Only Investments in respect of which income is exempt to be considered in working of disallowance U/s. 14A

Brief of the case :

• The ITAT bench of Panaji in the case of Sesa Resources Limited held that the disallowance under Sec 14A read with rule 8D can be made only in respect of investments which are earning income exempt from tax and not the total investments.
• Thus, in the present case AO made a factual error by taking the figure of total investments while working out disallowance as per formula prescribed in Rule 8D.
  

Facts of the case:

• The assessee had taken loans and also made some investments during the previous year. It filed its return of income reporting disallowance of Rs. 2,05,410/- u/s 14A read with Rule 8D.AO recomputed the disallowance and made disallowance u/s 14A of Rs. 2.41 crores in respect of interest and an additional 0.5% of the investments amounting to Rs. 89 lacs.
• The CIT(A) confirmed an addition of 86 lacs u/s 14A , aggrieved assessee is in appeal against CIT(A)’s order.

Contention of Assessee:

• The learned counsel for the assessee relied on the decision of co-ordinate bench of ITAT Kolkata in the case of REI Agro Limited and contended that the AO made a factual error in working out disallowance u/s 14A as per formula prescribed in Rule 8D. AO erred in taking all investments instead of taking only investments which are earning incomes not forming part of total income.

Issue before ITAT :

• Whether CIT(A) erred in upholding the disallowance u/s 14A considering all investments while working out disallowance as per Rule 8D?
  

Held by ITAT :

• As per the provisions of Sec 14A any expenditure incurred in relation to earning an income which is exempt from tax is to be disallowed. Further, the interest expenses which are not directly attributable to earning any income are required to be proportionately disallowed by applying formula as prescribed in Rule 8D.
• The formula prescribed require value of average investments from which exempt income is earned to be put in numerator. However, AO has considered the total investments including those which are not earning any exempt income.
• Thus, it is not the total investment rather average investment which have earned income exempt from tax(i.e. not forming part of total income) to be considered while working out disallowance as per formula prescribed under Rule 8D.
• Tribunal also placed reliance on the decision of co-ordinate bench of ITAT Kolkata in the case of REI Agro Ltd. , who gave the similar reasoning on identical facts. Accordingly, the matter was remitted back to file of AO to work out disallowance by correcting the factual error committed.

Issue – 2 Disallowance of commission paid to foreign agents u/s 40(a)(ia)-

• Assessee paid commission to foreign agents without deducting any tax at source. AO disallowed the same applying the provisions of Sec 195(1) read with Sec 40(a)(ia) and as per the AO the same was even otherwise not allowable as it was not incurred for the purpose of assessee’s business. However, the said disallowance was deleted by CIT(A).
• In appeal before tribunal , it observed that the provisions of Sec 195 have been amended retrospectively by Finance Act,2012 by way of insertion of Explanation II which provides that liability to deduct and pay such deducted tax at source would be of any person liable to pay sums chargeable to tax in India irrespective of the residential status of the person making payment and would extend even to cover up the cases when the person not having a residence or place of business in India or any other presence in India.
• It is therefore, the assessee was liable to deduct tax at source in view of the aforesaid explanation II to Sec 195 and failure of the assessee to do so , AO was right in disallowing the said sum u/s 40(a)(ia).
• In result the appeal of revenue was allowed on this ground.