Citation Codes

Equivalent Citations

citation codes

Case Number

ITA No. 3889.Mum/2011 (Asst Year 2008-09)

Advocates

Assessee by: Sh KK Ved
Revenue by: Sh AK Nayak

Judges

G.E Veerabhadrappa, President
Vijay Pal Rao, J.M

Acts

section 14A of the Income Tax Act, 1961 read with Rule 8D of the Income Tax Rules, 1962.2.
provisions of rule 8D of the Income Tax Rules, 1962
section 10 (35) of the Income Tax Act.
sub-section (2) & (3) of section 14A,
rule 8D of Income Tax Rules

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Smart Summary

Structured Summary of the Tribunal Opinion (Appeal by Assessee — Section 14A / Rule 8D)

Factual and Procedural Background

This is an appeal by the assessee against the order of the Commissioner of Income Tax (Appeals) dated 24/03/2001 in respect of the assessment year 2006-07. The assessing officer disallowed an amount of Rs. 2,26,581 under section 14A of the Income Tax Act, 1961 by applying Rule 8D of the Income Tax Rules, 1962, following a Tribunal decision in the case of M/s Daga Capital Management Pvt Ltd. The disallowance related to exempt income earned by the assessee during the year, specifically: dividend from mutual funds of Rs. 30,43,306, dividend from shares of Rs. 6,71,468, and interest on RBI tax-free bonds of Rs. 13,73,750. The CIT(A) confirmed the disallowance, and the assessee appealed to the Tribunal.

Legal Issues Presented

Whether the disallowance of Rs. 2,26,581 under section 14A read with Rule 8D of the Income Tax Rules, 1962 was justified where the assessee claimed that no expenditure was incurred for earning the exempt income.
Whether the Assessing Officer could apply Rule 8D without recording satisfaction that the assessee's books of account or submissions (claiming no expenditure for earning exempt income) were incorrect.
Whether Rule 8D was applicable to the assessment year in question, in light of the contention that Rule 8D is prospective and applicable only with effect from 1.4.2008 (relying on the decision in Godrej & Boyce).

Arguments of the Parties

Appellant's Arguments (Assessee)

The assessee contended that no expenditure was incurred for earning the dividend and other exempt income; all expenses claimed related to earning professional income.
The assessee maintained separate books of account for professional/business activity; investments (giving rise to exempt income) were made in the assessee's personal capacity out of personal funds.
Rule 8D is prospective and applicable only from 1.4.2008; therefore Rule 8D should not be applied to the assessment year under consideration (relying on Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT).
The assessee relied on Tribunal decisions including Pawan Kumar Parameshwarlal v. ACIT and Auchtel Products Ltd v. Asstt. CIT to support the contention that no disallowance is warranted where separate books are maintained and no expenditure is shown to be incurred in relation to exempt income.

Respondent's Arguments (Revenue)

The Departmental Representative submitted that the assessee did not raise before the lower authorities the specific plea that separate accounts were maintained and that investments were in a personal capacity from own funds.
The DR relied upon the orders of the authorities below (Assessing Officer and CIT(A)) which had applied Rule 8D to compute the disallowance.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT [2010] 194 Taxman 203 (Bom.)	That Rule 8D is prospective in operation and is applicable with effect from 1.4.2008 (i.e., not applicable for earlier assessment years).	The Tribunal relied on this High Court decision to conclude that Rule 8D was not applicable for the assessment year under consideration.
CIT v. Walfort Share & Stock Brokers (P.) Ltd. [2010] 326 ITR 1 / 192 Taxman 211 (Supreme Court)	Principle that to attract section 14A disallowance there should be a proximate cause/relationship between expenditure and tax-exempt income; expenses incurred in relation to exempt income cannot be allowed against taxable income.	The Tribunal cited this Supreme Court authority to explain the requirement of a proximate relationship between expenditure and exempt income before section 14A can be invoked.
Pawan Kumar Parameshwarlal v. ACIT (ITA No. 530/Mum/2009) (Tribunal order dated 11 Jan 2011)	Decision holding that where separate books are maintained and investments are in personal capacity, no disallowance under section 14A is called for; Rule 8D not to be invoked for assessment years prior to its prospective applicability.	The Tribunal considered this identical decision and quoted it to support deletion of disallowance where no expense relating to exempt income was shown.
Auchtel Products Ltd v. Asstt. CIT [2012] 22 taxmann.com 99 / 52 SOT 39 (Mum) (URO)	Principle that the Assessing Officer must first examine and be satisfied that the assessee's claim of no expenditure (or some expenditure) in relation to exempt income is incorrect before invoking Rule 8D; Rule 8D applies only after the AO is not satisfied with the assessee's claim.	The Tribunal relied on this decision to criticize the AO's approach of directly computing disallowance under Rule 8D without forming an opinion on the correctness of the assessee's claim, and to require remand/consideration if necessary.
M/s Daga Capital Management Pvt Ltd (Tribunal decision)	Used by the Assessing Officer as a precedent to apply Rule 8D and compute disallowance under section 14A.	The Tribunal noted that the AO had followed this Tribunal decision in applying Rule 8D to compute the disallowance; the present Tribunal evaluated whether such application was appropriate on the facts.

Court's Reasoning and Analysis

The Tribunal undertook a step-by-step analysis grounded in the statutory purpose and judicial interpretations of section 14A and Rule 8D:

Nature and objective of section 14A: The Tribunal explained that section 14A embodies an implicit apportionment principle applicable where expenditure is incurred for composite or indivisible activities yielding both taxable and non-taxable income. The objective is to prevent reduction of taxable income by debiting expenses attributable to tax-exempt income.
Proximate relationship requirement: Citing the Supreme Court in CIT v. Walfort Share & Stock Brokers, the Tribunal emphasized that disallowance under section 14A requires a proximate nexus between the expenditure and the exempt income; there must be an actual expenditure related to earning the exempt income (a proximate cause).
Role of notional apportionment: The Tribunal clarified that notional or automatic apportionment is impermissible where there is no actual expenditure connected with exempt income. If it is possible to determine that no expenditure was incurred in relation to exempt income, the apportionment principle does not operate.
Obligation of the Assessing Officer: When an assessee claims that no expenditure was incurred for earning exempt income, it is the AO's duty to determine whether any expenditure was in fact incurred and, if so, to quantify the disallowance. The AO must form a satisfaction (i.e., be convinced) that the assessee's claim is incorrect before invoking Rule 8D to compute disallowance.
Application to the present facts: The Tribunal observed that the assessee asserted that no expenditure was incurred for the exempt income and that the expenditures claimed related to professional income. The AO did not make any finding that claimed expenditures were attributable to earning exempt income, nor that the assessee had used official establishment/machinery for earning such income. Consequently, there was no material or finding establishing the necessary nexus required by section 14A.
On the applicability of Rule 8D: The Tribunal noted the assessee's contention (and the High Court authority in Godrej & Boyce) that Rule 8D operates prospectively from 1.4.2008; accordingly, Rule 8D was not applicable to the assessment year under consideration. The Tribunal also relied on Tribunal authorities (Pawan Kumar Parameshwarlal and Auchtel Products Ltd) emphasizing that Rule 8D should only be applied after the AO is not satisfied with the assessee's claim.
Conclusion of reasoning: In the absence of any finding by the AO that the claimed expenditures were in relation to exempt income and given the assessee's maintenance of separate books and claims of personal investment, the Tribunal concluded that section 14A could not be applied to disallow expenditure in this case.

Holding and Implications

HOLDING: The appeal of the assessee is ALLOWED. The Tribunal held that no disallowance under section 14A is called for on the facts of this case and that Rule 8D is not applicable for the assessment year under consideration (relying on the jurisdictional High Court in Godrej & Boyce).

Implications:

Direct effect on the parties: The disallowance of Rs. 2,26,581 made by the Assessing Officer under section 14A (computed under Rule 8D) was set aside/deleted and the appeal allowed in favour of the assessee.
On applicability of Rule 8D: The Tribunal recorded that Rule 8D is not applicable to the assessment year in question, consistent with the cited High Court decision.
On precedent and scope: The Tribunal applied established principles (including Supreme Court and Tribunal decisions) concerning the need for a proximate nexus and the requirement that the AO be satisfied of incorrectness of the assessee's claim before invoking Rule 8D. The opinion resolves the dispute on the specific facts before the Tribunal; the text does not purport to create a novel legal principle beyond these applications.

End of summary. This summary is based exclusively on the contents of the provided opinion and does not introduce information not contained therein.

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Justice Sam P Bharucha Premises Of Meneksha & Shethana Advocates Solicitors & Notaries 8 Amabala Doshi Marg(Hamam Street) Mumbai 23 () v. The Addl Commr Of Income Tax 11(3), Mumbai ().

Vijay Pal Rao, Judicial Member - This appeal by the assessee is directed against the order dated 24/03/2001 of CIT(A) for the assessment year 2006-07.

2. The assessee has raised the following grounds in this appeal:

1. The learned CIT(A) has erred in confirming the disallowance of expenditure of Rs. 2,26,58 1 under section 14A of the Income Tax Act, 1961 read with Rule 8D of the Income Tax Rules, 1962.

2. The learned CIT(A) has erred in not appreciating the fact that the AO applied the provisions of rule 8D of the Income Tax Rules, 1962 without giving any finding on why he was not satisfied with the appellant's books of accounts and submissions that he did not incur any expenditure for earning the exempt income.

3. During the year the assessee has earned dividend of Rs. 30,43,306 from mutual funds and Rs. 6,71,468/- from shares besides interest on RBI tax free bonds of Rs. 13,73,750/- which are exempt income. The assessing officer disallowed a sum of Rs. 2,26,581/- under section 14 A by applying rule 8D of Income Tax Rules by following the decision of this Tribunal in case of M/s Daga Capital Management Pvt Ltd.

3.1 On appeal, the Commissioner of Income Tax (Appeals) has confirmed the disallowance made by the Assessing Officer under section 14A.

4. Before us, the learned A.R. of the assessee has submitted that the assessee has not incurred any expenditure on earning the dividend and other exempt income. The assessee has not claimed any expenditure incurred for earning the exempt income and the expenses claimed by the assessee are in the nature of expenditure for earning professional income. Therefore, all expenses incurred and claimed by the assessee are in the nature of expenditure for earning professional income and no expenses have been incurred in relation to the dividend income from mutual funds. Thus, it was submitted that the provisions of section 14 A under r.w.r 8D of I T Rules is applicable in the case of the assessee.

4.1 Even otherwise, Rule 8D is applicable only with effect from 1.4.2008 and therefore, in view of the decision of honourable jurisdictional High Court in case of Godrej & Boyce Mfg Co Ltd. v. Dy. CIT [2010] 194 Taxman 203 (Bom.) Rule 8D is not applicable for the assessment year under consideration.

4.2 The ld AR of the assessee has referred the computation of total income and details of expenditure incurred during the year. He has pointed out that none of the expenditure incurred and claimed by the assessee is related to the dividend income, which is exempted under section 10 (35) of the Income Tax Act. He has further submitted that the assessee is maintaining separate books of account for the purpose of profession and no expenditure, which is personal in nature, has been shown in the books of account maintained for business or profession of the assessee. Since the investments in mutual funds are made by the assessee in his personal capacity and out of his own capital funds, no disallowance is called for under section 14 A on account of earning of dividend income on such investment. In support of his contention, he has relied upon the decision of Co-ordinate Bench of this Tribunal dated 11th Jan 2011 in case of Pawan Kumar Parameshwarlal v. ACIT [ITA No. 530/Mum/2009] as well as in case of Auchtel Products Ltd v. Asstt. CIT [2012] 22 taxmann.com 99/ 52 SOT 39 (Mum) (URO).

4.3 On the other hand, the learned DR has relied upon the orders of the authorities below and submitted that the assessee has not taken this plea before the authorities below that the assessee is maintaining separate accounts for business/profession of the assessee and the investment in question were made by the assessee in personal capacity out of his own funds.

5. We have considered the rival submissions as well as relevant material on record. Section 14A has within it implicit notion of apportionment in the cases where the expenditure is incurred for the composite/indivisible activities in which taxable and non-taxable income is received. But when it is possible to determine the actual expenditure in relation to the exempt income or when no expenditure has been incurred in relation to the exempt income, then principle of apportionment embedded in section 14A has no application. The objective of section 14A is not allowing to reduce tax payable on the normal exempt income by debiting the expenditure incurred to earn the exempt income. Thus, the expenses incurred to earn exempt income cannot be allowed and the expenses shall be allowed only to the extent they are related to the earning of taxable income. If there is expenditure directly or indirectly incurred in relation to exempt income, the same cannot be claimed against the income, which is taxable as it is held by the honourable Supreme Court in case of CIT v. Walfort Share & Stock Brokers (P.) Ltd. [2010] 326 ITR 1 / 192 Taxman 211 that for attracting the provisions of section 14A, there should be proximate cause for disallowance which as relationship with the tax exempt income.

5.1 The expenditure incurred in relation to the income which does not form part of total income has to be disallowed. However, it should be proximate relationship between the expenditure and the income, which does not form part of total income. Once such proximity relationships exist, the disallowance is to be effected. In case the assessee had claimed that no expenditure has been incurred for earning the exempt income, it was for the assessing officer to determine as to whether the assessee had incurred any expenditure in relation to income which did not form part of total income and if so to quantify the extent of disallowance. Thus, in order to disallow the expenditure under section 14A, there must be a live nexus between the expenditure incurred and the income not forming part of total income. No notional expenditure can be apportioned for the purpose of earning exempt income unless there is an actual expenditure in relation to earning the income not forming part of total income. If the expenditure is incurred with a view to earn taxable income and there is apparent dominant and immediate connection between the expenditure incurred and taxable income, then no disallowance can be made under section 14A merely because some tax exempt income is received by the assessee.

5.2 Averting to the facts of the case in hand, the assessee had made a claim that no expenditure has been incurred or claimed for earning the exempt income. From the details of the expenditure, it is clear that the expenditure incurred and claimed by the assessee has direct nexus with the professional income of the assessee. It is not the case of the revenue that the assessee has used his official machinery and Establishment for earning the exempt income. The Assessing Officer has not given any finding that any of the expenditure incurred and claimed by the assessee is attributable for earning the exempt income. In other words when the assessing officer has not pointed out that certain expenditure is not incurred for earning the professional income; but are incurred in relation to dividend income or such expenditure is incurred for inseparable and indivisible activities comprising professional as well as the activities on which is exempt income has been earned by the assessee, then in the absence of any such instance of expenditure, finding of Assessing Officer or any material to show that the expenditure incurred and claimed by the assessee against the taxable income has any relation for earning the exempt income, the provisions of section 14A cannot be applied.

5.3 In the case of Pawan Kumar Parameshwarlal supra this tribunal has considered and decided an identical issue in para 4 as under:

"4. After hearing the assessee in person and arguments of the learned D.R. we are of the opinion that no disallowance is called for under section 14A. Obviously the assessee is maintaining separate books of account for purpose of business and these investments are in his personal capacity. The A.O. also has not disallowed any expenditure of personal nature out of the income from business or profession in the computation of income in the assessment order. In view of this we are of the opinion that the expenditure claimed in the business of share dealings cannot be correlated to the incomes earned in personal capacity that too on dividend, PPF interest and tax free interest on RBI bonds. In view of this, we are of the opinion that estimation of expenditure of Rs. 20,000/- out of business expenditure claimed in business activity cannot be considered for being incurred for this earning of tax free income of above nature. In view of this disallowance so made under section 14A of Rs. 20,00/- is deleted. Not only that the CIT(A) directed the A.O. to consider the allowance invoking Rule 8D. The Hon'ble Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd. v. DCIT 328 ITR 81 has considered Rule 8D to be applicable prospective and since the assessment year involved is before the introduction of sub-section (2) & (3) of section 14A, there is no question of disallowing the amounts invoking Rule8D. Therefore, the CIT(A)'s direction on this is set aside and the additions so made by the A.O. in the computation of business income is deleted. Ground is considered allowed."

5.4 Similarly in case of Auchtel Products Ltd (supra), it was held by this Tribunal in para 15 has under:

"15. A bare perusal of the above provisions indicates that the AO shall determine the amount disallowable as per Rule 8D, if he, "is not satisfied with the correctness of the claim of the assessee" in respect of such expenditure in relation to exempt income. Even if the assessee claims that no expenditure was incurred in respect of exempt income, the AO is supposed to follow the mandate of Rule 8D if he is not satisfied with the correctness of the assessee's claim. To put it simply, the further disallowance u/s.14A is called for when the AO is not satisfied with the assessee's claim of having incurred no expenditure or some amount of expenditure in relation to exempt income. Satisfaction of the AO as to the incorrect claim made by the assessee in this regard is sine qua non for invoking the applicability of Rule 8D. Such satisfaction can be reached and recorded only when the claim of the assessee is verified. If the assessee proves before the AO that it incurred a particular expenditure in respect of earning the exempt income and the AO gets satisfied, then there is no requirement to still proceed with the computation of amount disallowable as per Rule 8D. From the assessment order, it is observed that the AO simply kept the assessee's submissions on record without appreciating as to whether these were correct or not. He proceeded on the premise as if the disallowance as per Rule 8D is automatic irrespective of the genuineness of the assessee's claim in respect of expenses incurred in relation to exempt income. It is an incorrect course adopted by the AO. The correct sequence, in our considered opinion, for making any disallowance u/s. 14A is to, firstly, examine the assessee's claim of having incurred some expenditure or no expenditure in relation to exempt income, If the AO gets satisfied with the same, then there is no need to compute disallowance as per Rule 8D. It is only when the AO is not satisfied with the correctness of the claim of the assessee in respect of such expenditure or no expenditure having been incurred in relation to exempt income, that the mandate of Rule 8D will operate. In the instant case, the authorities below have directly gone to the second stage of computing disallowance u/s. 14A as per Rule 8D without rendering any opinion on the correctness or otherwise of the assessee's claim in this regard. We, therefore, set aside the impugned order on this issue and restore the matter to the file of AO to re-compute disallowance, if any, in accordance with our above observations after duly examining the assessee's claim in this regard."

6. In view of the above discussion and facts and circumstances of the case, we are of the considered opinion that no disallowance under section 14A is called for when the assessee has not incurred and claimed any expenditure for earning the exempt income.

6.1 Needless to say the provisions of Rule 8D are not applicable for the assessment year under consideration as held by the honourable jurisdictional High Court in case of Godrej & Boyce Mfg. Co. Ltd. (supra).

7. In the results, the appeal of the assessee is allowed.

rp/abk

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Justice Sam P Bharuc... v. The Addl Commr Of In...