Dividend Income Taxability Defeats Section 14A Disallowance, Holds ITAT

The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) on 30 March held that disallowance under Section 14A of the Income-tax Act, 1961 cannot be made where the income in question is itself taxable and does not qualify as exempt income. A Bench comprising Judicial Member Raj Kumar Chauhan and Accountant Member Brajesh Kumar Singh deleted a disallowance of Rs. 6.28 lakh made against Ahluwalia Contracts India Ltd. under Section 14A read with Rule 8D for the AY 2023-24. The Tribunal observed that the very foundation for invoking Section 14A was absent in the present case.

The Assessing Officer (AO) had noticed that the assessee was holding non-current investments of Rs. 6.28 crore as on 31.03.2021 but had not made any disallowance under Section 14A in its return of income. The AO issued a show-cause notice proposing disallowance under Section 14A read with Rule 8D of the Income Tax Rules, 1962. After considering the assessee’s reply, the AO disallowed Rs. 6,28,000/-. The Commissioner of Income Tax (Appeals) upheld the addition by relying on the amendment introduced by the Finance Act, 2022.

Before the ITAT, Ahluwalia Contracts India Ltd. submitted that the investments were made much earlier out of its own surplus funds and that no exempt income had arisen during the relevant year. It further contended that after the amendment to Section 10(34) by the Finance Act, 2020, dividend income had become taxable in the hands of shareholders from AY 2021-22 onwards. Therefore, even if dividend income had been earned, it would not have constituted exempt income so as to attract Section 14A. The Bench pointed out that :

“The fundamental condition for invoking Section 14A is that the expenditure sought to be disallowed must be incurred in relation to income which does not form part of the total income under the Act.”

The Tribunal observed that although the Finance Act, 2022 clarified that Section 14A could apply even where no exempt income is earned during the year, the provision would still require the existence of income which is exempt from tax under the Act. It held that dividend income is now taxable in the hands of shareholders and therefore the basic requirement for invoking Section 14A no longer survived in the assessee’s case. The Bench pointed out that:

“The very foundation for invoking Section 14A is absent in the present case.”

The Bench held that the disallowance sustained by the CIT(A) was unsustainable in law and directed deletion of the addition of Rs. 6.28 lakh made under Section 14A read with Rule 8D. Accordingly, the appeal of the assessee was allowed.

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