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TMI Blog2017 (8) TMI 962X X X X Extracts X X X X X X X X Extracts X X X X ..... r 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. - ITA No. 548/2015, & ITA No. 549/2015 - - - Dated:- 23-8-2017 - S. MURALIDHAR PRATHIBA M. SINGH JJ. Appellant Through: Mr. Ajay Vohra, Senior Advocate with Mr. V.P. Gupta and Mr. Arunav Kumar, Advocates. Respondent Through: Mr. Raghvendra Singh and Mr. Rajesh Manchanda, Senior Stan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h dividend was received had been made by it out of its own funds and no borrowed funds had been utilized for the purpose. Accordingly, no interest expenditure had been incurred in relation to earning of exempt income. 7. Furthermore, in regard to the administrative expenses, it was submitted that the income had been earned on units of mutual funds. There were only nineteen entries during the year. It was stated that investments of the Assessee were under the reinvestment schemes. Accordingly, no day-to-day activity was involved in relation to earning of exempt income. Income had been reinvested and accounting entries had been passed in the books of account only on redemption or switching over to another scheme. Nevertheless, the Assessee had made disallowance of ₹ 3 lakhs in the return of income in order to cover administrative expenses which are said to have been incurred in relation to earning of exempt income. 8. In the assessment order dated 27th December 2010, the AO held that, from the three clauses of Rule 8D of the Income Tax Rules, 1962 ( Rules ), it clearly emerges that the stipulation of the provision is to compute the amount of expenditure which is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or any loan utilised for making investments. The interest payments made to ABN Amro Bank and Citibank related to the debit balances in the current accounts with them. They were not relatable to investments made by the company. The Assessee contended that even if pro rata interest out of the above was considered as relatable to exempt income, such expenditure would be covered within the amount of ₹ 3 lakhs offered by the Assessee as disallowance. 11. As regards disallowances on account of administrative expenses, the CIT (A) declined to follow the order earlier issued for the AY 200506. It was held that, for AY 2008-09, the AO was bound to apply Rule 8D of the Rules. The CIT (A) held that the AO was justified in determining the administrative cost at 0.5% of the average value of the investments. Accordingly, disallowance of expenses to the tune of ₹ 2,08,21,695/- was held to be justified. However, the CIT (A) deleted the disallowance of the interest amount of ₹ 6,86,27,884/- on the basis that no term loan had been utilized for making investments. Impugned order of the ITAT 12. Both the Assessee and the Revenue went in appeal before the ITAT against ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deration while computing finally disallowable amount under Section 14A of the Act. Assessee's application before the ITAT 15. An application was filed by the Assessee before the ITAT under Section 254 of the Act for rectification of the impugned order. It was pointed out that the impugned order of the ITAT had wrongly recorded that the CIT (A) had deleted the addition since the Assessee s own capital and interest free funds were more than the investments in securities yielding exempt income. The Assessee pointed out that the CIT (A) ordered the deletion on the basis of a factual holding that no interest bearing funds were utilized by the Assessee during the AY in question for the investments that yielded exempt income. Accordingly, it was prayed that the order of the ITAT be rectified. 16. The above application was dismissed by an order dated 4th December 2015 of the ITAT. The ITAT noted that upon perusal of Schedule 6 of the Annual Accounts of the Assessee for the relevant AY, it transpires that some of such Investments in securities have been made fresh during the year under consideration alone. Therefore, the ITAT disregarded the contention of the Authorize ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to any particular income or receipt, then the interest on loan amount to this extent or in entirety as the case may be, has to be excluded for making computation as per the formula prescribed. Reliance was placed on the decision in Principal Commissioner of Income Tax v. Bharti Overseas Pvt. Ltd. [2016] 237 Taxmann 417 (Del) where it was held that 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. 21. Mr. Vohra referred to the statement given in the accounts, balance sheets etc. for the years ended 31st March 2007 as well as 31st March 2008 and submitted that in the present case it has been accepted by the ITAT, on facts, that the loans had been utilized only for the purpose of business and not for making investment and therefore, no proportionate disallowance was required to be made. Mr. Vohra placed reliance on the decision of the Supreme Court in Godrej Boyce Manufacturing Co. Ltd. v. DCIT [2017] 394 ITR 449 (SC) which held that in case no disallowance was made in earlier years on the ground that no borrowed funds ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .e. ₹ 3 lakhs. Alternatively, it was submitted that for the purposes of Rule 8 D (iii) 0.5% of the average value of investment, in terms of the decision in ACB India Ltd. v. ACIT (2015) 374 ITR 108 (Del) worked out to ₹ 18.24 lakhs and not the exorbitant sum of ₹ 2,08,21,695 as directed by the AO. Submissions on behalf of the Revenue 24. Mr. Raghvendra Singh and Mr. Ashok Manchanda, learned Senior Standing counsel appearing for the Revenue, submitted as under: (i) Section 14 A (2) of the Act read with Rule 8D (1) has two limbs. First, is the exercise of discretion which requires the AO to record satisfaction regarding correctness of the claim of expenditure made by the Assessee. This will have to be determined having regard to the accounts of the Assessee of a previous year. Under the second limb, it is argued that, once such satisfaction has been validly recorded, the AO has no option but to apply the formula in accordance with sub-Rules (2) and (3) of Rule 8D. Reliance was placed on the decisions of this Court in CIT v. Taikisha Engineering India Limited (supra), ACB India Limited v. ACIT (supra) and PCIT v. Bharti Overseas Pvt. Ltd. (supra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act. (3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act: Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001. 26. The 'Memorandum Explaining the Provisions of the Finance Bill, 2001' [2001] 248 ITR (St.) 162, 195, by which Section 14 A was introduced, with retrospective effect from 1st April 1962, stated: Certain incomes are not includible while computing the total income as these ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rred in relation to exempt income against taxable income and at the same time avail of the tax incentive by way of an exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income . . . Expenses allowed can only be in respect of earning of taxable income. This is the purport of section 14A. In section 14A, the first phrase is 'for the purposes of computing the total income under this Chapter' which makes it clear that various heads of income as prescribed in the Chapter IV would fall within section 14A. The next phrase is, 'in relation to income which does not form part of total income under the Act'. It means that if an income does not form part of total income, then the related expenditure is outside the ambit of the applicability of section 14A. 28. In the same decision, the Supreme Court explained that The theory of apportionment of expenditure between taxable and nontaxable has, in principle, been now widened under section 14A. 29. How this apportionment should take place was prescribed under Rule 8D which came to be introduced with effect from 24th March 2008. Rule 8 D reads thus: 8D (1) Where th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is crossed i.e. the stage of the AO recording that he is not satisfied with the clam of the Assessee in the manner indicated i.e. after examining the Assessee's accounts, the question of applying the formula under Rule 8D (2) does not arise. That this is a mandatory pre-requisite for applying Rule 8D (2) is fairly well-settled. 31.1 Illustratively reference may be made to the decision of the Bombay High Court in Godrej Boyce Manufacturing Co. Ltd v. CIT (supra) which was concurred with by this Court in Maxopp Investment Limited v. CIT (supra) and reiterated in Commissioner of Income Tax v. Taikisha Engineering India Limited (supra). 31.2 The Bombay High Court in Godrej and Boyce Mfg. Co. Ltd v. DCIT (supra) upheld the constitutional validity of sub-sections (2) and (3) of Section 14 A of the Act. It was held that Section 14A was applicable to the dividend income earned from mutual funds. The exercise that had to be undertaken by the AO for applying Section 14A was explained thus: What merits emphasis is that the jurisdiction of the Assessing Officer to determine the expenditure incurred in relation to such income which does not form part of the tot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he exercise of the power is predicated . ( M. A. Rasheed v. State of Kerala [1974] AIR 1974 SC 2249 ). A decision by the Assessing Officer has to be arrived at in good faith on relevant considerations. The Assessing Officer must furnish to the Assessee a reasonable opportunity to show cause on the correctness of the claim made by him. In the event that the Assessing Officer is not satisfied with the correctness of the claim made by the Assessee, he must record reasons for his conclusion. These safeguards which are implicit in the requirements of fairness and fair procedure under Article 14 must be observed by the Assessing Officer when he arrives at his satisfaction under sub-section (2) of section 14A. Failure of the AO to record satisfaction 32. The question regarding the failure of the AO to record his dissatisfaction with the correctness of the Assessee's claim regarding administrative expenses of ₹ 3 lakhs arises in ITA 349 of 2015. Mr Raghvendra Singh is not entirely right in his submission that there is no question framed about the failure by the AO to record his satisfaction. In ITA 349 of 2015, the question framed by this Court by the order dated 15 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... direct expenses. It is then stated in para 3.4 that, in view of the above, the provisions of sub-section (2) of Section 14A and Rule 8D of the Rules are in operation and therefore, will strictly be adhered to by the Assessee. In para 3.6 of the assessment order, after discussing Section 14A(1) read with Rule 8D and referring to the decision of the Bombay High Court in Godrej and Boyce Mfg. Co. Ltd v. DCIT (supra), the AO simply stated that in view of the facts and circumstances and legal position on the issue as discussed above, I am satisfied that the Assessee had incurred expenses to manage its investments which may yield exempt income, and Assessee grossly failed to calculate such expenses in a reasonable manner to ascertain to ascertain the true and correct picture of its income and expenses. 37. In the considered view of this Court, the above observations of the AO in the assessment order are of a broad general nature not with particular reference to the facts of the case on hand. 38. The Court is also unable to agree with Mr. Singh that on this aspect there are concurrent findings of both the CIT (A) as well as the ITAT. The CIT (A) disallowed the exempt expenses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e in its letter dated 15th November 2010 in which it specifically stated that investments from where dividend units were received as income was not made out of borrowed fund taken by the company. A reference was made to Schedule 3 of Secured Loans of the audited financials which showed that the Assessee had not taken any new term loans. The balances of term loans as of 31st March 2008 were same as that at 31st March 2007. The term loan from Punjab National Bank was taken in the year 2004-05 and was utilized in repayment of term loan taken from Central Bank of India in the year 2004-05. The term loan from State Bank of India was taken in 2005-06, was utilized in repayment of existing term loans taken from Corporation Bank, State Bank of Patiala and Jammu Kashmir Bank respectively in the year 2005-06 itself. It was stated that term loans are not granted by the banks for making investments in mutual funds and same also cannot be utilities as per the terms of the loans for making investments in mutual funds. Further, an overdraft of ₹ 4,875.63 lakhs taken from the Deutsche Bank was showed under secured loans . From the details filed in Annexure B to the letter in quest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... indicate which part of the interest expense falls in the above category. The decision in Taikisha Engineering 46.1 At this stage it is necessary to examine the decision of this Court in Commissioner of Income Tax v. Taikisha Engineering India Limited (supra). It must be recalled that the ITAT has in the impugned order remanded the matter to the AO on the basis of the said decision. 46.2 In the first place, it requires to be noticed that said decision was in the context of two AYs 2008-09 and 2009-10, and, therefore, the question of applying Rule 8D of the Rules, which was inserted with effect from 24th March 2008, arose for consideration. 46.3 The facts of the case were that, for AY 2008-09, the Assessee had voluntarily disallowed expenditure of ₹ 1,15,000/- under Section 14A of the Act, the calculation for which was submitted before the AO. The AO noted that the voluntary disallowance offered in the return did not fulfil the requirements of Section 14A of the Act read with Rule 8D of the Rules. However, no other reason was indicated. After discussing the decision of the Bombay High Court in Godrej Boyce Mfg. Co. Limited v. CIT (supra), the AO r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for making computation as per the formula prescribed. 47. The above decision does not hold anything contrary to what has been contended by the Assessee in the present case. If indeed the AO had undertaken the exercise as mandated by this Court in Commissioner of Income Tax v. Taikisha Engineering India Limited (supra), he would have come to the conclusion that the interest paid during the AY by the Assessee was entirely towards loans borrowed in earlier years which had not been utilised for making investments that yielded exempt income. However, what is surprising is that the ITAT, by relying on the above observations, thought it fit to remand the matter to the AO for a fresh determination on the ground that the disallowance on account of interest under Rule 8D cannot be deleted simply on the ground that the assessee's capital and interest free funds are more than the funds invested in securities yielding exempt income. 48. In fact, as rightly pointed out by the Assessee, this was not the ground on which the disallowance was deleted by the CIT (A) in the present case. As already noted the CIT (A) ordered the deletion on the basis of a factual holding that no inter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... particularly, in the absence of any new fact or change of circumstances. Further, the Supreme Court held that no basis has been disclosed establishing a reasonable nexus between the expenditure disallowed and the dividend income received. 50.4 The Supreme Court was concerned with AY 2002-03, i.e. prior to Rule 8D being inserted in the statute book. Nevertheless it took note of the changes and observed that this would make no difference to the requirement of the AO having to establish a reasonable nexus between the expenditure disallowed and the dividend income received. What also weighed with the Supreme Court was that the fact that any part of the borrowings of the Assessee had been diverted to earn tax free income despite availability of surplus or interest free funds available.....remains unproved by any material whatsoever. 51. In the present case, the Assessee has been able to demonstrate that the AO has failed to establish any direct nexus between the investments made by the Assessee and the interest expenditure incurred. On the other hand , the Assessee was able to show that any interest expenditure incurred was in respect of various bank loans during the course ..... X X X X Extracts X X X X X X X X Extracts X X X X
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