2018 (4) TMI 2015 - AT - Income Tax

Disallowance made u/s 14A r/w Rule 8D - assessee itself disallowed 49% of expenses u/s 14A - HELD THAT - We are not in agreement with the observation of the AO that invoking of Rule 8D is a mandate and has an automatic application as the AO s dissatisfaction with the correctness of claim of the assessee in respect of expenditure in relation to the income which does not form part of the total income under the Act is conspicuously absent. In any case when 49% of expenses have disallowed on a scientific basis by the assessee disallowance of Rs. 61, 90, 287/- against the total expenditure of Rs. 56, 91, 320/- do not instill any confidence in enforcement of the Act. This is not a case where the assessee claims that no expenditure has been incurred by them with relation to the income which does not form part of the total income. Keeping in view the facts and circumstances of the case and the case laws referred by the revenue are not applicable to the issue in the instant case we decline to interfere in the order of the CIT(A) who has rightly ordered to delete the disallowance. Appeal of the Revenue is dismissed.

Summary

The core legal question considered in this appeal is whether the Assessing Officer (AO) was justified in making a disallowance under section 14A of the Income Tax Act, 1961 read with Rule 8D of the Income Tax Rules, 1962, and whether the deletion of such disallowance by the Commissioner of Income Tax (Appeals) was proper.

Section 14A deals with disallowance of expenditure incurred in relation to income which does not form part of the total income under the Act, specifically exempt income such as dividend income. Rule 8D prescribes a methodology for determining the amount of expenditure relatable to exempt income, including interest expenditure in cases of mixed funds.

Issue-wise detailed analysis is as follows:

1. Applicability and Interpretation of Section 14A and Rule 8D for Assessment Year 2009-10

The amended provisions of Section 14A, including subsections (2) and (3), and Rule 8D came into effect from Assessment Year 2008-09 onwards. The AO contended that these provisions are mandatory and require application of Rule 8D to determine expenditure relatable to exempt income, especially in cases involving mixed funds. The AO argued that judicial precedents prior to AY 2008-09 are not applicable for the present year.

The Tribunal reviewed several judicial decisions to clarify the scope and applicability of Section 14A and Rule 8D:

• The Punjab & Haryana High Court in the case of Punjab Tractors Ltd emphasized that if the AO is not satisfied with the correctness of the assessee's claim regarding expenditure relatable to exempt income, he is bound to apply Rule 8D. The Court held that the AO must record satisfaction, though not necessarily in express terms, and then apply the prescribed methodology under Rule 8D without resorting to arbitrary estimates.
• The Punjab & Haryana High Court in Avon Cycles Ltd upheld disallowance of interest expenditure computed under Rule 8D(2)(ii) for mixed funds, distinguishing earlier decisions where interest-free funds were found to be available and invested. The Court emphasized that the question of disallowance under Section 14A is a question of fact, dependent on findings regarding the nature of funds and expenditure.
• The ITAT Chandigarh in Munjal Sales Corporation held that the amendments to Section 14A and Rule 8D are prospective and applicable from AY 2008-09 onwards. It upheld the disallowance under Section 14A read with Rule 8D in a case involving mixed funds and found the theory of proportionate disallowance justified.
• The Delhi High Court in India Bulls Financial Services Ltd reiterated that the AO must be satisfied with the correctness of the assessee's claim before rejecting it and applying Rule 8D. The Court held that the AO is mandated to apply the prescribed formula under Rule 8D once dissatisfaction is recorded.

The Tribunal noted that the AO in the present case did not record any explicit dissatisfaction with the assessee's claim of expenditure relatable to exempt income. The AO observed that no separate accounts were maintained for surplus funds invested and that the assessee failed to produce direct evidence of expenses incurred to earn exempt income, leading to invocation of Rule 8D.

The Tribunal referred to the Punjab Tractors judgment which clarified that the AO's satisfaction need not be an elaborate or express recording but can be inferred from the facts and circumstances. The AO was justified in presuming that the assessee had incurred administrative expenses related to exempt income, but such presumption must be supported by cogent reasons.

2. Nature and Quantum of Disallowance under Section 14A

The assessee had declared dividend income of Rs. 2,69,51,703 and taxable income of Rs. 3,21,92,636. Total expenses debited to the Profit & Loss Account were Rs. 56,91,320, of which the assessee itself disallowed Rs. 22,55,654 (approximately 49%) on a proportionate basis relative to dividend income. The AO, however, made a disallowance of Rs. 61,90,287, which exceeded the total expenses debited.

The Tribunal observed that the disallowance made by the AO was not supported by any finding of dissatisfaction with the assessee's claim, nor was it consistent with the facts on record. The assessee had made a scientific and proportionate disallowance of expenses relatable to exempt income. The AO's invocation of Rule 8D as a mandatory and automatic provision without recording satisfaction was not justified in the present facts.

The Tribunal also noted that the disallowance exceeding the total expenses incurred did not inspire confidence in the enforcement of the Act. It held that where the assessee has made a bona fide and reasonable disallowance, the AO cannot arbitrarily increase the disallowance without proper basis.

3. Treatment of Competing Arguments and Precedents

The Revenue relied heavily on the mandatory nature of Rule 8D and the requirement of AO's satisfaction under Section 14A(2) and (3), citing various High Court and ITAT decisions supporting strict application of Rule 8D in cases involving mixed funds. The Revenue also distinguished earlier judgments favorable to the assessee on the ground that those pertained to assessment years prior to the amendment.

The assessee relied on the order of the CIT(A) and earlier ITAT decisions for AY 2008-09, which had deleted similar disallowances, arguing that the facts and circumstances of the present case were analogous and that the AO had not recorded dissatisfaction.

The Tribunal analyzed the precedents and found that while the legal framework mandates application of Rule 8D upon AO's dissatisfaction, such dissatisfaction must be recorded and based on cogent reasons. The Tribunal found no such recorded dissatisfaction in the present case. It distinguished cases where the AO had properly applied Rule 8D following recorded dissatisfaction from the present facts.

The Tribunal also noted that the Revenue's reliance on decisions such as Max India (pertaining to AY 2002-03) was misplaced as the facts and applicable law differed.

4. Conclusions

The Tribunal concluded that the AO was not justified in making the disallowance under Section 14A read with Rule 8D without recording satisfaction regarding the incorrectness of the assessee's claim. The assessee had itself disallowed a reasonable proportion of expenses relatable to exempt income. The AO's disallowance was excessive and not supported by evidence or legal mandate.

Accordingly, the Tribunal upheld the deletion of the disallowance by the CIT(A) and dismissed the Revenue's appeal.

Significant holdings and core principles established:

"The Assessing Officer's dissatisfaction with the correctness of the claim of the assessee in respect of expenditure in relation to the income which does not form part of the total income under the Act is a precondition for invoking Rule 8D. Such dissatisfaction need not be expressed in a formulaic manner but must be evident from the reasons recorded in the assessment order."

"Where the assessee has made a bona fide and reasonable disallowance of expenditure relatable to exempt income on a scientific basis, the AO cannot arbitrarily increase the disallowance without recording cogent reasons."

"Invocation of Rule 8D is mandatory only when the AO is not satisfied with the correctness of the assessee's claim. Absent such satisfaction, Rule 8D cannot be applied mechanically."

"Disallowance under Section 14A is a question of fact and depends upon the nature of funds and expenditure incurred. The presence of mixed funds requires proportionate disallowance as per Rule 8D, but only after AO's recorded dissatisfaction."

"The amendments to Section 14A and Rule 8D are prospective from AY 2008-09, and judicial precedents prior to that year may not be applicable without considering the changed legal framework."

"The AO must apply the prescribed methodology under Rule 8D in a fair and reasoned manner, and the parties have the liberty to challenge the quantum determined in accordance with law."