Disallowance under Section 14A of the Income Tax Act is not allowed in the absence of exempt income

Facts and Issues of the Case

The assessee has raised 13 grounds pertaining to TP adjustment and grounds 14 to 16 are with regard to disallowance u/s. 14A of theAct. Ground No.17 is general. The assessee has also raised additional grounds (No.18 & 19) with regard to the modified assessment order passed by the JCIT, Circle 7(1)(1) (jurisdictional AO), Bangalore modifying the final assessment order passed by NFAC. The additional grounds No.20 to 22 relate to the TP adjustment.

During the course of hearing, the ld. AR submitted that the final assessment passed by the NFAC is not in accordance with the directions of DRP and that the modification order passed by the jurisdictional is not tenable. The ld AR prayed for the admission of additional grounds raised in this regard and submitted that if this issue is adjudicated, then the rest of grounds raised by the assessee with regard to the TP adjustment may be left open.

The additional grounds raised are pure legal issue, which does not require investigation of new facts. Hence, placing reliance on the judgment of the Hon’ble Apex Court in the case of National Thermal Power Co. Ltd. v. CIT (1998) 229 ITR 383 (SC), we admit the additional grounds.

The assessee is engaged in the business of trading in automobile components, operating turnkey projects and logistics, primarily catering to automotive industry. The assessee is a wholly owned subsidiary of Toyota Tsusho Corporation, Japan (AE). The assessee filed return of income for the AY 2017-18 on 28.11.2017 declaring NIL income. The case was selected for scrutiny and notice u/s. 143(2) of the Act was duly served on the assessee. Since the assessee had entered into international transactions with its AE, a reference was made to the TPO to determine the ALP of the transaction. The TPO passed an order proposing TP adjustment of Rs.43,03,79,111. Consequently the AO passed the draft assessment order dated 13.4.2021 incorporating the TP adjustment and also made disallowance u/s. 14A of the Act for an amount of Rs.1,03,81,258 and disallowance towards R&D expenditure of Rs.36,000.

Aggrieved the assessee filed the objections before the DRP. The DRP by order dated 18.1.2022 issued directions to the TPO to reconsider the inclusion of certain comparables and also excluded some of the comparables included by the TPO. In the final assessment order dated 11.2.2022, the AO retained the TP adjustment at Rs.43,03,79,111 as in the draft assessment order by stating that the DRP has confirmed the addition made by the TPO. The assessee is in appeal before the Tribunal against the final order of the AO which according to the assessee is not in accordance with the directions of the DRP.

It is submitted by the ld AR that had the directions of the DRP, been considered the AO/TPO, then the amount of TP adjustment would have undergone change and the revised TP adjustment should have been included in the final assessment order. The ld AR submitted that the TP adjustment is retained in the final assessment order at the same figure as in the draft assessment order and therefore the final assessment order is not in accordance with the directions of the DRP and thus liable to be quashed. The ld. AR further submitted that the AO has wrongly mentioned in para 4.2 of the final assessment order that the DRP had confirmed the addition made by the TPO. In this regard, the ld. AR relied on the decision of the High Court in the case of ESPN Star Sports, Mauritius v. UOI & ANR.

In this regard the ld. AR contended that the final assessment order is already passed by NFAC, Delhi on 11.2.2022 and there is no provision under the Act under which it can be modified by the jurisdiction AO who has become functus officio. Therefore it is submitted that the OGE to the DRP directions dated 28.2.2022 passed by the jurisdictional AO revising the TP adjustment is infructuous. The ld. DR relied on the orders of the lower authorities.

Observation by the Court

The court have considered the rival submissions and perused the material on record. The court notice that the DRP as ex extracted above has given clear directions to the TPO to re-examine the inclusion of M/s. Archroma India Pvt Ltd and M/s. Tarak Chemicals Limited and has also directed for the exclusion of M/s. Sirea India Private Ltd. This would mean that the TP adjustment should be recomputed and thus should undergo change. This is supported by the fact that the jurisdictional AO in the OGE to the directions of the DRP dated 28.2.2022 has revised the TP adjustment to Rs.31,38,49,565. However, in the final assessment order passed by NFAC on 11.02.2011 which is passed prior to TPO’s order dated 15.2.2022 revising the TP adjustment, the AO has retained the same TP adjustment amount as in the draft assessment order by observing that the DRP has confirmed the addition made by the TPO. From these facts, it becomes clear that the final assessment order passed by the NFAC to the extent of TP adjustment is not in accordance with the directions of the DRP and to this extent, the TP adjustment is quashed.

The court see merit in the contention that the jurisdictional AO has become functus officio once the final assessment order is passed and that there is no authority for him to pass any order modifying the final assessment order. The court therefore hold that the order dated 28.02.2022 passed by the jurisdictional AO giving effect to the revised TP adjustment is not sustainable in law and is infructuous. This ground of the assessee is allowed.

Since the issue of TP adjustment is quashed on the basis that the final assessment order is not in accordance with the directions of the DRP,the court are not adjudicating the rest of the grounds raised with regard to TP adjustment leaving them open.

Disallowance u/s. 14A

During the course of proceedings, the AO noticed that the assessee has made an investment in unlisted equity for an amount of Rs.271,35,77,670 and the assessee has claimed interest expenditure of Rs.13,06,47,963. The AO therefore invoked the provisions of section 14A and made a disallowance of an amount of Rs.1,03,81,268. The DRP upheld the disallowance made by the AO.

Before us, the ld. AR submitted that the assessee does not have any exempt income and therefore the provisions of section 14A of the Act cannot be invoked. He further submitted that that the provisions of Section 14A of the Act provide for disallowance of expenses incurred in connection with the earning of exempt income and it is clear that the precondition for disallowance under section 14A is that the assessee should have earned exempt income during the year which is not included in the total income of the assessee. Further, such disallowance cannot exceed the exempt income earned by the taxpayer. Hence, in the absence of receipt of exempt income during the year, section 14A cannot be invoked.

The ld AR further submitted that the assessee had also made submissions before the lower authorities that the company had not earned any exempt income and thus disallowance under section 14A of the Act was unwarranted by pointing out that disallowance under section 14A of the Act is not attracted since the assessee has not earned any exempt income and that the assessee has not incurred any specific expenditure in undertaking the investments and therefore no disallowance under section 14A of the Act;

The ld AR further submitted that the investments made by the Assessee in the shares of the unlisted company are out of its own funds and hence no disallowance under section 14A of the Act is called for. The ld. AR relied on the recent ruling of the Hon’ble Delhi High Court in the case of PCIT vs Era Infrastructure (India) Ltd 141 taxmann.com 289 (2022) and submitted that the ruling of Hon’ble Delhi High Court is squarely applicable to the assessee’s case and accordingly the disallowance made under section 14A of the Act is liable to be deleted.The ld. DR supported the orders of lower authorities.

The court had heard the rival submissions and perused the material on record. The assessee is contending the disallowance made u/s.14A on the following grounds:

(i) The assessee has not earned any exempt income

(ii) The investments are out of own funds

(iii) The assessee has not incurred any specific expenditure towards investments

The court notice that the AO has made the disallowance on the basis that the investment could potentially earn income which substantiates the contention of the assessee that in the year under consideration the assessee has not earned any exempt income. The Hon’ble Delhi High Court in the case of Era Infrastructure (India) Ltd (supra) has considered the issue of disallowance u/s.14A when there is no exempt income and held that no disallowance under section 14A of the Act could be made if no exempt income was earned by the assessee.

The Hon’ble Delhi Court in the above has also considered the amendment to section 14A and has held that the explanation inserted to section 14A vide Finance Act 2022 is prospective in nature.

Considering the fact that the assessee has not earned any exempt income during the year under consideration and respectfully following the decision of the Hon’ble Delhi High Court in the case of Era Infrastructure India Ltd. (supra) the court hold that no disallowance is warranted u/s.14A and delete the disallowance made in this regard.