Business expenditure – Disallowance u/s. 14A – Variable ‘A’ prescribed in the formula in Rule 8D(2)(ii) (to make disallowance in case of common interest expenditure) would exclude both interest attributable to tax exempt income as well as taxable income

Considering the scope of Rule 8D(2)(ii) for computing disallowance u/s. 14A of the Income-tax Act, 1961, the Delhi High Court held as under:

“i) The object behind section 14A (1) is to disallow only such expense which is relatable to tax exempt income and not expenditure in relation to any taxable income. This object behind section 14A has to be kept in view while examining Rule 8D (2) (ii). In any event a rule can neither go beyond or restrict the scope of the statutory provision to which it relates.

ii) Rule 8D (2) states that the expenditure in relation to income which is exempt shall be the aggregate of (i) the expenditure attributable to tax exempt income, (ii) and where there is common expenditure which cannot be attributed to either tax exempt income or taxable income then a sum arrived at by applying the formula set out thereunder. What the formula does is basically to “allocate” some part of the common expenditure for disallowance by the proportion that average value of the investment from which the tax exempt income is earned bears to the average of the total assets. It acknowledges that funds are fungible and therefore it would otherwise be difficult to allocate the sum constituting borrowed funds used for making tax-free investments. Given that Rule 8D(2)(ii) is concerned with only ‘common interest expenditure’ i.e. expenditure which cannot be attributable to earning either tax exempt income or taxable income, it is indeed incongruous that variable A in the formula will not also exclude interest relatable to taxable income.”