AO Failed to Record Proper Satisfaction to Invoke R. 8D: ITAT Restricts Disallowance to SIDBI's Calculation [Read Order]

The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) restricted the disallowance made under Section 14A of the Income Tax Act to the suo-motu disallowance already computed by the assessee noting that Assessing Officer (AO) had failed to record the requisite satisfaction for rejecting the assessee’s working and invoking the mandatory provisions of Rule 8D.

Small Industries Development Bank of India (assessee), which had earned exempt income from dividends, tax-free bonds, and Long Term Capital Gains (LTCG). The assessee made a suo-motu disallowance of ₹1,16,75,281 under Section 14A of the Income Tax Act.

The assessee calculated based on a scientific method involving the proportion of employees in the Investment Department to the total number of employees. The AO rejected this self-calculated amount, stating the assessee had not maintained a separate set of accounts and that the computation was based on estimation, not actuals.

The AO proceeded to apply Rule 8D(2)(iii) to compute the disallowance at 0.5% of the average investment which resulted in a significantly higher total disallowance of ₹5,50,86,192 (after reducing the suo-motu amount). Aggrieved by the AO’s order, the assessee filed an appeal before the Commissioner of Income Tax (Appeals) [CIT(A)].

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The CIT(A) gave partial relief by upholding an adhoc disallowance of ₹50,00,000. Aggrieved by the CIT(A)’s order, the assessee appealed to the ITAT. The assessee’s counsel contended that the AO's mechanical resort to Rule 8D was invalid because the prerequisite of recording satisfaction as per Section 14A(2) was absent or improperly recorded.

The two-member bench, comprising Justice (Retd.) C V Bhadang (President) and Padmavathy S (Accountant Member) noted that the AO’s rejection was based on the premise that the assessee's working was an "estimation" and that separate books for exempt income were not maintained, which was a requirement.

The Tribunal observed that the AO while rejecting the suo-motu disallowance has not given any specific finding with regard to the books of accounts based on which the assessee has arrived at the disallowance.

Citing its own earlier decision in the assessee’s case for AY 2008-09 and judicial precedents, the Tribunal held that the AO must record satisfaction in an objective manner as to why the expenditure claimed by the assessee is incorrect, having regard to the accounts of the assessee, before invoking Rule 8D.

The tribunal concluded that the AO failed to record a proper and objective satisfaction. The Tribunal directed the AO to restrict the disallowance under Section 14A to the suo-motu disallowance made by the assessee. In the result, the ground raised by the assessee was allowed.

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