For the assessment year 2008-09 the assessee had reported a tax exempt income to the tune of Rs. 18,26,360/- amongst other heads of income. The AO added back Rs. 19,96,242/- under Section 14A. While doing so, the AO applied Rule 8D by taking into consideration the total quantum of interest other than that invested, under Section 14A in terms of Rule 8D, and arrived at the said figure after multiplying it with the result of the average value of investments and over average value of assets derived by him. He thus determined the disallowance of Rs. 19,96,242/-.
The CIT(Appeals) went into the record and found that the amount of investment attributable to dividend as on 31.3.2008 was Rs. 3,53,26,800/-, which constituted less than 1% of the total scheduled funds. He however accepted the basis of calculation applied by the AO and directed a disallowance of .05% of the amount determined to be average investment. The ITAT – to which the revenue appealed, restored the AO’s determination holding it to be a true calculation in terms of Rule 8D. It is argued by the assessee that since CIT(Appeals) correctly noted the facts as to the value of the investment in tax exempt investment, and at the same time noticed that the ultimate result on an application of .05% disallowance would be same.
Counsel for the revenue on the other hand, submitted that given the determination of average value of investment, the AO had no choice but to apply Rule 8D(2) in view of mandate of section 14A which required him to apply the prescribed method of determining disallowance. Facts as disclosed by the AO, who expressed his opinion that the claim of the assessee for no disallowance was warranted since no expenditure was incurred, had to be rejected. Therefore, the first condition for application of Section 14A in this case was fulfilled. In such eventuality the AO is required by the mandate of Rule 8D to follow Rule 8D(2). Clauses 1, 2 and 3 detail the methodology to be adopted.
The AO, instead of adopting the average value of investment of which income is not part of the total income i.e. the value of tax exempt investment, chose to factor in the total investment itself. Even though the CIT(Appeals) noticed the exact value of the investment which yielded taxable income, he did not correct the error but chose to apply his own equity. Given the record that had to be done so to substitute the figure of Rs. 38,61,09,287/- with the figure of Rs. 3,53,26,800/- and thereafter arrive at the exact disallowance of .05%.
In view of the above reasoning, the findings of the ITAT and the lower authorities are hereby set aside. The appeal is allowed and the matter is remitted to work out the tax effect to the AO who shall do so after giving due notice to the party.