2024 (4) TMI 1373 - AT - Income Tax

Disallowance under exempt income rules invalidated where AO failed to record dissatisfaction and miscomputed the adjustment

An assessing officer must record specific dissatisfaction with an assessee's claim before invoking the statutory disallowance mechanism for expenses ... Disallowance u/s 14A r/w rule 8D - suo-moto disallowance made by the appellant company rejected - Mandation of AO's recorded satisfaction before invoking Rule 8D HELD THAT:- The Hon'ble Supreme Court in the case of Godrej & Boyce Mfg. Co. Ltd. [2017 (5) TMI 403 - SUPREME COURT] had observed that it was only after the AO had recorded his dis-satisfaction as regards the correctness of the claim of the Assessee that the provisions of Section 14A r/w Rule 8D could be invoked. AO has rejected the suo-moto disallowance should u/s 14A. While doing so, AO has neither referred to any expenses incurred/claimed by the Appellant for earning the exempt income, nor made any reference to the accounts of the Appellant. The computation of the suo-moto disallowance offered by the Appellant u/s 14A. Appellant had disallowed consisting of the salary cost of one of its employees and telephone reimbursement expenses. AO has simply rejected the same without recording any dissatisfaction in relation to the same. AO has proceeded on incorrect understanding that the Appellant has claimed that no expenditure was incurred for earning exempt income. Even while computing the quantum of disallowance, the AO has not reduced the amount computed in terms of Rules 8D of the IT Rules by the amount of suo-moto disallowance offered to tax by the Appellant in the return of income, and has proceeded to make addition of the entire amount. We note that the AO has observed that even if no exempt income is earned provisions of Section 14A would attracted. The aforesaid observations made by the AO have no application to the facts of the present case since the Appellant has earned exempt income and offered suo-moto disallowance u/s 14A. AO has invoked the provisions of Section 14A of the Act read with Rule 8D of the IT Rules on incorrect understanding of facts and without due application of mind. Therefore, we hold that the AO has failed to record proper dis-satisfaction about the suo-moto disallowance made by the Appellant. Accordingly, in view the above judgments of addition made by the AO u/s 14A read with Rule 8D. Present appeal preferred by the Assessee is allowed for statistical purposes. Issues: Whether the Assessing Officer validly invoked Section 14A read with Rule 8D to compute disallowance when the assessee had made a suo-moto disallowance in the return, i.e., whether the AO recorded the required satisfaction/dissatisfaction with the assessee's suo-moto computation before applying Rule 8D.Analysis: Applicable legal framework includes Section 14A of the Income-tax Act, 1961 and Rule 8D of the Income Tax Rules, 1962 which permit computation of expenditure attributable to exempt income only after the Assessing Officer records dissatisfaction with the assessee's claim; authorities have held that such dissatisfaction must be formed with reference to the assessee's accounts and relevant facts. The AO's assessment order and computation were examined to determine whether the AO referred to the assessee's accounts, explained why the assessee's suo-moto disallowance was incorrect, or reduced the Rule 8D computation by the amount already disallowed by the assessee. The AO's observations merely stated statutory provisions, cited circulars and decisions, asserted that substantial exempt income existed, and proceeded to compute disallowance under Rule 8D without engaging with the assessee's submitted computation and without recording a specific satisfaction based on the accounts or expenses claimed. The AO also proceeded on an incorrect factual premise that the assessee had claimed no expenditure for exempt income despite the assessee having made a specific suo-moto disallowance consisting of salary and telephone expenses.Conclusion: The AO did not record the requisite dissatisfaction with the assessee's suo-moto disallowance based on the assessee's accounts or give cogent reasons for rejecting the assessee's computation; consequently, invocation of Rule 8D and the resulting addition were not legally sustainable and the addition is deleted in favour of the assessee.