S. 14A: Rule 8D(2)(ii) & (iii) do not apply to shares held as stock-in-trade

For AY 2008-09, the assessee, a dealer in shares, received dividend of Rs. 18.91 lakhs but did not offer any disallowance u/s 14A and Rule 8D on the ground that they were not applicable to shares held as stock-in-trade. The AO rejected the claim and computed the disallowance under Rule 8D at Rs. 21.45 lakhs. On appeal, the CIT(A) held that even if Rule 8D was not applicable to shares held as stock-in-trade, a disallowance had still to be made u/s 14A and this was estimated at Rs. 1.89 lakhs. On appeal by the department to the Tribunal HELD dismissing the appeal:

Though s. 14A applies to shares held as stock-in-trade, Rule 8D (2)(ii) & (iii) cannot apply if the shares are held as stock-in-trade because one of the variables on the basis of which disallowance under rules 8D(2)(ii) & (iii) is to be computed is the value of “investments, income from which does not or shall not form part of total income”. If there are no such “investments”, the rule cannot have any application. When no amount can be computed under the formula given in rule 8 D(ii) and (iii), no disallowance can be made under rule 8D (2)(ii) & (iii) either. As held in B. C. Srinivas Shetty 128 ITR 294 (SC), when the computation provisions fail, the charging provisions cannot be applied, and by the same logic, when the computation provisions under rule 8 D (2) (ii) and (iii) fail, disallowance there under cannot be made either as the said provision is rendered unworkable. However, this does not exclude the application of rule 8 D(2)(i) which refers to the “amount of expenditure directly relating to income which does not form part of total income”. Accordingly, in a case where shares are held as stock-in-trade and not as investments, the disallowance even under rule 8 D is restricted to the expenditure directly relatable to earning of exempt income. The result is that the scope of disallowance under Rule 8D is narrower than that of s. 14A.