H. T. Media Limited vs. Pr CIT (Delhi High Court)

The High Court had to consider the following questions of law:

(1) “Whether the ITAT erred in remitting the matter concerning the deletion of disallowance of interest under clause (ii) of Rule 8 D (2) of the Income Tax Rules, 1962 to the Assessing Officer for a fresh determination in light of the decision of this Court in CIT v. Taikisha Engineering India Ltd. (2015) 370 ITR 338 (Del)?”

(2) “Whether the Assessing Officer recorded a proper satisfaction in terms of Section 14A (2) and Rule 8 (D) of the Income Tax Rules, 1962 and, in calculating the disallowance at 0.5% of average value of investments as per clause (iii) of Rule 8 D (2) of the Income Tax Rules, 1962?”

HELD by the High Court:

27. In cases involving Section 14 A of the Act, the constant tug-of-war lies in the Revenue wanting to increase the expenditure incurred to earn exempt income for the purpose of disallowance, while the Assessee seeks to establish the opposite. In CIT v. Walfort Share and Stock Brokers P. Ltd. [2010] 326 ITR 1 (SC), the Supreme Court noted that legislative intent behind Section 14A was not to allow deduction in respect of any expenditure incurred by an Assessee in relation to exempt income, i.e. income which does not form part of the total income under the said Act, against the taxable income. The Supreme Court observed as under:

“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 of the tax incentive by way of an exemption of exempt income without making any apportionment of expenses incurred in relation to exempt 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 in the 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.”

28. In the same decision, the Supreme Court explained that ” The theory of apportionment of expenditure between taxable and non-taxable has, in principle, been now widened under section 14A.”

29. How this apportionment should take place was prescribed under Rule 8D which came to be introduced with effect from 24th March 2008. Rule 8 D reads thus:

“8D (1) Where the Assessing Officer, having regard to the accounts 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 shall determine the amount of expenditure in relation to such income in accordance with the pro visions 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:-
(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 assets 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 assets as appearing in the balance-sheet excluding the increase on account of revaluation of assets but including the decrease on account of revaluation of assets.”

30. Rule 8 D (1) states more or less what Section 14 A (2) of the Act states. It requires the AO to first examine the accounts of the Assessee and then record that he is not satisfied with (a) the correctness of the Assessee’s claim of expenditure or (b) the claim made by the assessee that no expenditure has been incurred. Unless this stage is crossed i.e. the stage of the AO recording that he is not satisfied with the clam of the Assessee in the manner indicated i.e. after examining the Assessee’s accounts, the question of applying the formula under Rule 8D (2) does not arise. That this is a mandatory pre-requisite for applying Rule 8D (2) is fairly well-settled.

31.1 Illustratively reference may be made to the decision of the Bombay High Court in Godrej & Boyce Manufacturing Co. Ltd v. CIT (supra) which was concurred with by this Court in Maxopp Investment Limited v. CIT (supra) and reiterated in Commissioner of Income Tax v. Taikisha Engineering India Limited (supra).

31.2 The Bombay High Court in Godrej and Boyce Mfg. Co. Ltd v. DCIT (supra) upheld the constitutional validity of sub-sections (2) and (3) of Section 14 A of the Act. It was held that Section 14A was applicable to the dividend income earned from mutual funds. The exercise that had to be undertaken by the AO for applying Section 14A was explained thus:

“What merits emphasis is that the jurisdiction of the Assessing Officer to determine the expenditure incurred in relation to such income which does not form part of the total income, in accordance with the prescribed method, arises if the Assessing Officer is not satisfied with the correctness of the claim of the Assessee in respect of the expenditure which the Assessee claims to have incurred in relation to income which does not part of the total income. Moreover, the satisfaction of the Assessing Officer has to be arrived at, having regard to the accounts of the Assessee. Hence, sub-section (2) does not ipso facto enable the Assessing Officer to apply the method prescribed by the rules straightaway without considering whether the claim made by the Assessee in respect of the expenditure incurred in relation to income which does not form part of the total income is correct. The Assessing Officer must, in the first instance, determine whether the claim of the Assessee in that regard is correct and the determination must be made having regard to the accounts of the Assessee. The satisfaction of the Assessing Officer must be arrived at on an objective basis. It is only when the Assessing Officer is not satisfied with the claim of the Assessee, that the Legislature directs him to follow the method that may be prescribed. In a situation where the accounts of the Assessee furnish an objective basis for the Assessing Officer to arrive at a satisfaction in regard to the correctness of the claim of the Assessee of the expenditure which has been incurred in relation to income which does not form part of the total income, there would be no warrant for taking recourse to the method prescribed by the rules. For, it is only in the event of the Assessing Officer not being so satisfied that recourse to the prescribed method is mandated by law.”

31.3 The Bombay High Court further observed as under:

“Parliament has provided an adequate safeguard to the invocation of the power to determine the expenditure incurred in relation to the earning of non-taxable income by adoption of the prescribed method. The invocation of the power is made conditional on the objective satisfaction of the Assessing Officer in regard to the correctness of the claim of the Assessee, having regard to the accounts of the Assessee. When a statute postulates the satisfaction of the Assessing Officer “Courts will not readily defer to the conclusiveness of an executive authority’s opinion as to the existence of a matter of law or fact upon which the validity of the exercise of the power is predicated”. (M. A. Rasheed v. State of Kerala [1974] AIR 1974 SC 2249).

A decision by the Assessing Officer has to be arrived at in good faith on relevant considerations. The Assessing Officer must furnish to the Assessee a reasonable opportunity to show cause on the correctness of the claim made by him. In the event that the Assessing Officer is not satisfied with the correctness of the claim made by the Assessee, he must record reasons for his conclusion. These safeguards which are implicit in the requirements of fairness and fair procedure under Article 14 must be observed by the Assessing Officer when he arrives at his satisfaction under sub-section (2) of section 14A.”

Failure of the AO to record satisfaction

32. The question regarding the failure of the AO to record his dissatisfaction with the correctness of the Assessee’s claim regarding administrative expenses of Rs. 3 lakhs arises in ITA 349 of 2015. Mr Raghvendra Singh is not entirely right in his submission that there is no question framed about the failure by the AO to record his satisfaction. In ITA 349 of 2015, the question framed by this Court by the order dated 15th October 2015 is in fact in two parts: viz., (i) Whether the AO recorded a proper satisfaction in terms of Section 14A (2) and Rule 8 (D) of the Rules and (ii) in calculating the disallowance at 0.5% of average value of investments as per clause (iii) of Rule 8 D (2) of the Rules?

33. The contention of Mr. Singh is that if there was a valid recording of satisfaction by the AO as required by Rule 8D (1), then there was no option available to the AO other than to apply Rule 8D (2) of the Rules. Therefore, even according to the Revenue, the applicability of Rule 8D (2) hinges on the recording of the AO in terms of Rule 8D (1) that he was not satisfied with the Assessee’s claim regarding expenditure incurred to earn the exempt income.

34. The Assessee had explained that Rs. 3 lakhs was being disallowed voluntarily as an “expenditure which could be attributable for earning the said income.” The Assessee explained that the disallowance had been determined on the basis of cost of finance department in the ratio of exempt income to total turnover. On that basis the disallowance in AY 2005-06 was upheld by CIT (A) at Rs. 1 lakh. The disallowance for this AY was worked out as Rs. 1,42,404/- and since the Assessee had already made a disallowance of Rs. 3 Lacs, no further disallowance was called for.

35. In order to disallow this expense the AO had to first record, on examining the accounts, that he was not satisfied with the correctness of the Assessee’s claim of Rs. 3 lakhs being the administrative expenses. This was mandatorily necessitated by Section 14 A (2) of the Act read with Rule 8D (1) (a) of the Rules.

36. In para 3.2 of the assessment order, the AO records that, in answer to the query posed by the AO requiring it to produce calculation for disallowances, the Assessee “submitted that they have not incurred any expenditure for earning the dividend income.” Thereafter, in para 3.3, the AO records “I have considered the submissions of the Assessee and found not to be acceptable.” Thereafter, the AO proceeded to deal with the said provisions of Section 14A and Rule 8D and observed, in para 3.3.1, that making of investment, maintaining or continuing investment and time of exit from investment are well informed and well coordinated management decisions that, in relation to earning of income, are embedded in indirect expenses. It is then stated in para 3.4 that, in view of the above, the provisions of sub-section (2) of Section 14A and Rule 8D of the Rules are in operation and therefore, will strictly be adhered to by the Assessee. In para 3.6 of the assessment order, after discussing Section 14A(1) read with Rule 8D and referring to the decision of the Bombay High Court in Godrej and Boyce Mfg. Co. Ltd v. DCIT (supra), the AO simply stated that “in view of the facts and circumstances and legal position on the issue as discussed above, I am satisfied that the Assessee had incurred expenses to manage its investments which may yield exempt income, and Assessee grossly failed to calculate such expenses in a reasonable manner to ascertain to ascertain the true and correct picture of its income and expenses.”

37. In the considered view of this Court, the above observations of the AO in the assessment order are of a broad general nature not with particular reference to the facts of the case on hand.

38. The Court is also unable to agree with Mr. Singh that on this aspect there are concurrent findings of both the CIT (A) as well as the ITAT.

The CIT (A) disallowed the exempt expenses by merely repeating what the AO had stated about the cost that is built into so called ‘passive’ investments and simply recorded that the AO was bound to Rule 8D and, therefore, was justified in determining administrative costs at 0.5%. Here again, the CIT (A) failed to note that without the mandatory requirement, under Section 14A of the Act and Rule 8D of the Rules, of satisfaction being recorded being met, the question of applying Rule 8D (1) did not arise.

39. Turning now to the order of the ITAT, in para 33, it recorded the submission of the AR that the AO did not record any satisfaction about the Assessee not properly offering expenditure incurred in relation to the exempt income at Rs. 3 lakhs. The ITAT reproduced the contents of para 3.3.1 of the assessment order, which has been extracted by this Court hereinbefore, which contains general observations regarding earning of exempt income.

This cannot be accepted as a recording by the AO of satisfaction regarding the claim of the Assessee after examining its accounts. Again, in para 34 of its order, the ITAT simply reproduced para 3.3.6 of the assessment order where, again, no reasons have been provided but only a conclusion has been reached that the AO was “satisfied that the Assessee had incurred expenses to manage its investments which may yield exempt income, and Assessee grossly failed to calculate such expenses in a reasonable manner to ascertain the true and correct picture of its income and expenses.”

40. Consequently on the aspect of administrative expenses being disallowed, since there was a failure by the AO to comply with the mandatory requirement of Section 14 A (2) of the Act read with Rule 8D (1) (a) of the Rules and record his satisfaction as required thereunder, the question of applying Rule 8D (2) (iii) of the Rules did not arise. The question framed in ITA 549 of 2015 is answered accordingly.

Disallowance of interest expenses

41. As far as disallowance of interest expenses were concerned, the said question arises and has been framed in ITA 548 of 2015. The stand of the Assessee was that no interest bearing fund was utilised during the AY in question for making investments which yielded exempt income. Therefore, no disallowance on that score was warranted.

42. In this the context a reference is required to be made to the detailed response given by the Assessee in its letter dated 15th November 2010 in which it specifically stated that investments from where dividend units were received as income “was not made out of borrowed fund taken by the company.” A reference was made to Schedule 3 of ‘Secured Loans’ of the audited financials which showed that the Assessee had not taken any new term loans. The balances of term loans as of 31st March 2008 were same as that at 31st March 2007. The term loan from Punjab National Bank was taken in the year 2004-05 and was utilized in repayment of term loan taken from Central Bank of India in the year 2004-05. The term loan from State Bank of India was taken in 2005-06, was utilized in repayment of existing term loans taken from Corporation Bank, State Bank of Patiala and Jammu & Kashmir Bank respectively in the year 2005-06 itself. It was stated that “term loans are not granted by the banks for making investments in mutual funds and same also cannot be utilities as per the terms of the loans for making investments in mutual funds.” Further, an overdraft of Rs. 4,875.63 lakhs taken from the Deutsche Bank was showed under ‘secured loans’. From the details filed in Annexure ‘B’ to the letter in question it was made evident that no investments in these mutual funds were made from Deutsche Bank. As of 31st March 2008, the Assessee had cheques in hand of Rs. 6,475.12 lakhs and this was sufficient to clear the overdraft facility. These cheques were credited on the next working day after close of the year and were utilized to clear the entire overdraft balance.

43. The Assessee further explained that the investments were made out of company bank accounts with overdraft facilities, viz., Central Bank of India, Citibank and ABN AMRO respectively. Some investments were also made out of switching over of funds from one scheme to another. A copy of the bank statements showed that “the company had utilized its own funds in form of collection from business operation, proceeds from realization of fixed deposits and re-investment from realization from other mutual funds schemes.” These were evidenced by the positive balances as on the date of investment in these bank statements.

44. It was stated by the Assessee that there was profit from operations of Rs. 20,123.12 lakhs after providing for depreciation of Rs. 26,363.04 lakhs and the net cash funds of the Assessee stood at Rs. 14,427.69 lakhs. Therefore, after making all disbursements, including the investments made during the year, funds to the tune of Rs. 6966.96 lakhs were available at year end under the heads ‘cash’ and ‘bank deposits’. Therefore, the Assessee had substantial funds of its own to make investments under reference.

45. What is plain from the explanation offered by the Assessee, which was not discarded by the AO on facts, was that there was no part of the interest expenditure which did not bear a direct nexus to a loan that was already borrowed in some earlier year. As explained by this Court in Principal Commissioner of Income Tax v. Bharti Overseas Pvt. Ltd. (supra), if there is no interest expenditure “which is not directly attributable to any particular income or receipt”, then “the question of applying the formula” under Rule 8D (ii) of the Rules will not arise. In other words, one of the pre-requisites for the applicability of the formula Rule 8 D (2) (ii) of the Rules for determining the extent of disallowance of interest, is that there must some interest expense which is not attributable to any particular income or receipt. In the present case, the AO does not indicate which part of the interest expense falls in the above category.

The decision in Taikisha Engineering

46.1 At this stage it is necessary to examine the decision of this Court in Commissioner of Income Tax v. Taikisha Engineering India Limited (supra). It must be recalled that the ITAT has in the impugned order remanded the matter to the AO on the basis of the said decision.
46.2 In the first place, it requires to be noticed that said decision was in the context of two AYs 2008-09 and 2009-10, and, therefore, the question of applying Rule 8D of the Rules, which was inserted with effect from 24th March 2008, arose for consideration.

46.3 The facts of the case were that, for AY 2008-09, the Assessee had voluntarily disallowed expenditure of Rs. 1,15,000/- under Section 14A of the Act, the calculation for which was submitted before the AO. The AO noted that the voluntary disallowance offered in the return did not fulfil the requirements of Section 14A of the Act read with Rule 8D of the Rules. However, “no other reason was indicated.” After discussing the decision of the Bombay High Court in Godrej & Boyce Mfg. Co. Limited v. CIT (supra), the AO recomputed the disallowance by applying Rule 8D of the Rules and quantified the disallowance at Rs. 42,59,540/-. The difference was accordingly added and the returned income enhanced.

46.4 A similar exercise was undertaken by the AO for AY 2009-10. Again, Rs.2,76,194/- was disallowed by the Assessee, the AO computed the disallowance at Rs. 5,36,393/- and the disallowance was deleted by the CIT (A) and affirmed by the ITAT. What weighed with the ITAT and the CIT (A) was that the Assessee had sufficient funds as well as non-interest funds which were in excess of total investment made and, therefore, the question of disallowing any interest expenditure did not arise.

46.5 The Court, after referring to the decision of this Court in Maxopp Investment Limited v. CIT (supra) and of the Bombay High Court in Godrej and Boyce Mfg. Co. Ltd v. DCIT (supra), emphasized that there was to be a minimum compliance with the mandatory requirement under Section 14A(2) read with Section Rule 8D which requires the AO to examine the accounts of the Assessee and, upon arriving at a dissatisfaction as to the correctness of the claim of the Assessee in respect of expenditure incurred in relation to exempt income, the AO can determine the amount of expenditure which should be disallowed in accordance with the method prescribed under Rule 8D of the Rules. The Court explained that, unless such dissatisfaction was recorded in the manner indicated under Section 14A of the Act, the question of invoking Rule 8D of the Rules and the formula there under does not arise.

46.6 On facts, this Court held that two factors were crucial in deciding the issue in favour of the Assessee. One was the failure of the AO to record his satisfaction and the second was the factual finding of the CIT (A) as well as the ITAT that “the Assessee had sufficient funds for making investments in shares and mutual funds.”

46.7 The Court explained that for the purposes of Rule 8D (2) (ii), the AO was required to examine whether “the assessee has incurred expenditure by way of interest in the previous year and secondly whether the interest paid was directly attributable to particular income or receipt. In case the interest paid was directly attributable to any particular income or receipt, then the interest on loan amount to this extent or in entirety as the case may be, has to be excluded for making computation as per the formula prescribed.”

47. The above decision does not hold anything contrary to what has been contended by the Assessee in the present case. If indeed the AO had undertaken the exercise as mandated by this Court in Commissioner of Income Tax v. Taikisha Engineering India Limited (supra), he would have come to the conclusion that the interest paid during the AY by the Assessee was entirely towards loans borrowed in earlier years which had not been utilised for making investments that yielded exempt income. However, what is surprising is that the ITAT, by relying on the above observations, thought it fit to remand the matter to the AO for a fresh determination on the ground that the disallowance on account of interest under Rule 8D “cannot be deleted simply on the ground that the assessee’s capital and interest free funds are more than the funds invested in securities yielding exempt income.”

48. In fact, as rightly pointed out by the Assessee, this was not the ground on which the disallowance was deleted by the CIT (A) in the present case. As already noted the CIT (A) ordered the deletion on the basis of a factual holding that no interest bearing funds were utilized by the Assessee during the AY in question for the investments that yielded exempt income. The Assessee went before the ITAT for rectification of the impugned order on account of the erroneous recording by the ITAT of its submission in this regard.

49. There was no necessity for the ITAT to have remanded the issue regarding disallowance of interest expenses under Section 14 A to the AO for a fresh determination. The details placed on record by the Assessee, and particularly its audited accounts, demonstrated with sufficient clarity that no part of any interest bearing funds had been utilised during the AY in question for making investments that yielded exempt income.

Decision of the Supreme Court in Godrej & Boyce

50.1 At this juncture reference may be made to the decision of the Supreme Court in Godrej & Boyce Manufacturing Co. Ltd. v. DCIT [2017] 394 ITR 449 (SC). The Supreme Court affirmed the decision of the Bombay High Court in Godrej & Boyce Manufacturing Co. Ltd. v. DCIT (supra) on one question, viz., that Section 14 A of the Act included within its scope dividend income on shares in respect of which tax is payable under Section 115-O of the Act and income on units and mutual funds on which tax is payable under Section 115 R of the Act. However, the Supreme Court reversed the Bombay High Court on the second question viz., the applicability of Section 14 A to the appellant in that case.

50.2 In the process of discussing the second question, the Supreme Court observed that, irrespective of whether sub-sections (2) and (3) of Section 14A of the Act were retrospective, “what cannot be denied is that the requirement for attracting the provisions of Section 14A (1) of the Act is proof of the fact that the expenditure sought to be disallowed/deducted had actually been incurred in earning the dividend income.” On facts, it was noted that, in all of the AYs 1998-99, 1999-2000 and 2001-02, “the Revenue had failed to establish any nexus between the expenditure disallowed and the earning of the dividend income in question.”

50.3 The Supreme Court found no mention of the reasons which had prevailed upon the AO to hold that the claims of the Assessee, that no expenditure was incurred to earn dividend income, cannot be accepted and why the order of the ITAT for the earlier AYs were not acceptable to the AO, particularly, in the absence of any new fact or change of circumstances. Further, the Supreme Court held that no basis has been disclosed establishing a reasonable nexus between the expenditure disallowed and the dividend income received.

50.4 The Supreme Court was concerned with AY 2002-03, i.e. prior to Rule 8D being inserted in the statute book. Nevertheless it took note of the changes and observed that this would make no difference to the requirement of the AO having to establish “a reasonable nexus between the expenditure disallowed and the dividend income received.” What also weighed with the Supreme Court was that the fact “that any part of the borrowings of the Assessee had been diverted to earn tax free income despite availability of surplus or interest free funds available…..remains unproved by any material whatsoever.”

51. In the present case, the Assessee has been able to demonstrate that the AO has failed to establish any direct nexus between the investments made by the Assessee and the interest expenditure incurred. On the other hand , the Assessee was able to show that any interest expenditure incurred was in respect of various bank loans during the course of the AY in question. The AO also failed to deal with the assertion of the Assessee that it had sufficient own funds and, as such, had no occasion to use borrowed interest bearing funds for that purpose.

Conclusion

52. As a result of the above discussion:

(i) The question as framed in ITA No. 548 of 2015 is answered in the affirmative by holding that the ITAT erred in remanding the matter concerning deletion of disallowance of any interest under clause (ii) of Rule 8D (2) of the Act to the AO for fresh determination in light of the decision in Commissioner of Income Tax v. Taikisha Engineering India Limited (supra)

(ii) The question framed in ITA No. 549 of 2015 is answered in the negative by holding that the AO failed to record proper satisfaction in terms of Section 14A (2) of the Act read with Rule 8D (1) (a) of the Rules and therefore, erred in calculating the disallowance at 0.5% on overall value of the investments as per the Rule 8D (2) (iii) of the Rules.

53. The appeals are accordingly allowed. The effect is that the Assessee’s appeal before the ITAT on the issue of Section 14 A read with Rule 8D of the Rules must be treated as allowed and the Revenue’s appeal on the said issue must be treated as dismissed.