ITAT Deletes Section 14A Disallowance for Failure to Record Mandatory Satisfaction Before Invoking Rule 8D

The Income Tax Appellate Tribunal (ITAT), Bangalore, held that the statutory requirement under Section 14A(2) obligates that the AO must first examine the books of account and record his satisfaction, supported by reasons, regarding the incorrectness of the assessee’s claim.

The assessee is engaged in the business of real estate development and filed its return of income for assessment year 2016-17 declaring a total income of Rs 37.23 crore. During the relevant year, it earned exempt dividend income of Rs 1.46 crore from investments in mutual funds and voluntarily disallowed Rs 7.30 lakh, being 5% of the exempt income, towards expenditure incurred in earning such income.

The AO rejected the voluntary disallowance and applied Section 14A read with Rule 8D of the Income Tax Rules. Later, a disallowance of Rs 9.18 crore was calculated, resulting in an addition of Rs 9.11 crore.

The CIT(A) directed that only investments generating exempt income should be considered for the calculation but upheld the application of Rule 8D. Aggrieved by the disallowance, the assessee approached the Tribunal.

The Tribunal found that the AO only rejected the assessee’s claim for “want of evidence” without identifying any specific incorrectness in the accounts or establishing any connection between borrowed funds and the investments generating exempt income. It further noted that the assessee had sufficient interest-free funds and that the audited cash-flow statements were not examined before making the disallowance.

The Tribunal allowed the assessee’s appeal and held that the AO had failed to fulfil the mandatory requirement of Section 14A(2). It observed that before applying Rule 8D, the AO must properly examine the assessee’s accounts and record clear reasons showing why the assessee’s claim regarding expenditure relating to exempt income is incorrect.

Accordingly, the Tribunal directed the AO to delete the disallowance made under Section 14A to the extent it exceeded the assessee’s voluntary disallowance of Rs 7.30 lakh.