Maxopp Investment Ltd vs. CIT (Delhi High Court)

No S. 14A or Rule 8D Disallowance without showing how assessee’s calculation is wrong. Only real expenditure can be disallowed

The High Court had to consider two issues: (a) whether interest paid on funds borrowed to acquire “trading shares” is hit by s. 14A given that the profits there from are assessable to tax as “business profits” and the dividend is incidental and (b) whether Rule 8D has retrospective operation. HELD by the Court:

(i) The argument that if the dominant and main objective of the expenditure was not the earning of ‘exempt’ income then, the expenditure cannot be disallowed u/s 14A is not acceptable. The expression “in relation to” cannot be given a narrow meaning and simply means “in connection with” or “pertaining to”. If the expenditure has a relation or connection with or pertains to exempt income, it cannot be allowed as a deduction even if it otherwise qualifies under the other provisions of the Act;

(ii) The expression “expenditure incurred” in s. 14A refers to actual expenditure and not to some imagined expenditure. If no expenditure is incurred in relation to the exempt income, no disallowance can be made u/s 14A (Hero Cycles Ltd 323 ITR 518 referred).

(iii) The AO cannot proceed to determine the amount of expenditure incurred in relation to exempt income without recording a finding that he is not satisfied with the correctness of the claim of the assessee. This is a condition precedent. While rejecting the claim of the assessee with regard to the expenditure or no expenditure in relation to exempt income, the AO will have to indicate cogent reasons for the same;

(iv) Rule 8D comes into play only when the AO records a finding that he is not satisfied with the assessee’s method. Though s. 14A(2) & (3) were inserted w.e.f. 1.4.1962, Rule 8D was inserted on 24.03.2008. Accordingly, Rule 8D would operate prospectively. (Godrej and Boyce Mfg. Co. Ltd 328 ITR 81 (Bom) followed);

(v) For periods prior to Rule 8D, the AO will have to adopt a reasonable method on the basis of objective criteria to determine the expenditure. However, here also, he will have to show why he is not satisfied with the correctness of the assessee’s claim (argument that Rule 8D exceeds the mandate of s. 14A left open).