Hero Motocorp Ltd v. Deputy Commissioner Of Income Tax

$~7 *IN THE HIGH COURT OF DELHI AT NEW DELHI +ITA No. 1253/2018 HERO MOTOCORP LTD...... AppellantThrough:Mr.Ajay Vohra, Mr.Aniket D.Agrawal and Ms.Deepika Agrawal,Advs. versus DEPUTY COMMISSIONER OF INCOME TAX..... RespondentThrough:Mr.Ruchir Bhatia, Adv. CORAM:HON'BLE MR. JUSTICE SANJIV KHANNAHON'BLE MR. JUSTICE ANUP JAIRAM BHAMBHANIO R D E R%11.01.2019 Learned senior counsel for the appellant submits that finding of theIncome Tax Appellate Tribunal with regard to recording of satisfactionunder sub-section 2 of Section 14A is wrong as the Assessing Officer by thesaid sub-section has to record specific finding having regard to accounts ofthe assessee which is missing in this case. We do not think that this contention is correct. In fact, the orderpassed by the Assessing Officer would show application of mind in allsenses of the phrase. We would reproduce the findings recorded by theAssessing Officer for the assessment year 2012-13 which read as under:- -19. Disallowance u/s 14A; Rs. 66,35,000/; “19.1 In the course of assessment proceedings assessee was requiredto show cause why disallowance u/s 14A read with Rule 8D should notbe made and added to its taxable income. 19.2 Assessee's submission: During the relevant previous year, the assessee company earneddividend/interest income of Rs. 11.54 crores from investments inshares, bonds, and mutual funds, which was exempt under section10(34)/10(35)/10(15)(iv)(h) of the Act. In view of the provisions ofsection 14A of the Act, the assessee computed expenses disallowableunder that section at Rs. 65.23 lacs, in the return of income filed for therelevant assessment year. While computing the amount of disallowance of Rs. 65.23 lacsunder section 14A of the Act in the return of income, the assesseeconsidered salary paid to employees, who were involved in treasuryfunction, as follows: Further entire Protfolio management fees Rs. 20,49,692/- were alsodisallowed. In the notice, the assessee has been asked to show cause as to whythe disallowance under Section 14A be not computed as per provisions ofRule 8D of the Rules. Reliance, in this regard, is placed on the recent decision of DelhiHigh Court in the case of Maxopp Investment Ltd. vs. CIT 247 CTR 162,wherein after considering the aforesaid decision of Supreme Court, theHigh Court has analyzed the scope of provisions of section 14A and thepowers vested with the assessing officer before invoking the same. TheHigh Court held, that the expression "expenditure incurred" refers toactual expenditure and not to some imagined expenditure. It was held, that-the provisions of subsection (2)/(3) of section 14A read with Rule 8D of-the Rules can be applied from assessment year 200809 and onwards, onlyif the assessing officer first rejects the claim of the assessee of having notincurred any expenditure in relation to earning of exempt income, withcogent reasons. In other words, the onus is on the assessing officer toestablish nexus of expenses with exempt income, before rejecting the claimof assessee and computing disallowance under section 14A as per Rule 8Dof the Rules. The relevant observations of the High Court are as under: “......... “......... Thus, we will have to consider the argument of the asssessees inrespect of the expression "expenditure incurred" in the context of theexpenditure being in connection with or pertaining to income whichdoes not form part of the total income under the said Act.27. A reference was made to the decision of the Punjab and HaryanaHigh Court in the case of CIT-II v. Hero Cycles Ltd [ITA No.331/2009: decided on 4/11/2009] wherein it was observed that:-"DisallowanceunderSectionl4Arequiresfindingofincurring expenditure where it is found that for earningexemptedincomenoexpenditurehasbeenincurred,disallowance under Section 14A cannot stand.”respect of the expression "expenditure incurred" in the context of theexpenditure being in connection with or pertaining to income whichdoes not form part of the total income under the said Act.27. A reference was made to the decision of the Punjab and HaryanaHigh Court in the case of CIT-II v. Hero Cycles Ltd [ITA No.331/2009: decided on 4/11/2009] wherein it was observed that:-"DisallowanceunderSectionl4Arequiresfindingofincurring expenditure where it is found that for earningexemptedincomenoexpenditurehasbeenincurred,disallowance under Section 14A cannot stand.” 28. It was contended that unless and until there was actualexpenditure for earning the exempted income, there could not be anydisallowance under section 14A. While we agree that the expression"expenditure incurred" refers to ‘actual’ expenditure and not tosome imagined expenditure we would like to make it clear that the'actual' expenditure that is in contemplation under section 14A(1) ofthe said Act is the 'actual' expenditure in relation to or in connectionwith or pertaining to exempt income. The corollary to this is that ifno expenditure is incurred in relation to the exempt income, nodisallowance can be made under section 14A of the said Act.Scope of sub-sections (2) and (3) of Section 14A 29. Sub-section (2) of Section 14A of the said Act provides themanner in which the Assessing Officer is to determine the amount ofexpenditure incurred in relation to income which does not form partof the total income. However, if we examine the provision carefully,we would find that the Assessing Officer is required to determine theamount of such expenditure only if the Assessing Officer, havingregard to the accounts of the assessee, is not satisfied with thecorrectness of the claim of the assessee in respect of suchexpenditure in relation to income which does not form part of thetotal income under the said Act. In other words, the requirement ofthe Assessing Officer embarking upon a determination of the amountof expenditure incurred in relation to exempt income would betriggered only if the Assessing Officer returns a finding that he is notsatisfied with the correctness of the claim of the assessee in respectof such expenditure. Therefore, the condition precedent for theAssessing Officer entering upon a determination of the amount ofthe expenditure incurred in relation to exempt income is that the Assessing Officer must record that he is not satisfied with thecorrectness of the claim of the assessee in respect of suchexpenditure. Sub-section (3) is nothing but an offshoot of sub-section(2) of Section 14A. Sub-section (3) applies to cases where theassessee claims that no expenditure has been incurred in relation toincome which does not form part of the total income under the saidAct. In other words, sub-section (2) deals with cases where theassessee specifies a positive amount of expenditure in relation toincome which does not form part of the total income under the saidAct and sub-section (3) applies to cases where the assessee assertsthat no expenditure had been incurred in relation to exempt income.In both cases, the Assessing Officer, if satisfied with the correctnessof the claim of the assessee in respect of such expenditure or noexpenditure,asthecasemaybe,cannotembarkuponadetermination of the amount of expenditure in accordance with anyprescribed method, as mentioned in sub-section (2) of Section 14A ofthe said Act. It is only if the Assessing Officer is not satisfied withthe correctness of the claim of the assessee, in both cases, that theAssessing Officer gets jurisdiction to determine the amount ofexpenditure incurred in relation to such income which does not formpart of the total income under the said Act in accordance with theprescribed method. The prescribed method being the methodstipulated in Rule 8D of the said Rules. While rejecting the claim ofthe assessee with regard to the expenditure or no expenditure, as thecase may be, in relation to exempt income, the Assessing Officerwould have to indicate cogent reasons for the same.Rule 8D 30. As we have already noticed, sub-section (2) of Section 14A of thesaid Act refers to the method of determination of the amount ofexpenditure incurred in relation to exempt income. The expressionused is - "such method as may be prescribed". We have alreadymentioned above that by virtue of Notification No.45/2008 dated24/03/2008, the Central Board of Direct Taxes introduced Rule 8Din the said Rules. The said Rule 8D also makes it clear that wherethe Assessing Officer, having regard to the accounts of the assesseeof a previous year, is not satisfied with (a) the correctness of theclaim of expenditure made by the assessee; or (b) the claim made bythe assessee that no expenditure has been incurred in relation toincome which does not form part of the total income under the saidAct for such previous year, the Assessing Officer shall determine theamount of the expenditure in relation to such income in accordance with the provisions of sub-rule (2) of Rule 8D. We may observe thatRule 8D(1) places the provisions of Section 14A(2) and (3) in thecorrect perspective. As we have already seen, while discussing theprovisions of Sub-sections (2) and (3) of Section 14A, the conditionprecedent for the Assessing Officer to himself determine the amountof expenditure is that he must record his dissatisfaction with thecorrectness of the claim of expenditure made by the assessee or withthe correctness of the claim made by the assessee that noexpenditure has been incurred. It is only when this conditionprecedent is satisfied that the Assessing Officer is required todetermine the amount of expenditure in relation to income notincludable in total income in the manner indicated in sub-rule (2) ofRule 8D of the said Rules. with the provisions of sub-rule (2) of Rule 8D. We may observe thatRule 8D(1) places the provisions of Section 14A(2) and (3) in thecorrect perspective. As we have already seen, while discussing theprovisions of Sub-sections (2) and (3) of Section 14A, the conditionprecedent for the Assessing Officer to himself determine the amountof expenditure is that he must record his dissatisfaction with thecorrectness of the claim of expenditure made by the assessee or withthe correctness of the claim made by the assessee that noexpenditure has been incurred. It is only when this conditionprecedent is satisfied that the Assessing Officer is required todetermine the amount of expenditure in relation to income notincludable in total income in the manner indicated in sub-rule (2) ofRule 8D of the said Rules. 31. It is, therefore, clear that determination of the amount ofexpenditure in relation to exempt income under Rule 8D would onlycome into play when the Assessing Officer rejects the claim of theassessee in this regard. If one examines ·sub-rule (2) of Rule 8D, wefind that the method for determining the expenditure in relation toexempt income has three components. The first component being theamount of expenditure directly relating to income which does notform part of the total income. The second component beingcomputed on the basis of the formula given therein in a case wherethe assessee incurs expenditure by way of interest which is notdirectly attributable to any particular income or receipt. Theformula essentially apportions the amount of expenditure by way ofinterest [other than the amount of interest included in clause (i)]incurred during the previous year in the ratio of the average valueof investment, income from which does not or shall not form part ofthe total income, to the average of the total assets of the assessee.The third component is an artificial figure – one half percent of theaverage value of the investment, income from which does not orshall not form part of the total income, as appearing in the balancesheets of the assessee, on the first day and the last day of theprevious year. It is the aggregate of these three components whichwould constitute the expenditure in relation to exempt income and itis this amount of expenditure which would be disallowed underSection 14A of the said Act. It is, therefore, clear that in terms of thesaid Rule, the amount of expenditure in relation to exempt incomehas two aspects - (a) direct and (b) indirect. The direct expenditureis straightaway taken into account by virtue of clause (i) of sub-rule(2) of Rule 8D. The indirect expenditure, where it is by way of interest, is computed through the principle of apportionment, asindicated above and, in cases where the indirect expenditure is notby way of interest, a rule of thumb figure of one half percent of theaverage value of the investment, income from which does not· orshall not form part of the total income, is taken.”(emphasissupplied) In the present case, as submitted above, the assessee suo motoidentified expenses having relation with earning of exempt dividendincome, viz., Salary of employees engaged in treasury functions andproprortionate PMS fees which has been suo moto disallowed in the returnof income. Apart from the aforesaid expenses, there is no other expenditurehas been pointed out to be related to exempt income in the subject noticeafter examination and verification of accounts of the assessee. Further, no portion of the borrowed funds also has nexus withinvestment in shares resulting in earning of exempt dividend income. Thedetails of ·interest expenditure incurred during the year are as under: It is submitted that the deposits were received from dealers as part · ofbusiness transaction with them and such funds were utilized in businessoperations itself. Further, no portion of the borrowed funds also has nexus withinvestment in shares resulting in earning of exempt dividend income. Thedetails of ·interest expenditure incurred during the year are as under: It is submitted that the deposits were received from dealers as part · ofbusiness transaction with them and such funds were utilized in businessoperations itself. That apart, it is submitted that the assessee had substantial freereserves of Rs 4249.89 crores at the beginning of the relevant previousyear and had also generated substantial surplus/interest free funds of Rs.1890.43 crores during the year. Further proceeds from sales of investmentswere higher than purchases thereof by Rs. 627.85 crores. In suchcircumstances, it is to be presumed that only interest free funds have beenutilized for making investments during the year. Reliance, in this regard, is placed on the following decisions: The Supreme Court in the case of East India Pharmaceutical WorksLtd. Vs. CIT: 224 ITR 627, approved the contention of the assessee that, where interest free funds/ profits available with an assessee are much morethan the borrowed funds, it should be presumed that, in essence and truecharacter, the amounts were paid out of the profits of the relevant year andnot out of borrowed funds. The relevant observations of the Court are asunder: "Having considered the rival submissions at the Bar, thoughwe find considerable force in the arguments advanced bylearned counsel appearing for the appellant, but in the factsand circumstances of the present case, on going through _theorder of the Tribunal as well as the question referred by theTribunal for being answered by the High Court and thearguments advanced before the Tribunal as well as in theHigh Court by counsel appearing for the assessee, it is notpossible for us to hold that any such contention, as wasadvanced before this court by the assessee had in fact beenadvanced either before the Tribunal or before the HighCourt. The question whether a presumption can be drawnthat the taxes were paid out of the profits of the relevant yearand not out of the overdraft account for the running of thebusiness as was drawn in Woolcombers's case [1982] 134ITR 219 by the Calcutta High Court and was followed inthree other cases of the same High Court, would essentiallydepend upon the fact as to whether the entire profits had beenpumped into the overdraft account, whether such profits weremore than the tax amount paid for the relevant year and allother germane factors. But when the assessee never advancedthe contention either before the Tribunal or before the HighCourt and the amplitude of the question posed before theHigh Court does not bring within its sweep the contention asis advanced by Mr. Bhattacharyya, learned counsel in thiscourt, it would not be appropriate for this court to look intotheadditionalpapersproducedbytheassesseeforentertainingthecontentionandansweringthesame."(emphasis supplied) The Calcutta High Court in the case of Woolcombers of India Ltd. v.CIT: 134 ITR 219 held that where the assessee was having an overdraftaccount with the bank, in which profits were deposited and such profitsexceeded the advance tax liability, it was to be presumed that advance taxwas paid out of profits and not out of overdraft account. The disallowanceof interest on overdraft related to payment of advance tax was held not tobe justified. The aforesaid decision of the Calcutta High Court in the case ofWoolcombers was approved by the Supreme Court in the case of East IndiaPharmaceutical Works vs. CIT (supra). The Calcutta High Court in the case of Woolcombers of India Ltd. v.CIT: 134 ITR 219 held that where the assessee was having an overdraftaccount with the bank, in which profits were deposited and such profitsexceeded the advance tax liability, it was to be presumed that advance taxwas paid out of profits and not out of overdraft account. The disallowanceof interest on overdraft related to payment of advance tax was held not tobe justified. The aforesaid decision of the Calcutta High Court in the case ofWoolcombers was approved by the Supreme Court in the case of East IndiaPharmaceutical Works vs. CIT (supra). The Madras High Court in the case of CIT vs. Hotel Savera: 239ITR 795 held that where· the amount borrowed by a firm were mixed withits own funds and amounts were lent interest free to private companies outof such funds, it could be presumed, in the absence of any nexus havingbeen established between the borrowed funds and the funds lent to privatecompanies, that the advance had been made with firm's own funds, wherethe firm had sufficient funds to cover the advance. It was, therefore, heldthat the interest paid on borrowed funds by the firm was allowable in fullunder section 36(1)(iii) of the Act. To the same effect are the following decisions: CIT v Radico Khitan Ltd: 274 ITR 354 (All) CIT v Dhampur Sugar Mills Ltd: 274 ITR 370 (All) CIT v. United Collieries Ltd. : 49 Taxman 227 (Cal) -CIT v. Enamour Investment Ltd.: 72 Taxman 370 (Cal) CIT v. Caroline Investment Ltd.: 87 Taxman 238 (Cal) CIT v. Kanoria Investment {P) Ltd.: 232 ITR 7 (Cal) Tata Fertilizers Ltd. v. DCIT: 92 Taxman (Mag) 423 (Mum) Smt. Chanchal Katyal V. CIT: 207 CTR 154 (All.) DCIT V. Samtel Electron Devices Ltd: 100 TTJ 706 (Del.) DCIT V. Samtel Electron Devices Ltd: 100 TTJ 706 (Del.) Motor General Finance Limited: 267 ITR 381 (SC) followed by Motor General Finance Limited: 267 ITR 381 (SC) followed byDelhi HC in 272 ITR 550. Kumaragiri Textiles Ltd V. DCIT: 100 ITD 57 (Chennai) (TM) CIT v. Reliance Utilities and Power Ltd.: 313 ITR 240 (BombayHC)HC) On the basis of the ratio of the aforesaid decisions, and havingregard to the facts. of the case, interest free funds available with theassessee were used for making investments and, accordingly, no portion ofthe interest expenditure incurred during the year co.uld also be said tohave been incurred in relation to earning of exempt income, warrantingrejection of disallowance computed by the assessee and adopting recourseto provisions of Rule 8D of the Rules. 19.3 Findings; i.Argument of the assessee is that no expenditure was incurred toearn the exempt income. It has just considered salary of two staff membersRs. 44, 73,323/- and portfolio management fees Rs. 20,49,692/- asexpenditure attributable to earn exempt income. This appears to be aproposition where assessee is trying to make a case that all decisions with regard to the extent of investment, nature of investment, period of theirholding etc. are decided by these two employees. The fact is that when theinvestment is running into hundred of crores and turnover in thousands ofcrores of rupees, it is decision of the management, to invest, continuetherein, exit there from or to deal with that in the manner as decided bythem. These two employees could be instrumental in only in managing theaccounts but in no way in having a say in decision making. It is consciousdecision of the management to make these investment, continue therein,deal with that and exit therefrom. Therefore, there is inherent cost ofbusiness establishment and control and management. regard to the extent of investment, nature of investment, period of theirholding etc. are decided by these two employees. The fact is that when theinvestment is running into hundred of crores and turnover in thousands ofcrores of rupees, it is decision of the management, to invest, continuetherein, exit there from or to deal with that in the manner as decided bythem. These two employees could be instrumental in only in managing theaccounts but in no way in having a say in decision making. It is consciousdecision of the management to make these investment, continue therein,deal with that and exit therefrom. Therefore, there is inherent cost ofbusiness establishment and control and management. ii.Coming next to the impugned disallowance u/s 14A of the Act, it isa fact that expenditure under the head administrative expenditure forearning dividend income cannot be ruled out. While allocating expensesrelating to exempt income not only the direct expenses like receiving anddepositing the dividend warrant has to be taken into consideration but alsothe indirect expenses including major managerial/ clerical expenses whichare involved in making and implementing the decision are also to be takennote of. The disallowance of administrative expenses and interest expenseson earning of exempted income is also held/permitted by the Hon'bleSupreme Court in the case of CIT vs. United General Trust, 200 ITR 488(SC). iii.The assessee company has earned exempt income amounting Rs11.54 crores on non trade current investment made by it in mutual funds,shares and bonds as per schedule of the accounts. iv.The decisions of investments in shares/mutual funds are vigil andupdated ones. Further equity oriented mutual fund schemes are prone tomarket forces, in the same manner, debts oriented mutual funds scheme aresubject to market fluctuation and their NAV also changes according to thegiven market sentiment. v.This fact that diversified investment in mutual funds revealed whole,that would suggest that considerable time, effort, application of skills,technical knowledge, expertise etc. have gone in toward these investments.vi.The assessee company has total profit before tax Rs. 2,529.20Crores and total exempt income is Rs. 11.54 crores. For both income majorexpenses are audit expenses, which is Rs. 126 lacs, as the auditor of thecompany audited all the ‘transaction recorded in the books of accounteither for turnover or for sale of securities. There are some other expensesat HO like Postage & telegram Rs. 55.82 lacs, Printing & stationary Rs.61.43 lacs, Telephone & Telex Rs. 289.22 lacs, Director sitting fees Rs.15.00 lacs, and misc expenses Rs. 87.98 lacs. All the expenses are directlyrelated to the total income of the company. Section 14A has been inserted by the Finance Act 2001, w.r.e.f. 1.4.62.Section 14A has been amended by section 10 of the Finance Act 2002 andagain by section 7 of the Finance Act, 2006. The CBDT issued Notification No.45 dated 24.3.2008 incorporating Rule8D pertaining to the "method of determining amount of expenditure inrelation to income not includible in total income". Section 14A has been inserted by the Finance Act 2001, w.r.e.f. 1.4.62.Section 14A has been amended by section 10 of the Finance Act 2002 andagain by section 7 of the Finance Act, 2006. The CBDT issued Notification No.45 dated 24.3.2008 incorporating Rule8D pertaining to the "method of determining amount of expenditure inrelation to income not includible in total income". CBDT has also issued Circular No. 5/2014 wherein it is stated that"the matter has been examined in the Board. It is pertinent tomention that section 14A of the Act was introduced by the FinanceAct, 2001 with retrospective effect from 01.04.1962. The purpose forintroduction of section 14A with retrospective effect since inceptionof the Act was clarified vide Circular No. 14 of 2001 as under:"Certain incomes are not includible while computing the totalincome, as these are exempt under various provisions of the Act.There have been cases where deductions have been claimed inrespect of such exempt income. This in effect means that the taxincentive given by way of exemptions to certain categories of incomeis being used to reduce also the tax payable on the non-exemptincome by debiting the expenses incurred to earn the exempt incomeagainst taxable income. This is against the basic principles oftaxation whereby only the net income, i.e. gross income minus theexpenditure, is taxed. On the same analogy, the exemption is also inrespect of the net income. Expenses incurred can be allowed only tothe extent they are relatable to the earning of taxable income." Thus,legislative intent is to allow only that expenditure which is relatableto earning of income and it therefore follows that the expenseswhich are relatable to earning of exempt income have to beconsidered for disallowance, irrespective of the fact whether anysuch income has been earned during the financial-year or not. Theabove position is further clarified by the usage of term 'includible' inthe Heading to section 14A of the Act and also the Heading to Rule8D of IT Rules, 1962 which indicates that it is not necessary thatexempt income should necessarily be included in a particular year'sincome, for disallowance to be triggered. Also, section 14A of theAct does not use the word "income of the year" but “income underthe Act". This also indicates that for invoking disallowance undersection 14A, it is not material that assessee should have earned suchexempt income during the FY under consideration. The above position is further substantiated by the language used in Rule8D[2(ii) & 8D(2)(ii) of the IT Rules which are extracted below:-"(ii) in a case where the assessee has incurred expenditure by wayof interest during the previous year which is not directly attributableto any particular income or receipt an amount computed inaccordance with the following formula, namely:-A*B/C where ......B= the average of value of investment, income from which does notor shall not form part of the total income,as appearing in thebalance sheet of the assessee, on the first day and the last day of theprevious years; .....(iii) an amount equal to one-half percent of theaverage of the value of investment, income from which does not orshall not form part of the total income, as appearing in the balancesheet of the assessee, on the first day and the last day of the previousyear." (Emphasis added) thus, in light of above, Central Board ofDirect Taxes, in exercise of its powers under section 119 of the Acthereby clarifies that Rule 8D r.w. section 14A of the Act provides fordisallowance of the expenditure even where taxpayer in a particularyear has not earned any exempt income." • The provision of sub-section (1) of Section 14A provides; "14A. for the purposes of computing the total income under this Chapter,no deduction shall be allowed in respect of expenditure incurred by theassessee in relation to income which does not form part of the total incomeunder this Act." • The provision of sub-section (1) of Section 14A provides; "14A. for the purposes of computing the total income under this Chapter,no deduction shall be allowed in respect of expenditure incurred by theassessee in relation to income which does not form part of the total incomeunder this Act." • The term “expenditure” occurring in Section 14A would take in its sweepnot only direct expenditure but also all forms of expenditure regardless ofwhethertheyarefixed,variable,direct,indirect,administrative,managerial or financial. • As regards the applicability of Rule 8D of the l.T. Rules, the Hon'ble ITATin the case of Citicorp Finance (I) Ld. Held that “ .... It is no longer opento the Assessing Officer to apply his discretion in computing thedisallowance or make adhoc disallowance u/s 14A ....” as “ ... sub sections(2) and (3) seek to achieve the underlying objection of section 14A(1) thatany expenditure incurred in relation to exempt income should not beallowed deduction ....”. • The earning of exempt income is not in the nature of passive activityhaving no input. In fact in present situation making of investment,maintaining or continuing investment and time of exit from the investmentsare well informed and well coordinate management decisions involving not only inputs from various source but also acumen of senior managementfunctionaries. Therefore cost is inbuilt into even so called "passive"investment. Incidental expenditures in this regard are bound to be incurredin collection, telephone, follow-up even directors time and energy etc.Assesee Company's claim that it has not incurred any expenditure is notacceptable as expenditures incurred for earning of exempted income areembedded in indirect expenditures. • The investments made, being a conscious decision and having deploymentof funds clearly brings into picture expenditure by way of cost of fundsinvested. • The Hon'ble Bombay High Court, in its judgment delivered on 12.08.2010in ITXA No. 626/2010 & Writ Petition No. 758/2010 in the case of Godrej& Boyce Manufacturing Co. Limited, Mumbai vs. Dy. CIT-10(2),Mumbai & others; has ruled in favour of the Department as regards theapplicability of Rule 8D for and from A.Y. 2008-09 onwards. • The assessee's plea that it has not earned any exempt income on itsinvestments, hence the provision of Section 14A is not applicable to itscase, is not acceptable in view of the clear position of law that thenomenclature of the heading before Rule 8D of the Rules, 1962 providesfor 'method for determining amount of expenditure in relation to incomenot includible in total income'. The words used are "income notincludible in total income", it is not "income not included in totalincome". There is a difference between the terms "not includible" and"not included" as such. Moreover, part 'B' of clause (ii) of sub-rule (2) ofRule 8D also prescribes the average of value of investment, income fromwhich does not or shall not form part of the total income, as appearing inthe balance sheet of the assessee, on the first day and the last day of theprevious year. Thus, the intent of legislature is very much clear from thewordings used in the heading as well as Rule 8D itself so as to cover all theinvestments which might generate such an income either in the present oreven in future, which is not includible in total income of the assessee. • If there is material to establish that there is direct nexus between theexpenditure incurred and the income not forming part of total income,disallowance would be justified even where there is no receipt of exemptincome u/s 10 in the year under consideration, in view of the latestdecision of the Hon'ble Delhi ITAT vide order dated 09.01.2012 for A.Y.2008-09 in the case of Technopak Advisors Private Limited [2012) 50SOT 31, wherein it has been held that as per provisions of Section 14A, • If there is material to establish that there is direct nexus between theexpenditure incurred and the income not forming part of total income,disallowance would be justified even where there is no receipt of exemptincome u/s 10 in the year under consideration, in view of the latestdecision of the Hon'ble Delhi ITAT vide order dated 09.01.2012 for A.Y.2008-09 in the case of Technopak Advisors Private Limited [2012) 50SOT 31, wherein it has been held that as per provisions of Section 14A, actual earning of income is not sine qua non for deciding deduction ofexpenditure laid out or expended wholly or exclusively for purpose ofsuch income. The Hon'ble Tribunal adjudicated upon the question of lawin affirmative as to whether, where investment had been made in shares,which did not yield any dividend in the year under consideration,expenditure incurred for earning income was deductible notwithstandingthe fact that no such income had been earned. • Hon'ble Supreme Court in the case of CIT Vs. United General Trust Ltd.,200 ITR 488 (SC) has held that expenditure in relation to earning ofexempt income are embedded in the indirect expenditures. Accordingly theclaim of the assesee that it has not incurred any expenditures in relation toearning of the exempted income is not acceptable. Further, The following instances will clarify the situation regarding thequantum and the accrual of income being of no relevance/cannot be ofrelevance to the disallowance of expenditure in question 1. Two assessees namely A & B both borrow capital of 100 crores @ 12%and invest in two different shares of company C and D respectively. Thecompany C doesn’t declare dividend whereas the Company D declares adividend of 1 Crore. The assessee’s argument tend to lay down that nodisallowance has to be made if no dividend income has been received bythe assessee Now, both the companies A & B have incurred an expenditure of Rs. 12crore on the said investment. The assessee's argument effectively proposesa theory of penalizing the company B selectively for earning the dividend.The company A will be allowed the interest expenditure ·of Rs. 12 croreand no disallowance would be made in the case of company A as nodividend has accrued to it, whereas in the case of company B the interestexpenditure of Rs. 12 crore will be disallowed. The above leads to a primafacie fallacy of such a conclusion, for which the Act doesn't intend in law .Therefore, the quantum of income has no role to play, rather cannot play arole in the determination of disallowance u/s 14A. r.w Rule 8D 2. Let us consider another situation in which two assessees namely A & Bboth borrow capital of 100 crores @ 12% and invest in shares of companyD respectively. The company D declares dividend of Rs. 1 crore. The entityA follows cash system of accounting and the entity B follows mercantilesystem of accounting and because of which the situation arises that the entity A accounts for dividend in the subsequent year on receipt basis, letsay financial year 2015-16 and the entity B accounts for the same onaccrual basis in financial year 2014-15, if the assessee's arguments are tobe followed, in the case of entity A no disallowance can be made in FY2014-15 and disallowance can be made in FY 2015-16 whereas in entity Bdisallowance can be made in FY 2014-15 and not in FY 2015-16, in spite ofthe fact that both the entities have incurred interest expenditure for both theyears under consideration and for the same dividend declared and thesame investments, the disallowance takes place selectively in a particularyear which leads to again a fallacy. entity A accounts for dividend in the subsequent year on receipt basis, letsay financial year 2015-16 and the entity B accounts for the same onaccrual basis in financial year 2014-15, if the assessee's arguments are tobe followed, in the case of entity A no disallowance can be made in FY2014-15 and disallowance can be made in FY 2015-16 whereas in entity Bdisallowance can be made in FY 2014-15 and not in FY 2015-16, in spite ofthe fact that both the entities have incurred interest expenditure for both theyears under consideration and for the same dividend declared and thesame investments, the disallowance takes place selectively in a particularyear which leads to again a fallacy. 3. Let us consider another situation in which two assessees namely A & Bboth borrow capital of 100 crores @ 12% and invest in shares of companyC & D respectively. Both incur an expenditure of Rs. 12 crore for the year.The company C declares a dividend of Rs. nil and the company D declaresa dividend of Rs. 12 crores. The assessee's argument tend to limit thedisallowance to the income earned ( in most of the cases the quantum ofdividend is not in control of the assessee and the assessee can't be said tohave a role as such regarding the quantum), therefore in the case of A thesum of Rs. 12 crores being the deficit will be allowed as a businessexpenditure, when the same was directly related to the earning of exemptincome, thus again leading to a fallacy, when both the assessee basicallyinvested same quantum at the same rate of borrowings and also a fallacyof creating an impression that an expenditure will just become a businessexpenditure of the assessee just for the want of exempt income and thequantum of exempt income will govern the allowance and quantum of anexpenditure to be characterized as a business expenditure inspite of thefact that it has no relation. Thus, just because no dividend was accrued,the same expenditure became a business expenditure & thus brings outthe fallacy in the argument of no dividend implies no disallowance. The above examples, which are simple in nature only tend to bring aboutthe implication of assessee's argument, leading to a the flawed and variedtreatment of the disallowance of same interest expenditure on sameinvestments as a measure of situation, accounting, quantum and accrual ofexempt income i.e dividend The neutrality of the Income Tax Act regarding the quantum of income andits accrual is very clearly brought out in the section 14A and also the intentis supported by the mechanism of disallowance provided in rule 8D. Further, the rule 8D which prescribes a method of disallowance(reproduced as under) 1. Where the Assessing Officer, having regard to the accounts of theassessee of a previous year, is not satisfied with:assessee of a previous year, is not satisfied with: a. The correctness of the claim of expenditure made by the assessee or b. The claim made by the assessee that no expenditure has beenincurred,incurred, In relation to income which does not form part of the total income underthe Act for such previous year, he shall determine the amount ofexpenditure in relation to such income in accordance with the provisions ofsub-rule{2). 2.)the expenditure in relation to income which does not formpart of the total income shall be the aggregate of following amount,-namely (i)the amount of expenditure directly relating to income whichdoes not form part of total income. (ii)in a case where the assessee has incurred expenditure by wayof interest during the previous year which is not directly attributableto any particular income or receipt, an amount computed inaccordance with the following formula, namely- or b. The claim made by the assessee that no expenditure has beenincurred,incurred, In relation to income which does not form part of the total income underthe Act for such previous year, he shall determine the amount ofexpenditure in relation to such income in accordance with the provisions ofsub-rule{2). 2.)the expenditure in relation to income which does not formpart of the total income shall be the aggregate of following amount,-namely (i)the amount of expenditure directly relating to income whichdoes not form part of total income. (ii)in a case where the assessee has incurred expenditure by wayof interest during the previous year which is not directly attributableto any particular income or receipt, an amount computed inaccordance with the following formula, namely- AXBCWhere A =amount of expenditure by way of interest otherthan the amount of interest included in clause(i) incurred during the previous year.B=the average of value of investment, incomefrom which does not or shall not form part ofthe total income, as appearing in the balancesheet of the assessee, on the first day and thelast day of the previous year:C=the average of total assets as appearing in thebalance sheet of the assessee, on the first day ofthe last day of the previous year: (iii)an amount equal to one-half per cent of the average of thevalue of investment, income from which does not or shall no formpart of the total income, as appearing in the balance sheet of theassessee, on the first day and the last day of the previous year. (3)For the purpose of this rule, the "total assets" shall mean, totalassets as appearing in the balance sheet excluding the increase on accountfre evaluating of assets but including the decrease on account ofrevaluation of assets The above rule for the purpose of disallowance is very clear that what ismaterial aspect is the quantum of expenditure incurred in relation to thequantum of investment made and there is no whiff of the quantum of incomegenerated by these investments. Therefore, the section 14A and consequentrule 8D in unison very clearly and unambiguously lays down the intend ofthe statue for making a disallowance. The Apex Court by admitting SLP in case of Tulip Star Hotel Ltd, whereinit was pronounced as under:- “ lssue notice on the applications for condonation of delay as also on thespecial leave petitions. In our view, S.A. Builders Ltd. vs. Commissioner ofIncome-Tax (Appeals) and Another, reported in 288 ITR 1, needsreconsideration." Which considers that the question of allowability ofinterest is open for consideration still The aforesaid provisions are procedural in nature and thedisallowance u/s 14A is, therefore, computed in accordance withRule 8D. In view of the above, the explanation furnished by the assessee is not fullyacceptable. Therefore, the undersigned has to apply the rule 8D for makingdisallowance u/s 14A. Here it may be pointed out that the insertion of Section 14A of theAct and subsequent introduction of Rule 8D are meant to clear theambiguity with regard to expenditure relatable to earning of exemptincome. The provisions are basically addressing the extent of funds havingbeen managed for such investment, expenditure directly relatable to suchearnings and interest charged to P/L account, in case not directly relatableto any particular income or receipt. In the absence of any scientificworking on part of the assessee to allocate expenses relatable to exemptincome and mere claim that no expenditure was incurred to earn theexempt income, the Assessing Officer is left with no alternative but to workout the same. Since any other working of expenditure relatable to exempt income will be mere estimate, it is necessary to invoke Rule 8D to work outsuch a disallowance. income will be mere estimate, it is necessary to invoke Rule 8D to work outsuch a disallowance. Furthermore, having regard to the accounts of the assessee of theprevious year, AO is not satisfied with the claim made by the assessee thatno expenditure hasbeen incurred in relation to income which does notform part of the total income of the previous year relevant to theassessment year under consideration and, therefore, the amount ofexpenditure in relation to such income is determined in accordance withthe provisions of sub-rule (2) of Rule 8D of the IT Rules, 1962. Since the assessee has already worked out disallowance u/s 14A atRs. 65.23 lacs, effect thereof is given here and net disallowance of Rs.66.35 lacs is being made and proposed to be added to the income of theassessee. The Hon'ble DRP vide its order dated 21.09.2017 has decided thisissue in favour of Revenue giving a detailed reasoning which is part of theDRP order and not reproduced for the sake of brevity. Accordingly inconformity with the order of DRP, disallowance of Rs. 66,35,000/- is beingmade and added to the total income of the assessee under normalprovisions as well as income computed u/s 115JB. I am satisfied that theassessee company has filed inaccurate particulars of income in respect ofthis issue with regards to income under normal provisions of the Act as well as income u/s 115JB. Penalty proceeding u/s 271(1)(c) is initiatedseparately.(Addition of Rs. 66,35,000/-) Without prejudice to the above, the above interest expenses are noteligible u/s 36(1)(iii) and the maintenance of investment cost as computedabove not eligible u/s 37(1). The assessee has made sizable investments in various entities, theassessee has claimed a sizable amount of interest expenditure u/s 36(1)(iii). The deduction of interest to the assessee under the head income frombusiness and profession is allowed u/s 36(1)(iii) of the Income Tax Act,1961, which reads as under:- "The amount of interest paid in respect of capital borrowed for thepurpose of business and profession" Therefore the interest has to be allowed only if the capital deployedis for business and profession It is important to note that the claim ofinterest u/s 36(1)(iii) is of the assessee and it has to be justified for thepurpose of business by the assessee. The onus is on the assessee and not ofthe department to justify its claim of interest, and if the assessee fails to doso, if on account of mixed funds, the A.O has all the right to estimate suchallowability and on direct nexus the same has to be disallowed. The assessee in the present case has made investments in shares andsecurities and has advanced share application money for investment inshares, the income generated from such investments has to be accountedunder the following heads: 1. Capital gains. 2. Income from other sources. The income from capital gains arises from the transfer of the assetheld as investment and depending on the period of holding, the indexationas applicable is allowed as a sort of compensation for the period ofholding. The provisions from section 45 to 55A for computation of incomeunder the head capital gains do not allow for any deduction of interest paidon the capital deployed for such an ass