2021 (1) TMI 922 - HC - Income Tax

Disallowance u/s 14A - larger disallowance proposed by the Assessee himself in the comput ation of disallowance under Rule 8D - HELD THAT - As relying on M/S. MARG LIMITED VERSUS COMMISSIONER OF INCOME TAX CHENNAI 2020 (10) TMI 102 - MADRAS HIGH COURT we dispose of the present appeal by answering question of law in favour of the Assessee and against the Revenue and by holding that the disallowance under rule 8D of the IT Rules read with Section 14A of the Act can never exceed the exempted income earned by the Assessee during the particular assessment year and further without recording the satisfaction by the Assessing Authority that the apportionment of such disallowable expenditure made by the Assessee with respect to the exempted income is not acceptable for reasons to be assigned the Assessing Authority he cannot resort to the computation method under Rule 8D of the Income-tax Rules 1962.

Summary

The core legal questions considered in this judgment revolve around the applicability and scope of Section 14A of the Income Tax Act, 1961, and the related Rule 8D of the Income Tax Rules, 1962, particularly in the context of disallowance of expenditure incurred in relation to exempt income. Specifically, the issues are:

1. Whether the Tribunal was correct in restricting disallowance under Section 14A by relying on precedents where the quantum of disallowance was not directly at issue.

2. Whether the Tribunal was justified in limiting disallowance under Section 14A to the extent of exempt income earned during the relevant previous year, despite Section 14A not explicitly permitting such restriction.

3. Whether the Tribunal was correct in deleting additions to book profits under Section 115JB on account of expenditure incurred to earn exempt income, despite explicit provisions in Explanation 1 to Section 115JB.

Issue-wise Detailed Analysis:

Issue 1 & 2: Restriction of Disallowance under Section 14A to Quantum of Exempt Income

The legal framework centers on Section 14A of the Income Tax Act, which disallows expenditure incurred in relation to income exempt from tax, and Rule 8D of the Income Tax Rules, which prescribes the method for determining such expenditure when the Assessing Officer is not satisfied with the assessee's claim.

Precedents from multiple High Courts, including the Madras, Karnataka, Delhi, and Punjab and Haryana High Courts, as well as Supreme Court rulings, were extensively relied upon. Notably, the judgment in Marg Ltd. vs Commissioner of Income Tax and Pragathi Krishna Gramin Bank v. Jt CIT emphasized that disallowance under Section 14A cannot exceed the exempt income earned. The Karnataka High Court held disallowance beyond actual exempt income to be "absurd and hypothetical." Similarly, the Supreme Court in Maxopp Investment Ltd. affirmed that disallowance must be rationally connected to the exempt income earned and cannot be arbitrary or exceed the exempt income.

The Court highlighted that the Assessing Officer must record satisfaction that the assessee's claim regarding expenditure is incorrect before invoking Rule 8D to compute disallowance. The disallowance must have a reasonable nexus with the exempt income and cannot be a "wild guesswork bereft of ground realities." The computation under Rule 8D is a method of calculation and cannot be treated as a standalone charging provision or exceed the limits imposed by Section 14A.

Key evidence included the assessee's investments and the dividend income earned during the relevant years, showing that the disallowance computed by the Assessing Officer and upheld by the Tribunal exceeded the exempt income by a wide margin, which was found to be impermissible.

The Court rejected the Revenue's argument that disallowance could be made on hypothetical future exempt income or on the basis that investments were made for strategic control, emphasizing that Section 14A deals with actual income and expenditure incurred in the relevant year only.

In application, the Court set aside the disallowance made by the Assessing Officer and upheld by the Tribunal, remanding the matter for recomputation in accordance with law, ensuring the disallowance does not exceed exempt income and is based on recorded satisfaction of the Assessing Officer.

Issue 3: Deletion of Addition to Book Profits under Section 115JB

This issue concerned whether the Tribunal was justified in deleting additions to book profits computed under Section 115JB on account of expenditure incurred to earn exempt income, despite Explanation 1(f) to Section 115JB explicitly providing for such additions.

The judgment did not elaborate extensively on this issue but implicitly followed the principle that statutory provisions such as Explanation 1(f) to Section 115JB must be applied as per their terms. However, the primary focus was on the disallowance under Section 14A and its limits, with the Tribunal's deletion of additions under Section 115JB not being upheld in the context of the overall reasoning.

Treatment of Competing Arguments:

The Revenue's contentions that disallowance could exceed exempt income, or be based on hypothetical future income, or that Rule 8D is an independent charging provision, were consistently rejected. The Court emphasized the need for Assessing Officer's satisfaction and rational nexus between expenditure disallowed and exempt income earned. The Revenue's reliance on Circular No. 5 of 2014 and the theory of dominant intention was also rejected as inconsistent with statutory provisions and judicial precedents.

Significant Holdings:

"The disallowance under section 14A of Rs. 2,48,85,000/- as expenses to earn exempted Dividend income of Rs. 1,80,30,965/- is per se absurd and hypothetical."

"The disallowance under section 14A cannot be a wild guesswork bereft of ground realities. It has to have a reasonable and close nexus with the factually incurred expenses."

"The Assessing Authority also could not have called upon the Assessee himself to undertake the exercise of computing the disallowance under section 8D of the Rules. Such abdication of duty in not permissible in law."

"The disallowance under rule 8D of the IT Rules read with Section 14A of the Act can never exceed the exempted income earned by the Assessee during the particular assessment year."

"Without recording the satisfaction by the Assessing Authority that the apportionment of such disallowable expenditure made by the Assessee with respect to the exempted income is not acceptable for reasons to be assigned, the Assessing Authority cannot resort to the computation method under Rule 8D."

"The nature of investment has nothing to do with section 14A of the Act. It is the exempted income in the form of dividend which forms the cap or roof limit for disallowance."

The Court conclusively determined that disallowance under Section 14A must be proportionate and cannot exceed the exempt income earned in the relevant year. The Assessing Officer must record satisfaction before invoking Rule 8D, and disallowance cannot be based on hypothetical or future exempt income. The Tribunal's order upholding disallowance beyond exempt income was set aside, and the matter remanded for fresh computation in accordance with law.