2025 (6) TMI 1711 - AT - Income Tax

Disallowance u/s 14A read with Rule 8D - exempt income to be earned in the relevant year for invoking disallowance - HELD THAT - CIT (A) has rightly directed the ld. AO to verify and recompute the disallowance u/s 14A read with Rule 8D of the Rules considering only those investments which have yielded exempt income during the year. MAT computation - Disallowance u/s. 14A rwr 8D is a notional disallowance and cannot be imported while computing book profit u/s. 115JB.

Summary

The core legal questions considered in this appeal pertain primarily to the correctness of the disallowance made under section 14A read with Rule 8D of the Income Tax Rules, 1962, specifically:

• Whether the disallowance under section 14A read with Rule 8D should be computed on the entire investment or only on those investments yielding exempt income during the relevant financial year;
• The applicability and interpretation of CBDT Circular No. 5/2014 dated 11.02.2014 in relation to the disallowance under section 14A;
• Whether the disallowance under section 14A read with Rule 8D can be imported while computing book profit under section 115JB of the Income Tax Act;
• The correctness of the appellate order directing the Assessing Officer (AO) to recompute the disallowance considering only investments yielding exempt income;
• The legal effect of section 115JB(2) and Explanation 1 clause (f) concerning the addition of expenditure relatable to exempt income in the computation of book profit.

Issue-wise detailed analysis:

1. Computation of disallowance under section 14A read with Rule 8D:

The legal framework governing this issue involves section 14A of the Income Tax Act, which disallows expenditure incurred in relation to income exempt from tax, and Rule 8D of the Income Tax Rules, which provides a methodology for computing such disallowance. The CBDT Circular No. 5/2014 clarifies that the term "income under the Act" in section 14A does not require exempt income to be earned in the relevant year for invoking disallowance.

The Revenue contended that the Assessing Officer rightly made disallowance on the entire investments appearing in the books, amounting to Rs.6,07,60,388/-, based on CBDT Circular No. 5/2014. The Revenue argued that the disallowance is not contingent on the assessee having earned exempt income during the year.

Conversely, the assessee and the CIT(A) held that disallowance should be restricted to investments actually yielding exempt income during the year. The assessee pointed out that the AO included investments that did not generate exempt income, including strategic investments in subsidiaries and group companies, which should be excluded. The CIT(A) directed the AO to recompute the disallowance accordingly.

The Tribunal examined relevant precedents, including coordinate Bench decisions in the assessee's own case for AY 2013-14 and others, which held that for Rule 8D computation, only investments yielding exempt income during the year should be considered. The Tribunal noted that the assessee had earned exempt income of Rs.31,50,337/- from interest on certain bonds but no exempt dividend or LTCG.

The Tribunal relied on the detailed calculation methodology affirmed in prior decisions, which involved computing the average value of investments that actually generated exempt income and applying the prescribed percentage to determine disallowance. The Tribunal found no infirmity in the CIT(A)'s direction to restrict disallowance to the proportionate investments yielding exempt income.

2. Applicability of CBDT Circular No. 5/2014:

The Revenue relied heavily on the Circular's clarification that disallowance under section 14A is not dependent on the assessee having earned exempt income in the relevant year. However, the Tribunal distinguished the Circular's general principle from the specific facts of the case, emphasizing that the Circular does not override judicial precedents which require the disallowance to be proportionate to exempt income actually earned, especially in the context of Rule 8D computations.

The Tribunal noted that the Circular's language about "income under the Act" and the heading to section 14A does not mandate disallowance on investments unrelated to exempt income. The Tribunal upheld the approach of considering only those investments that yielded exempt income for the purpose of disallowance calculation.

3. Disallowance under section 14A read with Rule 8D vis-`a-vis computation of book profit under section 115JB:

The Revenue challenged the CIT(A)'s order holding that disallowance under section 14A read with Rule 8D should not be imported while computing book profit under section 115JB. The Revenue argued that clause (f) of Explanation 1 to section 115JB requires addition of expenditure relatable to exempt income, and hence disallowance under section 14A should be added back.

The Tribunal examined the statutory language of section 115JB(2) and Explanation 1, noting that book profit is computed based on net profit as per the Profit & Loss Account prepared under the Companies Act. The Tribunal emphasized that section 115JB is a deeming provision and must be strictly construed.

It was held that only the disallowance under section 14A(1) can be imported into clause (f) of Explanation 1, and the disallowance computed under Rule 8D, which is a notional disallowance, cannot be imported into book profit computation under section 115JB. The Tribunal relied on binding precedent from the Apex Court which held that book profit computation under section 115JB is governed by Schedule VI of the Companies Act and disallowances under section 14A read with Rule 8D are not to be added back.

The Tribunal also referred to coordinate Bench decisions which had settled this issue, thereby rejecting the Revenue's contention and affirming the CIT(A)'s order.

4. Treatment of strategic investments and exempt income:

The Tribunal noted that investments in subsidiaries or group companies are strategic and should not be considered for disallowance under section 14A. The AO's indiscriminate inclusion of all investments without regard to their nature or yield of exempt income was found to be erroneous.

The Tribunal relied on the assessee's audited accounts and prior orders to confirm that only investments yielding exempt income should be considered for disallowance. This approach aligns with judicial precedents and the principle that disallowance must be proportionate and not arbitrary.

5. Delay in filing appeal:

Though procedural, the Tribunal condoned the delay of 60 days in filing the appeal by the Revenue, emphasizing the principle that cases should be decided on merits rather than technicalities. This allowed the Tribunal to proceed with the substantive issues without being barred by procedural delays.

Conclusions:

The Tribunal dismissed the Revenue's appeal, affirming the CIT(A)'s order which:

• Directed the AO to recompute the disallowance under section 14A read with Rule 8D considering only those investments that yielded exempt income during the year;
• Held that disallowance under section 14A read with Rule 8D is a notional disallowance and cannot be imported while computing book profit under section 115JB;
• Rejected the Revenue's reliance on CBDT Circular No. 5/2014 to justify disallowance on all investments irrespective of exempt income earned;
• Confirmed that strategic investments in subsidiaries or group companies are not subject to disallowance under section 14A;
• Condoned the delay in filing the appeal to ensure adjudication on merits.

Significant holdings include the Tribunal's verbatim reasoning that "The disallowance u/s. 14A rwr 8D of IT Rules, 1962 is a notional disallowance and cannot be imported while computing book profit u/s. 115JB" and that "Section 115JB being a deeming provision, the clauses contained therein has to be strictly construed."

Further, the Tribunal upheld the principle that disallowance under section 14A read with Rule 8D must be computed only on those investments which have yielded exempt income during the year, consistent with judicial precedents and coordinate Bench decisions.