IN THE INCOME TAX APPELLATE TRIBUNAL HYDERABAD BENCH B, HYDERABAD BEFORE SHRI B. RAMAKOTAIAH, ACCOUNTANT MEMBER AND SHRI SAKTIJIT DEY, JUDICIAL MEMBER

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1 IN THE INCOME TAX APPELLATE TRIBUNAL HYDERABAD BENCH B, HYDERABAD BEFORE SHRI B. RAMAKOTAIAH, ACCOUNTANT MEMBER AND SHRI SAKTIJIT DEY, JUDICIAL MEMBER ITA No. 1743/Hyd/2013 Assessment Year : Bellwether Microfinance Fund Pvt. Ltd., Hyderabad. PAN AADCS4132K Income-tax Officer, Ward 1 (1),Hyderabad. (Appellant) Assessee by Revenue by (Respondent) Shri Deepak Chopra Shri Solgy Joset T. Kottaram Date of hearing Date of pronouncement O R D E R PER SAKTIJIT DEY, J.M.: This appeal of the assessee is directed against the order dated 01/10/2013 passed by CIT(A)-II, Hyderabad relating to the AY The assessee has raised 7 grounds. At the outset, learned AR submitted that he does not want to press Ground No.1, hence, this ground is dismissed as not pressed. Ground Nos. 2 & 7 are general in nature and do not require any adjudication. Ground Nos. 3 to 5 relate to only one issue of disallowance of expenditure of Rs. 1,97,36,624/- u/s 14A read with rule 8D of the Act. In Ground No. 6, assessee has challenged levy of interest u/s 234B and 234D of the Act. 3, Briefly, the facts relating to the issue in dispute are, the assessee is a non-banking financing company engaged in the

2 2 business of investing in microfinance companies in India. The assessee was earlier known as Sufala Finance Ltd., which was incorporated on 25/11/1991 as a private limited company engaged in the business of providing financial services as hire purchase and leasing of incomes. After change of management, it also changed its business model by making investments in equity, mutual fund and also advanced loans to micro finance institutions. Assessee entered into a fund management agreement with Caspian Advisors Pvt. Ltd. (in short CAPL) on 27/05/2005 a per which the said company would render consultation services to the assessee in the matter of investment etc. as fund manager. For the assessment year under dispute assessee filed its return of income on 15/09/2009 declaring Nil income. Initially the return was processed u/s 143(1) and refund on account of TDS amounting to Rs. 62,21,130/- was also issued to the assessee. Subsequently, assessee s case was selected for scrutiny. During the scrutiny assessment proceeding, after examining the books of account and other details submitted by the assessee, it was noted by the AO that the fund manager i.e. CAPL was holding 18.7% shareholding in the assessee company. One of the Director in the assessee company Shri S. Viswanath Prasad was also a director in CAPL with 99% shareholding. He further noticed that in lieu of the services rendered, the fund manager was to be paid remuneration to the fund based services, which was agreed upon as under: a) 3.50% per annum on outstanding equity or equity linked investments on cost basis. b) 2.25% per annum on outstanding debt investments only on principal. c) 1.00% per annum on all other assets 3.1 The AO further noticed that while computing its income, assessee has disallowed expenditure of Rs. 35,65,860/- u/s 14A read with Rule 8D, out of the fund management fees claimed, which worked out as under:

3 3 Rule Details of working Amount disallowed Rule 8D(2)(i) Average value of mutual funds Add: 14,33,99,099 Average value of investments income from which is exempt 6,50,00,000 Average value of Investments 20,832,99,099 Rule 8D(2)(ii) 1% on Rs.20,83,99, Add: Performance pay Add: Service tax Total interest expenditure 14,394 25,20,080 Proportionate expenditure 3,785 Rule 8D(2)(iii) 0.5% of average value of investments (total assets adjusted by adding current 10,41,995 liabilities) Total 35,65, After examining the details, AO was of the view that the disallowance of fund management fees worked out by the assessee is not correct. On the basis of the agreement with fund manager, AO worked out the fees paid to the fund manager as under: Sl.No. Category Total investments Fund management fee investment %age Amount 1a Equity through 24,19,66,037 Bellwether Trust 1b Direct investment (equity) 24,34,5,747 Total of 1a & 1b 48,54,20, ,69,89,727 2 Debt (Loans) 13,41,25, ,17,828 3 Treasury i) Investment (pref. shares) ii) Cash & Bank balances 11,00,00, ,00,000 3,23,55, ,23,559 Fund Management fee performance day 16,41,067 Total fund

4 4 management fee 2,20,82,181 Add: service tax 26,66,863 Total 2,47,49, AO also quantified the expenditure pertaining to exempt/taxable income for the purpose of disallowance u/s 14A and called for an explanation from assessee for proposed disallowance. Assessee objecting to the disallowance proposed by the AO u/s 14A of the Act, submitted that dividend income and income from mutual fund cannot be regarded as exempt income since tax has been imposed and paid by the payer u/s 115-O and 115J. It was submitted that tax on dividend distributed cannot be any thing other than tax on dividend income of the recipient/shareholder, which for the sake of administrative convenience and cost effectiveness is collected from the paying company. It was further submitted that the situation is analogous to FBT paid on ESOP issued to non-resident. Vide CBDT Circular No. 9 of 2007 the non resident employee is allowed to take credit, in a foreign country, for the FBT paid by the employer on ESOPs. It was submitted that in terms with Ruled 8D assessee has computed disallowance u/s 14A by arriving at the direct expenditure by considering fees attributable to those investments which have yielded income. AO rejecting each of the arguments of the assessee held that the assessee having not correctly computed disallowance u/s 14A, worked out the disallowance in the following manner and accordingly added Rs. 1,97,36,624/- to the income of the impugned assessment year. Under Rule 8D(2)(i): Amount of expenditure directly relating to Income which does not form part of total income 2,04,06,834 Under Rule 8D(2)(ii): NIL Under Rule 8D(2)(iii): 0.5% of average value of opening and closing Values of total investments Opening bal. of investments 56,28,38,038/- Closing bal. of investments 59,54,22,178/- Average of the above 57,91,30,108/- 0.5% of average 28,95,650/-

5 5 Total disallowance u/s 14A 2,33,02,484 Less: admitted by assessee himself 35,65,860 1,97,36,624 ========= 3.4 Being aggrieved of the assessment order, so passed, assessee preferred appeal before the CIT(A). 4. Before the CIT(A), assessee relying upon various judicial precedents contended that the disallowance made by the AO is not in accordance with the statutory mandate. It was submitted that as the assessee has not incurred any expenditure to earn exempt income disallowance u/s 14A is not warranted. It was further submitted that fund management fees was not entirely towards exempt income. Assessee also earned long term capital gain which was taxable. It was further submitted that assessee has made investment in equity which has not earned any exempt income. Therefore, the AO should have determined fund management fees relating to equity investments, which actually gave rise to exempt income. It was further submitted that dividend income received by the assessee cannot be considered to be exempt from tax as the companies have paid dividend distribution tax u/s 115-O. The CIT(A) after examining the contentions of the assessee in the context of provisions contained u/s 14A read with rule 8D upheld the addition made by the AO on the following findings: 7 From the perusal of the assessment order it is evident that the AO was not satisfied with the correctness of the disallowance computed by the assessee. Based on the assessee s agreement with CAPL the AO correctly computed the disallowance under rule 8D(2)(i). The AO can apply the provisions of rule 14A even if no expenditure is incurred to earn exempt income. The AO was fair enough in computing the disallowance u/s 14A separately for exempt income and for taxable income. He disallowed only that part of expenditure which pertains to exempt income. It is also pertinent to mention that the Rule 8D(2)(iii) applies even in cases where there is no exempt income as the formula relates to investment and not to income earned. Meaning thereby certain disallowance has to be

6 6 made even in cases where there is no income at all and also in cases where no expenditure was actually incurred. 7.1 It is also pertinent to mention here that the Hon ble Mumbai High court in the case of Godrej & Boyce Co. Ltd., Vs. DCIT 328 ITR 81 held that the provisions of Rule 8D are prospective and are applicable with effect from AY It is also pertinent to mention that the CIT(A)-V, Hyderabad for the AY had dismissed the appeal on the same issue vide order in ITA No. 175/DCIT-1(3)/CIT(A)-V/ dated 14/02/ In view of the above discussion the disallowance made by the AO of Rs. 1,97,36,624/- is sustained, therefore, the grounds of the appeal of the assessee on this issue are dismissed. 5. The learned AR reiterating the contentions raised before the revenue authorities submitted that disallowance made by the AO being not in accordance with the mechanism laid down in rule 8D(2) of the IT Rules, it cannot be sustained. It was submitted by the ld. AR that there being no expenditure incurred by the assessee towards earning of exempt income, provisions of section 14A are not attracted. It was submitted that since dividend income earned by the assessee was subject to dividend distribution act u/s 115-O of the Act, it cannot be considered as exempt income so as to bring it within the ambit of section 14A of the Act. Challenging the computation made by the AO, it was submitted that AO has committed fundamental error by disallowing expenditure relating to investments which have not yielded any income during the year. In this context, learned AR referring to Rule 8D(2)(i) of the Rules submitted that disallowance under the aforesaid sub-rule must relate to the income actually earned which is exempt. It has no relation to the investments made by assessee as a whole whereas rule 8D(2)(iii) applies to the whole of the investments irrespective of the fact whether income has been earned or not. It was, therefore, contended that while the AO may be correct in computing disallowance under rule 8D(2)(iii) by considering total investments made by assessee irrespective of the fact whether they have yielded income or not, but, while computing disallowance

7 7 under rule 8D(2)(i), AO should not have considered the investments which have not yielded any income. It was, thus, contended by learned AR that computation made by AO being erroneous and not in accordance with statutory provisions, the addition made may be deleted and the disallowance made by the assessee itself be accepted. 6. The learned DR, on the other hand, submitted that AO is empowered to disallow expenditure relating to exempt income u/s 14A of the Act. Rule 8D only provides the mode of computation of disallowance. Therefore, assessee cannot claim that there should not be any disallowance of expenditure u/s 14A read with rule 8D. It was submitted that the balance sheet of the assessee since did not provide correct picture, AO has undertaken the exercise himself for quantifying disallowance to be made u/s 14A read with Rule 8D(2)(i). It was submitted by the learned DR that neither during the assessment proceeding nor before the CIT(A), assessee has substantiated by furnishing details what amount relates to earning of exempt income and what amount was towards earning of taxable income. Therefore, in absence of any details by the assessee, it cannot be said that the computation made by the AO is incorrect. 7. We have heard parties and perused materials on record as well as the orders of the authorities on this issue. So far as the contention of the learned AR that provisions of section 14A is not attracted and it has not incurred any expenditure towards earning of exempt income and further contention that dividend income cannot be considered as exempt income as it is subjected to dividend distribution Tax u/s 115J and 115-O of the Act, in our view, it is not acceptable simply because of the fact that the assessee itself recognizing the fact that it has incurred expenditure towards earning of exempt income has disallowed expenditure to the tune of Rs. 35,65,860/- u/s 14A read with Rule 8D(2) of the Act. Therefore, assessee s challenge with

8 8 regard to applicability of section 14A read with Rule 8D (2) cannot be sustained. However, so far as assessee s contention with regard to mode of computation of disallowance under Rule 8D(2), in our view, requires consideration. As can be seen, at the stage of assessment proceeding itself assessee has stated that disallowance under Rule 8D(2)(i) should be only in relation to the investment, which has yielded any exempt income in the relevant FY. Expenditure cannot be in relation to the total investment irrespective of the fact whether any income is earned or not during the year. Before going into the merits of assessee s contentions, it is deemed necessary to look into the provisions contained under rule 8D(2) which is relevant for our purpose. The same is extracted hereunder for the sake of convenience: 8D. (1) xxxxxxxxxxx (2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely : (i) the amount of expenditure directly relating to income which does not form part of total income; (ii) in a case where the assessee has incurred expenditure by way of interest during the previous year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely : A X B/C Where A = amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year ; B = the average of value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year ; C = the average of total assets as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year ; (iii) an amount equal to one-half per cent of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year.

9 9 (3) xxxxxxxxxxxx 7.1 On careful reading of the aforesaid provision, it would be evident that it is in three parts. The first part contained in sub-rule D(2)(i), speaks of disallowance of the amount of expenditure directly relating to income which does not form part of the total income. Second part under sub-rule 8D(2)((ii) deals with disallowance to be computed on the basis of formula given therein in a case where the assessee incurs expenditure by way of interest which is not directly attributable to any particular income or receipt. The third part as provided under Sub-Rule 8D(2)(iii) is an artificial figure i.e. one-half per cent of the average investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee on the first day and the last day of the previous year. Aggregate of these three components would constitute expenditure in relation to exempt income and would be disallowed u/s 14A of the Act. Therefore, if we examine the facts of the present case in the context of the aforesaid statutory provision, it is quite clear that AO while working out disallowance under rule 8D(2)(i) has taken the total investment irrespective of the fact whether they have yielded income or not during the assessment year under consideration. The reasoning of the AO in this regard is actual earning or receipt of income will not be a condition for disallowance of such expenditure under the provisions of section 14A as it speaks about expenditure in relation to income which does not form part of the total income. He was of the view that even if no income was received, expenditure incurred can be disallowed u/s 14A. However, Rule 8D(2)(i) speaks of expenditure directly relating to income which does not form part of total income. The term total income has not been defined either u/s 14A or under Rule 8D. Therefore, one has to look to the definition of total income as appearing in section 2(45) of the Act, which reads as under:

10 10 "total income" means the total amount of income referred to in section 5, computed in the manner laid down in this Act ; Section 5 of the Act reads as under:- Scope of total income. 5. (1) Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which (a) is received or is deemed to be received in India in such year by or on behalf of such person ; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year ; or (c) accrues or arises 57 to him outside India during such year : Provided that, in the case of a person not ordinarily resident in India within the meaning of sub-section (6)* of section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession set up in India. (2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which (a) is received or is deemed to be received in India in such year by or on behalf of such person ; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year. Explanation 1. Income accruing or arising outside India shall not be deemed to be received 57 in India within the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared in India. Explanation 2. For the removal of doubts, it is hereby declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India. 7.2 As can be seen, definition of total income u/s 2(45) refers to section 5 which envisages scope of total income. On a reading of section 5 of the IT Act, it would be evident that as per this section total income is of any previous year and which includes income from

11 11 whatever source derived which is received or deemed to be received in India in such year by or on behalf of such person or accrues or arises or is deemed to accrue or arises to him in India during such year or accrues or arise to him outside India during such year. Considered in aforesaid context, expression total income referred to in rule 8D(2)(i) cannot be in abstract. It must relate to a previous year income of which is sought to be assessed. Therefore, as a natural corollary it follows that only expenditure directly relating to income which is earned either on receipt basis or on accrual basis and which does not form part of total income of a particular assessment year can be disallowed under clause (i) of Rule 8D(2). Rule 8D(2)(i) does not refer to the investment made by the assessee. On a conjoint reading of clause (i) and clause (iii) of Rule 8D(2), the difference between them is clearly discernible. While clause (i) speaks of disallowance of expenditure directly relating to income which does not form part of total income, clause (iii) provides for disallowance of expenditure of the average value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee on first day and last day of the previous year. Therefore, while disallowance of expenditure under clause (i) is related to income earned which does not form part of total income, clause (iii) relates to the average of the value of investment appearing in the balance sheet. On a plain reading of Rule 8D(2) as a whole the legislative intent becomes clear that the disallowance of expenditure contemplated under subrule(i) must relate to the income which does not form part of the total income of that year. Therefore, investment, which has not resulted in any income cannot be considered for the purpose of disallowance under Rule 8D(2)(i). However, while computing disallowance under rule 8D(2)(iii), the average of the total investment of the assessee as appearing in the balance sheet on the first day and last day of the year irrespective of the fact whether it has yielded income or not can be considered for the purpose of disallowance. The use of the words

12 12 does not or shall not in Rule 8D(2)(iii) connotes that income not only does not form part of total income during the year but it also shall not form part of total income at any time. Had it been the intention of the Rule framing authorities to disallow under rule 8D(2)(i) expenditure relating to total value of investment or income which is not earned during the relevant previous year, then, they would have used the expression does not or shall not form part of total income as appearing in rule 8D(2)(iii) instead of words does not form part of total income. That being the case, AO cannot disallow expenditure relating to investment which has not yielded any exempt income during the previous year relevant to the assessment year under dispute. Therefore, we direct the AO to disallow the expenditure relating to investments resulting in income earned/accrued which does not form part of total income of the impugned assessment year. However, so far as AO s computation of expenditure to be disallowed under rule 8D(2)(iii), the same in our view, is in conformity with Rule 8D(2)(iii), hence, do not call for any interference. 8. In Ground No. 6 assessee has challenged levy of interest u/s 234B and 234D of the Act. At the time of hearing ld. AR has not argued this ground. Even otherwise also, levy of interest u/s 234B and 234D is consequential to income finally to be determined by AO. Hence, there is no necessity to adjudicate this ground at present. 9. In the result, appeal of the assessee is partly allowed. Pronounced in the open court on 27/06/2014 Sd/- (B. RAMAKOTAIAH) ACCOUNTANT MEMBER Sd/- (SAKTIJIT DEY) JUDICIAL MEMBER Hyderabad, Dated: 27 th June, 2014 kv

13 13 Copy to:- 1), /5/B/1/D, Road No. 10, Banjara Hills, Hyderabad ) ITO, Ward 1(1), Hyderabad. 3) CIT(A)-II, Hyderabad 4) CIT-I, Hyderabad 5)The Departmental Representative, I.T.A.T., Hyderabad.

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH `F : NEW DELHI BEFORE SHRI G.E. VEERABHADRAPPA, VICE PRESIDENT AND SHRI C.L.SETHI, JUDICIAL MEMBER.

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH `F : NEW DELHI BEFORE SHRI G.E. VEERABHADRAPPA, VICE PRESIDENT AND SHRI C.L.SETHI, JUDICIAL MEMBER. I.T. A. No.4931/Del/2010 Assessment Year: 2007-08 Quippo