Summary of points to be discussed on Disallowance u/s. 14A read with. Rule 8D & Discussion on Daga Capital Judgment of Mumbai ITAT
1. Section 14A inserted on 01/04/2001; retrospectively from 01/04/1962.
• Applicable to all pending Assessments and Appeals.
• AO cannot reopen Completed Cases, Notice cannot be issued u/s 147/148.
2. Sub – sections (2) and (3) to Section inserted on 01/04/2006 Whether Retrospective?
3. Rule 8D was notified on 24/03/2008. Silent on the date / the assessment year applicability. Whether Retrospective?
• Whether applicable to all pending Assessments ?
• Applicable to Returns filed after 24th March 2008 ?
• Effect on all Pending Appeals.
4. Importance of Rule 8D (1) to avoid harsh provisions of Rule 8D (2).
• If the AO is NOT satisfied with the method of calculating the Disallowance u/s Section 14A, only then he has to calculate u/s 8D(2). In other words make sure that the AO accepts your method to avoid Rule 8D(2).
5. Working of Disallowance amount under Rule 8D and Interpretation of various terms used in Rule 8D(2).
a) amount to be disallowed under Rule 8D(2) is the aggregate of the following :
i) Direct Expenses
ii) Interest * Average Investments/Total Average Asset
iii) 0.5% of Average Investments.
b) Various Terminologies used in Rule 8D.
• The Expenditure in relation to Income which does not from part of total income. (Total Income may include Income which is Taxable and exempt from Tax).
i. Partly taxable i.e. Trading and partly Exempt i.e. Dividend income in the case of Trading Companies.
ii. Partly taxable STCG in the next assessment year and/or LTCG on UN-QUOTED shares, where income is not exempt.
• Interest (whether Gross or Net).
i) For Net interest, the nature of interest income, i.e. interest income should be business income & not from Other Source.
ii) Requirements of Schedule VI that any item which is more than 5 % should be shown separately in Profit & Loss account.
i) Whether stock – in – trade included?
ii) Can you deduct Un-Quoted shares?
iii) Can you deduct shares on which STCG is earned next year?
• Total Asset.
i) Whether Intangible assets to be included?
ii) Whether Preliminary Expenses etc. to be included?
iii) Whether Deferred Tax Asset to be included?
iv)Income Tax not to be deducted as there will be corresponding Provision for Taxation on Liability side.
It is BETTER for the assessee to have Denominator at Higher amount, for the calculation of Investment to Total Asset.
6. Discussion on Special Bench ITAT judgment in the case of Daga Capital Management Private Ltd.
• WORST for the assessee in all respect:-
i)Rule 8D held to be Retrospective.
ii)Investment includes Stock in Trade.
iii)It had only Interest paid.
7. Five member Special Bench – Redundant as the matter is in Mumbai High Court. All Appeals before the Mumbai ITAT Blocked.
8. Discussion on the following RECENT JUDGEMENTS pronounced after Notification of Rule 8D and after Daga Capital Judgment:-
a) ITAT Mumbai in the cases of ACIT vs. Indexport Ltd. and DCIT vs Citizen Hotels held that :
Section 14A and Daga Capital can not put assessee in worse position. In other words section 14A disallowance under Rule 8D can not exceed original disallowance made at the time of assessment.
b) Delhi Tribunal has held that disallowance can be more than Dividend or Exempt Income.
c) ITAT Delhi Special Bench in the case of Cheminvest Ltd vs ITO has held that section 14A disallowance has to be made even if assessee has NO TAX FREE INCOME.
d) The recent judgment of P & H High Court in the case of CIT vs Hero Cycles held that : Even under rule 8D of section 14A, disallowance can be made only if there is actual nexus between tax free income and expenditure.
9. Various methods to calculate Disallowance u/s. 14A which can be accepted by the A. O. under Rule 8 D (1).
• Proportionate method for the Trading companies where % of Exempt Income to Total Income is Disallowed out of Interest / Total Expenses.
• Direct Nexus method for assesses having taxable business income & Exempt income, wherein the assessee shows the Nexus of Borrowed to its utilization.
• Show that Investment is out of Net Owned Fund so that entire interest is allowed as deduction & no amount is apportioned against Exempt income.
• Working based on Daga Capital with Net Interest and also with only Investment & not stock in trade while calculating amount of Average Investments. From Investment, the assessee can deduct Un-Quoted shares and Quoted shares on which STCG is earned in the Next Year as it will give rise to Taxable Income.
10. Penalty u/s. 271(1) (C ) for concealment.
• Position prior to Rule 8D, No penalty.
• Position after Rule 8D, the assessee has to disallow some amount voluntarily to avoid Penalty u/s 271(1)(C) for Concealment.
11. Applicability of section 148 or 263, if the A.O. has not followed Rule 8D(2) or Daga Capital.
• Different methods are available, if the AO has adopted one method, the Commissioner cannot set aside the Order u/s 263 just because other method would have resulted in higher Disallowance.
• Rule 8D (1) also allows the AO to accept the method of the assessee. In any method accepted by the AO, it is Deemed to have been covered u/rule 8D (2).
12. Submission to be kept on record during the assessment proceedings:-
• If the AO is not accepting your method, file all the methods so that any of your methods can be accepted after the Judgment of Mumbai High Court is announced in future.
• If the AO is accepting your method, file the working only for that method. If working of different other methods are on record, audit objection and may tempt the Commissioner for 263.
13. Tax Audit Reporting in Form in 3 CD:-
• Before Rule 8D, the Best way was to claim disclaimer that “ in the absence of the Prescribed method, it is not possible to Quantify the amount.”
• After Rule 8D, the Auditor has to be very Specific and Clear in Reporting.
• Any calculation is not binding on the Dept. and the assessee as well. However, any negative remark, the AO will rely on that working or the remark.
14. Applicability on Companies paying tax under Section 115 JB.
• As Dividend is not considered as income for determining Book Profit u/s 115 JB, corresponding expense has to be considered.
• LTCG is considered as income for Book Profit u/s 115 JB, hence no expense to be considered for Disallowance.
15. Individual who is Proprietor and also having share of profit from the Firm which is Exempt; Whether Section 14 A is applicable ?
• Held by Mumbai ITAT, No. the Partner is different entity from the Firm and expenses incurred in the Proprietary concern is for earning taxable income and no portion can be apportioned or allocated against tax free income of the Partnership firm.
16. For a small Tax Planning, Sale of shares and Units on 31st March to avoid 0.5 % Disallowance under Rule 8D(2)(iii).
17. Dividend covered u/s.94(7) whether considered to be Exempt u/s.10(34) or not while calculating disallowance u/s.14A r.w. Rule 8D.
• Dividend covered u/s.94(7) is Taxable as either Capital Gain or Business Income and not under the head Income from Other Sources.
• Once Dividend Distribution Tax is paid u/s.115-O, Dividend is Exempt u/s.10(34) in all cases irrespective of 94(7).
• Hence entire Dividend continues to be Exempt for calculating disallowance u/s.14A r.w. Rule 8D.