2015 (3) TMI 155 - HC - Income Tax

Disallowance u/s 14A read with Rule 8D - assessee volunteered sum attributable u/s 14A for the purpose of disallowance - AO on the basis of his own understanding of Rule 8D of the Income Tax Rules disallowed the sum - Held that - In the present case, the AO has not firstly disclosed why the appellant/assessee s claim for attributing disallowance under Section 14A had to be rejected. In Taikisha 2014 (12) TMI 482 - DELHI HIGH COURT 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. 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. Third, and in the opinion of this court, important anomaly which we cannot be unmindful is that whereas the entire tax exempt income is ₹ 48,90,000/-, the disallowance ultimately directed works out to nearly 110% of that sum, i.e., ₹ 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. Thus the impugned order of the ITAT is set aside. The question of law is answered in favour of the assessee.

Summary

Issues:
1. Disallowance under Rule 8D of the Income Tax Rules.
2. Interpretation of Section 14A and Rule 8D.
3. Validity of disallowance amounting to entire tax-exempt income.

Analysis:
1. The assessee challenged the order of the Income Tax Appellate Tribunal (ITAT) regarding disallowances made under Rule 8D of the Income Tax Rules. The assessee reported a loss but declared tax-exempt income from dividends. The Assessing Officer (AO) disallowed a sum under Section 14A based on Rule 8D, which the assessee contested at various levels without success. The ITAT upheld the disallowance, considering different components and the total amount disallowed. The ITAT concluded that no relief was due to the assessee from the disallowance made by the AO.

2. The counsel for the assessee argued that the ITAT, AO, and CIT (A) overlooked the mandate of Section 14A, especially Section 14A(2). It was contended that the AO should have first considered the voluntary disallowance made by the assessee before proceeding under Section 14A(3) with Rule 8D(2). The Revenue's counsel defended the interpretation of Rule 8D by the ITAT and CIT (A).

3. The Court referred to a previous judgment highlighting the importance of examining the assessee's claims with reference to accounts before proceeding to Rule 8D. In this case, the AO did not disclose reasons for rejecting the assessee's voluntary disallowance. The Court noted that there was no scrutiny of the accounts by the AO, a crucial aspect overlooked by the lower authorities. Additionally, the Court found that the disallowance amounting to nearly 110% of the tax-exempt income was excessive and not in line with the provisions of Section 14A and Rule 8D. Consequently, the Court set aside the ITAT's order, ruled in favor of the assessee, and remitted the matter to the AO for fresh consideration in accordance with the directions provided. The initiation of penalty proceedings was also set aside, and the appeal was partly allowed.