Case Law Details
Bombay HC held Rule 8D r.w. S. 14A (2) is not arbitrary or unreasonable and Rule 8D is not retrospective and applies from AY 2008-09, for earlier dis allowance can be worked on reasonable basis
Godrej & Boyce Vs. DCIT (Bombay High Court)
The decision in Godrej & Boyce v. DCIT, has not provided as much of a reprieve to assessees as would have been hoped- only holding that the dubious Rule 8D of the Income Tax Rules is to be applied prospectively, while upholding its constitutionality and that of section 14A of the Income Tax Act.
The case before the Court involved a typical scenario in which section 14A is usually invoked. Section 14A provides that in computing the total income of an assessee, no deduction shall be allowed in respect of expenditure incurred in relation to income which does not form a part of the total income under the Act. This expenditure can be that claimed by the assessee; or if the Assessing Officer is not satisfied with the claim made, such expenditure as the AO may compute in accordance with Rule 8D of the Rules (introduced w.e.f. March 2008). The assessee here had earned dividend income, which is exempt under the Act; and contended that no expenditure had been incurred in relation to that income. However, the AO differed and held made a disallowance of `6.92 crore, which was overturned in appeal by the Commissioner (Appeals). However, on appeal by the Revenue before the ITAT, it was held following Daga Capital, that Rule 8D had retrospective effect, and also applied to assessment year 2002-03, which was under consideration. On this ground, the matter was remanded back to the AO for a fresh consideration in light of section 14A(2) and Rule 8D. It was against this remand that the assessee appealed to the High Court, which clubbed with it a writ petition challenging the vires of section 14A and Rule 8D.
The Court formulated three questions for its consideration, answering two of them in favour of the Revenue, and the third in favour of the assessee-
(a) Can dividend income be considered to be income ‘not includible in total income’, for the purposes of section 14A?
(b) Do section 14A(2) and (3), and Rule 8D pass Constitutional muster?
(c) Can Rule 8D be applied with retrospective effect?
Bombay High Court held as under
(1) The argument that dividend on shares / units is not tax-free in view of the dividend-distribution tax paid by the payer u/s 115-O is not acceptable because such tax is not paid on behalf of the shareholder but is paid in respect of the payer’s own liability;
(2) S. 14A supersedes the principle of law that in the case of a composite business expenditure incurred towards tax-free income could not be disallowed and incorporates an implicit theory of apportionment of expenditure between taxable and non-taxable income. Once a proximate cause for dis allowance is established – which is the relationship of the expenditure with income which does not form part of the total income – a dis allowance u/s 14A has to be effected;
(3) The argument that a literal interpretation of s. 14A leads to absurd consequences is not acceptable. S 14A is founded on a valid rationale that the basic principle of taxation is to tax net income i.e gross income minus expenditure;
(4) The argument that the method in Rule 8D r.w.s 14A (2) for determining expenditure relating to the tax-free income is arbitrary and violative of Article 14 is not acceptable because there is an adequate safeguard before Rule 8D can be invoked. The AO cannot ipso facto apply Rule 8D but can do so only where he records satisfaction on an objective basis that the assessee is unable to establish the correctness of its claim. Also a uniform method prescribed to resolve disputes between assessees and the department cannot be said to be arbitrary or oppressive. There is a rationale in Rule 8D and its method is “fair & reasonable”. It cannot be said that there is “madness” in the method of Rule 8D so as to render it unconstitutional;
(5) Rule 8D, inserted w.e.f 24.3.2008 cannot be regarded as retrospective because it enacts an artificial method of estimating expenditure relatable to tax-free income. It applies w.e.f AY 2008-09;
(6) For the AYs where Rule 8D does not apply, the AO will have to determine the quantum of disallowable expenditure by a reasonable method having regard to all facts and circumstances;
(7) On facts, though in the earlier years, the Tribunal had held that the tax-free investments had been made out of the assessee’s own funds, this did not mean that there was no expenditure incurred to earn tax-free income. Even though Rule 8D did not apply to AY 02-03, the AO had to consider whether dis allowance could be made u/s 14A (1). Also, the principle of consistency would not apply as s. 14A had introduced a material change in the law.
