AO cannot reject Section 14A disallowance made by assessee without recording his satisfaction

ACIT Vs Indiabulls Real Estate Ltd. (ITAT Delhi)

AO cannot reject suo-moto disallowance made by assessee under Section 14A of the Income Tax Act, 1961 without recording his satisfaction as required under Section 14A(2) of the Income Tax Act, 1961.

FULL TEXT OF THE ITAT JUDGEMENT

The present appeals have been filed  by  the revenue  against the orders of the ld. CIT(A)-4 , New Delhi dated  18.10.2016 & 20. 10.2016.

2. Since, the issues involved in both the appeals are common, they were heard together and are being disposed off by common

3. In ITA No. 6602/Del/2016 , following grounds have been raised by the revenue:

“1.On the facts  and  circumstances of  the  case, the ld. CIT ( A) has erred in deleting the disallowance u/s 14A r. w. Rule 8D   of   the   Act,   amounting   to Rs.16,37,03,673/-.

2. On the facts and circumstances of the case, the ld. CIT (A) has erred in deleting the disallowance of  excess depreciation, amounting to 24,30,299/-.

3. On the facts and circumstances of the case, the ld. CIT (A) has erred in deleting the disallowance of additional claim of deduction on account of Employee Compensation Expenses, amounting to 66.33 crores.”

ITA No. 6602/Del/2016

Disallowance u/s 14 A:

4. The relevant facts required for the adjudication of this issue are:

5. Thus, prima facie we find that the  disallowance  made  by the revenue is much more than the  exempt  income  earned  by the From the assessment order, we find that the Assessing Officer resorted to re-computation of the disallowance on the grounds that no  rationale was  furnished by  the  assessee in deciding the amount disallowed. Further, no separate staff or work station has been maintained by the assessee towards investment activities. The Assessing Officer  further  held  that  the earning of income is not in  the nature of passive activity but in fact, it is a well  coordinated management decision regarding the deployment of funds. The Assessing Officer relied on the judgment of the ITAT Special Bench New Delhi in the case of Cheminvest Ltd. in ITA No. 87/Del/2008.

6. Before us, during the arguments, the DR relied on the assessment order and the ld. AR supported the order of the ld. CIT (A).

7. The relevant portion of  the  Assessing  Officer is  as  under: “ Para 2 : The assessee company is engaged in the   business of projects, engineering, industrial and technical consultancy, construction and development of real estate properties and  other related and ancillary The books of accounts were produced which have been examined on text check basis.

“ para 4 ……….During the assessment proceedings, the AR of  the assessee was asked to explain as to why the disallowance u/s  14 A should not be made in accordance with Rule 8 D. In response, the assessee filed its reply vide letter dated 15 .01 . 2015  wherein  it  stated that ” the assessee has already made disallowance u/ s14A amounting to Rs. 4 , 16 , 933 /- being the expenses attributable to exempt income”. However, nothing has been  furnished  by  the assessee in this regard. Hence, the claim of the  assessee  in  this  regard is not found to be acceptable and the issue is decided on the  basis of information available on record.

There is no rationale furnished by the assessee  in  deciding  the amount disallowed at Rs. 4, 16, 933 /-. Further, no separate staff or work station has been deployed /  maintained  by  the  assessee  towards the investment activities. Further, the earning of exempt income is not the  nature of  passive activity having no  input.  In  fact  in present situation making of  Investment, maintaining or  continuing of investment and time to  exit  from  investment  are  well  informed and well coordinated management decision involving not only inputs from various source but also acumen of senior management functionaries. Therefore cost is inbuilt into even so called “ passive” investment. There are incidental  expenditures  of  collection, telephone, follow up etc. Therefore expenses in relation to earning of income are embedded in indirect expenses.

Section 14 A of the I T Act, 1961 regulates the expenditure which was incurred in relation to exempt income. By virtue of this section no deduction is allowable in respect of expenditure incurred by  the assessee on account of income which does not form part of the total income under the Act. The CBDT has notified rule 8D to avoid ad- hoc disallowance to impart visibility to the expenditure  incurred  for  earning exempt income. Moreover, procedure for computation of disallowance has been provided in sub-sections (2 ) and (3 ) of  section 14 A of the I T Act. The Hon’ble ITAT, Special Bench, New Delhi in the case of  M/s Cheminvest Ltd. ITA no  87 /Del/2008 has  also held that  the disallowance u/ s 14 A is to be  made  even  if  no  exempt  income has resulted or earned by the assessee in the  year  under  consideration Therefore in view of the specific provisions for quantification of  disallowance  as  contained  in  sub- sections ( 2 )  and ( 3 ) of section 14 A, which are  procedural, the disallowance is strictly to be made in terms of the specific provisions of Rule 8D.

Attention is also invited to the language of Rule 8D( 2)( i i) wherein it has been dearly mentioned that the average value of assets shall be computed in respect of investment, income from which does not or shall not form part of the total income, as appearing in the  balance sheet of the assessee, on the first day and the  last  day  of  the  previous year.

Rule 8D(1 ) of Income Tax Rules, 1962 prescribed the applicability of  the procedure. In case, the Assessing Officer is not satisfied with the correctness of the claim of the  expenditure  made  by  the  assessee, the procedural provisions of Rule 8 D are very much applicable to compute the expenditure which are incurred in relation  to   such  income which does not form part of the total income.”

8. The DR argued relying on the following case judicial pronouncement and submitted the arguments in writing.

1. Maxopp Investment Vs CIT [2018] 91 taxmann.com 154 (SiC)/[2018] 254 Taxman 325 ( SC)/[2018] 402 ITR 640 (SC)/[2018 ] 301 CTR 489 (SC) where Hon’ble  Supreme  Court held that

(i) When the shares are held by the assessee not to  earn  exempt income but to retain controlling stake in the investee company, the dominant purpose test cannot be said  to  be  relevant for the purpose of Sec  14A  and  disallowance u/s  14A can be It is not the dominant purpose test  but  the  principle of apportionment which is  ingrained in the  provisions  of Section 14A. When the assessee itself makes disallowance of certain expenditure incurred to earn dividend income and if  the  AO does not accept such disallowance, it is  necessary for the  AO to record satisfaction before rejecting the same.

(2) Section 14 A would be applicable only to income arising from the investment portfolio and not from stock-in-trade.

2. India bulls Financial Services Vs DCIT [2016 ] 76 taxmann.com 268 (Delhi)/[2017 ] 395 ITR 242  ( Delhi)  where Hon’ ble Delhi High Court held that where Assessing Officer after carrying out elaborate analysis and following steps enacted in statute, had determined amount of expenditure incurred for earning tax exempt income, merely because  he  did  not expressly record his dissatisfaction about assessee’s calculation, his conclusion could not be rejected.

3. Jubilant Securities Ltd. Vs DCIT T20181 90 taxmann.com 126 (Delhi)/[2018] 253 Taxman 284 (Delhi)/[2018 ] 400 ITR 527 (Delhi), 2018-TIQL- 75-HC-DEL-IT where Hon’ ble Delhi High  Court held that when the CIT(A) reduced the quantum of disallowance made u/s 14A and the assessee did not file appeal against the same, raking up the same  issue  after  four  years when there is a favourable judicial decision on record, is akin to raising a dispute against a stale issue.

4. Lally Motors India (P.) Ltd. Vs PCIT (T20181 93 com 39 (Amritsar – Trib.)/[2018 ] 170 ITD 370 ( Amritsar  –  Trib.) where Hon’ ble ITAT Amritsar held that Section 14A would apply even if no dividend was earned by assessee from investments in shares.

5. Godrej & Boyce Manufacturing Company Vs DCIT [2017 ] 81 taxmann.com 111 ( SC)/[2017 ] 247Taxman361 (SC)/[2017] 394 ITR 449 (SC)/[2017 ] 295 CTR 121 (SC) where  Hon’ ble Supreme Court held that where Assessing Officer after carrying out elaborate analysis and following steps  enacted  in  statute, had  determined  amount of  expenditure incurred for earning tax exempt income, merely because he did not expressly record his dissatisfaction about assessee’s calculation, his conclusion could not be rejected.

6. Punjab Tractors Ltd Vs CIT [2017] 78 com  65 (Punjab & Haryana)/[2017 ] 246 Taxman 31 (Punjab & Haryana)/[2017] 393 ITR 223 ( Punjab & Harvana)/[2017 ] 293 CTR 50 ( Punjab & Haryana), 2017-TIQL-353- HC- P&H-IT where Hon’ ble Punjab & Haryana High Court held that AO is bound to apply provisions of Rule 8D where he is not satisfied with the correctness of the claim of assessee in respect of expenditures incurred to earn exempt income.

7. Avon Cycles Ltd Vs CIT [2015 ] 53 com 297 ( Punjab  & Haryana)/[2015] 228 Taxman 368 ( Punjab & Haryana HMAG.) where Hon’ble Punjab & Haryana High Court held  that  where funds utilized by assessee was mixed funds and, hence, interest paid on borrowed fund was also relatable to interest on investment made in tax free funds,    interest expenditure relatable to investment in tax free funds was to be  computed under provisions of Rule 8D(2)(ii).

8. Nahar Spinning Mills Ltd. Vs CIT [2017] 82 com 154 (Punjab & Haryana)/[2017] 395 ITR 12 (Punjab  &  Haryana) where Hon’ ble Punjab & Haryana High Court held  that disallowance of proportionate administrative expenditure  made for earning exempted dividend income computed on reasonable basis would be just (A.Y.2006 -07).

9. Dy. CIT v. Viraj Profiles Ltd. f20151 64 taxmann.com 52 (Mumbai – Trib.)/[2016 ] 46 ITR(T) 626 (Mumbai – Trib.)/[2016] 156 ITD 72 (Mumbai – Trib.)/[2016] 177 TTJ  466  (Mumbai  – Trib.) where Hon’ble ITAT Mumbai held that disallowance of expenditure – Addition on account of disallowance under S. 14 A read with Rule 8D being expenditure in relation to earning of exempt  income  to  book  profit  under  S.  115JB  justified. [S.115 JB]

10. Vipin Malik vs ACIT [2017] 88 com 415(Delhi  –  Trib) /[2016 ] 45 ITR(T) 589 (Delhi- trib) Where Hon’ ble ITAT Delhi held that disallowance of expenditure-Event income – No disallowance was made by the assesse- invoking the provision read with rule8D(2 )(iii) was held to be justified[R.8D] (AY 2009-10 )

9. The AR relied on the order of the ld. CIT (A).

10. Having gone through the facts on  record and  applicability  of the case laws quoted by the DR to the  case before us, we  find that the cases referred are mostly where the revenue has  gone through the books of accounts, not satisfied with the disallowance made by the Assessing Officer and the reasons of such non-satisfaction has been mentioned  in  detail  in  the orders, whereas in the instant case, the books of account have been produced before the Assessing Officer which have been examined on test check basis. ( refer Assessing Officer above) While re-computing the disallowance, the Assessing Officer has  not followed the provisions of Section 14 A(2 ) of the Income Tax Act, 1961 wherein it is mandated that, if the Assessing Officer having regard to the accounts of the assessee is  not  satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to which does not form part of the total income under the Act, then the Assessing Officer shall determine the amount of expenditure  incurred  in  relation  to such income. Further, the Act also mandates that such re- computation also applies in relation to a  case  where  the assessee claims that  no  expenditure has  been incurred by  him  in relation to the income which does not form part of the total income. From the reading of the judgment of the Hon’ ble Apex Court in the case of Maxopp Investment Ltd. Vs CIT in CA Nos. 104-109 OF 2015 , we find that having regard to the language of Section 14 A(2 ) of the Act, read with Rule 8D  of  the  Rules, it clear that before applying the theory of apportionment, the AO needs to record satisfaction that  having regard to  the  accounts of the assessee suo moto  disallowance under Section 14A  was not correct. It will be in those cases where the assessee in his return has himself apportioned but  the  AO  was  not  accepting the said apportionment, in that  eventuality,  the Assessing Officer will have to record its satisfaction to this effect.

11. In the instant case, we find that no such satisfaction has been recorded by the O to come to  the  conclusion to  invoke  the provisions of Section 14 A(2). Hence, we decline to interfere with the order of the ld. CIT  (A)  and  the  disallowance  is  directed to be deleted.

12. The similar ratio applies to ground 1 in ITA No. 6603/Del/2016 .

Depreciation:

13. The Assessing Officer allowed the claim of depreciation on software @25% against the 60 % depreciation claimed by the The ld. CIT (A) deleted the addition on the  grounds that the Assessing Officer has mislead himself treating the software as intangible asset.

14. Having gone through the record, we find that the nature of the software acquired were licenses, which do not confer any enduring right and  could be  used for the  duration as  acquired for by the The taxpayer’s objective  was  to  use computer software to maximize its performance and streamline efficiency. The Hon’ ble Bombay High Court in the case of M/ s I- Flex Solutions Ltd. reported in  225 Taxmann 37 held that there   is no reason to differentiate the  computer and  the  software as the latter is an integral part of  the  former. The  software cannot be seen in isolation delinked from  the  computers. Similar view has been taken by the Co-ordinate bench of ITAT in the case of Make My Trip (India) Pvt. Ltd. Vs  DCIT  in  ITA  No.  6055/Del/2010 and Globe Capital Market Ltd. Vs CIT in ITA No. 2926/Del/2012 . The issue of depreciation  @60%  on  the  software is now a  settled issue  beyond any  perplexity. Hence,  we decline to interfere with the order of the ld. CIT (A).

Employee Compensation Expenses:

15. For the ground relating to claim in respect of Employee  Stock  Option  Scheme  compensation  (ESOP   expenses)   of 66 .33 crores, the assessee relied on the decision  of  the Special Bench of ITAT (Bangalore), in the case  of  M/ s  Biocon  Ltd. Argues that in that order, a comprehensive over- view of the legal position regarding allowability of ESOP expenses has been made by the ITAT in the light of applicable accounting and taxation principles. The decision has since been approved by the Hon’ ble Jurisdictional High Court of Delhi in the case of  M/ s Lemon Tree Hotels Limited. Hence, it was reiterated  that  the claim of ESOP expenses is an allowable expenditure u/s 37(1 ) of the Act.

16. The DR argued that ESOP expenditure claimed by the assessee is not allowable in this year by going through the details furnished by the assessee in the paper book.

17. Heard the arguments of both the parties and perused the material available on record.

18. The Special Bench of ITAT examined the following issues:

*Whether any deduction of discount given on shares is allowable?

*If Yes when and how much?

*Subsequent adjustment to discount?

19. The Tribunal examined the issue from the perspective of capital expenditure as laid down by the Delhi  bench in the  case of Ranbaxy Laboratories Vs Addl. CIT  39  SOT 17.  It  was  held in VIP Industries Vs DCIT in  ITA No. 7242 /Mum/2008 that  the short receipt of premium on receiving option  to  the  employee will be notional loss but not actual loss for which any liability has incurred. The Chennai Bench of the Tribunal in SSI  Ltd. Vs DCIT 85 TTJ 1049 wherein granting of deduction of the discount on shares was treated as employee cost. The order has been relied upon by the order of the Hon’ ble High Court of Madras in the case of CIT Vs PVP Ventures Ltd. 211 Taxmann 554.

20. It was held the amount of discount represents the  difference between market price of the shares at the time of the grant of option and the offer In order to be eligible for acquiring the shares under the ESOP, the concerned employees  are obliged to render services to  the  company  during  the  vesting period as given in the scheme.

21. The Special Bench held that the discounted premium on shares is a substitute to giving direct incentive in cash  for availing the services of the There is no  difference in the situations,

(a) when the companies issues shares to public at market price and a part of premium is given to the employees in lieu of their services,

(b) When the shares are directly issued to employees at a reduced rate.

22. In both the situations, the employees stand compensated for their ESOP is one such mode of compensating the employees for their services. Since, it is an expenditure for the company, the same needs to be allowed u/s 37 (1) of the Act.

23. As to when and how much deduction is to be claimed, the Special Bench observed that the period from grant of option to  the vesting of option is the vesting period and it is during such period that an employee is  supposed to render the  service  to  the company so as to earn and entitlement to the shares at a discounted price. If the vesting period is, say, four years with equal vesting at  the end of  each year, then it is  at  the  end of  the vesting period or during the exercise period, which in turn immediately succeeds the vesting period, that the employee becomes entitled to  exercise 100  options or  qualify for  receipt of 100 shares at discount. Though the shares are allotted at the end of the vesting period, but it is  during such vesting period  that the entitlement is earned. It means that 25  options vest  with the employee at the end of each year on his  rendering  service for the respective year. If during the interregnum, he leaves the service, say after one year, he will  still  remain  entitled to exercise option for 25 shares at the discounted  premium at the time of exercise of option. In that  case,  the benefit which would have accrued to him at the end  of  the  second, third and fourth years would stand forfeited. Thus, it becomes abundantly clear that an employee becomes entitled to the shares at a discounted premium over the vesting period depending upon the length of service provided by him to the company. In all such schemes, it is at the end of  the  vesting period that option is  exercisable albeit the  proportionate right  to option is acquired by rendering service at the  end of  each  year.

24. The contra situation to the company is such that the obligation falls on the company to allot shares at the time of exercise of the option depending upon the length of the service rendered by the employee during the vesting    The  Special Bench held that such discount is deductible over the vesting period on straight line basis.

25. To sum up, it was held  that  the  discount  under  ESOP is in the nature of employee cost and  hence  deductible during the vesting period.

26. From the details filed in the case Indiabulls  Real  Estate Ltd., we find that two schemes have been  issued  by  the  assessee namely, IBREL ESOP 2006 and IBREL ESOP 2007. The spread of ESOP 2006 was from FY 2006-07 to 2013-14 whereas ESOP 2008 spread from FY 2008-09 to  FY  2009-10 .  The  assessee has also given the  details of  date of  vesting,  number  of shares granted, number of  shares  vested, perk  value,  taxed in the hands of employees, period of The  perk value of  the share ranged from Rs.635/- to Rs.134 /- and Rs.101 /-. The perk value of the share on the date of vesting i. e. 01.11 .2011  was Rs.6158/-. The discount given in  the  ESOP  2008  scheme was Rs.110 .50. Further, no material was placed as to what was  the value of the shares as per the market at different years of vesting ( page 143 to 154 PB). The details in the  case  of  Indiabulls Real Estate Ltd. are as per the table below:

27. The details in the case of Indiabulls Financial Services are as under:

28. Hence, while laying down the principle that the discount offered on the shares under the ESOP of scheme is allowable deduction u/s 37 (1) of the Act, we hereby remand the matter to the file of the AO for the limited  purpose  of  arithmetic calculation of apportioning the year wise discount  over  the  period of vesting  taking into consideration, the  options granted to the employees, determination of the perk  value,  FBT  levied and allow the same as per the provisions of the Income Tax Act, 1961.

29. The ratio on the issues in ITA 6602/Del/2016 would be applicable mutatis mutandis to the similar issues in ITA No. 6603/Del/2016.

30. In the result, both the appeals of the revenue are dismissed.

Order Pronounced in the  Open Court on  11 /03/2020.