Pr CIT vs. Bharti Overseas Pvt. Ltd (Delhi High Court)

The ITAT referred to the decision of the Kolkatta Bench of the ITAT in ACIT v. Champion Commercial Co. Ltd., (2012) 139 ITD 108, which in turn referred to the decision of the Bombay High Court in Godrej & Boyce Mfg. Co. Ltd (supra) and held that for the purposes of Rule 8D (2) (ii), the amount of interest not attributable to the earning of any particular item of income, i.e., ‘common interest expenses’ that was required to be allocated would have to exclude both expenditures, i.e., interest attributable to tax exempt income as well as that attributable to taxable income. The ITAT observed that notwithstanding the rigid wording of Rule 8D (2), this interpretation was permissible in view of the stand taken by the Revenue before the Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (supra). The ITAT, therefore, was of the view that since there was no common interest expenditure in the present case no portion of interest really survives for allocation under Rule 8D(2)(ii). On appeal by the department HELD dismissing the appeal:

(i) As far as Rule 8D (2) (i) is concerned, the AO has necessarily to record that he is not satisfied with the correctness of the claim of the expenditure made by the Assessee in relation to the income which does not form part of the total income . That this requirement is mandatory is now well settled in view of the decision of this Court in Maxopp Investment (supra). For Rule 8 D (2) (ii) to apply there has to be some expenditure by way of interest “which is not directly attributable to any particular income or receipt.” If there is no such expenditure, as has been found factually by the ITAT in the present case, then the question of applying the formula thereunder will not arise.

(ii) Nevertheless, the ITAT has had to interpret Rule 8D (2) (ii) since the AO applied it and the CIT (A) had to decide whether that interpretation was correct. That is how this Court too is called upon to decide whether the ITAT was right in its interpretation of that provision. The methodology set out under Rule 8D for determining the amount of expenditure in relation to the exempt income corresponds to Section 14 A (2) of the Act. Section 14A (3) clarifies that Section 14A (2) would apply when the Assessee claims that no expenditure has been incurred in relation to the exempt income.

(iii) The object behind Section 14A (1) is to disallow only such expense which is relatable to tax exempt income and not expenditure in relation to any taxable income. This object behind Section 14A has to be kept in view while examining Rule 8D (2) (ii). In any event a rule can neither go beyond or restrict the scope of the statutory provision to which it relates.

(iv) Rule 8D (2) states that the expenditure in relation to income which is exempt shall be the aggregate of (i) the expenditure attributable to tax exempt income, (ii) and where there is common expenditure which cannot be attributed to either tax exempt income or taxable income then a sum arrived at by applying the formula set out thereunder. What the formula does is basically to “allocate” some part of the common expenditure for disallowance by the proportion that average value of the investment from which the tax exempt income is earned bears to the average of the total assets. It acknowledges that funds are fungible and therefore it would otherwise be difficult to allocate the sum constituting borrowed funds used for making tax-free investments. Given that Rule 8 D (2) (ii) is concerned with only ‘common interest expenditure’ i.e. expenditure which cannot be attributable to earning either tax exempt income or taxable income, it is indeed incongruous that variable A in the formula will not also exclude interest relatable to taxable income. This is precisely what the ITAT has pointed out in Champion Commercial (supra). There the ITAT said that by not excluding expenditure directly relatable to taxable income, Rule 8D (2) (ii) ends up allocating “expenditure by way of interest, which is not directly attributable to any particular income or receipt, plus interest which is directly attributable to taxable income.” This is contrary to the intention behind Rule 8D (2) (ii) read with Section 14A of (1) and (2) of the Act.

(v) The following illustration provided by the ITAT in Champion Commercial (supra) demonstrates the incongruity:

“In the case of A & Co. Ltd., total interest expenditure is Rs.1,00,000, out of which interest expenditure in respect of acquiring shares from which tax free dividend earned is Rs.10,000. Out of the balance Rs. 90,000, the assessee has paid interest of Rs. 80,000 for factory building construction which clearly relates to the taxable income. The interest expenditure which is “not directly attributable to any particular receipt or income” is thus only Rs. 10,000. However, in terms of the formula in Rule 8D(2) (ii), allocation of interest which is not directly attributable to any particular income or receipt will be for Rs.90,000 because, as per formula the value of A (i.e. such interest expenses to be allocated between tax exempt and taxable income) will be “A = amount of expenditure by way of interest other than the amount of interest included in clause (i) [i.e. direct interest expenses for tax exempt income] incurred during the previous year”.

Let us say the assets relating to taxable income and tax exempt income are in the ratio of 4:1. In such a case, the interest disallowable under Rule 8D(2) (ii) will be Rs.18,000 whereas entire common interest expenditure will only be Rs.10,000”.

(vi) What the ITAT has done in the present case instead is to follow its earlier decision in Champion Commercial (supra) which in turn followed the decision of the Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (supra). The ITAT did not on its own read down rule 8D (2) (ii). Rather, it went by the stand taken by the Revenue before the Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (supra) in countering the challenge to the constitutional validity of Rule 8 D (2). The stand of the Revenue was that variable A in the formula in Rule 8D (2) (ii) would exclude both interest attributable tax exempt income as well as taxable income. The Bombay High Court took on board the said statement and negatived the challenge to the constitutional validity of the provision by holding as under:

“60. 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 Addl. Solicitor General it has been stated, with reference to R.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 investments. 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 et.)….. The justification that has been offered in support of the rationale for R.8D cannot be regarded as being capricious, perverse or arbitrary. Applying the tests formulated by the 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”.

(vii) Therefore the Court is unable to agree with the Revenue that in adopting the above interpretation the ITAT has on its own read down Rule 8D (2) (ii) of the Rules and therefore travelled beyond the scope of its jurisdiction and powers.

(viii) In the case in hand, in Note 4 of the computation of income submitted by the Assessee, the total interest debited to the profit and loss account was Rs.5,52,83,131. There was an entry regarding interest on loans given to two entities. After accounting for the other interest expenditure, the Assessee computed the total interest expenditure which was allowable as Rs.83,90,178. In the computation drawn up by the Assessee, the entire interest expenditure was incurred for earning either taxable income or exempt income. There was no interest amount which was not directly attributable to either the tax exempt or taxable income. The ITAT, therefore, correctly observed in the present case “no portion of interest really survives for allocation under Rule 8D (2) (ii)”. However, as rightly pointed out by the ITAT, since the Assessee did not challenge the order of the CIT (A) to the extent it restricted the disallowance, that part of the order of the CIT (A) remained.