Assessee is excepted from operation of Explanation to s. 73 where the total income of assessee mainly consists of income derived from the granting of loans and advances.

Held The period when the disallowance was to be calculated- in both appeals, was when there was no Rule 8D setting out the formula for calculating disallowance, under Section 14A(3). The assessee had claimed that it incurred no expenditure in earning dividend (i.e. tax exempt) income, which constituted approximately 40% of its income. The AO rejected its argument, and roughly apportioned about 9-10% of the exempt income, which bore some proportion to the tax exempt income. (Para 14) During AY 2005-06, the total expenditure incurred was about Rs. 90 lakhs. During the hearing, the break-up of these expenses was revealed: about Rs. 2.5 lakhs was spent on salaries; the rest was on professional fees (including legal fees) transport, maintenance of vehicles, stationery, postage, printing etc. It was within the power of the AO to have inquired into these items, to scientifically apportion amounts attributable to expenditure that could reasonably bear proximity with earning of tax exempt income; instead, the AO merely rested content with applying a proportion, which was not appropriate. Given that the funds and scrips (which yielded dividend) were legacy assets, the assessee’s arguments were reasonable. (Para 16)