The Chennai Bench of Income Tax Appellate Tribunal (ITAT) directed the assessing officer (AO) to limit the disallowance under Section 14A to 0.5% of exempt income earned by the assessee based on Rule 8D(2)(iii) of the Income Tax Rules, 1962.
Infrastructure Development Finance Company Limited (IDFC), the assessee received dividends of Rs. 134.25 crore and claimed a net exempt income of Rs. 133.50 crore under Section 10(34) of the Income Tax Act, 1961. It allocated Rs.74.98 lakh as expenses incurred to earn this exempt income. However, the AO, invoking Rule 8D, recalculated the expenses at Rs. 210.31 crore and disallowed this amount under Section 14A.
The assessee challenged the disallowance before the Chennai bench of ITAT arguing that the disallowance of Rs. 134.25 crore under Section 14A was excessive and not justified because only Rs. 74.98 lakh had been spent to earn the exempt income.
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The assessee’s counsel argued that Rule 8D was applied incorrectly because the investments yielding the exempt income were funded through the company’s own reserves, not borrowed funds and the disallowance was based on a misapplication of prior provisions.
On the contrary, the revenue counsel contended that Rule 8D had been correctly applied, as it was introduced for the 2007-08 assessment year onward, and emphasized that IDFC’s earlier records showed that borrowed funds had been used for dividend-earning investments, which continued during the relevant assessment year.
The two members comprising Aby T. Varkey (Judicial Member) and Jagadish (Accountant Member) noted that the assessee had consistently claimed in earlier years that borrowed funds were used for investments yielding exempt dividend income.
The tribunal agreed with the AO in rejecting the assessee’s claim that no interest expenditure was incurred to earn the exempt income. However, the tribunal noted procedural lapses in the computation made under Rule 8D(2)(ii).
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Therefore, the tribunal remanded the matter back to AO and directed the AO to limit disallowance under Rule 8D(2)(iii) to 0.5% of the investments yielding exempt income. The appeal of the assessee allowed for statistical purposes.
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