By IndiaHub 
The background of this case is that the taxpayer reported a tax-exempt income of Rs 81.567 crore in their income tax return (ITR) and claimed finance costs of Rs 117.28 crore. In the ITR, the taxpayer disallowed Rs 49.51 lakh under Section 14A based on a certificate from a chartered accountant dated March 19, 2021. The CA confirmed that the common indirect expenses amounted to Rs 1.874 crore.
The taxpayer’s auditor also noted that the exempt income made up 18% of the total income declared, so he suggested disallowing direct expenses of Rs 15.41 lakh along with 18% of the indirect expenses of Rs 1.874 crore as the disallowance under Section 14A. Consequently, the taxpayer reported a total disallowance of Rs 49,51,789 in the ITR.
The income tax assessing officer (AO), after confirming the need to apply Section 14A, made the disallowance by following the calculations outlined in Rule 8D of the Rules. As a result, an additional Rs 17.0949 crore was added to the taxpayer’s total income, which was upheld by the commissioner of appeals (CIT(A). Therefore, the taxpayer appealed to the ITAT Delhi.
On November 19, 2025, the taxpayer won the case at ITAT Delhi. Advocates Salil Kapoor and Ms. Soumya Singh represented the taxpayer.
Summary of the judgement
Chartered Accountant (Dr.) Suresh Surana, said to ET Wealth Online, in the given case (ITA No.961/Del/2023), the taxpayer, had earned exempt dividend income and had suo motu disallowed Rs 49.51 lakh based on a Chartered Accountant–certified working.
The Assessing Officer (AO), however, rejected this computation and made an additional disallowance of Rs 17.09 crore by applying Rule 8D to the entire investment portfolio, without distinguishing between investments that yielded exempt income and those that did not.
The Commissioner (Appeals) upheld the AO’s action, prompting the assessee to appeal before the Tribunal.
According to Surana, upon review, the Tribunal first examined whether the statutory requirement of recording satisfaction under Section 14A(2) was met.
Surana says: “It held that the AO had sufficiently demonstrated his dissatisfaction with the correctness of the assessee’s disallowance by referring to exempt income earned, finance cost claimed and the absence of complete working details, thus satisfying the statutory precondition for invoking Rule 8D.”
However, the Tribunal found merit in the taxpayer’s contention that the AO erred in computing the disallowance by applying Rule 8D(2)(ii) to all investments instead of restricting the calculation to investments that actually yielded exempt income.
Relying on binding judicial precedents, including the Delhi High Court ruling in Crago Motors Pvt. Ltd. and the Special Bench decision in Vireet Investments Pvt. Ltd., the Tribunal reaffirmed that only investments generating exempt income in the year under consideration may be factored into Rule 8D computation.
Accordingly, it held that the AO’s approach of applying 1% of the average value of total investments, irrespective of whether they produced exempt income, was inconsistent with established law.
Surana says: “Based on this reasoning, the Tribunal directed the AO to recompute the disallowance strictly in accordance with Rule 8D(2)(ii), limiting the calculation to investments that resulted in exempt income. Thus, the assessee succeeded to the extent of securing a substantial reduction in the disallowance imposed, and its appeal was partly allowed.”
ITAT Delhi analyses of facts of the case
ITAT Delhi in its judgement dated November 19, 2025, analysed Section 14A and Rule 8D and concluded that according to subsection 2 of Section 14A, the Assessing Officer (AO) must confirm the accuracy of the taxpayer’s claim regarding expensed related to income that isn’t included in total income.
However, ITAT Delhi pointed out that the AO’s assessment order showed he had confirmed his satisfaction by mentioning the exempt income earned, the investment made, and the finance costs claimed in the P&L Account.
The taxpayer failed to provide the detailed month-wise information about the investment made during the year in shares as well as mutual funds that generated exempt income, nor did they submit the calculations for the suo motto disallowance in their income computation.
Therefore, AO reached to the conclusion that the taxpayer did not disallow the expenditure directly linked to earning exempt income.
ITAT Delhi referenced a judgment of the Co-ordinate Bench of Mumbai Tribunal, which the taxpayers’ authorised representative cited in the Peim Hotels Ltd. Case. The Co-ordinate Bench noted that the assessment order did not mention any examination of the taxpayer’s claim, which was deemed incorrect without reviewing the taxpayer’s accounts.
However, ITAT Delhi clarified that in this case, the AO had not only examined the financial statements of the assessee (taxpayer) but also considered the expenses claimed and then reached the conclusion that the taxpayer’s claim of having incurred Rs 49,51,789 in expenses to earn exempt income was incorrect, and subsequently recalculated the expenses related to earning that exempt income according to Rule 8D of the Rules.
Under these circumstances, ITAT Delhi said that they are inclined to interfere in the order of the lower authorities with regarding the satisfaction noted before applying the rules of Section 14A r.w. Rule 8D of the Rules.
ITAT Delhi analyses Rule 8D computation
ITAT Delhi said that according to Rule 8D, the disallowance must be the total of the amounts that are either directly or indirectly related to income that isn’t included in the total income, plus an amount equal to 1% of the monthly average of the opening and closing balances of the value of the investments, the income from which does not or will not be part of the total income.
ITAT Delhi said: “From the perusal of the assessment order, we find that AO has taken 1% of the average value of total income irrespective of facts whether such investment had yielded exempt income or not.”
ITAT Delhi judgement:
- This being so, we direct the AO to compute the disallowance as per Rule 8D(2)(ii) on the amount of investment which had yielded exempt income only.
- With these directions, all the grounds raised by the assessee are partly allowed.
- In the result, appeal of the assessee is partly allowed.
Case law cited:
The jurisdictional high court in the case of Crago Motors Pvt. Ltd. Vs. DCIT reported in (2023) 453 ITR 554 (Delhi) and the Special Bench of ITAT Delhi in the case of Vireet Investments P Ltd reported in (2017) 82 taxmann.com 415 (Delhi) held that for the purpose of computing the disallowance u/s 14A, the investments which have yielded exempt income should only be considered for the purpose of computing the amount of disallowance in terms of rule 8D(2)(ii) of the Income Tax Rules, 1962.
Thus, ITAT Delhi said that they followed the aforesaid judgements of the jurisdictional high court and of the special bench of Tribunal, and directed the AO to recalculate the amount of disallowance as per Rule 8D(2)(ii) of the Rules by considering those investments which yielded exempt income.
With these directions, all the grounds taken by the assessee (taxpayer) was partly allowed.
How does Section 14A disallowance of income works?
According to Surana, Section 14A of the Income-tax Act, 1961 was introduced to ensure that taxpayers do not claim deductions for expenses incurred in earning income that is exempt from tax. The underlying rationale is that expenditure attributable to tax-free income cannot be allowed against taxable income, thereby maintaining the integrity of the tax base and ensuring neutrality between exempt and taxable streams of income.
Section 14A(1) provides that no deduction shall be allowed in respect of expenditure incurred by the taxpayer in relation to income which does not form part of the total income. Further, if the Assessing Officer (AO), having examined the accounts, is not satisfied with the correctness of the taxpayer’s claim including a claim that no expenditure was incurred, the AO must record such dissatisfaction in writing and then determine the disallowance in accordance with the method prescribed under Rule 8D of the Income-tax Rules, 1962.
Surana says: “This mechanism also applies even where the taxpayer claims that no expenditure has been incurred in relation to exempt income.”
Computation Mechanism under Rule 8D
According to Surana, Rule 8D prescribes a formula-based approach to quantify the disallowance once the AO has recorded valid dissatisfaction with the taxpayer’s computation. The disallowance comprises:
- Expenditure directly relating to exempt income; and
- 1% of the average value of investments (an annual average of monthly averages of the opening and closing value of the investment) that have actually generated exempt income during the year.
The aggregate disallowance, however, cannot exceed the total expenditure debited to the profit and loss account for the relevant year.
Surana says that in the context of the judgment, the term “disallowance of income” refers to the portion of expenditure that the tax authorities do not permit the taxpayer to deduct while computing taxable income, where such expenditure is considered attributable to earning exempt income.
Accordingly, the Assessing Officer increased the disallowance on the view that PTC India Ltd had understated the expenses relatable to its exempt income and recomputed the amount under Rule 8D.
Surana says: “The Tribunal upheld the principle of disallowance but clarified that such computation must be restricted only to investments that actually generated exempt income during the relevant year, thereby limiting the scope of the adjustment.”