O/TAXAP/409/2017 JUDGMENT IN HIGH COURT OF GUJARAT AT AHMEDABAD TAX APPEAL NO. 409 of 2017 With TAX APPEAL NO. 514 of 2017 FOR APPROVAL AND SIGNATURE: HONOURABLE MR.JUSTICE AKIL KURESHI and HONOURABLE MR.JUSTICE BIREN VAISHNAV 1 Whether Reporters of Local Papers may be allowed to see judgment ? 2 To be referred to Reporter or not ? 3 Whether their Lordships wish to see fair copy of judgment ? 4 Whether this case involves substantial question of law as to interpretation of Constitution of India or any order made thereunder ? PRINCIPAL COMMISSIONER OF INCOME TAX-3....Appellant(s) Versus NIRMA CREDIT AND CAPITAL PVT.LTD.....Opponent(s) Appearance: MR MR BHATT SENIOR COUNSEL WITH MRS MAUNA M BHATT, ADVOCATE for Appellant(s) No. 1 MR SN SOPARKAR SENIOR COUNSEL WITH MR B S SOPARKAR, ADVOCATE for Opponent(s) No. 1 CORAM: HONOURABLE MR.JUSTICE AKIL KURESHI Page 1 of 13 HC-NIC Page 1 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT and HONOURABLE MR.JUSTICE BIREN VAISHNAV Date : 31/08/2017 ORAL JUDGMENT (PER : HONOURABLE MR.JUSTICE AKIL KURESHI) 1. Considering fact that issues involved in Tax Appeal filed by Revenue would arise in number of other cases, we had issued notice for final disposal to respondent assessee for consideration of following substantial question of law : Whether Appellate Tribunal is right in law and on facts in deleting disallowance of Rs.1,06,56,837/ for A.Y.2008 09 made by Assessing Officer u/s 14A of Act ? 2. issues involved are identical in both tax appeals. We have therefore, heard them together. We may record facts from Tax Appeal No.409/2017. respondent assessee is company registered under Companies Act. For assessment year 2008 2009, assessee had filed return of income on 30.9.2008 declaring loss of Rs.5.63 crores (rounded off). return was taken in scrutiny by Assessing Officer. During such scrutiny, Assessing Officer noted that assessee had shown dividend income of Rs.25.26 lacs (rounded off) from investment made by it in shares and securities which was claimed as exempt income. In context of disallowance of expenditure to earn such income in terms of section 14A of Income Tax Act( Act for short), Page 2 of 13 HC-NIC Page 2 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT Assessing Officer called upon assessee to furnish details of investment and income earned thereon. Assessing Officer was of opinion that assessee failed to prove that investment in shares and securities was made out of interest free funds only. On contrary, he noted that assessee had made substantial borrowings in form of unsecured and secured loans and had claimed interest expense thereof. In that view of matter, Assessing Officer applied formula provided in Rule 8D of Income Tax Rules ( Rules for short) read with section 14A of Act. While computing disallowance of interest expenditure, assessee contended that against interest expenditure of Rs. 7.01 crores (rounded off) on borrowings, assessee had earned taxable interest of Rs.6.83 crores (rounded off) and, therefore, for purpose of computing disallowance under section 14A of Act, if at all, it is difference between interest paid and interest earned which should be considered as assessee's interest expenditure for working out formula provided under clause(ii) of sub rule(2) of Rule 8D. Assessing Officer however adopted full figure of Rs.7.01 crores towards interest expenditure and thereafter applied formula and computed sum of Rs.99.41 lakhs under sub rule(2) of Rule 8D. He then added half percent of average value of investments not forming part of total income in terms of clause(iii) of sub rule(2) of Rule 8D to come to total figure of Rs.1.06 crores (rounded off) for disallowance under section 14A of Act. 3. assessee carried matter in appeal. assessee Page 3 of 13 HC-NIC Page 3 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT again raised same issue contending that sizeable interest was earned through investment in Inter Corporate Deposits and other investments. CIT(Appeals) however, did not accept assessee's contention. While rejecting appeal on this point, he confirmed decision of Assessing Officer. 4. assessee thereupon approached Tribunal. Tribunal by impugned judgment confirmed applicability of section 14A of Act and Rule 8D of Rules but clarified that for computation of disallowance under Rule 8D, not gross interest payment but net interest payment would be considered. Against this judgment, Revenue has filed present appeal. 5. Facts on hand are not seriously in dispute. Upto stage of Tribunal, it has been concluded that assessee had made investments for earning income which did not form part of assessee's total income and that for disallowance under section 14A of Act, formula provided under Rule 8D was required to be invoked in present case. assessee had paid interest of Rs.7.01 crores on borrowings made and had also earned taxable interest to tune of Rs.6.83 crores from Inter Corporate Deposits and other similar investments. Short question is, for computation of disallowance under Rule 8D, should net figure of Rs.7.01 crores be reckoned as assessee's interest expenditure or difference between interest paid i.e. Rs.7.01 crores and interest received i.e. Rs.6.83 crores? Page 4 of 13 HC-NIC Page 4 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT 6. In this context, learned counsel Shri Bhatt for Revenue submitted that Rule 8D of Rules provide for complete formula for computing disallowance under section 14A of Act. Once this formula is invoked, there would thereafter be no possibility of any adjustment or tinkering with formula. He drew our attention to judgment of Supreme Court in case of Indian Molasses Co. Private Ltd. v. Commissioner of Income tax, West Bengal reported in 37 ITR 66 where term 'expenditure' came to be explained as under : But there is no case directly on what is expenditure , and if authorities under English statute were to be of real assistance, whole of matter should have been before us. question however limits approach to whether payments made towards policy were expenditure within clause(xv). Expenditure is equal to expense and expense is money laid out by calculation and intention though in many uses of word this element may not be present as when we speak of joke at another's expense. But idea of spending in sense of paying out or away money is primary meaning and it is with that meaning that we are concerned. Expenditure is thus what is paid out or away and is something which is gone irretrievably. Counsel further submitted that ignoring interest earned by assessee from interest expenditure for computation of disallowable expenditure in terms of Rule 8D, would distort formula provided in clause(ii) of sub rule(2) of Rule 8D and assessee would gain wholly unintended benefit. 7. On other hand, learned counsel Shri Soparkar for assessee opposed appeals contending that term Page 5 of 13 HC-NIC Page 5 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT 'interest expenditure' has to be understood in context of interest paid minus interest earned. This would be only reasonable way of interpreting term 'interest expenditure' used in section 14A of Act as well as Rule 8D of Rules. Counsel further submitted that in context of other provisions of Act, whenever question of exclusion of particular income for benefit of exemption or deduction came up for consideration, Courts have always viewed that it would be net income and not gross income which would be ignored for purpose of such benefit. In this context, counsel relied on decision of Supreme Court in case of ACG Associated Capsules Pvt. Ltd. v. Commissioner of Income tax reported in (2012) 343 ITR 89 (SC) in which for purpose of deduction under section 80HHC of Act, for ignoring interest or rent income, Supreme Court held that it would be net interest or net rent which alone would be ignored for purpose of computing deduction. Counsel pointed out that relying on said decision of Supreme Court in case of ACG Associated Capsules Pvt. Ltd.(supra), in case of Commissioner of Income tax v. Nirma Ltd. reported in (2014) 367 ITR 12(Guj), in context of deduction under sections 80 I, 80 IA and 80HH of Act while excluding income from sale of scrap, waste, etc., interest and other incomes, Court held that it would be net income which would be excluded and not gross income. Our attention was also drawn to judgment of Punjab and Haryana High Court in case of Commissioner of Income tax v. Hero Cycles Ltd. reported in (2010) 323 ITR 518 (P&H), in which it was held that when there was no nexus between Page 6 of 13 HC-NIC Page 6 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT expenditure incurred and exempt income generated, disallowance under section 14A of Act would not be permissible. 8. To resolve controversy, we may refer to statutory provisions applicable. Section 14A of Act, pertains to expenditure incurred in relation to income not includible in total income. Sub section (1) of section 14A provides that for purpose of computing total income under Chapter IV, no deduction shall be allowed in respect of expenditure incurred by assessee in relation to income which does not form part of total income. As per sub section(2) of section 14A, if Assessing Officer having regard to accounts of assessee, is not satisfied with correctness of of claim of assessee in respect of such expenditure, he would determine same in accordance with method as may be prescribed. Such method has been prescribed under Rule 8D which at relevant time read 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: Page 7 of 13 HC-NIC Page 7 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT (i) amount of expenditure directly relating to income which does not form part of total income; (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 A= 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 percent 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. 9. Sub rule(1) of Rule 8D substantially uses same language as is used in sub section(2) of section 14A and further provides that in such situation expenditure to be disallowed would be determined as per provisions contained in sub rule(2). expenditure in relation to income not forming part of total income would be aggregate of three computations provided in clauses (i), Page 8 of 13 HC-NIC Page 8 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT (ii) and (iii) of sub rule(2). Under clause (i) would come amount of expenditure directly relating to income which does not form part of total income. Clause(ii) provides for formula to be applied where assessee has incurred expenditure by way of interest during previous year which is not directly attributable to any particular income or receipt. Under clause(iii) ad hoc disallowance of amount equal to one half percent of average of value of investment not forming part of total income would be further disallowed in addition to those mentioned in clauses (i) and (ii) of sub rule(2) of Rule 8D. 10. Formula under clause(ii) of sub rule(2) of Rule 8D is X B/C, where 'A' represents amount of expenditure by way of interest other than amount of interest included in clause(i) incurred during previous year, 'B' represents average of value of investment, income from which does not form part of total income, as per balance sheet on first and last day of previous year and 'C' is average of total assets as per balance sheet again on first and last day of previous year. As per this formula therefore, interest expenditure to be disallowed would be total interest expenditure which is in proportion of assessee's average value of investment not forming part of total income to average total assets. legislature has therefore provided that whenever it is not possible to correlate with precision certain interest expenditure for purpose of earning income not forming part of total income, disallowance of such expenditure would be in proportion of assessee's average investment earning Page 9 of 13 HC-NIC Page 9 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT income not forming part of total income, to average value of assessee's total assets. 11. It is in this context that computation of factor 'A' in said formula assumes significance. In plain terms, 'A' represents amount of expenditure by way of interest ignoring interest expenditure already included in clause(i). expression used by legislature is amount of expenditure by way of interest . When legislature has therefore, used this expression amount of expenditure , said term shall have to be interpreted in manner that will bring about correct legislative intent and equitable application thereof. As in case on hand, when assessee pays interest on borrowings as also earns taxable interest on investments made by him during particular year, his interest expenditure has to be considered as one which is net of interest paid minus interest earned. Any other view would give unintended computation of factor 'A' provided in clause(ii) of sub rule(2) of Rule 8D which will in turn distort computation of disallowable expenditure under said clause. It is true that legislature has not given any further indication as to how such amount of expenditure would be ascertained. We would therefore have to apply reasonable test and interprete provision as is most likely to give effect to legislative intent for disallowance of expenditure by assessee for earning income which is not accountable to tax. It is true that investment made by assessee out of such borrowed funds will continue to be factored in denominator in formula provided in clause(ii) of sub rule(2) since factor 'C' which forms denominator refers Page 10 of 13 HC-NIC Page 10 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT to average of total assets of assessee as on first and last day of previous year. However, ignoring taxable interest earned by assessee for purpose of ascertaining amount of expenditure incurred by assessee by way of interest, would amount to distorting factor 'A' provided by legislature in clause(ii) of sub rule(2) of Rule 8D. It may be possible for variety of reasons that in given financial year assessee might have earned interest income which is higher than interest paid on borrowed funds. This may be because assessee's investments may have earned interest at rates higher than interest rate paid by assessee on borrowings or may also be because assessee's investment in earning interest may be higher in value than assessee's borrowings, inviting interest. In such situation, essentially, assessee would have earned more interest than interest paid. If we accept interpretation suggested by Revenue and apply formula by computing factor 'A' by taking into account interest paid ignoring interest earned, there would be disallowance under this formula even if in net result, assessee may have not paid any interest on borrowings. 12. Significantly Rule refers to interest expenditure and not interest paid. Expenditure in present context must mean interest paid minus taxable interest earned. In case of ACG Associated Capsules Pvt. Ltd.(supra), Supreme Court while considering ignorable portion of interest, rent etc. for computation of deduction under section 80HHC of Act had held and observed as under : Page 11 of 13 HC-NIC Page 11 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT 12.If we now apply Explanation (baa) as interpreted by us in this judgment to facts of case before us, if rent or interest is receipt chargeable as profits and gains of business and chargeable to tax under Section 28 of Act, and if any quantum of rent or interest of assessee is allowable as expense in accordance with Sections 30 to 44D of Act and is not to be included in profits of business of assessee as computed under head "Profits and Gains of Business or Profession", ninety per cent of such quantum of receipt of rent or interest will not be deducted under clause (1) of Explanation (baa) to Section 80HHC. In other words, ninety per cent of not gross rent or gross interest but only net interest or net rent, which has been included in profits of business of assessee as computed under head "Profits and Gains of Business or Profession", is to be deducted under clause (1) of Explanation (baa) to Section 80HHC for determining profits of business. 13. In case of Nirma Ltd.(supra), Division Bench of this Court in context of excluding income for deduction under sections 80 I, 80 IA and 80HH, relying upon and referring to decision of Supreme Court in case of ACG Associated Capsules Pvt. Ltd.(supra) held that it would be net profit which would be excluded from claim of deduction and not Gross Profit that is Gross Profit minus expenditure incurred for earning such profit which would be excluded. 14. While answering question in favour of assessee, we hold that for purpose of applying factors contained in clause(ii) of sub rule(2) of Rule 8D, prior to its amendment with effect from 2.6.2016, what Page 12 of 13 HC-NIC Page 12 of 13 Created On Wed Sep 06 09:56:27 IST 2017 O/TAXAP/409/2017 JUDGMENT would be considered as amount of expenditure by way of interest would be interest paid by assessee on borrowings minus taxable interest earned during financial year. 15. Tax appeals are dismissed accordingly. (AKIL KURESHI, J.) (BIREN VAISHNAV, J.) raghu Page 13 of 13 HC-NIC Page 13 of 13 Created On Wed Sep 06 09:56:27 IST 2017 Principal Commissioner of Income-tax-3 v. Nirma Credit and Capital Pvt. Ltd