2022 (8) TMI 1578 - AT - Income Tax

Disallowance u/s 14A r/w rule 8D - assessee s suo moto disallowance of expenses incurred in relation to exempt income - HELD THAT - As far as the question of Amendment to Rule 8D being prospective in nature is concerned case of the sister concern of the assessee i.e. Vardhman Acrylics Limited 2019 (7) TMI 1945 - ITAT CHANDIGARH has held that as far as the application of the substituted provision of Rule 8D w.e.f. 02.06.2016 was concerned the issue is settled by the judgment of CIT Vs. Essar Teleholding Ltd. 2018 (2) TMI 115 - SUPREME COURT wherein it was held that the Amended Rule 8D of the Income Tax Rules was applicable prospectively. Therefore CIT(A) was not justified in directing the AO to apply the provisions of amended Rule 8D. Issue of application of Rule 8D vis- -vis the provisions existing that particular time i.e. assessment year 2012-13 - As seen that the assessee has already made suo moto disallowance in terms of the provisions of section 14A which is undisputedly in proportion to the dividend income earned. It is also a case in point that the assessee has not made any fresh investments during the year under consideration and still further the AO has also not given any cogent reason for not accepting the suo moto disallowance made by the assessee and has simply mentioned in the assessment order the onus was on the assessee to prove that it had not incurred any expenditure to earn exempt income. AO has observed that as per the provisions of Rule 8D if the AO is not satisfied with the correctness of claim of expenditure made by the assessee or the claim by the assessee that no expenditure has been incurred the AO shall apply provisions of rule 8D(2). After that the AO has proceeded to make a further disallowance without recording the reason as to why he was dissatisfied with the assessee s suo moto disallowance. We are of the considered opinion that the action of the AO of recording the so called satisfaction was thus lacking any logic or sound reasoning and therefore he had no basis to make any further disallowance in the present case. CIT (A) has also upheld the disallowance without appreciating this aspect of the case. Appeal of the assessee stands allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal were:

• Whether the disallowance of Rs. 4,02,747/- under section 14A of the Income Tax Act, 1961 read with Rule 8D(2)(iii) of the Income Tax Rules, 1962, as confirmed by the Commissioner of Income Tax (Appeals) (CIT(A)), was justified for the assessment year 2012-13;
• Whether the amended Rule 8D, which came into effect from 02.06.2016, could be applied retrospectively to enhance the disallowance for the assessment year 2012-13;
• Whether the Assessing Officer (AO) was justified in rejecting the assessee's suo moto disallowance of expenses incurred in relation to exempt income and making a higher disallowance without recording cogent reasons;
• Whether the AO's satisfaction for invoking Rule 8D(2) and making further disallowance was based on sound reasoning and evidence;
• Whether the direction of the CIT(A) to apply the amended Rule 8D and enhance the disallowance was legally sustainable.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Justification of Disallowance under Section 14A and Rule 8D(2)(iii)

Relevant legal framework and precedents: Section 14A of the Income Tax Act disallows expenditure incurred in relation to exempt income. Rule 8D of the Income Tax Rules provides the methodology for computing such disallowance, including presumptive disallowance in certain cases. The AO relied on Rule 8D(2)(iii) to compute disallowance. The Tribunal referred to earlier decisions of the Chandigarh Bench of the ITAT where proportional disallowance based on dividend income was accepted.

Court's interpretation and reasoning: The Tribunal noted that the assessee had made a suo moto disallowance of Rs. 20,435/- proportionate to the exempt dividend income earned. The AO rejected this without providing cogent reasons and made a higher disallowance of Rs. 11,49,903/-. The CIT(A) upheld the AO's disallowance but applied the amended Rule 8D, resulting in further enhancement.

Key evidence and findings: The assessee's investments were fully covered by its Reserves and Surplus, indicating no fresh funds were deployed solely for earning exempt income. The assessee's proportional allocation of expenses was consistent with prior ITAT rulings on identical facts.

Application of law to facts: The Tribunal held that the AO failed to record any valid reason to be dissatisfied with the assessee's suo moto disallowance. The mere assertion that the onus was on the assessee without logical reasoning was insufficient to justify the higher disallowance.

Treatment of competing arguments: The Revenue argued that common funds were used for both business and investments, warranting higher disallowance. The Tribunal rejected this, emphasizing the lack of evidence and reasoning by the AO.

Conclusions: The disallowance under section 14A and Rule 8D(2)(iii) as confirmed by the lower authorities was not justified on the facts and law.

Issue 2: Applicability of Amended Rule 8D with Effect from 02.06.2016

Relevant legal framework and precedents: The amended Rule 8D, effective from 02.06.2016, introduced changes to the computation of disallowance under section 14A. The Supreme Court judgment in the case of CIT Vs. Essar Teleholding Ltd. held that the amended Rule 8D is prospective and cannot be applied retrospectively.

Court's interpretation and reasoning: The Tribunal relied on the Supreme Court ruling and consistent ITAT precedents to hold that the amended Rule 8D could not be applied for assessment year 2012-13, which preceded the amendment's effective date.

Key evidence and findings: The CIT(A) directed the AO to apply the amended Rule 8D, leading to enhanced disallowance. This direction was contrary to the established legal position on the prospective operation of the amended Rule.

Application of law to facts: Since the assessment year under consideration was prior to the amendment's effective date, the original Rule 8D provisions applied exclusively.

Treatment of competing arguments: The Revenue did not dispute the prospective nature of the amended Rule but argued for higher disallowance under the existing Rule 8D. The Tribunal found no basis for enhanced disallowance under the original Rule.

Conclusions: The application of the amended Rule 8D by the CIT(A) was legally unsustainable and was set aside.

Issue 3: Validity of AO's Satisfaction and Reasoning for Further Disallowance

Relevant legal framework and precedents: Rule 8D(2) empowers the AO to make disallowance if not satisfied with the assessee's claim regarding expenditure incurred to earn exempt income. The AO must record reasons for such satisfaction.

Court's interpretation and reasoning: The Tribunal found that the AO's satisfaction was recorded in a conclusory manner without logical reasoning or evidence. The AO did not explain why the suo moto disallowance by the assessee was unacceptable.

Key evidence and findings: The AO's order merely stated the onus on the assessee but failed to demonstrate any independent assessment or verification to justify disallowance beyond the suo moto amount.

Application of law to facts: The absence of reasoned satisfaction meant the AO's invocation of Rule 8D(2) was arbitrary and unsustainable.

Treatment of competing arguments: The Revenue contended that common funds justified higher disallowance, but the Tribunal emphasized the lack of any cogent reason or evidence supporting this.

Conclusions: The AO's additional disallowance was without basis and liable to be deleted.

3. SIGNIFICANT HOLDINGS

The Tribunal held:

"In view of the judgment of the Hon'ble Apex Court in the case of CIT Vs. Essar Teleholding Ltd., we hold that the Ld. CIT(A) was not justified in directing the AO to apply the provisions of amended Rule 8D."

"The action of the AO of recording the so called satisfaction was, thus, lacking any logic or sound reasoning and, therefore, he had no basis to make any further disallowance in the present case."

"We are unable to concur with the findings of the lower authorities and we set-aside the order of the Ld. CIT (A) and direct the AO to delete the impugned disallowance."

Core principles established include:

• The amended Rule 8D of the Income Tax Rules, 1962, is prospective in operation and cannot be applied retrospectively to assessment years prior to 02.06.2016;
• The AO must record cogent and logical reasons when invoking Rule 8D(2) to disallow expenditure related to exempt income beyond the assessee's claim;
• Proportional allocation of expenses by the assessee in relation to exempt income, when unchallenged by cogent evidence, should be accepted;
• Disallowance under section 14A must be based on sound reasoning and cannot be arbitrary or mechanical.

Final determinations:

• The disallowance of Rs. 4,02,747/- under section 14A and Rule 8D(2)(iii) as confirmed by the CIT(A) was not sustainable;
• The direction to apply the amended Rule 8D retrospectively was set aside;
• The AO was directed to delete the impugned disallowance;
• The appeal of the assessee was allowed.