Section 14A Rule 8D disallowance calculation should consider only exempt income-generating investments, not total investments

ITAT Bangalore ruled that for calculating disallowance under section 14A read with Rule 8D, only investments that have actually generated exempt income should be considered, not total investments. The assessee earned exempt income of Rs. 3.90 crores. Following the Delhi HC precedent in ACB India Ltd, the tribunal held that investment attributable to dividend income should be adopted for disallowance computation. The matter was remitted to AO for re-computation applying Rule 8D(2)(iii) considering only exempt income-generating investments. Appeal partly allowed for statistical purposes.

---

---

Issues Involved:
1. Disallowance under Section 14A read with Rule 8D(2)(iii) of the Income Tax Rules.
2. Whether disallowance can be made on a notional basis.
3. Consideration of investments yielding non-taxable income for disallowance calculation.
4. Effect of the explanation inserted in Section 14A by Finance Act 2022.

Summary:

Disallowance under Section 14A read with Rule 8D(2)(iii):
The assessee appealed against the NFAC order confirming the disallowance of Rs. 23,73,977/- under Section 14A read with Rule 8D(2)(iii) for the assessment year 2016-17. The assessee received a dividend of Rs. 3.9 crores from GEBE Private Limited, which was claimed as exempt under Section 10(34). The AO applied Rule 8D(2)(iii) and computed the disallowance based on the average value of investments.

Disallowance on a Notional Basis:
The assessee argued that no expenditure was incurred in earning the exempt income, and the disallowance was made on a presumption without establishing any nexus. The AO's reasoning that investments were made from common pool funds was contested. The assessee cited several judicial precedents, including CIT Vs Syndicate Bank and CIT Vs Reliance Industries Ltd, to support the argument that disallowance under Section 14A requires actual expenditure.

Consideration of Investments Yielding Non-Taxable Income:
The assessee contended that only investments yielding exempt income should be considered for disallowance under Rule 8D(2)(iii). Judicial precedents, such as ACB India Ltd. v. Astt. CIT and Pr. CIT v. Indiabulls Capital Services Ltd, were cited to support this view. The Tribunal in the assessee's own case for AY 2014-15 had held that only investments generating exempt income should be considered.

Effect of Explanation Inserted in Section 14A by Finance Act 2022:
The assessee argued that the explanation inserted by Finance Act 2022, which clarifies that disallowance under Section 14A applies even if no exempt income is earned, is prospective and not applicable to the assessment year under consideration. This view was supported by the Delhi High Court in Pr. CIT v. Era Infrastructure (India) Ltd.

Tribunal's Decision:
The Tribunal held that while calculating disallowance under Section 14A, only investments that have generated exempt income should be considered. The issue was remitted to the AO for re-computation of disallowance as per Rule 8D(2)(iii), considering only the investments that yielded exempt income. The appeal was partly allowed for statistical purposes.

---