Section 14A disallowance only for Expenses not directly relatable to exempt or taxable Income
Pr. CIT Vs. Bharti Overseas Pvt. Ltd. (Delhi High Court), ITA No. 802/2015,Date of decision: 17-12- 2015
Brief about the case
The assessee company was engaged in the promotion of international telecom business and insurance business and filed its original return of income on declaring loss of Rs.16,07,22,655. The income was revised on16thDecember 2009, at a loss of Rs. 13,93,37,943. Consequent to the return having been picked for scrutiny, the AO observed the Assessee had shown dividend income of Rs.89, 02,540 out of which Rs. 68, 44,790 was claimed as exempt under section 10(34) of the Act. The Assessee was asked to show cause why a disallowance under Section 14A of the Act read with Rule 8D should not be made for the expenditure incurred in relation to income not forming part of the total income.
The Assessee claimed that it had incurred 10% of the exempt income as expenditure but the AO did not accept his claim. Thereby the disallowance of Rs. 2,79,02,402 was added to the taxable income of the Assessee. The Assessee then appealed to the CIT(A). It was contended by the Assessee that Rule 8D would apply only if the AO,having regard to the accounts of the Assessee of a previous year, was not satisfied with the correctness of the claim of expenditure made by the Assessee. According to the Assessee there was no such recording of satisfaction to justify the invoking of Rule 8D.
The CIT(A) reduced the disallowance and therefore the Revenue went in appeal before the ITAT.The ITAT was of the view that since there was no common interest in the present case allocation under Rule 8D(2)(ii) does not apply.
The object behind Section 14A (1) is to disallow only such expense which is relatable to tax exempt income and not expenditure in relation to any taxable income. This object behind Section 14A has to be kept in view while examining Rule 8D (2) (ii). In any event a rule can neither go beyond or restrict the scope of the statutory provision to which it relates.
The Delhi High Court held that Variable ‘A’ prescribed in the formula in Rule 8D(2)(ii) (to make disallowance in case of common interest expenditure) would exclude both interest attributable to tax exempt income as well as taxable income.
Therefore the Court is unable to agree with the Revenue that in adopting the above interpretation the ITAT has on its own read down Rule 8D (2) (ii) of the Rules and therefore travelled beyond the scope of its jurisdiction and powers.
Facts of the case:
The assessee company was engaged in the promotion of international telecom business and insurance business and filed its original return of income on declaring loss of Rs.16,07,22,655.
the return having been picked for scrutiny, the AO observed the Assessee had shown dividend income of Rs.89, 02,540 out of which Rs. 68, 44,790 was claimed as exempt under section 10(34) of the Act. The Assessee was asked to show cause why a disallowance under Section 14A of the Act read with Rule 8D should not be made for the expenditure incurred in relation to income not forming part of the total income.
The Assessee claimed that it had incurred 10% of the exempt income as expenditure but the AO did not accept his claim.
The CIT (A) observed that during appeal proceedings, it was found that “actually the amount of interest attributable to the earning of dividend income should have been taken at proportion of Rs. 83 lacs for the purpose of applying Rule 8D and not Rs. 5,52,83,131 as adopted by the AO”. The disallowance was therefore re-worked at Rs.37,11,031. After adjusting the sum offered by the Assessee, the disallowance was restricted to Rs.30, 26,552.
The Revenue went in appeal before the ITAT. The ITAT referring to the deciusion of Kolkatta Bench of ITAT in ACIT v. Champion Commercial Co. Ltd., (2012) 139 ITD 108, which in turn referred to the decision of the Bombay High Court in Godrej & Boyce Mfg. Co. Ltd (supra) and held that for the purposes of Rule 8D (2) (ii), the amount of interest not attributable to the earning of any particular item of income, i.e., ‘common interest expenses’ that was required to be allocated would have to exclude both expenditures, i.e., interest attributable to tax exempt income as well as that attributable to taxable income. The ITAT, therefore, was of the view that since there was no common interest in the present case allocation under Rule 8D(2)(ii) does not apply. Hence ITAT upheld the decision of CIT(A).
The object behind Section 14A (1) is to disallow only such expense which is relatable to tax exempt income and not expenditure in relation to any taxable income. This object behind Section 14A has to be kept in view while examining Rule 8D (2) (ii). In any event a rule can neither go beyond or restrict the scope of the statutory provision to which it relates.
Rule 8D (2) states that the expenditure in relation to income which is exempt shall be the aggregate of (i) the expenditure attributable to tax exempt income, (ii) and where there is common expenditure which cannot be attributed to either tax exempt income or taxable income then a sum arrived at by applying the formula set out thereunder. What the formula does is basically to “allocate” some part of the common expenditure for disallowance by the proportion that average value of the investment from which the tax exempt income is earned bears to the average of the total assets. It acknowledges that funds are fungible and therefore it would otherwise be difficult to allocate the sum constituting borrowed funds used for making tax-free investments. Given that Rule 8D(2)(ii) is concerned with only ‘common interest expenditure’ i.e. expenditure which cannot be attributable to earning either tax exempt income or taxable income, it is indeed incongruous that variable A in the formula will not also exclude interest relatable to taxable income.
There the ITAT said that by not excluding expenditure directly relatable to taxable income, Rule 8D(2)(ii) ends up allocating “expenditure by way of interest, which is not directly attributable to any particular income or receipt, plus interest which is directly attributable to taxable income.” This is contrary to the intention behind Rule 8D(2)(ii) read with Section 14A of (1) and (2) of the Act.
What the ITAT has done in the present case instead is to follow its earlier decision in ACIT v. Champion Commercial ltd. [2012] 26 taxmann.com 342 (Kol.) which in turn followed the decision of the Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (supra). The ITAT did not on its own read down rule 8D (2) (ii). Rather, it went by the stand taken by the Revenue before the Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (supra) in countering the challenge to the constitutional validity of Rule 8 D (2). The stand of the Revenue was that variable A in the formula in Rule 8D (2) (ii) would exclude both interest attributable tax exempt income as well as taxable income.
In the case in hand, in the computation of income submitted by the Assessee, the total interest debited to the profit and loss account was Rs.5,52,83,131. There was an entry regarding interest on loans given to two entities. After accounting for the other interest expenditure, the Assessee computed the total interest expenditure which was allowable as Rs.83,90,178. In the computation drawn up by the Assessee, the entire interest expenditure was incurred for earning either taxable income or exempt income. There was no interest amount which was not directly attributable to either the tax exempt or taxable income. The ITAT, therefore, correctly observed in the present case “no portion of interest really survives for allocation under Rule 8D (2) (ii)”. However, as rightly pointed out by the ITAT, since the Assessee did not challenge the order of the CIT (A) to the extent it restricted the disallowance,that part of the order of the CIT (A) remained.
Therefore the Court is unable to agree with the Revenue that in adopting the above interpretation the ITAT has on its own read down Rule 8D (2) (ii) of the Rules and therefore travelled beyond the scope of its jurisdiction and powers.
Contention of the Revenue
The ITAT was incorrect in affirming the order of the CIT(A) which had confined the disallowance under Section 14A of the Act to Rs. 30,26,552 for the AY in question
The ITAT cannot read down ule 8D(2)(ii) of the Income Tax Rules 1962 as its beyond its jurisdiction.
Contention of the Assessee
The assessee submitted that on a collective reading of Section 14A of the Act and Rule 8D of the Rules, it is plain that if the variable ‘A’ under Rule 8D(2)(ii) is interpreted to include interest expense directly relatable to earning taxable income, then in effect it would result in disallowance of a certain portion of otherwise permissible deduction under the Act. This would be contrary to the very purpose and object of Section 14A of the Act.
Held by Delhi High Court
The question sought to be urged before this Court is whether the ITAT was correct in affirming the order of the Commissioner of Income Tax (A) [‘CIT(A)’] which had confined the disallowance under Section 14A of the Act to Rs. 30,26,552 for the AY in question?
In this regard the High Court held that As far as Rule 8D (2) (i) is concerned, the AO has necessarily to record that he is not satisfied with the correctness of the claim of the expenditure made by the Assessee in relation to the income which does not form part of the total income . That this requirement is mandatory is now well settled in view of the decision of this Court in Maxopp Investment (supra). For Rule 8 D (2) (ii) to apply there has to be some expenditure by way of interest “which is not directly attributable to any particular income or receipt.” If there is no such expenditure, as has been found factually by the ITAT in the present case, then the question of applying the formula thereunder will not arise.
The incidental issue that is sought to be raised is whether the ITAT could read down Rule 8D (2)(ii) of the Income Tax Rules 1962 (‘Rules’), and whether that was beyond the jurisdiction of the ITAT? In response to this question the High Court held that the ITAT did not go beyond its scope by reading down the Rules.
Hence appeal is dismissed.
