The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has held that strategic investments in subsidiary and associate companies cannot, by themselves, take an assessee outside the scope of Section 14A of the Income-tax Act, 1961, particularly where the Assessing Officer records dissatisfaction with the claim that no expenditure was incurred in relation to exempt income.
The Tribunal, comprising Accountant Member Ramit Kochar and Judicial Member Madhumita Roy restored the issue of computation of disallowance under Section 14A read with Rule 8D to the Assessing Officer.
The dispute arose from an assessment in which the Assessing Officer had made a disallowance of ₹18,29,50,905 under Section 14A read with Rule 8D on the ground that expenditure had been incurred in relation to income that did not form part of the assessee’s total income.
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The assessee had returned income of approximately ₹6.83 crore for AY 2018-19. The assessment was selected for complete scrutiny on several issues, including expenses incurred for earning exempt income. During the assessment proceedings, the assessee maintained that it had not incurred any expenditure for earning the exempt dividend income.
The Assessing Officer, however, rejected this explanation. According to the AO, investment decisions were taken at the level of the Board of Directors and involved strategic deliberation and deployment of organisational resources. The AO held that such activity could not be treated as merely incidental and that the expenses associated with investment decisions had a nexus with the exempt income.
Applying Rule 8D, the AO computed a disallowance of ₹18,29,50,905. The computation included an amount equal to one per cent of the prescribed average investment figure, apart from direct expenditure.
The assessee challenged the addition before the Commissioner of Income Tax (Appeals). The CIT(A) deleted the entire disallowance, relying substantially on an earlier ITAT ruling in the assessee’s own case for AY 2014-15.
In that earlier case, the Tribunal had found that the assessee had furnished details of its expenditure and had specifically stated that none of the expenditure was incurred for earning exempt income. The earlier Tribunal had also noted that the directors handling the investment work were employees of a sister concern and did not draw remuneration from the assessee. It consequently held that the Assessing Officer had merely applied the Rule 8D formula mechanically without identifying any error in the assessee’s claim.
The CIT(A), finding the facts to be similar, deleted the ₹18.29 crore addition.
Before the ITAT, the assessee argued that the mandatory precondition for invoking Rule 8D had not been fulfilled. Its case was that the AO had failed to record proper objective satisfaction, having regard to the accounts, as to why the assessee’s claim of having incurred no expenditure for earning exempt income was incorrect.
The assessee also relied upon the Tribunal’s decision for AY 2017-18, where a similar Section 14A disallowance had been deleted because the AO had not recorded the requisite objective satisfaction before applying Rule 8D.
It was further argued that the investments were primarily in Bajaj Group subsidiaries and associate companies and were strategic, long-term investments. According to the assessee, dividend income was directly credited to its bank account and no expenditure was incurred specifically for earning that income.
The assessee also placed before the Tribunal an expenditure chart showing total expenditure of approximately ₹221.36 lakh, contending that none of those expenses had been incurred in relation to the exempt income. However, the Tribunal noted that the assessee had not filed audited financial statements before it and had instead filed an unsigned/unaudited expenditure chart.
The Revenue defended the assessment order by arguing that strategic investments necessarily involve managerial and administrative resources.
According to the Department, investment decisions require management analysis and approval, monitoring and oversight, deployment of organisational resources and managerial involvement. Therefore, the fact that the investments were strategic could not by itself establish that no expenditure was incurred in relation to the exempt income.
The Revenue further contended that the AO had examined the assessee’s claim, considered the nature of its investments and recorded dissatisfaction before invoking Rule 8D. It argued that the amended Rule 8D applicable from June 2, 2016 had to be considered for AY 2018-19 and that the earlier AY 2014-15 decision could not automatically govern the present case.
The Tribunal examined the Supreme Court’s decision in Maxopp Investment Ltd. v. CIT, particularly its interpretation of Section 14A.
The ITAT noted that the dominant purpose behind making an investment is not decisive for determining the applicability of Section 14A. Even where shares are acquired for obtaining controlling interest or for strategic business purposes, if expenditure is incurred in relation to exempt dividend income, the portion attributable to such exempt income may be disallowed.
At the same time, the Supreme Court had made it clear that before applying the apportionment mechanism under Rule 8D, the AO must record satisfaction, having regard to the assessee’s accounts, that the assessee’s claim regarding expenditure relating to exempt income is not correct.
The Delhi ITAT specifically rejected the assessee’s contention that Section 14A could not apply merely because its investments were strategic.
The Tribunal observed that the assessee was a holding/investment company with substantial investments in subsidiary and associate companies and was also engaged in activities involving ownership and development of FMCG brands and royalty income.
It noted substantial investments and exempt dividend income running into hundreds of crores. In these circumstances, the Tribunal held that the theory of apportionment approved by the Supreme Court in Maxopp was relevant.
The Tribunal also distinguished the earlier decisions relied upon by the assessee. It noted that the AY 2014-15 ruling involved a different Rule 8D framework and principally concerned interest expenditure, whereas the present assessment year was governed by the amended Rule 8D applicable from June 2, 2016.
A significant observation of the Tribunal was its criticism of the assessee’s approach that no expenditure could be attributed to exempt income simply because the dividend was directly credited into its bank account.
The Tribunal described this as a “very myopic and simplistic view”, observing that strategic investments generally require planning, execution, monitoring and periodic review.
According to the Tribunal, strategic investments may involve market research, analysis of market trends, decisions concerning acquisition, retention and sale of shares, Board and shareholder meetings, regulatory approvals, statutory compliance, infrastructure and administrative expenditure.
The Tribunal further observed that mixed expenses such as infrastructure costs, staff salaries, travelling expenses, meeting expenses, audit fees and maintenance of statutory records can potentially relate to both taxable and exempt income. Where the AO is dissatisfied with the assessee’s claim, the principle of apportionment can therefore come into play.
The central procedural question was whether the AO had recorded the satisfaction required under Section 14A(2) before invoking Rule 8D.
The Tribunal found that, unlike the earlier assessment year relied upon by the assessee, the AO in the present case had expressly considered the assessee’s contention that no expenditure was incurred for earning exempt income and had rejected that claim.
The AO had recorded that Board-level investment activity involved deliberation and resources and that the activity had a direct correlation with the exempt income. The Tribunal therefore concluded that the mandatory requirement of recording dissatisfaction had been fulfilled in the facts of the present assessment year.
The Tribunal consequently distinguished the AY 2017-18 ruling, observing that each assessment year is a separate assessment unit and that the facts can vary from year to year.
Although the Tribunal upheld the applicability of Section 14A read with Rule 8D, it did not finally sustain the precise amount of ₹18.29 crore.
The Tribunal noted that the assessee had submitted an expenditure chart showing approximately ₹221.36 lakh of total expenditure. Importantly, Rule 8D itself provides that the prescribed disallowance cannot exceed the total expenditure claimed by the assessee.
Since the assessee had not placed its audited financial statements before the Tribunal, the Bench considered it appropriate to restore the matter to the Assessing Officer for fresh computation of the disallowance under Section 14A read with Rule 8D, in accordance with law and after considering the relevant expenditure.
The department’s appeal was therefore allowed for statistical purposes rather than by finally confirming the entire ₹18.29 crore addition.
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