1 Legislative History

1.1 Section 14A was first inserted by the Finance Act, 2001. However, same was inserted with retrospective effect from 1-4-1962. The inserted section reads as under:-

‘14A. Expenditure incurred in relation to income not includible in total income. – 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.’

Disallowance-under-Section-14A

Purpose for which the section was introduced, and given in the explanatory memorandum issued with the Finance Bill, 2001, the most relevant part reads as under:-

‘…… It is proposed to insert a new section 14A so as to clarify the intention of the Legislature, since the inception of the Income-tax Act, 1961, that no deduction shall be made in respect of any expenditure incurred by the assessee in relation to income which does not form part of the total income under the Income-tax Act. The proposed amendment will take effect retrospectively from 1st April, 1962 and will, accordingly, apply in relation to the assessment year 1962-1963 and subsequent assessment years.’

1.2 The introduced section was legally correctly being used by the Assessing Officers for reopening the assessments as section was retrospectively effected. When the Government realized the hardship caused to the assessees; another amendment was made by the Finance Act, 2002 and sub-section (2) of section 14A was inserted as under:-

Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001.’

1.3 It was found that the assessing officers were finding it difficult to arrive at a figure of disallowance required on the facts of the cases and unsubstantiated adhoc additions were being made. Subsequently, another amendment by the Finance Act, 2006 to section 14A enlarged the scope of applicability of section 14A. The new sub-sections w.e.f. 1-4-2007 read as under: –

‘14A….

(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.

(3) The provisions of sub-section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act’

The reasons for the above amendment were explained in explanatory statement for the Finance Act, 2006 under Circular No.14/2006, dated 28-12-2006 in para 11. It is reproduced hereunder:-

11. Method for allocating expenditure in relation to exempt income.

11.1 Section 14A of the Income-tax Act, 1961, provides that for the purposes of computing the total income under Chapter-IV of the said Act, 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 the Income-tax Act. In the existing provisions of section 14A, however, no method of computing the expenditure incurred in relation to income which does not form part of the total income has been provided for. Consequently, there is considerable dispute between the taxpayers and the Department on the method of determining such expenditure.

11.2 In view of the above, a new sub-section (2) has been inserted in section 14A so as to provide that it would be mandatory for the Assessing Officer to determine the amount of expenditure incurred in relation to such income which does not form part of the total income in accordance with such method as may be prescribed. However, the Assessing Officer shall follow the prescribed method if, having regard to the accounts of the assessee, he is not satisfied with the correctness of the claim of the assessee in respect of expenditure in relation to income which does not form part of the total income. Provisions of sub-section (2), will also be applicable in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income.

11.3 Applicability from assessment year 2007-08 onwards.’

1.4 Subsequently, Rules for determination of disallowance were prescribed vide I.T. (5th Amend.) Rules, 2008, w.e.f. 24-3-2008.

1.5 Further, under Form 3CD, a column was also inserted w.e.f. 23-8-2006 vide the Income-tax (Ninth Amendment) Rules, 2006 regarding amount of disallowance under section 14A. Hence, it is the liability of tax auditor to give appropriate finding in this regard. After prescribing formula for determination of disallowance under section 14A the scope of liability to disclose relevant facts has also been enlarged.

2. Scope of Section 14A

The scope and applicability of Section 14A w.e.f. 1-4-2007 is as under:-

> The assessee must have an exempted income which is not includible in his total income.

> The assessee must have incurred an expenditure in relation to income which is exempted under the Income-tax Act, 1961.

> However, actual earning of income is not sine qua non for deciding deduction of expenditure laid out or expended wholly or exclusively for purpose of earning such income.

> Just because the income earned is subject to taxation in some other form/other stage in hands of other assessees; it does not preclude the application of Section 14A; e.g. dividend income taxed otherwise under Section 115O or share from partnership firm.

> Rule 8D is prospective in application w.e.f. 24-3-2008 i.e. from AY 2008-09 only. However, the AO can disallow the expenses in earlier assessment years also after recording clear finding that the expenses on earning exempt income shown by the assessee are not correct and applying the reasonable and acceptable method of apportionment to determine such amount.

> Prescribed formula under Rule 8D can be applied only where the Assessing Officer is not satisfied with the accounts of the assessee with regard to correctness of the claim of expenses or assessee claims that no expenditure has been incurred

3. Important Judicial Announcements

3.1 Just because the income earned is subject to taxation in some other form/other stage in hands of other assessees; it does not preclude the application of section 14A; e.g. dividend income taxed otherwise under 115O.

i) Pradeep Kar 319 ITR 416 (Kar)

In my view, on the same principle expenses on earning the share of profits from the partnership firm may be tried to be disallowed.

3.2 Actual earning of income is not sine qua non for deciding deduction of expenditure laid out or expended wholly or exclusively for purpose of earning such income i.e. if dividend is not earned it doesn’t prevent the expenses on investment of shares etc., from being disallowed.

i) Shankar Chemical Works- 12 Taxmann.com 461 (Ahd ITAT)

ii) Technopak Advisors P Ltd-18 Taxmann.com 146 (Delhi ITAT)

3.3 In terms of section 14A(2) condition precedent for Assessing Officer to determine amount of expenditure incurred in relation to exempt income is that he must record his dissatisfaction with correctness of claim of expenditure made by assessee or with correctness of claim made by assessee that no expenditure has been incurred. Therefore, determination of amount of expenditure in relation to exempt income under rule 8D would only come into play when Assessing Officer rejects claim of assessee in this regard-

i) Maxopp Investment Ltd-15 taxmann.com 390 (Delhi)

ii) Consolidated Photo & Finvest Ltd-25 Taxmann. com 371 (Delhi)

3.4 As a corollary to the above, when no expense has been proved to be incurred, no disallowance can be made.

i) Hero Cycles Ltd – 323 ITR 518 (P&H)

ii) Winsome Textile Inds Ltd-319 ITR 204 (P&H)

3.5 Mere fact that shares were old ones and not acquired recently was immaterial; it was for assessee to show by production of materials that those shares were acquired from funds available in its hand at relevant point of time without taking benefit of any loan. Since no such material was produced by assessee, authorities below had rightly disallowed proportionate amount of interest having regard to total income and income from exempt source.

i) Dhanuka & Sons – 12 Taxmann.com 227 (Cal)

ii) Haryana Land Reclamation and Development Corpn., 302 ITR 218 (P&H)

iii) In similar circumstances, case was remanded after ITAT allowed relief in the case of Machino Plastic Ltd-20 Taxmann.com 819 (Del)

3.6 Rule 8D is prospective in application w.e.f. 24-3-2008 i.e. from AY 2008-09 only. However, the AO can disallow the expenses in earlier assessment years also after recording clear finding that the expenses on earning exempt income shown by the assessee are not correct and applying the reasonable and acceptable method of apportionment to determine such amount.

Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT [2010] 328 ITR 81 / 194 Taxman 203 (Bom.).

Catholic Syrian Bank Ltd-9 Taxmann.com 148 (Ker) Maxopp Investment Ltd-15 taxmann.com 390 (Delhi)

3.7 Object or purpose of investment does not affect operation of section 1 4A inasmuch as any expenditure incurred for earning tax free income is not an allowable deduction by virtue of operation of said section. Therefore, even though purchase of tax free bonds was for meeting SLR requirements, interest and other expenditure incurred on borrowals for investment in tax free bonds was to be disallowed.

i) State Bank of Travancore- 16 Tamann.com 289 (Ker)

3.8 ‘Non-maintenance of separate accounts by assessee with regard to expenditure incurred for earning non-taxable income is no justification for assessee to claim immunity from operation of section 1 4A’

i) Catholic Syrian Bank Ltd-9 Taxmann.com 148 (Ker)

4. SUGGESTIONS / GUIDELINES FOR ASSESSING OFFICERS FOR FRAMING QUALITY / SUSTAINABLE ASSESSMENT ORDERS.

  • The AO should concentrate on theØ investments in the balance sheets which would result in incomes not includible in taxable income; for e.g. tax free bonds, equities held as investments, PPF, LIC investments, capital in partnership firm or agriculture assets, assets pertaining to incomes exempt under Section 10 etc.
  • In Form 3CD, a column was also inserted w.e.f.23-8-2006 vide the Income-tax (Ninth Amendment) Rules, 2006 regarding amount of disallowance under section 14A. This is column 17 (l), which reads as follows:

(l) amount of deduction inadmissible in terms of Section 14A in respect of the expenditure incurred in relation to income which does not form part of the total income;

The chartered accountant is supposed to give specific information, and this should specifically gone through and made use of.

  • The assessee’s claim of expenditure incurred in relation to exempt income or the claim that no expenditure has been incurred has to be first seen from the computation of income filed with the return or Notes on Account. If the AO finds it difficult to ascertain it from the return of income; specific queries must be raised and categorical replies taken.
  • Before any further disallowance is made, it is absolutely mandatory for the AO to record his dissatisfaction with correctness of claim of expenditure made by assessee or with correctness of claim made by assessee that no expenditure has been incurred (refer to the case law in para.3.3 & 3.4, above)
  • The dissatisfaction of the AO should be based on substantive facts and logical conclusions based on facts. The Courts and judicial authorities do not appreciate, summary satisfactions based on conjectures like ‘some expenditure must have been incurred etc.’
  • In most of the cases, the assessee claims that the investments whose income is not part of total income; is old and from own interest free funds. Ignoring or summarily dismissing the assertion would almost certainly result in the disallowance being deleted. The correct course is categorically asking the assessee to submit proof of its claim. Then the onus shifts on the assessee and when it fails to discharge it, the disallowance would most likely be upheld (refer to the case law in para.3.5, above). The requisition of such proof from the assessee should be meticulously recorded in the order-sheet and the assessment order (referring to letter no. and date or the date of order sheet entry etc.). The failure on the part of the assessee to supply documentary details and proofs should also be preferably got recorded in the order sheet and mentioned in theassessment order. The disallowance under Rule 8D after that becomes highly sustainable in appeal.
  • Rule 8D is prospective in application w.e.f. 24-3-2008 i.e. from AY 2008-09 only. However, the AO can disallow the expenses in earlier assessment years also after recording clear finding that the expenses on earning exempt income shown by the assessee (appellant) are not correct and applying them reasonable and acceptable method of apportionment to determine such amount. From assessment year 2008-09; the disallowance cannot be adhoc or by any other method but only by method prescribed under Rule 8D.
  • The AOs are advised to go through the legislative history and important decisions on the section, as given in a very concise form earlier. It would help them to appreciate the scope of the section fully. They should understand that many controversies like ‘dividend income is subject to taxation in some other form/ other stage in hands of other assessees’ or ‘the investment not yielding any actual income in the year of assessment’ have been decided in favour of department(refer para. 3.1 & 3.2).

Authored by – Rajeev Agarwal- CIT (A), Gandhinagar

(Article was first published on 18.04.2013 and republished on 20.08.2018)

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  1. S G SAVADI says:

    Rate of Depreciation is 80%. In this regard Please refer to Schedule of Rate Of Depreciation under the heading
    A. Tangible assets,
    1. —
    2. —
    3. Machinery and Plant
    (1)
    (2)
    (3)
    (4)
    (5)
    (6)
    (7)
    (8)(xiii) Renewal Energy devices being –
    (a) Flat plate solar collectors
    (b) Concentrating and pipe type solar collectors
    (c) Solar Cookers
    (d) Solar water heaters and systems
    (e) Air/gas/fluid heating systems
    (f) Solar crop driers and systems
    (g) Solar refrigeration, cold storages and air
    conditioning systems
    (h) Solar steels and desalination systems
    (i) Solar power generating systems
    (j) Solar pumps based on solar thermal and solar
    photovoltaic conversions
    (k) Solar photovotaic modules and panels for
    water pumping and other applications
    (l) Wind mills and any specially designed
    devices which run on wind mills
    (m) Any special devices including electric
    generators and pumps running on wind energy
    (n) Biogas plant and biogas engines
    (o) Electrically operated vehicles including
    battery powered or fuel-cell powered vehicles
    (p) Agricultural and municipal waste conversion
    devices producing energy
    (q) Equipment for utilising ocean waste and
    thermal energy
    (r) Machinery and plant used in the manufacture
    of any of the above sub-items 80

  2. S G SAVADI says:

    Please refer to Schedule of Rate Of Depreciation under the heading
    A. Tangible assets,
    1. —
    2. —
    3. Machinery and Plant
    (1)
    (2)
    (3)
    (4)
    (5)
    (6)
    (7)
    (8)(xiii) Renewal Energy devices being –
    (a) Flat plate solar collectors
    (b) Concentrating and pipe type solar collectors
    (c) Solar Cookers
    (d) Solar water heaters and systems
    (e) Air/gas/fluid heating systems
    (f) Solar crop driers and systems
    (g) Solar refrigeration, cold storages and air
    conditioning systems
    (h) Solar steels and desalination systems
    (i) Solar power generating systems
    (j) Solar pumps based on solar thermal and solar
    photovoltaic conversions
    (k) Solar photovotaic modules and panels for
    water pumping and other applications
    (l) Wind mills and any specially designed
    devices which run on wind mills
    (m) Any special devices including electric
    generators and pumps running on wind energy
    (n) Biogas plant and biogas engines
    (o) Electrically operated vehicles including
    battery powered or fuel-cell powered vehicles
    (p) Agricultural and municipal waste conversion
    devices producing energy
    (q) Equipment for utilising ocean waste and
    thermal energy
    (r) Machinery and plant used in the manufacture
    of any of the above sub-items 80

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