2022 (12) TMI 873 - AT - Income Tax

Disallowance u/s 14A r.w.r. 8D - determination of expenditure incurred in relation to exempt income - HELD THAT - Hon ble Apex Court in the case of Godrej Boyce Manufacturing Co. Ltd. 2017 (5) TMI 403 - SUPREME COURT held that subsections (2) and (3) of Section 14A of the Act read with Rule 8D of the Rules merely prescribe a formula for determination of expenditure incurred in relation to income which does not form part of the total income under the Act in a situation where the AO is not satisfied with the claim of the assessee. Whether such determination is to be made on application of the formula prescribed under Rule 8D or in the best judgment of the AO, what the law postulates is the requirement of a satisfaction in the AO that having regard to the accounts of the assessee, as placed before him, it is not possible to generate the requisite satisfaction with regard to the correctness of the claim of the assessee. It is only thereafter that the provisions of Section 14A(2) and (3) read with Rule 8D of the Rules or a best judgment determination, as earlier prevailing, would become applicable. The said principle has been reiterated in the case of Marg Limited 2020 (10) TMI 102 - MADRAS HIGH COURT - Further in Maxopp Investment Limited 2018 (3) TMI 805 - SUPREME COURT observed that it is that expenditure alone which has been incurred in relation to the income which is not includible in total income, is to be disallowed. If expenditure has no casual connection with the exempt income, such expenditure would be an allowable expenditure. Applying the ratio of aforesaid principles as well as the consistent view of Tribunal in assessee s own case as cited before us, we would hold that since AO has mechanically applied the provisions of Rule 8D while making the aforesaid disallowance without establishing any nexus of expenditure claimed by the assessee with that of exempt income earned during the year, such disallowance is not sustainable in law. Accordingly, Ld. AO is directed to delete the additional disallowance while computing income under normal provisions as well as while computing Book profits u/s 115JB.

Summary

Issues Involved:
Confirmation of disallowance u/s 14A.

Detailed Analysis:

1. Assessment Proceedings:
The appellant, a resident corporate assessee engaged in making investments, appealed against the disallowance u/s 14A for AY 2016-17. The appellant had made a suo-motu disallowance of administrative expenditure, but the AO computed a higher disallowance using Rule 8D. The appellant argued that Rule 8D should not apply due to the nature of its business and that only income-yielding investments should be considered for disallowance. The disallowance was added to both normal income and book profits u/s 115JB.

2. Findings and Adjudication:
The CIT(A) upheld the AO's decision based on a previous order for AY 2014-15, which was later reversed by the Tribunal. The Tribunal found that the AO did not record objective satisfaction before making the disallowance under Rule 8D, as required by law. The Tribunal referenced previous cases where it was established that the AO must record satisfaction regarding the correctness of the claim before applying Rule 8D. The Tribunal held that the AO's failure to do so rendered the disallowance unsustainable in law.

3. Legal Principles and Precedents:
The Tribunal relied on various legal principles, including the requirement for the AO to record objective satisfaction before applying Rule 8D, as established by the Hon'ble Supreme Court in previous cases. It was emphasized that the application of Rule 8D is not automatic and must be based on a proper assessment of the nexus between expenditure and exempt income. The Tribunal also cited judgments from the High Court and Supreme Court affirming that the AO must establish a causal connection between the expenditure claimed and the exempt income.

4. Decision and Outcome:
The Tribunal allowed the appeal, directing the AO to delete the additional disallowance made under Rule 8D while computing both normal income and book profits u/s 115JB. The Tribunal held that the AO's mechanical application of Rule 8D without establishing a nexus between expenditure and exempt income rendered the disallowance unsustainable in law. The appeal was allowed based on these findings.

In conclusion, the Tribunal's decision emphasized the importance of the AO recording objective satisfaction before applying Rule 8D for disallowance u/s 14A and highlighted the necessity of establishing a causal connection between expenditure and exempt income. The judgment serves as a reminder of the legal principles governing such disallowances and the need for a thorough assessment before making such determinations.