2014 (12) TMI 482 - HC - Income Tax

HC upholds disallowance of expenses under Section 14A and Rule 8D, favoring assessee's claim and AO's method

Commissioner of Income Tax-VI Versus Taikisha Engineering India Ltd.

The HC upheld the Tribunal's order disallowing expenses under Section 14A read with Rule 8D related to exempt income from investments in shares and mutual ... Disallowance of expenses on exempt income u/s 14A r.w Rule 8D – investments in shares and mutual funds - Held that:- In Maxopp Investment Ltd. vs. Commissioner of Income Tax [2011 (11) TMI 267 - DELHI HIGH COURT], it has been held that it is only when the AO is not satisfied with the claim of the assessee, that the Legislature directs him to follow the method that may be prescribed - the findings recorded by the CIT(A) and the Tribunal are appropriate and relevant - the assessee had sufficient funds for making investments in shares and mutual funds - The self or voluntary deductions made by the assessee were not rejected and held to be unsatisfactory, on examination of accounts - the Rule in sub Rule (2) specifically prescribes the mode and method for computing the disallowance under Section 14A of the Act - under clause (ii) to Rule 8D(2) of the Rules, the AO is required to examine whether the assessee has incurred expenditure by way of interest in the previous year and secondly whether the interest paid was directly attributable to particular income or receipt - the amount to be disallowed as expenditure relatable to exempt income, under sub Rule (2) is the aggregate of the amount under clause (i), clause (ii) and clause (iii) - Clause (i) relates to direct expenditure relating to income forming part of the total income and under clause (iii) an amount equal to 0.5% of the average amount of value of investment, appearing in the balance sheet on the first day and the last day of the assessee has to be disallowed – thus, the order of the Tribunal is upheld – Decided against revenue. ISSUES: Whether the Assessing Officer can invoke the prescribed method under Section 14A(2) of the Income Tax Act, 1961 and Rule 8D of the Income Tax Rules, 1962 to disallow expenditure relating to exempt income without first recording satisfaction that the assessee's claim regarding such expenditure is incorrect or unsatisfactory.Whether disallowance under Section 14A and Rule 8D can be made when the assessee has sufficient interest-free funds to make investments yielding exempt income.Interpretation and applicability of the formula under Rule 8D(2)(ii) for apportioning interest expenditure to exempt income.The necessity of the Assessing Officer recording reasons and satisfaction objectively before applying Rule 8D for disallowance. RULINGS / HOLDINGS: The Assessing Officer must first be 'not satisfied with the correctness of the claim of the assessee' regarding expenditure incurred in relation to exempt income, 'having regard to the accounts of the assessee,' before invoking the prescribed method under Section 14A(2) and Rule 8D(1); absent such satisfaction, Rule 8D(2) cannot be applied.Where the assessee has 'interest free funds far in excess of amount invested' in shares or securities yielding exempt income, no disallowance under Section 14A is warranted as there is no question of attributing any interest expenditure to such investments.Rule 8D(2)(ii) applies only if the assessee has incurred interest expenditure not directly attributable to any particular income or receipt; in such cases, the prescribed formula must be applied to apportion interest expenditure to exempt income.The Assessing Officer must 'record reasons' and 'objective satisfaction' before rejecting the assessee's claim; failure to do so renders the disallowance under Rule 8D invalid. RATIONALE: The Court relied on the statutory framework of Section 14A of the Income Tax Act, 1961, which prohibits deduction of expenditure incurred in relation to exempt income and mandates the Assessing Officer to determine such expenditure by a prescribed method only if dissatisfied with the assessee's claim after examining accounts.Rule 8D of the Income Tax Rules, 1962 prescribes a three-part formula for computing disallowance: (i) direct expenditure related to exempt income, (ii) apportioned interest expenditure by a formula, and (iii) a fixed percentage (0.5%) of the average value of investments yielding exempt income.The Court emphasized that the pre-condition of the Assessing Officer's satisfaction under Section 14A(2) and Rule 8D(1) is mandatory and must be based on objective consideration of the accounts, with reasons recorded.Precedents from various High Courts, including the Delhi High Court in Maxopp Investment Ltd. and the Bombay High Court in Godrej & Boyce Mfg. Co. Ltd., were followed to affirm that disallowance under Section 14A and Rule 8D is not automatic and requires recorded dissatisfaction by the Assessing Officer.The Court distinguished between cases where the assessee maintains separate accounts or makes voluntary disallowance and cases where the Assessing Officer must apply Rule 8D; the latter arises only upon rejection of the assessee's claim.The Court rejected the Assessing Officer's invocation of Rule 8D(2) in the absence of recorded satisfaction and reasons, thereby upholding the deletion of disallowance where the assessee had sufficient interest-free funds for investment.