2014 (1) TMI 868 - AT - Income Tax

Disallowance of expenses u/s 14A of the Act r.w Rule 8D of the Rules - Held that - The Rule 8D of the Rules is not applicable to the assessment years i.e; AY 2006-07 as well as AY 2007-08 as Rule 8D is applicable with effect from assessment year 2008-09 and onwards as per the decision of the in the case of Godrej & Boyce Mfg Co Ltd Vs DCIT 2010 (8) TMI 77 - BOMBAY HIGH COURT . The assessee has not made any disallowance on account of direct as well as indirect expenses on account of the investment made in the various mutual funds - The assessee has earned dividend income on the investments which is exempt under the provisions of the Act - the AO has to record his objective satisfaction that he is not satisfied with the correctness of the claim of the assessee in respect of such expenditures in relation to income which does not form part of the total income of the assessee under the Act before he proceeds to make disallowance u/s 14A of the Act. For the purpose of making the investments in the various mutual funds and to keep a track of the dividend income received from them and also to manage the investments, the assessee needs not only an expert professional advise but to incur indirect and direct cost - The ld. CIT(A) has rightly stated that normally in managing similar schemes undertaken by Portfolio Managers, the total expenses charged by such Portfolio Managers are in the range of 2 to 3% which also includes their profit element of 1 to 1 % - it will be fair and reasonable to consider the indirect/direct cost in relation thereto on an adhoc basis of Rs.1,50,000/- as against Rs.2,64,521/- considered by the CIT(A). The estimate of Rs.1,50,000 has been considered keeping in view the facts that the assessee has to use the services of its employees to maintain proper record of the investment, the receipt of dividend income from the mutual funds in the bank account, to follow up with the mutual funds where the assessee has made investment and also the other administrative expenses indirectly the assessee has to incur with regard to the said investments - the disallowance restricted on adhoc basis of Rs.1,50,000 u/s 14A of the Act relating to the assessment year 2006-07 Decided partly in favour of Assessee.

Summary

Issues Involved:
1. Disallowance of expenses under Section 14A of the Income Tax Act, 1961 for the assessment years 2006-07 and 2007-08.
2. Applicability of Rule 8D of the Income Tax Rules, 1962 for the assessment years under consideration.

Detailed Analysis:

Disallowance of Expenses under Section 14A:
The core issue in both appeals pertains to the disallowance of expenses under Section 14A of the Income Tax Act, 1961. For the assessment year 2006-07, the disallowance amounted to Rs.2,64,521/-, and for the assessment year 2007-08, it was Rs.4,42,994/-. The assessee, a stockbroker and member of the National Stock Exchange, had shown dividend income from investments which was exempt under the Act. The Assessing Officer (AO) observed that no expenditure had been attributed to the earning of this exempt income in the return of income. The assessee contended that no expenditure was incurred towards earning the exempt income but provided an administrative expenditure estimate of Rs.88,800/- for the assessment year 2006-07.

The AO rejected the assessee's working and applied Rule 8D of the Income Tax Rules, 1962, to determine the disallowance, leading to the amounts mentioned above. The assessee appealed to the Commissioner of Income Tax (Appeals) [CIT(A)], who upheld the AO's disallowance but noted that Rule 8D was not applicable for the assessment years in question.

Applicability of Rule 8D:
The assessee argued that Rule 8D, introduced w.e.f. 24.3.2008, was not applicable for the assessment years 2006-07 and 2007-08, citing the decision of the Hon'ble Bombay High Court in the case of Godrej & Boyce Mfg Co Ltd Vs DCIT. The CIT(A) agreed that Rule 8D was not applicable for these assessment years but still upheld the disallowance using a similar rationale to Rule 8D.

Tribunal's Findings:
The Tribunal agreed with the assessee that Rule 8D was not applicable for the assessment years under consideration. However, it acknowledged that some expenditure must have been incurred to earn the exempt income. The Tribunal noted that the assessee needs professional advice and incurs indirect costs to manage investments and track dividend income. The CIT(A) had considered 0.5% of average investments as a reasonable estimate for such expenses, which the Tribunal found excessive.

Assessment Year 2006-07:
For the assessment year 2006-07, the Tribunal decided that an ad-hoc disallowance of Rs.1,50,000/- would be fair and reasonable, considering the need for professional advice and administrative costs related to managing investments. This amount was deemed more appropriate than the Rs.2,64,521/- disallowed by the AO and CIT(A).

Assessment Year 2007-08:
Similarly, for the assessment year 2007-08, the Tribunal restricted the disallowance to Rs.1,50,000/- instead of the Rs.4,42,994/- determined by the AO and upheld by the CIT(A). The Tribunal's rationale was consistent with its reasoning for the previous assessment year, acknowledging the necessity of some expenditure but finding the AO's and CIT(A)'s figures excessive.

Conclusion:
The Tribunal allowed both appeals in part, reducing the disallowances for both assessment years to Rs.1,50,000/-. The decision emphasized the necessity of incurring some expenditure to earn exempt income but found the AO's application of Rule 8D inappropriate for the assessment years in question. The Tribunal's order was pronounced in the open court on 26th June 2013.