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2025 (5) TMI 2043 - AT - Income TaxAddition u/s 14A read with Rule 8D - amount of exempt income earned - whether the disallowance u/s 14A read with Rule 8D can exceed the exempt income that has been earned by the assessee? HELD THAT - We find in the case of PCIT vs. HSBC Invest Direct (India) Ltd. 2019 (2) TMI 731 - BOMBAY HIGH COURT following the decision of Cheminvest Limited 2015 (9) TMI 238 - DELHI HIGH COURT and in the case of CIT vs. Holcim India (P) Ltd. 2014 (9) TMI 434 - DELHI HIGH COURT has held that the disallowance u/s 14A cannot exceed the exempt income earned. Similarly in the case of Nirved Traders Pvt. Ltd. 2019 (4) TMI 1738 - BOMBAY HIGH COURT has held that the disallowance u/s 14A read with Rule 8D cannot exceed the assessee s exempt income. Since the assessee in the instant case has admittedly earned the exempt income of only Rs. 2, 000/- therefore the disallowance u/s 14A read with Rule 8D cannot exceed the exempt income. Appeal filed by the assessee is allowed.
The core legal question considered in this appeal is whether the disallowance under section 14A of the Income Tax Act, 1961, read with Rule 8D of the Income Tax Rules, 1962, can exceed the amount of exempt income earned by the assessee during the relevant assessment year.
The issue arises from the Assessing Officer's addition of Rs. 40,53,508/- as disallowance under section 14A, which was sustained partially by the Commissioner of Income Tax (Appeals) / NFAC, who directed a disallowance of Rs. 8,61,197/-. The assessee contended that since it earned only Rs. 2,000/- as exempt income, the disallowance could not exceed this amount, relying on judicial precedents. Issue-wise Detailed Analysis: 1. Applicability and Extent of Disallowance under Section 14A read with Rule 8D Relevant Legal Framework and Precedents: Section 14A prohibits deduction of expenditure incurred in relation to income that does not form part of total taxable income, i.e., exempt income. Rule 8D provides a methodology for computing such disallowance where direct expenditure is not ascertainable. Several High Court decisions were cited, notably:
Court's Interpretation and Reasoning: The Tribunal examined the facts that the assessee had substantial investments in shares and securities but earned only Rs. 2,000/- as exempt income. The Assessing Officer had disallowed Rs. 40,53,508/-, and the CIT(A) directed a disallowance of Rs. 8,61,197/-, both exceeding the exempt income. Relying on the consistent judicial trend, the Tribunal concluded that disallowance under section 14A cannot exceed the exempt income earned. The rationale is grounded in principles of financial prudence and proportionality, preventing arbitrary or excessive disallowances unrelated to the actual exempt income. Key Evidence and Findings: Both the Assessing Officer and CIT(A) agreed that exempt income was only Rs. 2,000/-. The assessee had already disallowed this amount suo motu in its return. There was no dispute on this factual finding. Application of Law to Facts: Given the minimal exempt income, the Tribunal held that any disallowance exceeding Rs. 2,000/- was unwarranted. The Assessing Officer's and CIT(A)'s disallowances were therefore set aside to the extent they exceeded the exempt income. Treatment of Competing Arguments: The Department relied on the orders below and the formula in Rule 8D to justify higher disallowance. The assessee relied on binding High Court precedents limiting disallowance to the exempt income amount. The Tribunal favored the latter, emphasizing adherence to judicial precedents and the principle that disallowance must be rationally connected to exempt income. 2. Scope of Rule 8D Computation and Burden on Assessing Officer Relevant Legal Framework and Precedents: Rule 8D provides a mechanism to compute disallowance when direct expenditure on exempt income cannot be identified. Courts have held that the assessing authority must undertake the computation and cannot delegate this responsibility to the assessee. Court's Interpretation and Reasoning: The Tribunal noted the Karnataka High Court's observation that the assessing authority must compute disallowance based on facts and figures from the books of accounts and cannot rely on guesswork or abdicate its duty. Application of Law to Facts: The Assessing Officer had made a large disallowance without a clear nexus to the exempt income or detailed computation. The Tribunal implied that such disallowance lacked a rational basis and was contrary to settled legal principles. 3. Relationship Between Exempt Income and Expenditure Disallowance Relevant Legal Framework and Precedents: The principle that expenditure disallowance under section 14A must be proportionate to exempt income is well-established. This ensures fairness and prevents penalizing the assessee beyond the income that is exempt. Court's Interpretation and Reasoning: The Tribunal reiterated that disallowance must have a "reasonable and close nexus" with the exempt income. Disallowance exceeding exempt income is "per se absurd and hypothetical" as per Karnataka High Court. Application of Law to Facts: Since exempt income was only Rs. 2,000/-, the Tribunal held that disallowance cannot be Rs. 8,61,197/- or Rs. 40,53,508/- as assessed below. Conclusions: The Tribunal concluded that the disallowance under section 14A read with Rule 8D cannot exceed the exempt income earned by the assessee. Since the exempt income was Rs. 2,000/-, and the assessee had already disallowed this amount, further disallowance was unwarranted. The orders of the Assessing Officer and CIT(A) / NFAC were set aside to this extent, and the appeal was allowed. Significant Holdings: "It is an admitted fact that the total exempt income received by the assessee during the year is only Rs. 2,000/-. This finding of fact was given by the Assessing Officer as well as the Ld. CIT(A) / NFAC and there is no dispute to the same. Under these circumstances, we have to see as to whether the disallowance u/s 14A read with Rule 8D can exceed the exempt income that has been earned by the assessee." "Having heard the learned Counsel for the parties and having perused the documents on record, consistently different High Courts in the country have taken a view that the disallowance under Section 14A of the Act read with Rule 8D of the Rules cannot exceed the Assessee's exempt income." "We do not find any error in the view of the Tribunal. We record that the assessee had offered voluntary disallowance of expenditure of Rs. 1.30 crores, which is not been disturbed by the Tribunal." (citing similar principles) "Since the assessee in the instant case has admittedly earned the exempt income of only Rs. 2,000/-, therefore, the disallowance u/s 14A read with Rule 8D cannot exceed the exempt income. We, therefore, set aside the order of the Ld. CIT(A) / NFAC and direct the Assessing Officer to delete the addition made by him since the assessee has already suo motu disallowed an amount of Rs. 2,000/-." Core Principles Established:
Final Determinations:
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