JCIT vs. STATE BANK OF MYSORE,

IN THE INCOME TAX APPELATE TRIBUNAL BANGALORE “A” BENCH : BANGALORE BEFORE SMT. P. MADHAVI DEVI, JUDICIAL MEMBER AND SHRI JASON P. BOAZ, ACCOUNTANT MEMBER ITA.No.793/Bang/2013 Assessment Year 2009-2010 Joint Commissioner of State Bank of Mysore Income Tax, LTU, vs. Finance Accounts Dept Bangalore – 85. Bangalore. (Appellant) (Respondent) For Revenue : Mr. G.R. Reddy For Assessee : Mr. K.R. Vasudevan Date of Hearing : 20.07.2015 Date of Pronouncement : 18.09.2015 ORDER PER SMT. P. MADHAVI DEVI, J.M. This appeal filed by the Revenue is directed against the Order of the Ld. CIT(A), LTU, Bangalore dated 19.03.2013 for the A.Y. 2009-2010. In this appeal, the Revenue has raised five grounds which are as follows :

2 ITA.No.793/Bang/2013 State Bank of Mysore, Bangalore. 3. The Ld. CIT(A) erred in allowing the provision on depreciation on transfer of securities from AFS category to HTM category. 4. The Ld. CIT(A) erred in restricting the disallowance u/s.14A to 2% of the exempt income which is against the scope of provisions of the Act. 5. Any other ground that may be urged at the time of hearing of the appeal.” 2. As regard ground Nos. 2 and 3 are concerned, the Ld. Counsel for the assessee submitted that though the Ld. CIT(A) has granted relief to the assessee in the appeal under section 250 of the I.T. Act, subsequently vide proceedings under section 154 read with section 250, the said relief has been withdrawn. A copy of the order dated 17.03.2015 under section 154 read with section 250 is filed before us and on perusal of the same, we find that the contentions of the Ld. Counsel for the assessee are correct. Therefore, these two grounds raised by the Revenue are dismissed/rejected as infructuous.

3 ITA.No.793/Bang/2013 State Bank of Mysore, Bangalore. the opinion that the provisions of section 14A of the Act are applicable and no deduction is required to be allowed in respect of expenses incurred by the assessee in relation to the income which does not form part of the total income under the I.T. Act. Therefore, assessee’s explanation was called for. Vide letter dated 22.06.2011, the assessee explained that the provisions of section 14A makes it abundantly clear that the power of the A.O. to apply a prescribed method under Rule 8D arises only where the A.O. is not satisfied with the correctness of the claim of the assessee having regard to the accounts of the assessee and therefore, no disallowance in the case of the assessee was called for as no such exercise has been carried out by the A.O. The assessee placed reliance upon the decision of the Hon’ble High Court of Bombay in the case of Godrej & Boyce Mfg. Ltd. vs. DCIT reported in (2010) 194 Taxman 203 (Bom.). The A.O., however, held that the assessment order before him being A.Y. 2009- 2010, the provisions of Rule 8D of the I.T. Rules are applicable. Thereafter, he proceeded to compute the disallowance under Rule 8D of the Act. He accordingly calculated the disallowance at Rs.32,00,062 and brought it to tax.

4 ITA.No.793/Bang/2013 State Bank of Mysore, Bangalore. on Rule 8D is clearly premature. Thereafter, he observed that the ITAT for the A.Ys. 2003-2004 and 2004-2005 in assessee’s own case, have upheld the action of the assessee bank for disallowing 2% of the exempt income under section 14A of the Act. She held that since the A.O. has not brought out any material difference in the business carried by the assessee this financial year and since he has not pointed out specific weaknesses in assessee’s claim, she has directed the A.O. to restrict the disallowance to 2% of the exempt income. Thus, relief was granted to the assessee, against which, the Revenue is in appeal before us.

5 ITA.No.793/Bang/2013 State Bank of Mysore, Bangalore.

“57. Now in dealing with the challenge it is necessary to advert to the position that sub-section (2) of section 14A prescribes a uniform method for determining the amount of expenditure incurred in relation to income which does not form part of the total income only in a situation where the Assessing Officer, having regard to the accounts of the assessee is not satisfied with the correctness of the claim of the assessee in respect of such expenditure. It therefore merits emphasis that sub-section (2) of section 14A does not authorize or empower the Assessing Officer to apply the prescribed method irrespective of the nature of the claim made by the assessee. The Assessing Officer has to first consider the correctness of the claim of the assessee having regard to the accounts of the assessee. The satisfaction of the Assessing Officer has to be objectively arrived at on the basis of those accounts and after considering all the relevant facts and circumstances. The application of the prescribed method arises in a situation where the claim made by the assessee in respect of expenditure which is relatable to the earning of income which does not form part of the total income under the Act is found to be incorrect. In such a situation a method had to be devised for apportioning the expenditure incurred by the assessee between what is incurred in relation to the earning of taxable income and that which is incurred in relation to the earning of non- taxable income. As a matter of fact, the memorandum explaining the provisions of the Finance Bill, 2006 and the CBOT circular dated 28- 12-2006 state that since the existing provisions of section 14A did not provide a method of computing the expenditure incurred in relation to income which did not form part of the total income, there was a considerable dispute between taxpayers and the department on the method of determining such expenditure It was in this background that sub- section (2) was inserted so as to provide a uniform method applicable where the Assessing Officer is not satisfied with the correctness of the claim of the assessee Sub-section (3) clarifies that the application of the method would be attracted even to a situation where the assessee has claimed that

6 ITA.No.793/Bang/2013 State Bank of Mysore, Bangalore. no expenditure at all was incurred in relation to the earning of non-taxable income. 58. Parliament has provided an adequate safeguard to the invocation of the power to determine the expenditure incurred in relation to the earning of non-taxable income by adoption of the prescribed method. The invocation of the power is made conditional on the objective satisfaction of the Assessing Officer in regard to the correctness of the claim of the assessee, having regard to the accounts of the assessee. When a statute postulates the satisfaction of the Assessing Officer "Courts will not readily defer to the conclusiveness of an executive authority's opinion as to the existence of a matter of law or fact upon which the validity of the exercise of the power is predicated" - MA. Rasheed v. State of Kerala AIR 1974 SC 2249 (at para 7 page 2252) A decision by the Assessing Officer has to be arrived at in good faith on relevant considerations The Assessing Officer must furnish to the assessee a reasonable opportunity to show cause on the correctness of the claim made by him In the event that the Assessing Officer is not satisfied with the correctness of the claim made by the assessee, he must record reasons for his conclusion. These safeguards which are implicit in the requirements of fairness and fair procedure under Article 14 must be observed by the Assessing Officer when he arrives at his satisfaction under sub-section (2) of section 14A. As we shall note shortly hereafter, sub-rule (1) of rule 80 has also incorporated the essential requirements of sub- section (2) of section 14A before the Assessing Officer proceeds to apply the method prescribed under sub-rule (2). 59. The charge of the assessee that there is an inherent arbitrariness in prescribing a uniform method for determining the disallowance of expenditure in relation to the earning of non-taxable income must therefore, fail for three reasons. Firstly, as a matter of fundamental principle, when the Court is confronted with a challenge to a classification by tax legislation either QJ1 the ground of over or under inclusion, it is trite law that the Court must

7 ITA.No.793/Bang/2013 State Bank of Mysore, Bangalore. defer to the wisdom of the Legislature. Crudities and inequities are involved in making complex fiscal adjustments that are intrinsic to any fiscal measure. Diverse methods are open to the Legislature to achieve a result and if the Legislature adopts a particular method, the Court will not substitute its own view for that of the Legislature merely because another method appears more suitable or because a better crafted measure could have been put into place. Unless the method which has been selected is capricious, fanciful or arbitrary, the Court will defer to the wisdom of the Legislature and to its delegate who is subject to its legislative control. Burdens and disadvantages are not ground enough to strike down the constitutional validity of legislation or subordinate legislation. Cases of individual hardship are similarly not a valid ground for striking down constitutional validity. So long as the measure which has been put into place has nexus with the object sought to be achieved, it passes constitutional muster. Secondly, sub-section (2) of section 14A makes it abundantly clear that the power to apply the prescribed method arises only where the Assessing Officer is not satisfied with the correctness of the claim of the assessee having regard to the accounts of the assessee. It is because the assessee is unable to establish the correctness of the claim in respect of the expenditure incurred in earning income which does not form part of the taxable income that the Assessing Officer is compelled to make a determination. The Learned Additional Solicitor General has placed before the Court material that would indicate that if a simplistic pro rata disallowance were to be made, that would as a matter of fact have resulted in a disallowance of Rs. 82 crores on an expenditure of Rs. 189.77 crores. As opposed to this the disallowance under rule 8D(2)(iil) is restricted to Rs. 1.57 crores. Before the Legislature prescribed a uniform method, disputes had occurred between assessees and the department in regard to the method to be adopted in computing the expenditure relatable to the earning of non-taxable income. In this background, if the Legislature considered it appropriate to prescribe a particular method that legislative choice

8 ITA.No.793/Bang/2013 State Bank of Mysore, Bangalore. cannot be held to be arbitrary or oppressive. Thirdly, sub-sections (2) and (3) and the proviso to section 14A contain sufficient safeguards that would ensure a reasonable exercise of power. Apart from the safeguards to which a reference has been made earlier, the proviso stipulates that nothing contained in the section shall empower the Assessing Officer to reassess under section 147; or enhance the assessment or reduce the refund already made; or otherwise increase the liability of the assessee under section 154, for any assessment year beginning on or before 01/04/2001. 60. In the affidavit in reply that has been filed on behalf of the revenue an Explanation has been provided of the rationale underlying rule 80. In the written submissions which have been filed by the Additional Solicitor General it has been stated, with reference to Rule 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.). As regards rule 8D(2)(iii) it has been submitted that some mechanism or formula had to be adopted for attributing part of the administrative/managerial expenses to tax exempt investment income. The administrative expenses attributable to tax-free investment income have a fixed component and a variable component. A view was taken that the disallowance should also be linked to the value of the investment rather than the amount of exempt income. Under Portfolio Management Schemes (PMS) the fee charged ranges between 2 and 2.5 per cent of the portfolio value which would be inclusive of a profit element for the portfolio manager. While the fixed administrative expenses were excluded, on the ground that in the case of a large corporate taxpayer they would be spread over a large number

9 ITA.No.793/Bang/2013 State Bank of Mysore, Bangalore. of voluminous activities, the variable expenses were computed at one-half per cent of the value of the investment. The justification that has been offered in support of the rationale for rule 80 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'.”

Order pronounced in the open Court on 18th September, 2015. Sd/- Sd/- (JASON P. BOAZ) (P. MADHAVI DEVI) ACCOUNTANT MEMBER JUDICIAL MEMBER Hyderabad, Dated 18th September, 2015. VBP/-