2025 (6) TMI 1710 - AT - Income Tax

Disallowance u/s 14A - disallowance of expenses incurred in relation to exempt income - HELD THAT - We have taken note of the fact that the AO has not given any reasoning for rejecting the assessee s suo-moto working of disallowance u/s 14A of the Act. As contended that the AO could not enhance the disallowance u/s 14A of the Act without recording any reason for rejecting the assessee s working of disallowance u/s 14A of the Act. We find that this case is squarely covered by the decision of the Co-ordinate Bench in assessee s own case 2024 (5) TMI 1584 - ITAT DELHI and the decision of Jaypee Ventures Pvt. Ltd. 2018 (1) TMI 1759 - DELHI HIGH COURT . We therefore respectfully following the decision of (supra) we are inclined to delete the disallowance u/s 14A confirmed by the CIT(A). Thus we order accordingly and allow the respective grounds raised by the assessee. The assessee gets consequential relief in this regard. Appeal of assessee is allowed.

Summary

The core legal issue considered in this appeal pertains to the validity and extent of disallowance under Section 14A of the Income Tax Act, 1961, specifically regarding the disallowance of expenses incurred in relation to exempt income. The principal questions were:

• Whether the Assessing Officer (AO) was justified in making a disallowance of Rs. 7,42,37,499/- under Section 14A without providing reasons for rejecting the assessee's suo-moto disallowance of Rs. 26,06,419/-.
• The applicability and mandatory nature of Rule 8D of the Income Tax Rules, 1962 in computing disallowance under Section 14A.
• The appropriate quantum of disallowance under Section 14A, particularly whether it should be limited to the expenses claimed in the Profit & Loss Account or linked to the exempt income earned.
• Whether the disallowance under Section 14A can exceed the amount of exempt income or the investment yielding such income.

Issue-wise Detailed Analysis

1. Justification and Reasoning for Disallowance under Section 14A

The legal framework governing disallowance under Section 14A mandates that expenses incurred in relation to income which does not form part of the total income (exempt income) are to be disallowed. The AO initially computed a disallowance of Rs. 12,39,14,341/- applying Rule 8D but restricted it to Rs. 7,68,43,918/- as per expenses claimed in the Profit & Loss Account. The AO further reduced this by the assessee's suo-moto disallowance of Rs. 26,06,419/-, resulting in a net disallowance of Rs. 7,42,37,499/-. However, the AO failed to provide any reasoned rejection of the assessee's suo-moto calculation.

The Court noted that the AO's failure to record reasons for rejecting the assessee's own working of disallowance violated principles of natural justice and procedural fairness. Precedents emphasize that the AO must provide cogent reasons while enhancing disallowance beyond the assessee's computation. The absence of such reasoning rendered the AO's disallowance unsustainable.

2. Applicability and Mandatory Nature of Rule 8D

Rule 8D prescribes a methodology for computing disallowance under Section 14A. However, reliance was placed on Supreme Court decisions which clarified that application of Rule 8D is not mandatory but only a guiding principle. The Court observed that in cases where no purchase or sale of investments occurred during the relevant year, the strict application of Rule 8D may not be appropriate.

In the present case, the investments were longstanding in group concerns with no transactions during the year. Dividend income of Rs. 4,35,00,600/- was received from a group company. The Court found that the assessee's suo-moto disallowance calculation was reasonable and sufficient under these circumstances.

3. Quantum of Disallowance and Its Relation to Exempt Income and Investment

The CIT(A) had restricted the disallowance to the extent of exempt income of Rs. 4,35,00,000/-, following the Delhi High Court decision in Caraf Builders & Constructions (P) Ltd. The assessee argued that disallowance should not exceed the investment yielding exempt income, citing the dividend income and the corresponding investment of Rs. 395.46 crores, suggesting a disallowance capped at 1% of the investment.

The Court, referencing the coordinate bench's earlier ruling and the Delhi High Court's judgment in Jaypee Ventures Pvt. Ltd., held that the disallowance under Section 14A should be reasonable and linked to the exempt income. It should not be arbitrarily enhanced without justification, nor exceed the amount of exempt income or the investment generating such income.

4. Treatment of Competing Arguments

The Departmental Representative argued vehemently for dismissal, supporting the AO's disallowance. However, the Court found the Department's arguments unpersuasive in light of the AO's failure to provide reasons and the binding precedents favoring the assessee's approach. The Court accorded greater weight to the principle that disallowance must be justifiable, proportionate, and supported by evidence.

Conclusions

The Court concluded that the disallowance of Rs. 4,35,00,600/- under Section 14A, as confirmed by the CIT(A), was not sustainable. The AO's disallowance without reasoned rejection of the assessee's suo-moto computation was improper. The Court, following authoritative precedents, deleted the disallowance to the extent of exempt income and allowed the appeal.

Significant Holdings

"The AO has not given any reasoning for rejecting the assessee's suo-moto working of disallowance of Rs. 26,06,419/- under section 14A of the Act. Further, it was contended that the AO could not enhance the disallowance under section 14A of the Act without recording any reason for rejecting the assessee's working of disallowance under section 14A of the Act."

"We find that this case is squarely covered by the decision of the Co-ordinate Bench in assessee's own case in ITA no. 1484/Del/2023 (supra) and the decision of the Hon'ble Delhi High Court in the case of Jaypee Ventures Pvt. Ltd. in ITA No. 75/2018 order dated 23.01.2018. We therefore, respectfully following the decision of Hon'ble Delhi High Court in the case of Jaypee Ventures Pvt. Ltd. (supra) and the decision of the Co-ordinate Bench in assessee's own case (supra), we are inclined to delete the disallowance of Rs. 4,35,00,600/- under section 14A of the Act confirmed by the Ld. CIT(A)."

Core principles established include the necessity for the AO to provide reasoned justification when enhancing disallowance under Section 14A, the non-mandatory nature of Rule 8D, and the proportionality of disallowance to exempt income or the investment yielding such income.

Final determination was in favor of the assessee, deleting the disallowance under Section 14A to the extent of Rs. 4,35,00,600/-, thereby allowing the appeal and granting consequential relief.