S. 14A & Rule 8D: If AO does not deal with assessee’s arguments, it means that he has not reached objective satisfaction that assessee’s method is incorrect & cannot invoke Rule 8D

In AY 2008-08 the assessee earned dividends of Rs. 5.45 crore and offered a disallowance u/s 14A of Rs. 5 lakhs. It gave a detailed explanation on why the amount of disallowance was adequate. However, the AO refused to accept the explanation and made a disallowance under Rule 8D of Rs. 1.05 crore. This was upheld by the CIT(A). On appeal by the assessee to the Tribunal HELD allowing the appeal:

(i) The invoking of Rule 8D to compute the disallowance u/s 14A is neither automatic and nor is triggered merely because assessee has earned an exempt income. The invoking of rule 8D of the Rules is permissible only when the AO records the satisfaction in regard to the incorrectness of the claim of the assessee, having regard to the accounts of the assessee. This recording of satisfaction is a condition precedent in accordance with the law laid down in Godrej & Boyce Manufacturing Co 328 ITR 81 (Bom) & Maxopp Investment Ltd 247 CTR 162 (Del);

(ii) On facts, the AO has given no reasons why the assessee’s calculation was not proper except to say that “the said disallowance was not acceptable”. The detailed submissions of the assessee have been brushed aside by making a bland statement that the disallowance is “not acceptable”. Therefore, the AO has not recorded any objective satisfaction in regard to the correctness of the claim of the assessee, which is mandatorily required in terms of s. 14A(2) and so his action of invoking Rule 8D is untenable. The AO is directed to retain the disallowance u/s 14A to the extent of Rs.5 lakhs as returned by the assessee;

(iii) the department’s objection that since the assessee was not maintaining separate accounts with regard to the activity of earning exempt income, the satisfaction contemplated u/s 14A be considered as implied is contrary to how the implications of sub-section (2) of s. 14A have been understood and explained by the High Courts in Godrej & Boyce Manufacturing Co. Ltd & Maxopp Investment Ltd.