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Income Tax Appellate Tribunal, ‘ C’ BENCH : CHENNAI
Before: SHRI CHANDRA POOJARI & Shri Duvvuru RL Reddy
आदेश / O R D E R PER CHANDRA POOJARI, ACCOUNTANT MEMBER
This appeal of the Revenue is directed against the order of
the Commissioner of Income-tax (Appeals)-13, Chennai dated
19.12.2016 pertaining to assessment year 2012-13.
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The Revenue has raised the following grounds for our
adjudication.
The order. of the learned CIT(A) is contrary to law and facts and circumstances of the case.
2.1 The ld.CIT(A) erred in directing the AO to re-compute the disallowance under Rule 8D after excluding the appellant investment in subsidiary/associated companies though the assessee is in receipt of dividend income from the investment in subsidiary companies and claimed the same as exempted income.
2.2 The learned CIT(A) failed to appreciate that Rule 8D(2) does not differentiate between strategic investments and investments in subsidiary/associate companies with other investments and the word used in the rule is only uvalue of Investment’ and hence the investment in subsidiary company shall be included for calculation of disallowance under Rule 8D(2).
2.3 The learned CIT(A) erred in directing the AO to consider the assessee’s own funds i.e. capital reserves available on the date of investment which yields exempted income without giving any clear finding that the assessee has invested its own fund.
2.4 The learned CIT(A) ought to have seen that the assessee company has never given clear break up of investments along with the statistics of own funds and of borrowed funds during the assessment proceedings.
2.5 The learned CIT(A) ought to have taken into consideration that the decision of the Hon’ble Tribunal relied on by the CIT(A) has not been accepted by the Department and appeal filed before Hon’ble Madras High Court is pending as on date.
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After hearing both the parties, it is noticed that similar issue
came for consideration before this Tribunal in assessee's own case for
assessment year 2009-10 in ITA No.1231/Mds./2013 for assessment
year 2009-10 wherein the Tribunal held as follows:
“9.3. The main plea of the ld.A.R is that investment is a sister concern and associated companies and interest pertained to borrowings used for earning exempt income from the investments to be considered and he drew our attention to the paper book at page 21 to 22 to show that most of the investments are in equity shares of sister concerns and these investments are made on account of commercial expediency. He placed reliance on the judgment of Delhi High Court in the case of CIT Vs. Bharti Oversas Pvt. Ltd., reported in 17th December, 2015 wherein held that expenditure in relation to income which is exempt shall be aggregate of expenditure attributable to tax exempted income, and where there is common expenditure, that cannot be attributable to either tax exempt income or taxable income. He also submitted that interest on borrowings which is available for specific purpose cannot be considered for disallowance u/s.14A r.w.Rule 8D. In our opinion, the Tribunal considered this issue in the case of Farida Shoes Pvt. Ltd. in ITA Nos.2102 & 2103/Mds./15 for assessment years 2011-12 & 2012-12 vide order dated 08.01.16 wherein held that:- “5.1 Coming to the merits of the issue regarding disallowance u/s.14A r.w. Rule 8D of the I.T.Rules, in our opinion, similar issue was considered by this Tribunal in the case of ACIT v. M/s. Best & Crompton Engineering Ltd. in ITA No.1603/Mds/2012 dated 16.7.2013, wherein it was observed that interest on borrowings used for the business purpose cannot be considered for the purpose of computing disallowance u/s.14A r.w. Rule 8D(2)(ii) of the IT Rules and the relevant portion is reproduced as below:
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“10. Heard both sides. Perused the orders of lower authorities and the decision of Calcutta Bench of this Tribunal relied on by the assessee’s counsel. This issue has been considered elaborately by the Commissioner of Income Tax(Appeals) and deleted the interest on bank loan and term loans which were not utilized for making any investments having tax free income. While holding so, the Commissioner of Income Tax (Appeals) held as under:- “5.2.1 Having held that provisions of rule 0D are applicable, let us now examine whether the amount has been correctly quantified. The AO had calculated the disallowance at ` Nil, ` 1,04,38,000/- and ` 26,87,000/- under (i), (ii) & (iii) of rule 80 (2)respectively. There is no dispute regarding the first component, because it is Nil. With regard to the second component being the expenditure by way of interest which is not directly attributable to any particular income or receipt, the AO has determined the amount at ` 1,04,38,000/. The AO has taken into account the entire interest expenditure of `.5,79,46,000/- for computing the above disallowance. The Id.AR, in his submission, has given the break-Up of interest which includes (1) interest on bank loans: ` 67,92,000/- (2) interest on term loans ` 3,82,11,000/- and (3) interest on other accounts: ` 1,29,43,000/-. If loans have been sanctioned for specific projects/expansion and have been utilized towards the same, then obviously they could not have been utilized for making any investments having tax-free incomes. From the copy of the sanction letters from State Bank of Bikaner & Jaipur it can be seen that the loan was granted with a specific requirement that the loan shall be utilized for purchase of imported machinery while in the case of loan from Federal Bank, it is seen that the loan was to be utilized for expansion of projects. Sanction of both these loans prohibit utilization of funds for purposes other than for the utilization for which they are sanctioned. From the ledger extract for the year ended 31.03.2008 for both loan accounts, it is seen that no amount has been utilized for investment in subsidiaries which earns tax-free income. The loan amounts were fully disbursed and utilized in the year ended 31.03.2008 (A.Y. 2008-09) itself. Taking into all the facts as stated above, I am of the considered opinion that if loans/borrowed
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amounts are granted for specific projects/expansion and no amount from the same has been directly utilized for investments, then the first and second limb of rule 80 attributing the interest payments to the investments will not be applicable. Accordingly, interest on bank loan and term loan amounting to ` 67,92,000/- and `3,82,11,000/- respectively are to be excluded from the calculation to determine the disallowance under rule 8D(2)(ii). The AO is, therefore, directed to take into account only the remaining interest on other accounts amounting to ` 1,29,43,000/- for computing the proportionate disallowance under rule 80(2)(ii).”
On going through the order of the Commissioner of Income Tax (Appeals), we find that the Commissioner of Income Tax (Appeals) excluded the interest on bank loan and term loans from the calculation of disallowance under Rule 8D(2)(ii) as the assessee has utilized the bank loan and term loan for the purpose of purchase of machineries and for expansion of projects and these loans were specifically sanctioned for specific project and such loans were also used for the purpose for which they were sanctioned. In the circumstances, we find that the Commissioner of Income Tax (Appeals) has rightly excluded such interest from the purview of computation of disallowance under Rule 8D(2)(ii).
The decision of Calcutta Bench of this Tribunal in the case of Champion Commercial Co.Ltd. (supra) also supports the view of the Commissioner of Income Tax (Appeals). The Tribunal had considered a situation when the loans were utilized for the purchase of machineries, interest arising out of such loans, whether such interest is to be excluded for the purpose of computing disallowance under Rule 8D(2)(ii), the Tribunal held that such interest has to be excluded. While holding so, it has held as under:-
“11. There is no dispute about working of this method so far as rule 8D(2)(i) and (iii) is concerned. It is only with regard to the computation under rule 8D(2)(ii) that the Assessing Officer and the CIT(A) have different approaches. This provision admittedly deals with a situation in which “ the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt” . Clearly, therefore, this sub clause seeks to allocate ‘common interest expenses’ to taxable income and tax
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exempt income. In other words, going by the plain wordings of rule 8D(2)(ii) what is sought to be allocated is “expenditure by way of interest………..which is not directly attributable to any particular income or receipt” and the only categories of income and receipt, so far as scheme of rule 8 D is concerned, are mutually exclusive categories of ’tax exempt income and receipt’ and ‘taxable income and receipt’. No other classification is germane to the context in which rule 8 D is set out, nor does the scheme of Section 14 A leave any ambiguity about it.
Ironically, however, the definition of variable ‘A’ embedded in formula under rule 8D(2)(ii) is clearly incongruous inasmuch while it specifically excludes interest expenditure directly related to tax exempt income, it does not exclude interest expenditure directly related to taxable income. Resultantly, while rule 8D(2)(ii) admittedly seeks to allocate “expenditure by way of interest, which is not directly attributable to any particular income or receipt” it ends up allocating “expenditure by way of interest, which is not directly attributable to any particular income or receipt, plus interest which is directly attributable to taxable income” (emphasis by underlining supplied by us). This incongruity will be more glaring with the help of following simple example: In the case of A & Co Ltd, total interest expenditure is ` 1,00,000, out of which interest expenditure in respect of acquiring shares from which tax free dividend earned is ` 10,000. Out of the balance ` 90,000, the assessee has paid interest of ` 80,000 for factory building construction which clearly relates to the taxable income. The interest expenditure which is “not directly attributable to any particular receipt or income” is thus only ` 10,000. However, in terms of the formula in rule 8D (2)(ii), allocation of interest which is not directly attributable to any particular income or receipt will be for ` 90,000 because, as per formula the value of A (i.e. such interest expenses to be allocated between tax exempt and taxable income) will be “ A = amount of expenditure by way of interest other than the
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amount of interest included in clause (i) [ i.e. direct interest expenses for tax exempt income] incurred during the previous year”. Let us say the assets relating to taxable income and tax exempt income are in the ratio of 4:1. In such a case, the interest disallowable under rule 8 D(2)(ii) will be ` 18,000 whereas entire common interest expenditure will only be ` 10,000/-.
The incongruity arises because, as the wordings of rule 8D(2)(ii) exist, out of total interest expenses, interest expenses directly relatable to tax exempt income are excluded, interest expenses directly relatable to taxable income, even if any, are not excluded.
The question then arises whether we can tinker with the formula prescribed under rule 8D(2)(ii) of the Income Tax Rules, or construe it any other manner other than what is supported by plain words of the rule 8 D (2)(ii).
We find that notwithstanding the rigid words of Rule 8D(2)(ii), the stand taken by the revenue authorities about its application, as was before Hon’ble Bombay High Court in the case of Godrej & Boyce Mfg Co Ltd Vs DCIT (328 ITR 81) when constitutional validity of rule 8 D was in challenge, is that “ It is only the interest on borrowed funds that would be apportioned and the amount of expenditure by way of interest that will be taken (as 'A' in the formula) will exclude any expenditure by way of interest which is directly attributable to any particular income or receipt (for example—any aspect of the assessee's business such as plant/machinery etc.)”. Therefore, it is not only the interest directly attributable to tax exempt income, i.e. under rule 6D(2)(i), but also interest directly relatable to taxable income, which is to be excluded from the definition of variable ‘A’ in formula as per rule 6D(2)(ii), and rightly so, because it is only then that common interest expenses, which are to be allocated as indirectly relatable to taxable income and tax exempt income,
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can be computed. This is clear from the following observations made by Their Lordships of Hon’ble Bombay High Court in the case of Godrej & Boyce (supra):
In the affidavit-in-reply that has been filed on behalf of the Revenue an explanation has been provided of the rationale underlying r. 8D. In the written submissions which have been filed by the Addl. Solicitor General it has been stated, with reference to r. 8D(2)(ii) that since funds are fungible, it would be difficult to allocate the actual quantum of borrowed funds that have been used for making tax-free investments. It is only the interest on borrowed funds that would be apportioned and the amount of expenditure by way of interest that will be taken (as 'A' in the formula) will exclude any expenditure by way of interest which is directly attributable to any particular income or receipt (for example—any aspect of the assessee's business such as plant/machinery etc.)…………… The justification that has been offered in support of the rationale for r. 8D cannot be regarded as being capricious, perverse or arbitrary. Applying the tests formulated by the Supreme Court it is not possible for this Court to hold that there is writ on the statute or on the subordinate legislation perversity, caprice or irrationality. There is certainly no 'madness in the method'.
Once the revenue authorities have taken a particular stand about the applicability of formula set out in rule 8 D(2)(ii), and based on such a stand constitutional validity is upheld by Hon’ble High Court, it cannot be open to revenue authorities to take any other stand on the issue with regard to the actual implementation of the formula in the case of any assessee. Viewed thus, the correct application of the formula set out in rule 8D(2)(ii) is that, as has been noted by Hon’ble Bombay High Court in the case of Godrej and Boyce (supra), “amount of expenditure by way of interest that will be taken (as 'A' in the formula) will exclude any expenditure by way of interest which is
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directly attributable to any particular income or receipt (for example—any aspect of the assessee's business such as plant/machinery etc.)”. Accordingly, even by revenue’s own admission, interest expenses directly attributable to tax exempt income as also directly attributable to taxable income, are required to be excluded from computation of common interest expenses to be allocated under rule 8D(2)(ii).
To the above extent, therefore, we have to proceed on the basis that rigour of rule 8 D (2)(ii) is relaxed in actual implementation, and revenue authorities, having taken that stand when constitutional validity of rule 8 D was in challenge before Hon’ble High Court, cannot now decline the same. Ideally, it is for the Central Board of Direct Taxes to make the position clear one way or the other either by initiating suitable amendment to rule 8D(2)(ii) or by adopting an interpretation as per plain words of the said rule, but even on the face of things as they are at present , in our humble understanding, revenue authorities cannot take one stand when demonstrating lack of ‘perversity, caprice or irrationality’ in rule 8D before Hon’ble High Court, and take another stand when it comes to actual implementation of the rule in real life situations. Therefore, even as we are alive to the fact that the stand of the learned Departmental Representative is in accordance with the strict wording of rule 8D(2)(ii), we have to hold that, for the reasons set out above, this rigid stand cannot be applied in practice.”
In view of the decision of the Calcutta Bench of this Tribunal cited above, we uphold the order of the Commissioner of Income Tax (Appeals) in excluding the interest on bank loan and term loans for the purpose of computing disallowance under Rule 8D(2)(ii). The grounds raised by the Revenue are rejected on this issue.”
In view of the above decision, we are of the opinion that the interest on borrowing which are made for specific purpose of business cannot be considered for the purpose of Rule 8D of the
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Income Tax Rules. Further, investments in sister concerns or subsidiaries with which the assessee is having business transactions, that investments cannot be considered for the purpose of applicability of Rule-8D. For this proposition we rely on the judgments of Tribunal in the case of Sun TV Networks in ITA No.1340 & 1341/Mds./15 & 1578 to 1579/Mds,/15 wherein held that:- “12. We have considered the rival submissions on either side and perused the relevant material available on record. The main contention of the assessee is that the available share capital including reserves and surplus was `2385.7 Crores as on 31.03.2010. The available share capital is `1970.4 Crores and Reserves and surplus is ` 21,886.7 Crores. The investments made in mutual funds including subsidiary companies are only `541.11 Crores. Therefore, it cannot be said that the assessee has diverted the borrowed funds for making any investment either in the sister concerns or in the mutual funds. When the assessee has sufficient share capital, reserves and surplus, this Tribunal is of the considered opinion that there cannot be any disallowance towards the interest paid on the borrowed funds under Section 14A of the Act. For the purpose of disallowing interest income under Section 14A read with Rule 8D, there should be nexus between the borrowed funds and investment made by the assessee in the share capital and mutual funds. In the absence of any nexus, the presumption is that the assessee has invested the available interest-free funds in share capital and mutual funds. Furthermore, making investment in sister concerns is for commercial expediency in view of the judgment of Apex Court in S.A. Builders Ltd. v. CIT (2007) 288 ITR 1. It is not the case of the Revenue that the sister concern or any of the Directors has misused the funds invested by the assessee. When the sister concern uses the funds only for business purpose, there was commercial expediency for making investment. Therefore, this Tribunal is of the considered opinion that there cannot be any disallowance under Section 14A of the Act read with Rule 8D of the Income-tax Rules, 1962. 13. In view of the above, this Tribunal is unable to uphold the orders of the lower authorities. Accordingly, the orders of the lower authorities are set aside. The entire addition made by the Assessing Officer is deleted.”
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10.1 We also rely in the case of Beach Miners Co. Pvt Ltd. Vs. ACIT in ITA No.2110/Mds./14 dated 06.08.15 wherein held that:
“6.1. Ground No.3 – Disallowance of expenditure by invoking the
provisions of section 14A of the Act for `3,11,34,630/- since the
assessee had made investments of `71,55,33,570/- for earning
exempt income.
At the outset, we find that there is no merit for the Revenue to
make addition of `3,11,34,630/- invoking the provisions of section
14A of the Act because the investment made of `71,55,33,570/-,
bears no cost in the form of interest or whatsoever, since the funds
by which the investment is made is assessee’s own funds. Further,
these investments are made only with sister companies of the
assessee and no cost can be attributed for the management of such
funds. Therefore, we hereby delete the addition of Rs.
`3,11,34,630/- made by the Ld. Assessing Officer invoking the
provisions of section 14A of the Act. This ground raised by the
assessee is allowed in its favour. “
In view of the above judgments, the AO has to consider the assessee’s own fund i.e. capital and reserves as available for investment which yields exempted income and thereafter he shall apply the Formula in Rule 8D and also exclude investments in subsidiaries as held by the above order of Co-ordinate Bench. With this observation, we remit the issue to the file of AO for fresh consideration. Hence, this ground is allowed for statistical purposes.”
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In view of above Order of Tribunal in assessee's own case, we remit the issue to the file of ld. Assessing Officer on similar direction for fresh consideration.
In the result, the appeal of the Revenue is partly allowed for statistical purposes.
Order pronounced on 27th September, 2017, at Chennai. Sd/- Sd/- (धु�वु� आर.एल रे�डी) (चं� पूजार�) (DUVVURU RL REDDY)) (CHANDRA POOJARI) �या�यक सद�य/JUDICIAL MEMBER लेखा सद�य /ACCOUNTANT MEMBER चे�नई/Chennai �दनांक/Dated: 27th September, 2017. K S Sundaram आदेश क� ��त�ल�प अ�े�षत/Copy to: 1. अपीलाथ�/Appellant 3. आयकर आयु�त (अपील)/CIT(A) 5. �वभागीय ��त�न�ध/DR 2. ��यथ�/Respondent 4. आयकर आयु�त/CIT 6. गाड� फाईल/GF