2020 (7) TMI 211 - AT - Income Tax

Rectification of mistake u/s 154 - Disallowance u/s 14A r.w.r. 8D - Debatable issue or not? - disallowance made by an Assessee in not accordance with Rule-8D(2)(iii) - Addition of expenditure incurred in earning exempt income - HELD THAT - Even in a case where the AO rejects the claim of the Assessee regarding expenses incurred to earn the exempt income, it is not mandatory for him to invoke the method of calculation prescribed by Rule 8D(2) of the Rules and is free to make the disallowance on any reasonable basis. It is only when no reasonable and proper parameters for making disallowance can be arrived at, that resort to Rule 8D(2) can be had by the AO. Rule 8D(2) will thus be a last resort when it becomes impossible to arrive at a just conclusion on the amount of expenses that has to be disallowed as attributable or incurred in earning exempt income. The satisfaction contemplated u/.s 14A (2) of the Act is not merely restricted to rejecting the claim made by the Assessee and the disallowance to be made u/s 14A of the Act but also includes substituting the claim made by the Assessee on any other reasonable basis as the AO deems it fit. In such circumstances the correctness of the AO s judgment can be reviewed but it cannot be said that the AO had no jurisdiction to do so and AO ought to resort only to the provision of Rule 8D of the Rules. In other words Rule 8D is not automatic and can be resorted to by the AO only as a measure of last resort. In view of the aforesaid legal position with regard to disallowance u/s 14A of the Act, we are of the view that the issue before the AO was debatable and therefore, resort to proceedings u/s 154 of the Act was not appropriate. Appeal of the Assessee is allowed.

Summary

Issues Involved:
1. Justification of disallowance of ?41,48,681/- as expenditure incurred in earning exempt income under Sec.14A of the Income Tax Act, 1961.
2. Appropriateness of invoking Sec.154 of the Income Tax Act for rectification.

Issue-wise Detailed Analysis:

1. Justification of Disallowance under Sec.14A:
The core issue in the appeal was whether the revenue authorities were justified in disallowing ?41,48,681/- as expenditure incurred to earn exempt income by invoking Sec.14A of the Income Tax Act, 1961. The Assessee, a Pvt. Ltd. Company, had declared dividend income from mutual funds amounting to ?4,04,38,466/-, which was exempt under Sec.10(38). The Assessee had initially disallowed administrative expenses of ?3,55,660/- against the exempt income under Sec.14A. However, the AO, during rectification proceedings under Sec.154, recalculated the disallowance as ?45,04,341/- using Rule 8D(2)(iii) and added the difference of ?41,48,681/- to the total income.

The Assessee argued that the AO did not provide an opportunity for a hearing and that the issue of disallowance under Sec.14A was debatable. The Assessee contended that the methodology adopted for disallowance was conservative and inclusive of all related administrative expenses. The CIT(A) disagreed, stating that the disallowance had to be made as per Rule 8D(2)(iii) and was not debatable.

The Tribunal referred to the Supreme Court's decision in CIT Vs Maxopp Investments Ltd., which emphasized that the AO must record satisfaction regarding the incorrectness of the Assessee's disallowance before applying Rule 8D. The Tribunal concluded that the AO must follow Sec.14A(2) and examine the Assessee's claim based on the books of accounts. If dissatisfied, the AO can resort to Rule 8D as a last measure. The Tribunal held that the issue was debatable, making the rectification under Sec.154 inappropriate.

2. Appropriateness of Invoking Sec.154:
The Tribunal assessed whether the AO's initiation of rectification proceedings under Sec.154 was appropriate. The Assessee argued that the quantum of disallowance under Sec.14A was a debatable issue and outside the purview of Sec.154, which is meant for rectifying apparent mistakes. The Tribunal agreed, noting that the issue required examination and satisfaction by the AO regarding the Assessee's disallowance methodology. The Tribunal highlighted that Rule 8D should be used only when no reasonable basis for disallowance is found, and the AO must record satisfaction before applying it.

The Tribunal concluded that the proceedings under Sec.154 were inappropriate for addressing the debatable issue of disallowance under Sec.14A. Consequently, the rectification order was quashed.

Conclusion:
The Tribunal allowed the Assessee's appeal, holding that the rectification proceedings under Sec.154 were not appropriate for the debatable issue of disallowance under Sec.14A. The order pronounced on 03-07-2020 quashed the rectification proceedings and upheld the Assessee's initial disallowance.