Close on the heels of the decision of the Bombay High Court in Reliance Utilities & Power, which possibly has significant implications on the interpretation of section 14A of the Income Tax Act, the Bombay ITAT has, in a recent decision, taken a further step with the potential of limiting the inequity resulting from the current interpretation of the provision.
The current position with regard to section 14A is that the amount of expenditure of a company earning interest-free income is determined according to a predetermined formula provided in Rule 8D of the Income Tax Rules, having no connection with the actual investment which is expended in earning this income. Further, after the decision of the Special Bench of the Bombay Income Tax Appellate Tribunal (ITAT) in Daga Capital [26 SOT 603], this formula is to be used for computations of expenditures incurred even prior to the introduction of the amended section. The only solace for assessees in this scenario is the requirement that this mode of computation is to be used only when the Assessing Officer ‘is not satisfied’ with the assessee’s claim as to the amount of expenditure relatable to exempt income. It was in connection with the interpretation of this phrase that the decision in Reliance Utilities & Power was discussed earlier. The decision of the ITAT in ACIT v. Indexport Ltd. provides another mode of reading down section 14A.
At issue before the Tribunal in Indexport was a the decision of the Commissioner of Income Tax (Appeals) allowing the assessee’s claim and reducing the quantum of disallowed expenditure from 10% to 5%. It was this reduction that was being challenged by the Department. The decision of the CIT(A) predated Daga Capital, and the Department contended that, following that decision, the amount of expenditure to be disallowed had to be recalculated, and should be sent back to the AO for this purpose. The primary concern of the assessee here was the enhancement in the amount of disallowance (over the amount of 10% as originally calculated by the AO) on the application of the Rule 8D formula. It was in this context that the ITAT decided that while Daga Capital necessitated sending back the matter to the AO for re-computation, the resulting disallowance could not exceed 10%.The reason for this cap imposed by the ITAT was that the assessee cannot be put in a position worse than that he was originally in. This equitable rationale was further supported by the technical ground that the prayer sought by the Department was only that the CIT(A) had erred in reducing the disallowance from 10% to 5%. It was beyond the bounds of judicial propriety to allow a re-computation that would go beyond the prayer sought by the appealing party.
However, an examination of the provision and the facts here suggest that even apart from these grounds, there is another significant rationale for the 10% cap, and should ideally have been discussed by the ITAT. It is significant that the decision in Daga Capital does not require the use of the formula in all cases, but only when the AO is dissatisfied with the assessee’s claim. Here, it was the AO who had arrived at the disallowance of 10%, and not the assessee. Thus, to borrow the term from the provision, he could not but be ‘satisfied’ with this figure of 10%. In this situation, allowing the re-opening of the computation and disallowing an amount greater than 10%, which the AO was originally ‘satisfied’ with, would do violence to the section, in addition to being highly iniquitous. This rationale would not only have achieved the same result as the ITAT finally did, but explicitly added a much-needed respite to assessees in the face of the present interpretation of section 14A. However, the omission to examine the possibility of this interpretation consigns this decision to the fast expanding league of opinions which are gradually eroding the effects of Daga Capital.