THE issue before the Bench is - Whether, for the purpose of Sec 14A read with Rule 8D, there can be a situation where disallowance of expenditure can entirely swallow the entire tax exempt income. NO is the answer.
Facts of the case
The assessee is engaged in diverse investment activities and in the course of its business derives income from rent, sale of investments, dividend and interest. For AY 2009-10, it reported a loss of Rs.52,56,197/-. It had declared tax exempt income in the form of dividend to the tune of Rs.48,90,000/-. The assessee volunteered Rs.2,97,440/- as attributable u/s 14A for the purpose of disallowance. The AO on the basis of his own understanding of Rule 8D disallowed the sum of Rs.52,56,197/- u/s 14A read with Rule 8D. The assessee’s grievance was that the entire tax exempt income was lower than the disallowance.
On appeal, both CIT(A) and Tribunal had dismissed the assessee's contentions. Tribunal had observed that from the working of disallowance by AO which was already reproduced earlier in the order, it would be evident that all those expenses had not been considered by AO. In Part (i), AO had considered Rs.2,97,440/- which assessee himself had admitted as a direct expenditure incurred for earning exempt income, viz., securities, transaction tax, depository charges and custodian fees. In Part (ii), only the interest had been considered and in Part (iii), half per cent of average investment had been considered. Therefore, these expenses which assessee claimed to have been not incurred for earning of exempt income had not been considered by the AO at all. The assessee had also disputed the correctness of the disallowance of interest at Rs.34,08,582/-. The assessee's counsel had not disputed the value of investment as taken by AO for the purpose of computing the disallowance at half per cent as provided by Rule 8D(2)(iii). The disallowance at half per cent of the investment was Rs.65,36,743/- while finally, the AO restricted the disallowance to Rs.52,56,197/-. Therefore, whether the working of the disallowance of interest as per Rule 8D(2)(ii) was correct or not was of academic interest and, therefore, Tribunal did not go into the details of the assessee's arguments with regard to the correctness of the disallowance of interest. Finally, AO restricted the disallowance to Rs.52,56,197/-. Therefore, in Tribunal's opinion, no relief was due to the assessee from the disallowance made by AO at Rs.52,56,197/-.
Held that,
++ the Court in Taikisha Engineering highlighted the necessity in view of the peculiar wording of Section 14A (2) that computation or disallowance of the assessee, or claim that no expenditure was incurred for earning exempt income should be examined with reference to the accounts and only if the assessee’s explanation is unsatisfactory, can the AO proceed further. In that case it was pertinently observed that Section 14A(2) and Rule 8D(1) in unison and affirmatively record that the computation or disallowance made by the assessee or claim that no expenditure was incurred to earn exempt income must be examined with reference to the accounts, and only and when the explanation/claim of the assessee is not satisfactory, computation under sub Rule (2) to Rule 8D of the Rules is to be made. It was therefore observed that there was no need to go on to sub Rule (2) to Rule 8D of the Rules until and unless the AO has first recorded the satisfaction, which is mandated by sub Section (2) to Section 14A and sub Rule (1) to Rule 8D of the Rules;
++ in the present case, the AO has not firstly disclosed why the appellant/assessee’s claim for attributing Rs.2,97,440/- as a disallowance u/s 14A had to be rejected. Taikisha says that the jurisdiction to proceed further and determine amounts is derived after examination of the accounts and rejection if any of the assessee’s claim or explanation. The second aspect is there appears to have been no scrutiny of the accounts by the AO - an aspect which is completely unnoticed by the CIT (A) and the ITAT. The third, and in the opinion of HC, important anomaly which we cannot be unmindful is that whereas the entire tax exempt income is Rs.48,90,000/-, the disallowance ultimately directed works out to nearly 110% of that sum, i.e., Rs.52,56,197/-. By no stretch of imagination can Section 14A or Rule 8D be interpreted so as to mean that the entire tax exempt income is to be disallowed. The window for disallowance is indicated in Section 14A, and is only to the extent of disallowing expenditure “incurred by the assessee in relation to the tax exempt income”. This proportion or portion of the tax exempt income surely cannot swallow the entire amount as has happened in this case. For the above reasons, the impugned order of the ITAT is set aside. The question of law is answered in favour of the assessee. Consequently, order of the AO is set aside. The initiation of penalty proceedings also is set aside. The matter is remitted to the AO for fresh consideration in accordance with the above directions. The appeal is partly allowed.
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