RULE 8D: Method for determining amount of expenditure in relation to income not includible in total income

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What is Rule 8D of Income Tax Act, 1961?

Rule 8D of Income Tax Act reads as follow:

Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with—

(a) the correctness of the claim of expenditure made by the assessee; or

(b) the claim made by the assessee that no expenditure has been incurred,

in relation to income which does not form part of the total income under the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub-rule (2).

(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; and

(ii) an amount equal to one per cent of the annual average of the monthly average of the opening and closing balances of the value of investment, income from which does not or shall not form part of total income :

Provided that the amount referred to in clause (i) and clause (ii) shall not exceed the total expenditure claimed by the assessee.

This is an amended provisions applicable now while the estrwhile Rule specifically focussed on disallowance of interest on proportionate basis.

Example

Let us look at an example of calculation of expenditure according to Rule 8D

During the FY 2016-17, Mr X took a loan of Rs. 10,00,000/- @ 10% p.a. which was utilised for making various investments, from which Mr. X earned dividend income which is exempt from tax.

Monthly closing balances of this investment are as follows:

April- 1,00,000, May- 1,50,000, June-1,50,000, July- 2,00,000, August- 2,10,000, September- 2,40,000, October- 2,50,000, November-2,50,000, December- 2,80,000, January- 3,00,000, February- 3,20,000, March- 3,50,000.

Opening balance as on March 2016 is Rs. 50,000

Calculation of disallowance

ParticularsAmount (in Rs)
Any amount of expenditure which is directly relating to exempt income (10,00,000*10%)1,00,000
Amount equal to 1% of annual average of monthly average of opening and closing balances of value of investment whose income is or shall be exempt – 1% of Rs 2,27,500 (See computation below)

Monthly average of Investment
April-( 50000+100000)/2                                                          1,00,000
May-(100000+150000)/2                                                          1,75,000
June-(150000+150000)/2                                                          1,50,000
July- (150000+200000)/2                                                          1,75,000 August-(200000+210000)/2                                                      2,05,000 September- (210000+240000)/2                                               2,25,000 October- (240000+250000)/2                                                    2,45,000 November-(250000+250000)/2                                                 2,50,000 December-(250000+280000)/2                                                 2,65,000 January-(280000+300000)/2                                                     2,90,000 February-(300000+320000)/2                                                   3,10,000 March-(320000+350000)/2                                                       3,40,000 Total                                                                                     27,30,000 Period                                                                                      12 months
Annual average (2730000/12)                                2,27,500                            
2,275
Total disallowance under Section 14A read with Rule 8D1,02,275

Analysis of section 14A rule 8D

  1. Recording Satisfaction It is to be noted that as per the clause (2) of the section 14A, AO shall disallow expenditure in relation to the income which does not form part of the total income only after recording dissatisfaction of the correctness of the claim of expenditure made by the assessee in relation to the exempt income. According to the judgement of the High Court of Delhi in the case of PCIT vs. Vedanta Ltd. [2019] [102 taxmann.com 95], referring to the decision of Apex Court in Godrej & Boyce Manufacturing Company Ltd. has held that
    Rule 8D cannot be invoked and applied unless AO records his dissatisfaction regarding the correctness of claim made by assessee in relation to expenditure incurred to earn exempt income.
    Further, in the judgement of Honourable ITAT [Ahd Bench] in case of Alidhara Textool Engineers P. Ltd vs. DCIT[I.T. A. No. 2738/AHD/2011] for A.Y. 2008-09 dated 04.04.2016, wherein it was held that: “In  our  view,  Rule  8D  comes  into  operation  where  the  Assessing Officer is not satisfied in relation to income which does not form part of  the  total  income  under  this  Act  and  thereafter  if  the  Assessing Officer  is  unable  to  determine  the  amount  of  such  expenditure incurred in relation to the income which does not form part of the total income then he may resort to the method with prescribed in Rule 8D of  the  IT  Rules,  1962.  In  the  case  of  assessee  no  such  satisfaction has  been  recorded by  the  Assessing Officer  about the incorrectness of  the  claim  of  assessee  towards  expenditure  incurred  for  earning exempt  income.”

    Therefore, recording dissatisfaction by the AO is a necessary prerequisite for imposing Rule 8D.
  2. Rule 8D does not have any retrospective application As per the judgement of Supreme Court in case of Commissioner of Income-tax v. Essar Teleholdings Ltd. (2018) 401 ITR 445 (SC), Rule 8D does not have any retrospective application and it is applicable prospectively from A.Y. 2008-09. As a result, till AY 2008-09, disallowance cannot be made in accordance with Rule 8D but can be done as per the best judgment of the AO in accordance with the section 14A which has application from 1961.
  3. Disallowance cannot exceed exempt income: In the judgement of Honourable ITAT [Ahd Bench] in case of CLP India Pvt Ltd. Vs. DCIT[I.T.A No.: 1163 &1186/AHD/2018] it was held that assessee’s total dividend income is Rs. 50,000/-  so there cannot be disallowance of Rupees more than 50,000/-

    Further, as per the decision of High Court in case of CIT vs. Vision Finstock Ltd [I.T.A. No. 486 of 2017], it was held that “the assessee had earned exempt income of Rs. 55,604/-. As against that, the Assessing Officer had worked out the disallowance of expenditure under section 14A of the Act read with Rule 8D to Rs. 1,02,82,049/-. The Tribunal, while restricting the disallowance to Rs. 55,604/-, relied on the decision of Delhi High Court in case of Joint Investments (P) Ltd vs. CIT reported in 372 ITR 694 holding that disallowance of expenditure in terms of section 14A read with Rule 8D cannot exceed the exempt income itself.”

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