Special Bench of the Income Tax Appellate Tribunal, New Delhi holds that expenditure relating to exempt income to be disallowed even if assessee has not earned any tax-free income.
Section 14A of the Income-tax Act, 1961 (“Act?), inserted by the Finance Act, 2001 with retrospective effect from 1 April 1962, provides that no deduction shall be allowed in respect of expenditure incurred in relation to exempt income.
Cheminvest Ltd. („assessee?) deals in portfolio investment of shares on capital account as well as trading account. The assessee utilized borrowed funds for the purposes of investment. The assessee did not receive any dividend income during the year.
The Assessing Officer („AO?) disallowed the proportionate amount of interest under section 14A of the Act on the ground that borrowed funds were utilized for making long term investment.
The Commissioner of Income Tax (Appeals) upheld the disallowance made by the AO, but directed the AO to disallow only the proportionate amount of interest paid after adjusting the interest receipt.
The assessee and the Revenue filed cross appeals against the order of the CIT(A) to the Income Tax Appellate Tribunal („ITAT?).
In view of the contrary decisions rendered by different Benches of the ITAT, a Special Bench was constituted to decide whether dis allowance under section 14A of the Act can be made in a year in which no exempt income has been earned or received by the assessee.
Contentions of the assessee
- In respect of investments in shares held on capital account, capital gains were offered to tax and the expenses were disallowed with regard thereto.
- In respect of investments in shares held as part of the trading activity, business income was offered to tax and interest and other expenses were claimed as a deduction.
- No dividend was received in the year under consideration and hence the question of dis allowance of interest under section 14A does not arise.
- The provisions of section 14A apply, if and only if, any exempt income is received during the previous year, which is not includible in the taxable total income.
- Unless the assessee receives or is entitled to receive any income during the relevant previous year which does not form part of total income, the provisions of section 14A of the Act have no application.
Contentions of the Revenue
- Section 14A would apply to an exempt income whether received/earned or not received or not earned.
- Investment is the base for determining the dis allowance.
- Section 14A does not use the words “income of the year”, but income under the Act, and therefore the receipt of income in a particular year is not material for disallowing the expenditure.
Ruling of the ITAT
- If any income were exempt from tax because it is not included in the total income by virtue of section 10, section 14A prohibits allowance of any expenditure incurred in relation thereto.
- Income from deployment of funds in shares earned by way of dividend is not included in total income by virtue of the provisions contained in section 10(34) of the Act, irrespective of whether the shares are held as stock-in-trade or held as investment.
- When the expenditure of interest is incurred in relation to income which does not form part of total income, it has to suffer the dis allowance irrespective of the fact whether any income is earned by the assessee or not. Section 14A does not envisage any such exception.
- The fact that the expenditure is allowable under other sections of the Act is irrelevant because section 14A has overriding effect.
- Section 14A of the Act, in no way indicates that it does not encompass the dis allowance of expenditure incurred in relation to the income in absence of actual receipt of income during the relevant previous year.
- When the dividend is not taxable at all the interest pertaining to that would also not be allowable because there is no taxable income of the assessee against which such interest can be allowed.
- The dis allowance has to be of the entire amount of expenditure so related and cannot be reduced by the receipt of interest which has no relation to such expenditure.