Income Tax Appellate Tribunal - Chandigarh
Chadha Super Cars P. Ltd., Ludhiana vs Assessee on 1 November, 2011
IN THE INCOME TAX APPELLATE TRIBUNAL
CHANDIG ARH BENCH 'B', CHANDIG ARH
BEFORE SHRI T.R. SOOD, A.M AND Ms. SUSHMA CHOWLA, JM
ITA No. 1241/Chd/2011
Assessment Year : 2008-09
M/s Chadha Super Cars V A.C.I.T. C-V, Ludhiana
P. Ltd
G.T. Road
Jugiana
Ludhiana
AABCC 6944 R
ITA No. 36/Chd/2012
Assessment Year : 2008-09
A.C.I.T. C-V V M/s Chadha Super Cars
Ludhiana P. Ltd
G.T. Road
Jugiana
Ludhiana
(Appellant) (Respondent)
Assessee by Shri Sunil Kumar Mukhi
Department by: Shri Akhilesh Gupta.
Date of hearing 20.12.2012
Date of Pronouncement 28.12.2012
O R D E R
PER T.R.SOOD, A.M
These appeals are directed against the orders passed by the ld. CIT(A)-II, Ludhiana dated 1.11.2011. These are cross- appeals raising common issues, therefore, both the appeals were heard together and are being disposed off by this common order.
2. ITA No. 1241/Chd/2011 - In this appeal the assessee has raised the following grounds:-
"1 That the ld. CIT(A)-II, Ludhiana has erred in upholding the addition of Rs. 2,40,000/- u/s 36(1)(iii) of Income-tax Act, 1961 on account of advance of Rs. 20 2 lakhs to M/s Devbhumi Spinning and Weaving Mills was not for business purposes without giving any cogent reasons in his order. Therefore, the addition of Rs. 2,40,000/- is uncalled for unwarranted and may be deleted.
2. That the ld. CIT(A)-II, Ludhiana in upholding the addition of Rs. 4,51,931/- u/s 14A of Income-tax Act, 1961 without considering the reply filed by the appellant. Therefore, addition of Rs. 4,51,931/- is uncalled for unwarranted and may be deleted."
3. ITA No. 36/Chd/2012 - In this appeal the Revenue has raised the following grounds:-
"1(a) That the ld. CIT(A)-II, Ludhiana on facts as well as in law, has erred in partly deleting the interest disallowed u/s 36(i)(iii) of Income-tax Act, 1961 on account of interest free advance given to M/s Balwindra Tools Pvt Ltd.
(b) That the ld. CIT(A)-II, Ludhiana has erred in law by accepting additional evidence, which was not filed before the Assessing Officer without confronting the same to him, thus violating the provisions of Rule 46A of the I.T. Rules.
2(a) That the ld. CIT(A)-II, Ludhiana on facts as well as in law, has erred in deleting disallowance of Rs. 20,19,490/- out of total disallowance of Rs. 24,71,119/- mad;e u/s 14A of the Income-tax Act, 1961 r.w.r. 8D of I.T. Rules.
(b) That the ld. CIT(A)-II, Ludhiana has failed to appreciate that once it is held that, disallowance u/s 14A is called for, it has to be computed as per Rule 8D of the Income-tax Rules and not in any other manner."
4. First common issue regarding disallowance of interest u/s 36(i)(iii) - During assessment proceedings the Assessing Officer noticed that the assessee has made advance to ten parties. The explanation was given in respect of six parties but despite number of opportunity no explanation was given in respect of following four parties 1 Shri Suresh Kumar Rs. 3,00,000/-
2 M/s Panthur Farms Pvt Ltd Rs. 2,50,000/-
3 M/s Balwindra Tools Pvt Ltd Rs. 15,00,000/-
4 M/s Devbhumi Spinning & Weaving Rs. 20,00,000/-
Mills 3 It was further noticed that the assessee had borrowed funds and claimed interest therefore, the Assessing Officer after relying on the decision of Hon'ble Punjab & Haryana High Court in case of CIT V. Abhishek Industries, 286 ITR 1 (PH), disallowed 12% interest which was worked out as under:
Name Amount of No. of Disallowan
loan days ce of
interest @
12%
Shri Suresh Kumar 3,00,000/- 30 2,959/-
M/s Panthur Farms Pvt Ltd 2,50,000/- 365 30,000/-
M/s Balwindra Tools Pvt Ltd 15,00,000/- 365 1,80,000/-
M/s Devbhumi Spinning & 20,00,000/- 365 2,40,000/-
Weaving Mills
Total disallowance 4,52,959/-
5. On appeal before the ld. CIT(A), it was contended that the assessee had given all the advances for business purposes. It was specifically stated that advances to Shri Suresh Kumar, M/s Panthur Farms Pvt Ltd and M/s Balwindra Tools Pvt Ltd. were given as advances for negotiating suitable piece of land on behalf of the assessee. Confirmation in respect of Shri Suresh Kumar and M/s Panthur Farms Pvt Ltd were also filed. In case of M/s Balwindra Tools Pvt Ltd, copy of Iqrarnama was filed.
6. After considering the submissions, the ld CIT(A) was of the opinion that the assessee has satisfied the need for giving advances to three parties and accordingly the advances were deleted in case of Shri Suresh Kumar, M/s Panthur Farms Pvt Ltd and M/s Balwindra Tools Pvt Ltd. As far as the decision in respect of disallowance of interest on account of advance to M/s Devbhumi Spinning & W eaving Mills was confirmed. The assessee has challenged the disallowance in respect of 4 interest on account of advance to M/s Devbhumi Spinning & W eaving Mills whereas the Revenue has challenged the deletion of addition on account of M/s Balwindra Tools Pvt Ltd because the ld. CIT(A) has admitted additional evidence without giving any opportunity to the AO.
7. Before us, the ld. Counsel for the assessee submitted that a sum of 20 Lakhs was given to M/s Devbhumi Spinning & W eaving Mills on account of advances for arranging suitable property to be purchased by them. Therefore, the same was for a business purpose. However, the property could not be purchased and advance was returned in Fy 2010-11 by the said party. In this regard he referred to the copies of account of the party filed at page 19 to 22 of paper book. He also submitted that this party was not related to the assessee and therefore, interest could not have been disallowed at all. As far as disallowance on account of M/s Balwindra Tools Pvt Ltd is concerned, he agreed that since the first appellate authority has not given an opportunity to the Assessing Officer, the matter may be set aside.
8. On the other hand, the ld. D.R. for the Revenue submitted that no evidence was filed for justification of advance to M/s Devbhumi Spinning & W eaving Mills before the Assessing Officer or the ld. CIT(A) and therefore, the ld. Counsel for the assessee now cannot argue that the same was for the purpose of business and accordingly disallowance was justified. In respect of advance to M/s Balwindra Tools Pvt Ltd, he submitted that iqrarnama for purchase of godown was filed before the ld. CIT(A) for the first time during appellate proceedings and the ld. CIT(A) should not have admitted the 5 same without giving opportunity to the Assessing Officer to examine the same.
9 W e have considered the rival submissions carefully and find that as far as the advance to M/s Devbhumi Spinning & W eaving Mills is concerned, no purpose for the same was given before the Assessing Officer or the ld. CIT(A). Though before us, it was stated that the same was for the purpose of purchase of property but no evidence was filed before us, therefore, in the absence of any evidence it has to be concluded that money has been diverted for non business purpose. Since the assessee has admittedly borrowed huge amounts on interest, the proportionate interest has to be disallowed in respect of the advances made to M/s Devbhumi Spinning & W eaving Mills in view of the decision of Hon'ble Punjab & Haryana High Court in case of CIT V. Abhishek Industries (supra). Accordingly we confirm the disallowance in respect of interest relating to advances made to M/s Devbhumi Spinning & W eaving Mills. 10 As far as advance to M/s Balwindra Tools Pvt Ltd is concerned, it was admitted before us that iqrarnama was filed before the ld. CIT(A) for the first time, therefore, even if the same is admitted by the ld. CIT(A) he should have allowed an opportunity to the assessee to examine this evidence. Therefore, in the interest of justice, we set aside the order of the ld. CIT(A) and remit the issue relating to the disallowance of interest on account of advance to M/s Balwindra Tools Pvt Ltd to the file of Assessing Officer to examine the iqrarnama filed before the first appellate authority and decide the issue in accordance with law.
6
11. The second common issue is regarding disallowance of expenses of interest u/s 14A of the Act - During assessment proceedings the Assessing Officer noticed that the assessee has claimed interest expenses to the tune of Rs. 2,13,46,266/-. It was further noticed that the assessee has shown investment in the balance sheet amounting to Rs. 1,73,02,285/- and Rs. 2,64,46,428/- as on 31.3.2007 and on 31.3.2008 respectively. The investment was made in partnership firm, M/s Chadha Motors and also in mutual funds and income from both was exempt in the hands of the assessee. Therefore, the expenditure in relation to theseinvestment was required to be added back to the income of the assessee as per Sec 14A of the Act. In response to the show cause notice, it was submitted vide letter dated 10.12.2010 as under:
"That the assessee-company is a partner in M/s Chadha Motors, Transport Nagar, Ludhiana and introduced capital in M/s Chadha Motors at the time of start of the business of M/s Chadha Motors and also introduced sum capital during the year under consideration as this capital was required by the Chadha Motors for doing the business. The assessee-company receiving the profit from the above said firm which is exempt under the Income-tax Act, 1961. This profit is exempt because of the fact the M/s Chadha Motors paid the tax on this profit. So in order to avoid the double taxation the profit received by the company is exempt from tax under the provision of Income-tax Act, 1961. The section 14A can only contemplates the expenditure actually incurred for earning tax free income and not assumed expenditure or deemed expenditure as held by Hon'ble Bombay High Court in the case of CIT V. Wallfort Share and Stock Brokers Pvt Ltd. cited in (2009) 310 ITR 421 (Bom)."
The Assessing Officer after examining the submissions considered the provisions of section 14A. He also considered the Memorandum explaining the provisions in the Finance Act, 2001 as well as Circular No. 14. According to the Assessing Officer in view of these provisions the expenditure related to exempt income, could not be allowed. Accordingly he invoked 7 the Rule 8D and worked out the disallowance vide para 6.13 which is as under:
"Accordingly disallowance u/r 8D is computed as under:
(i) The amount of expenditure directly relating to income which does not form part of total income.
(ii) Interest during the previous year which is not directly attributable to any particular income or receipt:
A= amount of expenditure by way of interest other than the amount of interest included in cl. (i) incurred during the previous year = 21346266 B= the average of value of investment, income from which does not or shall not form part of the total income as appearing in the balance sheet of the assessee on the first day and the last day of the previous year) = 21874356 Investment, Income from which does not or shall not form part of the total income As appearing in the balance sheet Average of Value Of the assessee On the first day of the On the last day Previous year of the previous Year 17302285 26446428 21874356 C (the average of total assets as appearing in the balance sheet of the assessee, on the first day and the last day and the last day of the previous year)= 197707785 Total assets as appearing in the balance sheet of the assessee Appearing in the balance sheet Average of value Of the assessee On the first day of on the last day of The previous year the previous year 171204857 224210720 197707785 Interest during the previous year which is not directly attributable to any particular income or receipt.
B A X ---------- = 2361747 C 8
(iii) an amount equal to one half per cent of the average of the value of investment, income from which does not or shall not form part of the total income as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year.
= 0.5 X B = 109372 = 24,71,119 Aggregate amount = 24,71,119 Balance disallowable = 24,71,119 "
12 Before the ld. CIT(A) it was mainly contended that the Assessing Officer has wrongly observed that investment of Rs. 2,09,74,356/- is made to earn exempt income and the same was done for the business purpose with an emphasis to expand the business by floating the sister concern, M/s Chadha Motors has shown income from year to year and paying tax at the higher rate applicable, therefore, it cannot be said that investment made in the firm as working capital was to earn exempt income. The share of profit, resultant off-shoot of the partner, remaining in the firm after paying the income-tax which ultimately become the part of capital of a partner in the partnership firm. It was stressed that Sec 14A is applicable only when the investment is made to earn exempt income and the assessee had not earned any exempt income in the year. Therefore, provisions of Section 14A were not applicable. It was also contended that significant part of the investment was made out of the paid up capital available with the appellant company and therefore, that part of the capital cannot be considered for calculating disallowance u/s 14A. In this regard reliance was placed on the decision of Hon'ble Punjab & Haryana High Court in case of CIT V. W insom Textile, 319 ITR
204. The calculation was furnished to show that investment was made out of share capital and free reserves as under: 9
31.3.2008 Rs. In lakhs Share capital 78.36 Reserves and Surpluses 130.82 Own funds 209.18 Working capital borrowings 1779.62 Current assets 2243.45 Amount invested in excess of loan 463.83 Term loan borrowings 253.31 Fixed Assets 451.82 Amount invested in excess of loan 198.51 Amount invested in Chadha Motors 255.96 Finally reliance was placed on the decision of Hon'ble Punjab & Haryana High Court in case of CIT V. Hero Cycles, 323 ITR
518. 13 The ld. CIT(A) after considering these submissions quoted the provisions of Sec 14A(1) and ultimately decided the issue as under:
"After perusing the abovesaid factual position, I am not inclined to agree with the appellant's contention that the provisions of Section 14A are not applicable in this case as the language of this section is very clear in this regard. However, another contention of the appellant is concerned that investments were made from available interest free advances and company's own funds, a chart regarding availability of funds with the appellant and investment made from the same has been furnished. In that chart, the company has own funds including reserves and surpluses amounting to Rs. 209.18 lakhs but the amount of investment is Rs. 255.96 lakhs. Therefore, I am of the view that it will be fair and justifiable to allow the relief to the extent of amount available with the appellant in the shape of own funds for this investment. Thus the disallowance of Rs. 4,51,629/- (24,71,119 X 209.18/255.96) is hereby confirmed and remaining 20,19,490/- (24,71,119 - 4,51,629/-) is directed to be deleted. Therefore, this ground of the appellant is also hereby partly allowed."
14 Before us, the ld. Counsel for the assessee reiterated the submissions made before the first appellate authority. He emphasized that Sec 14A can be invoked only to disallow the expenditure which can be related to the exempt income. 10 According to him by making investment in a partnership firm as 99% share holder, it cannot be said that the assessee would earn exempt income because such partnership firm would pay taxes at the maximum rate and thus the taxes stand paid. In this regard he also referred to page 7 of the assessment order wherein the Assessing Officer has extracted the Memorandum explaining the provisions and Circular No. 14 issued by the CBDT wherein it has been observed that expenses relating to the exempt income cannot be allowed because the same is against the basic principle of taxation because only net income that is gross income minus expenditure only can be taxed. It was further stated in this Memorandum that "same analogy exemption is also in respect of net income". The expenditure against income can be allowed only to the extent they are relatable to the taxable income. Since investment in partnership firm is clearly taxable, expenditure so incurred against the same cannot be disallowed.
15 He also submitted that in any case the assessee has made investment out of share capital and reserves available with the assessee and not out of borrowed funds and therefore, the provisions of Section 14A were not applicable. For this he relied on the decision of Hon'ble Punjab & Haryana High Court in case of Hero Cycles (Supra) and CIT V. W insome Textile Inds Ltd, (supra). He also referred to the calculation of surplus funds which was given before the ld. CIT(A). However, on a specific query by the Bench it was admitted that during the year no separate account for surplus funds was being maintained and it was a case of mix funds.
1116 On the other hand, the ld. D.R. for the Revenue strongly supported the order of the Assessing Officer. He also submitted that the income charged in the hands of the partnership firm has to be treated as exempt income in the hands of the partners and in this regard he relied on the decision of Hon'ble Bombay Bench of the Tribunal in case of Dharmasingh M. Popat V ACIT, 127 TTJ (Mum) 61: 2 ITR 586. He also contended that the assessee is not maintaining separate accounts to show that the investment has been made out of surplus funds. Once the funds are mix funds then Rule 8D is applicable. In fact Rule 8D was brought to deal with the situation where the mix funds are there. Rule 8D is applicable from Assessment year 2008-09 and in this regard he relied on the case of Godrej and Boyce Mfg V DCIT, 328 ITR 81 (Bom). 17 W e have considered the rival submissions carefully and find that during the year the assessee has made investment in partnership and mutual fund. The profit from mutual fund in the form of dividend is exempt. As far as share profit from partnership firm is concerned, the same is also covered u/s 10(2A), therefore, there is no force in the submissions that the assessee has made investment in f irm which itself is paying tax, therefore, it cannot be called that the investment has been made to earn exempt income. Section 10(2A) reads as under:
" [(2A) in the case of a person being a partner of a firm which is separately assessed as such, his share in the total income of the firm.
Explanation.--For the purposes of this clause, the share of a partner in the total income of a firm separately assessed as such shall, notwithstanding anything contained in any other law, be an amount which bears to the total income of the firm the same proportion as the 12 amount of his share in the profits of the firm in accordance with the partnership deed bears to such profits ;] "
In any case Bombay Bench of the Tribunal had an occasion to consider this issue in case of D h a r m a s i n g h M . P o p a t V A C I T , 1 2 7 T T J ( M u m ) 6 1 . In that case it was held as under:-
"Though the partnership firm is not a separate entity as per general law, for a specific purpose it may be treated as independent of its partners under the provisions of IT Act, 1961. To put it differently, the concept of partnership firm, being a compendium of its partners is subject to the modifying such concept of partnership law which means that if there exist no provision in the tax laws for a particular situation, then, the provisions of partnership law would be the guiding factor for adjudication of that issue. The current judicial thought is leaning towards the concept of separate legal entity of partnership firm than that of its partners for the purposes of IT Act, 1961. "here was a judicial opinion that on distribution or division or allotment of assets to partners by the on dissolution or otherwise there resulted no gain exigible to tax, however, by incorporating s. -45(2), 45(3) and 45(4), the legislature has declared its intention in clear terms that partners and the firm are two independent entities not only for the purposes of assessment but also for the purpose of determining the charge of income-tax on the transactions entered into between them. Similarly, from asst. yr. 1993-94 partnership firms have been given a corporate personality in a limited sense by making necessary amendments in the provisions of ss. 10(2A), 28(v), 40(b) and relevant procedural sections which conclusively prove that partnership firm as such is independent from its partners as far as provisions of IT Act, 1961 are concerned. Specific provisions mentioned hereinabove read with Circular No. 636, dt. 31st Aug., 1992 go to show that a firm is to be taxed as separate entity and the gross total income of the firm is to be determined in the normal way under different heads as in the case of any taxable entity, hence, any expenditure which has been incurred by firm for the purposes of its business is to be allowed as a deduction in computing the total income of the firm subject to any specific limitation/prohibition provided for the allowance of such expenditure. Having regard to judicial opinion and also the legislative changes in the Act, a partnership firm is a separate entity than that of its partners under the IT Act and if there exists any specific provision in the income-tax law modifying the partnership law then, such specific provision shall be applied and if the tax law is silent on a specific issue, then a reference will have to be made to the provisions of partnership law for the adjudication of the same and in the present case, provisions of law sufficiently take care of the issue involved herein, hence, the issue is to be decided accordingly. There exist specific provisions for computing the income of the partnership firm as well as that of its partners, hence, total income of both is liable to be computed in accordance with such provisions. Since partnership firm, for the purpose of IT Act is a separate assessable entity and therefore partners vis-a-vis partnership firm would stand on the same footing of shareholders vis-a-vis company.
Accordingly income charged in the hands of a partnership firm therefore, provisions of section 14A would be applicable in computing the total income of such partner in respect of his share in the profits of such firm - CIT V. A.W. Figgies & Co. & Ors (1953) 24 ITR 405 (S.C), Dy CST (Law) V K. Kelukutty (1985) 155 ITR 158 (S.C), Bist & Sons, vs. CIT (1979) 8 CTR (SC) 152 : (1979) 116 ITR 131 (SC), QT vs. Kaluram Puranmal (1979) 12 CTR (Bom) 225 :
(1979) 119 ITR 564 (Bom) and CIT vs. Chase Trading Co. (1998) 147 CTR (Bom) 228 •. (1999) 236 ITR 665 (Bom) applied; CIT vs. R,M, Chidambararn.Pillai 1977 CTR (SC) 71 : (1977) 106 ITR 292 (SC) distinguished."13
Therefore, it is clear that investment made in a firm is to be treated as investment for earning exempt income. 18 Coming to the second aspect of the issue that whether in any nexus is required between the investment and the disallowance to be made u/s 14A, we shall first refer to the decision relied on by the ld. counsel of the assessee in case of CIT V. W insom Textile, 319 ITR 204. In that case following question of law was considered:
"Whether, in the facts and circumstances of the case and in law, the Hon'ble Income-tax Appellate Tribunal was justified in holding that the order of the jurisdictional High Court in the case of CIT V. Abhishek Industries Ltd. reported in (2006) 286 ITR 1 (PH); 156 Taxman 257 (PH) are not applicable in this case and the disallowance made by the Assessing Officer u/s 14A of the Income-tax Act is not as per law."
The assessee was engaged in the manufacturing and sale of cotton yarn and had made certain investments. The Assessing Officer disallowed interest on investment in shares u/s 14A because dividend income was exempt. The ld. CIT(A) deleted the disallowance by observing that the assessee had made investment using its own funds and no interest was incurred. The Tribunal confirmed the findings of the ld. CIT(A). Before the Hon'ble High Court the contention was raised that even if the assessee made investment out of its own funds the assessee had taken loans on which interest was paid and therefore, the money available with the assessee was in common kitty in view of the decision of the Court in case of CIT V.Abhishek Industries (supra). Hon'ble High Court held vide para 7 as under:-
14
"We do not find any merit in this submission. The judgment of this court in Abhishek Industries Ltd. (2006) 286 ITR 1 was on the issue of allowability of interest paid on loans given to sister concerns, without interest. It was held that deduction for interest was permissible when loan was taken for business purpose and not for diverting the same to sister concern without having nexus with the business. The observations made therein have to be read in that context. In the present cased, admittedly, the assessee did not make any claim for exemption. In such a situation, section 14A could have no application."
19 Second decision relied on is that of CIT V. Hero Cycles (supra). In that case following question was raised before the Court:
"Whether on the facts and in law, the Hon'ble Income-tax Appellate Tribunal was legally justified in deleting the disallowance of ignoring the evidence relied on by the Assessing Officer and holding that a clear nexus has not been established that the interest bearing funds have been vested for investments generating tax free dividend income."
20 In this case the Assessing Officer made disallowance u/s 14A(3) which was partly upheld by the ld. CIT(A). On further appeal, the Tribunal held that there was no nexus between the expenditure incurred and the income generated, therefore, disallowance cannot be made. It was also observed that main unit, Ludhiana had more interest income than the expenditure and the funds flow position shows that only non interest bearing funds have been utilized for making the investment. 21 Before the Court, the Department also contended that Rule 8D provide that even where the assessee claimed that no expenses have been incurred, correctness of such claim can be gone into by the Assessing Officer. Hon'ble High Court held vide para 5 as under:
"In view of the finding reproduced above, it is clear that the expenditure on interest was set off against the income from interest and the investment in the share and funds were out of 15 the dividend proceeds. In view of this finding of fact, disallowance u/s 14A was no sustainable. Whether, in a given situation, any expenditure was incurred which was to be disallowed, is a question of fact. The contention of the Revenue that directly or indirectly some expenditure is always incurred which must be disallowed under section 14A and the impact of expenditure so incurred cannot be allowed to be set off against the business income which may nullify the mandate of section 14A, cannot be accepted. Disallowance under section 14A requires finding of incurring of expenditure where it is found that for earning exempted income no expenditure has been incurred, disallowance under section 14A cannot stand. In the present case, finding on this aspect, against the Revenue, is not shown to be perverse. Conse- quently, disallowance is not permissible. We have taken this view earlier ^so in I. T. A. No. 504 of 2008 in CIT v. Winsome Textile Industries Ltd. 1)09] 319 ITR 204 (P&H), (decided on August 25, 2009), wherein it was observed as under (page 207) :
"The contention raised on behalf of the Revenue is that even if the assessee had made investment in shares out of its own funds, the assessee had taken loans on which interest was paid and all the money available with the assessee was in common kitty, as held by this court in CIT v. Abhishek Industries Ltd. [2006] 286 ITR 1 and, therefore, disallowance under section 14A was justified.
We do not find any merit in this submission. The judgment of this court in Abhishek Industries Ltd. [2006] 286 ITR 1 was on the issue of allowability of interest paid on loans given to sister concerns, without interest. It was held that deduction for interest was permissible when loan was taken for business purpose and not for diverting the same to sister concern without having nexus with the business. Observations made therein have to be read in that context. In the present case, admittedly, the assessee did not make any claim for exemption. In such a situation, section 14A could have no application."
In view of the above, we are of the opinion that no substantial question of law arise."
22 It is clear that both the above decisions pertain to Assessment year 2004-05 when Rule 8D was not even in statute book. Rule 8D has been introduced by I.T. Rules (5th Amendment) w.e.f. 24.3.2008. Therefore, in both the above cases, Rule 8D could not have been possibly applied. In any case in a leading judgment the Hon'ble Bombay High Court in case of Godrej and Boycee Manufacturing V DCIT, 328 ITR 81 (Bom) held that rule 8D can not have retrospective application and the same can be applied only from Assessment year 2008-
09. Further in case of CIT V. W insom Textile, 319 ITR 204, the issue was whether the principles laid down in case of Abhishek 16 Industries (supra) were applicable for the disallowance u/s 14A and the Hon'ble Court held that the decision of Abhishek Industries (supra) operates in a different field. Similarly In case of Hero Cycles (supra) the Tribunal has given a categorical finding that the investment has been made out of non interest bearing funds. From these two decisions only it can be concluded that if investment has been made clearly out of non interest bearing funds then section 14A is not be applicable. In case before us, the situation is different which we shall see little later. W e would also like to observe that even Hon'ble Punjab & Haryana High Court in a latter decision in case of CIT V. Punjab State Industrial Development Cooperative Ltd. has made observations which we will also like to discuss little later.
23 Hon'ble Bombay High Court considered the issues arising out of Section 14A as well as implications of Rule 8D. Hon'ble High Court reached the following conclusion at para 88 which reads as under:
"88 Our conclusion in t his judgment are as follows :
(i) Dividend income and income from mutual funds falling within the ambit of section 10(33) of the Income-tax Act, 1961, as was applicable for the assessment year 2002-03 is not includible in computing the total income of the assessee. Consequently, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to such income which does not form part of the total income under the Act, by virtue of the provisions of section 14A(1) ;
(ii) The payment by a domestic company under section 115-
O(1) of additional income-tax on profits declared, distributed or paid is a charge on a component of the profits of the company. The company is chargeable to tax on its profits as a distinct taxable entity and it pays tax in discharge of its own liability and not on behalf of or as an agent for its shareholders. In the hands of the shareholder as the recipient of dividend, income by way of dividend does not form part of the total income by virtue of the provisions of section 10(33). Income from mutual funds stands on the same basis ;
(iii) The provisions of sub-sections (2) and "(3) of section 14A of the Income-tax Act 1961 are constitutionally valid ; 17
(iv) The provisions of rule 8D of the Income-tax Rules as inserted by the Income-tax (Fifth Amendment) Rules, 2008, are not ultra vires the provisions of section 14A, more particularly sub-section (2) and do not offend article 14 of the Constitution ;
(v) The provisions of rule 8D of the Income-tax Rules which have been notified with effect from March 24, 2008, shall apply with effect from the assessment year 2008-09 ;
(vi) Even prior to the assessment year 2008-09, when rule 8D was not applicable, the Assessing Officer has to enforce the provisions of sub- section (1) of section 14A. For that purpose, the Assessing Officer is duty bound to determine the expenditure which has been incurred in relation to income which does not form part of the total income under the Act. The Assessing Officer must adopt a reasonable basis or method consistent with all the relevant facts and circumstances after furnishing a reasonable opportunity to the assessee to place all germane material on the record ; (yii) The proceedings for the assessment year 2002-03 shall stand remanded back to the Assessing Officer. The Assessing Officer shall determine as to whether the assessee has incurred any expenditure (direct or indirect) in relation to dividend income/income from mutual funds which does not form part of the total income as contemplated under section 14A. The Assessing Officer can adopt a reasonable basis for effecting the apportionment. While making that determination, the Assessing Officer shall provide a reasonable opportunity to the assessee of producing its accounts and relevant or germane material having a bearing on the facts and circumstances of the case."
From above, it is clear that even the taxes paid u/s 115-O which is also known as dividend distribution taxes, would not make dividend income in the hands of shareholder as non- exempt. Similarly the taxes paid by a firm would be taxes on the profit of the firm and not in the hands of the assessee. The above decision also held that rule 8D would be applicable only from Assessment year 2008-09. In this decision the theory of apportionment of expenditure which was confirmed by the Hon'ble Supreme Court in case of CIT V. W alfort Share and Stock Brokers P Ltd (2010) 326 ITR 1 (S.C), was followed. In fact before introduction of Section 14A, the assessee had a right to claim all the expenses if such expenses could not be bi-furcated against normal taxable income as well as exempted income in view of the decision of Hon'ble Supreme Court in case of Rajasthan W arehousing Cooperation V CIT, 242 ITR 18
450. This position got changed after the introduction of Section 14A by Finance Act, 2001. The Memorandum explaining the provisions of Finance Bill reads as under:
"Certain income are not includible while computating the total income as these are exempt under various provisions of the Act. There have been cases where deductions have been claimed in respect of such exempt income. This in effect means that the tax incentive given by way of exemptions to certain categories of income is being used to reduce also the tax payable on the non-exempt income by debiting the expenses incurred to earn the exempt income against taxable income. This is again the basic principles of taxation whereby only the net income, i.e., gross income minus the expenditure is taxed. On the same analogy, the exemption is also in respect of the net income. Expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income.
It is proposed to insert a new section 14A so as to clarify the intention of the Legislature since the inception of the Income- tax Act, 1961, that no deduction shall be made in respect of any expenditure incurred by the assessee in relation to income which does not form part of the total income under the Income- tax Act.
The proposed amendment will take effect retrospectively from April 1, 1962 and will accordingly, apply in relation to the assessment year 1962-63 and subsequent Assessment Year."
24 Hon'ble Bombay High Court noted this decision and then confirmed the theory of apportionment of expenses and held that same is very much applicable in Section 14A. At placitum 28 it has been observed as under:
"During the course of this judgment, it would be necessary to revisit the decision of Hon'ble Supreme Court in Walfort. At this stage, however, it needs to be emphasized that the provisions of section 14A were construed in Walfort to evince Parliamentary intent not to allow deduction in respect of any expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act against taxable income. Section 14A is clarificatory of the position that expense can be allowed only to the extent that they are relatable to the earning of taxable income. Only those expenses which are in respect of the earning of taxable income can be allowed. The section 14A broadens the theory of apportionment of expenditure between taxable and non-taxable income is evident from the following observations of the Hon'ble Supreme Court page 17) 19 "The theory of apportionment of expenditure between taxable and non-taxable has, in principle, been now widened u/s 14A. Reading section 14 in juxtaposition with sections 15 to 59, it is clear that the words 'expenditure incurred ' in section 14A refers to expenditure on rent, taxes, salaries, interest, etc., in respect of which allowances are provided for (see sections 30 to 37)."
Thus on the basis of above, it was held that after introduction of Section 14A, it was possible to apportion the expenditure between taxable income and exempted income.
25 As observed earlier, almost similar observations have been made by the Hon'ble Punjab & Haryana High Court in a recent judgment in case of CIT V. Punjab State Industrial Development Cooperation Ltd. in ITA No. 565 of 2006 vide order dated 18.7.2011.
" 11. Adverting to question No.(ii), learned counsel for the revenue submitted that while determining the quantum of deduction admissible to the assessee under Section 80M of the Act, the expenditure incurred relating to the earning of dividend income has to be excluded there-from. According to the learned counsel, the expenditure which was to be deducted was required to be deducted on proportional basis for incurring of such expenditure. Reliance was placed on Section 14A of the Act which was incorporated by Finance Act 2001 retrospectively .w.e.f. 1.4,1962. Support was gathered from the decision of the Rajasthan High Court in Shekhavati General Traders Ltd. vs. Commissioner of Income Tax (1987) 167 ITR116 and the judgment of this Court in Income Tax Appeal No. 530 of 2006 (The Punjab State Cooperative Milk Producer's Federation Ltd, vs. Commissioner of Income Tax-if and another) decided on 28,3,2011 and of the Apex Court in Commissioner of income Tax vs. Walfort Share & Stock Brokers (P) Ltd. (2010) 41 DTR Judgments 233.
12. Controverting the aforesaid submission, learned counsel for the assessee relied upon the decision of the Calcutta High Court in Commissioner of Income Tax vs. United Collieries Ltd. (1993) 203 ITR 857 (Calcutta). Learned counsel also relied upon Commissioner of Income Tax vs. Central Bank of India (2003) 264 ITR 522 (Bombay) and State Bank of Indore vs. Commissioner of Income Tax (2005) 275 ITR 23 (MP). It was contended that it was only the actual expense incurred for earning dividend which was to be deducted from the dividend income for calculating the admissible deductions under Section 80M of the Act. It was urged that the plea of the Revenue that proportional expenses should also be reduced, was against the statute.
13. We have given our thoughtful consideration to the respective submissions of the learned counsel for the parties and find 20 *force in the submissions of the learned counsel for the revenue. Finance Act 2001 had inserted Section 14A with effect from 1.4.1962. According to the said Section, any expenditure incurred by the assessee for earning income which did not form part of the total income under the Act was not to be allowed as expenses. This Court in the case of Punjab State Cooperative Milk Producer's Federation Ltd.'s case (supra) relying upon the decision of the Apex Court in Walfort Share and Stock Brokers's case (supra), wherein, while defining the scope of Section 14A of the Act, incorporated retrospectively w.e.f. 1.4.1962, it had laid down as under:
The insertion of Section 14A with retrospective effect is the serious attempt on the part of the Parliament not to allow deduction in respect of any expendiiure incurred by the assessee in relation to income, which does not form part of the total income under the Act against the taxable income (see Circular No.
14 of 2001 dated 22.11.2001 K In other words, Section 14A clarifies that expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income. In many cases the nature of expenses incurred by the assessee may be relatable partly to the exempt income and partly to the taxable income. In the absence of Section 14A, the expenditure incurred in respect of exempt income was being claimed against taxable income. The mandate of Section 14A is clear. It desires to curb the practice to claim deduction of expenses incurred in relation to exempt income against taxable income and at the same time avail the tax incentive by way of exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income. The basic reason for insertion of Section 14A is that certain Incomes are not includibie while computing total income as these are exempt under certain provisions of the Act. In the past, there have bean in which deduction has been sought In respect of such incomes which in effect would mean that tax incentives to certain incomes was being used to reduce the tax payable on the non-exempt Income by debiting the expenses, incurred to earn the exempt income, against taxable income. The basic principle of taxation is to tax the net income, i.e., gross income minus the expenditure. Oh the same analogy the exemption is also in respect of net income. Expenses allowed can only be in respect of earning of taxable income. This is the purport of Section 14A. In Section 14A, the first phrase is "for the purposes of computing the total income under this Chapter" which makes it clear that various heads of income as prescribed under Chapter IV would fall within Section 14A. The next phrase is, "in relation to income which does not form part of total income under the Act". It means that if an income does not form part of total income, then the related expenditure is outside the ambit of the applicability of Section 14A. Further, Section 14 specifies five heads of income which are chargeable to tax. In order to be chargeable, an income has to be brought under one of the five heads. Sections 15 to 59 lay down the rules for computing income for the purpose of chargeability to tax under those heads. Sections 15 to 59 quantify the total income chargeable to tax. The permissible deductions enumerated in Sections 15 to 59 are now to be allowed only with reference to income which is brought under one of the above heads and is chargeable to tax. If an income like dividend income is not a part of the total income, the expenditure/deduction though of the nature specified in part of total income could not be allowed against ore income includible in the total income for the purpose of chargeability to tax. The theory of apportionment of expenditures between taxable and non-taxable has, in principle, been now widened under Section 14A. Reading Section 14 in juxtaposition with Sections 15 to 59, it is clear that the words "expenditure incurred" in Section 14A refers to expenditure on rent, taxes, salaries, interest,etc. in respect of which allowances are provided for (see Sections 30 to 37)." '
14. The apex Court had specifically recorded that the theory of apportionment of amount of expense* between taxable and non- 21
taxable income stood widened by incorporation of Section 14A. It was further noticed that the expression 'expenses incurred' occurring in Section 14A referred to tax, salary, interest etc. in respect" of which allowances are provided for under Sections 30 to 37 of the Act.
15. In all fairness to the assessee, in the judgments relied upon by the learned counsel for the assessee, Section 14A as incorporated by Finance Act 2001, with effect from 1.4.1962, was not under consideration and, therefore, the same do not come to the rescue of the assessee.
16. In view of the above, the substantial question No.(ii) is answered in favour of the revenue and against the assessee. Income Tax Appeal Nos. 565, 567 and 569 stand disposed of accordingly." 26 Thus theory of apportionment as approved by the Hon'ble Supreme Court in case of CIT V. W alfort Share and Stock Brokers P Ltd (2010) 326 ITR 1 (S.C) followed by Hon'ble Bombay High Court in case of Godrej and Boycee (supra) has also been approved by Hon'ble Punjab & Haryana High Court in case of CIT V. Punjab State Industrial Development Coop Ltd. (supra).
27 Now the question is how such expenditure can be apportioned. There may be a situation whether the expenses or interest cannot be identified against the particular item of income to meet these difficulties rule 8D was introduced which has been held to be constitutionally valid by Hon'ble Bombay High Court in case of Godrej and Boycee (supra). Rule 8D reads as under:
" Rule 8D reads as under:
"(1) Where the Assessing Officer having regard to the account of the 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 been incurred in relation to income which does not form part of the total income under the Act for such previous year, he hall determine the amount of expenditure in relation to such income in accordance with the provisions of sub-rule (2).
(2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely:-22
(i) the amount of expenditure directly relating to income which does not form part of total income;
(ii) in a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely:-
A X B C Where A = amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year;
B = the average of value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year;
C = the average of total asset as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year;
(iii) an amount equal to one-half per cent of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year.
(3) For the purposes of this rule, the 'total assets' shall mean, total asset as appearing in the balance sheet excluding the increase on account of revaluation of asset but including the decrease on account of revaluation of assets.)."
28 Clause (ii) of Sub-Rule (2) clearly shows that if the assessee show that interest has been incurred specifically for a particular item of income then it has to be apportioned. In case before us, the assessee has provided sources of funds but they cannot be said to have been maintained separately. First of all it was conceded that the assessee is having mixed funds. The details of funds was stated to be as under before the ld. CIT(A):
31.3.2008 Rs. In Lakhs Share capital 78.36 Reserves and Surpluses 130.82 Own funds 209.18 Working capital borrowings 1779.62 Current assets 2243.45 Amount invested in excess of loan 463.83 23 Term loan borrowings 253.31 Fixed Assets 451.82 Amount invested in excess of loan 198.51 Amount invested in Chadha Motors 255.96 Consequently by simply saying that the funds invested in fixed assets and current assets are more than the borrowed funds, would not show that specific funds have been borrowed for specific purpose. For example it can be very easily said that the assessee supported its business with own funds and borrowed loans have been used for making investment in assets as well as in investments which generate exempted income. Once the funds are mixed, there is no way to find out actual usage of the funds. To meet this situation only Rule 8D was inserted to remove the difficulties. In fact this aspect was also examined by Hon'ble Bombay High Court in case of Godrej & Boycee (supra). Many observations were made under the head "parameters of judicial review at para 62 to 72 of the order". W ithout unnecessarily burdening this order with these observations we will quote para 73 which deals with justification of Rule 8D:
In the affidavit in reply that has been filed on behalf of the Revenue an explanation has been provided of the rationale underlying rule 8D. In the written submissions which have been filed by the Additional Solicitor General it has been stated, with reference to rule 8D(2)(ii) that since funds are fungible, it would be difficult to allocate the actual quantum of borrowed funds that have been used for making tax free investment. It is only the interest on borrowed funds that would be apportioned and the amount of expenditure by way of interest that will be taken (as "A" in the formula) will exclude any expenditure by way of interest which is directly attributable to any particular income or receipt (for example - any aspect of the assessee's business such as plant/machinery etc.). As regards rule 8D(2)(iii) it has been submitted that some mechanism or formula had to be adopted for attributing part of the administrative/managerial expenses to tax exempt investment income. The administrative expenses attributable to tax free investment income have a fixed component and a variable component. A view was taken that the disallowance should also be linked to the value of the investment rather than the amount of exempt income. Under Portfolio Management Scheme (PMS) the fee charged ranges between 2 and 2.5 per cent of the portfolio value which would be inclusive of a profit element for the portfolio manager. While the fixed administrative expense were excluded, on the ground that 24 in the caase ofa large corporate taxpayer they would be spread over a large number of voluminous activities, the variable expenses were computed at one-half per cent of the value of the investment. The justification that has been offered in support of the rationale for rule 8D cannot be regarded as being capricious, perverse or arbitrary. Applying the tests formulated by the Hon'ble Supreme Court it is not possible for this court to hold that there is writ on the statute or on the subordinate legislation perversity, caprice or irrationality. There is certainly no "madness in the method."
Thus above rule was found to be valid and rational. Coming back to the case in hand, the perusal of the assessment order shows as observed earlier, no where before the Assessing Officer or the ld. CIT(A), the assessee has made a specific mention to show which particular funds were borrowed for which particular requirement and in the absence of such specific utilization Rule 8D, would be applicable. Perusal of the assessment order shows that disallowance u/s 14A has been worked out on the basis of Rule 8D which is as observed earlier applicable in case of the assessee. Therefore, we set aside the order of the ld. CIT(A) and restore that of the Assessing Officer.
29. In the result, appeal of the assessee is dismissed and revenue's appeal is partly allowed.
Order pronounced on 28.12.2012.
Sd/- Sd/-
(SUSHMA CHOWLA) (T.R. SOOD)
JUDICI AL MEMBER ACCOUNTANT MEMBER
Dated : 28.12. 2012
SURESH
Copy to: The Appellant/The Respondent/The CIT/The CIT(A)/The DR 25