No disallowance u/s 14A & Rule 8D can be made if assessee does not have tax-free income and no claim for exemption is sought

Section 14A has been inserted in Chapter IV of the Income tax Act by the Finance Act, 2001, with retrospective effect from 1-4-1962. This Section provides for disallowance of expenditure incurred in relation to income which is not included in the total income of the assessee (i.e. exempt income). The operative part of this Section reads as under:

“For the purposes of computing the total income under this chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.”

 Proviso to the Section was added by the Finance Act, 2002 w.e.f. 11-5-2001. It provides that the A.O. cannot reopen the assessment u/s.147 for any assessment year prior to A.Y. 2001-02 for this purpose or pass any rectification order u/s.154 for prior years to disallow any such expenditure.

It has been a matter of discussion that whether expenses should be disallowed in case the assessee has not earned any exempt income during the relevant assessment year.

In a recent decision of Delhi High Court in the case of M/s Holcim India P. Ltd. vs. CIT-IV ( ITA No. 486/2014 & ITA No. 299/2014) dated September 5, 2014 (Date of Publication Oct 17, 2014)

The High Court has held that no disallowance can be made u/s 14A if there is no exempt income in the relevant year.

It has mentioned that

“There are three decisions of the different High Courts directly on the issue and against the Revenue;

  • First decision is of the Punjab and Haryana High Court in CIT vs. M/s. Lakhani Marketing Inc made reference to two earlier decisions of the same Court in CIT Vs. Hero Cycles Limited, 323 ITR 518 and CIT Vs. Winsome Textile Industries Ltd 319 ITR 204 to hold that Section 14A cannot be invoked when no exempt income was earned.

Further it held that

1. Income exempt under Section 10 in a particular assessment year, may not have been exempt earlier and can become taxable in future years.

2. Further, whether income earned in a subsequent year would or would not be taxable, may depend upon the nature of transaction entered into in the subsequent assessment year. For example, long term capital gain on sale of shares is presently not taxable where security transaction tax has been paid, but a private sale of shares in an off market transaction attracts capital gains tax. It is an undisputed position that assessee is an investment company and had invested by purchasing a substantial number of shares and thereby securing right to management. Possibility of sale of shares by private placement etc. cannot be ruled out and is not an improbability. Dividend may or may not be declared. Dividend is declared by the company and strictly in legal sense, a shareholder has no control and cannot insist on payment of dividend. When declared, it is subjected to dividend distribution tax;

3. What is also noticeable is that the entire or whole expenditure has been disallowed as if there was no expenditure incurred by the assessee for conducting business. The CIT(A) has positively held that the business was set up and had commenced. The said finding is accepted. The assessee, therefore, had to incur expenditure for the business in the form of investment in shares of cement companies and to further expand and consolidate their business. Expenditure had to be also incurred to protect the investment made. The genuineness of the said expenditure and the fact that it was incurred for business activities was not doubted by the Assessing Officer and has also not been doubted by the CIT(A).

Recently in one more decision in the case of Alliance infrastructure Projects Pvt. Ltd. vs. DCIT, ITAT Bangalore ITA Nos.220 & 1043(BNG.)/2013 dated September 12, 2014 (Date of Publication: Oct 17, 2014), it has held that

There is no dispute that the assessee had no exempt income during both the years involved. No doubt as mentioned by the DR, the Special Bench of this Tribunal in the case of Cheminvest Ltd. vs. ITO 121 ITD 318, had held that disallowance under section 14A could be made even in an year in which no exempt income was earned or received by the assessee. This decision of Special Bench of the Tribunal has been, in our opinion, impliedly overruled by various decisions of different High Courts, namely, CIT vs Shivam Motors P. Ltd. (All HC), CIT vs. Corrtech Energy Pvt. Ltd (Guj HC), CIT vs. Winsome Textile Industries Ltd 319 1TR 204 (P&H), CIT Vs. Delite Enterprises (Bom HC) & CIT vs. Lakhani Marketing (P&H HC). Therefore, unless and until there is receipt of exempted income for the concerned assessment years, s. 14A of the Act cannot be invoked. “
CBDT has also issued a circular, dated: 11th Feb, 2014 where it has clarified that expenditure incurred in relation to exempt income would be disallowed under Section 14A even if no such income has been earned in a particular year. It has been mentioned in the circular”

“That the legislative intent is to allow only that expenditure which is relatable to earning of taxable income and it therefore follows that the expenses which are relatable to earning of exempt income have to be considered for disallowance, irrespective of the fact whether any such income has been earned during the financial year or not”

Circular are binding on the Tax department but not on the assessee. In the case of K.P.Varghese-vs- I.T.O. 131 ITR 597 SC, UCO Bank-vs-CIT 237 ITR 889 SC, C.B.Gautam-vs-UOI 199 ITR 530 SC (constitution Bench), the apex court has decided that circulars issued by the CBDT are binding on the tax authorities meant for execution of the Act even though such circulars tone down the rigour of law or deviate from or relax the provisions of the Act. Further such circulars are not binding on the assessee.

It looks from the above that after this circular, the Department is bound to follow the circular and will disallow the allowance u/s 14A but assessee is not bound to follow the circular.

In the above mentioned cases which has been held by Different High courts or ITAT in favour of the assessee, no reference has been made of this circulars. However, in the case of ACIT, CC-1(2) vs. Mr. M. Baskaran (ITAT, Chennai Dated July 31st, 2014) while putting its case revenue had mentioned the above circular but while giving its judgment in the favour of the assessee ITAT had not given any reference to this circular.

Some more relevant cases with respect to Section 14A are as under:

1. Section 14A disallowance not sustainable if proper satisfaction not recorded – Vinay Bhasin Vs. ACIT (ITAT Delhi); ITA No. 6904/Del./2017

2. No further disallownce U/s. 14A warranted if Voluntary disallowance by Assessee exceeds exempted income – Coffeeday Enterprises Ltd. Vs DCIT (ITAT Bangalore); ITA No. 459/Bang/2020

3. Section 14A disallowance unjustified if Interest Free Funds exceeds Investment Value – Kingfisher Finvest India Ltd. Vs. DCIT (ITAT Bangalore); ITA No. 2641 & 2642/Bang/2019

4. Section 14A disallowance cannot exceed income earned by Assessee – DCIT Vs Oman International Bank S. A. O. G. (ITAT Mumbai); I.T.A. No. 4174/Mum/2014

5. No section 14A Disallowance if There is No Exempt Income – Tata Sky Limited Vs. ACIT (ITAT Mumbai); ITA No. 3214/Mum/2014

6. Disallowance of Expenditure u/s 14A by AO without Recording a Satisfaction is Not Justified – Shri Vinay Bhasin Vs. ACIT (Delhi ITAT); ITA No. 6904/Del./2017

(Author is a AGM – Direct Taxation with GMR Energy Group, Bangalore )

Read Other articles from Navneet Singal

Disclaimer: The contents of this article are for information purposes only and does not constitute advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer to relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc before acting on the basis of the above write up.  The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that Author / TaxGuru is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof. This is not any kind of advertisement or solicitation of work by a professional.

(Republished with Amendments by Team Taxguru)

Author Bio

Qualification: CA in Practice
Company: EvoBreyta TaxFinTech LLP
Location: Gurugyram, Haryana, India
Member Since: 07 Apr 2018 | Total Posts: 35
Navneet is an international tax and digital transformation expert with 20+ years of experience and has worked as the Head of Tax in various MNCs, e.g., Royal Dutch Shell, GMR Group, HCL Technologies Ltd, Vodafone (‘Hutchison Essar Mobile’) and BIOCON Group. His expertise lies in Direct and Indir View Full Profile

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  1. Nem Singh says:

    Each and every case has own facts and whether any disallowance should have been made or not depends on circumstances and facts, nature of investment, earning of dividend, expenditure and also the business in which the assessee is deals. Judicial pronouncement can only help before the higher authority not before the AO because of they blindly applied the Rule 8D for disallowance of expenses u/s 14A.

  2. Harshit says:

    so now after having the different decision from different court, what is the final decision? expenditure incurred in relation to exempt income which is not earned, still disallow?
    Circular issue by CBDT is effective on assessee also?

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