ACIT vs. Champion Commercial Co Ltd (ITAT Kolkata)

S. 14A & Rule 8D(2)(ii): Interest incurred on taxable income has also to be excluded to avoid incongruity & in view of Department’s stand before High Court

The Tribunal had to consider two issues on s. 14A & Rule 8D: (i) whether the AO has to record a specific satisfaction that the claim of the assessee that it has not incurred any expenditure on earning tax exempt dividend is incorrect & (ii) whether in view of the definition of variable ‘A’ embedded in the formula under Rule 8D(2)(ii), interest expenditure directly related to taxable income has also to be excluded even though it is not specifically referred to. HELD by the Tribunal:

(i) The submission that the AO has to record a specific finding that the assessee’s claim of not having incurred any expenditure to earn the tax-free income is incorrect is not acceptable. Though s. 14A(2) provides that the AO has to be “not satisfied” with the correctness of the assessee’s claim, s. 14A(3) provides that s. 14A(2) shall also apply to a case where an assessee claims that no expenditure has been incurred by him in relation to the tax-free income. The result is that when the assessee offers a disallowance u/s 14A, then s. 14A & Rule 8D cannot be invoked unless the AO is satisfied about the incorrectness of the disallowance so offered, but when assessee does not offer any disallowance u/s 14 A on his own, s. 14A(2) and Rule 8D can be invoked without any need to express satisfaction about the incorrectness of such a claim. Also, as held in Dhanuka & Sons 339 ITR 319 (Cal), when an assessee is paying interest on borrowings and is not able to show that the investment in shares is out of internal accruals or non interest bearing funds, s. 14A disallowance can be made;

(ii) Rule 8D(2)(ii) allocates “expenditure by way of interest ……….. which is not directly attributable to any particular income or receipt”. This refers to interest relatable to tax-free income as well as taxable income. However, the definition of variable ‘A’ embedded in the formula under Rule 8D(2)(ii) refers only to interest expenditure directly related to tax exempt income but not to interest expenditure directly related to taxable income. The result is that while Rule 8D(2)(ii) seeks to allocate all interest expenditure, it ends up allocating only interest expenditure relatable to tax-free income. This is clearly incongruous. In Godrej & Boyce Mfg Co Ltd 328 ITR 81 (Bom), the department took the stand, to defend the constitutional validity of Rule 8 D, that both, interest directly attributable to tax exempt income as well as interest directly relatable to taxable income would be excluded from the definition of variable ‘A’ in the Rule 8D(ii) formula. Once the Revenue has taken a particular stand about the applicability of the formula in Rule 8 D(2)(ii) based on which the constitutional validity of Rule 8D is upheld, it is not open to the Revenue to take any other stand on the issue with regard to the actual implementation of the formula in the case of any assessee. Accordingly, the correct application of the formula set out in Rule 8D(2)(ii) is, as noted in Godrej and Boyce, that interest expenses directly attributable to tax exempt income as also directly attributable to taxable income have to be excluded from the computation of common interest expenses to be allocated under Rule 8D(2)(ii).