2014 (4) TMI 269 - AT - Income Tax

No Disallowance Under Rule 8D(i) & (ii) for Strategic Investments; AO Must Exclude Subsidiary Funds Under 8D(iii)

ITAT Delhi held that no disallowance under Rule 8D(i) and 8D(ii) was warranted as the assessee used interest-free funds for investments in subsidiaries ... Disallowance u.s 14A of the Act r.w Rule 8d – investment in mutual funds - interest bearing loans were raised only as vehicle loans - Held that:- The cash flow statement reflects cash from operating activities including cash profits - The assessee has also raised an amount by issue of fresh preference shares - it is apparent that assessee had utilized interest free funds for making fresh investments and that too into its subsidiaries which is not for the purpose of earning exempt income and which are for strategic purposes only - no disallowance of interest is required to be made under rule 8D(i) & 8D (ii) as no direct or indirect interest expenditure has incurred for making investments. Disallowance under Rule 8D(iii) – Held that:- Assessee had invested in four debt oriented schemes of DSP Merile Lynch, reliance Liquid Plus, Reliance Monthly Interval Mutual Funds and SBI Liquid Plus Funds - these are not really investments and these are in fact parking of surplus funds in a more tax efficient manner – the decision in Maxopp Investment Ltd. & Others Versus Commissioner of Income Tax [2011 (11) TMI 267 - DELHI HIGH COURT] followed - the calculation of disallowance under Rule 8D(iii) made by the AO and upheld by CIT(A) is not correct In view of the fact that AO had included the value of total investments for calculation of disallowance whereas the value of those investments should have been included which were made for the purpose of earning exempt income – the assessee had made significant investments in the shares of subsidiary companies which are definitely not for the purpose of earning exempt income – thus, the value of strategic investments should be excluded for the purpose of disallowance under Rule 8D(iii) – the AO is directed to calculate the disallowance under Rule 8D(iii) by excluding the value of strategic investments in the calculation of disallowance – Decided partly in favour of Assessee. ISSUES: Whether disallowance of expenditure under section 14A read with Rule 8D is justified when no expenditure is incurred specifically for earning exempt income.Whether interest expenditure on vehicle loans can be disallowed under section 14A.Whether investments in subsidiary companies qualify as strategic investments and should be excluded from the disallowance calculation under Rule 8D(iii).Whether disallowance under Rule 8D(iii) should be computed on the total value of investments or only on investments generating exempt income.Whether disallowance under section 14A can exceed the amount of exempt income (dividend income) earned. RULINGS / HOLDINGS: The Court held that 'no disallowance of interest is required to be made under rule 8D(i) & 8D(ii) as no direct or indirect interest expenditure has incurred for making investments,' specifically noting that interest expense on vehicle loans is not attributable to exempt income.The Court affirmed that section 14A read with Rule 8D applies to investments in debt-oriented mutual fund schemes that yield exempt income, consistent with the principle that expenditure 'in relation to' exempt income is not allowable as a deduction.The Court held that 'value of strategic investments should be excluded for the purpose of disallowance under Rule 8D(iii)' and directed the Assessing Officer to recalculate disallowance excluding investments in subsidiary companies made for strategic purposes.The Court ruled that disallowance under Rule 8D(iii) must be calculated only on the average value of investments 'from which the income has been earned which does not form part of the total income,' rejecting the Assessing Officer's approach of including total investments irrespective of their nature.The Court accepted the submission, based on precedent, that disallowance under section 14A 'cannot exceed the dividend income' earned as exempt income. RATIONALE: The Court applied the legal framework of section 14A of the Income Tax Act and Rule 8D, as interpreted by the Hon'ble Delhi High Court in Maxopp Investments and the Hon'ble Bombay High Court in Godrej & Boyce Manufacturing Co. Ltd., emphasizing that the expression 'in relation to' in section 14A is broad and includes any expenditure 'in connection with' exempt income.The Court relied on the Supreme Court's decision in Walfort and subsequent Tribunal precedents (Promain Ltd. and Rei Agro Ltd.) to clarify that only those investments generating exempt income are relevant for disallowance calculations under Rule 8D(iii), thereby excluding strategic investments.The Court noted the retrospective nature of section 14A, introduced by the Finance Act 2001, which underscores Parliament's intent to disallow expenditure related to exempt income from the inception of the Act.The Court recognized the principle that disallowance should not be arbitrary or excessive and must be proportionate to the exempt income earned, reflecting a doctrinal emphasis on net income taxation.No dissent or doctrinal shift was noted; the Court followed established judicial precedents and statutory interpretation principles.