2012 (7) TMI 244 - AT - Income Tax

Rule 8D disallowance under Section 14A not applicable for AY 2007-08, assessee's self-disallowance upheld as reasonable

Asstt. Commissioner of Income-tax, Versus M/s. Hexa Securities & Finance Co. Ltd.,

ITAT Delhi held that Rule 8D for disallowance under Section 14A is not applicable for AY 2007-08, as it applies from AY 2008-09 onwards per Godrej Boyce ... Dis-allowance u/s 14A of expenditure incurred in earning dividend income - application of Rule 8D - AY 07-08 - Revenue contesting restriction of dis-allowance by CIT(A) - Held that:- It has been held in case of Godrej & Boyce Manufacturing Co. Ltd. vs. DCIT [2010 (8) TMI 77 - BOMBAY HIGH COURT] that provisions of Rule 8D would apply with effect from AY 2008-09. In the case before us the AY involved is AY 2007-08. Therefore, Rule 8D will not be applicable in the case of the assessee. However, disallowance can be made in relation to exempt income on reasonable basis. The assessee had himself disallowed Rs.1,73,98,255/- in the proportion of exempt and taxable income earned by way of dividend and interest income, which is reasonable. Since Rule 8D is not applicable for AY under consideration, the disallowance made by the assessee on proportionate basis of exempt income and taxable income in our considered opinion is justified - Decided against Revenue. The core legal question considered in this appeal pertains to the correctness and extent of disallowance under section 14A of the Income-tax Act, 1961, specifically whether the disallowance made by the Assessing Officer (AO) under section 14A read with Rule 8D of the Income-tax Rules, 1962, can be sustained or should be restricted to the amount disallowed by the assessee itself.More precisely, the issue is whether the AO was justified in making a disallowance of Rs. 2,04,25,115/- under section 14A against the assessee's own disallowance of Rs. 1,66,57,982/-, or whether the disallowance should be restricted to Rs. 1,73,98,255/- as held by the Commissioner of Income-tax (Appeals) [CIT(A)].The Tribunal also considered the applicability of Rule 8D of the Income-tax Rules, 1962 to the assessment year 2007-08 and the principles governing disallowance under section 14A prior to the introduction of Rule 8D.Issue-wise Detailed Analysis:1. Applicability of Section 14A and Rule 8D for Assessment Year 2007-08Relevant Legal Framework and Precedents: Section 14A was inserted retrospectively from 1.4.1962 by the Finance Act, 2001, to empower the Revenue to disallow expenditure incurred in relation to exempt income. Prior to this, the Supreme Court in Rajasthan State Warehousing Corporation vs. CIT held that expenditure relating to an indivisible business earning both taxable and exempt income could not be apportioned to exempt income for disallowance.Rule 8D, notified on 24th March 2008, provides a detailed mechanism for computing disallowance under section 14A. However, the Bombay High Court in Godrej & Boyce Manufacturing Co. Ltd. vs. DCIT held that Rule 8D applies prospectively from Assessment Year 2008-09 and is not retrospective.Court's Interpretation and Reasoning: The Tribunal observed that since the assessment year under consideration is 2007-08, Rule 8D is not applicable. Nonetheless, the AO was required to determine the expenditure incurred in relation to exempt income on a reasonable basis, consistent with the facts and circumstances, in accordance with sub-section (1) of section 14A.Application of Law to Facts: The AO attempted to apply Rule 8D for disallowance, which was held to be erroneous as the Rule was not yet applicable. The CIT(A) found arithmetical errors in the AO's computation of average investments and assets, further undermining the AO's approach.Treatment of Competing Arguments: The Revenue contended that the AO correctly applied Rule 8D and that the higher disallowance was justified. The assessee argued that it had itself made a disallowance of Rs. 1,73,98,255/- on a proportionate basis, which was reasonable and should be accepted.Conclusion: The Tribunal agreed with the assessee and CIT(A) that Rule 8D was not applicable for AY 2007-08, and that disallowance under section 14A must be made on a reasonable and acceptable basis. Since the assessee had suo moto disallowed Rs. 1,73,98,255/- proportionate to exempt and taxable income, this was held to be justified and reasonable.2. Correctness of the Quantum of Disallowance under Section 14ARelevant Legal Framework and Precedents: The principle underlying section 14A is to disallow expenditure incurred in relation to exempt income. The methodology for computing such disallowance must be reasonable and based on relevant facts. The Delhi High Court in Maxopp Investment Ltd. vs. CIT held that the AO must adopt a reasonable and acceptable method of apportionment in the absence of Rule 8D.Court's Interpretation and Reasoning: The CIT(A) identified arithmetical errors in the AO's calculation of average investments and assets, specifically the incorrect deduction of net current assets from investments instead of adding them. This led to an inflated disallowance figure by the AO. The CIT(A) accepted the assessee's proportionate disallowance based on exempt income as reasonable.Key Evidence and Findings: The assessee's detailed working showed disallowance of Rs. 1,73,98,255/- by proportionate allocation of interest and other expenses relative to exempt dividend income and taxable income. The AO's disallowance of Rs. 2,04,25,115/- was based on incorrect asset valuation and an erroneous application of Rule 8D.Application of Law to Facts: Given the absence of Rule 8D for the relevant year, the AO's method was not appropriate. The assessee's self-imposed disallowance was a reasonable basis for disallowance under section 14A.Treatment of Competing Arguments: The Revenue urged acceptance of the AO's higher disallowance, relying on Rule 8D. The assessee and CIT(A) rejected this, emphasizing the retrospective inapplicability of Rule 8D and the reasonableness of the assessee's own disallowance.Conclusion: The Tribunal upheld the CIT(A)'s restriction of disallowance to Rs. 1,73,98,255/-, finding the AO's calculation flawed and the assessee's approach reasonable.Significant Holdings:'The provisions of Rule 8D of the IT Rules, 1962 have been held to be prospective in nature and thus, are not applicable to the subject assessment year.''The AO must adopt a reasonable basis or method consistent with all the relevant facts and circumstances after furnishing a reasonable opportunity to the assessee to place all germane material on record.''Since Rule 8D is not applicable for Assessment Year under consideration, the disallowance made by the assessee on proportionate basis of exempt income and taxable income in our considered opinion is justified.''The learned CIT(A) is justified in upholding the disallowance to the extent of Rs.1,73,98,255/-. Accordingly, we do not find any infirmity in the order of the CIT(A).'Core principles established include the retrospective non-applicability of Rule 8D for AY 2007-08, the necessity for the AO to apply a reasonable and fact-based method for disallowance under section 14A in the absence of Rule 8D, and the acceptance of the assessee's own proportionate disallowance as a reasonable basis for such disallowance.Final determination was that the Revenue's appeal was dismissed, with the disallowance under section 14A restricted to Rs. 1,73,98,255/- as held by the CIT(A), rejecting the AO's higher disallowance based on Rule 8D and erroneous asset valuation.