Disallowance under Section 14A must mirror exempt income and cannot be increased beyond a bonafide suo moto computation.

Disallowance under section 14A read with Rule 8D must bear a rational nexus to exempt income and is restricted so that it cannot exceed the exempt income actually earned in the relevant year; this principle was applied in favour of the assessee. An assessing officer may not raise or recompute the disallowance beyond a bonafide suo moto disallowance declared by the assessee without demonstrating error and providing a proper computation. The Finance Act, 2022 amendment was held not to operate retrospectively to justify disallowance where no exempt income accrued in the year.

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Issues: (i) Whether disallowance under section 14A read with Rule 8D is to be restricted to the exempt income earned during the year; (ii) Whether the assessing officer can increase/recompute disallowance beyond the suo moto disallowance made by the assessee where the assessee has made a bonafide computation in its return; (iii) Whether the amendment by Finance Act, 2022 operates retrospectively to permit disallowance even where exempt income has not accrued in the relevant year.

Issue (i): Whether disallowance under section 14A read with Rule 8D is to be restricted to the exempt income earned during the year.

Analysis: The Tribunal considered precedent of various High Courts and coordinate benches which hold that disallowance under section 14A read with Rule 8D must bear a reasonable nexus to exempt income and ordinarily cannot exceed the exempt income earned in the year. The Tribunal noted the decisions of the Delhi High Court and other authorities and applied them to the facts.

Conclusion: Disallowance under section 14A read with Rule 8D cannot exceed the exempt income earned by the assessee in the relevant year; this principle is applied in favour of the assessee.

Issue (ii): Whether the assessing officer can increase/recompute disallowance beyond the suo moto disallowance made by the assessee where the assessee has made a bonafide computation in its return.

Analysis: The Tribunal examined the assessee's voluntary (suo moto) disallowance, the absence of demonstrated error in that computation, and authorities requiring a rational nexus and proper computation by the assessing officer if he seeks to alter the assessee's figures. The Tribunal observed that the assessee's computation was based on books of account and contemporaneous law, and that the AO's higher disallowance lacked justification to reduce the assessee's declared position.

Conclusion: The assessing officer's disallowance in excess of the suo moto disallowance made by the assessee cannot be upheld; the assessee's suo moto disallowance stands.

Issue (iii): Whether the amendment by Finance Act, 2022 operates retrospectively to permit disallowance even where exempt income has not accrued in the relevant year.

Analysis: The Tribunal considered recent judicial decisions holding that the Finance Act, 2022 amendment does not apply retrospectively to the year under consideration and that reliance on that amendment for prior years is not permissible.

Conclusion: The amendment introduced by Finance Act, 2022 does not apply retrospectively to justify disallowance for years where no exempt income accrued; the revenue's contention is dismissed.

Final Conclusion: The decision preserves the principle that disallowance under section 14A/Rule 8D must have a reasonable nexus to exempt income and cannot exceed such income, and also protects a bonafide suo moto disallowance made by the assessee from being increased by the assessing officer without proper justification.

Ratio Decidendi: Disallowance under section 14A read with Rule 8D must bear a rational nexus to exempt income and cannot exceed the exempt income actually earned in the relevant year; an assessing officer cannot validly increase a bonafide suo moto disallowance declared by the assessee without proper computation and justification.

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