2016 (4) TMI 119 - AT - Income Tax

Validity of the disallowance u/s. 14A - correct quantification of the disallowance of the indirect interest expenditure u/s. 14A r/w r. 8D(2)(ii)- Held that - The excess current liabilities (over current assets) translate into liquid funds with the entity only on the liquidation of the corresponding current assets. It is only this excess and to that extent only, that represents a non-dedicated source of funds, and go to swell the general pool of funds or the common hotch-potch, funding any asset that may be acquired for the time being. This would also hold in relation to advance for orders (from customers), at ₹ 52.55 cr. as at 31.3.2008, as well, as to the extent the amount is retained in the form of current assets (as cash/bank balance or inventory of goods), the same is only a targeted funding, financing current assets only. The unsecured loans, constituting the other major source of finance, is similarly not toward financing any specific asset/s (or class of assets). Self generated funds (profits), which are normally also available, again on a non-dedicated basis, is absent in-as-much as the assessee-company has suffered a loss during the year, which is primarily responsible for the decline in the NWC. Rather than being a generator or source of funds, the firm s operations have become an avenue for absorption of the funds for the current year. In fact, the excess (outstanding) current liabilities (as at the year-end), as a portfolio, represents such loss to the extent not met - the assessee continuing to maintain the current assets at the same level. Looked at in any manner, the enhanced current liabilities or funds generated from the decline in NWC can therefore only be said to finance all the additions to the assets proportionately. The pro-rata formula of funding enshrined in Rule 8D(2)(ii) would thus apply on facts to the assets, both as at the beginning and the close of the relevant year and, thus, to the average assets, including investments, held during the year, signifying the appropriateness of the formula u/r. 8D(2)(ii) both on facts and in law. Finally, the ld. CIT(A) has, subject to A.O. s verification, held for an adjustment for interest on (bank) FDRs. The same shall, accordingly, stand to be similarly excluded, at an average for the year, both from the value of investments and the total assets in computing the pro-rata indirect interest u/r. 8D(2)(ii). Subject to these adjustments in applying the said rule, we confirm the same.

Issues Involved:
1. Validity of disallowance under Section 14A of the Income Tax Act, 1961.
2. Applicability of Rule 8D of the Income Tax Rules, 1962.
3. Recording of satisfaction by the Assessing Officer (A.O.).
4. Limitation of disallowance to the amount of exempt income.

Issue-wise Detailed Analysis:

1. Validity of Disallowance under Section 14A:
The primary issue in this appeal is the validity of the disallowance under Section 14A effected by the Assessing Officer (A.O.) and modified by the Commissioner of Income Tax (Appeals) (CIT(A)). The A.O. disallowed Rs. 3,799 towards direct (Demat) charges and invoked Rule 8D to disallow indirect interest and administrative expenditure. The CIT(A) partly allowed the assessee's appeal, considering the taxable interest income on FDRs, and adjusted the net interest expenditure for Rule 8D(2)(ii) computation.

2. Applicability of Rule 8D:
The A.O. applied Rule 8D(2)(ii) and 8D(2)(iii) to compute the disallowance. The assessee contended that the proportionate formula should not apply due to a decline in net working capital, indicating that non-interest-bearing current liabilities funded the investments. The tribunal noted that the disallowance under Section 14A(1) pertains only to expenditure incurred in relation to tax-exempt income. The tribunal emphasized that the A.O. must consider the assessee's accounts before applying Rule 8D. The tribunal upheld the statutory formula (ratio) applied by the Revenue authorities, indicating that the formula is valid irrespective of the financing nature and composition.

3. Recording of Satisfaction by the A.O.:
The assessee argued that the A.O. did not record satisfaction as required under Section 14A. The tribunal observed that the A.O. noted the absence of any disallowance by the assessee despite incurring interest and administrative expenditure. The tribunal clarified that the onus is on the assessee to prove its return and claims. The CIT(A) provided reasons based on the balance sheet, justifying the disallowance. The tribunal found the Revenue's approach valid and dismissed the assessee's contention regarding the A.O.'s satisfaction recording.

4. Limitation of Disallowance to Exempt Income:
The assessee contended that the disallowance should not exceed the exempt dividend income of Rs. 1,98,500. The tribunal rejected this argument, stating that expenditure incurred in relation to tax-exempt income must be deducted to arrive at net income, which could be positive, negative, or zero. The tribunal emphasized that the assessee's plea lacked merit and referenced relevant judicial decisions to support its stance.

Conclusion:
The tribunal upheld the Revenue's application of Rule 8D(2)(ii) and 8D(2)(iii) for disallowance computation, subject to adjustments for interest on FDRs. The tribunal confirmed the statutory prescription for disallowing indirect administrative expenses under Rule 8D(2)(iii). The assessee's appeal was partly allowed for statistical purposes, with adjustments as directed.

Order Pronouncement:
The order was pronounced in the open court on February 17, 2016.

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