2022 (10) TMI 571 - HC - Income Tax

Disallowance u/s 14A r.w.r. 8D - ITAT confirming the disallowance made under Rule 8D not restricting the disallowance to 0.5% of those investment only where the assessee had earned exempt income - HELD THAT - While Section 14A is the charging Section, Rule 8D is a method/mechanism to determine the amount of expenditure incurred in relation to income, which does not form part of the total income of the assessee. By virtue of the charging Section, namely, Section 14A, the Assessing Officer has the power only to determine the amount of expenditure incurred in relation to such income which does not form part of the total income under the Act. This Court is further of the view that Rule 8D(2)(iii) clearly postulates that in the calculation of the disallowance amount, an amount equal to onehalf percent of the value of the investment, income from which does not or shall not form part of the total income should be taken into consideration. Thus, it is not all investment but only that which is expressly spelt out in Rule 8D(2)(iii) read with Section 14A and Rule 8D(i) which is to be reckoned for the purpose of calculation of average of half percent. Only those investments are to be considered for computing average value of investments which yielded exempt income during the relevant assessment year. The question of law is answered in favour of the appellant-assessee, as this Court is of the view that the ITAT has erred in confirming the disallowance made under Rule 8D by not restricting the disallowance to 0.5% of those investment only where the assessee had earned exempt income.

Issues Involved:
1. Disallowance under Section 14A of the Income Tax Act, 1961.
2. Application of Rule 8D for computing disallowance.
3. Interpretation of investments yielding exempt income.
4. Validity of CBDT Circular No.5/2014.

Detailed Analysis:

Disallowance under Section 14A of the Income Tax Act, 1961:
The appellant challenged the ITAT's order upholding the disallowance of Rs.6,05,176/- under Section 14A of the Income Tax Act, 1961. The disallowance was made by the Assessing Officer (AO) using Rule 8D, which the appellant contended should be restricted to 0.5% of investments that yielded exempt income.

Application of Rule 8D for Computing Disallowance:
The AO computed the disallowance by applying 0.5% of the total average investments, rather than only those investments that yielded dividend income. This was upheld by the CIT(A) and the ITAT. The appellant argued that disallowance should be limited to investments that generated exempt income, citing various judicial precedents.

Interpretation of Investments Yielding Exempt Income:
The court held that only those investments which yielded exempt income during the relevant assessment year should be considered for computing the average value of investments under Rule 8D. The court referenced several judgments, including ACB India Limited vs. Assistant Commissioner of Income Tax and Pr. Commissioner of Income Tax-2 vs. M/s Caraf Builders & Constructions Pvt. Ltd., which supported the appellant's contention.

Validity of CBDT Circular No.5/2014:
The respondent relied on CBDT Circular No.5/2014, which stated that disallowance under Rule 8D applies even if no exempt income is earned in a particular year. The court found this reliance untenable, citing its own decision in Pr. Commissioner of Income Tax-04 vs. IL & FS Energy Development Company Ltd., which held that the circular cannot override the express provisions of Section 14A read with Rule 8D.

Court's Reasoning:
The court emphasized that Section 14A is the charging section, while Rule 8D is merely a mechanism to determine the amount of expenditure related to exempt income. The court clarified that Rule 8D(2)(iii) specifies that only investments yielding exempt income should be considered for disallowance computation. This interpretation aligns with the principle that disallowance should be linked to actual income earned, not potential income.

Conclusion:
The court concluded that the ITAT erred in confirming the disallowance under Rule 8D without restricting it to 0.5% of investments that yielded exempt income. The question of law was answered in favor of the appellant-assessee, and the disallowance should be computed only on those investments that generated exempt income during the relevant assessment year.

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