section 14a of the income tax act, 1961

SECTION 14A OF THE

INCOME TAX ACT, 1961

By Deepika Mevadi(CA Final)

TOPICS

COVERED Background of Section 14A Rationale of Section 14A Objective Method of Allocating Expenditure relating

to Exempt Income Computation of Disallowance Judicial Decisions (Rule 8D) Decision to Section 14A Recent Developments Special Bench Decision (SB) Implication of SB

Brought onto the statute by the Finance Act, 2001

Provides for disallowance of expenditure incurred in relation to income which is not included in the total income of the assessee

Proviso to the Section was added by the Finance Act, 2002 w.e.f. 11-5-2001.

RATIONALE FOR THIS SECTION

No deduction for

expenditure

Incurred in respect of

exempt income

Against taxable income

Tax incentive given by way of

Exemptions to certain

categories of income

Used to reduce also the tax

payable on the non-exempt

income

Incurred to earn the exempt

income against taxable income.

Exemption is also in

respect of the net income

Expenses incurred can be allowed

Only to the extent they

are relatable

To the earning of taxable

income

To prevent tax payers from setting off expenses

To earn tax free income

Against other income which

is taxable

MEANS TO OBJECTIVE

To earn such tax free income

Tax payer must

Have tax free income

&

Have actually incurred expenses

To quantify such

expenses

ensure that the same

are not claimed by assessee

as a deduction

against any other

income

METHOD FOR ALLOCATING EXPENDITURE IN RELATION TO EXEMPT INCOME

[Section 14A(2) and Rule 8D]

Assessing officer is

satisfied with the correctness of claim

not satisfied with the correctness of claim

(a) Assessing officer is satisfied

No expenditure has been incurred for• Such exempt

income

No further action is required• By the Assessing

Officer in this regard

(b) Assessing officer is not satisfied with

Correctness of the claim of expenditure

The claim made by the assessee that no expenditure has been incurred

For that Rule 8D lays down the computation mechanism for this purpose

Introduction of RULE 8D Formula laid down in the

said Rule is Highly unfair and does

not take into cognizance the facts of any case.

It merely lays down an arithmetical method of arriving at a disallowance.

This disallowance often comes to much more than the entire expenses debited to the Profit and Loss Account by the tax payer.

COMPUTATION OF DISALLOWANCE

aggregate of (i) amount of expenditure

directly relating to income

which does not form part

of total income


aggregate of (ii) interest on borrowed

funds not directly

attributable toany particular

income or receipt

FORMULA FOR DISALLOWANCE

= A X BC

• Amount of interest other than directly attributable to the exempt income A

• average of value of investment• income from which does not or shall

not form part of the total incomeB

• average of total assets as appearing in the balance sheet

• on the first day and the last day of the relevant accounting year

C


aggregate of (iii) ½ % of the average of the value

of investment

income from which does not or shall not form part of the total

income

as appearing in the balance sheet on the first day and the last day of the relevant

accounting year

RULE 8D PROVIDES

Disallowance of

direct expenditure

indirect

expenditur

e

JUDICIAL DECISIONS (ISSUES TO RULE 8D)

[Godrej & Boyce Manufacturing Company Limited vs. DCIT (2010) 194 Taxman 203 (Bom.)]

Rule 8D shall not be applicable for assessment year prior to assessment year 2008-09

Applicable to all pending cases even prior to notification of rule 8D


[ K.V. Trading Co. Limited vs. DCIT (supra) ]

Section 14A prevails over other general law due to

Special Provision

Special Law


[CIT vs. Hero Cycles Limited 323(2010) ITR 518 (P&H)]

Borrowed funds

Utilized business purposes & Investment in shares made

out of own fundsDISALLOWANCENOT PERMISSIBLE


[Dy. CIT vs. Maharashtra Seamless Limited (2011) 16 Taxman.com 97 (Del.)

No Disallowance of Interest on borrowed funds

if Assessing officer does not show

Between Borrowed funds &

NEXUS

Tax free investme

nt


Morgan Stanley India Securities (P) Limited vs. ACIT (2011) 55 DTYR (Mub) (Trib) 177

Disallowance of

Net Interest

or

Gross Interest


[ Varun Shipping Company Limited vs. Addl CIT (2012) 134 ITD 339 (Mum) ]

Separate Disallowance under Presumptive Tax Scheme?

No scope for separate disallowance


K. V. Trading Co. Limited vs. DCIT (supra)

Consequences where composite expenditure is incurred on

earning income, which is partly taxable and Partly exempt

Where assessee maintain composite account of expenditure

Assessee have to prove that

Expenditure incurred by him is in relation to

For both the exempted income and non exempted income

Non exempted income as it is the assessee which is claiming deduction


State Bank of Travancore vs. ACIT (2009) 318 ITR (AT) 171 (Coach)


Daga Capital Management P Ltd [312 ITR 1 ] &

ACIT vs Cheminvest Ltd case [124 TTJ 577]

No Disallowance u/s 14A

if Dividend Incidental to Business


CIT vs. New India Investment Corporation Limited (1978) 113 ITR 778 (Cal.)

Rule 8D Not

Applicable

JUDICIAL DECISIONS(ISSUES TO RULE 8D)

[CIT vs. Kribhco (2012) 75 DTR 265 (Del.)

No disallow

ance

• Income entitled to deduction under section 80P(2)(d)

• Relating to co-operative society

Disallowance

• Exempt income• Deduction under

chapter VI-A

JUDICIAL DECISIONS(ISSUES TO RULE 8D)

Gillette Group India (P.) Limited vs. ACIT 12(1)

Disallowance

Can’t Exceed

Expenditure Claimed

TO SECTION 14A

No Disallowance Exemption is granted

Exemption is given u/s.10(38) Not as an incentive

In respect of long term capital gains on which STT is paid

But because the tax is levied at source

TO SECTION 14A

e.g. Dividend Distribution tax, Tax payable by firms, etc

No Distinction between

Income which is completely

exempt from tax &

Income received after

payment of tax

TO SECTION 14A

Disallowance u/s.14A

Agricultural IncomeHaryana

Land Reclamation

& Development Corp. v. CIT, 159 Taxman 271 (P & H)

Dividend on shares and

units of mutual fundsWallfort

Shares & Stock

Brokers Ltd. v. ITO, 96 ITD

1 (Mum.) (SB)

Share of Profit from

FirmSudhirDattar

amPatil v. DCIT, 2 SOT 678 (Mum.)

Tax Free Bonds

Punjab National Bank v. DCIT, 103 TTJ 908

(Del.)

Chapter VIA Income

Punjab State Co-operative Milk

Producers Federation Ltd. v. ITO, 104 ITD

408 (Chand)

TO SECTION 14A

New Rule 8D prescribed by CBDT

working of the amount disallowable u/s.14A

adhoc basis was being adopted

notional amount will be disallowed

RECENT DEVELOPMENTS Once the Rule 8D was notified sometime

in early 2008, the tax officers have been mechanically applying the said Rule to all pending assessments.

In most cases, they have been rejecting the working prepared by the tax payer and huge disallowances have been made under section 14A based on the irrational computational mechanism laid down in the Rule.

RECENT DEVELOPMENTS However, the latest development has made matters

even worse now. Recently, the Income-tax Appellate Tribunal had

occasion to decide on the issue of applicability of the section in those cases,

Where a tax payer had invested money in investments, the income from which, as and when received, would be tax free in the hands of the tax payer.

In view of conflicting decisions of various Tribunals in the matter, it was decided to constitute a SPECIAL BENCH. This Special Bench at Delhi has given its decision vide its consolidated order dated 5th August, 2009 in the case of ITA Nos. 87/Del/2008, 4788/Del/2007 and 233/Ahd/2006

SPECIAL BENCH DECISIONRelevance was

Work out the expenditure

In relation to the exempt income &

Not to examine whether the expenditure incurred by the assessee

Has resulted into exempt income or taxable income

SPECIAL BENCH DECISION

Gist of the Special Bench decision

Section 14A would be applicable

Where the tax payer has not earned any income which is tax free

But has invested funds in investments which

When they start yielding income

Such income would be tax free

SPECIAL BENCH DECISIONDisallowance

Irrespective ofWhether the income is

Earned by the assessee or not

SPECIAL BENCH DECISION

Decisions of the Supreme Court in the case of Maharashtra Sugar Mills and Rajasthan State Warehousing

One indivisible business

Entire expenditure is allowable

No application after the introduction of section 14A

DECISION OF SPECIAL BENCH

Even if the tax payer has not earned any tax free income in a year

if funds have been borrowed at a cost

a part of his expenses would necessarily have to

be disallowed under section 14A read with Rule 8D

if the tax payer has investments in shares or

mutual funds

the income from which, when received, would

be tax free

IMPLICATIONS OF THE DECISION

Disallowance of part of the interest paid


Who have borrowings &

Who have invested

In shares &

Mutual funds


That no expenses have been incurred

To earn tax free income

There is no tax free income

No Disallowance

section 14a of the income tax act, 1961

Documents

said rule

withintroduction of

mum judicial decisions

arationale of section

judicial decisionsissues

income tax act

tax payer

maharashtra seamless