2017 (1) TMI 1857 - AT - Income Tax

Disallowance made u/s 14A r.w.r. 8D - assessee company had made investments amounting from which exempt income accrued - CIT(A) deleted addition - HELD THAT - AO had not dislodged the correctness of the claim of the assessee of computing the expenses incurred on the tax free income on proportionate basis. AO has not pointed out as to how the same was incorrect but has merely stated that since no separate books are maintained the expenses incurred are not correct. There is no requirement under the law to maintain separate books for taxable and tax free income and therefore this cannot be the basis for questioning/disbelieving the correctness of the allocation made by the assessee. We therefore hold that the Ld. CIT (Appeals) has rightly applied the decision of the I.T.A.T. in the case of the assessee for assessment year 2008-09 to the present case. 2015 (9) TMI 1772 - ITAT CHANDIGARH But at the same time we find that the allocation made by the assessee needs to be examined on the basis of parameters which were applied in assessment year 2008-09 and held as reasonable by the I.T.A.T. in the light of the contentions of the Ld. DR made before us. For this limited purpose we restore the issue to the file of the Ld. CIT (Appeals) to verify whether the disallowance computed in the present case is on the same basis which was applied in assessment year 2008-09. Ground of appeal raised by the Revenue is therefore partly allowed for statistical purposes.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal question considered in this appeal is whether the disallowance made under section 14A of the Income Tax Act, 1961 (read with Rule 8D of the Income Tax Rules) by the Assessing Officer (AO) was justified and legally sustainable. More specifically, the Tribunal examined:

• Whether the Assessing Officer was justified in disallowing expenses attributable to earning exempt income without proper satisfaction or basis;
• Whether the allocation of expenses by the assessee on a proportionate basis between exempt and taxable income was reasonable and acceptable;
• Whether the absence of separate books of account for exempt and taxable income could be a valid ground for disallowance under section 14A;
• Whether the precedent decision of the ITAT in the assessee's own case for assessment year 2008-09 was applicable to the present facts;
• The extent to which Rule 8D of the Income Tax Rules can be applied to disallow expenses in a disproportionate manner;
• Whether the CIT (Appeals) was justified in deleting the disallowance made by the AO and restoring the expenses allocated by the assessee.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Justification for disallowance under section 14A read with Rule 8D

The legal framework governing disallowance under section 14A arises from the principle that expenses incurred to earn exempt income cannot be claimed as deductions against taxable income. Rule 8D prescribes the method to compute such disallowance where direct expenditure cannot be identified.

In the present case, the AO disallowed Rs.88,11,782/- on the ground that the assessee had not maintained separate books of account to demonstrate that expenses were not incurred to earn exempt income. The AO was not satisfied with the assessee's allocation of Rs.44,47,195/- as expenses attributable to exempt income on a proportionate basis.

The Tribunal referred to the decision in the assessee's own case for assessment year 2008-09, where it was held that disallowance under section 14A cannot be made in a disproportionate manner that leaves no expenses attributable to taxable income. The Tribunal emphasized that the assessee had adopted a "scientific basis" by allocating expenses in proportion to exempt and taxable income, which was not challenged substantively by the AO in that year.

The Tribunal noted that in the 2008-09 decision, the AO had failed to record satisfaction on how the disallowance computed by the assessee was incorrect, and that disallowing the entire expenses was "totally bad in law." This principle was held to be applicable to the present case as well.

Issue 2: Applicability of precedent decision (Assessment Year 2008-09)

The Revenue argued that the facts in the present case were distinguishable from the 2008-09 year, pointing out that in the earlier year the AO had not recorded satisfaction, whereas here he had done so by noting the absence of separate books. The Revenue also contended that the method of allocation of expenses was different and disproportionate.

The Tribunal examined these contentions and found that the present case was substantially similar to the 2008-09 year, particularly as the assessee had allocated expenses on a proportionate basis between exempt and taxable income. The Tribunal reiterated the principle that there is no legal requirement to maintain separate books of account for exempt and taxable income, and the absence of such books cannot be a ground to disbelieve the allocation made by the assessee.

However, the Tribunal acknowledged the Revenue's argument that the allocation in the present case needed to be scrutinized to ensure it conformed to the parameters applied in the 2008-09 decision.

Issue 3: Validity of allocation of expenses on proportionate basis

The assessee had allocated Rs.44,47,195/- out of total expenses of Rs.91,35,462/- on the basis of the ratio of exempt income (Rs.9,96,24,828/-) to taxable income (Rs.4,35,43,741/-). The AO challenged this allocation, disallowing a higher amount of Rs.88,11,782/-, implying a disproportionate attribution of expenses to exempt income.

The Tribunal held that such disproportionate disallowance, which effectively attributes no expenses to taxable income, is not permissible under law. The Tribunal emphasized that the Income Tax Act intends to allow expenses incurred for earning taxable income and that Rule 8D cannot be stretched to disallow expenses in a manner that creates an unreasonable situation.

Nevertheless, the Tribunal directed that the CIT (Appeals) should re-examine the allocation to verify whether the calculation of disallowance in the present case is consistent with the scientific and reasonable basis approved in the 2008-09 assessment year. This remand was for the limited purpose of ensuring the correctness and reasonableness of the allocation.

Issue 4: Requirement of separate books of account

The AO's dissatisfaction stemmed from the absence of separate books of account for exempt and taxable income. The Tribunal clarified that there is no statutory requirement to maintain separate books for exempt income and taxable income. Accordingly, the absence of separate books cannot be a valid basis for disallowance under section 14A.

The Tribunal noted that the AO had not pointed out any specific error or incorrectness in the assessee's method of allocation other than the absence of separate books, which was insufficient to discredit the assessee's claim.

Issue 5: Treatment of competing arguments

The Revenue's argument focused on the AO's recorded satisfaction and the need for disallowance under Rule 8D, while the assessee relied heavily on the binding precedent of the ITAT for assessment year 2008-09 and the reasonableness of its allocation method.

The Tribunal balanced these arguments by upholding the principle that disallowance under section 14A must be reasonable and cannot be disproportionate to exempt income, but also recognized the Revenue's concern for verifying the correctness of allocation. This led to the partial allowance of the appeal and remand for re-examination.

3. SIGNIFICANT HOLDINGS

The Tribunal preserved the following crucial legal reasoning from the 2008-09 ITAT decision, which was applied to the present case:

"By disallowing all these expenses, it appears that the assessee has earned this huge taxable income of more than Rs.2 crores without incurring any expenses. The conclusion drawn by the Assessing Officer has reached to a very weird situation, whereby it inferred as if to earn a very small non-taxable income amounting to Rs.2,96,383/-, the assessee has incurred expenses to the extent of Rs.20,32,695/-, while for earning the taxable income amounting to Rs.2,17,56,363/-, no expenses have been incurred at all. By no stretch of imagination, this situation can be true. Thus, the disallowance made by the Assessing Officer is not as per law."

Core principles established include:

• Disallowance under section 14A must be based on proper satisfaction and reasonable basis;
• Expenses must be allocated on a scientific and proportionate basis between exempt and taxable income;
• Absence of separate books of account is not a valid ground to disallow expenses attributable to exempt income;
• Rule 8D cannot be applied to create disproportionate disallowance that leaves no expenses attributable to taxable income;
• Precedent decisions of the ITAT in the assessee's own case are binding and applicable unless distinguishable on facts.

Final determinations on each issue were:

• The CIT (Appeals) was justified in deleting the disallowance made by the AO to the extent it was disproportionate and lacked proper basis;
• The allocation of expenses by the assessee on a proportionate basis was acceptable, subject to verification of its correctness;
• The absence of separate books of account cannot be a ground for disallowance;
• The issue was remanded to the CIT (Appeals) for verification of the allocation method to ensure conformity with the principles laid down in the 2008-09 assessment year decision;
• The appeal filed by the Revenue was partly allowed for statistical purposes, with the disallowance to be reworked accordingly.