ITAT Mumbai grants Manugraph relief on Section 14A disallowance and allows R&D expense deduction under Section 37(1).

June 4, 2026 : The Income Tax Appellate Tribunal (ITAT) has granted substantial relief to Manugraph India Limited by restricting the scope of disallowance under Section 14A of the Income Tax Act and allowing deduction of certain research and development (R&D) expenses that were not approved for weighted deduction by the Department of Scientific and Industrial Research (DSIR). The Tribunal partly allowed the company’s appeals for Assessment Years 2016-17 and 2017-18, holding that only investments that actually generated exempt income can be considered while computing disallowance under Section 14A and that genuine R&D expenditure remains deductible even if it does not qualify for weighted deduction under Section 35(2AB).

The dispute arose from assessment proceedings against Manugraph India Limited, a company engaged in the manufacture and export of sophisticated printing machines. For AY 2016-17, the Assessing Officer had made additions including a disallowance of ₹27.75 lakh under Section 14A read with Rule 8D, disallowance of scientific research expenditure, and disallowance of rent expenses paid for a farmhouse in Alibaug. Similar issues were raised in AY 2017-18. The company challenged these additions before the appellate authorities and subsequently approached the ITAT after receiving only partial relief from the Commissioner of Income Tax (Appeals).

One of the key issues before the Tribunal concerned the interpretation of Section 14A, which restricts deduction of expenditure incurred in relation to exempt income. The company argued that the Assessing Officer had incorrectly considered all investments while calculating disallowance under Rule 8D, including investments that did not yield exempt income. It further contended that investments in growth-oriented mutual funds did not generate exempt dividend income and therefore could not be included for the purpose of Section 14A disallowance. The company also maintained that borrowed funds were not used for investments and that its interest-free funds significantly exceeded the value of investments.

After examining the record, the Tribunal accepted the assessee’s contention that only those investments which actually yielded exempt income should be considered while computing disallowance under Rule 8D. Referring to the Special Bench decision in ACIT v. Vireet Investments Pvt. Ltd., the Tribunal directed the Assessing Officer to recalculate the disallowance accordingly. The Bench observed that the assessee’s interest-free funds were substantially higher than its investments and relied on the Bombay High Court judgment in CIT v. HDFC Bank Ltd. to hold that a presumption arises that investments are made from interest-free funds when such funds exceed the investment amount. Consequently, the Tribunal directed deletion of the entire interest disallowance made under Rule 8D(2)(ii).

The Tribunal stated that “only those investments which yielded exempt income” should be considered for the purpose of Section 14A disallowance and held that where interest-free funds are substantially higher than investments, the disallowance of interest expenditure is not justified.

Another significant issue related to rental expenditure of ₹13.20 lakh paid for a farmhouse located in Alibaug and owned by directors and related parties covered under Section 40A(2)(b) of the Income Tax Act. The company claimed that the property was used for accommodating foreign business visitors and customers and that the expenditure was incurred wholly and exclusively for business purposes. During the hearing, the company furnished details of foreign visitors, including business representatives from Russia and Japan who stayed at the property during negotiations related to printing machine business.

However, the Tribunal noted that the property had been rented continuously for six months while evidence was produced only regarding the stay of two foreign guests for a short duration. The Bench observed that the company failed to provide sufficient evidence demonstrating extensive business use of the farmhouse. It further noted that the property belonged to directors and related parties and that the possibility of personal use could not be ruled out. Considering these factors, the Tribunal partly upheld the disallowance but restricted it to 50% of the rental expenditure instead of sustaining the entire addition made by the tax authorities.

The ruling is particularly important for companies claiming weighted deductions for scientific research expenditure under Section 35(2AB). Manugraph had claimed weighted deduction on R&D expenses, but the DSIR approved only part of the expenditure. Based on the DSIR certification, the Assessing Officer disallowed the balance claim. The company argued that even if a portion of the expenditure was not approved for weighted deduction under Section 35(2AB), it still represented genuine business-related research expenditure and should be allowed under Section 37(1) or Section 35(1)(i).

Accepting this argument, the Tribunal relied on earlier decisions including Auto Ignition Ltd. v. ADIT and BEML Ltd. v. DCIT. The Bench held that although the disputed expenditure may not qualify for enhanced weighted deduction under Section 35(2AB), it remains allowable as ordinary business expenditure if incurred wholly and exclusively for business purposes. Accordingly, the Tribunal directed the Assessing Officer to allow deduction of ₹22 lakh for AY 2016-17 under Section 37(1). Similar relief was granted for AY 2017-18 with respect to comparable R&D expenditure.

The decision reinforces two important principles in income tax law. First, Section 14A disallowance cannot be mechanically computed by including investments that do not generate exempt income, and authorities must examine the actual nature of investments and availability of interest-free funds. Second, denial of weighted deduction under Section 35(2AB) does not automatically result in complete disallowance of R&D expenditure if the expenditure is otherwise genuine and incurred for business purposes. The ruling is likely to benefit companies engaged in research-intensive industries and taxpayers facing disputes over Section 14A disallowances and DSIR-certified R&D deductions.

The appeals for both Assessment Years 2016-17 and 2017-18 were ultimately partly allowed by the Mumbai Bench of the ITAT through its order pronounced on June 4, 2026.

Case Reference: Manugraph India Limited v. ACIT Circle-3(2)(1), Mumbai, ITA Nos. 7160/MUM/2025 & 7161/MUM/2025 (ITAT Mumbai), Order dated June 4, 2026.