2025 (6) TMI 1481 - AT - Income Tax

Disallowance u/s 14A r/w rule 8D - as per DR assessee has though made suomoto disallowance which as per the assessee is directly related to earning such income however has failed to compute to disallowance in terms of rule 8D(2)(ii) of the I.T. Rules 1962 - HELD THAT - The language of section 14A is not at all ambiguous and in fact very clear and by virtue of the same only expenditure actually incurred in relation to income not includible in total income shall be disallowed. Therefore disallowance u/s 14A can be made only when assessee has actually earned exempt income. As observed above in the instant case the assessee has exempt income in the shape of Dividend and further admitted that the expenditure to the extent of Rs. 45.87 lacs were incurred to earn the exempt income which does not form part of total taxable income. Therefore in view of these facts the provisions of section 14A are applicable to the facts of the present case of the assessee. Sub-section 2 of section 14A provides the mode and manner of computing the disallowance according to which the mechanism is to be followed as provided in Rule 8D of the Rules. Rule 8D sub rule (1) the AO should record his dissatisfaction about the correctness of the claim of expenditure made by the assessee in relation to income which does not form part of total income and then he has to proceed to compute the amount of disallowance as provided in sub rule (2) of rule 8D. As observed above in the instant case the AO has duly recorded his dissatisfaction with regard to the suo-moto disallowance made by the assessee by issue of the show cause notice. As per the AO the provisions of rule 8D has been changed w.e.f. 02.06.2016 and thereafter as per the AO the provision of section rule 8D(2) are applicable. We find that it is an admitted position that out of total investment of Rs. 26400.88 crores only investments of Rs. 2437.37 crores earned exempt income of Rs. 210.4 crores as dividend. Once it is established that the AO is not satisfied with the claim of the assessee that the expenses shown under suo-moto disallowance are sufficient and correct with respect to the income earned not forming part of the total taxable income the provisions of sub rule (2) of rule 8D come into play according to which the cumulative figure of expenses directly relating to income which does not form part of total income and 1% of average of monthly value of investments should be the amount of disallowance. Computing the amount of disallowance in terms of rule 8D(2)(ii) - Delhi Special Bench of ITAT in the case of Vireet Investments P Ltd 2017 (6) TMI 1124 - ITAT DELHI and Crago Motors Pvt. Ltd. 2022 (10) TMI 571 - DELHI HIGH COURT that the investments which have yielded exempt income should only be considered for the purpose of computing the amount of disallowance in terms of rule 8D(2)(ii) of the Income Tax Rules 1962. Thus by respectfully following the judgement s supra we accept the alternative prayer of the assessee and direct the AO to recompute the amount of disallowance u/s 14A by considering those only investments which yielded exempt income. Appeal of the assessee is partly allowed.

Summary

The core legal questions considered in this appeal revolve around the disallowance made under section 14A of the Income Tax Act, 1961 read with Rule 8D of the Income Tax Rules, 1962. Specifically, the issues are:

1. Whether the Assessing Officer (AO) was justified in making a disallowance of Rs. 147,63,92,907/- under section 14A read with Rule 8D despite the assessee having suo-moto disallowed Rs. 45,87,471/- as expenses related to exempt income.

2. Whether the AO recorded the requisite satisfaction as mandated under Rule 8D(1) before invoking the provisions for disallowance under section 14A.

3. Whether the disallowance under section 14A and Rule 8D should be computed considering the entire investment portfolio or only those investments which yielded exempt income.

4. The applicability and interpretation of section 14A and Rule 8D in the context of the facts of the case, including the nature of investments and the source of funds utilized.

Regarding the first issue, the legal framework is section 14A of the Income Tax Act, which disallows expenditure incurred in relation to income not includible in total income, and Rule 8D which prescribes the method for determining the amount of such expenditure. The AO disallowed Rs. 147.63 crore under section 14A, rejecting the assessee's suo-moto disallowance of Rs. 45.87 lacs. The AO's reasoning was that the assessee's claim was not correct and insufficient to cover the expenses related to exempt income. The AO issued a show cause notice and recorded detailed satisfaction about the inadequacy of the assessee's claim, thus complying with the procedural requirement under Rule 8D(1). The assessee contended that the suo-moto disallowance was adequate and the AO failed to record proper satisfaction before making further disallowance. The Tribunal examined the AO's order and found that the AO had indeed recorded his dissatisfaction and issued a show cause notice, thereby fulfilling the statutory mandate. The Tribunal also noted that the assessee itself admitted to having incurred expenses related to exempt income and had made a suo-moto disallowance accordingly, which negated the claim that no such expenses were incurred.

On the second issue concerning the requirement of recording satisfaction by the AO, the Tribunal referred to the provisions of Rule 8D(1), which mandate that the AO must be dissatisfied with the correctness of the assessee's claim or the claim that no expenditure was incurred before determining the disallowance under Rule 8D(2). The Tribunal found that the AO had duly recorded his dissatisfaction in the assessment order and issued a show cause notice proposing the disallowance. This was held sufficient to satisfy the procedural requirement of Rule 8D(1). The Tribunal relied on the Supreme Court ruling in Maxopp Investment Ltd v. CIT, which clarified that the AO's jurisdiction to determine the amount of expenditure under section 14A arises only upon dissatisfaction with the assessee's claim.

The third issue relates to the quantum of investments to be considered for computing disallowance under Rule 8D(2)(ii). The AO computed disallowance on the basis of the entire investment portfolio of Rs. 26,400.88 crores, whereas the assessee argued that only investments yielding exempt income of Rs. 2,437.37 crores should be considered. The Tribunal examined relevant precedents, including the Delhi Special Bench ITAT decision in Vireet Investments P Ltd and the jurisdictional High Court ruling in Crago Motors Pvt. Ltd. Vs. DCIT, both of which held that only those investments which have yielded exempt income should be considered for the purpose of disallowance under Rule 8D(2)(ii). Respectfully following these precedents, the Tribunal directed the AO to recompute the disallowance considering only the investments yielding exempt income.

In its detailed analysis, the Tribunal emphasized that section 14A applies only when there is income exempt from tax and expenditure incurred in relation to such exempt income. The Tribunal noted that the assessee had declared exempt dividend income of Rs. 210.4 crores and admitted to expenses directly relatable to earning such income. The Tribunal observed that the AO's invocation of Rule 8D was therefore justified. However, the AO's application of the formula to the entire investment portfolio was not in consonance with the settled legal position, which restricts the disallowance to investments yielding exempt income.

The Tribunal also addressed the assessee's contention that no borrowed funds were used for investments and hence no disallowance should be made. The Tribunal found this argument inapplicable since the AO's disallowance was not premised on borrowed funds but on the overall expenses related to exempt income, which the assessee itself admitted partly by suo-moto disallowance.

Regarding competing arguments, the Tribunal gave due weight to the AO's detailed satisfaction and show cause proceedings, rejecting the assessee's claim of procedural lapses. Simultaneously, it accepted the assessee's alternative plea on the quantum of investments for disallowance computation, aligning with judicial precedents. The Tribunal thus balanced the need for procedural compliance by the AO with the substantive correctness of disallowance quantum.

The significant holdings established by the Tribunal include the following:

"The AO having recorded his dissatisfaction with the correctness of the claim of the assessee and having issued a show cause notice, has complied with the requirement of Rule 8D(1) and is entitled to compute disallowance under Rule 8D(2)."

"Disallowance under section 14A read with Rule 8D can be made only when the assessee has earned exempt income and incurred expenditure in relation thereto."

"For computing disallowance under Rule 8D(2)(ii), only those investments which have yielded exempt income should be considered, as held by the Delhi Special Bench ITAT and the jurisdictional High Court."

"The suo-moto disallowance made by the assessee does not preclude the AO from making further disallowance if he is not satisfied with the correctness of the claim."

In conclusion, the Tribunal partly allowed the appeal by directing the AO to recompute the disallowance under section 14A considering only the investments yielding exempt income, while upholding the AO's jurisdiction and satisfaction recorded for making the disallowance. This nuanced approach preserves the statutory intent of section 14A and Rule 8D, ensuring that disallowance is fair, justified, and legally sustainable.