Rule 8D applicable on Shares held as Stock in Trade

DCIT vs. Damani Estates & Finance Pvt. Ltd (ITAT Mumbai)

S. 14A/ Rule 8D: Scope in the context of shares held as stock-in-trade explained

In AY 2008-08, the assessee, a trader cum investor in shares, offered Rs. 10 lakhs as disallowance u/s 14A. It claimed that the amount invested in shares was funded by its own, non-interest bearing funds and that there was no direct expenditure relatable to the investments. The AO applied Rule 8D and computed the disallowance at Rs. 1.40 crore. On appeal, the CIT(A) upheld the stand of the assessee as to the quantum of the disallowance. On appeal by the department, the Tribunal had to consider (i) whether s. 14A applies to shares held as stock-in-trade?, (ii) whether it could be said that the expenditure having been incurred for the share trading business, no expenditure can be said to be in relation to the dividend income?, (iii) whether it can be argued that the investment in tax-free securities is made out of own funds and no disallowance of interest on borrowed funds can be made?, (iv) whether Rule 8D(2)(ii) which deals with interest expenditure not directly attributable to any particular income or receipt requires modification if the dominant purpose is to earn share trading income?, (v) Whether Rule 8D(2)(iii) which prescribes the ratio in respect of indirect expenditure can be modified if the dominant purpose is to earn share trading income? & (vi) whether the allowance for depreciation u/s 32 has to be excluded in computing the disallowance? HELD by the Tribunal:

(i) S. 14A gets attracted on incurring of expenditure in relation to tax-exempt income. The purpose for which the shares are purchased and held would not impact the applicability of s. 14A. S. 14A comes into play irrespective of the head of income (on account of it arising qua a trading asset) under which the income is assessable. The fact that the share trading business yields both taxable income in the form of share trading profit and tax-exempt income by way of dividend income makes no difference to the applicability of s. 14A. Accordingly, s. 14A applies to shares held as stock-in-trade;

(ii) The argument that all expenditure has been incurred for the share trading business and that there is no additional expenditure incurred for earning dividend is not acceptable because though the expenditure is incurred for the purpose of the business of share trading, the said business yields taxable and non-taxable income. It is the integral activity of purchase and holding the shares which generates two separate streams of income. Accordingly, some of the expenditure has to be attributed to the dividend income;

(iii) The argument that investment in shares yielding tax-free dividend income has been made out of own funds and so no interest expenditure has been incurred in relation to the dividend income is not acceptable. No presumption of investment of own funds, on ground of its sufficiency, on the basis of Reliance Utilities and Power Ltd 313 ITR 340 (Bom) can be drawn;

(iv) If Rule 8D(2)(ii) which quantifies the interest on the investments, income from which is not taxable, on a proportionate basis, is applied literally, it will lead to absurd results because then the entire interest relatable to the average share holding will be attributed to the tax exempt dividend income even though the shares are bought and held primarily for share trading income. Rule 8D(2)(ii) needs to be scaled down by bifurcating the expenditure so arrived at between the tax-free and the taxable incomes. Given that the dominant objective of the share holding is to earn share trading income, an ad hoc ratio of 20% toward tax-exempt dividend income will be reasonable. Accordingly, in arriving at the disallowance u/r 8D, the amount as per Rule 8D(2)(ii) qua shares held as stock-in-trade would be restricted to 20% thereof;

(v) Rule 8D(2)(iii) which prescribes the ratio of indirect expenditure required to support an investment need not be modified because though the expenditure prescribed for disallowance is based only on one variable, i.e. the average value of investments, the prescribed allocation ratio of 0.5% of the investment value qua indirect expenditure is very nominal and not harsh;

(vi) Depreciation – an economic and accounting concept – statutorily recognized and provided, is only a charge on capital account, i.e., a capital expenditure. It has to be excluded in computing the s. 14A disallowance (Daga Capital 117 ITD 169 (Mum)(SB), Dhanuka & Sons 339 ITR 319 (Cal) & American Express Bank followed; CCI Ltd 71 DTR (Kar) 141, Leena Ramachandran 339 ITR 296 (Ker) & Yatish Trading not followed; Godrej & Boyce 328 ITR 81 (Bom) & Walfort Share and Stock Brokers 326 ITR 1 (SC) referred/ followed).

Note: Though the appeal against Daga Capital 117 ITD 169 (Mum)(SB) is pending in the Bombay High Court, given the conflict on whether s. 14A applies to stock-in-trade or not (Damani Estates & American Express Bank hold that it does while Yatish Trading, India Advantage & Gulshan Investments hold that it does not) the matter deserves to be referred to a 5 Member Special Bench in view of the High Court verdicts in CCI Ltd 71 DTR (Kar) 141 & Leena Ramachandran 339 ITR 296 (Ker)