EDELCAP SECURITIES LIMITED,MUMBAI vs. DEPUTY COMMISSIONER OF INCOME TAX CIRCLE 3(1)(1), MUMBAI

Ground Nos. 2(a) to 2(f) relate to the disallowance made under section 14A read with Rule 8D under the normal provisions of the Act, whereas Ground No. 3 relates to the corresponding addition made while computing book profit under section 115JB of the Act.

During the year under consideration, the assessee earned dividend income of Rs. 1,37,20,696/-, which was exempt under section 10(34) of the Act. The assessee suo motu disallowed an amount of Rs. 2,37,427/- towards expenditure relatable to the exempt income, based on proportionate employee and administrative costs. The AO, however, was not satisfied with the computation made by the assessee and proceeded to invoke Rule 8D, determining the disallowance at Rs. 2,29,26,930/-. Accordingly, the AO made a further disallowance of Rs. 2,26,89,503/- after reducing the suo motu disallowance of Rs. 2,37,427/-.

The ld. CIT(A) upheld the disallowance under the normal provisions of the Act. However, as regards the adjustment made under section 115JB, the ld. CIT(A) deleted the same by following the decision of the Special Bench of the Tribunal in the case of ACIT v. Vireet Investment Pvt. Ltd.

Before us, the Ld. AR submitted that the AO had invoked Rule 8D mechanically without recording the requisite objective satisfaction, having regard to the accounts of the assessee, as contemplated under section 14A(2) of the Act. He placed reliance, inter alia, on the decisions of the Hon’ble jurisdictional High Court in CIT v. Bombay Stock Exchange Ltd., the Hon’ble Supreme Court in Maxopp Investment Ltd. v. CIT and the Hon’ble jurisdictional High Court in Godrej & Boyce Manufacturing Co. Ltd. It was submitted that the assessee had already made a suo motu disallowance of Rs. 2,37,427/- on a reasonable basis and the AO had not demonstrated with reference to the accounts of the assessee as to why the said disallowance was incorrect.

The Ld. AR further submitted that the assessee was predominantly engaged in trading and arbitrage activities and that a substantial part of the securities in question constituted stock-in-trade. It was also submitted that the assessee had sufficient interest-free own funds in excess of the investments and, therefore, no disallowance of interest expenditure under Rule 8D(2)(ii) was warranted. Without prejudice, it was submitted that only those investments which had actually yielded exempt income during the year could be considered for the purpose of computing the disallowance. The Ld. AR also relied upon various decisions of the Tribunal, including decisions in the assessee’s own case and in the cases of group concerns, wherein the disallowance was restricted to the amount suo motu offered by the assessee.

The Ld. DR, on the other hand, supported the orders of the lower authorities and submitted that the AO had rightly invoked Rule 8D and computed the disallowance thereunder.

We have considered the rival submissions and perused the material available on record. It is a settled position that, before invoking Rule 8D, the AO is required to examine the correctness of the assessee’s claim with regard to the expenditure incurred in relation to exempt income and record his satisfaction, having regard to the accounts of the assessee, that the claim made by the assessee is not correct. Such satisfaction is a statutory condition precedent for invoking the prescribed method under Rule 8D. The Hon’ble Supreme Court in Maxopp Investment Ltd. v. CIT has also held that the AO must record satisfaction, having regard to the accounts of the assessee, before resorting to the mechanism prescribed under Rule 8D.

In the present case, the assessee had suo motu disallowed Rs. 2,37,427/- towards expenditure relatable to exempt income. From the material placed before us, we find that the AO has not demonstrated, with reference to the accounts of the assessee, as to why the said computation was incorrect or inadequate so as to warrant invocation of Rule 8D. A mere rejection of the assessee’s computation, without recording the requisite objective satisfaction contemplated under section 14A(2) of the Act, cannot by itself justify the mechanical application of Rule 8D.

We further note that the assessee was engaged in the business of trading and arbitrage and that the securities were also held as stock-in-trade. The legal position regarding shares held as stock-in-trade has been considered by the Hon’ble Supreme Court in Maxopp Investment Ltd. v. CIT and subsequently in the case of PCIT v. PNB Housing Finance Ltd. In the facts of the present case, however, having regard to the failure of the AO to record the requisite satisfaction under section 14A(2), it is not necessary for us to adjudicate the other alternative contentions raised by the assessee regarding the treatment of stock-in-trade.

As regards the disallowance of interest under Rule 8D(2)(ii), the assessee has also contended that its own interest-free funds were sufficient to cover the investments. However, since the very invocation of Rule 8D is found to be unsustainable for want of the requisite satisfaction under section 14A(2), no further computation under Rule 8D is warranted in the present case.

We also take note of the fact that, on identical or substantially similar facts, the Tribunal has, in the assessee’s own case and in the cases of group concerns, accepted the proportionate disallowance offered by the assessee and deleted the further disallowance made by applying Rule 8D.

In view of the foregoing discussion and respectfully following the judicial precedents referred to above, we hold that the further disallowance of Rs. 2,26,89,503/- made by the AO under section 14A read with Rule 8D is not sustainable. The disallowance under section 14A is accordingly restricted to Rs. 2,37,427/- as suo motu offered by the assessee. Ground Nos. 2(a) to 2(f) are accordingly allowed.

As regards Ground No. 3, we find that the ld. CIT(A) has already deleted the adjustment made by the AO while computing book profit under section 115JB of the Act by following the decision of the Special Bench of the Tribunal in ACIT v. Vireet Investment Pvt. Ltd. Further, the computation under section 115JB cannot be made by importing the mechanism prescribed under Rule 8D. Since the adjustment in question already stands deleted by the ld. CIT(A), no further adjudication is called for. Ground No. 3 is accordingly dismissed as infructuous.

Ground Nos. 4(a) and 4(b) relate to the disallowance of Rs. 65,03,738/- representing provision for expenses under the normal provisions of the Act and the corresponding addition to book profit under section 115JB of the Act.

During the year, the assessee created a provision of Rs. 65,03,738/- towards expenses relating to services/business activities undertaken during the year, on the basis of a realistic and reasonable estimate, since the relevant invoices had not been received by the close of the year. The provision was subsequently reversed in the following financial year and, upon receipt of invoices, actual expenditure of Rs. 33,17,413/- was recorded in the books.

The AO treated the provision as an unascertained liability on the ground that the exact amount of the liability had not been finally quantified as at the end of the relevant previous year and accordingly made a disallowance under the normal provisions of the Act as well as an addition to the book profit under section 115JB. The ld. CIT(A) upheld the action of the AO.

Before us, the Ld. AR submitted that the liability had accrued during the relevant previous year since the services had already been rendered to the assessee. It was submitted that only the precise quantification of the liability was pending on account of non-receipt of invoices. The provision was stated to have been made on a realistic and scientific basis and consistently in accordance with the mercantile system of accounting. Reliance was placed on the decisions of the Hon’ble Supreme Court in Bharat Earth Movers v. CIT and Rotork Controls India Pvt. Ltd. v. CIT. It was further submitted that identical disallowances had been deleted in the assessee’s own case for AY 2013-14 and AY 2015-16.

On the other hand Ld. DR supported the orders of the lower authorities.

We have considered the rival submissions. Under the mercantile system of accounting, a liability which has accrued during the relevant previous year cannot be disallowed merely because the exact amount thereof is quantified subsequently, provided the liability is based on a reasonable and reliable estimate and the underlying obligation had arisen during the relevant year. The Hon’ble Supreme Court in Bharat Earth Movers v. CIT and Rotork Controls India Pvt. Ltd. v. CIT has explained the distinction between an accrued liability capable of reasonable estimation and a mere contingent liability.

In the present case, it is not in dispute that the provision related to expenses pertaining to the relevant previous year and that the assessee had made the provision on the basis of an estimate. It is also relevant that the entire provision was reversed in the subsequent year and actual expenditure of Rs. 33,17,413/- was subsequently accounted for upon receipt of the relevant invoices. Thus, the mere fact that the precise amount was not finally quantified as at the year-end cannot, by itself, lead to the conclusion that the liability was unascertained or contingent, if the liability had otherwise accrued in the relevant year.

We further note that the assessee has relied upon orders of the Tribunal in its own case for AY 2013-14 and AY 2015-16, wherein, as stated before us, identical disallowances were deleted. The principle of consistency also supports the assessee’s claim where the facts and circumstances remain materially identical.

In these circumstances, we are of the considered view that the provision represents an accrued business liability based on a reasonable estimate and cannot be treated as a mere contingent or unascertained liability merely because the corresponding invoices were received subsequently. Accordingly, the disallowance of Rs. 65,03,738/- under the normal provisions of the Act is deleted.

As regards the corresponding addition under section 115JB, the AO treated the provision as an unascertained liability for the purposes of clause (c) of Explanation 1 to section 115JB. Since, on the facts before us, the provision represents an accrued liability based on a reasonable estimate and is not in the nature of a mere provision for an unascertained liability, the impugned adjustment under section 115JB is also not sustainable. The addition of Rs. 65,03,738/- to the book profit is accordingly deleted. Ground Nos. 4(a) and 4(b) are allowed.

Ground No. 5 relates to the short grant of credit for tax deducted at source. The assessee has claimed TDS credit of Rs. 1,09,44,181/- in its return of income, whereas the AO has allowed credit of only Rs. 1,01,78,676/-, resulting in a difference of Rs. 7,65,505/-.

We have considered the submissions. In terms of section 199 of the Act read with Rule 37BA of the Rules, credit for TDS is to be allowed in accordance with the tax deducted and reported in the prescribed records, subject to verification. Accordingly, we direct the AO to verify the assessee’s claim of TDS credit of Rs. 1,09,44,181/- from the relevant TDS certificates, Form 26AS/AIS and other records and allow the credit to the extent found legally admissible, after giving credit for the amount already allowed. Needless to say, the assessee shall be afforded an opportunity to furnish the necessary supporting documents. Ground No. 5 is allowed for statistical purposes.

Ground No. 1 is general and consequential in nature and does not require any separate adjudication. The assessed total income and book profit shall stand modified in accordance with the findings recorded hereinabove.

Ground No. 6 relates to initiation of penalty proceedings under section 270A of the Act. The initiation of penalty proceedings is premature at this stage and, accordingly, this ground is dismissed.

In the result, the appeal of the assessee is allowed, subject to Ground No. 5 being allowed for statistical purposes.

In the result, appeal filed by the assessee stands partly allowed and partly allowed for statistical purposes.