Section 14A disallowance needs recorded satisfaction, while the amended Rule 8D applies prospectively and only exempt-income investments count.

Disallowance of indirect expenditure under section 14A read with rule 8D requires the Assessing Officer to first record satisfaction, based on the accounts, that the assessee's claim of no such expenditure is incorrect; absent that recorded satisfaction, the disallowance cannot be sustained. The amendment to rule 8D effective from 02.06.2016 is prospective and applies from assessment year 2017-18 onwards. For computing the average value of investments, only investments that yielded exempt income are to be included. On that basis, the disallowance was set aside and the matter remanded for fresh consideration and recomputation under the unamended rule 8D.

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Issues: Whether disallowance of indirect expenditure under section 14A read with rule 8D could be sustained without recording satisfaction, whether the amended rule 8D applied retrospectively, and whether only investments yielding exempt income were to be considered for computing the average value of investments.

Analysis: It was held that invocation of section 14A read with rule 8D is conditioned upon the Assessing Officer first recording satisfaction, on the basis of the books of account, that the assessee's claim of no indirect expenditure incurred for earning exempt income is incorrect. Since no such satisfaction was recorded, the disallowance could not be sustained. It was further held that the amendment to rule 8D inserted with effect from 02.06.2016 is prospective and applies from assessment year 2017-18 onwards. For computing the average value of investments, only those investments which yielded exempt income are to be included.

Conclusion: The disallowance was set aside and the matter was remanded to the Assessing Officer for fresh consideration after recording the requisite satisfaction and recomputing the disallowance under the unamended rule 8D by taking only exempt-income yielding investments.

Ratio Decidendi: Disallowance under section 14A read with rule 8D cannot be made unless the Assessing Officer records a prior satisfaction on the assessee's accounts, and the amended rule 8D operates prospectively.

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