AI Insights
The case involves Yesha Electricals P. Ltd., which appealed against the order of the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre, Delhi, concerning the disallowance of expenses related to earning exempt income under Section 14A of the Income Tax Act, 1961. The primary issue was whether the AO was justified in invoking Rule 8D for computing disallowance without first satisfying the conditions set out in Section 14A(2). The Tribunal examined the procedural compliance of the AO in invoking Rule 8D and found that the AO's dissatisfaction with the assessee's claim was not based on a thorough examination of the accounts, but rather on general observations.
Appeal details
Counselvise Citation
[2023] 140 COUNSELVISE.COM (IT) 133469 (ITAT-AHMEDABAD)
Assessee PAN
Bench
Appeal Number
Duration Of Justice
8 month(s) 17 day(s)
Appellant
Respondent
Appeal Type
Income Tax Appeal
Pronouncement Date
26-09-2023
Appeal Filed By
Assessee
Order Result
Allowed
Bench Allotted
A
Next Hearing Date
20-09-2023
Assessment Year
2017-2018
Appeal Filed On
08-01-2023
Judgement Text
आयकर अपीलीय अिधकरण आयकर अपीलीय अिधकरणआयकर अपीलीय अिधकरण आयकर अपीलीय अिधकरण, अहमदाबाद 瀈यायपीठ अहमदाबाद 瀈यायपीठअहमदाबाद 瀈यायपीठ अहमदाबाद 瀈यायपीठ ‘A’ अहमदाबाद। अहमदाबाद।अहमदाबाद। अहमदाबाद। IN THE INCOME TAX APPELLATE TRIBUNAL “A” BENCH, AHMEDABAD BEFORE SMT.ANNAPURNA GUPTA, ACCOUNTANT MEMBER AND SHRI T.R.SENTHIL KUMAR, JUDICIAL MEMBER ITA No.15/Ahd/2023 Assessment Year :2017-18 Yesha Electricals P.Ltd. C-2/18, Industrial Estate, Gorwa Vadodara 390 016 PAN : AAACY 0661 L Vs. ITO, Ward-2(1)(3) Vadodara. (Applicant) (Responent) Assessee by : Shri M.J. Shah, AR with Rushin Patel & Jimi Patel, ARs. Revenue by : Ms.Saumya Pandey Jain, Sr.DR स ु नवाई क तार ख/D a t e o f H e a r i n g : 2 1 / 0 9 / 2 0 2 3 घोषणा क तार ख /D a t e o f P r o n o u n c e m e n t : 2 7 / 0 9 / 2 0 2 3 आदेश/O R D E R PER ANNAPURNA GUPTA, ACCOUNTANT MEMBER This appeal has been filed by the assessee against order passed by the ld.Commissioner of Income Tax(A), National Faceless Appeal Centre (NFAC), Delhi dated 7.12.2022 passed under section 250 of the Income Tax Act, 1961 [hereinafter referred to as "the Act" for short]for the Asst.Year 2017-18. 2. The assessee has raised the following ground: “The ld.CIT(A) has erred in law and on facts of the case in upholding the action of the AO of involving the provisions of section 14A r.w.r. 8D.” ITA No.15/Ahd/2023 2 3. As is evident from the grounds before us, the solitary grievance raised by the assessee relates to the disallowance of expenditure incurred in relation to earning exempt income under the provisions of section 14A of the Act. 4. Brief facts pertaining to the issue are that the; • assessee had earned exempt income by way of dividend amounting to Rs.2,28,32,577/- • had disallowed expenses u/s 14A of the Act suo moto of Rs.6,56,966/- • its total non current investments as reflected in its audited accounts were Rs.96,88,65,627/- and current investments in Mutual Funds , PMS and Equity was Rs.1,57,77,486/- • Expenses held disallowable by the AO by invoking Rule 8D of the Rules, and confirmed by Ld.CIT(A) Rs.46,80,510/- resulting net disallowance of Rs.40,23,544/- after taking into account suo moto disallowance made by the assessee. 5. Argument of the ld.counsel for the assessee before us was that the AO had invoked Rule 8D of the Income Tax Rules, 1962 (“Rules” in short)for the purposeof computing disallowance of expenses under section 14A of the Act without first complying with conditions set out in section 14A(2) of the Act for invoking Rule 8D of the Rules. To put in other words, his contention was to the effect that the provisions of section 14A require that Rule 8D can be invoked only in a situation when the AO is dissatisfied with the claim of the assessee regarding expenses incurred for earning exempt income, and his dissatisfaction has to be an objective satisfaction arrived at after considering the accounts of the assessee. He contended that ITA No.15/Ahd/2023 3 there was a plethora of judgments in this regard of the Hon’ble courts including the decision of Hon’ble Apex Court in the case of Maxopp Investment Ltd. CIT, (2018) 402 ITR 640 (SC) laying down the law that the satisfaction of the AO ,that the assessee’s claim of expenses pertaining to exempt income is not correct,is a pre- requisite for invoking Rule 8D of the Rules for computing the quantum of disallowance to be made under section 14A of the Act. The ld.DR did not dispute this proposition of law. 6. The dispute in the present case is only vis a vis existence of such satisfaction so as to justify invoking Rule 8D of the Rules for computing disallowance of expenses u/s 14A of the Act. In this regard our attention was drawn to the explanation offered by the assessee regarding its claim of expenditure pertaining to earning of exempt income, which is reproduced at page no.2 to 4 of the assessment order as under: Applicability of Section 14A. "Without Prejudice It is pertinent to note that ours is a cash rich company and having sufficient surplus fund as part of reverses and surplus. It is also pertinent to note that net profit before tax for the year under consideration is Rs. 10,18,89,208/- which works out to be 67.61 0% of turnover Rs.15,07,06,227/-). Further please also note that against all the investments, we have not earned dividend income. In fact, while filing tax return, we have worked out disallowance u/ s 14A of the Act. The same is worked out as under. Expenditure directly related to income which Does not form part of Total Income : Management Fees charged by PMS: Rs. 7,80,927/- Demat charges Rs. 7,725/- Expenditure not directly related to income which Does not form part of Total Income based on estimate by The Assessee : 5% of Mg Director Remuneration Who is taking investment decision Rs.3,01,124/- ITA No.15/Ahd/2023 4 Telephone expenditure used for Investment purpose Rs. 6,027/- Accountant Salary Rs. 7,67,769/- Total Rs. 6,56,966/- The said methodology of making disallowance u/s 14A of the Act as % of such income which does not form part of total income has been accepted in a way also in earlier years. Further, it is to be noted that for making investments, there need not be involvement of other man-power, telephone and stationery etc. Such expenditure are fixed in nature and do not have any linkage with investment activities. On the contrary attributable expenditure towards investments activities incurred by Portfolio managers and cost from our end is disallowed by us. It is further stated in the instant case it is necessary to examine whether Section 14 A is correctly applied or not. Section 14A speaks about the non availability of expenses incurred in relation to income which does not form part of the total income. In the case no expenditure is incurred in relation to income which is exempt except as disallowed voluntarily while furnishing return of income. In the instant case no expenditure incurred in relation to income which is exempt except as disallowed voluntarily while furnishing return of income. The intention of the legislature was that no deduction for expenditure incurred in respect of exempt income against taxable income. If we reiterate, the intention of the legislature is that no deduction is allowable against the income from taxable business, in respect of any expenditure incurred by the assessee in relation to income, which does not form part of the total income. In the above context it is very much clear that the legislature wants to tax expenditure incurred in relation to income which is exempt from tax. In our case of, no such expenditure has been incurred for earning exempt income except voluntarily disallowed. Under section, 14A Sub-Section (2) provides the procedure for determining the amount of expenditure incurred by the assessee in relation to such income which does not form part of the total income if the A.O. is not satisfied with the correctness of claim of assessee in respect of such expenditure. Sub-Section (3) further provides that the provisions of Sub-Section (2) shall apply in relation to a case where an assesses claims that the expenditure incurred by the assessee and A.O. is not satisfied with the contention of the assessee. Further, the procedure for determining the amount of expenditure incurred in relation to the exempt income is to be worked out in accordance with Rule 8D. On going through the above, it is clearly noticed that the purpose of these two Sub-Sections is to determine the amount of expenditure incurred in relation to exempt income. These only lay down the procedure and mechanism for working out the expenditure in relation to income which is exempt from tax. Rule 8D has been enshrined to the Income Tax Rules, 1962 which prescribes the method by which the A. O. has to determine the disallowance of expenditure as relatable to exempt income in terms of Sub- ITA No.15/Ahd/2023 5 Section (2) and (3) providing the mechanism to do what is provided in SubSection (1), can be construed as substantive and hence prospective expenditure incurred in relation to exempt income. We further submit that Sec. 14A talks of the relation between the expenditure and the exempt income:- The contention is that one has to view the items of expenditure first. If these have resulted in exempt income, only then disallowance is to be considered. ; In other words, starting point for applying Section 14A is to consider the amount of f expenditure and then moving forward for examining if it has resulted in the exempt income or not, Unless there is a direct and proximate connection between income and expenditure, Section 14A will not apply. It is very much clear from the forgoing discussion that unless there is a direct and proximate connection between expenditure and the exempt income, there cannot be any disallowance of the expenditure under this section. This view point is based on the expression 'in relation to' used in section as having only direct and proximate connection between the expenditure and exempt income. Be that as it may, we would also deal with the contention that there should be a dominant and immediate connection between the expenditure incurred and the exempt income so as to make disallowance U/s 14A. A great deal of emphasis has been laid on establishing of dominant and immediate connection between the expenditure incurred and the exempt income. Dominant and immediate connection refers to first degree of relation between the two things. However, it would cease to be dominant if the degree of relationship slips from first to second. With the foregoing discussion, it is very much clear that no further disallowance should be made u/s 14A of the Act as specially considering fact that all the investments have not yielded dividend income.” 7. Thereafter, our attention was drawn to the satisfaction recorded by the AO that he was not convinced with claim of the assessee, and Rule 8D therefore not to be invoked. At para-4.1 of the order is as under: “4.1 The assessee's reply has-been considered but it is not acceptable for the following reasons: 1. Investment decisions are very complex in nature. They require substantial market research, day to day analysis of market trends and decisions with regard to acquisition, retention and sale of shares at the most appropriate ITA No.15/Ahd/2023 6 time. They require huge investments in shares and consequential blocking of funds. (ii) It is well known that capital has cost and that element of cost is represented by interest. It is therefore not correct to say that dividend income can be earned by incurring no or nominal expenditure. (iii) Had this money been not invested into various instrument from which assessee will have /had exempt income then it would have been available to the assessee for its business purposes and to that extent it may not have been necessary to borrow from the banks. And it is not out place to mention that as assessee claims that it had surplus funds then why need of borrowing arose for business purpose as claimed by assessee itself. .Moreover, it cannot be said that because, in the concerned assessment year investment came only out of the profit. The actual financial liquidity position on the relevant date has to be established by the assessee. Section 106 of the Indian Evidence Act or the principles analogous thereto places the burden in respect thereof upon the assessee, as the facts are within its special knowledge. The determinative question in a case of this nature is the source from which the assessee makes investments or advances. Where an assessee seeks to deduct certain items from his business profits, the onus of proving the same falls on him. The burden of proving a claim to an allowance or deduction is on an assessee. The assessee has denied any interest expenditure in its disallowance hence its calculation cannot be accepted. (iv) The monies received as share capital, as term loan, as working capital loan, as sale proceeds etc. do not have any different colour. Whatever are the receipts in the business, that have the colour of business receipts and have no separate identification. Sources has no concern whatsoever. The only thing sufficient to disallow the interest paid on the borrowing to the extent the amount is lent to sister concern without carrying any interest for non-business purposes would be that the assessee has some loans or other interest bearing debts to be repaid. In case the assessee had some surplus amount which, according to it, could not be repaid prematurely to any financial institution, still the same is either required to be circulated and utilised for the purpose of business or to be invested in a manner in which it generates income and not that it is diverted towards sister concern free of interest.' CIT Vs Abhishekh Industries Ltd (2006) 280 ITR 1 ( P& H) (v) The Hon'ble Jurisdictional High Court in the case of Godrej & Boyce Mfg. Co.Ltd, reported in (2010) 328 ITR 81 (Bom) has categorically held that Rule 8D r.w.s. 14A is not arbitrary or unreasonable but can be applied only if assessee's method is not satisfactory. The Hon'ble Court also held that from Assessment Year 2008-09 provisions of Rule 8D will apply. The court further held that Section 14A is founded on the valid rationale that the basic principle of taxation is to tax net income i.e. gross income minus expenditure. The Hon'ble court further elaborated that once a proximate cause for disallowance is established - which is the relationship of the expenditure with income which does not form part of the Total Income - a disallowance u/s 14A has to be effected. ITA No.15/Ahd/2023 7 (vii) Further, in Laxmi Ring Travellers vs ACIT ITA 2083/Mds/2011- order dated 2/03/2012 it was pointed out that Rule 8D is mandatory from AY 2008-09 even when assessee claims that no expenditure was incurred to earn exempt income. (viii) Section 14A makes a distinction between exempt income and taxable income. It treats both of them as separate classes for computation of income after allocation of expenditure relating thereto and mandates that no deduction in respect of any expenditure shall be allowed against taxable income which is incurred in relation to exempt income. The underlying object is to compute both the exempt income and taxable income correctly, which is possible only after the expenditure incurred in relating thereto is allocated to them. In other words, section 14A bars the deduction of expenditure incurred in relation to exempt income out of taxable income, as this would have the effect of artificially inflating the exempt income and thereby deflating the taxable income. (ix) The term expenditure occurring in section 14A would take in its sweep not only direct expenditure but also all forms of expenditure regardless of whether they are fixed, variable, direct, indirect, administrative, managerial or financial. The Phraseology used in section 14A prohibiting the deduction in respect of expenditure incurred by the assessee in relation to exempt income is thus wide enough to cover all forms of expenses provided they have some connection with the exempt income. This is based on the principle that expenses must be allocated to that income to which they are connected to avoid distortions in the computation of both taxable as well as exempt income. This is also achieved by the matching principle of accountancy (as explained in Taparia Tools Limited Vs. Joint CIT [2003] 260 ITR 102 (Bom). (x) Further in Maxopp Investment Ltd. vs Commissioner of Income Tax, New Delhi [2018] 91 taxmann.com 154 (SC), it is held by Hon. Supreme court of India that, dominant purpose for which investment into shares is made by assessee may not be relevant. As section 14A applies irrespective of whether shares are held to gain control or as stock-in-trade. However where shares are held as stock-in-trade, main purpose is to trade in those shares and earn profits there from and, in process, certain dividend is also earned which is tax exempt under section 10(34); expenditure attributable to exempt dividend income will have to be appointed to be disallowed under section 14A. (xi) In circular No. 5/2014 dated 11.02.2014 issued by CBDT which clarifies that even in case of absence of exempt income; section 14A disallowance shall be made in case the assessee has made investment which is capable of yielding exempt income even though there might not be an actual receipt of exempt income. This circular has clarified the legislative intent as to allow only debt expenditure which is relatable to earning of income and it therefore follows that the expenses which are relatable to earning of exempt income have to be considered for disallowances, irrespective of fact that whether any such income has been earned during the financial year or not. ITA No.15/Ahd/2023 8 (xii) Interest bearing fund has been claimed against income of assessee from business income By matching principle that must be related /employed for that only. (See quantum taken from market and employed for operation of wire making). Now assessee was asked to give source for which he replied that they were only excess funds which were not required immediately for business needs. As he is in possession of this special knowledge so only he can provide such information that on the day of investment how much of surplus was present. More over it is to be noted that even if contention of assessee is accepted about that this fund is not in immediate need, then also it does not mean that this fund was not needed for whole financial year. And it is not out of the place to mention that assessee has incurred borrowing cost of.... Thus such logic falls flat on its face. In such a situation alternatively not to prejudice to above arguments it can be seen that the interest expenditure incurred on borrowed funds cannot be allowed as business expenditure u/s 36(1 )(iii)of the act. For the reasons stated above the assessing officer is satisfied that the provisions u/s 14A and Rule 8D are attracted in this case.” 8. The argument of the ld.counsel for the assessee was that it had been clearly pointed out to the AO that all expenses pertaining to the investment made by the assessee, which had earned or were capable of earning exempt income by way of dividend, had been disallowed by the assessee, be that in relation to management fees to PMS, DEMAT charges etc. so much so, even 5% of the Managing Director’s remuneration, who was taking managerial decision; the expenditure incurred on telephone which was used for investment purpose and entire salary of accountant was disallowed by the assessee under section 14A of the Act, resulting in total disallowance of Rs.6,56,966/-. He pointed out that it was also explained that besides the aforesaid expenses no other expenses of manpower, telephone, stationery needed to be involved for making/managing the investments. That, since there were sufficient own funds available, even interest expense was not disallowable. It was explained that investment related expenses were primarily fixed in nature and had no direct link with the activity. That all possible ITA No.15/Ahd/2023 9 investment related expenses had been disallowed by the assessee as relating to PMS and such others. Having so pointed out that, the ld.counsel for the assessee submitted that the AO recorded his dissatisfaction with the assessee’s claim in very general terms, merely stating at para 4.1 that the investment decisions were very complex in nature, they required substantial market research, day-to-day analysis of market trends and decisions etc. and he also required huge investment in shares and consequential blocking of funds. He further pointed out that the rest of the dissatisfaction against the claim of the assessee, noted by the AO, related to interest expenditure incurred onloans allegedly utilized for making investment. 9. The ld.counsel for the assessee contended that having huge surplus funds, presumption was that surplus funds have been used for making investment, and there was no occasion for any interest to be disallowed, which he pointed out was settled position of law by the Hon’ble Apex Court in the case of CIT Vs. Reliance Industries Ltd., 410 ITR 466 (SC). Therefore the AO’s dissatisfaction with the interest expenses not being disallowed was, he stated not in accordance with law. He, thereafter, stated that the AO has not stated as to how on going through the accounts of the assessee he found the assesses claim of expenses of Rs. 6,59,966/- relating to exempt income as being incorrect. He pointed out that the AO in fact has not even gone through the accounts for arriving at his dissatisfaction with the claim of the assessee. He, therefore, stated that the dissatisfaction of the AO with the assesses claim of disallowable expenses u/s 14A of the Act was not in accordance with ITA No.15/Ahd/2023 10 law, and invocation of Rule 8D of the Rules, therefore, was against the provision of law. 10. In this regard, he referred to various decision of the ITAT as well as Hon’ble High Court, which were placed before us in the Index running from ‘A’ to ‘J’, more particularly, our attention was drawn to the decision of Hon’ble Gujarat High Court in the case of Pr.CIT Vs. Gujarat State Fertilizers & Chemicals Ld., wherein he pointed out that the Hon’ble Gujarat High Court had categorically stated that having regard to section 14A of the Act before invoking Rule 8D, the AO is obliged to indicate that having regard to the accounts of the assessee, he is not satisfied with the correctnessof the claim of the assessee in respect of such expenditure, in relation to the income which does not form part of the total income. He drew our attention to para 18 of the said order, which reads as under: “The language of section 14A of the Act is plain and clear. Before invoking rule 8D, the Assessing Officer is obliged to indicate that having regard to the accounts of the assessee, he is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to the income which does not form part of the total income under the Act. To put it in other words, the condition precedent of recording the requisite satisfaction which is a safeguard provided in section 14A should not be overlooked before going to rule 8D. In such circumstances, we are not impressed by the submission canvassed on behalf of the Revenue that once there are fixed funds, rule 8D would be attracted automatically.” 11. The ld.counsel for the assessee, during the course of arguments also referred to the decision of the ITAT in Edelweiss Financial Services Ltd. vs DCIT in ITA No.2467-2470 and 2478/M/22 dated30-11-22, wherein he pointed out that identical general observations of the AO ,of huge investment involving huge ITA No.15/Ahd/2023 11 expenditure, were held by the ITAT as not being sufficient for invoking Rule 8D of the Rules. 12. The ld.DR on the other hand, pointed out that the onus was on the assessee to prove that the entire expenses pertaining to earning of exempt income had been disallowed by it. Her contention was that the assessee had merely furnished details of expenditure disallowed without pointing out as to how only these expenses pertained to earning of exempt income and not any other administrative expenses. She, therefore, stated that the satisfaction recorded by the AO was sufficient for invoking Rule 8D of the IT Rules. 13. Having heard both the parties and after carefully going through the orders of the authorities below, we are in complete agreement with the ld.counsel for the assessee that the AO had failed to comply with the conditions set out in law prior to invoking Rule 8D of IT Rules for computing disallowance of expenses u/s 14A of the Act. The AO, we hold, has not recorded the requisite satisfaction about the incorrectness of the claim of the assessee. There is no dispute with regard to the interpretation of provision of section 14A(2) of the Act; that the AO can invoking rule 8D of the Rules for computing expenses disallowable u/s 14A of the Act, only after rejecting assesses claim of expenses relating to exempt income. His dissatisfaction with the assesses claim being arrived at having regard to its accounts. The language of the section is also clear that the primary onus is on the AO to demonstrate that claim of the assessee was incorrect. This is evident from a plain reading of the section itself as under: ITA No.15/Ahd/2023 12 14A. (1) [Notwithstanding anything to the contrary contained in this Act, 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. (2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under 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. .... ..... .... .... 14. In the present case, it is evident from the satisfaction recorded by the AO of the assesses claim of expenses relating to exempt income not being correct, that it is merely based on general observations with no reference to the accounts of the assessee. The assessee had claimed such expenses to amount to Rs.6,56,966/- and had given details of nature of such expenses also. The AO, we find,has expressed his dissatisfaction with the claim by giving general reasons stating that investment decisions were very complex in nature, they required substantial market research, day-to-day analysis of market trends and decisions etc. and also required huge investment in shares and consequential blocking of funds. He has not recorded any dissatisfaction having regard to the accounts of the assessee. 15. The satisfaction of the AO, has to be an objective satisfaction, and it cannot be based on general statements made; statements which are not supported with any facts or figures. Therefore, we have no hesitation in holding, that the satisfaction recorded in the present case by the AO did not fulfill the requirements prescribed by the law under section 14A(2) of the Act for invoking Rule 8D of the IT Rules for the purpose of computing the expenses disallowable under section 14A of the Act. The disallowance, therefore, computed by ITA No.15/Ahd/2023 13 the AO by invoking Rule 8D in the present case, amounting to Rs.6,56,966/- is therefore held not to be in accordance with law and is directed to be deleted. The ground of appeal of the assessee is allowed. 16. In the result, the appeal of the assessee is allowed. Order pronounced in the Court on 27 th September, 2023 at Ahmedabad. (T.R. SENTHIL KUMAR) JUDICIAL MEMBER (ANNAPURNA GUPTA) ACCOUNTANT MEMBER Ahmedabad,dated 27/09/2023
