2025 (9) TMI 152 - AT - Income Tax

Appeal dismissed; s.14A r.w. Rule 8D(2)(ii) disallowance upheld based on investments and suo moto computation requirement

Sapphire Foods India Limited Versus DCIT, Circle-3 (3) (1), Mumbai.

Sapphire Foods India Limited Versus DCIT, Circle-3 (3) (1), Mumbai. - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether disallowance under section 14A of the Income-tax Act read with Rule 8D is attracted for the assessment year 2022-23 where no exempt income (dividend) was earned during the year. 2. Whether the amendment to section 14A by Finance Act, 2022 (insertion of a non-obstante clause and an Explanation with retrospective deeming language) applies to the assessment year 2022-23 and mandates disallowance even where exempt income has not accrued/been received in the relevant year. 3. Whether the Assessing Officer was obliged to record satisfaction before invoking Rule 8D and whether such satisfaction was absent or merely not in formulaic language (i.e., whether there was non-application of mind in making the disallowance). 4. Whether the assessee's assertion that investments were made from interest-free own funds (and that no borrowed funds were attributable) precludes disallowance under section 14A / Rule 8D. 5. Whether the computation under Rule 8D(2)(ii) (1% of annual average of monthly averages of opening and closing balances of investments) was correctly applied by the AO without requiring a proportionate disallowance of interest or other direct expenses. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Applicability of section 14A / Rule 8D where no exempt income was earned Legal framework: Section 14A prohibits deduction of expenditure 'incurred by the assessee in relation to income which does not form part of the total income'; Rule 8D prescribes methodology to determine expenditure relatable to exempt income, including (i) expenditure directly relating to exempt income and (ii) an amount equal to 1% of the annual average of specified investment balances. Precedent treatment: Earlier judicial decisions held that disallowance under s.14A may not be warranted in the absence of exempt income realized in that year; CBDT Circular No.5/2014 and subsequent jurisprudence generated divergent views pre-amendment. Interpretation and reasoning: The Tribunal examined the statutory language of s.14A and Rule 8D and observed that Rule 8D(1) empowers the AO-if not satisfied with the assessee's claim (including a claim of no expenditure)-to determine the amount under Rule 8D(2). The AO, upon examination of accounts and documents, applied Rule 8D(2)(ii) to compute 1% of the average investment balance. The Court accepted that Rule 8D applies even if no exempt income is earned, where the AO is not satisfied with the assessee's claim and the computation prescribed by Rule 8D is applicable. Ratio vs. Obiter: Ratio - For AY 2022-23, where Rule 8D is invoked upon AO's dissatisfaction, disallowance can be made even if no exempt income was earned, subject to the statutory method. Conclusion: Disallowance under s.14A r.w. Rule 8D is maintainable for AY 2022-23 notwithstanding absence of exempt income, provided statutory preconditions in Rule 8D are met and the AO applies the prescribed computation. Issue 2 - Effect and temporal operation of Finance Act, 2022 amendment to section 14A Legal framework: Finance Act, 2022 inserted a non-obstante clause in s.14A(1) and an Explanation stating that the provision shall apply and be deemed always to have applied where exempt income has not accrued/arisen/been received during the relevant previous year but expenditure has been incurred in relation to such income. The amendment is stated to take effect from 1-4-2022 and to apply to AY 2022-23 onwards. Precedent treatment: Some precedents held the amendment could not be read retrospectively to earlier assessment years; others examined the amended text for years to which it applies. Memorandum to Finance Bill 2022 clarifies legislative intent and effective date. Interpretation and reasoning: The Tribunal read the Finance Bill Memorandum and the statutory amendment literally: the amendment takes effect from 1-4-2022 and applies to AY 2022-23 and subsequent years. The non-obstante clause and Explanation strengthen the legislative position that disallowance may be made even where exempt income was not realized in the same year. The Tribunal held that there is a departure from earlier law for years to which the amendment applies and that the amendment is applicable to the year under consideration. Ratio vs. Obiter: Ratio - The Finance Act, 2022 amendment governs AY 2022-23 and makes s.14A applicable notwithstanding absence of realized exempt income; prior decisions on pre-amendment years are distinguishable for AY 2022-23. Conclusion: The amended s.14A (Finance Act, 2022) applies to AY 2022-23 and mandates that expenditure incurred in relation to exempt income may be disallowed even if such income was not accrued/received in that previous year. Issue 3 - Requirement and sufficiency of Assessing Officer's satisfaction under Rule 8D; allegation of non-application of mind Legal framework: Rule 8D(1) requires the AO, 'having regard to the accounts of the assessee,' to be satisfied before invoking the determination under Rule 8D(2). Jurisprudence requires AO to record reasons when rejecting the assessee's claim, but does not require ritualistic language if substantial compliance exists. Precedent treatment: Courts have held that AO must record cogent reasons for rejecting the assessee's claim, but that substantial compliance (elaborate analysis showing elements considered) suffices even if express formulaic recital of 'I am not satisfied' is lacking. Interpretation and reasoning: The Tribunal found that the AO had carried out verification, called for and examined documents (including working under Rule 8D), and articulated reasons why the assessee's claim of no attributable expenditure was untenable (investment capable of earning exempt income; administrative/indirect expenses; lack of separate accounts for investment activity). The Tribunal relied on authoritative statements that the AO's elaborate analysis constitutes recorded satisfaction and that insisting on formal words would defeat the mandate of Rule 8D. Ratio vs. Obiter: Ratio - AO's satisfaction is to be judged by substance of reasons and analysis; formal recital is not indispensable if records show cogent reasoning and application of Rule 8D methodology. Conclusion: There was no failure to apply mind; AO's actions and reasoning amounted to recorded satisfaction under Rule 8D and justified the invocation of Rule 8D(2). Issue 4 - Effect of assessee's use of interest-free own funds and prior absence of exempt income on disallowance Legal framework: Where expenditure (including interest) is directly attributable to earning exempt income, s.14A prohibits its deduction; Rule 8D provides for computation of disallowance irrespective of source of funds when AO is not satisfied with assessee's claim. Precedent treatment: Prior to the 2022 amendment, several decisions held that if investments were made wholly from own funds and no exempt income arose, disallowance could be inappropriate; such precedents are, however, distinguishable for years after amendment. Interpretation and reasoning: The Tribunal noted the assessee's claim of sufficient interest-free funds but observed that accounts showed interest expenditure and administrative costs, and that investments are part of mixed funds. Given the AO's examination and the statutory prescription under amended s.14A and Rule 8D, the mere assertion of own funds and historical absence of exempt income did not preclude disallowance. The Tribunal also observed that the assessee failed to make suo motu disallowance as required, thereby weakening the contention. Ratio vs. Obiter: Ratio - Assertion of investment from interest-free funds does not automatically preclude disallowance under s.14A/Rule 8D where AO is not satisfied and statutory method is applied; prior non-realization of exempt income is not determinative post-amendment. Conclusion: The factual claim of own funds and prior absence of exempt income did not prevent application of s.14A/Rule 8D; AO permissibly discounted that contention after account scrutiny. Issue 5 - Correctness of computation under Rule 8D(2)(ii) and omission of proportionate interest disallowance Legal framework: Rule 8D(2) aggregates (i) expenditure directly relating to exempt income and (ii) an amount equal to 1% of specified investment balances, subject to not exceeding total expenditure claimed. Precedent treatment: AO may apply one or both limbs depending on facts; Rule 8D allows AO to compute disallowance under either or both limbs where he is not satisfied with assessee's claim. Interpretation and reasoning: In the present case the AO computed disallowance only under Rule 8D(2)(ii) (1% of the annual average investment balance). The Tribunal found no infirmity in applying the second limb alone, noting that the formulaic method was rightly applied and that the AO had the statutory mandate to determine the amount when not satisfied. The Tribunal also observed that although interest expenditure existed, AO did not make proportionate interest disallowance; that omission did not vitiate the disallowance computed under clause (ii) because Rule 8D permits determining expenditure under either clause subject to the statutory cap. Ratio vs. Obiter: Ratio - AO may compute disallowance under Rule 8D(2)(ii) alone where satisfaction and account scrutiny justify it; absence of proportional interest disallowance does not invalidate a compliant Rule 8D(2)(ii) calculation. Conclusion: The computation of Rs. 16,38,260 under Rule 8D(2)(ii) was correct and sustainable; no error found in applying 1% formula and upholding that disallowance.