2025 (7) TMI 1887 - AT - Income Tax

Only investments yielding exempt income considered for Section 14A disallowance under Rule 8D(2)(iii); balance addition Rs 14,40,993

Dosti Realty Limited Versus Deputy Commissioner of Income Tax, Circle-1 (1) (1), Mumbai

ITAT MUMBAI held that for computing disallowance u/s 14A under Rule 8D(2)(iii) only investments that yielded exempt income during the year are to be ... Disallowance u/s.14A by applying Rule 8D(2)(iii) - dissatisfaction on the suo moto disallowance made by the assessee which is computed by applying Rule 8D(2)(iii) - HELD THAT:- Not all the investments made in various partnership firms have yielded share of profit. Thus, by applying the decision of Vireet Investment [2017 (6) TMI 1124 - ITAT DELHI] wherein it was held that only those investments are to be considered for computing average value of investment which yielded investment income during the year, the investments in partnership firms which yielded share of profit ought to be considered. Assessee has earned share of profit only from two partnership firms. Based on the above finding, disallowance u/s. 14A by applying Rule 8D(2)(iii) is re-calculated by taking into account those investments from which exempt income has been earned by the assessee. Thus, the disallowance u/s. 14A comes to Rs. 19,54,691/- against which assessee has already suo moto disallowed Rs. 5,13,698/-, the balance of Rs. 14,40,993/- is to be disallowed and added to the total income of the assessee as against addition of Rs. 33,68,410/- made by the ld. Assessing Officer. Accordingly, grounds raised by the assessee are partly allowed. 1. ISSUES PRESENTED AND CONSIDERED 1. Whether investments made in partnership firms should be included for computing disallowance under section 14A read with Rule 8D(2)(iii) when the assessee has earned share of profit from such firms. 2. Whether, when Rule 8D(2)(iii) is applied suo motu by the assessee (instead of computing disallowance with reference to actual expenses in books), the Assessing Officer is entitled to substitute his own computation by including investments excluded by the assessee. 3. Whether, in applying Rule 8D(2)(iii), only those investments that yielded exempt income during the year are to be taken into account. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Inclusion of investments in partnership firms for computation under section 14A read with Rule 8D(2)(iii) Legal framework: Section 14A disallows expenditure in relation to exempt income. Rule 8D(2)(iii) prescribes a method (0.5% of average value of investments) for computing disallowance where direct attribution or interest-based apportionment is not practicable; Rule 8D applies to investments yielding exempt income. Precedent treatment: The Court relied on binding pronouncements of the Special Bench in Vishnu Anant Mahajan (Ahmedabad) holding that share of profit of a partner from a partnership firm (not taxable under section 10(2A)) attracts section 14A; and the Special Bench in Vireet Investment (Delhi) holding that, for Rule 8D computation, only those investments which yielded investment income during the year are to be considered. Interpretation and reasoning: The Tribunal observed that share of profit from partnership firms is exempt income for the assessee and therefore falls within the ambit of section 14A. Accordingly, investments relating to partnership concerns from which exempt share of profit arose must be considered in computing disallowance under Rule 8D(2)(iii). However, applying Vireet Investment, the Tribunal limited the inclusion to only those partnership capital balances/ investments which actually yielded exempt income during the year - not all partnership investments indiscriminately. The Assessing Officer correctly identified deficiency in the assessee's working (exclusion of partnership investments) and was therefore entitled to re-compute Rule 8D(2)(iii) provided the re-computation adhered to legal principles as to which investments to include. Ratio vs. Obiter: Ratio - Share of profit from partnership firms being exempt income attracts section 14A; for application of Rule 8D(2)(iii) investments in partnership firms that yielded exempt income during the year must be included in the average investments. Obiter - Observations distinguishing Coordinate Bench authority that did not consider the Special Bench decisions. Conclusion: Investments in partnership firms that yielded share of profit during the year must be included in the base for Rule 8D(2)(iii) computation of disallowance under section 14A; investments in partnership firms that did not yield exempt income in the relevant year need not be included. Issue 2 - Assessing Officer's power to substitute his own computation when assessee has made a suo motu disallowance under Rule 8D(2)(iii) Legal framework: The Assessing Officer may verify and, if satisfied that the assessee's computation is incorrect or incomplete, recompute disallowance consistent with law. Where the assessee applies Rule 8D(2)(iii) suo motu rather than computing actual attributable expenses from books, the AO may point out defects and substitute a correct computation if properly reasoned. Precedent treatment: The Tribunal referred to a Coordinate Bench decision in the assessee's own case (AY 2016-17) which noted that AO must point out specific mistake/deficiency in the assessee's working before substituting computations; the Tribunal distinguished that decision on the factual ground that here the AO specifically pointed out omission of partnership investments from the Rule 8D(2)(iii) base. The Tribunal treated the Special Bench authority as binding on the point that partnership share profits attract section 14A. Interpretation and reasoning: The Tribunal found that the Assessing Officer had recorded dissatisfaction with the assessee's computation and had identified the specific deficiency (non-inclusion of certain investments). That identification satisfied the requirement that the AO point out mistake/deficiency before substituting his own working. The AO's substitution was also required to conform to legal standards - i.e., inclusion only of investments that produced exempt income - which the Tribunal enforced by recalculating the disallowance accordingly. Ratio vs. Obiter: Ratio - AO may substitute the assessee's Rule 8D(2)(iii) computation if he points out specific deficiencies and then applies the correct legal approach in recomputation. Obiter - Reference to Coordinate Bench authority that criticized substitution where no deficiency was pointed out (distinguished on facts). Conclusion: The Assessing Officer was entitled to substitute the assessee's suo motu Rule 8D(2)(iii) computation after pointing out the specific omission; however the substitution must follow legal principles (i.e., include only investments yielding exempt income) - failure to do so justifies correction by the Tribunal. Issue 3 - Scope of investments to be considered under Rule 8D(2)(iii): only those yielding exempt income Legal framework: Rule 8D(2)(iii) contemplates use of average value of investments for computation of 0.5% disallowance where attribution is not practicable. The calculation requires correct identification of the relevant investments linked to exempt income. Precedent treatment: Vireet Investment (Del)(SB) was applied to hold that only investments which yielded investment income during the year are to be included in the average investment base for Rule 8D computation. Vishnu Anant Mahajan (Ahd)(SB) supported treating partner's share of profit as exempt income subject to section 14A disallowance. Interpretation and reasoning: The Tribunal reconciled the authorities by first recognizing that partnership share profits are exempt income attracting section 14A (Vishnu Anant Mahajan) and then applying the principle of Vireet Investment to limit the Rule 8D base to only those partnership investments from which exempt income was actually earned in the year. On the facts, only two partnership concerns produced exempt share of profit; therefore only their capital balances were aggregated with mutual fund investments for the 0.5% computation. Ratio vs. Obiter: Ratio - For Rule 8D(2)(iii) computation, include only those investments that yielded exempt income in the relevant year; partnership investments are includible to the extent they generated share of profit (exempt income). Obiter - Numerical illustration of recalculation specific to facts. Conclusion: The correct method is to compute 0.5% under Rule 8D(2)(iii) on the average value of investments that gave rise to exempt income in the year; applying that method reduced the disallowance from the AO's figure to a lesser amount calculated by the Tribunal. Result reached by The Court The Court held that partnership investments which produced exempt share of profit must be included in the Rule 8D(2)(iii) base, but investments in partnerships that did not yield exempt income during the year are excluded. Applying these principles, the Tribunal recalculated the disallowance under section 14A read with Rule 8D(2)(iii), determining total disallowance at Rs. 19,54,691/-, set off the assessee's suo motu disallowance of Rs. 5,13,698/-, and directed an additional disallowance of Rs. 14,40,993/-. The appeal was partly allowed on that basis.