Rule 8D second limb computation mandatory: recompute disallowance limited to investments yielding exempt income; remit depreciation inquiry.

Challenge concerns computation of disallowance for exempt income and allowability of depreciation where premises yield rent. Rule 8D(2) contains a mandatory second limb percentage formula which must be applied and the disallowance limited to investments that actually produced exempt income; recomputation is directed accordingly. Allowability of depreciation depends on the head of income: rent offered under Income from House Property admits section 24 deductions, whereas depreciation under the block regime is available only if letting amounts to commercial exploitation and the property forms part of business assets; the latter requires factual enquiry by the assessing officer.

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Issues: (i) Whether the disallowance under section 14A read with Rule 8D(2) was correctly computed and whether the assessee's suo moto disallowance sufficed; (ii) Whether depreciation under section 32 is allowable in respect of office premises included in a block of assets when rental income from those premises is offered under the head Income from House Property.

Issue (i): Whether the disallowance under section 14A read with Rule 8D(2) was correctly computed and whether the assessee's suo moto disallowance sufficed.

Analysis: Rule 8D(2) contains two limbs: one dealing with direct and indirect expenditure attributable to exempt income and the second providing a formulaic percentage-based computation. The statutory second limb is mandatory and must be applied where applicable. Principles established by the Special Bench in ACIT vs. Vireet Investment Pvt. Ltd. restrict the quantum of disallowance to investments that actually yielded exempt income during the relevant year. The assessee has made a suo moto disallowance under the first limb but did not apply the mandatory second-limb computation; therefore the calculation under Rule 8D(2) requires application of the second limb and restriction to investments yielding exempt income.

Conclusion: Disallowance under section 14A read with Rule 8D(2) is to be recomputed by applying the second limb of Rule 8D(2) and restricting the computation to investments that yielded exempt income; appeal on this issue is partly allowed in favour of the assessee.

Issue (ii): Whether depreciation under section 32 is allowable in respect of office premises included in a block of assets when rental income from those premises is offered under the head Income from House Property.

Analysis: Allowability of deductions depends on the head of income under which receipts are assessed. Income offered under Income from House Property permits deductions under section 24, not section 32. Where letting constitutes commercial exploitation of a business asset, income may be assessable under Profits and Gains of Business or Profession and the asset may remain within a block allowing depreciation under section 32. The factual determination whether the letting amounts to commercial exploitation and whether the property formed part of commercial/business assets was not conducted by the assessing authority in the present record. A limited factual enquiry is therefore necessary to determine the correct head of assessment and the consequent allowability of depreciation.

Conclusion: The issue is restored to the assessing officer for fresh examination of whether the letting constituted commercial exploitation and whether the properties formed part of the commercial/business block of assets; ground stands allowed for statistical purposes in favour of the assessee.

Final Conclusion: The appeal is partly allowed by directing recomputation of disallowance under section 14A read with Rule 8D(2) restricted to investments yielding exempt income and by remanding the depreciation issue to the assessing officer for factual examination regarding commercial exploitation and block membership of the properties.

Ratio Decidendi: Where Rule 8D(2) applies, its second-limb computation is mandatory and disallowance under section 14A must be restricted to investments which have actually yielded exempt income during the relevant year; depreciation under section 32 is allowable only where letting constitutes commercial exploitation of a business asset assessed under profits and gains of business or profession.

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