Guarantee commission and section 14A computation: contractual State guarantee fees escape disallowance, and non-dividend investments are excluded from rule 8D base.

Section 40(a)(iib) was held inapplicable to guarantee commission paid by a State Government undertaking where the payment was contractual and not shown to be an exclusive statutory levy of the kind targeted by the provision; the disallowance was therefore unsustainable. For disallowance under section 14A read with rule 8D, only investments that actually yielded exempt dividend income during the year were to be included in the average value of investments; investments that produced no dividend income were to be excluded from the computation base. The assessee succeeded on both issues, and the Revenue's challenge failed.

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Issues: (i) Whether guarantee commission paid to the State Government by a State Government undertaking was disallowable under section 40(a)(iib) of the Income-tax Act, 1961. (ii) Whether, for disallowance under section 14A read with rule 8D, the average value of investments had to exclude investments that did not yield dividend income during the year.

Issue (i): Whether guarantee commission paid to the State Government by a State Government undertaking was disallowable under section 40(a)(iib) of the Income-tax Act, 1961.

Analysis: The provision applies to amounts in the nature of royalty, licence fee, service fee, privilege fee, service charge or any other fee or charge levied exclusively on a State Government undertaking by the State Government. The guarantee commission in question was payable under the State guarantee regime and was not shown to be an exclusive statutory levy on the assessee alone. The State also extended guarantees to other government bodies and institutions. The payment was held to be contractual in nature and not a compulsory exaction or levy falling within the mischief targeted by section 40(a)(iib).

Conclusion: The disallowance under section 40(a)(iib) was not sustainable and the issue was decided in favour of the assessee.

Issue (ii): Whether, for disallowance under section 14A read with rule 8D, the average value of investments had to exclude investments that did not yield dividend income during the year.

Analysis: The relevant computation under rule 8D was held to be confined to investments that actually yielded exempt dividend income during the previous year. Investments which did not produce dividend income were not to be included in the average value of investments for the purpose of the disallowance formula. The CIT(A) had applied this principle consistently with the Tribunal and Special Bench line of authority relied on in the record.

Conclusion: The Revenue's challenge to the computation was rejected and the issue was decided in favour of the assessee.

Final Conclusion: The assessee succeeded on the guarantee commission disallowance and on the section 14A computation issue, while the Revenue's appeal failed.

Ratio Decidendi: Section 40(a)(iib) applies only to an exclusive statutory levy of the specified nature imposed by the State Government on a State Government undertaking, and section 14A read with rule 8D excludes investments that did not yield exempt income from the computation base.

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