1. Issue for consideration: S. 14A
provides for disallowance of an expenditure incurred in relation to an
income which does not form part of the total income under the Act.
Ss.(1) of the said Section reads as under:
“For the purposes of
computing the total income under this Chapter, no deduction shall be
allowed in respect of expenditure incurred by the assessee in relation
to income which does not form part of the total income under this Act.”
Ss.(2) and Ss.(3) inserted by the Finance Act, 2006 w.e.f. 1-4-2007,
are held to be prospectively applicable w.e.f. A.Y. 2007-08 by the
Bombay High Court in the case of Godrej and Boyce Mfg. Co. Ltd., 328 ITR
81. These provisions provide for the manner of determination of the
amount of expenditure liable for disallowance in accordance with the
prescribed method and vests the government with the power to prescribe
the rules for computation. In pursuance of this power, Rule 8D has been
introduced by Notification dated 24-3-2008 which is held to be
prospectively applicable from A.Y. 2008-09 onwards, by the said decision
in the case of Godrej and Boyce Mfg. Co. Ltd. (supra).
Ss.(3)
of the said Section provides that the provisions of Ss.(2) shall apply
even in cases where an assessee claims that no expenditure has been
incurred by him in relation to an exempt income.
The Punjab and
Haryana High Court in some of the cases has held that no disallowance
u/s.14A was possible where the nexus between the expenditure claimed and
the exempt income was not established and where there was no finding by
the AO, of the assessee having incurred expenditure for earning an
exempt income. This finding of the Punjab and Haryana High Court
requires to be tested and considered afresh in view of the observations
of the Bombay High Court in its recent decision.
2. Hero Cycles Ltd.’s case:
In CIT v. Hero Cycles Ltd., 323 ITR 518 (P & H), the Revenue for
the A.Y. 2004-05 raised the following substantial question of law:
“Whether on the facts and in law, the Tribunal was legally justified in
deleting the disallowance of Rs.3,48,04,375 u/s.14A of the Income-tax
Act, 1961 by ignoring the evidence relied on by the AO and holding that a
clear nexus has not been established that the interest-bearing funds
have been vested for investments generating tax-free dividend income?”
In that case, the assessee was engaged in manufacturing of cycles and
parts of two-wheelers in multiple units. It earned dividend income,
which was exempted u/s.10(34) and u/s.(35). The AO made an inquiry
whether any expenditure was incurred for earning this income and as a
result of the said inquiry addition was made by way of disallowance
u/s.14A(3), which was partly upheld by the CIT(A). The Tribunal held
that there was no nexus with the expenditure incurred and the income
generated and recorded as under:
“We have perused the same and
find that the plea of the assessee that the entire investments have been
made out of the dividend proceeds, sale proceeds, debenture redemption,
etc., is borne out of record. In fact the CIT(A) has also come to a
categorical finding that insofar as other units are concerned, none of
their funds have been utilised to make the investments in question. One
aspect which is evident that the interest income earned by the main
unit, Ludhiana, exceeds the expenditure by way of interest incurred by
it, thus obviating the application of S. 14A of the Act. Even with
regard to the funds of the main unit, Ludhiana the funds flow position
explained shows that only the non-interest bearing funds have been
utilised for making the investments. At pp. 3 to 6 of the paper book are
placed the details of the bank accounts, wherein the amount of
dividend, sale proceeds of shares, debenture redemption, etc. have been
received and later on invested in the investments in question. Such
funds are ostensibly without any burden of interest expenditure. Thus,
on facts we do not find any evidence to show that the assessee has
incurred interest expenditure in relation to earning the tax-exempt
income in question. We find that all the details in question were
produced before the AO and the CIT(A) also. The entire evidence in this
regard, which is submitted before the lower authorities have been
compiled in the paper book, to which we have already adverted to in the
earlier part of the order. Therefore, merely because the assessee has
incurred interest expenditure on funds borrowed in the main unit,
Ludhiana, it would not ipso facto invite the disallowance u/s.14A,
unless there is evidence to show that such interest-bearing funds have
been invested in the investments which have generated the ‘tax-exempt
dividend income’. As noted earlier, there is no nexus established by the
Revenue in this regard and therefore, on a mere presumption, the
provisions of S. 14A cannot be applied. Thus, we find that the CIT(A)
erred in partly sustaining the addition. In fact, in the absence of such
nexus, the entire addition made was required to be deleted. We
accordingly hold so.”
The counsel for the Revenue relied upon
S. 14A(3) and Rule 8D(1)(b) to submit that even where the assessee
claimed that no expenditure had been incurred, the correctness of such
claim could be gone into by the AO and in the present case, the claim of
the assessee that no expenditure was incurred was found to be not
acceptable by the AO and thus disallowance was justified.
The
Court was unable to accept the submission in view of finding that the
expenditure on interest was set off against the income from interest and
the investments in the shares and mutual funds were out of the dividend
proceeds. In view of this finding of fact, the High Court held that
disallowance u/s.14A was not sustainable. It observed that whether, in a
given situation, any expenditure was incurred which was to be
disallowed, was a question of fact. The Court rejected the contention of
the Revenue that directly or indirectly some expenditure was always
incurred which must be disallowed u/s.14A, and the expenditure so
incurred could not be allowed to be set off against the business income
which may nullify the mandate of S. 14A. It held that the disallowance
u/s.14A required finding of incurring of expenditure; where it was found
that, for earning exempted income, no expenditure had been incurred,
disallowance u/s.14A could not stand. In the case before the Court, the
finding on this aspect, against the Revenue, was not shown to be
perverse. Consequently, disallowance was held to be not permissible. The
Court relied upon the view earlier taken by the Court in IT Appeal No.
504 of 2008, CIT v. Winsome Textile Industries Ltd., decided on 25th
August, 2009, wherein it was observed as under :
“Contention
raised on behalf of the Revenue is that even if the assessee had made
investment in shares out of its own funds, the assessee had taken loans
on which interest was paid and all the money available with the assessee
was in common kitty, as held by this Court in CIT v. Abhishek
Industries Ltd., (2006) 205 CTR (P&H) 304; (2006) 286 ITR 1
(P&H) and therefore, disallowance u/s.14A was justified. We do not
find any merit in this submission. Judgment of this Court in Abhishek
Industries (supra) was on the issue of allowability of interest paid on
loans given to sister concerns, without interest. It was held that
deduction for interest was permissible when loan was taken for business
purpose and not for diverting the same to sister concern without having
nexus with the business. Observations made therein have to be read in
that context. In the present case, admittedly, the assessee did not make
any claim for exemption. In such a situation, S. 14A could have no
application.”
The Punjab and Haryana High Court held that no
substantial question of law arose for consideration in the appeal filed
by the Revenue.
3. Godrej and Boyce Mfg. Co. Ltd.’s case:
The issue of disallowance u/s.14A was recently examined in detail by
the Bombay High Court in the case of Godrej and Boyce Mfg. Co. Ltd. v.
CIT, 328 ITR 81. In that case the assessee had claimed a dividend of
Rs.34.34 crore as exempt from the total taxable income u/s.10(33) for
A.Y. 2002-03 by claiming that no expenditure was incurred in relation to
the said dividend income. The AO was of the view that if the assessee
had not made investments in these securities, it would not have been
required to borrow funds to that extent and consequently, the interest
burden could have been reduced. On this basis, the AO concluded that a
part of the interest payment of Rs.51.71 crore, claimed as deduction,
pertained to funds utilised for the purpose of investment in shares to
the extent of Rs.6.92 crore and disallowed the said amount by resorting
to the provisions of S. 14A. The CIT(A) relying on the decisions for the
earlier years held that no expenditure was incurred for earning the
dividend income. The Tribunal however restored the matter to the file of
the Assessing Officer to verify whether any expenditure besides
interest was incurred for the year in relation to the said dividend
income.
On the above facts, several questions were raised for
consideration of the High Court by the company, which inter alia
required the Court to examine the need for establishing the nexus of an
expenditure claimed with that of the exempt income.
It was
contented by the company in the context that no expenditure was incurred
by it in relation to the said dividend income and the interest claimed
by it pertained to earning of the taxable income and that the investment
in shares on which dividend was received was made out of own funds and
therefore no disallowance was possible u/s.14A read with or without Rule
8D. It was further contended that the Tribunal was in error in
restoring the matter back to the file of the Assessing Officer for
examining the facts afresh, as the facts during the year were the same
as were prevailing in the earlier years for which the disallowance was
deleted.
The Revenue countered the contentions of the company
by stating that the provisions of S. 14A, in particular of Ss.(3), were
applicable to the case of a company where a claim was made by the
company that no expenditure was incurred by the company in relation to
the said dividend income. The Bombay High Court, in the context,
observed in paragraphs 25 and 69 to 73 of the judgment that once the
Assessing Officer was satisfied about the fact that some expenditure was
incurred in relation to the income not included in the total income, it
was mandatory for him to disallow an appropriate amount computed under
Rule 8D. It noted that Ss.(3) covered a case where the assessee claimed
that no expenditure was made in relation to the concerned income. The
Court held that the claim of the assessee that no expenditure was
incurred was required to be examined by the Assessing Officer,
irrespective of the finding of fact in earlier year that investment in
the shares was made out of the company’s own funds, inasmuch as some
expenditure besides interest could have been incurred and such a
possibility was not examined by the Assessing Officer. Lastly, the Court
held that irrespective of Rule 8D, the Assessing Officer was entitled
to apportion an indirect expenditure by virtue of S. 14A (1) itself and
once a proximate nexus was established, a disallowance by resorting to
apportionment of an expenditure claimed was permissible in law.
4. Observations:
The decision of the Punjab & Haryana High Court was for A.Y.
2004-05, while that of the Bombay High Court was for A.Y. 2002-03.
Admittedly, the benefit of the provisions of S. 14A(2) and (3) and Rule
8D was not available to the Courts, where those provisions are accepted
to be prospective in their application. Under the circumstances,
irrespective of the relevance of the issue being examined for and from
A.Y. 2008-09, the same would continue to be relevant for assessment
years up to A.Y. 2007-08. Accordingly, for a valid disallowance for
those years, the Assessing Officer should have established that an
expenditure was incurred for earning the income not included in the
total income and should have further established nexus of such
expenditure to the income not included in the total income. The issue,
in our opinion, however continues to be relevant even for A.Y. 2008-09
and onwards.
It is true that Ss.(3) provides expressly for
applicability of S. 14A even in cases where an assessee claims that no
expenditure has been incurred. But then, it is equally true that Ss.(2)
specifically provides that an AO shall proceed to determine the amount
of disallowance only if he is not satisfied with the correctness of the
claim of the assessee that no expenditure was incurred by him in
relation to an exempt income. In doing so, the Assessing Officer shall
be required to establish the nexus of the expenditure sought to be
disallowed with the income not included in total income before
quantifying the disallowance as per Rule 8D.
Even the Bombay
High Court in Godrej & Boyce’s case (supra) has confirmed that
satisfaction of the AO is an essential pre-condition for applicability
of S. 14A and of Rule 8D and it is for achieving this satisfaction that
the Court restored the case to the file of the Assessing Officer. In
fact, even Rule 8D requires such satisfaction by the AO before
permitting him to compute the amount of disallowance.
The stand
of the Income-tax Department that applicability of the formula under
Rule 8D is irrespective of absence of expenditure and that a
disallowance of an amount computed as per Rule 8D is mandatory, appears
to be incorrect. Irrespective of the assessment year involved, the
finding by the AO that some expenditure in relation to an exempt income
was incurred by the assessee would be essential for invoking the
provisions of S. 14A, more so, in cases where an assessee has claimed
that he has not incurred any expenditure. It is in the context of the
continued validity of this proposition, that the case for reading down
clause (iii) of sub-rule (2) of Rule 8D continues to be meritorious, as
the said clause (iii) provides for an ad-hoc disallowance independent of
nexus of an expenditure sought to be disallowed to an income not
included in the total income.
It will be equally incorrect for
the Income-tax Department to solely rely on the provisions of Clause
(iii) of sub-Rule (2) of Rule 8D to advance the case of disallowance by
stating that the amount computed thereunder is deemed to be an
expenditure incurred in relation to an exempt income. The need for nexus
continues to be of relevance. Further, it is well settled that a rule
cannot travel beyond the provisions of the Section under which it falls.
The decisions of the Punjab & Haryana High Court, to the effect
that S. 14A requires a finding by the AO of having incurred some
expenditure before the disallowance can be made, continues to be of
significant relevance.
