2025 (11) TMI 45 - AT - Income Tax

Appeal allowed: s.14A disallowance under Rule 8D deleted where AO's vague satisfaction lacked specific facts and no attributable interest

Indraprastha Gas Limited Versus Joint Commissioner of Income Tax (OSD), New Delhi

ITAT DELHI-AT allowed the appeal and deleted the AO's disallowance under s.14A read with Rule 8D. The tribunal found the AO's recorded 'satisfaction' to ... Disallowance u/s 14A read with rule 8D - suo-moto disallowance made by assessee - Mandation of recording satisfaction - HELD THAT:- AO has recorded his satisfaction/reasoning for invoking the Rule 8D r/w section 14A of the Act. However, we do not find the said satisfaction sufficient for rejecting the assessee’s working of disallowance particularly when the assessee has not made any fresh investment during the relevant year and the assessee’s exempted income consists of market gain on growth of mutual fund and dividend income from the associate companies. The amount of expenditure in relation to exempt income has two aspects - (i) direct and (ii) indirect. The direct expenditure is straightaway taken into account by virtue Rule 8D(2)(i) of the Income Tax Rules. The indirect expenditure has to be considered as per Rule 8D(2)(ii) of the Income Tax Rules. Rule 8D of the Income Tax Rules comes into effect only when the AO, having regard to the accounts of the assessee, records his dissatisfaction about the correctness of the claim of expenditure made by the assessee; or the claim made by the assessee that no expenditure has been incurred in relation to exempt income. Here, we find the Ld. AO’s dissatisfaction recorded in general and is not corroborated with facts and specific finding. AO has not specified any expenditure incurred exclusively for deriving the exempted income. There is no finding that there is interest expenditure directly attributable to any particular income or receipt. The disallowance of indirect expenditure is an artificial figure i.e. one per cent of the annual average of the monthly averages of the opening and closing balances of the value of investment, income from which does not or shall not form part of the total income. AO’s satisfaction for rejecting the appellant assessee’s working of suo-moto disallowance made under section 14A of the Act is not justified. AO has erred in working out the monthly averages of the opening and closing balances of the value of investment, to which the Ld. CIT-DR appeared in agreement. Here, the assessee has sufficient surplus to make investments from its own funds. Hence, the indirect expenditure should not include any disallowance of interest subsumed in the indirect expenditure. Thus, only the disallowance out of administrative expenditure can be made. The assessee has already made suo-moto disallowance in accordance with section 14A of the Act read with Rule 8D of the Income Tax Rules and has explained the working thereof. We are satisfied with the working of said disallowance u/s 14A, therefore, delete the disallowance made u/s 14A of the Act. Assessee appeal allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether disallowance under section 14A read with Rule 8D is justified where exempt income arises from (i) mark-to-market gain on mutual fund investments and (ii) dividend from associate companies, when no fresh investment or exclusive expenditure for earning such exempt income was incurred in the year. 2. Whether the Assessing Officer's general recording of 'dissatisfaction' suffices to invoke Rule 8D and compute an indirect disallowance based on prescribed formulae, including an imputed interest component, without specific findings of expenditure directly attributable to exempt income. 3. In circumstances where the assessee has made a suo-moto disallowance computed under Rule 8D, whether the AO is required to demonstrate specific facts to displace the assessee's working and whether administrative expenses alone are the appropriate component of disallowance. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Applicability of section 14A/Rule 8D where exempt income arises from market gains on mutual funds and dividends from associates and no fresh investment/exclusive expenditure incurred Legal framework: Section 14A disallows expenditure incurred in relation to income exempt under the Act; Rule 8D prescribes mechanics for computing such disallowance where AO records dissatisfaction with the assessee's claim. Rule 8D separates (i) direct expenditure, (ii) indirect expenditure (formula-based), and (iii) apportioned interest where applicable. Precedent Treatment: The Court applied the settled principle that Rule 8D operates only upon a recorded dissatisfaction that is supported by facts; in cases where investments are made from own surplus and no exclusive expenditure is shown, wide imputations of interest are inappropriate. Higher-court authorities establishing that interest disallowance is not to be mechanically applied where investments are from own funds were followed. Interpretation and reasoning: The Tribunal examined the nature of exempt income - mark-to-market gains on mutual funds and dividends received from associate companies - and the fact that no fresh investments or exclusive expenditures were incurred during the year. Given these facts, the Tribunal found the assessee's contention (that no specific expenditure was incurred to earn the exempt income) credible and observed that Rule 8D should not be applied to generate an artificial disallowance in the absence of factual foundation. The Tribunal distinguished situations where interest or other costs can be specifically linked to earning exempt income from the present facts where investments were funded from internal surplus and managed externally. Ratio vs. Obiter: Ratio - Where exempt income arises from investments funded from internal surplus and no exclusive expenditure is shown, Rule 8D cannot be mechanically invoked to impose a large indirect disallowance. Obiter - Observations on the managerial role of portfolio managers and absence of fresh investment are supportive but not dispositive beyond the facts. Conclusion: Disallowance under section 14A/Rule 8D cannot be upheld in respect of amounts disallowed by the AO where exempt income arose without fresh investment or exclusive expenditure; the assessee's suo-moto disallowance (a limited figure) was acceptable. Issue 2 - Sufficiency of AO's recorded dissatisfaction under Rule 8D and requirement of specific findings to compute indirect disallowance including imputed interest Legal framework: Rule 8D is triggered only when the AO records dissatisfaction, and the AO must specify/explain basis for rejecting the assessee's claim/no-expenditure position; indirect disallowance (formulaic) and interest component require factual nexus or specific findings. Precedent Treatment: The Tribunal followed established jurisprudence that general or conclusory satisfaction by the AO without corroborative facts is insufficient to displace the assessee's computed disallowance; where AO fails to identify expenditure exclusively incurred for exempt income or to show attributable interest, the mechanical application of Rule 8D is impermissible. Interpretation and reasoning: The AO's recorded dissatisfaction was found to be general and unsupported - there was no identification of exclusive or directly attributable expenditure, nor any finding of interest-bearing borrowings used for the exempt investments. The Tribunal emphasized that the indirect disallowance by formula (one per cent of specified average balances) becomes unjustified when the factual matrix does not support inclusion of an imputed interest component, particularly where the assessee has adequate surplus funds. The AO's errors in computing monthly averages and acceptance by the lower appellate authority were also noted as undermining the disallowance. Ratio vs. Obiter: Ratio - AO must record specific, factual reasons to invoke Rule 8D; a general dissatisfaction is insufficient and cannot justify an imputed indirect disallowance that includes interest where no factual nexus exists. Obiter - Critique of AO's computation methodology and monthly-average calculations is consequential to the decision but emanates from the facts. Conclusion: The AO's general dissatisfaction did not justify rejecting the assessee's working; indirect disallowance including interest was not sustainable on the facts and was to be restricted. Issue 3 - Validity of assessee's suo-moto disallowance and the permissible scope of disallowance (administrative expenses only) when investments are from own funds Legal framework: Where an assessee has made a reasonable suo-moto disallowance under Rule 8D and provided workings, the AO must demonstrate error in that computation or point to additional relevant expenditure to justify further disallowance. Jurisprudence recognizes that only those components of administrative expenditure that are attributable to earning exempt income may be disallowed where interest is not attributable. Precedent Treatment: The Tribunal followed precedent holding that where investments are funded from own surplus, imputation of interest as part of indirect disallowance is inappropriate; only administrative/other non-interest indirect costs may be examinable for disallowance. Previous appellate and higher court rulings to this effect were applied. Interpretation and reasoning: The assessee had made a suo-moto disallowance of a modest amount and supplied workings. The AO failed to identify any additional specific expenditure exclusively linked to exempt income. Given that the assessee had sufficient internal funds and no attributable interest cost, the Tribunal concluded that only administrative expenditure (as demonstrable) could form the basis of any disallowance. Having accepted the assessee's working, the Tribunal held that the larger disallowance made by the AO/CIT(A) must be deleted. Ratio vs. Obiter: Ratio - A bona fide suo-moto disallowance supported by workings is to be accepted unless the AO can point to specific expenditures or errors; where investments are from internal surplus, disallowance of imputed interest is not warranted and disallowance should be limited to administrative expenses attributable to exempt income. Obiter - Remarks on the mechanics of portfolio management and non-involvement of the assessee post-investment are factual observations supporting the ratio. Conclusion: The assessee's suo-moto disallowance was satisfactory; the larger disallowance under section 14A/Rule 8D was deleted and only the self-assessed figure warranted recognition. Cross-references and Practical Holding Where an assessing authority relies on Rule 8D to disallow expenditure related to exempt income, the authority must (i) record specific factual dissatisfaction, (ii) identify exclusive or directly attributable expenditure or interest, or (iii) demonstrate errors in the assessee's computation; failing this, only demonstrated administrative expenses may be disallowed and reasonable suo-moto disallowance by the assessee should be accepted.