PRINCIPAL COMMISSIONER OF INCOME TAX 2, VADODARA vs. SHRENO LTD

These appeals filed by the Revenue involve the same assessee. Facts are similar. We may record them from Tax Appeal No.1065 of 2018. 2. This   appeal   is   filed   by   the   Revenue   to challenge   the   judgment   of   the   Income­tax Appellate

2017. Following   questions   are   presented   for   our consideration : “(a) Whether   on   the   facts   and   in circumstances   of   the   case,   the   learned ITAT has erred in law and on facts in not upholding the disallowance u/s.14A of the Income   Tax   Act   made   by   the   Assessing Officer ?

The issue pertains to assessment year 2010­11. Respondent assessee is a registered company   and   is   engaged   in   the   business   of manufacturing glass ware items, machinery and equipments   for   chemical   glass   and   other industries   and   also   in   real   estate development.

The Assessing Officer was not satisfied with   this   working   out   presented   by   the assessee.  He  therefore  issued  a notice  why disallowance should not be made under Section 14A   read   with   Rule   8D   of   the   Income   Tax Rules,   1961   (‘the   Rules’   for   short).   The assessee   replied   to   such   notice   contending that   it had  sufficient  interest  free   funds for   making   the   investments   from   which dividend was earned. The investment was thus made   out   of   its   own   funds.   The   principal borrowing of the assessee comprised of cash credit, corporate loans and term loans from banks.   Such   loans   were   opted   through hypothecation   of   assets,   investments   in securities   was   not   permissible   from   such borrowed funds. The assessee supplied details of   its   own   interest   free   funds   available contending that its reserves and surplus are sufficient to cover the investments made in shares.

The   Assessing   Officer   rejected   such   a contention of the assessee observing that the assessee   has   not   adduced   any   evidence   in support   of   such   a   contention   except   for providing aggregate figures of share capital and   reserves   as   on   31.3.2010. He   observed that the business funds and investment funds of the assessee are mixed up and it cannot be assumed that the funds deployed for earning tax free income were entirely out of interest free   funds and   resultantly   the   entire interest   cost   is   to   be   loaded   on   to activities leading to taxable income. Merely because the assessee has positive net worth, it  does  not  mean   that  the  entire   tax  free income yielding activities were carried out by deploying own or surplus funds. He further observed   that  “the  tax  free  income  earning activities   and   taxable   income   earning activities   are   both   carried   out   using   the common kitty of funds, it would be reasonable to apportion the interest burden between the two activities”.

The assessee carried the matter in appeal. The CIT (Appeals) gave partial relief to the assessee.   To   the   extent   co­relation   of interest   free   funds   being   used   for investments yielding tax free income could be established,   he   spared   the   assessee   the disallownace. For the rest, he approved the view of the Assessing Officer.

The assessee carried the matter in further appeal. The Tribunal by the impugned judgment deleted the entire disallowance. The Tribunal referred to the earlier judgment in case of the   assessee   itself   and   borrowed   the

Before   us,   counsel   for   the   Revenue contended   that   the   view   adopted   by   the Tribunal is incorrect. Present was the case where   the   assessee   had   mixed   funds   i.e. interest   bearing   as   well   as   interest   free funds. The assessee could not establish the co­relation between the funds received from such   sources   and   the   investment   thereof. Under   the   circumstances,   the   Assessing Officer was perfectly justified in applying the   formula   contained   in   Rule   8D   which   is made   precisely   for   such   purpose.   While agreeing that in case of assessee itself in earlier  year,  this  Court   had  ruled  against the   Revenue,   counsel   submitted   that   since then   the   judgment   of   the   Hon'ble   Supreme income, formula provided in sub­rule of Rule 8D cannot be applied. In the present case the assessee   had   established   through   reliable evidence   that   the   assessee   had   sufficient interest free funds which were utilized for making investment yielding tax free income. He   submitted   that   the   decision   of   Supreme Court   in   case   of  Maxopp   Investment   Ltd., (Supra) does not alter the basic requirements of applicability of Rule 8D, understood and explained, by various decisions of the High Courts.

As is well known, Section 14A of the Act relates to expenditure incurred in relation to   income   not   includable   in   total   income. Sub­section (1) of Section 14A provides that for  the  purposes   of computing  total  income under   Chapter­IV   no   deduction   shall   be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act. As per sub­section (2) of Section 14A the   Assessing   Officer   would   determine   the amount of expenditure incurred in relation to such income which does not form part of the total income in accordance with the method as may be prescribed, if having regard to the accounts of the assessee he is not satisfied with   the   correctness   of   the   claim   of   the assessee in respect of such expenditure. The method for such purpose has been prescribed under Rule 8D of the Rules. Sub­rule (1) of Rule   8D   substantially   reiterates   what   sub­ section   (2)   of   Section   14A   provides. Essentially under sub­rule (1), the Assessing Officer would be authorized to determine the expenditure to be disallowed in relation to earning tax free income in terms of sub­rule (2) where having regard to the accounts of Income­Tax

As   pointed   out  by   the   counsel   for   the assessee Punjab & Haryana High Court in case of  M/s.  Max India Ltd.,  in a  judgment dated 8.3.2017   considered   a   similar   issue   as under :

The   primary   question   which   the   Supreme Court considered in case of Maxopp Investment Ltd.,   (Supra)  was   whether   disallowance   of expenditure   under   Section   14A   of   the   Act would be applicable in a case where shares or stocks of a company were purchased for the purpose   of   gaining   control   over   the   said company   and   incidentally   tax   free   dividend income   was   generated.   The   assessee   had contended   that   the   dominant   intention   for purchasing the shares was not for earning the dividend   but   to   gain   control   over   the business in the company in which the shares were purchased. The Supreme Court held that the   purpose   for   which   the   shares   were purchased   was   inconsequential.   As   long   as such   investment   generated   tax   free   income, disallowance of expenditure for making such investment   would   be   justified.   This   issue does not arise in the present case. However, it is true that while disposing of bunch of appeals   by   the   said   judgment   the   Supreme Court also considered the correctness of the view of the Punjab & Haryana High Court in case of Avon Cycles Ltd. It was the case in which   the   Assessing   Officer   had   invoked Section 14A read with Rule 8D and apportion the expenditure between investments made for earning tax free income and the rest. The CIT (Appeals) had deleted the entire disallowance upon which in the appeal filed by the Revenue the   Tribunal   restored   portion   of   the disallowance   observing   that   the   funds utilized by the assessee being mixed funds, the disallowance is confirmed in view of the provisions   under   Rule   8D(2)   of   the   Rules. This decision of the Tribunal was challenged before the High Court. The Court held that the funds utilized by the assessee were mixed funds and the interest paid by the assessee is also an interest on the investments made, was   the   finding   of   fact   and   therefore,   no substantial   question   of   law   arises.   This judgment   was   carried   in   appeal   by   the assessee.   The   Supreme   Court   dismissed   the appeal  confirming  the  decision  of  the  High Court.

We do not find that this portion of the judgment   of   the   Supreme   Court   in   case   of Maxopp   Investment   Ltd.,  can   be   seen   as fundamentally changing the understanding and interpretation of Section 14A and Rule 8D of the Rules adopted by this Court and various Courts, noted above. This judgment does not lay down a proposition that the requirement of   sub­rule   (1)   of  Rule   8D of   the satisfaction to be arrived by the Assessing Officer before applying the formula given in sub­rule (2) of Rule 8D is done away with. In other words, the judgment in case of  Maxopp Investment   Ltd., does   not   lay   down   a proposition   that   the   moment   it   is demonstrated that the assessee had availed of mixed   funds   i.e.   interest   free   as   well   as interest bearing funds and utilized them for making   investments   into   securities   earning tax free income and the rest applicability of the Section 14A read with Rule 8D would be automatic. We are conscious that neither in M/s. Max India Ltd., Punjab & Haryana nor in Gujarat State Fertilizer and Chemicals case, this High Court had noticed the judgment of the   Supreme   Court   in   case   of  Maxopp Investment Ltd.  Nevertheless in view of the

All tax appeals are dismissed. (AKIL KURESHI, J) (B.N. KARIA, J) K.K. SAIYED