2017 (8) TMI 962 - HC - Income Tax

Disallowance under Section 14A - Failure of the AO to record satisfaction - Held that - On the aspect of administrative expenses being disallowed, since there was a failure by the AO to comply with the mandatory requirement of Section 14 A (2) of the Act read with Rule 8D (1) (a) of the Rules and record his satisfaction as required thereunder, the question of applying Rule 8D (2) (iii) of the Rules did not arise. What is plain from the explanation offered by the Assessee, which was not discarded by the AO on facts, was that there was no part of the interest expenditure which did not bear a direct nexus to a loan that was already borrowed in some earlier year. As explained by this Court in Principal Commissioner of Income Tax v. Bharti Overseas Pvt. Ltd. (2015 (12) TMI 1423 - DELHI HIGH COURT) if there is no interest expenditure which is not directly attributable to any particular income or receipt , then the question of applying the formula under Rule 8D (ii) of the Rules will not arise. In other words, one of the pre-requisites for the applicability of the formula Rule 8 D (2) (ii) of the Rules for determining the extent of disallowance of interest, is that there must some interest expense which is not attributable to any particular income or receipt. In the present case, the AO does not indicate which part of the interest expense falls in the above category. ITAT erred in remanding the matter concerning deletion of disallowance of any interest under clause (ii) of Rule 8D (2) of the Act to the AO for fresh determination in light of the decision in Commissioner of Income Tax v. Taikisha Engineering India Limited (2014 (12) TMI 482 - DELHI HIGH COURT ) AO failed to record proper satisfaction in terms of Section 14A (2) of the Act read with Rule 8D (1) (a) of the Rules and therefore, erred in calculating the disallowance at 0.5% on overall value of the investments as per the Rule 8D (2) (iii) of the Rules.

Issues Involved:
1. Disallowance of interest under Rule 8D(2)(ii) of the Income Tax Rules, 1962.
2. Recording of proper satisfaction by the Assessing Officer (AO) under Section 14A(2) and Rule 8D(1) of the Income Tax Rules, 1962.
3. Calculation of disallowance at 0.5% of the average value of investments under Rule 8D(2)(iii).

Detailed Analysis:

1. Disallowance of Interest under Rule 8D(2)(ii):
The Assessee, engaged in printing and publishing newspapers, filed returns declaring exempt income from dividends. The AO disallowed interest expenses under Rule 8D(2) without considering the Assessee's claim that investments were made from its own funds, not borrowed funds. The CIT (A) deleted the disallowance, noting that no term loans were used for investments. However, the ITAT remanded the issue back to the AO for fresh determination, which was challenged by the Assessee.

The High Court held that the AO failed to establish a direct nexus between the interest expenditure and the exempt income. The Assessee demonstrated that the interest expenses were related to business loans and not investments. The Court emphasized the need for the AO to record dissatisfaction with the Assessee's claim before applying Rule 8D(2). The AO's failure to do so invalidated the disallowance.

2. Recording of Proper Satisfaction by the AO:
The AO must record dissatisfaction with the Assessee's claim regarding expenditure incurred to earn exempt income, as mandated by Section 14A(2) and Rule 8D(1). The AO's general observations about management decisions and indirect expenses were insufficient. The CIT (A) and ITAT also failed to note the mandatory requirement of recording satisfaction.

The High Court found that the AO did not provide specific reasons for dissatisfaction with the Assessee's claim of ?3 lakhs as administrative expenses. The AO's broad statements did not meet the requirement of examining the Assessee's accounts and recording dissatisfaction. Therefore, the application of Rule 8D(2)(iii) was unjustified.

3. Calculation of Disallowance at 0.5% of Average Value of Investments:
The AO computed disallowance at 0.5% of the average value of investments under Rule 8D(2)(iii), resulting in a disallowance of ?2,08,21,695/-. The Assessee argued that the calculation should be based on the cost of the finance department, which was ?3 lakhs. The CIT (A) upheld the AO's calculation, and the ITAT agreed.

The High Court ruled that the AO's failure to record proper satisfaction invalidated the calculation under Rule 8D(2)(iii). The AO's broad statements did not justify the application of the formula. Therefore, the disallowance should be restricted to the amount provided by the Assessee.

Conclusion:
The High Court allowed the appeals, holding that:
1. The ITAT erred in remanding the matter concerning disallowance of interest under Rule 8D(2)(ii) to the AO.
2. The AO failed to record proper satisfaction under Section 14A(2) and Rule 8D(1), making the calculation under Rule 8D(2)(iii) unjustified.

The Assessee's appeal before the ITAT on the issue of Section 14A read with Rule 8D was allowed, and the Revenue's appeal was dismissed. There was no order as to costs.

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