The Bombay High Court has recently admitted a writ petition that challenges an Income-Tax rule allowing the taxation of expenditure incurred on earning tax-free income like dividends and long-term capital gains. The writ petition was filed by Technocraft Industries India, a Mumbai-based exporter, along with Indian Exporters Grievance Forum, a body under the Federation of Indian Export Organisations (FIEO). The final hearing of the matter is slated for February 15.

The specific rule challenged in the court, according to the petitioners, stipulates a stringent structure for taxing expenditure related to earning income that is exempt from taxation.

This rule Rule 8 D of section 14 A of the Income-Tax Act also authorises an assessing officer to use a formula for computing expenditure incurred on earning the tax-free income if he is not satisfied with the declaration of the taxpayer. Section 14 A provides for taxing the expenditure related to earning the income thats exempt from taxation.

The petitioner stated that at times the rule leads to situations in which a disproportionately huge expenditure incurred on earning a small income was brought into the tax net. In the process, the benefit derived by the taxpayer by earning income which is exempt from taxation is substantially reduced and even leads to double taxation.

Elaborating its stand, the petitioner said when it had earned tax exempt dividend from surplus not borrowed funds and which did not form part of the total income, the assessing officer (AO) could not consider the value of those investments on which no tax-exempt dividend was earned. For instance, the AO could not consider as expenditure the interest that the company paid on loans taken for purposes other than earning tax-free dividend.

Rule 8 D is not a procedural provision but a substantive provision on parity with a charging section as it disallows expenditure whose tax effect may be much more than the tax on the dividend as explained above, stated the petitioner.

The petitioners forum represented by Pankaj R Toprani, stated in the writ petition that Rule 8 is against the basic principle of taxation which allows levy of tax calculated as gross income minus expenditure. This specific rule is tantamount to double taxation, the petitioner contended.