Two Recent Judgments Proving Very Taxing For Assessee!

October 2, 2009 by taxworry · Leave a Comment

Income Tax Act has a provision u/s 14A which states, in simple terms , that any expense incurred by a taxpayer on earning of income which is exempt from tax is not allowable as deduction. There was however , no method of computation provided and thus considerable litigation ensued between Income Tax Department and the tax payers related to computation of expense used for earning income exempt from taxation.

For example ,a tax payer who received huge amount of dividend. Dividend is exempt from tax. In his P & L accounts, although he debits many expense like-interest,other indirect cost like salary ,electricity,telephone expense etc. However, he claims all expense deduction under I T Act stating that for earning dividend , it did not spend a penny .

The department does not agree and wants to apply section 14A of the I T Act . However, since there was no uniform computation method, each A.O used to apply different yardstick for computation of amount to be disallowed.

Act 2006 inserted new subsections 2 & 3 under section 14A by which it was provided that if the Assesseeing Officer is dissatisfied with the claim of the assessee regarding the expense deduction against earning of exempt income , he (the A.O ) shall compute the dis allowance as per the prescribed rule.

What does section 14A states?

14A. (1)Expenditure incurred in relation to income not includible in total income
14A. For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.

Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1 st day of April, 2001.

(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.

(3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act

However, the Rule for such computation was notified with effect from 24-3-2008.

Controversies

Whether the Rule 8D which was notified on 24/03/2008 can be applied from 1/4/2007 .
Whether the Rule is applicable simply because there is claim of exempted income?
Whether disallowance u/s 14A of the I.T. Act can be made in a year in which no exempt income has been earned or received by the assessee?

Two Decisions Unfavourable to Tax payers
The first decision is of Special Bench of Mumbai Tribunal in ITO vs DagaCapital Management P Ltd [312 ITR 1 ] or [117 ITD 169]which answered both the aforesaid questions 1 & 2 in affirmative . That is :

Rule 8D is retrospective in nature and thus can be applied from 1/04/2007 .
Rule 8D is simply applicable if the assessee has claimed exempted income.

The decision of ITAT , Delhi in ACIT vs Cheminvest Ltd reported in [124 TTJ 577] is against the assessee and in affirmative.

The facts of the case was that the Assessing Officer noted that the assessee had invested Rs.17,36,89,230 in purchase of shares earmarked as other than trade – long term capital gain. The assessee borrowed funds of Rs.8,51,65,000. It had paid interest of Rs. 1,21,02,367 thereon. It was observed that out of said unsecured loan, a sum of Rs.6,88,70,000 was invested in shares which was shown as investment for the purpose of long term capital gain by following the decision of Calcutta Bench of the Tribunal in the case K.V. Trading Co. Ltd. (formerly known as. Kangra Valey Investment and Finance Co. Ltd.) vs. DCIT in ITA NO.924 (Kol.) 2003 for assessment year 1998- 99 and of Twenty First Securities Ltd. vs. DCIT in ITA No.1126 (Kol)/2003, on proportionate basis i.e. interest paid on borrowed funds invested in the form of long term investment other than the trading investment.

The Tribunal held

What one has to see is whether any expenditure were incurred by an assessee in relation to an income that does not form part of total income of the assessee under this Act, and if the answer is in affirmative then that expenditure cannot be allowed irrespective of the fact that it was allowable under different provisions of the Act where a different phraseology is used in allowing that expenditure as the focus has to on disallowance within parameters of section 14A, an overriding provision over allowance provisions. It would result in disallowance even of no income has resulted or made or earned by the assessee in the year under consideration. We also make it clear that the disallowance has to be of the entire amount of the expenditure so related and, as claimed in Revenue’s appeal, cannot be reduced by the receipt of interest which has no relation to such expenditure.

In my personal opinion, the Rule 8D creates absurd computation of disallowance u/s 14A many times , specially in those cases where the huge investments have been made , but no interest is paid .Even in that case 0.5 % of average investment shall disallow unreasonable amount of expense.

The Daga Management & Chemiinvest Ltd decision are contradictory in the sense that in Daga Management case , the Hon’ble Tribunal stated that what one needs to see whether the exemption is claimed and it is not necessary to see , however , in Chemiinvest, Delhi Tribunal stated that even if the exempted income is not claimed , expense has to be disallowed u/s 14A.

I believe , in near future, some relief will certainly come from High Courts. Till then , its really , difficult time for taxpayers.

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