DCIT, Circle-11(1), New Delhi vs. Hero Solar Energy Pvt. Ltd.: Disallowance Under Section 14A for AY 2016-17

Case Overview

The case titled DCIT, Circle-11(1), New Delhi vs. Hero Solar Energy Pvt. Ltd. (ITA 6361/DEL/2019) concerns the assessment year 2016-17. The appeal was filed by the Deputy Commissioner of Income Tax (DCIT) on 29th July 2019, challenging the order passed by the Commissioner of Income Tax (Appeals)-4 [CIT(A)], New Delhi, on 2nd May 2019. The final tribunal order was pronounced on 23rd January 2023 by the Income Tax Appellate Tribunal (ITAT) Delhi Bench “B.”

Background of the Case

The respondent, Hero Solar Energy Pvt. Ltd., is engaged in the business of generating solar energy through its subsidiaries, which are Special Purpose Vehicles (SPVs) specifically incorporated for this purpose. The company filed its return of income for the assessment year 2016-17 on 13th October 2016, declaring an income of Rs. 3,09,76,320/-. The case was selected for scrutiny through the Computer Aided Scrutiny Selection (CASS) system.

During the assessment proceedings, the Assessing Officer (AO) observed that the assessee had made investments amounting to Rs. 12,00,00,000/- in M/s. Clear Solar Power Pvt. Ltd. and earned an exempt income of Rs. 5,84,093/-. The assessee claimed that the direct cost attributable to earning the exempt income, incurred by way of interest, had already been disallowed under Section 14A of the Income Tax Act, 1961.

Why the Case Was Filed

The DCIT filed the appeal challenging the CIT(A)’s order, which significantly reduced the disallowance made under Section 14A by the AO. The Revenue contended that the CIT(A)’s decision to restrict the disallowance to Rs. 3,37,628/- was not in line with the legislative intent behind Section 14A and the guidelines provided by the Central Board of Direct Taxes (CBDT) Circular No. 5/2014. The primary issue was whether the disallowance under Section 14A should be confined to the amount of exempt income or whether it should also account for the expenditure related to investments that might yield exempt income in the future.

Tribunal Proceedings

The appeal was heard by a bench comprising Shri Shamim Yahya, Accountant Member, and Ms. Astha Chandra, Judicial Member. The Revenue raised four grounds of appeal, all challenging the CIT(A)’s decision to reduce the disallowance made under Section 14A of the Income Tax Act.

Disallowance Under Section 14A

The AO initially computed a disallowance of Rs. 1,78,96,862/- under Section 14A read with Rule 8D, which included the following components:

• Direct expenditure relating to the exempt income: Rs. 2,46,465/-
• Indirect interest expenditure not directly attributable to any specific income: Rs. 1,53,16,362/-
• 0.5% of the average value of investments: Rs. 25,80,500/-

The total disallowance calculated by the AO was Rs. 1,81,43,327/-, out of which Rs. 2,46,465/- had already been disallowed by the assessee, resulting in a net disallowance of Rs. 1,78,96,862/-.

However, the assessee contended that the disallowance should not exceed the amount of exempt income earned, relying on the Delhi High Court’s decision in the case of Joint Investment Pvt. Ltd. vs. CIT. The CIT(A) accepted this argument and restricted the disallowance to Rs. 3,37,628/-, providing relief of Rs. 1,75,59,234/- to the assessee.

Revenue’s Grounds of Appeal

The Revenue’s primary contention was that the CIT(A) had not appropriately considered the legislative intent behind Section 14A, which is to disallow expenditure incurred in relation to income that does not form part of the total income. The Revenue argued that the CIT(A) failed to uphold the disallowance in line with CBDT Circular No. 5/2014, which clarifies that the disallowance under Section 14A applies even if no exempt income is earned during the year.

Assessee’s Defense

The assessee’s defense was based on the argument that the disallowance should be limited to the exempt income earned, citing the Delhi High Court’s ruling in the Joint Investment Pvt. Ltd. case. The assessee also relied on recent decisions by the ITAT Delhi Bench and the Delhi High Court, which held that the explanation to Section 14A, inserted by the Finance Act, 2022, is not retrospective and does not apply to assessment years prior to its enactment.

Tribunal’s Final Decision

After considering the submissions and reviewing the relevant case law, the tribunal upheld the CIT(A)’s decision. The tribunal noted that the explanation to Section 14A, introduced by the Finance Act, 2022, is not retrospective and, therefore, does not apply to the assessment year 2016-17. The tribunal also cited its own decisions in similar cases involving Hero Future Energies Pvt. Ltd. and Hero Wind Energy Pvt. Ltd., where it had ruled in favor of the assessee on similar grounds.

The tribunal concluded that the CIT(A) was correct in restricting the disallowance under Section 14A to the amount of exempt income earned by the assessee, in accordance with the precedent set by the Delhi High Court in the Joint Investment Pvt. Ltd. case. As a result, the tribunal dismissed the Revenue’s appeal.

Significance of the Case

This case is significant as it addresses the application of Section 14A of the Income Tax Act, particularly in cases where the assessee has not earned significant exempt income. The tribunal’s decision reinforces the principle that disallowance under Section 14A should not exceed the exempt income earned, aligning with judicial precedents set by higher courts.

The ruling also highlights the importance of adhering to judicial precedents and the limited retrospective application of amendments to the Income Tax Act. By upholding the CIT(A)’s decision, the tribunal has provided clarity on the interpretation of Section 14A in the context of investments that may generate exempt income.

Conclusion

The case of DCIT, Circle-11(1), New Delhi vs. Hero Solar Energy Pvt. Ltd. (ITA 6361/DEL/2019) underscores the complexities involved in applying Section 14A of the Income Tax Act, especially when dealing with investments that yield exempt income. The tribunal’s decision to dismiss the Revenue’s appeal and uphold the CIT(A)’s order reflects a commitment to ensuring fairness and consistency in tax assessments.

This ruling may serve as a reference point for future cases involving similar issues, providing guidance on how disallowances under Section 14A should be calculated and applied. It also emphasizes the importance of judicial precedent in shaping the interpretation and application of tax laws in India.

DCIT, Circle-11(1), New Delhi vs. Hero Solar Energy Pvt. Ltd.: Disallowance Under Section 14A for AY 2016-17