ITAT Kolkata Sets Aside Section 14A Disallowance, Directs Recomputation Considering Only Exempt-Income-Generating Investments

Case Overview

Background and Facts of the Case

CHNHB Health Insurance Co. Ltd., a private limited company, filed its return of income for Assessment Year 2017-18 declaring a total loss of ₹(-)1,03,10,740/-. The case was picked up for limited scrutiny under the Computer Assisted Scrutiny Selection (CASS) mechanism, specifically to examine whether expenses attributable to exempt income had been correctly computed and disallowed.

Upon issuance of notices under Section 143(2) and Section 142(1) of the Income Tax Act, 1961, the Assessing Officer observed that the assessee had reflected investments in equity shares aggregating to ₹122,22,51,000/- in the balance sheet as at 31.03.2017. The assessee had claimed dividend income and interest on Tax Free Bonds totalling ₹2,33,02,492/- as exempt from tax.

Assessee's Own Computation and the Assessing Officer's Response

How the Assessee Computed the Disallowance

The assessee independently calculated the expenditure attributable to exempt income. Since exempt income (tax-free dividend and interest) of ₹2,33,02,492/- constituted 56.90% of the total dividend and interest income of ₹4,09,49,451/-, the assessee applied this percentage to aggregate non-insurance expenses of ₹87,41,989/- as per audited accounts. This worked out to ₹49,74,192/-, which the assessee suo motu disallowed.

Assessing Officer's Dissatisfaction and Invocation of Rule 8D

The Assessing Officer, relying on CBDT Circular No. 5/2014 dated 11.02.2014, was not satisfied with the assessee's methodology and held that it did not conform to the requirements of Section 14A read with Rule 8D of the Income Tax Rules, 1962. He therefore proceeded to compute the disallowance independently.

The Assessing Officer's computation was as follows:

• Rule 8D(2)(i) — Direct expenses relating to exempt income: ₹49,74,192/-
• Annual average of monthly averages of investment (entire investment considered): ₹115,53,26,850/-
• 1% thereof (under Rule 8D(2)(ii)): ₹1,15,53,269/-
• Total disallowable expenditure computed: ₹1,65,27,461/-

However, since the total non-insurance expenses per accounts were only ₹87,41,989/-, and ₹49,74,192/- had already been disallowed by the assessee, the Assessing Officer restricted the further disallowance under Section 14A read with Rule 8D to the balance amount of ₹37,67,797/- (i.e., ₹87,41,989/- minus ₹49,74,192/-).

Consequently, total income was assessed at ₹65,42,943/- under Section 143(3) of the Income Tax Act, 1961.

First Appellate Stage: Addl/JCIT(A)-1, Gurugram

The assessee challenged the assessment order before the Addl/Joint Commissioner of Income-tax (Appeals)-1, Gurugram. The appeal was dismissed vide order dated 31.01.2025.

Findings of the Appellate Authority

The Addl/JCIT(A) upheld the Assessing Officer's disallowance on the following reasoning: