THE questions before the Bench are - Whether for invoking the provisions of section 14A read with rule 8D a proximate connection between the expenditure incurred and income earned is sine-qua-non; Whether burden of proving the proximate nexus between the exempt income and expenditure incurred is on Revenue; Whether any disallowance under section 14A can be made without proving the proximate nexus; Whether expenses which are not directly related to the exempt income can be disallowed merely because rule 8D permits to do so; Whether for invoking the provisions of rule 8D the “satisfaction” of the AO about the inaccuracy of accounts and also to correctness of expenses suo-motto disallowed is a condition precedent; Whether Revenue can sit in the arm chair of a businessmen and decide what expense is necessary; Whether once it is proved that an expense is bonafide and has been incurred wholly and exclusively for the purpose of business any disallowance can be made by checking the necessity of the expense; Whether necessity behind an expense is an alien if the expense is incurred in the interest of business; Whether any disallowance under section 40(a)(ia) can be made on account of payment of commission to foreign residents and Whether education cess is revenue expense. And the verdict partly goes in favour of the assessee.
Facts of the case
Assessee Company filed its ROI declaring substantial income. The same was selected for scrutiny and assessment under section 143(3) was made- During the course of assessment proceedings the AO observed that the assessee has earned huge dividend income, the AO was of the view that disallowance of expenses in the light of the provisions of section 14A and rule 8D is required to be made, the AO while disallowing expenses as per the provisions of section 14A ignored that the assessee had suo-motto disallowed certain expenses- Beside this the AO also disallowed certain business expenses which were in the shape of payment of commission to Foreign Agents, the AO has disallowed these payments on the ground that assessee had not deducted TDS while making the remittance The AO further observed that the assessee has claimed the payment of education cess as revenue expense, the AO disallowed the same on the ground that the same is part of income tax and hence cannot be claimed as revenue expense- CIT(A) affirmed the order of the AO in respect of first ground i.e of 14A however in relation to second ground he held that provisions of section 40(a)(ia) are not applicable however the payments which the assessee had made were not necessary for the purpose of business- Matter reached to the ITAT wherein the AR of the assessee vehemently argued the matter at length.
After hearing the parties the ITAT held that,
++ Rule 8D was inserted by gazette notification dated 24/3/2008 in view of the power conferred under sub-sec (2). This Rule prescribes the method for computing the expenditure incurred in relation to the income not forming part of the total income;
++ Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd. Vs DCIT (2010-TIOL-564-HC-MUM-IT) therefore at page-28 has clearly laid down that there must be proximate cause based on the relationship of the expenditure that tax exempt income is established, only then a disallowance would have to be effected u/s 14A of the IT Act. Therefore, in view of the decision of the jurisdictional High Court and the decision of the Hon'ble Supreme Court, we are of the view that sec.14A cannot be applied unless there is a proximate cause for disallowance;
++ the onus to establish that there is proximate cause based on the relationship of the expenditure with the exempt income in our opinion is on the Revenue. Thus, the application of the provisions of sec. (2) & (3) of Sec.14A and Rule 8D is not automatic in each and every case, where there is income not forming part of the total income;
++ therefore, it is necessary for the AO first to ascertain whether there is proximate connection between the expenditure incurred and the income not forming part of the total income, if such proximate connection is established with the exempt income, the AO would be justified in applying the provisions of sub-sec (2) & (3) of sec.14A and Rule 8D of the IT Act, 1961. The expenditure incurred u/s 14A would include direct and indirect expenditure, but relationship with exempted income must be proximate;
++ before making any disallowance u/s 14A, the AO is required to record a satisfaction, having regard to the accounts of the assessee, that claim of assessee that expenditure incurred is not related to the income forming part of the total income is incorrect. Such satisfaction must be arrived at on the objective basis. He is also required to record the reasons for arriving at such satisfaction. The assessing officer in this case, we noted is not satisfied with the correctness of the disallowance made by the assessee even though he has accepted the explanation of the assessee that no interest is incurred with regard to exempt income. He rejected the explanation of the assessee that no administrative expenditure incurred on earning dividend income considering the magnitude of the investments and dividend income received and the disallowance according to him made by the assessee u/s 14A towards administrative expenditure is very less. The assessing officer nowhere pointed out the proximate connection of other expenses not apportioned by the assessee for the earning of the dividend income. He merely observed that the administrative expenses disallowed by the assessee is very less but how they are less and how the other expenses incurred by the assessee related to the dividend income has not been brought on record;
++ no discrepancy in the claim of the assessee was pointed out. The assessing officer in our opinion in view of the jurisdictional High Court decision is bound to record satisfaction as to how the expenses claimed by the assessee have been incurred on earning dividend income were not sufficient and correct. We have already held that the onus to prove in this regard lies on the assessing officer;
++ in view of our aforesaid discussion and respectively following the decision of the jurisdictional High Court in the case of Godrej & Boyce Mfg. co. Ltd. Vs. DCIT & another (2010-TIOL-564-HC-MUM-IT), we delete the disallowance made u/s 14A r.w. Rule 8D;
++ the expression "wholly and exclusively" used in section 37(1) does not mean "necessarily". Ordinarily, it is for the assessee to decide whether any expenditure should be incurred in the course of its or his business. Such expenditure may be incurred voluntarily and without any necessity, and if is incurred for promoting the business and to earn profits, the assessee can claim deduction therefore under section 37(1) even though there was no compelling necessity to incur such expenditure. The Supreme Court, in the case of CIT Vs Malayalam Plantation, held that it is not only expenditure which directly results in benefit or advantage to the assessee's business that is entitled to deduction, but also any expenditure which is incurred with a view to facilitating the carrying on of the business;
++ once doubt arise about the bonafide nature of the payment, it is necessary to look into the necessary circumstances such as relationship of the payee to the assessee, the general standard of similar expenditure in comparable business, the true worth of the services or goods in question and so forth. It is also open to the A.O. to question the reality of the expenditure i.e., the true nature of the payment, the true consideration for it and so forth. Once the A.O. considers the payment and the purpose to be bonafide, it is not open for him to substitute his own judgment what is the reasonable quantum of expenditure for the assessee;
++ if we apply the principles of the law as enunciated in the various judgments, we are of the opinion that once the A.O. finds that the assessee has bonafidely incurred the expenditure for the business, the A.O. cannot decide the quantum of the expenditure to be incurred by the assessee. In this case before us the assessing officer has disputed the fact that commission has been paid for the purpose of the business and also disallowed the said expenditure by applying the provisions of sec. 40(a)(i) as well as on the basis of the genuineness of the expenditure incurred;
++ CIT (A) while holding that the assessee was not liable to deduct tax in respect of the commission payment made to the non-resident agents took the view that the assessing officer was not justified in disallowing the commission payment by invoking the provision of sec. 40(a)(i). The CIT(A), however, disallowed the commission paid by the assessee to the foreign non-resident agents by applying the provisions of sec. 37 as according to him the assessee had not able to substantiate the claim for payment of commission to non-resident agents by adducing specific and tangible evidence to demonstrate that the services were rendered by the sales agents to justify the commission payment as claimed by the assessee;
++ there is no law which mandates that a middleman is entitled to his commission only for the first time when he introduces both the parties to each other. We agree with the ld. AR that in fact, it is a normal business practice all over the world that after the parties are introduced the actual work of a commission agent starts. Here in the instant case of the assessee, the buyers had been introduced by the said agents in the past. The emails exhibit that the agents were deeply involved with the buyers vis-a-vis the assessee in actual transportation of goods and securing payments to the assessee. Emails show that the agent was confirming vessel nomination from the buyer, which was later accepted by the assessee. Other emails show the assessee's request to the agent for opening of LC and subsequently requesting the agent for LC amendments and LC acceptances;
++ the assessee is not getting any benefit or services in return by making the payment towards the education cess and secondary higher education cess. Therefore, it cannot be said that it is an expenditure incurred wholly and exclusively for the purpose of the business and is not part of tax. We do not find any infirmity or illegality in the order of the CIT(A) while confirming the disallowance made by the assessing officer in this regard. Thus, disallowance of Rs.19,72,00,814/- is hereby confirmed. Thus, this ground stand dismissed.
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