Section 14A disallowance cannot rest on ad hoc estimates for accrued exempt bond interest without proof of actual expenditure.

Exempt interest accrued on earlier investment in RBI tax free relief bonds did not justify an ad hoc disallowance under section 14A where no borrowing of interest-bearing funds was shown and no actual expenditure was proved to have been incurred to earn the income. The Tribunal also noted that Rule 8D could not be applied to assessment year 2003-04. On that basis, the estimated expenditure disallowance was held unsustainable and deleted.

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Issues: Whether any disallowance under section 14A could be made in respect of interest accrued on RBI tax free relief bonds, and whether the ad hoc estimate of expenditure was sustainable for the assessment year 2003-04.

Analysis: The assessee's interest income from tax free bonds was claimed as exempt, and the assessment authorities invoked section 14A on the footing that some expenditure must have been incurred to earn that income. The investment in the bonds had been made earlier, and the interest in the relevant year was merely accrued. The Tribunal found that there was no case of borrowing of interest-bearing funds for the investment, no actual expenditure shown to have been incurred for earning the exempt interest, and therefore no basis for estimating expenditure on an ad hoc percentage of the income. The Tribunal also noted that Rule 8D, apart from the Supreme Court and High Court position on the point, could not apply to assessment year 2003-04.

Conclusion: The disallowance under section 14A was not sustainable and was deleted, in favour of the assessee.

Ratio Decidendi: Where exempt interest income is only accrued on earlier investment and no actual expenditure is shown to have been incurred for earning it, an ad hoc disallowance under section 14A cannot be made, and Rule 8D has no application to assessment year 2003-04.

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