2013 (1) TMI 786 - AT - Income Tax

Disallowance of expenditure incurred in relation to income not includible in total income u/s 14A - Held that - AO will have to verify the correctness of the claim that no expenditure has been incurred in relation to income which does not form part of total income - AO has to accept the claim of the assessee -after giving the reasonable opportunity with the correctness of the claim AO can reject the claim and state the reasons for doing do - further AO will have to determine the amount of expenditure incurred in relation to such income - As per the judjement of Hon ble Jurisdictional High Court in T.C.(A.) No. 2621 of 2006 titled as M/s. Simpson and Co. Ltd. vs. DCIT - it would be reasonable and appropriate if the disallowance is restricted @2% of the exempt income as returned by the assessee - decided partly in favor of assessee

Summary

Issues Involved:
1. Application of Section 14A of the Income Tax Act, 1961 read with Rule 8D of the Income Tax Rules.
2. Determination of the period of applicability of Rule 8D.
3. Computation of disallowance for expenditure incurred to earn exempt income.

Detailed Analysis:

1. Application of Section 14A of the Income Tax Act, 1961 read with Rule 8D of the Income Tax Rules:
The primary contention raised by the assessee was that the Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] erred in applying Section 14A of the Income Tax Act, 1961 read with Rule 8D of the Income Tax Rules. The AO had initially disallowed Rs. 1,83,11,520/- under Section 14A read with Rule 8D, which was later reduced by the CIT(A) to Rs. 41,40,913/-. The assessee argued that this application was incorrect and relied on the case law of Maxopp Investment Ltd. v. CIT [2012] 347 ITR 272 (Delhi) to support its claim.

2. Determination of the period of applicability of Rule 8D:
The Tribunal examined whether Rule 8D, which was notified on 24.03.2008, would be applicable for the period from 01.04.2007 to 23.03.2008. Referring to the judgment of the Hon'ble Delhi High Court in Maxopp Investment Ltd. v. CIT, it was noted that Rule 8D would operate prospectively and not retrospectively. The Tribunal emphasized that Rule 8D would apply from the date of its notification and not for any period before that. The Tribunal cited the relevant portions of the Delhi High Court's judgment, which clarified that Rule 8D was introduced by the Income-tax (Fifth Amendment) Rules, 2008, and its applicability was prospective.

3. Computation of disallowance for expenditure incurred to earn exempt income:
Given that Rule 8D could not be applied retrospectively, the Tribunal had to determine a reasonable method for computing the disallowance for the period before the rule's notification. The Tribunal referred to the judgment of the Hon'ble Jurisdictional High Court in T.C.(A.) No. 2621 of 2006 (M/s. Simpson and Co. Ltd. vs. DCIT) which upheld an estimated disallowance of 2% of the expenditure incidental to earning dividend income under Section 14A. The Tribunal concluded that it would be reasonable and appropriate to restrict the disallowance to 2% of the exempt income declared by the assessee. Consequently, the AO was directed to compute the disallowance at 2% of the exempt income.

Conclusion:
The Tribunal held that both the AO and the CIT(A) erred in applying Section 14A read with Rule 8D for the period prior to the notification of Rule 8D. It directed that the disallowance for the expenditure incurred to earn exempt income should be computed at 2% of the exempt income, as per the precedent set by the Hon'ble Jurisdictional High Court. The assessee's appeal was thus partly allowed, and the AO was instructed to restrict the disallowance to 2% of the exempt income. The order was pronounced on January 29, 2013, at Chennai.