ASST. COMMISSIONER OF INCOME-TAX,BANGALORE vs. M/S.KAUSTHUBHA PROJECT PRIVATE LIMITED, BANGALORE

We have heard the Ld. DR. The AO had made two disallowances as follows :

We will first deal with the ground pertaining to Rule 8D(2)(ii). In this regard the CIT (A) has reproduced the fund-flow of the term loan in his order which is as follows :

The assessee earned dividend income of Rs.38,75,857. It quantified a sum of Rs.3,22,426 as expenditure incurred in earning tax free income dividend income which does not form part of the total income and which is to be disallowed u/s. 14A of the Act.

The break-up of the sum of Rs.3,22,426 is not specifically given, but is stated to be relating to management fee, legal & professional charges, security transaction charges and NSDL charges. It is thus clear that the assessee by implication had claimed that there was no expenditure incurred by way of interest, either directly or indirectly, which is attributable to the borrowed funds which were used for the purpose of investment which yielded tax free income.

The AO observed that Schedule G to the Financial Statements of the assessee had shown investment to the tune of Rs.28,45,29,937 in shares mutual funds of various companies. He was of the view that such investments cannot be made routinely. No prudent businessman would make any investment without applying the resources wisely. Obviously this entails expenditure, direct as well as indirect. He thereafter proceeded to make disallowance u/s. 14A of the Act, which is given as annexure to the assessment order and enclosed as ANNEXURE-II to this order.

Aggrieved by the assessment order, the assessee preferred appeal before the CIT(Appeals).

Before CIT(A), the assessee submitted that interest bearing loans were borrowed for specific purposes and not for investment purposes and in support of the above contention, the Assessee filed copies of balance sheets as on 31.03.2003 upto 31.03.2009 to show that the various loans availed from banks were all taken for specific purposes and could not have been utilized for making any investments out of which exempt income was earned. These loans include short term loans from IDBI Bank, Exim Bank, Barclays Bank and Standard Chartered Bank in respect of which it was explained that the loans could not have been used for making any long term investment. Copies of some communications from banks regarding sanction of the loans were also filed before me to substantiate the nature of the loan. In respect of IDBI loan, it was submitted that the ITA.1310/Bang/2016 Page - 5 same had been returned back before the year end, thus bringing the balance to Nil.

On consideration of the above submissions and on perusal of the relevant documents, the CIT(A) was of the view that the claim of the Assessee was not evidenced from the documents submitted in view of the loans and other sources of funds being mixed up in the common pool of funds. The CIT(A) further held that the burden of proof in this matter clearly continues to rest with the Assessee and that it was not enough to merely show that surplus funds were available or that bank loans had been availed for specific purposes including short term reasons. A one-to-one correlation must also be established to prove that the loans were absolutely utilized for the purpose for which they were claimed. The CIT(A) also held that there was no utilization certificate from the bank filed before the AO nor was such evidence furnished before the CIT(A). The CIT(A) also held that the documents submitted from the bank during the course of appeal only refer to the disbursal of the loan and even these specify certain conditions required to be met. The date-wise actual disbursal and utilization is not proved from the ledger copies as submitted. The CIT(A) also referred to the decision of Mumbai ITAT in the case of Hercules Hoists Ltd. (ITA No.7944, 7946, 2255 & 7943/mum/2011), wherein it was held that with the introduction of Rule 8D the burden of proof on the assessee has become "more stringent, so that rather than showing existence of sufficient capital, the matter would be required to be examined from the stand point of utilization of the borrowed interest bearing funds." In the absence of categorical utilization certificate from the bank, the CIT(A) was of the view that there was no evidentiary support of the assessee's claim. Hence, the disallowance u/s.14A of the Act as made by the AO was upheld by the CIT(A).

Aggrieved by the order of CIT(A), the assessee has raised ground No.2.

We have heard the rival submissions. A copy of the availability of funds and investments made was filed before us which is at pages 38 to 42 of the assessee's paper book and the same is enclosed as ANNEXURE-III to this order. It is clear from the said statement that the availability of profit, share capital and reserves & surplus was much more than investments made by the assessee which could yield tax free income.

The Hon'ble Bombay High Court in Reliance Utilities & Power Ltd. 313 ITR 340 (Bom) has held that where the interest free funds far exceed the value of investments, it should be considered that investments have been made out of interest free funds and no disallowance u/s. 14A towards any interest expenditure can be made. This view was again confirmed by the Hon'ble Bombay High Court in CIT v. HDFC Bank Ltd., of 2012, judgment dated 23.7.14, wherein it was held that when investments are made out of common pool of funds and non-interest bearing funds were more than the investments in tax free securities, no disallowance of interest expenditure u/s. 14A can be made.

In the light of above said decisions, we are of the view that disallowance of interest expenses in the present case of Rs.49,42,473 made under Rule 8D(2)(ii) of the I.T. Rules should be deleted. We order accordingly." The aforesaid shows that the Tribunal has followed a decision of the Bombay High Court in the case of CIT v. HDFC Bank Ltd. [2014] 366 ITR 505/226 Taxman 132 (Mag.)/49 taxmann.com 335 . When the issue is already covered by a decision of the High Court of Bombay with which we concur, we do not find any substantial question of law would arise for consideration as canvassed.”

Similar view was also expressed by the Hon’ble jurisdictional High Court in the matter of CIT v. Karnataka State Industrial & Infrastructure Development Corporation [(2016) 65 taxmann.com 295] in para 5, which is as under : 5. As regards the issue of computation of the expenditure, Rule 8D of the Rules contains three limbs, namely:— (i) Expenditure directly related to the earning of exempt income; (ii) Interest expenditure not directly attributable to any particular income; and (iii) Amount equal to one-half per cent of the average value of ITA.1310/Bang/2016 Page - 7

The second ground is with respect to the disallowance of Rs.6,60,000/- being 0.5% of the average amount of tax-exempt investments. In this regard, the assessee has brought on record that during the assessment year under consideration, no exempt income was earned by the assessee and therefore the order of the AO in disallowing the amount of Rs.6,60,000/- was without any basis. In our view this issue is also no more res integra. The Hon’ble Delhi High Court in the matter of PCIT-04 v. IL & FS Energy Development Co., [(2017) 84 taxmann.com 186] in paras 11 to 23 has held as under:

At the outset, it requires to be noticed that we are concerned with the AY 2011-12 and, therefore, the question of the applicability of Rule 8D, which was inserted with effect from 24th March 2008, is not in doubt.

Section 14A of the Act, which was inserted with retrospective effect from 1st April 1962, provides for disallowance of the expenditure incurred in relation to income exempted from tax. From 11th May 2001, a proviso was inserted in Section 14A to clarify that it could not be used to reopen or rectify a completed assessment. Sub- sections (2) and (3) of Section 14A were inserted with effect from 1st April, 2007 to provide for methodology for computing of disallowance under Section 14A. However, the actual methodology was provided in terms of Rule 8D only from 24th March 2008. There was a further amendment to Rule 8D with effect from 2nd June 2016 limiting the disallowance the aggregate of the amount of expenditure directly relating to income which does not form part of total income and an amount equal to one per cent of the annual average of the monthly average of the opening and closing balances of the value of investment, income from which does not form part of the total income. It is also provided that the amount shall not exceed the total expenditure claimed by the Assessee. 13. In the above background, the key question in the present case is whether the disallowance of the expenditure will be made even where the investment has not resulted in any exempt income during the AY in question but where potential exists for exempt income being earned in later AYs. 14. In the Explanatory Memorandum to the Finance Act 2001, by which Section 14A was inserted with effect from 1st April 1962, it was clarified that "expenses incurred can be allowed only to the extent they are relatable to the earned income of taxable income". The object behind Section 14A was to provide that "no deduction shall be made in respect of any expenditure incurred by the Assessee in relation to income which does not form part of the total income under the Income Tax Act". 15. What is taxable under Section 5 of the Act is the "total income" which is neither notional nor speculative. It has to be 'real income'. The subsequent amendment to Section 14A does not particularly clarify whether the disallowance of the expenditure would apply even ITA.1310/Bang/2016 Page - 9

The words "in relation to income which does not form part of the total income under the Act for such previous year" in the above Rule 8 D (1) indicates a correlation between the exempt income earned in the AY and the expenditure incurred to earn it. In other words, the expenditure as claimed by the Assessee has to be in relation to the income earned in 'such previous year'. This implies that if there is no exempt income earned in the AY in question, the question of disallowance of the expenditure incurred to earn exempt income in terms of Section 14A read with Rule 8D would not arise.

The CBDT Circular upon which extensive reliance is placed by Mr. Hossain does not refer to Rule 8D (1) of the Rules at all but only refers to the word "includible" occurring in the title to Rule 8D as well as the title to Section 14A. The Circular concludes that it is not necessary that exempt income should necessarily be included in a particular year's income for the disallowance to be triggered.

In the considered view of the Court, this will be a truncated reading of Section 14 A and Rule 8D particularly when Rule 8D (1) uses the expression 'such previous year'. Further, it does not ITA.1310/Bang/2016 Page - 10 account for the concept of 'real income'. It does not note that under Section 5 of the Act, the question of taxation of 'notional income' does not arise. As explained in CIT v. Walfort Share & Stock Brokers (P.) Ltd. [2010] 326 ITR 1/192 Taxman 211 (SC), the mandate of Section 14A of the Act is to curb the practice of claiming deduction of expenses incurred in relation to exempt income being taxable income and at the same time avail of the tax incentives by way of exemption of exempt income without making any apportionment of expenses incurred in relation to exempt income. Consequently, the Court is not persuaded that in view of the Circular of the CBDT dated 11th May 2014, the decision of this Court in Cheminvest Ltd. (supra) requires reconsideration.

In Redington (India) Ltd. v. Addl. CIT [2017] 392 ITR 633/77 taxmann.com 257 (Mad.), a similar contention of the Revenue was negated. The Court there declined to apply the CBDT Circular by explaining that Section 14A is "clearly relatable to the earning of the actual income and not notional income or anticipated income." It was further explained that, "The computation of total income in terms of Rule 8D is by way of a determination involving direct as well as indirect attribution. Thus, accepting the submission of the Revenue would result in the imposition of an artificial method of computation on notional and assumed income. We believe thus would be carrying the artifice too far."

The decisions in CIT v. Lakhani Marketing Inc. [2014] 49 taxmann.com 257/226 Taxman 45 (Mag.), CIT v. Winsome Textile Industries Ltd. [2009] 319 ITR 204, CIT v. Shivam Motors (P.) Ltd. [2015] 230 Taxman 63/55 taxmann.com 262 (All.) have all taken a similar view. The decision in Taikisha Engineering India (P.) Ltd. (supra) does not specifically deal with this issue.

It was suggested by Mr. Hossain that, in the context of Section 57(iii), the Supreme Court in CIT v. Rajendra Prasad Moody [1978] 115 ITR 519explained that deduction is allowable even where income was not actually earned in the AY in question. This aspect of the matter was dealt with by this Court in Cheminvest Ltd. (supra) where it reversed the decision of the Special Bench of the ITAT by observing as under:

In the result, appeal of the Revenue is dismissed.