2014 (12) TMI 482 - HC - Income Tax

Disallowance of expenses on exempt income u/s 14A r.w Rule 8D investments in shares and mutual funds - Held that - In Maxopp Investment Ltd. vs. Commissioner of Income Tax 2011 (11) TMI 267 - Delhi High Court it has been held that it is only when the AO is not satisfied with the claim of the assessee that the Legislature directs him to follow the method that may be prescribed - the findings recorded by the CIT(A) and the Tribunal are appropriate and relevant - the assessee had sufficient funds for making investments in shares and mutual funds - The self or voluntary deductions made by the assessee were not rejected and held to be unsatisfactory on examination of accounts - the Rule in sub Rule (2) specifically prescribes the mode and method for computing the disallowance under Section 14A of the Act - under clause (ii) to Rule 8D(2) of the Rules the AO is required to examine whether the assessee has incurred expenditure by way of interest in the previous year and secondly whether the interest paid was directly attributable to particular income or receipt - the amount to be disallowed as expenditure relatable to exempt income under sub Rule (2) is the aggregate of the amount under clause (i) clause (ii) and clause (iii) - Clause (i) relates to direct expenditure relating to income forming part of the total income and under clause (iii) an amount equal to 0.5% of the average amount of value of investment appearing in the balance sheet on the first day and the last day of the assessee has to be disallowed thus the order of the Tribunal is upheld Decided against revenue.

Summary

Issues Involved:
1. Application of Section 14A of the Income Tax Act, 1961.
2. Application of Rule 8D of the Income Tax Rules, 1962.
3. Disallowance of expenditure relating to exempt income.
4. Satisfaction of the Assessing Officer regarding the correctness of the assessee's claim.

Detailed Analysis:

1. Application of Section 14A of the Income Tax Act, 1961:
The core issue raised by the Revenue pertains to the application of Section 14A of the Income Tax Act, which disallows deductions in respect of expenditure incurred by the assessee in relation to income that does not form part of the total income under the Act. The Assessing Officer (AO) must examine the accounts of the assessee and only when not satisfied with the correctness of the claim of the assessee regarding such expenditure, can the AO determine the amount of disallowance. This is in line with the legal requirement that the AO must record dissatisfaction with the assessee's claim before invoking Rule 8D.

2. Application of Rule 8D of the Income Tax Rules, 1962:
Rule 8D prescribes the method for determining the amount of expenditure in relation to exempt income. The AO applied Rule 8D to recompute the disallowance of expenses for the assessment years 2008-09 and 2009-10. However, the AO did not record any dissatisfaction with the assessee's voluntary disallowance before applying Rule 8D. The Tribunal and CIT(A) both found that the AO failed to record the necessary satisfaction as mandated by Section 14A(2) and Rule 8D(1).

3. Disallowance of Expenditure Relating to Exempt Income:
For the assessment years in question, the assessee had voluntarily disallowed certain amounts under Section 14A. The AO, however, recalculated the disallowance using Rule 8D, leading to higher disallowance amounts. The Tribunal upheld the findings of the CIT(A) that the assessee had sufficient interest-free funds to make the investments yielding exempt income, and therefore, no additional disallowance was warranted. The Tribunal also noted that the AO did not provide any cogent reasons for rejecting the assessee's voluntary disallowance.

4. Satisfaction of the Assessing Officer Regarding the Correctness of the Assessee's Claim:
The judgment emphasizes that the AO must record satisfaction regarding the correctness of the assessee's claim of expenditure before invoking Rule 8D. The Delhi High Court, in Maxopp Investment Ltd. vs. CIT, and the Bombay High Court, in Godrej and Boyce Mfg. Co. Ltd. vs. DCIT, have both held that the AO's satisfaction must be recorded with reference to the accounts of the assessee. The AO in this case did not record such satisfaction, rendering the application of Rule 8D improper.

Conclusion:
The appeals by the Revenue were dismissed as the AO failed to record the necessary satisfaction before invoking Rule 8D. The Tribunal and CIT(A) correctly held that the assessee had sufficient interest-free funds and the voluntary disallowances made by the assessee were not unsatisfactory. Therefore, the conditions for applying Rule 8D were not met, and the AO's recalculations were invalid. The judgment reaffirms the requirement for the AO to record dissatisfaction with the assessee's claim before applying Rule 8D and disallowing expenditures under Section 14A.