33. Business expenditure – Exempt income- Disallowance u/s. 14A- A. Y. 2011-12 – If no exempt income is earned in the assessment year in question, there can be no disallowance of expenditure in terms of section 14A read with Rule 8D even if tax auditor has indicated in his tax audit report that there ought to be such a disallowance

Principal CIT vs. IL & FS Energy Development Company
Ltd.; [2017] 84 taxmann.com 186 (Delhi)

Assessee is a company engaged in provision of consultancy
services. On 26^th September 2011, the Assessee filed its return at a
loss of Rs. 2,42,63,176/- for the A. Y. 2011-12. The Assessee had not earned
any exempt income in the relevant year. The assessee had not made any
disallowance u/s. 14A of the Act, 1961. The Assessing Officer computed the
disallowable amount u/r. 8D and made disallowance. The Tribunal held that since
the assessee had not earned any exempt income in the relevant year there can be
no disallowance u/s. 14A of the Act and allowed the assessee’s claim.

On appeal by the Revenue, the Delhi High Court upheld the
decision of the Tribunal and held as under:

“i)  The key question in the present case is
whether the disallowance of the expenditure will be made even where the
investment has not resulted in any exempt income during the AY in question but
where potential exists for exempt income being earned in later AYs.

ii)  Section 14A does not particularly clarify
whether the disallowance of the expenditure would apply even where no exempt
income is earned in the AY in question from investments made, not in that AY,
but earlier AYs.

iii)  The words “in relation to income which
does not form part of the total income under the Act for such previous year”
in the above Rule 8D(1) indicates a correlation between the exempt income
earned in the AY and the expenditure incurred to earn it. In other words, the
expenditure as claimed by the Assessee has to be in relation to the income
earned in ‘such previous year‘.

iv) This
implies that if there is no exempt income earned in the AY in question, the
question of disallowance of the expenditure incurred to earn exempt income in
terms of section 14A read with Rule 8D would not arise.

v)  The mere fact that in the audit report for the
AY in question, the auditors may have suggested that there should be a
disallowance cannot be determinative of the legal position. That would not
preclude the assessee from taking a stand that no disallowance u/s. 14A of the
Act was called for in the AY in question because no exempt income was earned.”