Definition of ‘total income u/s 2(45) refers to section 5 which envisages ‘scope of total income’. On a reading of section 5 of the IT Act, it would be evident that as per this section ‘total income’ is of any previous year and which includes income from whatever source derived which is received or deemed to be received in India in such year by or on behalf of such person or accrues or arises or is deemed to accrue or arises to him in India during such year or accrues or arise to him outside India during such year.
Considered in aforesaid context, expression ‘total income’ referred to in rule 8D(2)(i) cannot be in abstract. It must relate to a previous year income of which is sought to be assessed. Therefore, as a natural corollary it follows that only expenditure directly relating to income which is earned either on receipt basis or on accrual basis and which does not form part of total income of a particular assessment year can be disallowed under clause (i) of Rule 8D(2). Rule 8D(2)(i) does not refer to the investment made by the assessee. On a conjoint reading of clause (i) and clause (iii) of Rule 8D(2), the difference between them is clearly discernible. While clause (i) speaks of disallowance of expenditure directly relating to income which does not form part of total income, clause (iii) provides for disallowance of expenditure of the average value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee on first day and last day of the previous year. Therefore, while disallowance of expenditure under clause (i) is related to income earned which does not form part of total income, clause (iii) relates to the average of the value of investment appearing in the balance sheet. On a plain reading of Rule 8D(2) as a whole the legislative intent becomes clear that the disallowance of expenditure contemplated under subrule( i) must relate to the income which does not form part of the total income of that year. Therefore, investment, which has not resulted in any income cannot be considered for the purpose of disallowance under Rule 8D(2)(i). However, while computing disallowance under rule 8D(2)(iii), the average of the total investment of the assessee as appearing in the balance sheet on the first day and last day of the year irrespective of the fact whether it has yielded income or not can be considered for the purpose of disallowance. The use of the words does not or shall not in Rule 8D(2)(iii) connotes that income not only does not form part of total income during the year but it also shall not form part of total income at any time. Had it been the intention of the Rule framing authorities to disallow under rule 8D(2)(i) expenditure relating to total value of investment or income which is not earned during the relevant previous year, then, they would have used the expression ‘does not or shall not form part of total income’ as appearing in rule 8D(2)(iii) instead of words ‘does not form part of total income’. That being the case, AO cannot disallow expenditure relating to investment which has not yielded any exempt income during the previous year relevant to the assessment year under dispute. Therefore, we direct the AO to disallow the expenditure relating to investments resulting in income earned/accrued which does not form part of total income of the impugned assessment year.However, so far as AO’s computation of expenditure to be disallowed under rule 8D(2)(iii), the same in our view, is in conformity with Rule 8D(2)(iii), hence, do not call for any interference.