Provisions of Rule 8D are not ultra virus the provision of sec 14A and do not offend Article 14 of the Constitution

IN THE INCOME TAX APPELLATE TRIBUNAL, MUMBAI BENCH “C”,

MUMBAI

BEFORE SHRI N.V.VASUDEVAN(J.M) &SHRI.RAJENDRA (A.M.)

ITA NO. 6805/MUM/2010(A.Y.2007-08)

Centrum Capital Limited,

2nd Floor, Bombay Mutual Ldg.,

Dr. D.N. Road, Fort,

Mumbai - 400 001.

PAN:AAACC 5099G

(Appellant)

Vs.

The ACIT, Cir. 2(1),

Aaykar Bhavan, MK Road,

Mumbai - 20.

(Respondent)

Appellant by: S/ Shri Jahangir Mistry / Surender Nijsule

Respondent by: Shri A.K.Nayak

Date of hearing: 26/04/2012

Date of pronouncement: 02/05/2012

ORDER

PER N.V.VASUDEVAN, J.M

This is an appeal by the assessee against the order dated 19/7/2010 of CIT(A)-4, Mumbai relating to assessment year 2007-08. The only issue to be decided in this appeal is with regard to the question whether any disallowance under section 14A of the Income Tax Act, 1961 (the Act) should be made and if so what is the quantum of such disallowance that has to be made while computing total income of the assessee.

2. The assessee is a company engaged in the business of syndication of loans, placement of bond and other financial instruments. The assessee received dividend income of Rs. 21,09,430/-, which did not form part of the total income under the Act. In view of the provisions of section 14A of the Act which provides that any expenditure incurred in earning income which does not form part of the total income under the Act should not be allowed as deduction while computing total income. The AO examined the as to what would be the expenditure by the assessee in earning the dividend income which does not form part of the total income under the Act. The AO relying on the decision of the Hon’ble Special Bench of Mumbai ITAT in the case of ITO vs. Daga Capital Management Pvt. Ltd., wherein it was held that Rule 8D, which was introduced w.e.f. A.Y 2008-09 was retrospective in operation, made the disallowance of expenditure under section 14 A of the Act by following the mandate of the Rule 8D of the Income Tax Rules, 1962.

3. Before CIT(A) the assessee submitted that no prior expenses were incurred in earning the exempt income and gave details in this regard. The CIT(A) however held as follows:

“6. I have duly considered the submissions of the A.R and I agree with the submissions of the A.R that the assessee has not incurred any direct expenditure on earning of the exempt dividend income. In fact the A.O has himself determined the direct expenses for earning the direct income at Nil. The A.O. has only computed the indirect expenses under Rule 8D(ii) and Rule 8D(2)(m) as prescribed in the Rule. It is not correct to say that the assessee has not incurred any expenditure for earning the exempt income. Hence, the disallowance made by the A.O. is required to be confirmed. The decision of Punjab and Haryana High Court in the case of Hero Cycles (159 Taxman 50) is distinguishable on facts as in that case the assessee did not claim any exempt income. It is immaterial whether the assessee has made the investment for earning exempt dividend income or for strategic investment in subsidiary. No relief can le granted to the appellant on the ground that the disallowance is more than the exempt income as the A.O. has simply followed the Rule 8D as promulgated by the Government. The A.O. has rightly relied on the decision of ITAT, Mumbai (SB) in the case of Daga Capital & Management (119 TTJ 289). This ground of appeal is dismissed.”

4. Aggrieved by the order of the CIT(A) the assessee has preferred the present appeal before the Tribunal.

5. We have heard the rival submission. Ld. Counsel for the assessee argued before us that the CIT(A) himself had accepted that there are direct expenses incurred in earning exempt dividend income and, therefore, no disallowance could be made. We are of the view that the disallowance made by the AO was only with regard to indirect expenses and the issue needs to be examined only to this extent.

The Hon’ble Bombay High Court in INCOME TAX APPEAL NO.626 OF 2010 in the case of Godrej & Boyce Mfg.Co.Ltd. Mumbai. Vs. Dy. Commissioner of Income Tax,Range 10(2), Mumbai & Anr. And W.P. 758/10 Godrej & Boyce Mfg.Co.Ltd. Mumbai. Vs.Dy. Commissioner of Income Tax Range 10(2), Mumbai & Ors. by Judgment dated 12-8-2010 has dealt with the disallowance that can be made u/s.14-A of the Act. The Hon’ble Court also dealt with the decision of the Special Bench of the ITAT in the case of Daga Capital Management Pvt.Ltd. 117 ITD 169 (mum) (SB) and has laid down the following proposition:

i) Dividend income and income from mutual funds falling within the ambit of Section 10(33) of the Income Tax Act 1961, as was applicable for Assessment Year 2002-03 is not includible in computing the total income of the assessee. Consequently, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to such income which does not form part of the total income under the Act, by virtue of the provisions of Section 14A(1);

ii) The payment by a domestic company under Section 115O(1) of additional income tax on profits declared, distributed or paid is a charge on a component of the profits of the company. The company is chargeable to tax on its profits as a distinct taxable entity and it pays tax in discharge of its own liability and not on behalf of or as an agent for its shareholders. In the hands of the shareholder as the recipient of dividend, income by way of dividend does not\ form part of the total income by virtue of the provisions of Section 10(33). Income from mutual funds stands on the same basis;

iii)The provisions of sub sections (2) and (3) of Section 14A of the Income Tax Act 1961 are constitutionally valid;

iv)The provisions of Rule 8D of the Income Tax Rules as inserted by the Income Tax (Fifth Amendment) Rules 2008 are not ultra vires the provisions of Section 14A, more particularly sub section (2) and do not offend Article 14 of the Constitution;

v) The provisions of Rule 8D of the Income Tax Rules which have been notified with effect from 24 March 2008 shall apply with effect from Assessment Year 2008-09;

vi) Even prior to Assessment Year 2008-09, when Rule 8D was not applicable, the Assessing Officer has to enforce the provisions of sub section (1) of Section 14A. For that purpose, the Assessing Officer is duty bound to determine the expenditure which has been incurred in relation to income which does not form part of the total income under the Act. The Assessing Officer must adopt a reasonable basis or method consistent with all the relevant facts and circumstances after furnishing a reasonable opportunity to the assessee to place all germane material on the record;

vii)The proceedings for Assessment Year 2002-03 shall stand remanded back to the Assessing Officer. The Assessing Officer shall determine as to whether the assessee has incurred any expenditure (direct or indirect) in relation to dividend income / income from mutual funds which does not form part of the total income as contemplated under Section 14A. The Assessing Officer can adopt a reasonable basis for effecting the apportionment. While making that determination, the Assessing Officer shall provide a reasonable opportunity to the assessee of producing its accounts and relevant or germane material having a bearing on the facts and circumstances of the case.

6. In view of the aforesaid decision of the Hon’ble Bombay High Court the issue with regard to disallowance under section 14A has to be made in accordance with the principle laid down by the Hon’ble Bombay High Court. Rule 8D should not be applied and the AO has to adopt a reasonable basis or method consistent with all relevant facts and circumstances and after affording reasonable opportunity to the assessee to place all germane material on the record. We, therefore, remit the issue to the A.O for fresh consideration as stated above.

7. In the result, the appeal by the assessee is allowed for statistical purposes.

Order pronounced in the open court on the 2nd day of May, 2012

                                                              Sd/-                                   Sd/-

                                                   (RAJENDRA)               (N.V.VASUDEVAN)

                                        ACCOUNTANT MEMBER    JUDICIAL MEMBER

Mumbai, Dated 2nd May 2012

Copy to:

1. The Appellant

2. The Respondent

3. The CIT City –concerned

4. The CIT (A)- concerned

5. The D.R”C” Bench.

(True copy)

By Order

Asst. Registrar, ITAT, Mumbai Benches

MUMBAI.

Vm.