PUNJAB TRACTORS LTD. vs. COMMR. OF INCOME TAX PATIALA & ANR.

Section 14A specifies the circumstances in which the Assessing Officer is entitled to determine the amount of expenditure incurred in relation to exempt income in accordance with such method as may be prescribed. The method prescribed is in Rule 8D of the Income Tax Rules, 1962 which was introduced with effect from the assessment year 2008-09. The conditions specified in sub-sections (2) and (3) of Section 14-A must exist in order to entitle the Assessing Officer to invoke Rule 8D. This is clear from the language of these sub-sections. Sub-section (2) provides that the Assessing Officer shall determine the amount of expenditure incurred in respect of exempt income in accordance with the method prescribed i.e. Rule 8D “if” having regard to the accounts of the assessee, he is not satisfied with the correctness of the assesses claim in respect of such expenditure in relation to exempt income. The word “if” indicates that to invoke the method prescribed namely Rule 8D, the Assessing Officer must not be satisfied with the correctness of the assessee’s said claim.

Sub-section (3) provides that the provisions of sub-section (2) shall apply in relation to a case where the assessee claims that no expenditure has been incurred by him in relation to exempt income. The opening words of sub- Ravinder Sharma 2017.02.06 18:06 authenticity of this document section (3) make the provisions of sub section (2) applicable in relation to cases under sub section (3). Thus where an assessee claims that no expenditure has been incurred by him in relation to exempt income, the Assessing Officer can resort to Rule 8D only if having regard to the accounts of the assessee he is not satisfied with the correctness of the claim of the assessee that no expenditure has been incurred by him in relation to the income which does not form part of the total income under this Act.

Thus under sub sections (2) and (3) of Section 14A, an Assessing Officer can resort to Rule 8D only if he is not satisfied with the correctness of the assessee’s claim in respect of the expenditure in relation to the income which does not form part of the total income under the Act or if he is not satisfied with the correctness of the assessee’s claim that no expenditure has been incurred by him in relation to such income.

It is not necessary that the conditions specified both in sub-section (2) and sub-section(3) must be satisfied in order to enable the Assessing Officer to invoke Rule 8D. Sub-section (3) states that sub-section (2) “shall also apply” in relation to a case specified therein. The word “also” establishes this. For the purpose of invoking Rule 8D, it is not necessary, therefore, that the conditions in both the sub-sections exist. It is sufficient if the condition in either of the sub sections exist.

Our view is supported by the judgment of the Division Bench of the Bombay High Court in Godrej and Boyce MFG. Co. Ltd. v. Deputy Commissioner of Income Tax and Ravinder Sharma 2017.02.06 18:06 authenticity of this document another, [2010] 328 ITR 81 (Bom). The Division Bench held as under:- “33. Under sub-section (2), the Assessing Officer is required to determine the amount of expenditure incurred by an assessee in relation to such income which does not form part of the total income under the Act in accordance with such method as may be prescribed. The method, having regard to the meaning of the expression ‘prescribed’ in Section 2(33), must be prescribed by rules made under the Act. 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. Sub section Ravinder Sharma 2017.02.06 18:06 authenticity of this document (3) of Section 14A provides for the application of sub section (2) also to a situation where the assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under the Act. Under the proviso, it has been stipulated that nothing in the section will empower the Assessing Officer, for an Assessment Year beginning on or before 1 April 2001 either to reassess under Section 147 or pass an order enhancing the assessment or reducing the refund already made or otherwise increasing the liability of the assessee under Section 154.”

A Division Bench of the Delhi High Court has taken a similar view in Maxopp Investment Ltd. v. Commissioner of Income Tax [2012] 347 ITR 272 (Delhi). The Division Bench held as under:-

We are in respectful agreement with the judgments of the Bombay High Court and the Delhi High Court in this regard.

The next question is as to whether it is necessary for the Assessing Officer to record his reasons for not being satisfied with the correctness of the assessee’s claim.

It is mandatory for the Assessing Officer to record that 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 in relation to income which does not form part of the total income under the Act or that he is not satisfied with the assessee’s claim that no expenditure had been incurred by him in relation to the income which does not form part of the total income under the Act.

The matter stands concluded by a judgment of this Court dated 27.01.2015 in Commissioner of Income Tax-1, Ludhiana v. M/s Abhishek Industries Ltd. Ludhiana, ITA No. 320 of 2013, where the Division Bench held:- “Section 14A of the Act requires the Assessing Officer to record satisfaction that interest bearing funds have been used to earn tax free income. The satisfaction to be recorded must be based upon credible and relevant evidence………………………………..”

The judgment in Maxopp Investment Ltd. (supra) also supports this view namely that the Assessing Officer must record reasons for not being satisfied with the correctness of the assessee’s contentions with regard to the aspects mentioned in sub sections (2) and (3) of Section 14A. It is true that the Delhi High Court merely states that such rejection must be for disclosed cogent reasons. The disclosure, however, can only be in writing. It can Ravinder Sharma 2017.02.06 18:06 authenticity of this document hardly be suggested that the disclosure remains in the Assessing Officer’s mind. The assessee is entitled to test the basis of the rejection of his contentions. This can be done only if the Assessing Officer records his reasons for his not being satisfied in writing.

The next question, therefore, is whether the Assessing Officer has disclosed cogent reasons for invoking the method prescribed in section 14A(1), namely Rule 8D. Mrs. Suri’s submission that the Assessing Officer had not recorded his satisfaction for invoking Rule 8D is not well founded. In our view, however, he has.

We have already quoted the relevant part of the assessment order. The Assessing Officer concluded this aspect by observing that the assessee had deployed sufficient staff/officers to handle its investment portfolio for which it would have incurred substantial expenditure for various operations. Infact the Assessing Officer came to the conclusion that a decision to invest a large amount of about ` 150 crores would require not merely the funds but also the deployment and use of the assesses administrative machinery. The assessee claimed that it had not incurred any expenditure whatsoever. It is reasonable to presume that an investment of this nature would require the deployment of the assesses’s intellectual, physical and financial resources.

In Commissioner of Income Tax (Central) Ludhiana v. Hero Cycles Ltd. [2016] 74 Taxmann.com 254 (P&H) we considered a case under section 80M of the Act. We had raised the following substantial question of law:- Ravinder Sharma 2017.02.06 18:06 authenticity of this document (v) Whether on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in law in deleting the proportionate management expenses allocated against dividend income for purpose of computation of deduction u/s 80M?

Admittedly, Section 80M applies only to income from other sources. Both the counsel agreed that in view of the judgment of the Supreme Court in Distributors (Baroda) P. Ltd. vs. Union of India and others, [1985] 155 ITR 120, it is the net dividend on which the deduction is to be determined for the purpose of Section 80M.

Mr. Mittal contended that in the present case the assessee’s gross dividend is also the net dividend as the assessee has not incurred any expenses for earning the dividend received. No amount had been borrowed and no interest was paid in connection therewith. 19A. The Assessing Officer enumerated under a table the management expenses incurred by the assessee debited under the head “Administrative expenses”………………………………………………

The Tribunal then observed that the assessee had not incurred any expenditure to earn the dividend income and that it had not even incurred any expenditure for the purpose of realizing the dividend. It was further observed that the assessee had not claimed any deduction under section 57 of the Act and that the Assessing Officer had not allowed any deduction while computing income by way of dividend.

The Tribunal thereafter held that section 80(M) does not authorize an Assessing Officer to estimate the expenditure and recompute the income by way of dividend for the purpose of deduction allowable under section 80(M) of the Act.

Where the assessee does not provide any bifurcation of the expenditure incurred in respect of its income, the Assessing Officer has no option but to estimate the expenditure Ravinder Sharma 2017.02.06 18:06 authenticity of this document and to recompute the income by way of dividend to arrive at the deduction that may be allowed under section 80M of the Act. Assuming that some portion of the expenditure is attributable to the dividend earned, the Assessing Officer must estimate the extent thereof. If the assessee furnishes proof or details of such expenditure to the satisfaction of the the Assessing Officer he may accept the same. however, the assessee does not furnish a bifurcation of the expenses or any reasonable basis for arriving at the same, the Assessing Officer has no option but to make a reasonable estimate of the same.

The Tribunal’s observation that when an assessee claims that it has not incurred any expenditure for earning the dividend income, the onus of proof lies on the Assessing Officer to prove otherwise namely that the assessee has incurred the expenditure is correct. The Tribunal’s further observation that the Assessing Officer had not brought out any material or evidence on record which may establish that the assessee had incurred any expenditure for the purpose of earning the dividend, is, however, incorrect. In cases such as this, the Assessing Officer is justified in presuming that some expenditure had been incurred for the purpose of earning the dividend. Even if the investments yielding the dividend are in group companies, it cannot be said that no expenditure for making the investments which yielded the dividend had been incurred. For instance there is a decision making process that is undertaken before making the investment. Group companies do not blindly invest in each other. Even the decision whether or not to invest in the group companies requires application of mind. If the investment is merely to yield the dividend the management of the investing company is bound to apply its Ravinder Sharma 2017.02.06 18:06 authenticity of this document mind as to whether it would be a prudent investment or not. Even if an investment is only for the larger benefit of the group itself or for the benefit of the particular company in the group, the management of the investing company would have to apply its mind on a variety of issues including as to whether the investment would serve this purpose; whether the investment would be detrimental to the investing company and to weigh the pros and cons of such investment for itself and for the members of the group. Further the management of the funds on a regular basis and monitoring the investment even in group companies would be imperative. It is not even the assessee’s case that there was an over all policy decision by which the investments had to be made irrespective of the facts and circumstances obtaining at any given point of time. Indeed it would be difficult to envisage such a situation. In cases such as this, therefore, there would arise a justifiable presumption that some expenditure would be required for the purpose of earning dividend on such investments. The onus would then shift to the assessee to establish that no expenditure whatsoever was incurred for earning the dividend. The Assessing Officer was, therefore, justified in coming to the conclusion that the assessee had incurred expenditure towards earning the said dividend. The assessee has not furnished any material in this regard. As we observed earlier, the Assessing Officer must, therefore, estimate the same if he satisfied that some expenditure for earning the dividend had been incurred.”

Mrs. Suri firstly submitted that the observations in paragraph-25 of the judgment are incorrect. Till the observations are set-aside by the Supreme Court or by a larger Bench of this Court, we are bound by the same. Ravinder Sharma 2017.02.06 18:06 authenticity of this document

The contention that the observations must be restricted to cases under section 80M is not well founded. The basis on which we arrived at those conclusions would apply equally to a case under section 14A of the Act.

Mrs. Suri then submitted that the observations in paragraph-25 of the judgment are per-incurium being contrary to the earlier judgments of this Court in Commissioner of Income Tax v. Winsome Textile Industries [2009] 319 ITR 204 (P&H); Commissioner of Income Tax v. Hero Cycles Ltd. [2010] 323 ITR 518 (P&H); Commissioner of Income Tax, Jalandhar-1, Jalandhar v. Deepak Mittal [2014] 361 ITR 131 and unreported judgment of this Court dated 27.01.2015 in Commissioner of Income Tax-1 Ludhiana v. M/s Abhishek Industries Ltd. Ludhiana, ITA No. 320 of 2013. We will now deal with each of the judgments.

In Commissioner of Income Tax v. Winsome Textile Industries [2009] 319 ITR 204 (P&H), a Division Bench of this Court upheld the observations of the Tribunal which were set out extensively. The decision was based on the findings of fact that the assessee had not incurred any expenditure for making investments in the purchase of shares referred to therein and that, therefore, no disallowance was warranted under section 40A. The entire discussion by the Tribunal was related to whether the assessee had made the investment for purchase of shares out of the borrowed funds or invested its own funds. The question of administrative expenses and the effect thereof on Section 14A was neither raised before nor decided by this Court. Our judgment in Commissioner of Income Tax v. Hero Cycles Ltd. [2010] 323 ITR 518 (P&H) cannot be held to be per-incurium in view of the judgment of Ravinder Sharma 2017.02.06 18:06 authenticity of this document Commissioner of Income Tax v. Winsome Textile Industries (supra).

For the same reason our judgment in Commissioner of Income Tax (Central) Ludhiana v. Hero Cycles Ltd. [2016] 74 Taxmann.com 254 (P&H) cannot be said to be per-incurium in view of the judgment in Commissioner of Income Tax v. Hero Cycles Ltd. [2010] 323 ITR 518 (P&H). Here again the Division Bench set out the observations of the Tribunal in considerable detail and we will presume, affirmed them. These observations make it clear that the discussion related to the utilization of funds. The assessee contended that the entire investment had been made out of the dividend proceeds, sale proceeds, debenture redemption etc. The Tribunal found that the funds flow position showed that only the non- interest bearing funds had been utilized for making the investments. The Tribunal, therefore, held that on facts it did not find any evidence to show that the assessee had incurred interest expenditure in relation to earning the tax exempt income. It is in this context that the Tribunal observed that there was no nexus established by the Revenue in this regard and therefore, on a mere presumption the provisions of Section 14A cannot be applied.

In Commissioner of Income Tax-1, Ludhiana v. M/s Abhishek Industries Ltd. Ludhiana, ITA No. 320 of 2013, a Division Bench of this Court by its judgment dated 27.01.2015 quoted the observations of the Tribunal which were quoted by the Division Bench in Commissioner of Income Tax v. Winsome Textile Industries [2009] 319 ITR 204 (P&H). The Division Bench went on to hold:-

Mrs. Suri submitted that the Assessing Officer can resort to Rule 8D only if he determines that the claim of the assessee in respect of expenditure in relation to income which does not form part of the total income under the Act is incorrect or where he determines that the assessee’s claim that no expenditure has been incurred by him in relation to such income is incorrect. She further submitted that in order to come to such a conclusion the Assessing Officer must first determine the amount of expenditure incurred in relation to exempt income or he must determine that no expenditure was incurred in relation to exempt income for it is only then Ravinder Sharma 2017.02.06 18:06 authenticity of this document that he would be in a position to come to the conclusion that he is not satisfied with the correctness of the assessee’s claim in either case.

The first part of Mrs. Suri’s submission is well founded but not the second. Both parts require a consideration of the nature of the lack of satisfaction required to entitle the Assessing Officer to invoke Rule 8D. The issue relates to the ambit of the expression “is not satisfied”.

In our view it is sufficient if the Assessing Officer comes to the conclusion that the claim of the assessee in this regard is not correct. It is not necessary for him to decide the extent or the quantum of the incorrect claim. He must, however, correctly conclude that the claim of the assessee is incorrect. It is necessary for the Assessing Officer to rightly come to the conclusion that the claim of the assessee is incorrect. The language of Section 14(2) is “is not satisfied with the correctness of the claim” and not “reasonably doubts it” or “has reasons to doubt the correctness of the claim”.

Mrs. Suri’s reliance upon the word “determine” in sub section (2) of Section 14A as regards the second part of her submission is misplaced. The term “determination” in Section 14A(2) applies to the computation of the expenditure incurred in relation to exempt income by resorting to the method as may be prescribed. The method is prescribed by Rule 8-D. Under section 14A(2) where the Assessing Officer is not satisfied with the correctness of the claim in respect of the expenditure in relation to exempt income or the assessee’s claim that no expenditure has been incurred in relation to Ravinder Sharma 2017.02.06 18:06 authenticity of this document such income, ‘he shall’ determine the amount of such expenditure in accordance with the method prescribed, namely, Rule 8D. The word ‘determine’ in Section 14A(2), therefore, is in respect of the exercise to be undertaken for the purpose of computing the expenditure in relation to exempt income in accordance with the method as may be prescribed. The Assessing Officer is not required to quantify the amount prior to the invocation of Rule 8D.

For an Assessing Officer not to be satisfied with the correctness of the claim of the assessee, it is not necessary for him to determine the expenditure incurred for earning the exempt income. Indeed, if that were so, Rule 8D would be redundant. It is sufficient for the Assessing Officer to come to the conclusion that the claim of the assessee is not correct. It is not necessary, however, for him to determine the extent to which it is incorrect in order to resort to Rule 8D.

There would be several instances where an Assessing Officer can come to the conclusion that the claim is incorrect but would be unable to assess the extent of the inaccuracy. That is precisely the purpose of Rule 8D. For instance in the present case, the Assessing Officer was entitled to presume that a part of the expenses from the common fund are attributable to the expenditure incurred for earning the exempt income. He was entitled to resort to Rule 8D without determining the amount expended by the assessee towards earning the exempt income. Indeed if he could have done so, it would not have been necessary for him to resort to Rule 8D at all. Ravinder Sharma 2017.02.06 18:06 authenticity of this document

It follows, therefore, that Mrs. Suri’s submission that a determination means an actual quantification of the expenditure incurred for earning exempt income is erroneous. As Mr.Klar rightly pointed out an Assessing Officer can on the basis of inferences, adverse inferences and reasonable presumptions come to the conclusion that the claim of the assessee in relation to such expenditure is not correct.

In the case before us, the Assessing Officer cannot be faulted for not being satisfied with the claim of the assessee. As we noted earlier the Assessing Officer was entirely justified in presuming that the assessee had incurred expenditure towards administrative activities necessary to earn the exempt income. If the presumption or inference is correct, as we have held it is, the Assessing Officer is entitled to resort to Rule 8D.

We are, however, unable to agree with Mr.Klar that the assessee is estopped from challenging the Assessing Officer’s application of Rule 8D, as the assessee had itself furnished its working under Rule 8D. The assessee furnished a calculation only to show that the Assessing Officer’s calculation is in any event incorrect. That is not an admission by the assessee that Rule 8D was validly invoked. It was only an alternative case assuming that Rule 8D was validly invoked or ought to be invoked.

The Assessing Officer on not being satisfied with the correctness of the claim by the assessee in respect of the expenditure incurred to earn exempt income ought to have applied Rule 8D which he did not. Instead he made an estimate on the basis that he considered to be reasonable. This he was not entitled to do. Where an Assessing Officer is not Ravinder Sharma 2017.02.06 18:06 authenticity of this document satisfied with the correctness of the claim of the assessee, in this regard, he is bound by the provisions of sub section (2) of Section 14A to follow the prescribed method which at the relevant time was Rule 8D.

Questions (i) and (ii) are, therefore, answered in favour of the Revenue.

Mrs.Suri clarified that what is sought to be contended is that the assessee earned exempt income by investing its own funds and not from the interest bearing funds.

The application of Rule 8D does not preclude an assessee from contending that he has not incurred any expenditure towards interest to earn the exempt income. Rule 8D(2) provides that the expenditure in relation to income which does not form part of the total income shall be the aggregate of the three amounts mentioned in clauses (i) (ii) and (iii) thereof. The Assessing Officer must while applying Rule 8D compute each part of it. All the contentions of the assessee in regard thereto would be open. For instance, clause (ii) relates to the expenditure by way of interest which is not directly attributable to any particular income or receipt. It is open to the assessee in this regard to establish that it has not incurred any expenditure by way of interest during the previous year to earn the exempt income. The amount in clause (ii) of sub rule (2) of Rule 8D, would be nil where the assessee establishes that it has not incurred any expenditure by way of interest during the previous year to earn the exempt income. Ravinder Sharma 2017.02.06 18:06 authenticity of this document Mrs. Suri’s submission that if the value of clause-2 of Rule 8D is nil, Rule 8D would be inapplicable altogether is erroneous. Rule 8D is applicable whether the amount computed in respect of any part of it is nil or not. One variable may be nil and others may have a positive value. A nil value does not make the rule inapplicable. It only reflects upon the aggregate of the amounts determined under the three sub clauses of sub-rule (2).

Further to establish this, the assessee is entitled to invite the Assessing Officer to raise a presumption or draw inferences permissible in law. For instance, if an assessee establishes that its interest free funds were equal to or more than the interest bearing funds, it would be open to it to contend that presumption arises that the expenditure for earning exempt income was incurred from out of its interest free funds. By our order and judgment dated 06.09.2016 in Commissioner of Income Tax, Jalandhar-1, Jalandhar v. M/s Max India Ltd. ITA No. 186 of 2013, we came to this conclusion both on principle and on authority. We referred to several judgments including of the Supreme Court, the Bombay High Court and of the Delhi High Court. We have referred to these judgments extensively. It is unnecessary to reproduce the relevant portions thereof again in this judgment. It would be sufficient to note the judgments which we referred to in that judgment, namely, East India Pharmaceutical Works Ltd. v. Commissioner of Income Tax 1997 Income Tax Reports 224 (SC), Commissioner of Income Tax v. Reliance Utilities and Power Ltd. 2009 (313) ITR, 340 (Bombay), HDFC Bank Ltd. v. Deputy Commissioner of Income Tax and others, 2016 (383) ITR 529 (Bombay), Commissioner of Income Tax v. HDFC Ravinder Sharma 2017.02.06 18:06 authenticity of this document Bank Ltd. 2014 (366) ITR 505 and Bright Enterprises Pvt. Ltd. v. Commissioner of Income Tax 2016 (381) ITR 107. If the presumption as held by us in Commissioner of Income Tax (Jalandhar) v. Max India Ltd. (supra) is applicable, the Assessing Officer is bound to apply the same and to take it into consideration even while considering the correctness of the assessee’s claim regarding the expenditure in relation to the exempt income. In other words, in coming to the conclusion as to whether he is satisfied or not satisfied regarding the correctness of the assessee’s claim about the expenditure in relation to exempt income, the Assessing Officer must decide whether the presumption ought to be raised or not. If he finds that the presumption ought to be raised then he must raise it before being satisfied or not satisfied regarding the correctness of the assessee’s claim.

Mr.Klar on the other hand submitted that our judgment is not good law in view of the judgment of this Court in the case of CIT v. M/s Abhishek Industries Ltd. [2006] 286 ITR 1. Mrs. Suri, however, submitted that this judgment is in no longer good law in view of the judgment of the Supreme Court in Hero Cycles Ltd. v. CIT [2015] 379 ITR 347 (SC).

We leave the question as to whether such a presumption is valid and if valid whether it arises in this case open. The Assessing Officer must determine the same after taking all the provisions of law and the precedents into consideration.

If the Assessing Officer justifiably is not satisfied with the correctness of the assessee’s claim regarding the expenditure, he must resort to Rule 8D entirely for the determination of the expenditure incurred with respect to the exempt income for the purpose of section 14A. Ravinder Sharma 2017.02.06 18:06 authenticity of this document For instance, if the assessee claims that he has not incurred any interest expenditure but has incurred administrative expenses or vice-versa and the Assessing Officer disagrees with either claim, Rule 8D cannot be applied only in respect of any particular clause of sub-rule (2) of Rule 8D. He must then determine the amount of expenditure incurred in relation to exempt income entirely in accordance with Rule 8D.

Mr. Klar’s submission that Rule 8D(ii) includes amounts other than interest such as bank charges for courier handling etc. is not well founded. Rule 8D(ii) refers only to interest. We cannot read into it words that are clearly not there.

In the circumstances, questions (i) and (ii) are answered in favour of the respondent-revenue. It is agreed that the computation under Rule 8D shall be carried out in the first instance by the Assessing Officer. Needless to add that the parties are always at liberty to question the same in accordance with law.

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