DCIT CEN CIR 4(4) CEN RG 4, MUMBAI vs. UMA POLYMERS LTD, MUMBAI

Revenue is aggrieved for restricting disallowance u/s.14A read with Rule 8D to Rs.12,27,785/- in place of Rs.53,01,885/-, however, assessee is aggrieved for upholding disallowance of Rs.12,27,785/- under Rule 8D(2)(iii).

Rival contentions have been heard and record perused.

Facts in brief are that assessee is engaged in manufacturing and dealing of flexible packaging material. During the course of scrutiny assessment, AO made disallowance u/s.14A in respect of interest 2 3884 /Mum/2015 M/s. Uma Polymers Ltd., expenditure and other administrative expenses. AO observed that assessee is in receipt of dividend income of Rs.32,400/- which was claimed as exempt from tax u/s.10(34). Accordingly, by applying Rule 8D, AO made disallowance on account of interest and other expenditure. By impugned order CIT(A) deleted the disallowance on account of interest after observing as under:- 5. Ground No.1, 2. & 3 5.1 The' above grounds are taken together as they address a common issue. I find from the balance sheet of the appellant company as at 31.03.2011 that .the share capital (Rs.11,15,51,500/-) and reserve & surplus of (Rs.41,85,79,205/-) totalling to Rs.53,01,30,705/- are more than the investment made of Rs.28,23,07,012/-. In the case of CIT v. HDFC Ltd,(ITA No. 330 of 2012) Order dated 23/07/2014,the Hon'ble Bombay High Court held that in view of the factual position as per the judgement in the case of Cl'F v. Reliance Utilities' and Power Ltd. :(2009) "313 ITR 340 [Bom], it would have to be presumed that the investment made by the assessee would be out of the interest free funds available with, the assessee. In: the relevant years, the assessee churned that no disallowance of interest be made u/s. 14A of the LT. Act, 1961 in view of the fact that the assessee had interest free funds available more than the investment in tax free securities. The AO rejected the claim and made disallowance of interest uJ.s.14A on proportionate basis. The Tribunal deleted the addition; On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under: i) 'We find that the facts of the present case are squarely covered by the judgement in the case of Reliance Utilities and Power Ltd. '313 ITR340 (Born). The findings of fact given by the ITA T in the present case is that the assessee's own funds and other non-'interest bearing funds were more than the investment in the tax-free securities. ii] In the present case, undisputedly the assessee's capital, profit reserve, surplus .and current' account deposits were higher than the investment in the tax-free, securities. In view of 3 3884 /Mum/2015 M/s. Uma Polymers Ltd., the factual position,- as per the judgement of this Court in the case of 'Reliance Utilities and Power Ltd. 313 ITR 340 (Born), it would have to be presumed that the investment made by the assessee would be' out of the interest-free funds available with the assessee. iii) We therefore, are unable to agree with the submission of Suresh Kumar that the Tribunal had erred in dismissing the appeal of the Revenue on this ground . iv)' .We do not find that the question gives rise to any substantial question of law. -Appeal is therefore rejected. In view of the above, the disallowance of Rs.40,74,100/- made by the AO under rule 8D (2)(ii) is deleted. 5.2 Hon'ble Supreme Court in their decision dated 6.7.2010 in CIT v. WalfortShare & Stock'Brokers (P.)Ltd.,326 ITR 1, inter alia, observed that the theory of apportionment of expenditure between taxable and non-taxable has, in principle, been now widened under section 14A. In the words of Hon'ble Supreme Court: "17 . The insertion of section 14A with retrospective effect is the serious attempt on the part of the Parliament not to allow' deduction in respect of any expenditure incurred by the assessee in relation to income, which does not form part of the total income under the act against the taxable income (see Circular No. 14 of 2001, dated 22-11-2001). In other words, section 14A Clarifies that expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income. In many cases the nature of expenses incurred by the assessee may be relatable partly to the exempt income and partly to the taxable income. In the absence of section 14A; the- expenditure incurred in respect. 'of exempt income was being claimed against taxable income. The mandate of section 14A is clear. It desires to curb the practice to claim deduction of expenses incurred in relation to exempt income against taxable income and at the same time avail the tax incentive by way of exemption 'of exempt income without making any apportionment of expenses incurred in relation to exempt income. The basic reason for insertion of section 14A is that certain incomes are not includible while computing total income as these are exempt under certain provisions of the' Act. In the past, there have been cases in which deduction has been sought in respect of such incomes which in effect would mean that tax incentives to certain· incomes was being u sed to 4 3884 /Mum/2015 M/s. Uma Polymers Ltd., reduce the tax payable on the .non-exempt income by debiting the expenses, incurred to earn the exempt income, against taxable income: The basic principle of taxation is to tax the net income, i.e., gross income minus the expenditure. On the same analogy the exemptions also in respect of net income. Expenses allowed can only be in respect of earning of taxable income. This is the purport of section 14A. In section 14A, the first phrase is "for the purposes of computing the total income under this Chapter" which makes it clear that various heads' of income as prescribed under Chapter IV would fall within section 14A.The next phrase is, "in relation to income which does not form part of total income under the Act" .It means 'that if an income does not form part of total income, then the related expenditure is outside the ambit of the applicability of section 14A. Further, section 14 specifies five heads of income which are chargeable to tax. In order to be chargeable, an income has to be brought under one of the five heads. Sections 15 to 59 lay down the rules for computing income for the purpose of chargeability to tax under those heads. Sections 15 to 59 quantify the total income '.chargeable to tax, The 'permissible deductions enumerated in sections 15 to 59 are now to be allowed only with, reference to income which is brought under one of the above heads .and is chargeable to tax. If an income like dividend income is not apart of the total income, the expenditure/deduction though of the nature specified in sections 15 to ~9but related to the income not forming part of total income could not be allowed against other income includible in the total income for the 'purpose of chargeability to tax. The theory of apportionment of expenditures between taxable and non-taxable has, in principle, been now widened under section 14A. Reading section 14 in juxtaposition with sections 15 to 59, it is clear that the, words "expenditure incurred 'in section 14A refers to expenditure on rent, taxes, salaries, interest, .etc. in respect of which allowances are provided for (see sections 30 to 37.)" In Maicopp Investment Ltd. v. Cl'I' [2011] 15 taxmann.com 390 (Delhi), the Court explained the method prescribed by Rule8D(2) as under: • If one examines sub-rule (2) of rule 8D, it is found that the method for determining the expenditure in relation to exempt income has three components. • The first component being the amount of expenditure directly relating to income which does not form part of the total income.

5 3884 /Mum/2015 M/s. Uma Polymers Ltd., • The-second component being computed, on the basis of the formula given therein in a case where the assessee incurs expenditure by way of interest which was not directly attributable to any particular income or receipt. 'The formula essentially apportions the amount of expenditure by way of interest [other than the amount Of interest included in clause (i)]incurred during the previous year in the ratio of the average value of investment, income from which does not or shall not 'form part of the total income to the average of the total assets of the assessee'. • 'The third component is an artificial figure-0.5% of the average value of the investment income from which does not or shall not 'form part of the total income, as appearing in the balance sheets of the assessee; on the first day and the last day of the previous year. • It is the aggregate of these three' components which would constitute the expenditure in relation to exempt income and it Is this amount of expenditure which would be disallowed under section 14A.' It is therefore, clear that in terms' of the said rule, the amount of expenditure in relation to exempt income has two aspects - (a) direct and (b) indirect. • The direct expenditure is straightaway taken into account by virtue of clause{i] of sub-rule (2) of rule 8D. 'The indirect expenditure, where it is, by way of interest, is computed through the principle of apportionment, as indicated above. , • In cases where the indirect expenditure is not by way of interest, a rule of thumb figure of 0.5% of the average value of the investment, income from which does not or shall not form part of the total income, is taken.'" In view of the above, the disallowance of Rs.12,27,785/- made by the AO as per rule 8D(2)(iii)· is confirmed.' , 5.3,' The', Hon'ble ITAT, 'Mumbai 'H' Bench ill the case of Hindustan Construction Company Ltd.,. v.DCIT (2013) 140 ITD 642 (Mum) has held the following; "The Hon'ble jurisdictional High Court in the case of Godrej & Boyce Mfg. Co. Ltd. (supra) has clearly held that, section 14A has implicit within a notion of apportionment, Sub-sec. (2) &(3) are only machinery provisions for the purpose of computation of the amount of expenditure incurred in relation to such income. Therefore sofar as the expenditure incurred in relation to the income which does' not form part of the total income as per 6 3884 /Mum/2015 M/s. Uma Polymers Ltd., 'section 10 of the IT Act, the said expenditure clearly falls under clause (f) of Explanation 1 to sec. 115JB. Therefore, in view of the decision of the Hon'ble High Court in the case of Godrej & Boyce Mfg. Co. Ltd. (supra),any expenditure which is disallowed u/s. 14A and attained the finality has to be added back while computing the book profit." In ITO v. RBK Share Broking (P) Ltd. (2013) 37 taxmann.com 128 Mum-Trib) it was held as under: • It would be relevant to note that 'Book profit' u/s.. 115JB is computed as per Explanation 1 to sub-section (2) of section 11SJB. A bare perusal of clause (f) of Explanation 1 makes it abundantly clear that the amount of expenditure 'relatable to' any exempt Income, other than section 10(38), is liable to be added back to the amount' of net profit as shown in the profit' and loss account. • As per section 14A, it transpires that it talks of disallowing any Expenditure incurred in relation to income not includible in the total income 'The expression 'in relation to' used for making disallowance u/s. 14Ahas been employed in Explanation 1 to section'115JB(2) as expenditure 'relatable to', iri more or less the same form. It is manifest, that the amount of dividend is exempted u/ s. 10(33) [not section 10(38)] of the Act. Thus,' any expenditure 'relatable to' the exempt dividend income would fall under clause (f). • The assessee. argued that, unless an amount is specifically debited to. the profit and loss account in respect of an exempt , income, the same cannot 'he brought within the purview of clause (f) of the Explanation 1 to section 115JB(2). He stated that since the disallowance u/s.14A is computed as per rule 8D, the origin of the expenses disallowed cannot be traced to the profit and loss account and hence it cannot be covered within ' the mischief of clause (f) of the, Explanation. • There was no logic in this submission because of the clear 'language of the Explanation 1, which provides in unequivocal terms .that the amount of expenditure 'relatable to' exempt ' income shall be added back " • 'Neither, the language of c1au~e' (f) expressly refers to the amount " specifically debited to the profit and loss account nor can there be an implication in this regard. 'What has been contemplated by the provision is the amount of the expenditure 'relatable to' 'exempt income . • 'Further the amount disallowable u/s.14A is always part of the. ',expenses specifically debited 'to the profit and loss account.

Against the above order of CIT(A), both assessee and revenue are in appeal before us.

Learned AR Mr. Rajendra Jain, Chartered Accountant on behalf of assessee contended that during the relevant assessment year, the assessee company has deployed its own capital reserve and surplus for making investment in shares, thus there was no use of any borrowed funds therefore no disallowance of interest under Rule 8D (2)(ii) was warranted.

Our attention was also invited to the audited accounts for the year under consideration. Learned AR precisely pointed out the fact that assessee company has invested in Umex Packaging Ltd., for having controlling interest therein, it acquired almost'100% equity share capital of the above company by raising its own equity share capital largely and partly from free reserves and surpluses of the assessee company.

Learned AR further argued that strategic investment made in subsidiary companies that have controlling interest, no disallowance is warranted u/s.14A. In support of this proposition, reliance was placed on the following judicial pronouncements, which was also placed on record.  Garware Wall Ropes Vs. Addl. CIT (2004)65 SOT 86 (ITAT Mumbai Bench)  JM Financial Ltd., vs. Addl CIT (ITA 4521/Mum/2012) Order dt 26.03.2014.  CIT vs. Oriental Structural Engg. (Pvt.) Ltd., (ITA 605/2012) (Delhi High Court decision dt. 15/01/2013) 10. As per learned AR, investment not yielding tax free income during the assessment year is required to be excluded from investment while computing average investment in rule 8D (2)(iii). For this purpose reliance was placed on the following judicial pronouncements.  Coal India Ltd., vs.Addl.CIT (2015) 172 TTJ 0103 (Kol)

We have considered rival contentions and carefully gone through the orders of the authorities below. We had also deliberated on the judicial pronouncements referred by lower authorities in their respective orders as well as cited by learned AR during the course of hearing before us in the context of factual matrix of the case. From the record, we found that as per the audited balance sheet on record, assessee was having its own capital and free reserves which were much more than the investment made in tax free securities. A categorical finding has been recorded by CIT(A) to the effect that assessee company was having its own capital as on 31/03/2011 at Rs.11,15,51,500/- and reserves and surplus of Rs.41,85,75,205/- total to Rs.53,01,30,705/-. These capital and reserves were much more than the investment made of Rs.28,23,07,012/-. In terms of the decision of jurisdictional High Court in case of HDFC bank (supra) and Reliance Utilities (supra), it would have to be presumed that investment made by assessee would be out of interest free funds available with the assessee.

The ratio and the principle laid down by the Hon'ble Bombay High Court in the case of Reliance Utilities Ltd., (supra) and HDFC Bank, (supra) are clearly applicable, wherein their Lordships have reiterated several times that if the assessee has surplus funds in the form of reserves & surplus or share capital, then presumption is that investment 10 3884 /Mum/2015 M/s. Uma Polymers Ltd., would have been made from surplus funds/interest free funds and not from the borrowed funds.

Applying the proposition of law laid down by Jurisdictional High Court to the findings recorded by CIT(A) which are as per material on record, we do not find any reason to interfere in the findings of CIT(A) deleting the disallowance of interest u/s.14A read with Rule 8D (2)(ii). Accordingly appeal filed by Revenue is dismissed.

In the appeal of assessee, assessee is aggrieved for restricting disallowance of other expenditure under Rule 8D (2)(iii) to Rs.12,27,785/-. As per the judicial pronouncements in case of Garware Wall Ropes (supra) and JM Financial Ltd., (supra) and Oriental Structural Engg.(P) Ltd., (supra), Interglobe Enterprises Ltd vs DCIT ITA Nos, 1362/De1/2013, 1032/Del/2013 and 1580/De1/2013 (Delhi ITAT); M/s. Binani Industries Limited ITA No.l44/Ko1/2013 (Kol ITAT); EIH Associated Hotels Limited ITA No.1503 & 1624/Mds/2012 (Madras ITAT); the strategic investment made in subsidiary companies for having controlling interest should be excluded from the average investment while computing disallowance under Rule 8D (2)(iii). Similarly in the case of Coal India Ltd., 172 TTJ 0103 and REI Agro Ltd., 144 ITD 141, investment not yielding tax free income should be excluded from investment while computing average investment under Rule 8D (2)(iii).

In view of these judicial pronouncements we are inclined to agree with Ld. Counsel of assessee that the investments from where income is taxable or the investments which are for business or strategic reasons 11 3884 /Mum/2015 M/s. Uma Polymers Ltd., need to be removed from the working of the average value of investments as contemplated in rule 8D(2)(iii). These propositions have been consistently held in catena of cases by this Tribunal as referred to by ld. Counsel before us.

Applying proposition of law discussed in above judicial pronouncements we have to exclude the strategic investment made in the group concerns, which works out to 98% of the investment so made. The other investments are earlier investments and not made during the year. Accordingly, no disallowance of other expenditure is warranted under Rule 8D(2)(iii) to this extent.

Learned AR Mr. Rajendra Jain also relied on following judicial pronouncements in support of the proposition that disallowance u/s.14A read with Rule 8D(2)(iii) cannot exceed the exempt income.  Joint Investment (P) Ltd., vs. CIT (ITA 117 / 2015) Delhi High Court order dated 25/02/2015.  -Pr CIT vs. Empire Package (P) Ltd. ,(ITA 415 of 2015 (O & M) Punjab and Haryana Court order dated 12/01/2016.  Daga Global Chemicals (P) Ltd., vs. ACIT (ITA 5592/Mum/2012) dt. 01/01/2015.

In the result, appeal of the Revenue is dismissed whereas appeal of the assessee is allowed in part.