Sub-sections (2) and (3) of sec. 14A and Rule 8D are constitutionally valid

Brief: Bombay High Court rules on prospective operation of Rule 8D and upholds the constitutional validity of sub-sections (2) and (3) of section 14A and Rule 8D.

Citation: Godrej & Boyce Mfg. Co. Ltd. Vs. DCIT (Bombay High Court), ITA No. 626/2010 and W.P. 758/2010 dated 12 August 2010

Facts: – The assessee filed its return of income for the Assessment Year (AY) 2002- 03 claiming exemption under section 10(33) (See Note-1 below) of the Income tax Act, 1961 (ITA) in respect of gross dividend earned on shares and units.

In the scrutiny proceedings, the assessee contended that it had not incurred any expenditure for earning the dividend income. The Assessing Officer (AO) rejected the claim of the assessee and disallowed certain expenses as being attributable towards earning dividend income. The Commissioner of Income-tax (Appeals) deleted the dis allowance.

The Tribunal following its judgment in the case of Daga Capital Management Private Limited (See Note-2 below) , held that the provisions of sub-sections (2) and (3) of section 14A (See Note-3below) of the ITA are procedural in nature and have retrospective effect. The Tribunal directed the AO to examine the issue afresh in the light of the specific provisions contained under sub-section (2) of section 14A and Rule 8D of the Income-tax Rules, 1962 (Rules).

The assessee filed an appeal against the decision of the Tribunal to the High Court.

Issues before the High Court

The following substantial questions of law were raised before the High Court:

• · Whether the Tribunal ought to have held that no dis allowance could be made under section 14A of the ITA?
• · Whether the Tribunal erred in directing the AO to apply Rule 8D for computing the amount of dis allowance under section 14A?
• · In addition, the assessee filed a Writ Petition challenging the constitutional validity of the provisions of section 14A and Rule 8D.

Contentions of the taxpayer

· Section 14A can be invoked if the income is exempt from tax. The dividend received cannot be regarded as exempt as it has been subjected to dividend distribution tax under section 115-O of the ITA.

· The provisions of sub-sections (2) and (3) of section 14A inserted w.e.f. 1 April 2007 and Rule 8D inserted w.e.f. 24 March 2008 are not procedural in nature since they determine the income chargeable to tax. The provisions are prospective and hence do not apply to the AY 2002-03.

· Sub-sections (2) and (3) of section 14A and Rule 8D are arbitrary and violative of Article 14 of the Constitution since they provide for a uniform rule for determining the expenditure and treat unequals alike. A literal interpretation of these provisions would result in unintended consequences and must be disregarded since the amount computed under the Rule can exceed the total expenditure incurred by the assessee.

Contentions of the Revenue

· Section 14A and Rule 8D apply to dividend income since it is exempt in the hands of the recipient.

· Rule 8D provides for a rational, fair and reasonable method for computing the expenditure and there is no perversity or capriciousness that would be violative of Article 14 of the Constitution.

· The provisions of sub-section (2) of section 14A and Rule 8D are procedural since they provide a machinery for implementation of the principle of apportionment and being curative and declaratory of the intention of the legislature, are retrospective in operation.

Observations and ruling of the High Court

Scope of section 14A and Rule 8D

· Section 14A widens the theory of apportionment of expenditure. As a result thereof, even in the case of a composite and indivisible business, which results in the earning of taxable and non-taxable income, it would be necessary to apportion the expenditure incurred by the assessee.

· The object of sub-section (2) of section 14A is to provide a uniform method where the AO is, on the basis of the accounts of the assessee, not satisfied with the correctness of the claim of the assessee in respect of expenditure in relation to income which does not form part of total income under the ITA. The provision does not ipso facto enable the AO to apply the method prescribed by Rule 8D without considering whether the claim made by the assessee is correct. The satisfaction by the AO should be on an objective basis, having regard to the accounts of the assessee. An objective satisfaction contemplates the issue of a notice by the AO, provision of sufficient opportunity for placing on record all relevant facts including accounts and the recording of reasons by the AO in the event that he comes to the conclusion that he is not satisfied with the claim of the assessee.

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