$ * IN HIGH COURT OF DELHI AT NEW DELHI 19. + ITA 802/2015 PR. COMMISSIONER OF INCOME TAX DELHI-2 ..... Appellant Through: Mr. P. Roy Chaudhari, Senior Standing counsel with Ms. Lakshmi Gurung and Mr. Ishant Goswami, Advocates. versus BHARTI OVERSEAS PVT. LTD. ..... Respondent Through: Mr.Arvind Kumar, Advocate. CORAM: JUSTICE S. MURALIDHAR JUSTICE RAJIV SHAKDHER ORDER % 17.12.2015 Dr. S. Muralidhar, J.: 1. This appeal by Revenue under Section 260A of Income Tax Act, 1961 ( Act ) is directed against order dated 23rd March 2015 passed by Income Tax Appellate Tribunal ( ITAT ) in ITA No. 460/Del/2013. 2. question sought to be urged before this Court is whether ITAT was correct in affirming order of Commissioner of Income Tax (A) [ CIT(A) ] which had confined disallowance under Section 14A of Act to Rs. 30,26,552 for AY in question? 3. incidental issue that is sought to be raised is whether ITAT could I.T.A No. 802 of 2015 Page 1 of 12 read down Rule 8D (2)(ii) of Income Tax Rules 1962 ( Rules ), and whether that was beyond jurisdiction of ITAT? 4. Assessee Company was incorporated on 21st November 2005 as service sector company engaged in promotion of international telecom business and insurance business. For AY 2008-09, Assessee filed its original return of income on 19th September 2008 declaring loss of Rs.16,07,22,655. income was revised on 16th December 2009, at loss of Rs. 13,93,37,943. revision of amount of loss was pursuant to scheme of arrangement approved by High Court with effect from 1st October 2007. 5. return was picked up for scrutiny. It was observed by Assessing Officer ( AO ) that Assessee had shown dividend income of Rs.89, 02,540 out of which Rs. 68, 44,790 was claimed as exempt under Section 10 (34) of Act. Assessee was asked to show cause why disallowance under Section 14A of Act read with Rule 8D should not be made for expenditure incurred in relation to income not forming part of total income. authorised representative (AR) of Assessee in response thereto submitted letter dated 24th November 2010, stating that in terms of Note 4 of computation of taxable income, sum of Rs. 6,84,479 constituting 10% of net exempted dividend income had already been disallowed on account of indirect expenditure incurred in earning such income. AO was, however, of view that all expenses connected with exempt income have to be necessarily disallowed regardless of whether they were direct or indirect, fixed or variable, and managerial or financial. I.T.A No. 802 of 2015 Page 2 of 12 claim of Assessee that it had incurred 10% of exempt income as expenditure was rejected. AO then re-worked disallowance by taking into account interest which was not directly attributable to any particular income/receipt into account. disallowance was worked out at Rs. 2,85,86,881 and after adjusting disallowance already made by Assessee itself, disallowance of Rs. 2,79,02,402 was added to taxable income of Assessee. 6. Assessee then appealed to CIT (A). It was contended by Assessee that Rule 8D would apply only if AO, having regard to accounts of Assessee of previous year, was not satisfied with correctness of claim of expenditure made by Assessee. According to Assessee there was no such recording of satisfaction to justify invoking of Rule 8D. It was pointed out that AO had disallowed against exempt income of Rs. 68,44,790, sum of Rs. 41,37,781 as expense attributable under Section 14A of Act, and that this mismatch of disallowance and non-taxable income indicated that it was unreal and had no nexus to exempt income. It was submitted that application of Rule 8D should not be such that it becomes incongruent. It cannot disallow expenses which relate to taxable Income . Reliance was placed on decisions of this Court in Maxopp Investment Ltd. v. CIT (2012) 347 ITR 272 (Del) and Punjab & Haryana High Court in CIT v. Hero Cycles Ltd., 323 ITR 518 (P&.H). Reference was also made to decision of Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. v. CIT, 328 ITR 81 (Mum). I.T.A No. 802 of 2015 Page 3 of 12 7. CIT(A) noted that indeed AO had not recorded reasons for rejecting claim of Assessee regarding disallowance 10% of exempt income as expenditure. CIT (A) proceeded to observe that during appeal proceedings, it was found that actually amount of interest attributable to earning of dividend income should have been taken at proportion of Rs. 83 lacs for purpose of applying Rule 8D and not Rs. 5,52,83,131 as adopted by AO . disallowance was therefore re- worked at Rs.37,11,031. After adjusting sum offered by Assessee, disallowance was restricted to Rs.30, 26,552. 8. Revenue went in appeal before ITAT. Significantly, no cross objections were filed by Assessee. Therefore only question considered by ITAT was whether CIT (A) was justified in restricting disallowance under Section 14A of Act as noted hereinbefore. ITAT referred to decision of Kolkatta Bench of ITAT in ACIT v. Champion Commercial Co. Ltd., (2012) 139 ITD 108, which in turn referred to decision of Bombay High Court in Godrej & Boyce Mfg. Co. Ltd (supra) and held that for purposes of Rule 8D (2) (ii), amount of interest not attributable to earning of any particular item of income, i.e., common interest expenses that was required to be allocated would have to exclude both expenditures, i.e., interest attributable to tax exempt income as well as that attributable to taxable income. ITAT observed that notwithstanding rigid wording of Rule 8D (2), this interpretation was permissible in view of stand taken by Revenue before Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (supra). ITAT, therefore, was of view that since there was no common I.T.A No. 802 of 2015 Page 4 of 12 interest expenditure in present case no portion of interest really survives for allocation under Rule 8D(2)(ii). Therefore relief granted by CIT (A) did not require interference. It was also noted that Assessee did not file any appeal. 9. It is urged by Mr. P. Roy Chaudhary, learned Standing counsel for Revenue, that ITAT could not have read down Rule 8D (2)(ii) of Rules as it was Tribunal of limited jurisdiction. It is further submitted that ITAT erred in ignoring provisions of Rule 8D (2) (iii) thereby deleting disallowance of Rs. 41,37,781 made by AO under said clause. 10. Mr. Arvind Kumar, learned counsel for Assessee, submitted that on collective reading of Section 14A of Act and Rule 8D of Rules, it is plain that if variable under Rule 8D(2)(ii) is interpreted to include interest expense directly relatable to earning taxable income, then in effect it would result in disallowance of certain portion of otherwise permissible deduction under Act. This would be contrary to very purpose and object of Section 14A of Act. According to him if Rule 8 D (ii) is read with Section 14 of Act, then only possible interpretation was that adopted by ITAT. He further submitted that although Assessee was not in appeal before ITAT, or before this Court, he would still like to urge issue concerning AO not having recorded any satisfaction about untenablility of claim of Assessee as to what constituted legitimate expenditure incurred for earning exempt income. I.T.A No. 802 of 2015 Page 5 of 12 11. As regards last submission of learned counsel for Assessee, this Court is not inclined to entertain such plea. fact of matter is that Assessee accepted order of CIT (A) limiting disallowance and did not question it further before ITAT. 12. central issue that requires to be considered is whether ITAT was justified in upholding order of CIT (A) by interpreting Rule 8D (2) (ii) of Rules in manner in which it has in impugned order. 13. Section 14A (1) of Act states that no deduction shall be allowed in respect of expenditure incurred by Assessee in relation to income which does not form part of total income under this Act . Rule 8D of Rules sets out method for determining amount of expenditure in relation to income which does not form part of income . Rule 8D reads as under: 8D. (1) Where Assessing Officer, having regard to accounts of assessee of previous year, is not satisfied with (a) correctness of claim of expenditure made by assessee; or (b) claim made by assessee that no expenditure has been incurred, in relation to income which does not form part of total income under Act for such previous year, he shall determine amount of expenditure in relation to such income in accordance with provisions of sub-rule (2). (2) expenditure in relation to income which does not form part of total income shall be aggregate of following amounts, namely (i) amount of expenditure directly relating to income which does not form part of total income; I.T.A No. 802 of 2015 Page 6 of 12 (ii) in case where assessee has incurred expenditure by way of interest during previous year which is not directly attributable to any particular income or receipt, amount computed in accordance with following formula, namely: x B/C Where = amount of expenditure by way of interest other than amount of interest included in clause (i) incurred during previous year ; B = average of value of investment, income from which does not or shall not form part of total income, as appearing in balance sheet of assessee, on first day and last day of previous year ; C = average of total assets as appearing in balance sheet of assessee, on first day and last day of previous year ; (iii) amount equal to one-half per cent of average of value of investment, income from which does not or shall not form part of total income, as appearing in balance sheet of assessee, on first day and last day of previous year. (3) For purposes of this rule, total assets shall mean, total assets as appearing in balance sheet excluding increase on account of revaluation of assets but including decrease on account of revaluation of assets. 14. As far as Rule 8D (2) (i) is concerned, AO has necessarily to record that he is not satisfied with correctness of claim of expenditure made by Assessee in relation to income which does not form part of total income . That this requirement is mandatory is now well settled in view of decision of this Court in Maxopp Investment (supra). For Rule 8 D (2) (ii) to apply there has to be some expenditure by way of interest I.T.A No. 802 of 2015 Page 7 of 12 "which is not directly attributable to any particular income or receipt." If there is no such expenditure, as has been found factually by ITAT in present case, then question of applying formula thereunder will not arise. 15. Nevertheless, ITAT has had to interpret Rule 8D (2) (ii) since AO applied it and CIT (A) had to decide whether that interpretation was correct. That is how this Court too is called upon to decide whether ITAT was right in its interpretation of that provision. methodology set out under Rule 8D for determining amount of expenditure in relation to exempt income corresponds to Section 14 (2) of Act. Section 14A (3) clarifies that Section 14A (2) would apply when Assessee claims that no expenditure has been incurred in relation to exempt income. 16. object behind Section 14A (1) is to disallow only such expense which is relatable to tax exempt income and not expenditure in relation to any taxable income. This object behind Section 14A has to be kept in view while examining Rule 8D (2) (ii). In any event rule can neither go beyond or restrict scope of statutory provision to which it relates. 17. Rule 8D (2) states that expenditure in relation to income which is exempt shall be aggregate of (i) expenditure attributable to tax exempt income, (ii) and where there is common expenditure which cannot be attributed to either tax exempt income or taxable income then sum arrived at by applying formula set out thereunder. What formula does is basically to "allocate" some part of common expenditure for I.T.A No. 802 of 2015 Page 8 of 12 disallowance by proportion that average value of investment from which tax exempt income is earned bears to average of total assets. It acknowledges that funds are fungible and therefore it would otherwise be difficult to allocate sum constituting borrowed funds used for making tax-free investments. Given that Rule 8 D (2) (ii) is concerned with only 'common interest expenditure' i.e. expenditure which cannot be attributable to earning either tax exempt income or taxable income, it is indeed incongruous that variable in formula will not also exclude interest relatable to taxable income. This is precisely what ITAT has pointed out in Champion Commercial (supra). There ITAT said that by not excluding expenditure directly relatable to taxable income, Rule 8D (2) (ii) 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." This is contrary to intention behind Rule 8D (2) (ii) read with Section 14A of (1) and (2) of Act. 18. following illustration provided by ITAT in Champion Commercial (supra) demonstrates incongruity: In case of & Co. Ltd., total interest expenditure is Rs.1,00,000, out of which interest expenditure in respect of acquiring shares from which tax free dividend earned is Rs.10,000. Out of balance Rs. 90,000, assessee has paid interest of Rs. 80,000 for factory building construction which clearly relates to taxable income. interest expenditure which is not directly attributable to any particular receipt or income is thus only Rs. 10,000. However, in terms of formula in Rule 8D(2) (ii), allocation of interest which is not directly attributable to any particular income or receipt will be for Rs.90,000 because, as per formula value of I.T.A No. 802 of 2015 Page 9 of 12 A(i.e. such interest expenses to be allocated between tax exempt and taxable income) will be = amount of expenditure by way of interest other than amount of interest included in clause (i) [i.e. direct interest expenses for tax exempt income] incurred during previous year . Let us say assets relating to taxable income and tax exempt income are in ratio of 4:1. In such case, interest disallowable under Rule 8D(2) (ii) will be Rs.18,000 whereas entire common interest expenditure will only be Rs.10,000 . 19. What ITAT has done in present case instead is to follow its earlier decision in Champion Commercial (supra) which in turn followed decision of Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (supra). ITAT did not on its own read down rule 8D (2) (ii). Rather, it went by stand taken by Revenue before Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (supra) in countering challenge to constitutional validity of Rule 8 D (2). stand of Revenue was that variable in formula in Rule 8D (2) (ii) would exclude both interest attributable tax exempt income as well as taxable income. Bombay High Court took on board said statement and negatived challenge to constitutional validity of provision by holding as under: 60. In affidavit-in-reply that has been filed on behalf of Revenue explanation has been provided of rationale underlying Rule 8D. In written submissions which have been filed by 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 actual quantum of borrowed funds that have been used for making tax-free investments. It is only interest on borrowed funds that would be apportioned and amount of expenditure by way of interest that will be taken (as in formula) will exclude any expenditure by way of interest which is directly attributable to any I.T.A No. 802 of 2015 Page 10 of 12 particular income or receipt (for example- any aspect of assessee s business such as plant/machinery et.) .. justification that has been offered in support of rationale for R.8D cannot be regarded as being capricious, perverse or arbitrary. Applying tests formulated by Supreme Court it is not possible for this Court to hold that there is writ on statute or on subordinate legislation perversity, caprice or irrationality. There is certainly no madness in method . 20. Therefore Court is unable to agree with Revenue that in adopting above interpretation ITAT has on its own read down Rule 8D (2) (ii) of Rules and therefore travelled beyond scope of its jurisdiction and powers. 21. In case in hand, in Note 4 of computation of income submitted by Assessee, total interest debited to profit and loss account was Rs.5,52,83,131. There was entry regarding interest on loans given to two entities. After accounting for other interest expenditure, Assessee computed total interest expenditure which was allowable as Rs.83,90,178. In computation drawn up by Assessee, entire interest expenditure was incurred for earning either taxable income or exempt income. There was no interest amount which was not directly attributable to either tax exempt or taxable income. ITAT, therefore, correctly observed in present case no portion of interest really survives for allocation under Rule 8D (2) (ii) . However, as rightly pointed out by ITAT, since Assessee did not challenge order of CIT (A) to extent it restricted disallowance, that part of order of CIT (A) remained. I.T.A No. 802 of 2015 Page 11 of 12 22. point concerning Rule 8D (2) (iii) does not appear to have been urged by Revenue before ITAT and therefore not considered by it. In any event that does not affect interpretation of Rule 8D (2) (ii) which was only issue considered by ITAT in impugned order. 23. For aforementioned reasons, impugned order of ITAT does not call for any interference. No substantial question of law arises for consideration. 24. appeal is dismissed. S. MURALIDHAR, J RAJIV SHAKDHER, J DECEMBER 17, 2015 mg I.T.A No. 802 of 2015 Page 12 of 12 Pr. Commissioner of Income Tax Delhi-2 v. Bharti Overseas Pvt. Ltd