RULE 8D IS FOR THE A.O. AND NOT THE ASSESSEE OR THE TAX AUDITOR.

[C.A. DEV KUMAR KOTHARI]

Case of Vishnu Solutions P. Ltd.

Direct expenses like STT of LTCG (with STT), brokerage for selling LTC assets. Can be disallowed.

DP charges may not be disallowed because they are to hold securities and not to earn dividend or capital gain. The gains may be STCG which will be taxable.

There is no interest burden.

The expenses are mostly for STP unit (ITES) which are not considered as exempt in view of declaration field by assessee company.

The disallowance as per Rule 8D is not required because expense incurred are very nominal.

I suggest to prepare a columnar P & L a/c for  taxable income and tax free income. Allocate direct expenses directly and indirect expenses on reasonable Basis .

                        RULE 8D IS FOR THE A.O. AND NOT THE ASSESSEE OR THE TAX AUDITOR.

Applicability of Rule:

The Rule 8D is applicable only when the A.O. is not satisfied that the claim made by the assessee that he has not incurred any expenses to earn exempt income or when the A.O. is not satisfied with the amount of expenses considered by the assessee as inadmissible under section 14A.

This is clear from the following wordings used in the Rule:

8D. (1) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with -

(a) the correctness of the claim of expenditure made by the assessee; or

(b) the claim made by the assessee that no expenditure has been incurred

in relation to income which does not form part of the total income under the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub-rule (2).

From the above highlighted portion it is clear that the Rule is not mandatory on the assessee and tax auditors. The applicability of Rule is attracted only when the A.O. form an opinion of dissatisfaction as to the claim made by the assessee about expenses disallowable under section 14A.

The A.O. has to form an opinion after due consideration of the accounts of the assessee and the claims made by the assessee  for the previous year. Then only the  A.O.  can disallow  expenses in excess of disallowance made by the assessee or he can make a disallowance  even if the assessee has not made any disallowance.

The limit fixed for disallowance is upper limit for indirect or common expenses:

It appears that the amount which can be disallowed by the A.O. by application of Rule 8D is the upper limit for indirect or common expenses. The A.O. can at most disallow such   expenses to that extent. However, where total indirect expenses incurred by the assessee are less than the upper limit of disallowance, the A.O. cannot disallow as per amount worked out as per Rule 8(2).

For example suppose total indirect expenses incurred for general administration are Rs.500000/-. The formulae gives a disallowance of say Rs.1,50,000/-. The simple question is how the A.O. can disallow Rs.1,50,000/- when the assessee has incurred only Rs.50000/-. In such a case the A.O. has to make a reasonable estimate for the amount relatable to earning of tax free income. Suppose the assessee has made a reasonable estimate of Rs. 15000 and disallowed the same, then the A.O. should not generally disturb estimate of the assessee, unless he form an opinion that the real expenses for such income are more than the disallowance made by the assessee.

Responsibility of assessee and the Tax auditor:

The assessee  and Tax Auditors are not bound by Rule 8D. They can work out disallowance on real basis by considering direct expenses as far as possible and by allocating some of indirect or common expenses on some reasonable basis.

Experience:

In practice we find that the assessee might have incurred very nominal amount to earn taxable income. In fact is many cases it has been noticed that total expenses incurred by the assessee , debited in P & L account or claimed otherwise  for all incomes ( taxable and tax free both)  are far less than the amount which can be worked out under Rule 8D. In some cases, it has been noticed that the A.O. has disallowed expenses in excess of the total claim made by assessee.

 Real case of disallowance under section 14A:

The following is relevant portion from a rectification petition filed by an assessee before the A.O. in one of case of excessive disallowance under section 14A by application of Rule 8D:

"I had offered major income as STCG which was taxable under section 111A and not an exempt income. You have held STCG as business income and included the same in taxable income. Therefore, Section 14A is not applicable in respect of short-term investments. D.P. charges are not paid to earn dividend but to hold and carry investment so Section 14A is not applicable. Total administrative expenses debited in my P & L account are just Rs. 41424/- therefore, disallowance of Rs.4,15,510/- under section 14A is wrong and it constitute mistake apparent from records."

In this case the assessee has disallowed (a) full amount of STT and (b)  D.P. charges in relation to long-term capital gains, which were claimed exempt. Learned A.O. considered all capital gains (STCG and LTCG) as business income and imposed tax. In spite of that learned A.O. also made disallowance under section 14A which is more than ten times of total expenses claimed by assessee.

The assessee had to file rectification petition as well as appeal.    

The above example is an eye opener as to how wrongly Rule 8D is being practiced by the officers in making arbitrary disallowances.

Requirement of Tax auditor reporting  in  For 3CD:

Vide Paragraph 17 (l) the following information is to be reported in tax audit report:

"amount of deduction inadmissible in terms of section 14A in respect of the expenditure incurred in relation to income which does not form part of total income"

As observed earlier, the assessee and the tax auditor are not bound by Rule 8D. They can consider direct expenses, like security transaction tax and   brokerage for disallowance against long term capital gains (with STT) ,  fully and indirect expenses on some reasonable basis, for working out the amount disallowable.

If there is borrowing costs and some borrowed funds are used for earning exempted income, then only a reasonable estimate can be made for disallowance of borrowing costs and not otherwise.

[Method for determining amount of expenditure in relation to income not includible in total income.

8D. (1) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with -

(a) the correctness of the claim of expenditure made by the assessee; or

(b) the claim made by the assessee that no expenditure has been incurred

in relation to income which does not form part of the total income under the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub-rule (2).

(2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely:—

(i) the amount of expenditure directly relating to income which does not form part of total income;

(ii) in a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely :—

Ax	B
	C

Where A =       amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year ;

B=     the average of value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year ;

C=    the average of total assets as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year ;

(iii)       an amount equal to one-half per cent of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year.

3. For the purposes of this rule, the 'total assets' shall mean, total assets as appearing in the balance sheet excluding the increase on account of revaluation of assets but including the decrease on account of revaluation of assets.]

 

1a. Inserted by the IT (Fifth Amdt.) Rules, 2008, w.e.f. 24-3-2008.