Rule 8D was not applicable in A.Y. 2006-07 for making disallowance U/s. 14A

ITAT MUMBAI BENCH ‘G’

Great Eastern Shipping Co. Ltd.

Versus

Additional Commissioner of Income-tax

IT Appeal Nos. 4507 & 4992 (Mum.) of 2011

SEPTEMBER 14, 2012

ORDER

P.M. Jagtap, Accountant Member.

These two appeals being I.T.A. No. 4507/Mum/2011 and I. T. A. No. 4992/Mum/2011 are cross-appeals which are directed against the order of the learned Commissioner of Income-tax (Appeals)-9, Mumbai dated March 15, 2011. First we shall take up the appeal of the Revenue being I.T.A. No. 4992/Mum/2011.

2. In the solitary ground as originally raised in this appeal, the Revenue has challenged the action of the learned Commissioner of Income-tax (Appeals) in directing the Assessing Officer to allow the interest expenses of Rs. 4,52,82,241.

3. The assessee in the present case is a company which is engaged in the business of shipping, property development and finance. The return of income for the year under consideration was filed by it on November 21, 2006 declaring total income of Rs. 71,06,56,632 and book profit of Rs.303,33,26,270 under section 115J. In the said return, interest expenditure to the extent of Rs. 11,32,79,905 was claimed by the assessee as deduction against income from non-tonnage activities. During the course of assessment proceedings, the assessee was called upon by the Assessing Officer to furnish a fund flow statement, details of the loans taken and the interest expenditure incurred on such loans. The assessee vide its letter dated December 5, 2008 furnished the details required by the Assessing Officer including particulars of loan-wise interest expenditure incurred, the purpose for which the loan was availed of the rate and amount of interest paid and the reasons for treating such interest expenditure as part of the non-tonnage activities. On verification of these details furnished by the assessee, the Assessing Officer was of the opinion that out of interest expenditure of Rs. 11,32,79,905 claimed by the assessee as deduction against the income from non-tonnage activities, an amount of Rs. 4,52,88,241 was attributable to tonnage activities, i.e., shipping of the assessee- company. The reasons given by him for coming to this conclusion are extracted below from pages 3 and 4 of the assessment order :

4. For the reasons given above, the Assessing Officer came to the conclusion that interest attributable to various non-tonnage activities of the assessee- company was only to the extent of Rs. 6,79,97,654 and not Rs. 11,32,79,905 as claimed by the assessee. Accordingly, he held that the assessee was entitled to claim deduction on account of interest expenditure against the income from non-tonnage activities only to the extent of Rs. 6,79,97,654 and disallowed the balance amount of Rs. 4,52,84,241 claimed by the assessee on this issue in the assessment completed under section 143(3) vide an order dated December 31, 2008.

5. Against the order passed by the Assessing Officer under section 143(3), an appeal was preferred by the assessee before the learned Commissioner of Income-tax (Appeals) and various submissions were made on behalf of the assessee in support of its case on this issue before the learned Commissioner of Income-tax (Appeals) which as summarized by the latter in his impugned order, are extracted below :

(a) The statement giving the complete details of the loans utilized for non-tonnage tax activities, giving the details of each individual loan amount outstanding, the purpose for which the loan was availed, the rate of interest, the amount of interest paid and the reasons for treating such interest expenditure as part of the non-tonnage tax activities of the appellant, were furnished.

(b) Further thereto, during the course of assessment proceedings, the complete utilization of each and every such loan towards the non-tonnage tax activities was also explained and the annual loan utilization statements for each such loan were explained to the Assessing Officer. The day-wise loan utilization statements for investments were also produced before the Assessing Officer and it was explained that the interest claimed against the non-tonnage tax activities, was on the basis of the actual loan utilization towards such activities. The aforesaid statements were also furnished during the course of the appellate proceedings and the utilization of such loans by way of investments in mutual funds and bank deposits was duly explained. It was also explained that such interest expenditure was therefore also considered for the purposes of computing the dis allowance under section 14A of the Act.

(c) It was explained that there are instances where a loan transaction is finalized and the loan is disbursed, but such funds are not immediately required for tonnage activities. Thus, such funds are utilized for non-tonnage tax activities and consequent thereto, the interest expenditure for such funds, forms part of the non-tonnage tax activities of the appellant.

(d) It was further explained that there were also cases where loans were availed of and invested in ships in earlier years. Such ships were sold during the year or preceding year. The funds so realized on sale of ships were invested into deposits and mutual funds. The loans against such ships had remained partly unpaid and were due for repayment over the loan repayment period. Consequent thereto, the interest expenditure on such loans from the date on which the sale proceeds were invested into deposits and mutual funds has been considered as part of the non-tonnage tax business of the appellant-company, since the loan funds were used for non-tonnage activities. In fact, the company could have used such sale proceeds and repaid the loan immediately incurring prepayment charges and other finance costs, causing a loss to the company. It has on the other hand used these funds to generate additional income and has claimed the interest expenses attributable to earning such income accordingly.

(e) If the Assessing Officer was not satisfied with the details furnished, she should have informed the appellant accordingly and any further details to substantiate the claim of the appellant would have been furnished.

6. On the basis of the above submissions, it was contended on behalf of the assessee before the learned Commissioner of Income-tax (Appeals) that interest expenditure against income from non-tonnage activities was claimed on actual basis and it was not a case of allocation of interest expenditure between tonnage and non-tonnage activities. It was contended that actual utilization of borrowed funds was taken into account while claiming such interest expenditure and there was no justification in the dis allowance made by the Assessing Officer out of such interest expenditure.

7. The learned Commissioner of Income-tax (Appeals) found merit in the submissions made on behalf of the assessee on this issue and deleted the dis allowance made by the Assessing Officer out of interest expenditure for the following reasons given in paragraph 2.8 of his impugned order :

“I have carefully considered the facts of the case. The appellant has furnished complete details of the loans utilised for non-tonnage tax activities, the loan amount outstanding, the purpose for which the loan was availed, the rate of interest, the amount of interest paid and the reasons for treating such interest expenditure as part of the non-tonnage tax activities. The complete utilization of each and every such loan towards the non-tonnage tax activities was also explained and the annual loan utilization statements for investments have also been furnished and it was explained that the interest claimed against the non-tonnage tax activities, was on the basis of the actual loan utilization towards such activities. It is apparent that the loan funds have been utilized for investments in bank deposits and other investments. Such funds have not been utilized for tonnage tax activities. The commercial rationale for treating such funds as part of the non-tonnage tax business was also explained. The Assessing Officer has also stated that the loans which were availed of for ship related activities have been diverted to non-tonnage tax activities. If that is so, the interest expenditure on such loans would have to be treated as non-tonnage tax expenditure and cannot be attributed to the tonnage tax business of the appellant-company. The expenditure incurred for earning such income has to be allowed against such income. In view of the above, the Assessing Officer’s action of attributing interest expenditure to the tonnage income of the appellant is erroneous and contrary to the facts on record and such interest expenditure aggregating to Rs. 4.53 crores is to be treated as part of the non-tonnage tax business of the appellant-company.”

8. We have heard the arguments of both sides and also perused the relevant material on record. It is observed that complete details of the loans utilized for non-tonnage tax activities were furnished by the assessee before the learned Commissioner of Income-tax (Appeals) and on examination of these details, it was found by the learned Commissioner of Income-tax (Appeals) that interest expenditure to the extent of Rs. 11,32,79,905 was incurred by the assessee wholly and exclusively for the purpose of its non-tonnage tax activities. At the time of hearing before us, learned counsel for the assessee has also taken us through the relevant details furnished on record by the assessee to show that the finding recorded by the learned Commissioner of Income-tax (Appeals) in this regard on verification of actual utilisation of loan is factually correct. The learned Departmental representative, on the other hand, has not been able to raise any contention to dispute or controvert the said finding of fact recorded by the learned Commissioner of Income-tax (Appeals) and has simply relied on the order of the Assessing Officer in support of the Revenue’s case on this issue.

Further, as noted by the learned Commissioner of Income-tax (Appeals) in his impugned order, the Assessing Officer himself has stated in the assessment order that the loans availed of by the assessee for shipping activities had been diverted to non-tonnage tax activities. As rightly held by the learned Commissioner of Income-tax (Appeals), if this was the position as admitted by the Assessing Officer himself, interest expenditure incurred on such loans should be treated as incurred for the purpose of non-tonnage tax activities as claimed by the assessee. As such, considering all the facts of the case, we find no infirmity in the impugned order of the learned Commissioner of Income-tax (Appeals) deleting the disallowance of Rs. 4.35 crores made by the Assessing Officer out of interest expenditure after having found on verification of the relevant details that the said interest expenditure was incurred wholly and exclusively for the purpose of non-tonnage tax activities. The impugned order of the learned Commissioner of Income-tax (Appeals) giving relief to the assessee on this issue is accordingly upheld and the ground as raised originally by the Revenue in this appeal is dismissed.

9. During the course of the appellate proceedings before the Tribunal, the Revenue has raised the following additional ground :

“Whether, on the facts and circumstances and in law, the learned Commissioner of Income-tax (Appeals) erred in computing the dis allowance under section 14A/rule 8D at Rs. 5,98,139 as against Rs. 1,30,41,628 computed by the Assessing Officer and further holding that rule 8D provisions are not applicable for the year for the purpose to compute dis allowance under section 14A of the Income-tax Act, 1961.”

10. During the year under consideration, the assessee- company had earned total dividend income of Rs. 8,58,27,056 out of which a sum of Rs. 8,42,59,363 was claimed as exempt under section 10(34) of the Act. In the computation of total income, a dis allowance of Rs. 1,42,35,303 was suomotu made by the assessee under section 14A being the expenditure incurred in relation to earning of exempt dividend income. The working furnished by the assessee to arrive at the said figure of Rs. 1,42,35,303 was not according to rule 8D of the Income-tax Rules which, according to the Assessing Officer, was applicable to the year under consideration. He, therefore, recomputed the dis allowance of expenses to be made under section 14A applying the said rule 8D at Rs. 1,48,33,441 which resulted in additional dis allowance of Rs. 5,98,139 under section 14A.

11. The additional dis allowance of Rs. 5,98,139 made by the Assessing Officer under section 14A was disputed by the assessee in the appeal filed before the learned Commissioner of Income-tax (Appeals) and the following submissions were made on behalf of the assessee before the learned Commissioner of Income-tax (Appeals) in support of its case on this issue :

“(a) The aggregate administrative and other expenditure incurred by the treasury department of the appellant, which was managing the investment activities of the company, was Rs. 69.58 lakhs. Such expenses consisted of staff costs of Rs. 45.56 lakhs and other administrative costs of Rs. 24.02 lakhs, which amounts were also duly reconciled with the division-wise profit and loss account.

(b) Such aggregate administrative costs were apportioned in the ratio of tax-free to taxable investment income earned by the company. As per the extract of the tax audit report furnished, the taxable interest and dividend income earned amounted to Rs. 6274.37 lakhs and the tax-free dividend income amounted to Rs. 842.59 lakhs, both aggregating to Rs. 7116.96 lakhs. Based thereon, the proportion as computed by the appellant was that 11.84 per cent. of the treasury receipts pertained to tax-free receipts and 88.16 per cent. pertained to taxable receipts of the appellant. Consequent thereto, the administrative and interest expenses were attributed in such proportion while computing the dis allowance under section 14A of the Act.

(c) The Assessing Officer has, while determining the amount liable for dis allowance under clause 2(i) of rule 8D, considered the aggregate expenditure incurred by the treasury department at Rs. 69.58 lakhs and has disallowed the same as incurred only for earning tax-free dividend income.

(d) This implies that the said treasury division has carried out activities only for earning dividend income (tax-free income) and there is no expenditure incurred for earning any taxable income.

(e) Thereafter, the Assessing Officer has once again disallowed a further amount under clause 2(iii) of rule 8D, being the amount computed at 0.5 per cent. of the average investments held by the appellant. Hence, a further ad hoc amount of Rs. 60.83 lakhs has been disallowed by the Assessing Officer under the said sub-clause.

Consequently, as against the actual aggregate administrative and other expenditure of Rs. 69.58 lakhs incurred by the treasury division of the appellant-company, the Assessing Officer has disallowed expenditure aggregating to Rs. 130.41 lakhs under clause 2(i) and clause 2(iii) of rule 8D.”

12. Keeping in view the above submissions and relying on the decision of the Honorable Bombay High Court in the case of Godrej and Boyce Mfg. Co. Ltd. v. Dy. CIT [2010] 328 ITR 81wherein it was held that the provisions of rule 8D are applicable only from the assessment year 2008-09, the assessee submitted before the learned Commissioner of Income-tax (Appeals) that the additional dis allowance made by the Assessing Officer under section 14A is not sustainable.

13. The learned Commissioner of Income-tax (Appeals) found merit in the submissions made on behalf of the assessee on this issue and deleted the additional dis-allowance of Rs. 5,98,139 made by the Assessing Officer for the following reasons given in paragraphs 4.7 and 4.8 of his impugned order :

“4.7 I have carefully considered the facts of the case. Based on the factual matrix of the case, the issue in dispute is regarding the attribution of administrative expenditure to the earning of dividend income. The point to be noted is that the appellant-company had disallowed an amount of Rs. 142.35 lakhs while filing the return of income. This consisted of interest expenditure of Rs. 134.11 lakhs and administrative expenditure of Rs. 8.24 lakhs. The Assessing Officer has while relying on the provisions of rule 8D disallowed interest expenses of Rs. 17.91 lakhs and administrative expenses of Rs. 130.42 lakhs, both aggregating to Rs. 148.33 lakhs. Hence, the Assessing Officer has reduced the dis allowance on account of interest expenditure by relying on the provisions of rule 8D and the appellant has not filed any appeal against this dis allowance. However, as against an amount of Rs. 8.24 lakhs disallowed by the appellant on account of administrative expenses attributable to earning exempt income, the Assessing Officer has disallowed an amount of Rs. 130.42 lakhs. Based on the submissions of the appellant, the total administrative expenses incurred by the treasury department during the year are only Rs. 69.58 lakhs. Hence, the question of disallowing expenditure in excess of that incurred cannot arise. Thus, the total administrative expenditure that could possibly be disallowed cannot exceed Rs. 69.58 lakhs. Further, the interest expenditure disallowed by the Assessing Officer is only Rs. 17.91 lakhs. Hence, even if the provisions of rule 8D were relied upon, the total dis allowance computed under the said rule 8D works out to Rs. 87.49 lakhs.

4.8 However, as held by the Bombay High Court in the case of Godrej and Boyce Mfg. Co. Ltd. [2010] 328 ITR 81 (Bom) referred to above, the provisions of rule 8D are applicable from the assessment year 2008-09 and cannot be applied retrospectively and are not applicable to the current assessment year. Hence, the method of computing the dis allowance under rule 8D as adopted by the Assessing Officer cannot be sustained and the dis-allowance computed by the Assessing Officer on this basis is therefore deleted. The appellant-company has adopted a reasonable basis by computing the dis allowance under section 14A by considering the administrative and interest expenditure and allocating the aggregate expenditure in the proportion of exempt receipts to the total receipts earned by the company on the investment activities. In this manner, all the expenses are allocated to both streams of income in an equitable manner based on the gross receipts of the said investment activities for the year under consideration. Based on this method, the dis allowance under section 14A has been computed by the appellant, whereby interest expenditure of Rs. 134.12 lakhs has been disallowed and the total dis allowance is computed at Rs. 142.36 lakhs. The interest expenditure disallowed by the appellant is therefore restored and the administrative expenses disallowed by the appellant are upheld. The said dis allowance computed by the appellant-company under section 14A, while filing the return of income is therefore upheld and these grounds of appeal are therefore disposed of accordingly and partly allowed.”

14. We have heard the arguments of both sides and also perused the relevant material on record. As rightly submitted by learned counsel for the assessee, the impugned order of the learned Commissioner of Income-tax (Appeals) is well reasoned and well discussed on this issue and the same is self explanatory as regards the reasons given by him for deleting the additional dis allowance of Rs. 5,98,139 made by the Assessing Officer under section 14A. As held by him relying on the decision of the hon’ble Bombay High Court in the case of Godrej and Boyce Mfg. Co. Ltd. (supra), rule 8D applied by the Assessing Officer to work out the dis allowance under section 14A was not applicable to the year under consideration. The said dis allowance for the year under consideration, therefore, was required to be worked out on some reasonable basis as held by the Honorable Bombay High Court in the case of Godrej and Boyce Mfg. Co. Ltd. (supra) and since the working furnished by the assessee for making the dis allowance under section 14A was fair and reasonable as found by the learned Commissioner of Income-tax (Appeals), we are of the view that the additional dis-allowance made by the Assessing Officer under section 14A by applying rule 8D is rightly deleted by the learned Commissioner of Income-tax (Appeals). At the time of hearing before us, the learned Departmental representative has not been able to controvert or rebut the finding given by the learned Commissioner of Income-tax (Appeals) while deciding this issue in favour of the assessee and has simply relied on the order of the Assessing Officer in support of the Revenue’s case on this issue. We, therefore, find no infirmity in the impugned order of the learned Commissioner of Income-tax (Appeals) giving relief to the assessee on this issue and upholding the same, we dismiss the additional ground raised by the Revenue.

15. Now, we shall take up the appeal of the assessee wherein the following grounds are raised :

(1) The learned Commissioner of Income-tax (Appeals) erred in partly conforming the action of the Assessing Officer in disallowing the contribution paid by the appellant-company towards the major repair fund aggregating to Rs. 1,89,975. Having regard to the facts and circumstances of the case, the appellant submits that the disallowance is unwarranted and requires to be deleted.

(2) The learned Commissioner of Income-tax (Appeals) erred in conforming the action of the Assessing Officer in excluding the bad debts recovered of Rs. 1,30,116 and crude oil refund of Rs. 4,80,262 from the tonnage income of the appellant. Having regard to the facts and circumstances of the case, the appellant submits that the said items are to be treated as forming part of the tonnage income as claimed by the appellant in its return of income.

(3) The learned Commissioner of Income-tax (Appeals) erred in conforming the action of the Assessing Officer in excluding general average claims received aggregating to Rs. 1,43,58,796 from the tonnage income of the appellant. Having regard to the facts and circumstances of the case, the appellant submits that the said items are to be treated as forming part of the tonnage income as claimed by the appellant in its return of income.

(4) The learned Commissioner of Income-tax (Appeals) erred in conforming the action of the Assessing Officer in excluding liabilities of prior periods written back aggregating to Rs. 1,84,22,235 from the tonnage income of the appellant. Having regard to the facts and circumstances of the case, the appellant submits that the said items are to be treated as forming part of the tonnage income as claimed by the appellant in its return of income.

16. At the time of hearing before us, learned counsel for the assessee has not pressed ground No. 1. The same is accordingly dismissed as not pressed.

17. As submitted by learned counsel for the assessee and remained uncontroverted/unrebutted by the by the learned Departmental representative who has simply relied on the order of the Assessing Officer in support of the Revenue’s case, the issues raised in ground Nos. 2, 3 and 4 of the assessee’s appeal are squarely covered in favour of the assessee by the decision of co-ordinate Bench of this Tribunal in the case of Shipping Corpn. of India Ltd. v. Addl. CIT [2011] 133 ITD 290 rendered vide its order dated July 29, 2011, passed in I. T. A. No. 145/Mum/2011. A copy of the said order is placed on record before us and perusal of the same shows that similar issues involved in the case of Shipping Corpn. of India Ltd. (supra) have been decided by the Tribunal in favour of the assessee wherein after identifying the issues and referring to the relevant provisions of the Act laying down the tonnage tax scheme, the Tribunal has given its findings/decision in paragraphs 29 and 30 which read as under (pages 347 and 348) :

“29. The provisions of section 115VA provides that the income from business of operating qualifying ships may be computed in accordance with the provisions of Chapter XII-G, and that the income so computed shall be deemed to be the profits and income from qualifying ships are defined in section 115VC, and there is no dispute on this aspect. Section 115VE mandates that profits from the business of a company engaged in the business of operating qualifying ships shall be computed under the tonnage tax scheme. It also specifies that such business of operating qualifying ships shall be considered as a separate business distinct from all other activities or business carried on by the company. The mode of computation of tonnage income is given under section 115VG. The term ‘relevant shipping income’ has been defined in section 115VI. It is basically classified into two categories, i.e., profits from core activities referred to in sub-section (2) and profits from incidental activity referred to in sub-section (5). The issue is, whether the income by way of right back of the provisions of sundry credit balances and prior period expenses can be considered as income from core activities of a tonnage tax company. In our opinion, write back of these items is to be considered as income from core activity. In a going concern, such write backs and making of supplementary provisions takes place. The Assessing Officer as well as the Commissioner (Appeals) have treated the very same income which is taxable under section 41(1) differently. The first being expenditure claimed in pre-tonnage tax scheme assessment years and the second being expenditure claimed in post tonnage tax scheme assessment years. Such a segregation is not permissible under the Act. Both the incomes are incomes from core activity and just because tax rates are different, they cannot be treated as non-business income. The Assessing Officer as well as the Commissioner (Appeals) seem to have been influenced by the fact that the assessee has an income of Rs. 800 crores in its profit and loss account and whereas he has offered only Rs. 18 crores to tax under the tonnage tax scheme. The decision whether a particular income has to be brought to tax or not, cannot be based on such a view of the matter. The Legislature in its wisdom provided the manner of computation of income under the tonnage tax scheme. In section 115VA, it is clearly provided that sections 28 to 43C would not over ride the computation of profits and gains under section 115VA. As section 41(1) falls within sections 28 to 43C, no separate addition under that section can be made. As section 41(1) seeks to bring to tax certain specified items of receipts under the head ‘Profits and gains of business’ the scheme should not be invoked while computing profits and gains of business under Chapter XII-G. Hence, we are of the opinion that the argument of the assessee should succeed.

30. With the introduction of Chapter XII-G, the entire methodology of taxing income from the business of operating qualifying ships has changed and recourse to the normal provisions of the Act in a peace-meal manner is not authorised by law. Though the assessee has computed other income while filing its return of income, in our opinion, the income arising from section 41(1), cannot be classified as, either income from other sources or income from incidental activities. When all the ships of the assessee are qualifying ships and when there is no other activity other than core activities and incidental activities, in our opinion, a third category of other business income cannot be created. As pointed out by the learned senior counsel, if such introduction is allowed then, a claim of the assessee of deduction under section 43B, i.e., deduction only on actual payment would be required through the expenditure actually belongs to pretonnage period, to be allowed. The Assessing Officer cannot take recourse to sections 28 to 43C, when there is no other activity or business carried on by the company, other than business of operating qualifying ships. In view of the above discussion, we allow ground No. 1 of the assessee.”

18.As the ratio of the decision rendered by the Tribunal in the case of Shipping Corpn. of India Ltd. (supra) is directly applicable to the issues raised in ground Nos. 2, 3 and 4 of the assessee’s appeal filed in the present case, we respectfully follow the said decision of the co-ordinate Bench of this Tribunal and allow ground Nos. 2, 3 and 4 of the assessee’s appeal.

19. In the result, the appeal of the Revenue is dismissed whereas the appeal of the assessee is partly allowed.