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Case Number

I.T.A No. 4645(Del)/2011, Assessment Year: 2008-09

Advocates

Applicant by: Shri O.P Dua & Shri P.N Bhatia, Advocates
Respondent by: Mrs. Pratima Kaushik, Sr. D.R

Judges

R.P Tolani
K.G Bansal

Acts

u/s 14A of the Income-tax Act read with Rule 8D of the Income-tax Rules.

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Smart Summary

Summary of Opinion — K.G. Bansal, Accountant Member

Factual and Procedural Background

The assessee-company (a manufacturer and trader of footwear) filed its return on 30.09.2008 declaring total income of Rs. 20,28,20,185/-. The Assessing Officer (AO) issued a notice under section 143(2) on 11.08.2009. During assessment, the AO disallowed expenditure under section 14A read with Rule 8D amounting to Rs. 33,337/-. An additional unrelated disallowance of Rs. 4,84,422/- was made (quality discount), resulting in total income computed at Rs. 20,33,37,944/-.

On appeal, the Commissioner of Income Tax (Appeals) (CIT(A)) upheld the disallowance of Rs. 33,337/-, relying on the proposition that expenditure is incurred in relation to investments and that Rule 8D is applicable from assessment year 2008-09. The CIT(A) cited Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT and ITO v. Daga Capital Management (P.) Ltd.

The assessee appealed to the forum represented by K.G. Bansal (Accountant Member). The assessee raised four grounds, the principal grievance being that the CIT(A) erred in upholding the disallowance based on a presumption that some expenditure must have been incurred even though no exempt income was actually earned in the year under consideration.

Legal Issues Presented

Whether, in the absence of any income that is not includible in total income for the year, the provisions of section 14A of the Income-tax Act can be invoked to disallow expenditure?
Whether the AO/CIT(A) can assume the existence of expenditure (i.e., treat some expenditure as in-built) or whether there must be facts on record showing that expenditure was actually incurred in relation to earning the exempt income (and the AO must record satisfaction/consider the assessee's claim)?

Arguments of the Parties

Appellant's (Assessee's) Arguments

The investments (shares, mutual fund units and National Savings Certificates (NSCs)) were old; no further investment was made in the year and no income was earned on those investments in the year under consideration.
The NSCs were said to be lost and no interest had been earned; NSCs were purchased in 2003-04 and shares in 1996-97. (The record, however, contained no evidence of loss of NSCs.)
Because no exempt income was actually earned in the year, no disallowance under section 14A should be made; alternatively, the AO failed to bring any evidence to show that expenditure was incurred in relation to earning the exempt income.
The CIT(A) erred by upholding the disallowance based on a presumption that some expenditure must have been incurred whenever exempt income exists or investments are held.

Respondent's (Revenue/Department's) Arguments

There is no dispute that investments existed in shares, units and NSCs; there was no plea before the lower authorities that no expenditure had been incurred.
Some attention and related expenditure are necessarily required to safeguard investments; such expenditure is effectively in-built once investment is made.
The established approach is that disallowance under section 14A must be worked out under Rule 8D, and this computation was carried out by the lower authorities and should be upheld.

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 (Hon'ble Bombay High Court)	The opinion notes that the Hon'ble Bombay High Court upheld the validity of Rule 8D and held that the rule applies in relation to assessment year 2008-09 and onwards.	The CIT(A) relied on this decision to justify application of Rule 8D for AY 2008-09; the tribunal nevertheless treated the decision as not relieving the AO of the obligation to consider facts before making a reasonable disallowance (see tribunal's analysis).
ITO v. Daga Capital Management (P.) Ltd. [2009] 117 ITD 169 (Special Bench, Mumbai Tribunal)	The provided opinion cites the case but does not state a specific rule or principle drawn from it in the text excerpt.	Cited by the CIT(A) alongside Godrej; the opinion does not describe any specific application of this precedent by the tribunal beyond noting it was cited by the lower authority.
The Commissioner Of Income Tax v. Jindal Photo Ltd. (Delhi Tribunal, 'D' Bench) — No. 814 of 2011 (dated 23.09.2011)	The opinion cites the tribunal's observation that it is incorrect to apply Rule 8D where the AO has not recorded satisfaction; specifically, the satisfaction of the AO is a pre-requisite to invoke Rule 8D, and the CIT(A) erred in partially approving the AO's action without such satisfaction.	The tribunal relied on this authority to support the proposition that the AO must record satisfaction (or otherwise address the assessee's claim) before applying Rule 8D, and that the lower authorities in the present case failed to do so.
Maxopp Investment Ltd. v. Commissioner Of Income-Tax, New Delhi [2011] 203 Taxman 364 / 15 taxmann.com 390 (Delhi High Court)	The opinion records the High Court's direction that when section 14A is in issue, the AO must ascertain the correctness of the assessee's claim about expenditure; if the assessee claims no such expenditure, the AO must verify that claim and, if satisfied, cannot determine a disallowance; if not satisfied, the AO must hear the assessee and record reasons for rejecting the claim.	The tribunal relied on Maxopp to hold that the AO should have examined the assessee's claim that no expenditure was incurred, and that the AO cannot simply apply Rule 8D without first addressing such a claim and recording reasons.

Court's Reasoning and Analysis

The tribunal considered admitted facts: the assessee had investments in shares, mutual fund units and NSCs; there was no evidence on record to substantiate the claim of loss of NSCs; no income had been earned on shares and units in the year.

The tribunal addressed two central questions (as framed in the opinion).

First, whether section 14A can be invoked in the absence of exempt income actually earned in the year. The tribunal analysed the statutory language of section 14A(1) and compared it to the enabling/analogous provision in section 57(iii) (which allows deduction of expenditure incurred wholly and exclusively for earning income from other sources even in years when income may be nil). On that basis the tribunal concluded that the word "income" in section 14A should not be given an unduly narrow meaning; investments capable of yielding exempt income may render expenditure relating to holding them disallowable even if no exempt income is actually earned in that specific year. Accordingly, the tribunal rejected the assessee's first-line argument that absence of actual exempt income precludes invocation of section 14A.

Second, whether the AO may assume expenditure (treat some expenditure as in-built) or must have facts on record demonstrating that expenditure was incurred. The tribunal examined the language "expenditure incurred by the assessee in relation to income" and considered authorities (Jindal Photo and Maxopp) requiring the AO to examine and satisfy himself about the correctness of the assessee's claim (including claims of no expenditure). The tribunal noted that, per Maxopp, if the assessee claims no such expenditure the AO must verify that claim and record reasons if dissatisfied; per Jindal Photo the satisfaction of the AO is a pre-requisite before invoking Rule 8D.

Applying these principles, the tribunal found that neither the AO nor the CIT(A) had examined the assessee's specific claim that no expenditure had been incurred in relation to the exempt income. Instead, the AO immediately proceeded to compute disallowance under Rule 8D and the CIT(A) upheld the disallowance on the basis of a presumption that expenditure is necessarily incurred with investments. The tribunal held that such a presumption cannot substitute for the statutory requirement that the AO consider the assessee's claim and, if not satisfied, record reasons before applying Rule 8D or making a reasonable disallowance.

Having found that the lower authorities did not follow the requirements of section 14A(1) and the principles laid down in the cited cases (as described above), the tribunal concluded the disallowance could not be upheld. The tribunal also noted that, because the amount involved was small, it did not deem it appropriate to remit the matter back to the AO for fresh adjudication.

Holding and Implications

DISALLOWANCE SET ASIDE; APPEAL ALLOWED

Holding: The tribunal allowed the appeal and set aside the disallowance of Rs. 33,337/-, concluding that the AO and CIT(A) failed to examine the assessee's claim that no expenditure was incurred and therefore did not comply with the requirements of section 14A(1) and the principles articulated in the authorities discussed.

Implications: The direct effect is that the specific disallowance made by the AO and upheld by the CIT(A) is not sustained. The tribunal emphasized that an AO must first consider and verify any claim by an assessee that no expenditure relating to exempt income has been incurred; only if the AO is not satisfied should disallowance be computed (and reasons recorded). The opinion does not purport to create any new legal precedent beyond applying existing authorities; it stresses procedural and factual compliance with section 14A(1) and the need for the AO to record satisfaction or reasons before applying Rule 8D.

Result: In the result, the appeal was allowed.

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Relaxo Footwears Limited v. Cit

K.G. Bansal, Accountant Member - The facts of the case are that the assessee-company filed its return on 30.09.2008 declaring total income of Rs. 20,28,20,185/-. The assessment proceedings were taken up by issuing a notice u/s 143(2) on 11.08.2009. It was found that the assessee is engaged in the business of manufacturing of and trading in footwear. Coming to the specifics, it is mentioned in the assessment order that the assessee had made investment the income from which is not includible in the total income. Therefore, expenditure has to be disallowed u/s 14A of the Income-tax Act read with Rule 8D of the Income-tax Rules. Such disallowance was worked out at Rs. 33,337/-. Another amount of Rs. 4,84,422/- was disallowed as excess provision made in respect of quality discount. This issue, however, is not relevant for our purpose. Thus, the total income was computed at Rs. 20,33,37,944/-.

1.1 The matter regarding disallowance u/s 14A was agitated in ground no. 3 before the CIT (Appeals). It was submitted that the assessee had made investment in shares, units of mutual funds and National Saving Certificates (NSCs). However, these investments were old and no further investment was made in this year. No income has been earned on the investment in this year. Therefore, it was argued that no disallowance can be made by invoking the provision contained in section 14A of the Act. The ld. CIT (Appeals) examined the matter. He came to the conclusion that some expenditure will have to be incurred on earning any kind of income, includible or not includible in the total income. Such expenditure is generally not segregated in the account books and it gets mixed up with other expenses of the business. In such a situation, the AO is duty bound to reasonably allocate expenditure relatable to income which is not includible in the total income. Section 14A deals with disallowance of the expenditure incurred in relation to income which does not form part of the total income. Such expenditure has to be worked out as per Rule 8D, which is applicable to the proceedings of assessment year 2008-09. The matter had come up for decision before Hon'ble Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT [2010] 194 Taxman 203 and also before Special Bench of Mumbai Tribunal in the case of ITO v. Daga Capital Management (P.) Ltd. [2009] 117 ITD 169 . The Hon'ble Bombay High Court has upheld the validity of Rule 8D. Further, it has been held that the rule applies in relation to assessment year 2008-09 and onwards. In view of this discussion, the disallowance of Rs. 33,337/- made by the AO has been upheld.

1.2 Aggrieved by this order, the assessee is in appeal before us. It has taken up four grounds in the appeal. It is explained to us by the ld. counsel for the assessee that the gist of the grounds is that the ld. CIT (Appeals) erred upholding the disallowance of Rs. 33,337/- on the basis of presumption that no income can be earned without incurring some expenditure. Other grounds deal with the facts or the state of law, which shall be discussed to the extent argued by the ld. counsel.

2. Before us, the ld. counsel referred to the fact that investments were old on which no income was earned in this year. It is also his case that apart from shares and units of the mutual funds, there was investment in NSCs. However, the certificates were lost and no interest was earned on the certificates. The certificates were purchased in financial year 2003-04 and the shares of Relaxo Rubbers Pvt. Ltd. were purchased in financial year 1996-97 from own funds. It may be added here that there is no evidence regarding loss of NSCs on record. The case of the ld. counsel is two-fold- (i) no income has been earned and, therefore, no expenditure can be disallowed; and (ii) the Assessing Officer has not brought any evidence on record to show that any expenditure was incurred in relation to earning the income which was not includible in the total income.

2.1 In reply, the ld. senior DR submitted that there is no dispute that investment has been made in shares, units and NSCs. There is no plea before any of the lower authorities that no expenditure has been incurred in respect of income from the investments. As a matter of fact some amount of attention has to be paid towards investments to safeguard the interest of the company and, therefore, the expenditure is in-built once an investment is made. It is the accepted proposition of law that the expenditure to be disallowed has to be worked out under Rule 8D. This is what has been done by the lower authorities. Therefore, it is strongly agitated that the expenditure disallowed by the lower authorities may be upheld.

3. We have considered the facts of the case and submissions made before us. The admitted facts are that the assessee had made investment in shares, units and NSCs. Although it is made out that the certificates have been lost and no interest thereon has been paid, there is no evidence to this effect. The assessee can very well claim the principal amount and interest on the certificates on or after the date of maturity. No income has been earned on shares and units.

3.1 The first question is-whether in absence of income which is not includible in the total income, the provision contained in section 14A can be invoked. None of the parties has cited any case before us. Therefore, the issue is to be decided on the basis of statutory language and general principles of interpretation of law. Sub-section (1) of section 14A contains a provision to the effect that for the purpose of computing the total income under chapter IV, 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. The factual position in this case is that no such income is statedly earned in this year although interest on NSCs has accrued as per the terms and conditions. Other investments may not have yielded income in this year but are capable of yielding the income. The question is whether the word "income" should be interpreted narrowly or widely? The narrow interpretation would be that only when such income is actually earned, the expenditure can be disallowed. The wider meaning would be that even if no income is earned in a particular year but the investments are capable of earning the income, the expenditure relatable to holding of the investments becomes disallowable. In this connection, we may examine a reverse provision contained in section 57(iii), which allows the deduction of any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly or exclusively for the purpose of making or earning such income from income chargeable under the head "income from other sources". There are a number of decisions which hold that the earning of the income in a particular year is not sine qua non of allowing expenditure. Thus, the income may be nil, yet the expenditure incurred in pursuit of earning such income is deductible. We are of the view that similar proposition will apply while interpreting the aforesaid provision contained in section 14A(1). Therefore, we are not in agreement with the ld. counsel in respect of first line of argument.

3.2 The second question is-whether, there is an assumption of expenditure as some kind of in-built expenditure or some facts must exist on record to show that the expenditure was actually incurred in relation to earning the income. In this connection, the words used in the provision "expenditure incurred by the assessee in relation to income" assume importance. In the case of The Commissioner Of Income Tax v. Jindal Photo Ltd…. No. 814 of (Delhi) of 2011] for assessment year 2008-09 dated 23.09.2011, decided by 'D' bench of Delhi Tribunal, a copy of which has been placed in the paper book, it has been observed in paragraph no. 14 that it is not incorrect when the assessee contends that no satisfaction has been recorded by the AO regarding the assessee's calculation being incorrect. Even so, Rule 8D has been applied. It has been opined that it is not correct. The satisfaction of the AO is a pre-requisite to invoke the provision of Rule 8D. Finally, it has been held that the ld. CIT (Appeals) erred in partially approving the action of the AO.

3.3 In the case of Maxopp Investment Ltd…. v. Commissioner Of Income-Tax, New Delhi [2011] 203 Taxman 364 / 15 taxmann.com 390 (Delhi) a copy of which has been placed before us by the ld. counsel, the Hon'ble Delhi High Court has mentioned that whenever the issue of section 14A arises before an assessing officer, he has to ascertain the correctness of the claim of the assessee in respect of expenditure incurred in relation to income which does not form part of the total income. Where the assessee claims that no such expenditure has been incurred the Assessing Officer will have to verify the correctness of such claim. If he is satisfied with the claim, there will be no question of any dispute. In such an eventuality, the AO cannot embark upon a determination of the amount of expenditure to be disallowed for the purpose of section 14A(1). However, where he is not satisfied with the claim of the assessee, he will have to hear the assessee and thereafter record the reasons for not accepting the claim.

3.4 We also find that in the case of Godrej & Boyce Mfg. Co. Ltd. (supra), the decision is that prior to assessment year 2008-09, the AO can make reasonable disallowance after considering all the facts of the case. Obviously the consideration has to be in respect of expenditure incurred in relation to earning the income.

3.5 Having considered these cases, we are of the view that the AO should have considered the claim of the assessee that no expenditure has been incurred in relation to earning the exempt income. If the claim was not found to be in consonance with the facts on record, it could have been rejected and disallowance could have been made as per Rule 8D. However, we find that the AO has not considered the claim of the assessee at all and he has straightway embarked upon computing disallowance under Rule 8D. The ld. CIT (Appeals) made an assumption that whenever exempt income is earned there will be some expenditure incurred in relation thereto. Such presumption cannot form the basis for making disallowance under Rule 8D. As mentioned in the case of Godrej & Boyce Mfg. Co. Ltd. (supra), a reasonable disallowance can be made only after considering all the facts. The decision of Hon'ble Delhi High Court in the case of Maxopp Investment Ltd. (supra) also says the same thing when it is mentioned that the claim of the assessee has to be examined in the first place in terms of its correctness. This has not been done by any of the lower authorities. We may also mention that the decision in the case of Jindal Photo Ltd. (supra) also arrived at the same conclusion when it is held that the AO has to record his satisfaction about correctness or otherwise of the computation made by the AO, which mutatis mutandis means that if the contention is that no expenditure has been incurred, it has to be rebutted.

3.6 As mentioned earlier, the lower authorities have not examined the claim of the assessee at all. In such a situation, we do not think it fit to restore the matter to the file of the AO for fresh adjudication for the reason that the amount involved is very small. The lower authorities have not followed the provision contained in section 14A(1) of the Act. Therefore, the disallowance cannot be upheld. It is ordered accordingly.

4. In the result, the appeal is allowed.

Relaxo Footwears Limited v. Cit

Summary of Opinion — K.G. Bansal, Accountant Member

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Appellant's (Assessee's) Arguments

Respondent's (Revenue/Department's) Arguments

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Relaxo Footwears Limited v. Cit

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