Case summary, Income Tax

ITAT Chennai decides: Can expenses related to dividend earned from strategic investments be disallowed? + 2 more issues

Case Name: Lakshmi Machine Works v. Addl. CIT

Forum: Chennai ITAT

Members: Ramit Kochhar, N.R.S. Ganesan

About Lakshmi Machine Works: The assessee is engaged in the business of manufacturing of textile machinery and had made investments in various corporate entities amounting to INR 154 Crores as at 31 Mar 2012.

Issue 1 

Under the provisions of Section 14A along with Rule 8D(2)(iii), the AO made a disallowance of 0.5% of average investments held by the assessee during the year under consideration, which led to disallowance of about INR 63+ lakhs. The assessee appealed against the same before the CIT(A). CIT(A) confirmed the disallowance. The issue before the tribunal now is that whether the CIT(A) was correct in confirming the said disallowance?

Revenue’s Arguments

The AO argued that the disallowance was done in accordance with Section 14A, as these were expenses incurred in relation to earning an exempt income.

Assessee’s Arguments

  • The assessee has invested in shares of foreign companies, wholly-owned Indian subsidiary company and Group Companies, for strategic purpose, from out of its own surplus funds and not for the purpose of any earning exempt income from tax. Hence u/s 14A of the Income-tax Act, 1961, the disallowance of INR 63 lakhs has been wrongly confirmed.
  • The dividend income is taxable in India and hence Section 14A of the 1961 Act cannot be invoked as dividend income received from foreign companies in which assessee made investments is itself taxable and not exempt from income tax.
  • The dividend received was to the tune of INR. 46.63 lakhs during the year under and in any case the disallowance of expenses u/s 14A of the 1961 Act cannot exceed exempt income.


  • If the assessee has offered for tax dividend income received from foreign companies, then no disallowance of expenses u/s 14A of the 1961 Act is warranted so far as such investments in foreign companies as dividend income is already subjected to tax in India.
  • As regards to the assessee had made strategic investments or investments in subsidiary companies or group /associated companies in India or companies promoted by it, such investments are to be considered/included for making disallowance of expenses u/s.14A of the 1961 Act.
  • The investments which yielded dividend income during the year under consideration are only to be considered for the purposes of making disallowance of expenses u/s 14A and such expense cannot exceed exempt income.

Hence, the order of learned CIT(A) was set aside and the issue was remanded to the AO for fresh adjudication.

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Issue 2

AO disallowed the deduction of expenses claimed by the assessee u/s. 37(1). The assessee had claimed about INR 121 crores as business expenses. Out of this amount, INR 25 Lakhs were incurred for pooja in temples located outside the factory premises, while the balance expenses were incurred towards local area expenses, claimed to be for social contribution for the welfare of the residents of the locality where the factory of the assessee is situated. The assessee appealed to the CIT(A). The CIT(A) dismissed the appeal, holding that these expenses were not business expenses and cannot be claimed as such. The issue before the tribunal is whether the CIT(A) was correct in holding that the incurred expenses are not business expenses and hence consequently, confirming the disallowance?

Revenue’s Arguments

The expenses of about INR 121 crores are incurred towards Corporate Social Responsibility and not for the purposes of the assessee’s business. 

Assessee’s Arguments

CIT(A) has earlier allowed a deduction of 50%, hence, at least 50% of INR 1,21,53,963 be allowed as deduction. 


The assessee has failed to prove that these expenses were incurred for the purposes of a business as no supporting evidence has been produced. These expenses cannot be allowed as business deductions and disallowance of the same by the AO is confirmed.

Issue 3

AO disallowed the deduction of INR 15.52 crores which the assessee claimed as business deduction being provision for-profit incentive payable to its employees. The assessee wanted this expenditure to be allowed as revenue expenses, however, the AO was of the view that the only provider for these expenses was made in the previous year and the expenses will be allowed only in the year in which such expenditure was incurred. The assessee appealed to the CIT(A), which confirmed the AO’s order. The issue which arose was whether the CIT(A) was correct in confirming the AO’s order of disallowance on the basis that expenses can be claimed only in the year of actual payment.

Revenue’s Arguments

  • Expenses will only be allowed in the year in which the expenditure was incurred by the assessee and hence, expenses of INR 15.52 crores were disallowed.
  • Provision for profit incentive is merely a charge on profits of the assessee company payable @7% of the net profit. It is in the nature of commission paid to workers and is hit by provisions of Section 36(1)(ii) of the 1961 Act read with Section 43B of the 1961 Act.

Assessee’s Arguments

  • The appellant has incurred the expenditure relating to INR15.52 crores, during 2011-12 wholly and exclusively for the purpose of their business and therefore, the claim should be allowed in the AY 2012-13 as per Section 43(2) of the Act.
  • The deduction of INR 15.52 crores can only be allowed in the year of actual payment and not on the basis of the method of accounting upon the basis of which the profits or gains are computed.
  • The amount of INR 15.52 crores was paid and income-tax was also deducted at source as it is required u/s 192 of the 1961 Act. Hence, said provisions for expenses are allowable as a business deduction from income for the previous year relevant to the AY 2012-13.
  • The assessee has debited to P&L A/c provision for liability towards production incentive computed @7% of profits, which was paid in the subsequent year and it was submitted that these expenses be allowed.


  • The tribunal held that Section 37(1) and not Section 36(1)(ii) is to be applied as these payments are not towards bonus but are governed by commercial expediency to have smooth operations and to avert the strike.
  • The Memorandum of Settlement was valid only till 1980. The relevant assessment year in question was 2012-13. In the absence of a valid memorandum of settlement, the tribunal could not conclusively decide whether these payments were made under the said settlement. Hence, the tribunal directed the matter to be restored to the AO for fresh adjudication. It directed the assessee to produce a settlement which is pertinent to the relevant assessment year before the AO.

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