2018 (12) TMI 1145 - HC - Income Tax

Disallowance u/s.14A r.w.r. 8D - Held that - The exposition of law made by the Supreme Court in case of S. A. Builders 2006 (12) TMI 82 - SUPREME COURT and observation made therein have been applied by this court on various occasions, particularly in connection with the disallowance to be made under Section 14A of the Act. It has been held that if the assessee can demonstrate availability of surplus interest free funds for making investment generating tax free income, disallowance under Section 14A of the Act would not be justified. As decided in assessee s own case Section 14A read with Rule 8D could be applied only after the Assessing Officer is not satisfied with the claim of the assessee regarding the expenditure 2017 (9) TMI 531 - GUJARAT HIGH COURT The judgment in case of Maxopp Investment Ltd. 2018 (3) TMI 805 - SUPREME COURT OF INDIA does not lay down a proposition that the moment it is demonstrated that the assessee had availed of mixed funds i.e. interest free as well as interest bearing funds and utilized them for making investments into securities earning tax free income and the rest applicability of the Section 14A read with Rule 8D would be automatic. - Decided against revenue

Issues Involved:
1. Disallowance under Section 14A of the Income Tax Act.
2. Application of Rule 8D(2)(iii) of the Income Tax Rules, 1961.
3. Satisfaction of the Assessing Officer regarding the correctness of the assessee's claim.

Detailed Analysis:

1. Disallowance under Section 14A of the Income Tax Act:
The primary issue pertains to whether the Income Tax Appellate Tribunal (ITAT) erred in not upholding the disallowance under Section 14A made by the Assessing Officer (AO). The AO observed that the assessee had earned a dividend income of ?1.24 crores, which was claimed as exempt under Section 10(34) of the Income Tax Act. The assessee had voluntarily added back ?1 lac as disallowance under Section 14A for administrative expenses incurred in earning the exempt income. However, the AO was not satisfied with this calculation and issued a notice for further disallowance under Section 14A read with Rule 8D.

2. Application of Rule 8D(2)(iii) of the Income Tax Rules, 1961:
The AO applied Rule 8D(2)(iii) to determine the disallowance, arguing that the assessee had mixed funds (both interest-bearing and interest-free) and could not establish a clear correlation between the funds and the investments. The AO contended that the business funds and investment funds were mixed, and thus, it was reasonable to apportion the interest burden between tax-free and taxable income activities. The CIT (Appeals) provided partial relief, sparing the assessee from disallowance to the extent that interest-free funds were used for investments yielding tax-free income. However, the Tribunal deleted the entire disallowance, emphasizing that the AO must record specific satisfaction before resorting to disallowance under Section 14A read with Rule 8D.

3. Satisfaction of the Assessing Officer regarding the correctness of the assessee's claim:
The Tribunal referred to earlier judgments, noting that the AO must record specific satisfaction that the assessee's claim of expenditure is inadequate before applying Rule 8D. The Tribunal held that the application of Rule 8D is not automatic and requires the AO's satisfaction regarding the correctness of the assessee's claim. The Revenue argued that the assessee had mixed funds and could not establish a clear correlation, justifying the AO's application of Rule 8D. However, the Tribunal maintained that the AO's satisfaction is a prerequisite for applying Rule 8D.

Relevant Judgments and Legal Principles:
1. Supreme Court in S. A. Builders Ltd. vs. CIT (2007): The Court held that once a nexus between expenditure and the purpose of business is established, the Revenue cannot dictate the reasonableness of the expenditure. The principle of commercial expediency must be considered.

2. High Court's earlier judgment in the assessee's case: It was held that if the assessee demonstrates the availability of surplus interest-free funds for investments generating tax-free income, disallowance under Section 14A is not justified.

3. Supreme Court in Maxopp Investment Ltd. vs. CIT (2018): The Court held that the purpose of investment (e.g., gaining control over a company) is inconsequential as long as the investment generates tax-free income. The judgment also emphasized that the AO must record satisfaction before applying Rule 8D.

4. Punjab & Haryana High Court in M/s. Max India Ltd.: The Court held that if the assessee has sufficient interest-free funds to cover investments, the presumption is that these funds were used for tax-free income investments.

5. Gujarat State Fertilizer and Chemicals Ltd.: The Court reiterated that if the assessee has sufficient surplus interest-free funds, disallowance under Section 14A is not permissible. This principle has been consistently applied in subsequent years.

Conclusion:
The High Court dismissed the Revenue's appeals, upholding the Tribunal's decision to delete the disallowance under Section 14A. The Court emphasized that the AO must record specific satisfaction regarding the inadequacy of the assessee's claim before applying Rule 8D. The decision aligns with earlier judgments and legal principles, affirming that disallowance under Section 14A is not automatic and requires the AO's satisfaction. The judgment of the Supreme Court in Maxopp Investment Ltd. does not alter the fundamental requirement of the AO's satisfaction before applying Rule 8D.

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