2017 (2) TMI 647 - HC - Income Tax

Disallowance u/s 14A - application of Rule 8-D - Held that - There would be several instances where an Assessing Officer can come to the conclusion that the claim is incorrect but would be unable to assess the extent of the inaccuracy. That is precisely the purpose of Rule 8D. For instance in the present case, the Assessing Officer was entitled to presume that a part of the expenses from the common fund are attributable to the expenditure incurred for earning the exempt income. He was entitled to resort to Rule 8D without determining the amount expended by the assessee towards earning the exempt income. Indeed if he could have done so, it would not have been necessary for him to resort to Rule 8D at all. In the case before us, the Assessing Officer cannot be faulted for not being satisfied with the claim of the assessee. As we noted earlier the Assessing Officer was entirely justified in presuming that the assessee had incurred expenditure towards administrative activities necessary to earn the exempt income. If the presumption or inference is correct, as we have held it is, the Assessing Officer is entitled to resort to Rule 8D. AO on not being satisfied with the correctness of the claim by the assessee in respect of the expenditure incurred to earn exempt income ought to have applied Rule 8D which he did not. Instead he made an estimate on the basis that he considered to be reasonable. This he was not entitled to do. Where an Assessing Officer is not satisfied with the correctness of the claim of the assessee, in this regard, he is bound by the provisions of sub section (2) of Section 14A to follow the prescribed method which at the relevant time was Rule 8D. - Decided in favour of the Revenue. Whether assessee earned exempt income by investing its own funds and not from the interest bearing funds? - Held that - We leave the question as to whether such a presumption is valid and if valid whether it arises in this case open. The Assessing Officer must determine the same after taking all the provisions of law and the precedents into consideration. If the Assessing Officer justifiably is not satisfied with the correctness of the assessee s claim regarding the expenditure, he must resort to Rule 8D entirely for the determination of the expenditure incurred with respect to the exempt income for the purpose of section 14A. For instance, if the assessee claims that he has not incurred any interest expenditure but has incurred administrative expenses or vice-versa and the Assessing Officer disagrees with either claim, Rule 8D cannot be applied only in respect of any particular clause of sub-rule (2) of Rule 8D. He must then determine the amount of expenditure incurred in relation to exempt income entirely in accordance with Rule 8D. Mr. Klar s submission that Rule 8D(ii) includes amounts other than interest such as bank charges for courier handling etc. is not well founded. Rule 8D(ii) refers only to interest. We cannot read into it words that are clearly not there.

Summary

Issues Involved:
1. Whether the Assessing Officer had recorded satisfaction that the appellant-assessee’s claim was incorrect.
2. Whether the Income Tax Appellate Tribunal had erred in upholding the application of Rule 8-D of the Income Tax Rules, 1962.
3. Whether the Tribunal erred in applying the provisions of Rule 8D(2)(ii) to the interest paid as opposed to the net interest earned by the appellant.

Detailed Analysis:

Issue 1: Recording of Satisfaction by the Assessing Officer
The court examined whether the Assessing Officer (AO) had recorded satisfaction regarding the appellant-assessee’s claim of no expenditure incurred for earning exempt income. The AO had rejected the assessee’s contention that no expenditure was incurred for earning dividend income, noting that the assessee had invested a substantial amount in securities, which required constant monitoring and administrative expenses. The AO concluded that the assessee had deployed sufficient staff and officers to handle its investment portfolio, incurring substantial expenditure for various operations. The court held that the AO had indeed recorded satisfaction that the appellant’s claim was incorrect, thereby justifying the invocation of Rule 8D.

Issue 2: Application of Rule 8-D
The court analyzed whether the Income Tax Appellate Tribunal (ITAT) erred in upholding the application of Rule 8-D. Section 14A of the Income Tax Act, 1961, and Rule 8-D of the Income Tax Rules, 1962, were examined. The court emphasized that the AO can resort to Rule 8D only if he is not satisfied with the correctness of the assessee’s claim regarding the expenditure in relation to exempt income. The court noted that the AO must record reasons for not being satisfied with the assessee’s claim. In this case, the AO had provided cogent reasons, including the administrative expenses involved in managing a large investment portfolio. The court concluded that the ITAT was correct in upholding the application of Rule 8-D.

Issue 3: Application of Rule 8D(2)(ii) to Interest Paid
The court addressed whether the Tribunal erred in applying Rule 8D(2)(ii) to the interest paid as opposed to the net interest earned by the appellant. The court clarified that the application of Rule 8D does not preclude an assessee from contending that no expenditure towards interest was incurred to earn exempt income. The court stated that if the assessee establishes that its interest-free funds were equal to or more than the interest-bearing funds, a presumption arises that the expenditure for earning exempt income was incurred from interest-free funds. The court held that the AO must consider this presumption before applying Rule 8D. The court directed the AO to verify whether any interest expenditure was incurred and to apply Rule 8D accordingly.

Conclusion:
The court disposed of the appeal, answering the questions in favor of the respondent-revenue. The AO was directed to recompute the expenditure under Rule 8D, considering the clarifications provided by the court. The appeal was accordingly disposed of.