2014 (6) TMI 705 - AT - Income Tax

Disallowance u/s 14A of the Act Held that - Following Godrej Boyce Mfg. Co. Ltd. vs. DCIT 2010 (8) TMI 77 - BOMBAY HIGH COUR - Rule 8D of the Income Tax Rules is applicable only prospectively i.e., from AY 2008-09- The AY pertaining to the case in hand is 2006-07 to which the Rule is not applicable - the authorities below are not justified in making the disallowance by invoking Rule 8D of the Income Tax Rules. Disallowance out of the interest expenses Held that - Borrowings have actually been reduced though investments have significantly increased - the own funds of the assessee is sufficient to cover the investments - the authorities are not justified in disallowing out of expenditure involved on account of interest. Percentage of the exempt income can constitute a reasonable estimate for making disallowance in the years earlier to the AY 2008-09 - disallowance ranges between 2 to 5 percentage of the dividend income thus, it would be just and reasonable that 2% of the exempt income would constitute a reasonable disallowance on account of indirect expenses for earning the exempt income u/s 14A of the Act Decided in favour of Assessee.

Summary

Issues Involved:
Disallowance under section 14A of the Income Tax Act for assessment year 2006-07.

Detailed Analysis:

1. Disallowance under Section 14A:
The appeal was filed against the order confirming the disallowance of Rs.2,27,22,918/- under section 14A of the Income Tax Act. The assessee, a company, had made investments in shares and mutual funds, earning dividend income. The AO required justification for not making disallowance under section 14A. The AO disallowed the amount based on Rule 8D of the Income Tax Rules. The Ld. CIT(A) upheld the disallowance. However, the ITAT held that Rule 8D is applicable only from Assessment Year 2008-09, not for 2006-07. Therefore, the disallowance was not justified based on Rule 8D.

2. Interest Expenditure Disallowance:
Regarding the disallowance of Rs.43,76,918/- for interest expenditure, it was noted that the borrowings had reduced during the year, and the own funds were sufficient to cover the investments. The ITAT found the disallowance unjustified as the facts did not support the disallowance of interest expenditure.

3. Indirect Expenses Disallowance:
The disallowance of Rs.1,83,46,000/- for indirect expenses was also challenged. The AO used Rule 8D for calculation, which was upheld by the Ld. CIT(A). The ITAT acknowledged that Rule 8D was not applicable for the year in question but emphasized the need for a reasonable method for disallowance. Considering various arguments, the ITAT determined that 2% of the exempt income would be a reasonable disallowance for indirect expenses. Thus, the appeal was allowed for statistical purposes.

In conclusion, the ITAT ruled in favor of the assessee, stating that the disallowance under section 14A was not justified based on Rule 8D for the assessment year 2006-07. The disallowance of interest expenditure and indirect expenses was also deemed unjustified, with the ITAT determining a reasonable disallowance percentage for indirect expenses.