Rule 8D not retrospective; sec.14A disallowance partly set aside, recomputation under Rule 8D(2)(iii); sec.32(1) proviso denies goodwill depreciation

ITAT BANGALORE held Rule 8D is not retrospective; disallowance under sec.14A for the year was set aside to the AO with directions similar to AY 2007-08. Interest disallowance was negated for fresh investments funded from the assessee's own funds; disallowance relating to pre-existing (old) investments was remitted to the AO for fresh adjudication. For AY 2008-09 administrative-expense disallowance under Rule 8D(2)(iii) must be recomputed by the AO considering only mutual fund investments that yielded dividend. Claim for depreciation on goodwill was disallowed under the 5th proviso to sec.32(1); decision against the assessee.

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Issues Involved:
1. Disallowance under Section 14A of the Income Tax Act, 1961.
2. Disallowance of claim of depreciation on goodwill and valuation of goodwill.

Issue-wise Detailed Analysis:

1. Disallowance under Section 14A of the Income Tax Act, 1961:

The first issue pertains to the disallowance made by the Assessing Officer (AO) under Section 14A of the Income Tax Act, 1961, read with Rule 8D of the Income Tax Rules, for the Assessment Year (AY) 2007-08. The Commissioner of Income Tax (Appeals) [CIT(A)] deleted the disallowance on the grounds that the borrowed funds were utilized for business purposes and not for investment purposes. The CIT(A) relied on the order for AY 2006-07.

The Departmental Representative (DR) argued that the CIT(A) did not examine the direct nexus between the assessee's own funds and the investment made. The Tribunal had previously set aside the CIT(A)'s order for AY 2006-07 and remitted the issue back to the AO for reconsideration without applying Rule 8D.

The Authorised Representative (AR) for the assessee contended that the assessee's own funds were sufficient for the investments, and no disallowance could be made under Section 14A on account of interest. The AR also pointed out that no dividend income was received for AYs 2007-08 and 2008-09, and hence no disallowance should be made under Section 14A, citing the judgment of the Delhi High Court in the case of Cheminvest Ltd. vs. CIT.

The Tribunal noted that there was no fresh investment during AY 2007-08 except Rs. 50,000 and remitted the issue back to the AO for reconsideration in light of the Tribunal's directions for AY 2006-07. For AYs 2008-09 and 2009-10, Rule 8D was applicable, and the Tribunal directed the AO to verify the use of interest-bearing funds for investments and recompute the disallowance accordingly.

2. Disallowance of Claim of Depreciation on Goodwill and Valuation of Goodwill:

The second issue involved the disallowance of the claim of depreciation on goodwill and the valuation of goodwill. The assessee, engaged in the business of production and sale of beer, had amalgamated its subsidiaries, resulting in the recording of goodwill. The AO disallowed the depreciation on goodwill, arguing that the fair value of the tangible assets should have been recorded, reducing the goodwill valuation.

The AR for the assessee argued that the issue of depreciation on goodwill was covered by the Supreme Court's judgment in CIT vs. Smifs Securities Ltd. and that the valuation of goodwill was the differential between the consideration and the fair market value (FMV) of tangible assets. The AR also cited the valuation report by a valuer and other judicial precedents.

The DR contended that the AO rightly disallowed the depreciation, as the valuation of goodwill was not justified, and the 5th proviso to Section 32(1) of the Act restricted the claim of depreciation in the hands of the assessee to the extent allowable to the amalgamating company.

The Tribunal held that the AO had the jurisdiction to examine the valuation of assets under Explanation 3 to Section 43(1) of the Act. The Tribunal noted that the AO should have examined the valuation of all assets acquired under amalgamation and determined the actual cost to the assessee. The Tribunal also referred to the 5th proviso to Section 32(1), which restricts the claim of depreciation in cases of succession or amalgamation to the extent allowable to the predecessor or amalgamating company.

The Tribunal concluded that the claim of depreciation on goodwill in the hands of the assessee was subject to the 5th proviso to Section 32(1) of the Act and decided the issue against the assessee.

Conclusion:

The appeals were partly allowed, with the Tribunal remitting the issue of disallowance under Section 14A back to the AO for reconsideration and upholding the disallowance of depreciation on goodwill. The order was pronounced in the open court on 30th September 2016.

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