)

Whether invocation of Section 14A is automatic and comes into operation as soon as dividend income is claimed exempt and whether the AO can make additions u/s 14A without indicating cogent reasons for the same.

Contention of the Assessee

The assessee submitted that no disallowance was warranted for as no expenses was incurred for earning of dividend income.

Contention of the Revenue

The AO asked the assessee to explain why expenses relevant to earning of dividend should not be disallowed u/s 14A of the Act. The AO with the understanding that invocation of Section 14A is automatic and comes into operation, without any exception, as soon as the dividend income is claimed as an exemption, made disallowance to the above extent u/s 14A read with Rule 8D.

Appeals to CIT (A) and ITAT

The CIT(A) allowed the appeal of the assessee after recording a finding that the AO had failed to examine the contention of the assessee that it had sufficient funds and no interest expenditure was incurred and also the investments generating tax exempt income were done by using the administrative machinery of PMS, who did not charge any fees. The CIT (A) also found that the AO has contravened the decision of Delhi High Court in Maxopp Investment (P) Ltd. v. CIT (2012) 347 ITR 272  by not recording the satisfaction or otherwise in course of assessment, which is a pre requisite for invoking Section 14A of the Act.

The ITAT dismissed the Revenue’s appeal and also additionally noted that CIT(A) has followed the order of ITAT for AY 2007-08.

Held by the High Court of New Delhi

The Court found that the AO has indeed proceeded on the erroneous premise that the invocation of Section 14A is automatic and comes into operation as soon as the dividend income is claimed exempt.

The Court also cited its own judgement in the case of Maxopp Investment (P) Ltd (supra) , the crux of it is as under

“The AO can proceed to make addition u/s 14A only if he returns a finding that he is not satisfied (emphasis supplied) with the correctness of the claim of the assessee in respect of such expenditure or correctness in the case of claiming that no expenditure is incurred.”

The Court also referred to a similar judgement of the same court in the case of CIT v. Taikisha Engineering India Ltd. 370 ITR 338 (Del.), and noted that the recording of satisfaction as to why “the voluntary disallowance made by the assessee was unreasonable and unsatisfactory”is a mandatory requirement of the law.

The Court dismissed the appeals of the revenue stating that no substantial question of law arises.