By TIOL News Service

BANGALORE, JUNE 05, 2018: THE ISSUE IS - Whether the sum of Sec 14A disallowance can be more than the amount of exempt income earned by the assessee. NO IS THE ANSWER.

Facts of the case

The assessee bank engaged in banking business had filed its returns for the relevant AYs. On assessment, the AO observed that the assessee had earned dividend income of Rs.1,80,30,965/- and the same was claimed as exempted. Pursuantly, the assessee stated that no separate accounts have been maintained for earning such exempted income and that no expenses were incurred towards earning the alleged exempted income for AY 2011-12. The AO also observed that the assessee had added back the amortization and depreciation expenses in the SLR investments thereby raising its net profits to claim higher deduction u/s 36(1)(viii). However, the AO disallowed the claim of such excess deductions and also disallowed expenditure to the extent of Rs.2,48,85,000/- incurred in earning exempt income u/s 14A r.w. Rule 8D for AYs 2011-12. Similar additions were made also for the year 2012-13 w.r.t. Sec.14A disallowance. The AO's views were for both the AYs were upheld by the first and second appellate authorities as well.

High Court held that,

++ the expenditure for earning exempted income has to have a reasonable proportion to the income, so earned, going by the common financial prudence. Therefore, even if the Assessing Authority has to make an estimate of such an expenditure incurred to earn exempted income, it has to have a rational nexus with the amount of income earned itself. Disallowance u/s 14A of Rs.2,48,85,000/- as expenses to earn exempted Dividend income of Rs.1,80,30,965/- is per se absurd and hypothetical. The disallowance u/s 14A cannot exceed the expenses claimed by assessee under the Proviso to Rule 8D. Therefore, where the assessee claimed that assessee did not incur any such expenditure during the year in question to earn Dividends of Rs.1,80,30,965/-, the burden was upon the assessing authority to compute the interest on such borrowed funds which were dedicatedly used for investment in securities to earn such exempted Dividend income. The disallowance u/s 14A cannot be a wild guesswork bereft of ground realities. It has to have a reasonable and close nexus with the factually incurred expenses. It is not deemed disallowance u/s 14A but an enabling provision for assessing authority to compute the same on the given facts and figures in the regularly maintained Books of Accounts. The assessing authority also could not have called upon the assessee himself to undertake the exercise of computing the disallowance u/s 8D of the Rules. Such abdication of duty in not permissible in law. Since no such exercise has been undertaken by the assessing authority, the case calls for a remand. In this view of the matter, the findings of all the three authorities below for Sec.14A are set aside and the matter is remanded back to the Assessing Authority for re-computing the disallowance of expenditure, if any, u/s 14A in accordance with law;

++ the profits and gains of business or profession for the purpose of claiming deduction of 20% thereof u/s 36(1)(viii) does not envisage any such artificial raising of the "profits" by adding back the amortization and depreciation in the SLR investments, as has been done by the assessee Bank in the present case. The profits and gains of business, as simply computed as per the accounting practices followed by the assessee in normal course of business u/s 28 has to be the basis for computing 20% deduction. The artificial increase of the profits by adding back amortization and depreciation in SLR investments by the assessee as done by it before the assessing authority was not justified and therefore, the authorities below appear to be justified in reducing the said deduction, ignoring the said adding back of the amortization and depreciation in SLR investments. The said deduction has to be restricted to 20% of profits of banking business as computed by the assessing authority. Therefore, the contention raised by the assessee in this regard in the present appeals is not sustainable. The said contention, therefore, is liable to be rejected. The same is accordingly rejected.

(See 2018-TIOL-1070-HC-KAR-IT)