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:
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.
· Even in the absence of section 14A, the AO would have to apportion and disallow the expenditure incurred by the assessee in relation to income which does not form part of the total income under the ITA.
· In order to determine the quantum of the dis allowance under section 14A, there must be a proximate relationship between the expenditure and the income which does not form part of the total income. Once such a proximate relationship exists, the dis allowance has to be effected.
Whether section 14A is attracted in the case of dividend income from shares and units
The additional income-tax paid under section 1 15-O (See Note-4) on the profits declared, distributed or paid as dividend by a domestic company is a tax on the profits of the company and cannot be considered as a tax on dividend income. The additional tax is not paid on behalf of or as an agent of, the shareholders of the company.
Dividend income being exempt under section 10(33) of the ITA, the expenditure incurred in relation to earning such income cannot be allowed under section 14A.
Constitutional validity of sub-sections (2) and (3) of section 14A and Rule 8D
Burdens, disadvantages and individual cases of hardship are not reasons enough to strike down the constitutional validity of legislation. So long as the measure which has been put into place has a nexus with the object sought to be achieved, it passes constitutional muster.
The AO is compelled to make a determination under Rule 8D if the assessee is unable to establish the correctness of the claim in respect of the expenditure incurred in earning income which does not form part of taxable income. Before the legislature prescribed a uniform method, disputes had occurred between assessees and the department in regard to the method to be adopted in computing such expenditure. In this background, if the legislature considered it appropriate to prescribe a particular method, that legislative choice cannot be held to be arbitrary or oppressive.
Section 14A contains sufficient safeguards that would ensure a reasonable exercise of power by the AO.
The provisions of sub-sections (2) and (3) of section 14A are therefore constitutionally valid. The provisions of Rule 8D are not ultra vires the provisions of section 14A of the ITA and do not offend the Constitution.
Retrospective application of section 14A and Rule 8D
Sub-sections (2) and (3) of section 14A were inserted w.e.f. 1 April 2007. The memorandum explaining the provisions of the Finance Bill of 2006 [by which sub sections (2) and (3) were inserted in section 14A] provided that the amendment will take effect from 1 April 2007 and will, accordingly apply in relation to AY 2007-08 and subsequent years. A circular issued by the CBDT on 28 December 2006 also clarified that the amendment would be applicable from AY 2007-08 and on wards.
Rule 8D was notified on 24 March 2008. It is a trite principle that the law which would apply to an assessment year is the law prevailing on the first day of April of the assessment year. Consequently, Rule 8D which has been notified on 24 March 2008, would apply with effect from AY 2008-09.
Unless expressly or by necessary indication, a contrary provision is made, no retrospective effect is to be given to any rule so as to prejudicially affect the interests of the assessee. Accordingly, sub-sections (2) and (3) of section 14A and Rule 8D would apply prospectively and were not applicable to the AY 2002- 03.
The High Court decision restricts the applicability of Rule 8D to AY 2008- 09 and on wards. For earlier years, the AO may adopt a reasonable method for ascertaining the quantum of expenditure attributable towards earning non-taxable income.
The Court has held that the AO can resort to the computation mechanism under Rule 8D only if he is not satisfied with the claim of the assessee having regard to the accounts. The satisfaction is required to be arrived at on an objective basis. Thus, if the assessee is able to substantiate its claim under section 14A, the AO would be required to accept the same and not compute the dis allowance as per Rule 8D.
Download Full Text of the Judgment – Godrej & Boyce vs. DCIT (Bombay High Court)
1. The provisions of section 10(33) of the ITA granted tax exemption in respect of dividends on which dividend distribution tax had been paid and income received from specified mutual funds.
2. 117 ITD 169 (Mum)
3. Sub-sections (2) and (3) of section 14A enable the AO to determine the amount of expenditure incurred for earning income which does not form part of the total income under the ITA if the AO is not satisfied with the correctness of the claim of the assessee or where the assessee claims that no expenditure has been incurred by him in relation to earning such income. The expenditure is to be determined in accordance with Rule 8D of the Rules.
4. Section 115-O contains the provisions of dividend distribution