Disallowances under Section 14A of the Income Tax Act must be based on actual expenditures, not generalized rules that were not applicable for the concerned assessment year.

Harisankar V. Menon, J.

This appeal under Section 260A of the Income Tax Act , 1961 (hereinafter referred to as the ‘Act’ for short), at the instance of the assessee, seeks to challenge the order dated 19.05.2020 in I.T.A No.60/COCH/2015 of the Income Tax Appellate Tribunal, Cochin Bench with respect to the assessment year 2006-07 relevant to the financial year 2005-

06.

2. The assessment for the year 2006-07 was subjected to re-assessment steps on various grounds. One such ground is with reference to the provisions of Section 14A of the Act, which provides for disallowing deductions with respect to expenditures incurred in relation to income which does not form part of the total income under the Act. The assessing authority noticed that the appellant-assessee made long-term investments in subsidiary companies and, by applying the ratio prescribed under Rule 8D of the Income Tax Rules , 1962 (hereinafter referred to as the ‘Rules’ for short), disallowed a claim for deduction of Rs.18,43,500/-. The first appeal was unsuccessful. The second appeal was instituted before the Tribunal, contending that Rule 8D of the Rules has no application regarding the assessment year 2006-07, as it was introduced only by the Finance Act, 2008, with prospective operation. The Tribunal, though it accepted this contention, went on to direct the assessing authority to disallow 2% of expenses incurred towards the exempted income. It is this direction that is challenged by the appellant in this appeal.

3. The following questions of law arise for consideration in this appeal: -

i. Whether the Appellate Tribunal is justified in overlooking the decision of the Hon'ble Supreme Court in CIT v. Essar Teleholdings Ltd. , reported in (2018) 401 ITR 445 (SC), which held that Rule 8D of the Income Tax Rules , 1963, cannot apply to the assessment years prior to 2008-09?

ii. Whether the Appellate Tribunal is justified in not setting aside the assessment in entirety, which it ought to have done, holding that the invocation of Rule 8D and the adoption of the methodology/computation envisaged under Rule 8D cannot apply to the A.Y. 2006-07?

iii. Whether the Appellate Tribunal is justified in placing reliance on an unreported decision of the Hon'ble High Court of Madras in Simpson and Company Ltd. , in T.C. No. 26212/2006 dated 15.10.2012, which admittedly cannot stand against the decision in Essar Teleholdings Ltd. , reported in (2018) 401 ITR

445 (SC)?

iv. Whether the Appellate Tribunal is justified in directing the assessing authority to disallow 2% of the expenditure, in the absence of any statutory provision authorising the said direction?

v. In the alternative, whether the disallowance of expenditure made under Rule 8D read with Section 14A of the Act, can be sustained, in the absence of the finding regarding the nexus between the exempt income and the interest-bearing funds?

vi. In the alternative, whether the lower authorities committed an error in disregarding the proof submitted by the appellant to show that the investments, which led to the earning of exempt income, were made prior to the year 2002, utilizing their own funds?

vii. In the alternative, whether the lower authorities erred in making the disallowance of expenditure amounting to Rs. 18,43,500/-, which far exceeds the actual exempt income earned amounting to Rs. 6,59,278/-; which is not in accordance with the binding precedents?

viii. Is not the finding of fact by the Appellate Tribunal erroneous and perverse?

4. Sri.Raja Kannan, the learned counsel for the appellant-assessee, would rely onCommissioner of Income- Tax v. Essar Teleholdings Ltd. [(2018) 401 ITR 445 (SC)] to contend that Rule 8D of the Rules can have application only from the assessment year 2008-09 and therefore, the Tribunal ought to have allowed the appeal. 5. Per contra, Sri.Jose Joseph, the learned Standing Counsel for the revenue, would