2011 (8) TMI 1193 - AT - Income Tax

Disallowance u/s 14A - Held that - The application of Rule 8D of the Rules is not automatic. When the assessee makes the claim regarding the quantum of expenses to be disallowed in terms of section 14A of the Act, it was incumbent on the part of the AO to consider the claim of the assessee. It is only when the AO is not satisfied with the claim of the assessee he can have recourse with the provisions of Rule 8D of the Income Tax Rules. The satisfaction that the claim made by the assessee regarding expenses incurred in relation to the income which does not form part of the total income under the Act, is not correct, has to be arrived at by the AO, on an objective basis. In the present case, we find that the AO has proceeded to apply Rule 8D without giving any finding with regard to the correctness of the claim made by the assessee regarding the disallowance to be made under section 14A of the Act. The CIT(A) has also proceeded on the same basis. We are, therefore, of the view that the orders of the CIT(A) has to be set aside and the issue should be remanded to the AO for fresh consideration.

Summary

Issues Involved:
1. Disallowance of expenses under Section 14A of the Income Tax Act, 1961.
2. Application of Rule 8D of the Income Tax Rules, 1962.
3. Jurisdiction and validity of Rule 8D.
4. Correctness of the disallowance computation by the Assessing Officer (AO).

Issue-wise Detailed Analysis:

1. Disallowance of Expenses under Section 14A of the Income Tax Act, 1961:
The assessee, a company operating a commodity exchange, earned dividend income which it claimed as exempt under Section 10(35)(a) of the Income Tax Act, 1961. The AO examined the disallowance of expenses incurred in earning this exempt income under Section 14A of the Act. The assessee claimed no direct expenses were incurred for earning the exempt income, and only a sum of Rs. 6,03,821/- was incurred as indirect expenses, which included rent, salary, staff welfare, and telephone expenses.

2. Application of Rule 8D of the Income Tax Rules, 1962:
The AO, however, did not accept the assessee's claim and applied Rule 8D of the Income Tax Rules, 1962, resulting in a disallowance of Rs. 2,14,41,162/-. The CIT(A) upheld the AO's decision, stating that once it is admitted that some expenditure was incurred to earn exempt income, the provisions of Section 14A(2) and 14A(3) read with Rule 8D automatically apply.

3. Jurisdiction and Validity of Rule 8D:
The assessee contended that the application of Rule 8D was without jurisdiction and bad in law, arguing that Rule 8D is ultra vires the provisions of Section 14A. The assessee also argued that since it had already made a disallowance under Section 14A, the provisions of Rule 8D should not apply.

4. Correctness of the Disallowance Computation by the AO:
The Tribunal referred to the decision of the Hon'ble Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd., which held that Rule 8D can be invoked only if the AO is not satisfied with the correctness of the claim made by the assessee regarding expenses incurred in relation to exempt income. The Tribunal noted that the AO must first consider the assessee's claim and give a finding on its correctness before resorting to Rule 8D. In this case, the AO applied Rule 8D without providing any reasons for not accepting the assessee's claim.

Conclusion:
The Tribunal concluded that the application of Rule 8D was not automatic and required the AO to first evaluate the assessee's claim objectively. Since the AO did not provide any findings on the correctness of the assessee's claim, the Tribunal set aside the orders of the CIT(A) and remanded the issue back to the AO for fresh consideration in light of the Bombay High Court's decision. The AO was directed to decide the issue after affording the assessee an opportunity of being heard.

Result:
The appeal of the assessee was treated as allowed for statistical purposes. The order was pronounced in the open court on the 5th day of August, 2011.