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Issues: (i) whether, while computing disallowance under section 14A read with Rule 8D, investments which did not yield exempt income were to be excluded; (ii) whether education cess paid on income-tax was allowable as a deduction in computing business income.
Issue (i): whether, while computing disallowance under section 14A read with Rule 8D, investments which did not yield exempt income were to be excluded.
Analysis: The disallowance under section 14A applies only to expenditure incurred in relation to exempt income. For Rule 8D computation, the investment base must be restricted to investments having a nexus with exempt income. Investments that did not yield exempt income cannot be brought into the computation merely because they form part of the overall investment portfolio.
Conclusion: The exclusion of investments not yielding exempt income was directed, and the issue was decided in favour of the assessee.
Issue (ii): whether education cess paid on income-tax was allowable as a deduction in computing business income.
Analysis: Section 40(a)(ii) disallows rates or taxes levied on business profits, but does not expressly refer to cess. Applying the plain language of the provision and the legislative history, education cess was held not to fall within the disallowance. The appellate authorities were also competent to entertain the claim even though it was not made in the original return.
Conclusion: Education cess was held allowable as a deduction, and the issue was decided in favour of the assessee.
Final Conclusion: The appeal succeeded on both substantive issues and the disallowance was interfered with to the extent indicated.
Ratio Decidendi: For section 14A read with Rule 8D, only investments yielding exempt income form the relevant base, and education cess is not covered by the disallowance in section 40(a)(ii) of the Income-tax Act, 1961.
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