2025 (8) TMI 54 - AT - Income Tax

Section 14A and Rule 8D Disallowance Remanded for Fresh AO Examination with Assessee Hearing Opportunity

DCIT Versus ATS Infrastructure Ltd. And (Vice-Versa)

The ITAT DELHI-AT remanded the issue of disallowance under section 14A read with Rule 8D to the AO for fresh examination. The AO is directed to consider ... Disallowance u/s 14A r.w.r. 8D - AO made addition under 8D(2)(ii) in respect of interest and disallowance under 8D(2)(iii) being 0.5% of average investments -primary contention of the assessee is that the disallowance u/s 14A read with Rule 8D cannot be made on the basis of investment that do not yield any exempt income - HELD THAT:- We restore this issue to the file of the Assessing Officer who shall examine as to whether the opening balance of investment as on 01.04.2014 and also as on 31.03.2015 is Nil and consider only the income yielding investments if any for the purpose of disallowance under Rule 8D(2)(iii) r.w.s. 14A of the Act. Disallowance under Rule 8D(2) is concerned, we direct the Assessing Officer to examine whether the assessee for the year ended 21.03.2015 has sufficient interest free funds for making investments which yielded dividend income during the year under consideration and if the interest free funds are more than the investments there cannot be any disallowance under Rule 8D(2)(ii). The AO shall examine this aspect with reference to the financials of the assessee and decide in accordance with law after providing adequate opportunity to the assessee. Whether no satisfaction recorded? - We noticed that there was no suo moto disallowance made by the assessee u/s 14A towards expenditure incurred for earning exempt income during the current assessment year. On perusal of the assessment order, we noticed that the AO on examination of the audited financials of the assessee and considering the replies furnished by the assessee, recorded that he is not satisfied with the replies furnished by the assessee. Since the assessee had not made any suo moto disallowance there was no occasion for the AO to examine the expenditure incurred for earning exempt income. Therefore, the contention of the assessee that no satisfaction has been recorded is apparently not correct as the AO considered the reply and examined the financials and recorded his satisfaction that he is not satisfied with the submissions of the assessee that no expenditure has been incurred for earning exempt income. Thus, the contention of the assessee that there was no satisfaction recorded and therefore no disallowance can be made u/s 14A is rejected. ISSUES: Whether disallowance under section 14A read with Rule 8D can be made on investments that do not yield any exempt income.Whether disallowance under section 14A can be made in the absence of any expenditure incurred for earning tax-free income.Whether the Assessing Officer is required to record satisfaction before making disallowance under section 14A.Whether the disallowance under Rule 8D(2)(ii) should be restricted based on availability of interest-free funds for investments yielding exempt income.Whether the disallowance under section 14A can exceed the amount of exempt income earned during the year. RULINGS / HOLDINGS: The disallowance under section 14A read with Rule 8D cannot be made on the basis of investments that do not yield any exempt income; the Assessing Officer is directed to consider only income-yielding investments for disallowance under Rule 8D(2)(iii).Disallowance under section 14A can be made even if no suo moto disallowance is made by the assessee, provided the Assessing Officer records satisfaction that expenditures have been incurred in relation to exempt income; mere absence of suo moto disallowance by the assessee does not preclude the AO from making disallowance.The Assessing Officer must record satisfaction regarding the reasonableness and justification for disallowance under section 14A before making such disallowance; in the present case, the AO recorded dissatisfaction with the assessee's submissions, thus satisfying this requirement.Disallowance under Rule 8D(2)(ii) relating to interest expenses should be examined in light of whether sufficient interest-free funds were available for making investments yielding exempt income; if interest-free funds exceed such investments, no disallowance is warranted.The disallowance under section 14A should not exceed the amount of exempt income earned during the year; the Commissioner of Income Tax (Appeals) correctly restricted the disallowance to the exempt income of Rs. 2,29,417/- as against the higher disallowance made by the Assessing Officer. RATIONALE: The Court applied the provisions of section 14A of the Income Tax Act, 1961, and Rule 8D of the Income Tax Rules, 1962, which govern disallowance of expenditure incurred in relation to exempt income.Precedents cited include the Hon'ble Bombay High Court decision holding that the Assessing Officer is bound to determine expenditure related to income not forming part of total income, and the Hon'ble Delhi High Court rulings emphasizing the necessity of recorded satisfaction before disallowance under section 14A.The Tribunal distinguished the present facts from earlier decisions where no suo moto disallowance was made by the assessee, noting that here the AO recorded dissatisfaction after examining audited financials and replies, thus fulfilling the requirement of satisfaction.The Court emphasized that disallowance must be proportionate and linked to actual exempt income earned, reflecting a doctrinal adherence to limiting disallowance to the extent of exempt income.Directions were given to reassess the disallowance considering the opening and closing balances of investments, and availability of interest-free funds, ensuring a fact-specific and legally compliant determination.