2012 (7) TMI 235 - AT - Income Tax

Estimation of expenditure incurred in earning the exempt income - applicability of Rule 8D by AO disallowing 10% of the income - assessee submitted that no expenditure can be identified which has been incurred for earning the dividend from units - Held that - The total of the investments when compared at the beginning of the year with the end of the year clearly shows that substantial activity has taken place in purchase / subscription, and sale / redemption of the units. Therefore, it will be na ve to accept that such activities have been undertaken merely at the advice of the bank and without any substantial participation of the managerial personnel in this behalf - Such investments require constant monitoring and undoubtedly expenditure has been incurred for earning income by way of management, establishment and office expenses. As the investments at the beginning of the year stood at about Rs. 14.65 crores, which were reduced to about Rs. 13.01 crores at the end of the year. The assessee has earned dividend income and capital gain, which are tax-free incomes as mentioned earlier. Therefore, these incomes have not been included in the total income - as the assesee s explanation is not satisfactory, therefore, provisions contained in 14A are applicable r.w.r.8D - CIT(A) erred in estimating the expenditure by ignoring the mandatory provision contained in Rule 8D - against assessee.

Summary

Issues Involved:
1. Determination of expenditure incurred in relation to income not includible in total income under Section 14A for assessment years 2005-06 to 2007-08.
2. Applicability of Rule 8D of Income Tax Rules, 1962, for assessment year 2009-10.
3. Assessment of whether administrative and interest expenses are attributable to earning exempt income.

Issue-wise Detailed Analysis:

1. Determination of Expenditure for Assessment Years 2005-06 to 2007-08:
The primary issue for these years was the determination of expenditure related to income not includible in total income under Section 14A. The Tribunal previously held that Rule 8D could not be applied for these years, but the Assessing Officer (AO) was still required to determine the expenditure on a reasonable basis.

The assessee argued that no identifiable expenditure was incurred for earning dividend income, particularly no interest or administrative expenses. However, the AO did not accept this claim, stating that substantial investments required constant monitoring, and thus, general and administrative expenses, staff and personnel expenses, and interest expenses should be considered. The AO ultimately disallowed 10% of the dividend income, amounting to Rs. 7,16,753/-.

The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO's decision, noting that the assessee failed to prove no expenditure was incurred. The CIT(A) considered the available reserves and surplus and concluded that no part of the interest expenditure was attributable to earning dividend income. However, the administrative expenses could not be properly allocated, and thus, the AO's disallowance was deemed fair and proper.

2. Applicability of Rule 8D for Assessment Year 2009-10:
For the assessment year 2009-10, the assessee earned dividend income and long-term capital gain, both excluded from total income under Section 10. The AO disallowed Rs. 10,19,977/- under Rule 8D, while the assessee had suo motu disallowed Rs. 50,000/-. The CIT(A) reduced the disallowance to Rs. 88,208/-, stating that no fresh investments were made and the investments were from own funds, thus no interest expenditure was incurred.

The AO's application of Rule 8D was contested, but the CIT(A) upheld the disallowance of 10% of the exempt income as fair and reasonable. The Tribunal, however, found that the CIT(A) erred by not following the mandatory Rule 8D, thus restoring the AO's original disallowance.

3. Attribution of Administrative and Interest Expenses:
The Tribunal examined the assessee's claim that no expenditure was incurred for earning exempt income. The assessee's portfolio management activities indicated substantial participation of managerial personnel, contradicting the claim of no related expenditure. The Tribunal referred to the Jurisdictional High Court's decision in Maxopp Investment Ltd., which required the AO to ascertain the correctness of the assessee's claim and determine the expenditure on a reasonable basis if the claim was found unsatisfactory.

The Tribunal concluded that the AO's estimation of 10% of the income as expenditure was fair and reasonable, given the substantial portfolio management activities. For the assessment year 2009-10, the Tribunal emphasized the mandatory application of Rule 8D, setting aside the CIT(A)'s order and restoring the AO's disallowance.

Conclusion:
The Tribunal dismissed the assessee's appeals for assessment years 2005-06 to 2007-08, upholding the disallowance of 10% of the dividend income as fair and reasonable. For assessment year 2009-10, the Tribunal allowed the revenue's appeal, reinstating the AO's disallowance under Rule 8D, emphasizing the mandatory nature of the rule.