2024 (5) TMI 1584 - AT - Income Tax

Disallowance made u/s 14A r/w Rule 8D(2) both under the normal provisions of the Act as well as in the computation of book profits u/s 115JB - satisfaction recorded by the AO - HELD THAT - The very basis of AO shifting to adoption of computation mechanism provided under Rule 8D(2) of the Rules ignoring the suo moto disallowance made by the assessee is flawed. We find that the assessee had taken the direct expenditure as well as indirect expenditure incurred which has linkage with the investment activity and made suo moto disallowance. If any mistake or deficiency is found thereon having regard to the books of account of the assessee the AO is entitled to ignore the same and proceed with Rule 8D(2) of the Rules. In the instant case it was not done by the ld AO. As per the provisions of section 14A(2) of the Act read with Rule 8D(1) of the Rules the ld AO is duty bound to record an objective satisfaction as to why the suo moto disallowance made by the assessee is incorrect having regard to the accounts of the assessee. No such satisfaction in the manner acceptable to law had been recorded in the instant case by the AO. This view of ours is further fortified by the decision of Maxopp Investments 2018 (3) TMI 805 - SUPREME COURT . Hence we have no hesitation to delete the disallowance made u/s 14A both under normal provisions of the Act as well as in the computation of book profits u/s 115JB. Appeal of the assessee is allowed.

Summary

The core legal issue considered by the Tribunal pertains to the validity and quantum of disallowance made under section 14A of the Income-tax Act, 1961 (hereinafter "the Act"), read with Rule 8D(2) of the Income Tax Rules, 1962 (hereinafter "the Rules"), both under the normal provisions of the Act and in the computation of book profits under section 115JB of the Act. Specifically, the Tribunal examined whether the Assessing Officer (AO) was justified in ignoring the assessee's suo moto disallowance of expenditure under section 14A and instead applying the formula prescribed under Rule 8D(2) to arrive at a substantially higher disallowance.

In addressing this issue, the Tribunal analyzed the relevant statutory provisions, the factual matrix regarding the assessee's investment and expenditure pattern, and the procedural requirements for recording satisfaction before invoking Rule 8D(2). The competing contentions centered on the correctness of the AO's approach in disregarding the assessee's own disallowance and the quantum of interest expenditure attributable to earning exempt income.

Issue-wise Detailed Analysis:

1. Legality and correctness of disallowance under section 14A read with Rule 8D(2)

Relevant legal framework and precedents: Section 14A of the Act mandates disallowance of expenditure incurred in relation to income that does not form part of total income, i.e., exempt income. Rule 8D of the Rules prescribes the methodology for computing such disallowance where direct expenditure cannot be identified. The Supreme Court's decision in Maxopp Investments (402 ITR 640 (SC)) clarified that the AO must record an objective satisfaction, based on the facts and accounts, before applying the formula under Rule 8D(2), especially when rejecting the assessee's own disallowance.

Court's interpretation and reasoning: The Tribunal found that the AO's foundational premise-that the assessee had incurred substantial interest expenditure for earning exempt income-was factually incorrect. The financial statements showed interest expenditure of only Rs. 18,436, which was negligible. This undermined the AO's justification for ignoring the assessee's suo moto disallowance and applying Rule 8D(2) directly.

The Tribunal emphasized that the assessee had proactively made disallowance of Rs. 1,22,30,414, comprising depository expenses, 50% of directors' and accountant's salaries, and company secretary administration expenses, all linked to investment activities generating exempt dividend income of Rs. 36.46 crores. The AO's failure to objectively examine and record satisfaction on the correctness of this disallowance, as mandated by section 14A(2) read with Rule 8D(1), rendered the subsequent application of Rule 8D(2) formula invalid.

Key evidence and findings: The Tribunal scrutinized the financial statements and noted the negligible interest expenditure. It also observed the nature of investments-primarily old group company investments acquired on amalgamation with minimal fresh transactions during the year-indicating limited administrative expenses directly relatable to earning exempt income.

Application of law to facts: Given the minimal interest expenditure and the assessee's detailed suo moto disallowance, the AO was required to record specific and objective reasons for rejecting the assessee's computation before resorting to the Rule 8D(2) formula. The AO's failure to do so, and the reliance on an incorrect factual premise, led to an unsustainable disallowance of Rs. 6.05 crores.

Treatment of competing arguments: The Revenue argued that the AO was justified in applying Rule 8D(2) because the assessee's disallowance was insufficient and did not cover indirect expenses. The assessee contended that its disallowance was comprehensive and the AO's basis for ignoring it was factually wrong. The Tribunal sided with the assessee, underscoring the procedural and substantive deficiencies in the AO's approach.

Conclusions: The Tribunal concluded that the disallowance under section 14A both under normal provisions and for computation of book profits under section 115JB was not sustainable. It deleted the disallowance entirely, allowing the assessee's grounds.

Significant holdings:

"We find that the assessee had taken the direct expenditure as well as indirect expenditure incurred which has linkage with the investment activity and made suo moto disallowance. If any mistake or deficiency is found thereon having regard to the books of account of the assessee, the ld AO is entitled to ignore the same and proceed with Rule 8D(2) of the Rules. In the instant case, it was not done by the ld AO. Moreover, as per the provisions of section 14A(2) of the Act read with Rule 8D(1) of the Rules, the ld AO is duty bound to record an objective satisfaction as to why the suo moto disallowance made by the assessee is incorrect having regard to the accounts of the assessee. No such satisfaction in the manner acceptable to law had been recorded in the instant case by the ld AO."

"The very basis of alleged satisfaction recorded by the ld AO, that the assessee had incurred substantial interest expenditure for the purpose of earning exempt income, per se is factually incorrect as is evident from the perusal of the financial statement that the assessee had incurred interest expenditure only to the extent of Rs 18,436/-. Hence, the very basis of ld AO shifting to adoption of computation mechanism provided under Rule 8D(2) of the Rules ignoring the suo moto disallowance made by the assessee is flawed."

These holdings reaffirm the principle that the AO must record a clear and objective satisfaction based on facts and accounts before invoking Rule 8D(2) to disallow expenditure under section 14A, especially when the assessee has already made a suo moto disallowance. The Tribunal's decision underscores that mere mechanical application of Rule 8D(2) without such satisfaction is impermissible.

In final determination, the Tribunal allowed the appeal, deleted the disallowance under section 14A both under normal provisions and for computation of book profits under section 115JB, and restored the assessee's computation as per its suo moto disallowance.