The assessee, an individual, filed his return of income for Assessment Year 2017–18 declaring total income of ₹21,70,080. The return was processed under section 143(1) of the Income-tax Act, 1961. Subsequently, the case was selected for limited scrutiny to examine the allowability of expenditure incurred in relation to exempt income. During the relevant year, the assessee earned exempt income in the form of dividend income and long-term capital gains exempt under section 10(38).

In the return of income, the assessee did not make any suo motu disallowance under section 14A, contending that no expenditure relating to exempt income had been claimed. During assessment proceedings, the assessee explained that expenses relatable to exempt income were not debited to the Profit and Loss Account but were directly debited to the capital account and, therefore, were never claimed as deductible expenditure.

The Assessing Officer rejected the explanation and proceeded to apply section 14A read with Rule 8D. Although the disallowance computed under Rule 8D worked out to a higher amount, the Assessing Officer restricted the disallowance to ₹13,76,621, being the total expenditure incurred during the year, and added the same to the total income.

On appeal, the Commissioner (Appeals) confirmed the disallowance by relying on the decisions of the Hon’ble Supreme Court in Maxopp Investment Ltd. v. CIT and Godrej & Boyce Mfg. Co. Ltd. v. DCIT, holding that section 14A applies even where the assessee claims that no expenditure has been incurred in relation to exempt income.

Before the Tribunal, the assessee contended that only expenditure actually claimed as deduction could be subjected to disallowance under section 14A. It was submitted that expenses of ₹7,92,077 were directly debited to the capital account and never claimed in the computation of income, and the remaining expenses were incurred exclusively for earning taxable consultancy income. It was further argued that the Assessing Officer failed to record objective satisfaction or establish any nexus between the expenditure claimed and the earning of exempt income.

The Tribunal observed that section 14A contemplates disallowance only of expenditure which is claimed as deduction and is incurred in relation to exempt income. Expenditure not claimed in the computation of income cannot be disallowed, as there is no deduction to be withdrawn. Relying on the Supreme Court decision in CIT v. Hero Cycles Ltd. and the Special Bench ruling in ACIT v. Vireet Investment Pvt. Ltd., the Tribunal reiterated that Rule 8D cannot be applied mechanically and requires clear recording of dissatisfaction and nexus with exempt income.

In the present case, neither the Assessing Officer nor the Commissioner (Appeals) recorded any specific finding to show that the expenditure debited to the capital account was claimed as deduction or incurred in relation to exempt income. The satisfaction recorded was held to be general and insufficient. Consequently, the disallowance of ₹13,76,621 under section 14A read with Rule 8D was held to be unsustainable and was deleted.

Accordingly, the appeal of the assessee was allowed.

Source Link- https://itat.gov.in/public/files/upload/1768294759-E4Zerz-1-TO.pdf

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