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<h1>Tribunal limits Section 14A disallowance to 5% of dividend income under Rule 8D(iii); excludes it from Section 115JB(2) book profit</h1> <h3>Deputy Commissioner of Income Tax 3 (2) (1), Maharashtra Versus M/s Jindal Drugs Pvt. Ltd. And M/s Jindal Drugs Pvt. Ltd. Versus Assistant Commissioner of Income Tax 3 (2) (1), Maharashtra</h3> ITAT upheld the assessee's position, finding the AO had not examined accounts or the claimed calculation and therefore restricting the section 14A ... Disallowance of expenses u/s 14A r/w Rule 8D(2) - HELD THAT:- In the present case, the AO has neither examined the accounts nor the correctness of the claim of the calculation given by the assessee. He simply rejected the disallowance offered by the assessee. In view of the alternative submission of the AR, we consider it reasonable and fair to accept its proposition for restricting the disallowance u/r 8D(iii) at 5% of the dividend income respectfully following decisions of the co-ordinate bench in assessee’s own case in AYs 2011-12 and 201213 where facts were identical as those prevailing in the year under consideration. Disallowance u/s 14A r.w. rule 8D not to be part of section 115JB(2) of the Act in the computation of income - This issue is covered in favour of assessee and against Revenue by the decision of Vireet Investments (P.) Ltd. [2017 (6) TMI 1124 - ITAT DELHI] wherein the Tribunal has clearly held that no disallowance under section 14A of the Act r.w.r 8D of the Rules can be made while computing book profit under section 115JB. Revenue appeal dismissed. ISSUES PRESENTED AND CONSIDERED 1. Whether remand to the Assessing Officer to verify hedging loss claimed from commodity trading was justified. 2. Whether disallowance under section 14A read with Rule 8D of the Income-tax Rules of expenses (including interest) relatable to exempt dividend income was sustainable where: (a) the Assessing Officer did not record cogent satisfaction after examination of accounts; (b) the assessee contended investments were made out of own/interest-free funds; and (c) the quantification under Rule 8D could be restricted. 3. Whether disallowance under section 14A/Rule 8D can be applied in computation of book profit under section 115JB(2) (i.e., whether section 14A is available for computing adjustments under Explanation 1 to section 115JB(2)). ISSUE-WISE DETAILED ANALYSIS Issue 1 - Remand to verify hedging loss Legal framework: Procedure for appellate remand and verification by AO; treatment of business losses and remand where tribunal/appeal authority accepts quantum or facts. Precedent treatment: No separate precedent relied upon in reasoning; appellate practice observed. Interpretation and reasoning: The ground concerning remand was not pressed by the appellant at hearing and AO subsequently gave effect to appellate order by allowing the claim. Therefore the point became infructuous. The Tribunal treated the ground as withdrawn and dismissed the challenge to the remand as moot. Ratio vs. Obiter: Ratio limited to factual disposition - where a ground is not pressed and relief already granted in compliance with appellate order, appellate challenge is rendered infructuous. Conclusion: Ground withdrawn/dismissed as infructuous. Issue 2 - Disallowance under section 14A read with Rule 8D (scope, satisfaction requirement, and quantification) Legal framework: Section 14A disallows expenditure relatable to exempt income; Rule 8D prescribes formulae for computing disallowance where AO is 'not satisfied' with assessee's claim, and section 14A(2) requires AO to have regard to accounts and record satisfaction. Precedent treatment: Followed and applied - Maxopp Investment Ltd. (Supreme Court) on requirement of recording satisfaction; decisions of various High Courts and Supreme Court (including Reliance Utilities & Power; UTI Bank; South Indian Bank) and coordinate tribunals on inference that where interest-free own funds exceed investments, disallowance of interest is not warranted; Special Bench authority on non-application of section 14A to book profit under section 115JB also considered (separately under Issue 3). Interpretation and reasoning: Tribunal found the AO mechanically applied Rule 8D without adequate, objective satisfaction as mandated by section 14A(2). The AO did not properly examine the assessee's accounts or give reasons demonstrating why the assessee's suo-moto computation was incorrect; mere expression of dissatisfaction in the assessment order is insufficient. The Tribunal articulated the required content of AO's satisfaction: an objective, account-based examination addressing whether (i) expenditure charged to taxable income is actually for exempt income, (ii) expenditures are recharacterised, (iii) mixing prevents separation, (iv) expenditures are unvouched, or (v) accounts are defective with specific reasons. Following Maxopp, absence of such recorded satisfaction renders Rule 8D(2)(ii) disallowance of interest impermissible. The Tribunal further applied authority holding that where interest-free own funds exceed investments in tax-free securities, investments are presumed financed from own funds and interest disallowance is not warranted. On quantification, the AO/first appellate authority had ignored the assessee's submissions and previous consistent tribunal outcomes in identical factual matrices; the Tribunal found it reasonable to cap disallowance under Rule 8D(iii) at 5% of dividend income following co-ordinate bench decisions in identical earlier years of the assessee, given the defective approach by the AO and lack of probative examination. Ratio vs. Obiter: Ratio - (1) AO must record objective, substantive satisfaction on the record after examination of accounts before invoking Rule 8D; mechanical application of Rule 8D without such satisfaction invalidates disallowance of interest under Rule 8D(2)(ii) (followed Maxopp). (2) Where interest-free own funds substantially exceed investments in tax-free securities, proportionate disallowance of interest is not warranted (following High Court and Supreme Court precedents). The restriction of Rule 8D(iii) disallowance to 5% was a fact-based remedy applied on the record (ratio to the extent of facts here); the precise percentage stems from co-ordinate bench practice in identical facts (practical adjudicatory relief rather than a general rule of law). Conclusion: Disallowance was made in a mechanically applied manner and without required recorded satisfaction; interest disallowance under Rule 8D(2)(ii) cannot be sustained. On facts and in exercise of appellate discretion and following coordinate precedents, disallowance under Rule 8D(iii) was restricted to 5% of dividend income. The assessee's appeal on this issue partly allowed. Issue 3 - Applicability of section 14A/Rule 8D for computation of book profit under section 115JB(2) Legal framework: Section 115JB computes book profit for Minimum Alternate Tax (MAT) with Explanation 1 containing clause (f) which adjusts for expenditure relatable to exempt income; question whether section 14A (and Rule 8D) can be resorted to for that computation. Precedent treatment: Followed Special Bench decision (Vireet Investments (P.) Ltd.) which held section 14A cannot be applied for computing book profit under section 115JB(2); reasoning considers legislative context, object of deeming provisions, and that similar words in different parts of statute must be read in context. Tribunal treated Special Bench authority as binding and not disputed by Departmental Representative. Interpretation and reasoning: Tribunal accepted the Special Bench analysis that clause (f) of Explanation 1 to section 115JB(2) must be interpreted in its context and that resort to section 14A/Rule 8D for computing book profit would be inappropriate. Literalism that applies section 14A across computations was rejected in favour of contextual reading; the Tribunal concluded the issue is settled by the Special Bench and that disallowance under section 14A cannot be applied in computation under section 115JB(2). Ratio vs. Obiter: Ratio - Section 14A/Rule 8D are not to be applied for computing adjustments under Explanation 1 to section 115JB(2); the Special Bench view is followed and applied. Conclusion: Revenue's ground seeking inclusion of the section 14A disallowance in computation of book profit under section 115JB(2) is dismissed; Special Bench precedent is followed and the ground lacks merit.