14A is applicable to shares held as stock-in-trade; but Rule 8D cannot be applied – Kol ITAT


DCIT v Gulshan Investment Co Ltd. (I.T.A. No.: 666/ Kol. / 2012 dtd March 11, 2013) (Kolkata ITAT)

The assessee is engaged in the business of share trading. During the course of assessment proceedings, the AO noticed that while the assesse has earned dividend income of Rs 18,91,556, the assessee has not made any disallowance under section 14A in respect of “expenses relatable to the above exempt income”. The AO also noticed that the assessee had paid interest of Rs 10,34,315. The assessee contended that disallowance under section 14A of the Income Tax Act, read with rule 8D of the Income Tax Rules, is not applicable in the case of the assessee since the shares were kept as stock in trade. However, the AO did not accept the contentions of the assessee and computed the disallowance under Rule 8D by applying 0.5% of the average stock-in-trade.

HELD:

  • A plain look at Rule 8D shows that 8 D(2)(ii) and (iii) can only be applied in the situations in which shares are held as investments, and that this rule will not have any application when the share is held as stock in trade.
  • When no amount can be computed in the light of the formula given in rule 8 D(ii) and (iii), no disallowance can be made under rule 8D (2)(ii) and (iii).
  • Hon’ble Supreme Court in the case of CIT Vs B C Srinivas Shetty ( 128 ITR 294) held that when computation provisions fail, the charging provisions cannot be applied, and by the same logic, when the computation provisions under rule 8 D (2) (ii) and (iii) fail, disallowance under the said provisions cannot be made either as the said provision is rendered unworkable.
  • However, that does not exclude the application of rule 8 D(2)(i) which refers to the “amount of expenditure directly relating to income which does not form part of total income”. Consequently, section 14 A will still apply in the cases whether shares are held as stock in trade or as investments.
  • Bombay High Court in the case of Godrej & Boyce Mfg Co Ltd Vs DOT (328 ITR 81) dealt with the issue where the period when rule 8D was not applicable, the AO has to enforce the provisions of sub section (1) of Section 14A, and for that purpose, the AO is duty bound to determine the expenditure which has been incurred in relation to exempt income.
  • As a corollary to the above legal position, so far as disallowance under section 14 A in a situation in which the exempt income yielding asset, such as shares in question, is held as stock in trade, and not as investment, the disallowance will be of related direct and indirect expenditure, whereas disallowance under rule 8 D will be restricted to disallowance of only direct expenses.

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