+Ita 7/2019 v. J U D G M E N T

Signature Not Verified $~12 IN THE HIGH COURT OF DELHI AT NEW DELHI +ITA 7/2019 versus CORAM: HON'BLE MR. JUSTICE MANMOHAN HON'BLE MS. JUSTICE MANMEET PRITAM SINGH ARORA J U D G M E N T MANMEET PRITAM SINGH ARORA, J (ORAL): 1.The present appeal has been filed by the Revenue under Section 260Aof the Income Tax Act, 1961, (the ‘Act’) against the order dated 5[th]July,2018, passed by the Income Tax Appellate Tribunal (‘ITAT’) in ITA No.594/Del/2016, for the Assessment Year (‘AY’) 2012-13. 2.The facts of the case relevant for deciding the present appeal are asfollows: 2.1.The Respondent-Assessee, is engaged in the business of dealing ofshares and securities. On 29[th]September, 2012, the Assessee filed itsIncome Tax Return (‘ITR’) declaring a loss of Rs. 4,86,38,974/-. The case of ITA 7/2019 the Assessee was selected for scrutiny assessment and notice under Section143(2) of the Act was issued. 2.2.During the assessment proceedings, the Assessing Officer (‘AO’)noticed that, for the relevant previous year, the Assessee had earned a sumof Rs. 1.57 crore as dividend from the stock held as investment and the samehas been claimed as exempt income. The AO issued a notice to the Assesseeseeking an explanation as to why no disallowance should be made underSection 14A of the Act read with Rule 8D of the Income-tax Rules, 1962(the ‘Rule 8D’). 2.2.1. For computing the taxable income, the Assessee had suo motodisallowed Rs. 1,19,592/- towards administrative expenditure, whichincluded proportionate expenses of salary of staffs and other expenses. Withrespect to interest paid on the unsecured loan attributable to the investment,the Assessee stated that it has capitalized the interest with the investments,which was to the tune of Rs. 12.24 crores and has charged to the profit andloss account and a sum of Rs. 6.03 crores on account of interest. TheAssessee, therefore, contended before the AO that Section 14A of the Acthas no application and the formula of Rule 8D cannot be applied. 2.2.2. The AO held that the apportionment of direct or indirect expendituretowards taxable and exempt income has now become academic in view ofRule 8D, which prescribes the mechanism for working out the disallowanceunder Section 14A of the Act for exempt income earned by Assessee. TheAO, accordingly, by applying the formula of Rule 8D(2)(ii) of the Income-tax Rules, 1962 (the ‘Rule 8D(2)(ii)’) determined a disallowance of Rs.3,32,32,761/- on account of interest and by applying a formula of Rule8D(2)(iii) of the Income-tax Rules, 1962 (the ‘Rule 8D(2)(iii)’) determined a disallowance of Rs. 48,29,200/- towards administrative expenditure. TheAssessee was, therefore, issued with the Assessment Order dated 12[th]February, 2015, resulting in an addition on account of disallowance of Rs.3,80,61,962/- under Section 14A of the Act read with Rule 8D. 2.3.The Assessee filed an appeal against the assessment order before theCommissioner of Income Tax (Appeals) [‘CIT(A)’] challenging theaforesaid addition under Section 14A of the Act. The CIT(A) partly allowedtheappealvideorderdated18[th]November,2015,restrictingthedisallowance under Section 14A read with Rule 8D(iii) of the Income-taxRules, 1962 (the ‘Rule 8D(iii)’) for administrative expenditure to Rs.1,62,209/-. Pertinently, the CIT(A) deleted in entirety the disallowance madeunder Rule 8D(2)(ii) towards interest. The relevant portion of the order ofthe CIT(A) reads as follows: “C. For the proposition that assessing officer has drawn an adverseinference, must record a reasonable satisfaction before disallowing theclaim of the assessee (as per section 14A (2) of the Act) xxxxxxxxx 2.3.The Assessee filed an appeal against the assessment order before theCommissioner of Income Tax (Appeals) [‘CIT(A)’] challenging theaforesaid addition under Section 14A of the Act. The CIT(A) partly allowedtheappealvideorderdated18[th]November,2015,restrictingthedisallowance under Section 14A read with Rule 8D(iii) of the Income-taxRules, 1962 (the ‘Rule 8D(iii)’) for administrative expenditure to Rs.1,62,209/-. Pertinently, the CIT(A) deleted in entirety the disallowance madeunder Rule 8D(2)(ii) towards interest. The relevant portion of the order ofthe CIT(A) reads as follows: “C. For the proposition that assessing officer has drawn an adverseinference, must record a reasonable satisfaction before disallowing theclaim of the assessee (as per section 14A (2) of the Act) xxxxxxxxx v. In the case of the appellant, the Assessing officer has invoked the provisionsof section 14A of the Act, without complying with the essential requirements ofsection 14A. As already submitted above, since the Learned AO has failed torecord any objective satisfaction with reference to the incorrectness of theclaim of the appellant, having regard to the accounts of the appellant, thedisallowance made under section 14A of the Act in the assessment order isagainst the provisions of section 14A of the Act. xxxxxx xxx 2.1 Having gone through the detailed submissions of the appellant, the orderof assessment passed by the Assessing Officer and the material facts placed onthe record, it emerges from the facts that the Assessing Officer has made thefurther disallowance of interest of Rs. 3,32,32,761/- under Rule 8D(ii) of theIncome Tax Rules, The evidence adduced during the assessment as well as appellate proceedings indicate that appellant has paid total interest of Rs,18.27 crores and out of that interest of Rs. 12.24 crores has been capitalizedto the investment portfolio. The Assessing Officer has further worked out thedisallowance of interest of Rs. 3,32,32,761/- without giving any findings onthis aspect. In view of the irrefutable facts on the record, the addition of Rs.3,32,32,761/- u/s 14A read with Rule 8D(ii) of the Income Tax Rules made bythe Assessing Officer is hereby deleted and the Assessing Officer is directed tomodify the order of assessment accordingly. xxx xxx xxx “4. Accordingly, I am of the considered view that appellant has incurredvarious indirect expenses for earning the exempt income and such expenseshave been debited in the profit and loss account. There may not be a directhead relating to investment expenditure but all indirect expenses debited toprofit and loss account indirectly relates to investment activities also. TheAssessing Officer may not have given a finding in this regard but the powers-of CIT(Appeal) are coterminus with that of the Assessing Officer, therefore, Iam satisfied that the appellant has incurred various indirect expenses onadministration which are indirectly related to investment activities andearning of exempt income. The appellant has incurred administrativeexpenditure of Rs. 3,34,118. This expenditure contains the amount of Rs.9,700 which has been expended on the travelling for the purpose of purchaseand the sale of securities. The remaining expenditure of Rs. 3,24,418 isapportionedequallyforthetradingandinvestmentactivities.Thedisallowance of Rs. 48,29,200 made by the Assessing Officer is therefore,-restricted to Rs. 1,62,209/ under Rule 8D(iii) read with Section 14A of theAct.” (Emphasis supplied) (Emphasis supplied) 2.4.Aggrieved by the order dated 18[th]November, 2015, the Revenuepreferred an appeal before the ITAT, whereby vide the impugned order, theappeal was dismissed. The ITAT noted that the Assessee had given adetailed explanation regarding the expenditure incurred and the manner inwhich the exempt income has been received, however, the AO proceededwith the disallowance without recording its satisfaction which is amandatory requirement in terms of Section 14A(2) read with Rule 8D(1).The relevant portion of the impugned order reads as follows: “4. After considering the rival submissions and on perusal of the relevantfinding given in the impugned order as well as material referred to before usat the time of hearing, we find that before the Assessing Officer the assesseehas given a very detailed explanation not only with regard to the nature ofinterest expenditure debited but also the details of administrative expensesincurred by the assessee and the manner in which the exempt income has beenreceived by the assessee after placing the entire nature of accounts. TheAssessing Officer without even examining the said accounts has proceeded tosimply apply the formula laid down in Rule 8D without recording his‘satisfaction’ which is mandatory requirements in terms of Section 142A(2)read with Rule 8D(1). Ld. CIT(A) has taken note of entire nature ofexpenditure debited, the amount of interest capitalized by the assessee and thenature of administrative expenditure debited and then has given a categoricalfinding that out of the administrative expenditure of Rs. 3,34,118/- only Rs.1,62,209/- can at best be treated as expenditure attributable for earning of theexempt income. Moreover the assessee’s contention that it had huge surplusfunds for making the investment has not been rebutted at any stage.Accordingly, the said finding of the CIT(A) is inconsonance with theconditions laid down in Rule 14A (2) and therefore, attribution of theexpenditure by him is not only correct on faces but also in law, therefore, wedo not find any infirmity in such order of the ld. CIT (A). Hence the same ishereby affirmed.” (Emphasis supplied) 3.The learned counsel for the Appellant, Revenue, states that the ITATerred in deleting the disallowance of Rs. 3,32,32,761/- made by the AOunder Section 14A of the Act read with Rule 8D(2)(ii) and Rs. 46,66,991/-under Rule 8D(2)(iii). He states that the ITAT fell in error in notconsidering the circular of the Board No. 5/2014 dated 10[th]February, 2014,wherein it has been held that the disallowance of expenditure under Section14A of the Act shall be made even in a year when the taxpayer has notearned any exempt income. 4.The learned counsel for the Respondent states that AO invoked theprovisions of the Section 14A of the Act without recording any objectivesatisfaction with respect to the incorrectness of the explanation of theprovisions of the Section 14A of the Act without recording any objectivesatisfaction with respect to the incorrectness of the explanation of the Assessee for the expenditure incurred and suo moto disallowed by theAssessee. He states that on this ground alone the disallowance made underSection 14A of the Act is incorrect. 4.The learned counsel for the Respondent states that AO invoked theprovisions of the Section 14A of the Act without recording any objectivesatisfaction with respect to the incorrectness of the explanation of theprovisions of the Section 14A of the Act without recording any objectivesatisfaction with respect to the incorrectness of the explanation of the Assessee for the expenditure incurred and suo moto disallowed by theAssessee. He states that on this ground alone the disallowance made underSection 14A of the Act is incorrect. 5.He states that without prejudice to the above in the facts of this case,the Assessee had made payment of Rs. 18,26,65,176/- towards interestavailed on loans. However, the Assessee had capitalized Rs. 12,23,74,218/-to cost of investment and not claimed the same as expenses in its profit andloss account. He states that the AO despite duly noting and confirming thesaid fact from the Assessee’s accounts erred in applying Rule 8D(2)(ii) formaking a further disallowance of Rs. 3,32,32,761/- and therefore, theappellate authorities have correctly deleted the said disallowance.the Assessee had made payment of Rs. 18,26,65,176/- towards interestavailed on loans. However, the Assessee had capitalized Rs. 12,23,74,218/-to cost of investment and not claimed the same as expenses in its profit andloss account. He states that the AO despite duly noting and confirming thesaid fact from the Assessee’s accounts erred in applying Rule 8D(2)(ii) formaking a further disallowance of Rs. 3,32,32,761/- and therefore, theappellate authorities have correctly deleted the said disallowance. 6.He further, states that with regard to administrative expenditure, thetotal expenses incurred by the Assessee during the relevant previous yearwas Rs. 3,34,118/- and therefore, the disallowance of Rs. 48,29,200/- isuntenable. He states that the Assessee had duly apportioned a sum of Rs.1,19,592/- as administrative expenditure towards the exempt income andtherefore, the ITAT has rightly deleted the disallowance made under Rule8D(2)(iii). He states that in the facts of this case, the suo moto disallowancemade by the Assessee on account of interest and administrative expenditureis far in excess of the exempt dividend income of Rs. 1.57 crores.total expenses incurred by the Assessee during the relevant previous yearwas Rs. 3,34,118/- and therefore, the disallowance of Rs. 48,29,200/- isuntenable. He states that the Assessee had duly apportioned a sum of Rs.1,19,592/- as administrative expenditure towards the exempt income andtherefore, the ITAT has rightly deleted the disallowance made under Rule8D(2)(iii). He states that in the facts of this case, the suo moto disallowancemade by the Assessee on account of interest and administrative expenditureis far in excess of the exempt dividend income of Rs. 1.57 crores. 7.We have heard the learned counsel for the parties and perused thepaper-book. The appellate authorities have returned a concurrent findingthat the AO, without examining the accounts of the Assessee, mechanicallyproceeded to apply the formula laid down in Rule 8D.paper-book. The appellate authorities have returned a concurrent findingthat the AO, without examining the accounts of the Assessee, mechanicallyproceeded to apply the formula laid down in Rule 8D. 8.The assessment order records that the Assessee filed a detailed replydated 16[th]December, 2014, and an additional reply dated 16[th]January,dated 16[th]December, 2014, and an additional reply dated 16[th]January, Signature Not Verified 7.We have heard the learned counsel for the parties and perused thepaper-book. The appellate authorities have returned a concurrent findingthat the AO, without examining the accounts of the Assessee, mechanicallyproceeded to apply the formula laid down in Rule 8D.paper-book. The appellate authorities have returned a concurrent findingthat the AO, without examining the accounts of the Assessee, mechanicallyproceeded to apply the formula laid down in Rule 8D. 8.The assessment order records that the Assessee filed a detailed replydated 16[th]December, 2014, and an additional reply dated 16[th]January,dated 16[th]December, 2014, and an additional reply dated 16[th]January, Signature Not Verified 2015, explaining the suo moto disallowance made by the Assessee onaccount of interest and administrative expenditure. In its explanation, theAssessee categorically asserted that it has capitalised interest expenditure ofRs. 12.24 crores to its investment and not claimed the same as its businessexpense. The Assessee also clarified that proportionate administrativeexpenditure of Rs. 1.19 lakhs has been disallowed and not debited to theprofit and loss account. A perusal of the assessment order reveals that theAO without recording his dissatisfaction with the explanation offered bythe Assessee proceeded to apply the formula of Rule 8D perfunctorily. Therelevant portion of AO’s order reads as follows: “6.In reply of above Show Cause Notice, the assessee submitted its replyvide letter dared 16.01.2015 and made the following submissions; - xxxxxxxxx The reply of the assessee have been considered it is seen that out of theinterest payment of Rs. 18,26,65,176/- the company has capitalized Rs.12,23,74,218/- to the cost of investment and not-claimed the same as expensesin the Profit and Loss Account. 7. However, in view of the Supreme Court judgment in the case of CIT VsUnited General Trust Ltd 200 ITR 455 (SC) coupled with the finding thatexpenditure has been incurred by the assesses Company on the earning of thedividend income and in absence of any better method, suggested by Rule 8Dof the income Tax Rules is adopted in determining the expenditure incurred bythe assessee company in relation to dividend income/ exempt income, which isnot includible in the total income.” 9.Pertinently, the AO after examination of the accounts of the Assesseewas convinced that the Assessee has capitalised the interest expenditure ofRs. 12.24 crores to the cost of investment and not debited the same to theprofit and loss account. The AO, has also not made any adverse observation with respect to the Assessee’s disallowance for administrative expenditureof Rs. 1.19 lakhs. However, without expressing any dissatisfaction with theaforesaid disallowances made by the Assessee, which is a mandatoryrequirement of Section 14A(2) read with Rule 8D(1), the AO on anerroneous understanding of law observed that disallowance of expenditurewith has to be made mechanically, in each case where exempt income isearned, as per the fixed formula of Rule 8D. 10.We are of the considered view that the AO had misdirected himself inlaw by holding as above. The formula under Rule 8D(2) can be applied bythe AO only if he is dissatisfied with the explanation offered by theAssessee with respect to the expenditure incurred for earning exemptincome. There cannot be a default application of Rule 8D in every casewhere the Assessee has earned exempt income. The Rule can haveapplication only where the working of the assessee has not been found to besatisfactory as held in Income Tax-VI Vs. Taikisha Engineering IndiaLtd., 2014 SCC Online Del 7156 at para 20 which reads as under: 10.We are of the considered view that the AO had misdirected himself inlaw by holding as above. The formula under Rule 8D(2) can be applied bythe AO only if he is dissatisfied with the explanation offered by theAssessee with respect to the expenditure incurred for earning exemptincome. There cannot be a default application of Rule 8D in every casewhere the Assessee has earned exempt income. The Rule can haveapplication only where the working of the assessee has not been found to besatisfactory as held in Income Tax-VI Vs. Taikisha Engineering IndiaLtd., 2014 SCC Online Del 7156 at para 20 which reads as under: “20. However, in the present case we need not refer to sub Rule (2) to Rule8D of the Rules as conditions mentioned in sub Section (2) to Section 14A ofthe Act read with sub Rule (1) to Rule 8D of the Rules were not satisfied andthe Assessing Officer erred in invoking sub Rule (2), without elucidating andexplaining why the voluntary disallowance made by the assessee wasunreasonable and unsatisfactory. We do not find any such satisfactionrecorded in the present case by the Assessing Officer, before he invoked subRule (2) to Rule 8D of the Rules and made the re-computation. Therefore, therespondent assessee would succeed and the appeal should be dismissed.” In the facts of the present case as well, the AO without recording anydissatisfaction with respect to the expenditure disallowed by the Assesseeproceeded to invoke the provisions of Section 14A of the Act erroneouslyand therefore, there is no infirmity in the finding of the ITAT. 11.The order of the AO suffers from another anomaly as it is contrary tothe judgment of this Court in Joint Investments Pvt. Ltd. v. Commissionerof Income Tax, [2015] 372 ITR 694 which lays down the principle thatdisallowance of expenditure cannot exceed the total exempt income earned.The Assessee has earned dividend income of Rs. 1.57 crores and it hasdisallowed interest expenditure of Rs. 12.24 crores and administrativeexpenditure Rs. 48,29,200/- which is far in excess of the exempt incomeearned. The AO by making a further disallowance of Rs. 3,80,61,962/- isacting contrary to the said principle of law. For this additional reason, inview of the judgment of this Court, no further disallowance could havebeen made by the AO. In order dated 25[th]February, 2015 in Joint Investments Pvt. Ltd. (supra) it was held as follows: “9. In the present case, the AO has not firstly disclosed why theappellant/assessee's claim for attributing Rs. 2,97,440/- as a disallowanceunder Section 14A had to be rejected. Taikisha says that the jurisdiction toproceed further and determine amounts is derived after examination of theaccounts and rejection if any of the assessee's claim or explanation. Thesecond aspect is there appears to have been no scrutiny of the accounts by theAO - an aspect which is completely unnoticed by the CIT (A) and the ITAT.The third, and in the opinion of this court, important anomaly which wecannot be unmindful is that whereas the entire tax exempt income is Rs.-48,90,000/, the disallowance ultimately directed works out to nearly 110% ofthat sum, i.e., Rs. 52,56,197/-. By no stretch of imagination can Section 14Aor Rule 8D be interpreted so as to mean that the entire tax exempt income isto be disallowed. The window for disallowance is indicated in Section 14A,and is only to the extent of disallowing expenditure “incurred by the assesseein relation to the tax exempt income”. This proportion or portion of the taxexempt income surely cannot swallow the entire amount as has happened inthis case.” (Emphasis supplied) 12.The contention of the learned counsel for the Revenue with respect tothe CBDT Circular No. 5/2014 is untenable in law as this Court in CargoMotors Pvt. Ltd. v. Deputy Commissioner of Income Tax, ITA No. 7/2020the CBDT Circular No. 5/2014 is untenable in law as this Court in CargoMotors Pvt. Ltd. v. Deputy Commissioner of Income Tax, ITA No. 7/2020 (Emphasis supplied) 12.The contention of the learned counsel for the Revenue with respect tothe CBDT Circular No. 5/2014 is untenable in law as this Court in CargoMotors Pvt. Ltd. v. Deputy Commissioner of Income Tax, ITA No. 7/2020the CBDT Circular No. 5/2014 is untenable in law as this Court in CargoMotors Pvt. Ltd. v. Deputy Commissioner of Income Tax, ITA No. 7/2020 decided on 7[th]October, 2022 has held that the said circular cannot overridethe express provisions of the Section 14A of the Act. However, in the factsof the present case, since the Assessee has itself disallowed interest andadministrative expenditure, which has not been doubted by the AO, thereliance placed on the circular is misplaced. 13.We are of the considered view that the facts and law have beencorrectly assessed by the ITAT and no substantial question of law arises forconsideration in the present appeal and accordingly the same is dismissed. MANMEET PRITAM SINGH ARORA, J NOVEMBER 24, 2022msh/kv MANMOHAN, J