No penalty u/s 271(1)(c) for faliure to disallow u/s 14A unless malafide is proved- Delhi ITAT

I have found the order of Delhi ITAT in the case namely DCIT Vs Nalwa Investments Ltd. very important one wherein it  has been held that mere faliure to disallow expenses u/s 14A will not amount to levy of penalty u/s 271(1)(c) unless malafide is proved. In this case even the auditors did not suggest disallowance u/s 14A in respect of expenses relating to tax free income. Hence no malafide intention for not attributing expenses to tax free income was proved consequently no penalty u/s 271(1)(c) could be levied.

Brief facts:  For AY 2005-06 the assessee had investments in shares of Rs. 37 crores on which it earned tax-free dividend. The assessee also had borrowings of Rs. 33 crores on which it paid interest of Rs. 1.10 crores. However, no disallowance u/s 14A was made. The AO computed the disallowance at Rs. 95 lakhs and levied penalty under Explanation 1 to 271(1)(c) on the ground that there was no satisfactory explanation for not attributing expenses to tax-free income. This was deleted by the CIT (A). On appeal by the department, appeal is dismissed.

Verdict:  Though the computation of s. 14A disallowance was not made, the figures of dividend and interest were stated in the P&L A/c. Even the tax auditors did not state that s. 14A disallowance should be made. As there is no allegation by the AO that there was collusion between the auditor and the assessee to ignore s. 14A, it cannot be said that the explanation was not bona fide. Further, as Rule 8D was not enacted at the time, segregation of expenditure relatable to tax-free income would be disputable and lead to bona fide difference in opinion. So, penalty u/s 271(1)(c) cannot be levied.

Full Judgment can be downloaded herebelow:
DCIT V Nalwa Investments Ltd.
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