S.14A + Rule 8D Disallowance: Onus On AO To Show Direct Nexus Between Exempt Income And Expenditure

DCIT vs. Allied Investments Housing P. Ltd (ITAT Chennai)

S. 14A & Rule 8D: Onus is on AO to show how assessee’s claim is incorrect. AO has to show direct nexus between expenditure & exempt income. Disallowance cannot be made on presumptions


In AY 2009-10 the AO made a disallowance of Rs 58 lakhs u/s 14A read with Rule 8D. The assessee claimed that the disallowance was not permissible on the grounds that (i) the AO had not recorded any satisfaction as to the correctness of the assessee’s claim that it had not incurred expenditure of more than 2% of the dividend income earned, (ii) it had not made any fresh investment during the year and the dividend was received from an unlisted company out of an investment made in an earlier year & (iii) the AO had not pointed out any direct nexus between the interest expenditure incurred and the exempt income earned during the year. The CIT(A) accepted the claim & restricted the disallowance to Rs 50,000 On appeal by the department to the Tribunal HELD dismissing the appeal:

(i) A disallowance u/s 14A read with Rule 8D cannot be made without recording satisfaction as to how the assessee’s calculation of s. 14A disallowance is incorrect. It is a prerequisite that before invoking Rule 8D, the AO must record his satisfaction on how the assessee’s calculation is incorrect. The AO cannot apply Rule 8D without pointing out any inaccuracy in the method of apportionment or allocation of expenses. Further, the onus is on the AO to show that expenditure has been incurred by the assessee for earning tax-free income. Without discharging the onus, the AO is not entitled to make an ad hoc disallowance. A clear finding of incurring of expenditure is necessary. No disallowance can be made on the basis of presumptions, (ii) the mere fact that some interest expenses were incurred cannot be the reason for disallowance unless the nexus between the expense and the exempt income is established, (iii) the assessee did not make any fresh investment during the year which could generate exempt income in forthcoming years, (iii) the exempt income earned during the year comprised of dividend received from an investment made in an earlier year, (iv) the interest expenditure of the year is not directly related to the earning of exempt income & (v) the AO has not pointed out any direct nexus between the interest expenditure incurred and the exempt income earned during the year (Hero Cycles Ltd 323 ITR 518 P&H) & Godrej and Boyce 328 ITR 81 (Bom) followed)