2013 (8) TMI 457 - AT - Income Tax

Disallowance u/s 14A r.w.r 8D - Dividend income - investment in shares - In the instant case, shares, which yield the tax exempt dividend income, interest qua which is to be disallowed, being held as stock-in-trade, also yield share trading income, which is taxable Held that - The exempt income falls under Chapter III, which precedes Chapter IV, providing for the heads of income, which is only toward classifying the income forming part of the total income under different heads of income for the purpose of computing the same. The exempt income, on the other hand, does not enter the computation process and, accordingly, does not fall under, nor is required to be allocated to, any specific head of income. That is, the dividend income may well have been in law, in some circumstances, assessable as business income, to no effect or consequence. Likewise, the expenditure to be disallowed could fall under any of the sections, i.e., from section 15 to section 59. The disallowance of expenditure is governed completely by section 14A, which is a separate and complete code in itself, and as long as its ingredients are satisfied, a disallowance in its terms would follow. Expenses are incurred during and in the regular course of business, and with a view to earn income. No direct relationship or correspondence therewith, particularly for costs other than direct costs, on account of a variety of factors, hold. A proximate relationship though exists. Even for direct expenditure, the relationship (with income) cannot be said to be linear, though we are primarily here concerned with allocation of indirect expenditure. All such expenditure is deductible and, therefore, would be required to be apportioned between the taxable and non-taxable incomes where the business generates more than one income stream, at least one of which is not taxable. Clearly, the direct expenditure would stand to be set off against the relevant income/s and the apportionment, in substance, comes into play only for the indirect expenditure. Apportionment of expenses - Rule 8D - Held that - There could be no quarrel with regard to the allocation of direct expenditure, which in fact states the obvious, and would in any case warrant a disallowance, i.e., even in the absence of the rule. No disallowance thereunder, in any case, has been made by the AO in the instant case. To say that the entire interest relatable to the average share holding is to be attributed to the tax exempt dividend income would be patently incorrect on facts - Shares are bought and held primarily for share trading income, further accentuates the apparent incongruity of the situation arising on the mechanical application of r. 8D(2)(ii). Clearly, therefore, the amount as per r. 8D(2)(ii) would need to be scaled down, bifurcating the expenditure so arrived at between these two incomes - Considering that the dominant objective of the share holding, which in our view should be dispositive of the matter, is the share trading income, we propose a ratio of 20% toward the tax-exempt dividend income - As regards the ratio of such scaling down, no hard and fast rule for the purpose would hold, each fact situation being different - Already explained that an indirect expenditure, including by way of interest, has no direct relation with the income, much less its quantum, allocating it on the basis of the income generated or arising would not be appropriate, and neither does rule 8D support the same - Accordingly, in arriving at the disallowance u/r. 8D, the amount as per r. 8D(2)(ii) qua shares held as stock-in-trade would stand to be restricted to 20% thereof. The language of r. 8D(2)(ii) itself provides the mandate inasmuch as it prescribes or authorizes a disallowance only qua investment, income from which is not taxable, so that in limiting the amount worked out with reference to the total investment; the same also yielding taxable income - The disallowance by the Revenue, per r. 8D, works to ₹ 140.69 lacs, a part of which would, as indicated above, stand to be deleted and the balance confirmed - Decided partly in favor of assessee.

Issues Involved:
1. Maintainability of disallowance under Section 14A read with Rule 8D of the Income Tax Act, 1961.
2. Applicability of Section 14A to shares held as stock-in-trade.
3. Allocation of direct and indirect expenditure in relation to tax-exempt income.
4. Proportionate disallowance of interest expenditure under Rule 8D(2)(ii).
5. Quantum of disallowance under Rule 8D.

Issue-wise Detailed Analysis:

1. Maintainability of Disallowance under Section 14A read with Rule 8D:
The core issue in this appeal was the maintainability of the disallowance of Rs. 1,40,69,402/- under Section 14A read with Rule 8D by the Assessing Officer (AO). The CIT(A) restricted this disallowance to Rs. 10 lacs, the amount disallowed suo motu by the assessee. The Revenue contended that the AO's disallowance was justified as it was based on Rule 8D, which is mandatory and applicable for the assessment year 2008-09. The assessee argued that the AO did not examine the correctness of the suo motu disallowance and that the investments were funded by non-interest-bearing funds.

2. Applicability of Section 14A to Shares Held as Stock-in-Trade:
The Tribunal examined whether Section 14A applies to shares held as stock-in-trade. It concluded that the purpose of holding shares does not impact the applicability of Section 14A, which is attracted by the incurrence of expenditure in relation to tax-exempt income such as dividends. The Tribunal referred to the decisions in ITO vs. Daga Capital & Management Services Pvt. Ltd., CCI Ltd. vs. Jt. CIT, and CIT v. Smt. Leena Ramachandran, among others, to support its view that Section 14A applies irrespective of whether the shares are held as investments or stock-in-trade.

3. Allocation of Direct and Indirect Expenditure:
The Tribunal clarified that both direct and indirect expenditures fall within the scope of Section 14A. It emphasized that the expenditure incurred for earning tax-exempt income must be disallowed, even if the income arises incidentally from the business of share trading. The Tribunal rejected the assessee's argument that no specific expenditure was incurred for earning the dividend income, stating that the expenditure incurred for the business of share trading, which also yields tax-exempt dividend income, must be apportioned accordingly.

4. Proportionate Disallowance of Interest Expenditure under Rule 8D(2)(ii):
The Tribunal addressed the issue of proportionate disallowance of interest expenditure under Rule 8D(2)(ii). It noted that shares held as stock-in-trade yield both taxable share trading income and tax-exempt dividend income. Therefore, attributing the entire interest expenditure to the tax-exempt dividend income would be incorrect. The Tribunal proposed a ratio of 20% of the interest expenditure to be attributed to the tax-exempt dividend income, considering the dominant objective of holding shares for share trading income.

5. Quantum of Disallowance under Rule 8D:
The Tribunal examined the quantum of disallowance under Rule 8D, which consists of three parts: direct expenditure, interest expenditure, and indirect expenditure. It found no issue with the allocation of direct expenditure. However, for interest expenditure under Rule 8D(2)(ii), it proposed a 20% allocation to tax-exempt dividend income. For indirect expenditure under Rule 8D(2)(iii), the Tribunal upheld the prescribed allocation ratio of 0.5% of the average value of investments, noting that this ratio is nominal and reasonable.

Conclusion:
The Tribunal, guided by the decision of the jurisdictional High Court in Godrej & Boyce Mfg. Co. Ltd., held that Section 14A and Rule 8D apply to shares held as stock-in-trade. It partially allowed the Revenue's appeal by confirming a portion of the disallowance and granting part relief to the assessee. The disallowance by the Revenue, per Rule 8D, was reduced from Rs. 1,40,69,402/- to an amount consistent with the Tribunal's findings on the proportionate allocation of interest expenditure. The appeal was thus partly allowed.

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