Disallowance requires a direct nexus – No disallowance of expenses u/s 14A for exempt dividend income when investments were made in earlier years




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Disallowance requires a direct nexus – No disallowance of expenses u/s 14A for exempt dividend income when investments were made in earlier years

 

Ahemedabad ITAT in the case of Ambalal Sarabhai Enterprises Ltd vs ACIT [ITA No 1772/Ahd/2015; AYs 2002-03 to 2007-08; Dt. of Judgement: 3/12/2024] has held that no disallowance of expenses u/s 14A for exempt dividend income when investments were made in earlier years. ITAT held that disallowance requires a direct nexus.

Let us have a Short Overview of the case:

In this case, the appellant was engaged in manufacture of drugs and pharmaceuticals. It also offered marketing and consultancy services like fine chemicals, industrial glass containers, packing materials, and electronic instruments.

During the assessment, the AO noted that the taxpayer claimed dividend income as exempt but failed to provide details of expenses incurred to earn it. The AO stated that even minimal indirect expenses should be apportioned and disallowed.

Without direct evidence, the AO made an estimated disallowance of Rs.67.50 lakhs calculated at 10% of dividend income.

In appeal, the assessee argued that no expenses were incurred to earn exempt dividend income of Rs.6.75 crores and the investments were made using internal funds, not borrowed money, and were for business growth, not just to earn dividends.

The income was received passively, with no significant effort required. The assessee also stated that the AO didn’t prove a direct link between any expenses and the exempt income.

The CIT(A) agreed that disallowance was too high and reduced it to Rs.33.75 lakhs (5% of total dividend income). The assessee appealed before the tribunal.

The Tribunal after reviewing the case and hearing both the parties held that the assessee has challenged disallowance of Rs.33.75 lakhs under Sec 14A, which was upheld by the CIT(A).

This amount was 50% of the original disallowance of Rs.67.50 lakhs made by the AO for expenses related to earning exempt dividend income of Rs.6.75 crores.

The assessee’s arguement is that investments in SPPL were made in earlier years for business reasons, not just to earn dividends.

No new investments or additional expenses were incurred during the year.

The dividend income was passively received, with no significant effort involved. The assessee’s own funds were more than enough to cover the investment, so no disallowance of interest or other expenses was necessary. The AO disallowed Rs.67.50 lakhs based on the assumption that administrative expenses were incurred. The CIT(A) reduced it to Rs.33.75 lakhs without providing a clear reason.

The tribunal noted that the investments were made in prior years and that courts have ruled that no disallowance can be made for past investments unless new expenses were incurred in the current year. The dividend income was also passively received, requiring minimal effort. It stated that disallowance can only happen if there is clear evidence linking expenses to exempt income. Since no such evidence was provided, the tribunal deleted the disallowance.

This decision needs to read after considering the impacts of amendments made by the Finance Act 2006, w.e.f. 1-4-2007, Rule 8D, and the Finance Act 2022

 

The Copy of the order is as under:

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