M/S. STARLIGHT SYSTEMS PRIVATE LIMITED (NOW MERGED WITH SUNTECK REALTY LTD),MUMBAI vs. DEPUTY COMMISSIONER OF INCOME TAX CENTRAL CIRCLE 3(4), MUMBAI, MUMBAI

The solitary grievance of the assessee is directed against the addition of Rs. 45,27,360/- made by the Assessing Officer ("AO") by invoking the provisions of section 14A of the Act read with Rule 8D of the Income-tax Rules, 1962 ("the Rules").

The assessee-company filed its original return of income on 29.09.2018 and subsequently filed a revised return on 18.07.2018, declaring total income of Rs. 1,29,11,360/-. The return was selected for scrutiny under the Computer Aided Scrutiny Selection ("CASS") system and statutory notice under section 143(2) of the Act was issued on 22.09.2019. In response thereto, the assessee complied with the statutory notices and furnished the requisite details.

During the relevant previous year, the assessee earned exempt dividend income amounting to Rs. 45,30,510/- and made a suo motu disallowance of Rs. 3,150/- under section 14A of the Act read with Rule 8D of the Rules. The AO, however, did not accept the suo motu disallowance made by the assessee and invoked Rule 8D(2) of the Rules. The AO computed the aggregate disallowance at Rs. 45,30,510/-, restricting the same to the amount of exempt income earned by the assessee. After adjusting the suo motu disallowance of Rs. 3,150/-, the AO made an incremental addition of Rs. 45,27,360/- under section 14A read with Rule 8D of the Rules.

Before us, the learned Authorised Representative ("AR") raised two-fold contentions.

Secondly, without prejudice to the above contention, the AR submitted that the assessee is a wholly-owned subsidiary of Sunteck Realty Limited, a listed entity, and is mandatorily governed by the Indian Accounting Standards ("Ind- AS"). Consequently, the investments of the assessee are carried at fair value through other comprehensive income ("FVTOCI") rather than at historical cost. The comparative position furnished before us is as under:

The AR submitted that the actual cost incurred by the assessee for acquiring the investments which yielded dividend income was only Rs. 77,47,656/-. The balance amount of Rs. 1,26,32,99,844/- represents unrealised fair-value

The learned Departmental Representative ("DR"), on the other hand, relied upon the order of the AO and submitted that Rule 8D refers to the value of investments as appearing in the balance sheet and, therefore, the AO was justified in adopting the fair value of the investments reflected in the audited balance sheet.

We have heard the rival submissions and perused the material available on record.

As regards the first contention of the assessee, section 14A(2) of the Act provides that the AO shall determine the amount of expenditure incurred in relation to exempt income in accordance with the prescribed method only if, having regard to the accounts of the assessee, he is not satisfied with the correctness of the claim of the assessee in respect of such expenditure.

The Hon'ble Supreme Court in Maxopp Investment Ltd. v. CIT, (2018) 402 ITR 640 (SC), has held that the AO is required to record satisfaction, having regard to the accounts of the assessee, as to the correctness of the claim made by the assessee before resorting to the prescribed method for determining the amount of expenditure incurred in relation to exempt income. Thus, the recording of satisfaction under section 14A(2) of the Act is a condition precedent for invoking the provisions of Rule 8D of the Rules.

In the present case, the assessee had itself made a suo motu disallowance of Rs. 3,150/- under section 14A of the Act. The AO, however, proceeded to invoke Rule 8D and determine the disallowance without demonstrating, with

Even otherwise, we find merit in the alternative contention of the assessee regarding the treatment of the fair-value adjustment while determining the value of investments for the purposes of Rule 8D.

The assessee has demonstrated that the actual cost of the investments yielding exempt income was Rs. 77,47,656/-, whereas the carrying value of the investments as on 31.03.2018, after taking into account the fair-value adjustments under Ind-AS, was Rs. 1,27,10,47,500/-. The substantial difference between the two figures is attributable to the unrealised fair-value adjustment of Rs. 1,26,32,99,844/-.

The fair-value adjustment is an accounting adjustment arising from the application of Ind-AS and, on the facts placed before us, does not represent any fresh deployment of funds by the assessee. Therefore, while determining the disallowance under section 14A read with Rule 8D, the notional increase in the carrying value of the investments on account of such unrealised fair-value adjustment cannot, by itself, be regarded as representing actual funds deployed by the assessee.

Accordingly, for the purpose of computing the disallowance under Rule 8D(2), the AO is directed to adopt the actual cost of the investments, amounting to Rs. 77,47,656/-, instead of the carrying value of Rs. 1,27,10,47,500/- after including the unrealised fair-value adjustment. The disallowance shall be recomputed accordingly, subject to verification of the actual cost of the

In view of the above, the appeal of the assessee is partly allowed for statistical purposes.