Section 14A disallowance must match exempt income nexus, excluding stock-in-trade shares and non-yielding investments.

Under section 14A read with rule 8D, shares held as stock-in-trade are to be excluded from a blanket disallowance because the dominant activity is trading and any dividend is incidental; the Assessing Officer was directed to recompute the disallowance accordingly. For the same provision, only investments that actually yielded exempt income can be considered, since disallowance is confined to expenditure having a nexus with exempt income; the computation was to be restricted on that basis. The disallowance was set aside for fresh computation in line with these principles.

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Issues: (i) Whether shares held as stock-in-trade are to be excluded while computing disallowance under section 14A read with rule 8D; (ii) Whether, for section 14A disallowance, only those investments that yielded exempt income are to be considered.

Issue (i): Whether shares held as stock-in-trade are to be excluded while computing disallowance under section 14A read with rule 8D

Analysis: The shares were reflected as stock-in-trade. The governing principle drawn from the Supreme Court decisions is that where shares are held as stock-in-trade, the dominant activity is trading and the incidental dividend does not justify a blanket disallowance of expenditure beyond what is relatable to exempt income. The Assessing Officer was therefore required to exclude such stock-in-trade shares while recomputing the disallowance.

Conclusion: The issue is decided in favour of the assessee.

Issue (ii): Whether, for section 14A disallowance, only those investments that yielded exempt income are to be considered

Analysis: The decision follows the principle that disallowance under section 14A is confined to expenditure having a nexus with exempt income. Consistent with the Special Bench view in Vireet Investment and the settled approach on apportionment, only those investments that actually yielded exempt income could be taken into account for the purpose of rule 8D computation.

Conclusion: The issue is decided in favour of the assessee.

Final Conclusion: The disallowance under section 14A was set aside for fresh computation by the Assessing Officer in accordance with the governing precedents, and the assessees' appeals succeeded to that extent.

Ratio Decidendi: For section 14A, expenditure can be disallowed only to the extent it is attributable to exempt income, and shares held as stock-in-trade are to be treated in accordance with that nexus-based apportionment principle rather than as ordinary investments for a blanket disallowance.

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