Hero Motocorp Ltd v. Deputy Commissioner Of Income Tax

$~8 *IN THE HIGH COURT OF DELHI AT NEW DELHI+ITA No. 1272/2018 HERO MOTOCORP LTD. ..... AppellantThrough :Mr. Ajay Vohra, Sr. Adv. withMr. Aniket D. Agrawal &Ms. Deepika Agarwal, 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:- “-22. Disallowance u/s 14A; Rs. 62,30,000/ ; 22.1 In the course of assessment proceedings assessee was requiredto show cause why disallowance u/s 14A read with Rule 8D shouldnot be made and added to its taxable income. 22.2 Assessee's submission: During the relevant previous year, the assessee companyearneddividend/interestincomeofRs.11.02croresfrominvestments in shares, bonds, and mutual funds, which was exemptunder section 10(34)/10(35)/10(15)(iv)(h) of the Act. In view of theprovisions of section 14A of the Act, the assessee computed expensesdisallowable under that section at Rs. 70.76 lacs, in the return ofincome filed for the relevant assessment year. While computing the amount of disallowance of Rs. 70.76lacs under section 14A of the Act in the return of income, theassessee considered salary paid to employees, who were involved intreasury function, as follows: Proportional Employee’s Cost Further entire Protfolio management fees Rs. 28,64,867/- 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, thatthe provisions of sub-section (2)/(3) of section 14A read with Rule 8D ofthe Rules can be applied from assessment year 2008-09 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, with cogent 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.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. cogent 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.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 andHaryana High Court in the case of CIT-II/ v. Hero Cycles Ltd [ITANo. 331/2009: decided on 4/11/2009] wherein it was observed that:-"DisallowanceunderSection14Arequiresfindingofincurring expenditure where it is found that for earningexemptedincomenoexpenditurehasbeenincurred,disallowance under Section14A 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 to someimagined expenditure we would like to make it clear that the 'actual'expenditure that is in contemplation under section 14A(1) of the saidAct is the 'actual' expenditure in relation to or in connection with orpertaining to exempt income. The corollary to this is that if noexpenditure 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 respect of 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 theAssessing 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 to income 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 accordancewith 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 income has 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 ofinterest, 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:ParticularsAmount in Rs. (Lakhs)Interest on Dealer deposits157Interest on temporary overdraft5Interest on late deposit of TDS671(already disallowed in return)Interest on other statutory dues andPayments to vendor1297Total2130 It is submitted that the deposits were received from dealers as partof business transaction with them and such funds were utilized in businessoperations itself. That apart, it is submitted that the assessee had substantial freereserves of Rs 2916.12 crores at the beginning of the relevant previousyear and had also generated substantial surplus/interest free funds of Rs.2359. 78 crores during the year. Further proceeds from sales ofinvestments were higher than purchases thereof by Rs. 92.79 crores. Insuch circumstances, it is to be presumed that only interest free funds havebeen utilized 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 more That apart, it is submitted that the assessee had substantial freereserves of Rs 2916.12 crores at the beginning of the relevant previousyear and had also generated substantial surplus/interest free funds of Rs.2359. 78 crores during the year. Further proceeds from sales ofinvestments were higher than purchases thereof by Rs. 92.79 crores. Insuch circumstances, it is to be presumed that only interest free funds havebeen utilized 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 more than 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,though we find considerable force in the argumentsadvancedbylearnedcounselappearingfortheappellant, but in the facts and circumstances of thepresent case, on going through the order of theTribunal as well as the question referred by theTribunal for being answered by the High Court and thearguments advanced before the Tribunal as well as inthe High Court by counsel appearing for the assessee,it is not possible for us to hold that any suchcontention, as was advanced before this court by theassessee had in fact been advanced either before theTribunal or before the High Court. The questionwhether a presumption can be drawn that the taxeswere paid out of the profits of the relevant year and notout of the overdraft account for the running of thebusiness as was drawn in Woolcombers's case [1982]134 ITR 219 by the Calcutta High Court and wasfollowed in three other cases of the same High Court,would essentially depend upon the fact as to whetherthe entire profits had been pumped into the overdraftaccount, whether such profits were more than the taxamount paid for the relevant year and all othergermanefactors.Butwhentheassesseeneveradvanced the contention either before the Tribunal orbefore the High Court and the amplitude of thequestion posed before the High Court does not bringwithin its sweep the contention as is advanced by Mr.Bhattacharyya, learned counsel in this court, it wouldnot be appropriate for this court to look into theadditionalpapersproducedbytheassesseeforentertaining the contention and answering the same."(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 tax was 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 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) To the same effect are the following decisions:- CIT v Radico Khitan Ltd: 274 ITR 354 (All)- 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.) 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 (Bombay HC) On the basis of the ratio of the aforesaid decisions, and having regard tothe facts of the case, interest free funds available with the assessee wereused for making investments and, accordingly, no portion of the interestexpenditure incurred during the year could also be said to have beenincurred in relation to earning of exempt income, warranting rejection ofdisallowance computed by the assesseeand adopting recourse toprovisions of Rule 8D of the Rules. 24.3 Findings; i.Argument of the assessee is that no expenditure was incurred toearn the exempt income. It has just considered salary of two staff members Rs.42,11,900/-andportfoliomanagementfeesRs.28,64,867/-asexpenditure attributable to earn exempt income. This appears to be aproposition where assessee is trying to make a case that all decisions withregard 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 is afact that expenditure under the head administrative expenditure for earningdividend income cannot be ruled out. While allocating expenses relating toexempt income not only the direct expenses like receiving and depositingthe dividend warrant has to be taken into consideration but also theindirect expenses including major managerial/clerical expenses which areinvolved, 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 Rs.11.02 crores on non trade current investment made by it in mutual fundsand shares 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. iii.The assessee company has earned exempt income amounting Rs.11.02 crores on non trade current investment made by it in mutual fundsand shares 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. 2,864.77Crores and total exempt income is Rs. 11.02 crores. For both income majorexpenses are audit expenses, which is Rs. 58.09 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. 51.23 lacs, Printing & stationary Rs. 64.40 lacs, General administrative expenses Rs. 315.25 lacs, Telephone &Telex Rs. 226.16 lacs, Director sitting fees Rs. 14.00 lacs, and miscexpenses Rs. 44.64 lacs. All the expenses are directly related to the totalincome of the company. 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 exemptincome 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 has been 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. 70.77 lacs, effect thereof is given here and net disallowance of Rs.62.30 lacs is being made and added to the income of the assessee.The Hon'ble DRP vide its order dated 21.12.2016 has decided thisissue in favour of Revenue. Accordingly in conformity with the order ofDRP, disallowance of Rs. 62,30,000/- is being made and added to the totalincome of the assessee. I am satisfied that the assessee company has filedinaccurate particulars of income and concealed the income with respect tothis issue. Penalty proceedings u/s 271(1)(c) have been initiated separately. (Addition of Rs 62,30,000/-) 23.Expenses at Head Office towards Cost of Inventory, Rs. 66,84,000/- 23.1 The assessee has valued semi finished goods and finished goodsinventory at the raw material cost and allocated production overheads ofrespective units on closing inventory. However assessee has not consideredexpenses incurred at head office towards the valuation of inventory.Closing stock valuation is accordingly required to be modified. Therefore -assessee was required to show cause why the valuation of inventory not beenhanced on account of non inclusion of HO expenses.” (Addition of Rs 62,30,000/-) 23.Expenses at Head Office towards Cost of Inventory, Rs. 66,84,000/- 23.1 The assessee has valued semi finished goods and finished goodsinventory at the raw material cost and allocated production overheads ofrespective units on closing inventory. However assessee has not consideredexpenses incurred at head office towards the valuation of inventory.Closing stock valuation is accordingly required to be modified. Therefore -assessee was required to show cause why the valuation of inventory not beenhanced on account of non inclusion of HO expenses.” It is the complete substance of the order which has to be taken intoconsideration. The figures mentioned in the aforesaid reasoning comes fromthe accounts of the appellant assessee itself. We may also record that the question of merits of the deduction underSection 80D has been remitted by the Tribunal to the Assessing Officer forfresh consideration. With regard to the proposed question (F), learned senior counsel forthe appellant submits that they have filed a miscellaneous application beforethe Tribunal which is pending. He submits that liberty may be granted to theappellant to file a fresh appeal after the miscellaneous application is decided. We clarify that we have not examined merits of proposed question (F) forwhich the assessee has filed the miscellaneous application before theTribunal. We grant liberty to the appellant to file a fresh appeal in case themiscellaneous application is dismissed by the Tribunal. Recording the aforesaid, the appeal is dismissed on the questionrelating to Section 14A of the Act. Question (F) is left open to be decided ifrequired by way of a fresh appeal.For record, present appeal would betreated as disposed of. No costs. SANJIV KHANNA, J. JANUARY 11, 2019neelam ANUP JAIRAM BHAMBHANI, J.