THE NEW GREAT EASTERN SPINNING AND WEAVING COMPANY LIMITED,MUMBAI vs. DCIT, CIRCLE 8(3)(1), MUMBAI

The principal grievance raised by the assessee is against the action of the Assessing Officer, as upheld by the Ld. CIT(A), in making/confirming disallowance u/s 14A read with The New Great Eastern Spinning and Weaving Company Ltd. Rule 8D aggregating to Rs.1,18,68,867/-, over and above the suo motu disallowance offered by the assessee of Rs.17,79,133/-.

Briefly stated, the assessee company is engaged in the business of yarn and trading of cloth and home décor items. It is borne out from the record that the assessee had surplus funds emanating from sale of factory land in A.Y. 2015-16 and such surplus was deployed in investments in shares and mutual funds, predominantly in debt mutual funds, and partly through PMS (Portfolio Management Services). For the purposes of section 14A, the assessee, on its own, computed disallowance by identifying direct and proximate expenses attributable to earning of exempt income. It quantified proportionate salary costs of two employees and one financial advisor, estimating that their involvement in investment monitoring/decision-making, given the nature of activity, would be confined cumulatively to 60 days each; accordingly, proportionate salary was worked out at Rs.15,00,000/-, and along with other incidental items, the assessee offered a total suo motu disallowance of Rs.17,79,133/-. It is also on record that the assessee had separately disallowed specific direct expenses such as demat charges, PMS fees, DP charges and bank charges relating to PMS.

The Assessing Officer, however, did not accept the assessee’s working. He observed, inter alia, that the salary quantification lacked evidentiary backing, there was no separate bank account to ascertain linkage of expenses with The New Great Eastern Spinning and Weaving Company Ltd. investments, and “there is no clarity”. Proceeding on such general observations, he computed disallowance by applying Rule 8D with reference to average value of investments and arrived at disallowance of Rs.1,36,48,000/-, and after reducing the assessee’s suo motu disallowance, made net addition of Rs.1,18,68,867/-. The Ld. CIT(A) confirmed the action essentially on the premise that the assessee had an “appreciable investment portfolio” which would necessarily entail management, periodic review and decision-making even for holding investments, and therefore disallowance of indirect administrative expenditure was justified.

We have heard the parties at length and perused the material on record, including the reasoning and working furnished by the assessee during assessment proceedings (including the response dated 23/03/2021) as noticed in the impugned order.

At the outset, it is important to note that section 14A is not an engine of conjecture; it is a rule of proximate cause. The disallowance contemplated is only of such expenditure which is actually incurred and which has a live and discernible nexus with earning of exempt income. Equally, Rule 8D is not to be set in motion as a matter of course. The statutory architecture mandates that the Assessing Officer must first examine the correctness of the assessee’s claim, having regard to the accounts, and record a clear satisfaction as to why the claim is not acceptable. Only thereafter can the machinery provision under Rule 8D be applied.

Tested on the aforesaid touchstone, we find that the assessee had not merely made a token or ad hoc disallowance; rather, it attempted a reasoned attribution. It identified (i) specific direct expenses relating to investment activity such as PMS fees, demat/DP/bank charges, etc., and (ii) a limited proportion of employee/advisory cost based on estimated time involvement, given the nature of investment activity and the fact that the investments were largely through PMS/debt funds where day-to-day execution is handled by the portfolio manager/fund manager. This working, whether ultimately accepted in toto or adjusted marginally, at least demonstrated a bona fide and account- based approach to quantify “expenditure incurred” in relation to exempt income.

Per contra, what emerges from the assessment order reasoning as captured in the record is that the Assessing Officer’s rejection is premised on broad assertions, absence of separate bank account, lack of “clarity”, and a general disapproval of the assessee’s estimation without pinning down, from the Profit & Loss account and ledgers, which particular items of expenditure (other than those already disallowed by the assessee) have a proximate connection with investment activity. In fact, the record notes that the Profit & Loss account predominantly comprises core business expenditure such as material consumption, purchases/stock- in-trade, inventory changes, depreciation and amortization; it is further noted that there was no finance cost, and that direct PMS and allied charges had already been offered for The New Great Eastern Spinning and Weaving Company Ltd. disallowance. In such a factual matrix, the bare invocation of Rule 8D, without a concrete and reasoned satisfaction “having regard to the accounts”, does not meet the statutory threshold.

The Ld. CIT(A) has proceeded largely on a theoretical assumption that any sizable investment portfolio necessarily requires managerial attention and periodic review, and therefore indirect administrative expenditure must be presumed. Such an approach, with respect, reverses the burden contemplated under section 14A. The law does not permit disallowance on the basis of a presumption untethered from the assessee’s accounts, particularly where the assessee has already disallowed direct investment-related expenses and has offered a reasoned estimate of limited administrative involvement. The disallowance must be founded on identifiable expenditure and a recorded dissatisfaction based on accounts; it cannot rest on generalities that “portfolio needs monitoring”.

We also find force in the assessee’s stand, as noted in the record, that the investments were made out of surplus funds generated from sale of land (Rs.325 crores) and were largely through PMS/debt funds, and that the investment activity was not the principal business operation but an ancillary deployment of surplus. This aspect is relevant to appreciate the scale and nature of administrative involvement. When the assessee has demonstrated that direct costs have been disallowed and only a limited internal time- cost is attributable, the revenue authorities cannot, without The New Great Eastern Spinning and Weaving Company Ltd. pointing out any concrete expenditure item left out, mechanically compute a much larger disallowance through Rule 8D.

In sum, on the facts as emanating from the record before us, we are satisfied that (i) the Assessing Officer has not recorded a legally sustainable satisfaction for rejecting the assessee’s working “having regard to the accounts”, and (ii) the disallowance as computed is not shown to be rooted in any specific expenditure which bears proximate nexus to exempt income, beyond what the assessee has already offered. In such circumstances, the mechanical application of Rule 8D cannot be upheld. Further, disallowance under section 14A cannot be permitted to travel beyond the realm of real expenditure attributable to the exempt income activity, as borne out from accounts and supporting material.

Accordingly, we direct deletion of the disallowance made by the Assessing Officer amounting to Rs.1,18,68,867/- (being the enhancement over and above the assessee’s suo motu disallowance). The ground raised by the assessee is allowed.

In the result, the appeal of the assessee is allowed.