HC (BOM):- 14A Rule 8 d , defined. Godrej & Boyce vs. DCIT

Godrej & Boyce vs. DCIT (Bombay High Court)

(435.0 KiB, 806 DLs)

Rule 8D r.w. S. 14A (2) is not arbitrary or unreasonable but can be applied only if assessee's method not satisfactory. Rule 8D is not retrospective and applies from AY 2008-09. For earlier years, disallowance has to be worked out on "reasonable basis" u/s 14A (1)

 

In AY 2002-03, the assessee claimed that no disallowance u/s 14A in respect of the tax-free dividend earned by it could be made as it had not incurred any expenditure to earn the dividend. The AO rejected the claim and made a disallowance u/s 14A. This was deleted by the CIT (A). On appeal by the department, the Tribunal followed the judgement of the Special Bench in Daga Capital 117 ITD 169 (Mum) (where it had been held that s. 14A(2) & (3) & Rule 8D are procedural in nature and have retrospective effect) and remanded the matter to the AO for re-computing the disallowance. The assessee challenged the decision of the Tribunal. HELD:

 

(1) The argument that dividend on shares / units is not tax-free in view of the dividend-distribution tax paid by the payer u/s 115-O is not acceptable because such tax is not paid on behalf of the shareholder but is paid in respect of the payer's own liability;

 

(2) S. 14A supersedes the principle of law that in the case of a composite business expenditure incurred towards tax-free income could not be disallowed and incorporates an implicit theory of apportionment of expenditure between taxable and non-taxable income. 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;

 

(3) The argument that a literal interpretation of s. 14A leads to absurd consequences is not acceptable. S 14A is founded on a valid rationale that the basic principle of taxation is to tax net income i.e gross income minus expenditure;

 

(4) The argument that the method in Rule 8D r.w.s 14A (2) for determining expenditure relating to the tax-free income is arbitrary and violative of Article 14 is not acceptable because there is an adequate safeguard before Rule 8D can be invoked. The AO cannot ipso facto apply Rule 8D but can do so only where he records satisfaction on an objective basis that the assessee is unable to establish the correctness of its claim. Also a uniform method prescribed to resolve disputes between assessees and the department cannot be said to be arbitrary or oppressive. There is a rationale in Rule 8D and its method is "fair & reasonable". It cannot be said that there is "madness" in the method of Rule 8D so as to render it unconstitutional;

 

(5) Rule 8D, inserted w.e.f 24.3.2008 cannot be regarded as retrospective because it enacts an artificial method of estimating expenditure relatable to tax-free income. It applies w.e.f AY 2008-09;

 

(6) For the AYs where Rule 8D does not apply, the AO will have to determine the quantum of disallowable expenditure by a reasonable method having regard to all facts and circumstances;

 

(7) On facts, though in the earlier years, the Tribunal had held that the tax-free investments had been made out of the assessee's own funds, this did not mean that there was no expenditure incurred to earn tax-free income. Even though Rule 8D did not apply to AY 02-03, the AO had to consider whether disallowance could be made u/s 14A (1). Also, the principle of consistency would not apply as s. 14A had introduced a material change in the law.

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Judgments 14A

CIT vs. Leena Ramachandran (Kerala High Court)

S. 14A applies where shares are held as investment and the only benefit derived is dividend. S. 36(1)(iii) deduction allowable if shares held as stock-in-trade

 

The assessee borrowed funds to acquire controlling interest shares in a company with which she claimed to have business dealings. The interest on the borrowings was claimed as a deduction u/s 36(1)(iii). The AO rejected the claim on the ground that the only benefit derived from the investment in shares was dividend and that the interest had to be disallowed u/s 14A. This was confirmed by the CIT (A). The Tribunal held that the deduction of interest was allowable u/s 36(1)(iii) in principle though a portion of the interest paid had to be regarded as attributable to the dividend and was disallowable u/s 14A. On appeal by the Revenue, HELD reversing the order of the Tribunal:

 

(i) The only benefit derived by the assessee from the investment in shares was the dividend income and no other benefit was derived from the company for the business carried on by it. As dividend is exempt u/s 10(33), the disallowance u/s 14A would apply. The Tribunal was not correct in estimating the s. 14A disallowance to a lesser figure than the interest paid on the borrowing when the whole of the borrowed funds were utilized by the assessee for purchase of shares;

 

(ii) Deduction of interest u/s 36(1)(iii) on borrowed funds utilized for the acquisition of shares is admissible only if shares are held as stock in trade and the assessee is engaged in trading in shares. So far as acquisition of shares in the form of investment is concerned and where the only benefit derived is dividend income which is not assessable under the Act, disallowance u/s 14A is squarely attracted.

 

Note: In CIT vs. Hero Cycles 323 ITR 518 (P&H) it was held that held that in the absence of an actual nexus between tax-free income and expenditure, s. 14A disallowance could not be made.


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