Section 14A and Rule 8D – Assessee engaged in the business of share trading – Shares held as stock-intrade – Held that the Rule 8D(2) (ii) & (iii) do not apply and only the direct expenses incurred by the assessee could be subjected to disallowance.

The assessee was engaged in the business of share trading. During the course of scrutiny assessment proceedings, the Assessing Officer noticed that while the assessee had earned dividend income of Rs. 18.92 lakh, it had not made any disallowance u/s. 14A. The Assessing Officer computed the disallowance u/s. 14 A r.w.r. 8 D at Rs. 21.45 lakh. Being aggrieved, the assessee appealed before the CIT(A).

The CIT(A) in turn relied on the judgments of the Kerala High Court in CIT vs. Leena Ramchandran (ITA No.1784 of 2009) and of the Mumbai Tribunal in the case of Yatish Trading Co. P. Ltd. vs. ACIT (ITA No. 456/ Mum./2009 dt.10.11.2010) and held that Rule 8D was not applicable in the case of the assessee since there were no investments and all the shares were held as stock in trade. However, he held that since the assessee had earned exempt income, the provisions of section 14A were applicable. He estimated that expenditure equal to 10% of the dividend income was fair and reasonable and disallowed the sum of Rs. 1.89 lakh u/s 14A. The revenue did not agree with the CIT(A) and challenged his order before the tribunal.

Held:

According to the Tribunal, a plain reading of Rule 8D(2)(ii) & (iii) showed that the Rules can only be applied when shares are held as investments while in the case of the assessee, the shares were held as stock in trade. The tribunal came to this conclusion because it noted that, one of the variables on the basis of which the disallowance under the Rules are computed is “the value of investment, income from which does not form part of total income.” It further observed that when there are no investments, the Rule cannot have any application. According to it, when no amount can be computed in the light of the formula given in rule 8D (ii) and (iii), the computation provision fails and no disallowance can be made under the said Rules as held by the Supreme Court in the case of CIT vs. B C Srinivas Shetty (128 ITR 294). The tribunal further noted that where shares are held as stock in trade and not as investments, the disallowance, if any, would be restricted to the expenditure directly relatable to earning of exempt income.

Thus, the provisions of Section 14 A would be applicable, but the disallowance would be restricted to direct expenses incurred in earning of dividend income. For the said proposition, it also found support from the decision of the Special Bench of Tribunal in the case of ITO vs. Daga Capital Management Pvt. Ltd. (117 ITD SB 169).