Section 14A of Income Tax Act,1961
Section 14A was inserted by Finance Act ,2001 with retrospective effect from April 1,1962. The object was to disallow expenditure that had been incurred in relation to income which did not form part of the total income under the Act (Sec 10 ) and to overcome certain decisions of Supreme court that held that entire expenditure would be allowed where there was one indivisible business that gave rise to taxable and exempt income. In the case of CIT v. Indian Bank Ltd., (56 ITR 77), Supreme Court had decided in 1964 that the condition for deductibility of an expenditure does not depend upon its quality of directly or indirectly producing taxable income and, therefore, there was no warrant for disallowing a proportionate part of the interest referable to moneys borrowed for the purchase of tax free securities. This principle was reiterated in the case of CIT v. Maharashtra Sugar Mills Ltd.,(82 ITR 452). Again, in the case of Rajasthan State Warehousing Corporation v. CIT, (242 ITR 450) the above principle was once again reiterated by the Supreme Court. In this case, it was held that if business is one and indivisible, the expenditure cannot be apportioned and disallowed to the extent it may relate to income which is exempt from income tax.
The proviso was inserted in sec 14A by FA 2002 which provides that this section shall not empower an AO to take action under s 147 for reassessment or pass rectification order u s154 for Asst year 01-02 or any earlier year to disallow any expenditure by applying this section.
Sub Sec 2 and 3 were later added by FA 2006. This section has to be read with r 8D which provides method of calculation of disallowance under this section.
Expenditure incurred in relation to income not includible in total income.
Section 14A. (1) 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.
(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 prescribed1,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
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.
Method of allocating expenditure in relation to exempt income.[Section 14A(2) and Rule 8D]
Rule 8D. (1) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with—
(a) the correctness of the claim of expenditure made by the assessee; or the claim made by the assessee that no expenditure has been incurred,
(b) in relation to income which does not form part of the total income under the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub-rule (2).
Rule 8D(2) applicable w.e.f 02.06.2016 [As per Notification No 43/2016, dated 02.06.16.]
(2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely:—
(i) the amount of expenditure directly relating to income which does not form part of total income; and
(ii) an amount equal to one per cent of the annual average of the monthly average of the opening and closing balances of the value of investment, income from which does not or shall not form part of total income :
Provided that the amount referred to in clause (i) and clause (ii) shall not exceed the total expenditure claimed by the assessee.]
This section has been subject matter of much debate and the said provision has been interpreted differently by the taxpayer and Revenue. Various Judgements/ Circulars/Notifications issued by Central Board of Direct Taxes with a view to simplify the provision and reduce litigation, has not helped matters and infact only increased the litigation
The CBDT vide circular 5/2014 dated 11.02.2014 clarified that Rule 8D read with Sec 14A provides disallowance of expenditure incurred in relation to the exempt income even where tax payer in a particular year has not earned any exempt income. However, circular is binding on the Income Tax Authorities and not binding on Tribunals /Courts or even the taxpayer.
Recent decisions of the Honable Supreme Court, High Court(s) and Tribunal(s).
Dominant purpose for which the investment into shares is made by an assessee may not be relevant. No doubt, the assessee like Maxopp Investment Limited may have made the investment in order to gain control of the investee company. However, that does not appear to be a relevant factor in determining the issue at hand.
Fact remains that such dividend income is non-taxable. In this scenario, if expenditure is incurred on earning the dividend income, that much of the expenditure which is attributable to the dividend income has to be disallowed and cannot be treated as business expenditure. Keeping this objective behind Section14A of the Act in mind, the said provision has to be interpreted, particularly, the word ‘in relation to the income’ that does not form part of total income. Considered in this hue, the principle of apportionment of expenses comes into play as that is the principle which is engrained in Section 14A of the Act.
Where the assessee would continue to hold those shares as it wants to retain control over the investee company. In that case, whenever dividend is declared by the investee company that would necessarily be earned by the assessee and the assessee alone. Therefore, even at the time of investing into those shares, the assessee knows that it may generate dividend income as well and as and when such dividend income is generated that would be earned by the assessee.
The Supreme Court has also held that when the shares are held as stock-in-trade, dividend income is earned, which is exempt under section 10(34) of the Act. The same also triggers applicability of Section 14A of the Act and the depending upon the facts of each case, expenses have to be apportioned between taxable and non-taxable income.
“7. .In our opinion , there is no merit in the above submissions of the Ld DR in view of decision of Honable Calcutta High Court in the case of Bhartia Industries Ltd vs CIT (2013) 353 ITR 486 (Cal) wherein the Honable High Court has observed as under:-
“The circular issued by the CBDT under sec 119 of the Income Tax Act, 1961 is meant for guiding the officers of the Revenue for administrative purpose of enforcing the provisions of the Act. But when an authority under the Act is required to perform quasi – judicial functions, such authorities should be guided by law of Land as enunciated on the questions involved by various judicial authorities which have binding effect. If an existing circular is in conflict with the law of the Land laid down by High Courts or the Supreme Court, the Revenue authorities while acting quasi –judicially , should ignore such circulars in discharge of their quasi judicial functions.”
To conclude, despite a plethora of judicial precedents attempting to clear the air on the controversial issues associated with section 14A of the Act, it cannot be said that there is complete clarity on the application of the said section, and the days to come will witness a few more such landmark cases on the subject.
Interest on Borrowed Capital – Sec 36 (1) (iii)
The amount of Interest paid in respect of capital borrowed for purpose of business or profession is allowed as deduction .
36 (1)The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28—
(iii) the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession :
Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset (whether capitalised in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.
Explanation.—Recurring subscriptions paid periodically by shareholders, or subscribers in Mutual Benefit Societies which fulfil such conditions as may be prescribed, shall be deemed to be capital borrowed within the meaning of this clause;
Interest means interest payable in any manner in respect of any moneys borrowed or debt incurred(including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized.[Section 2(28A)].
As per the Supreme Court in the case of Madhav Prasad Jatia v CIT(1979) 118 ITR 200(SC) for claiming deductions under this sub-clause, the basic requirements are:
(A) The money i. e (capital) must have been borrowed by the assesse;
(B) It must have been borrowed by the assessee for his business, profession or vocation; and
(C) The assessee must have paid interest on the amount and claimed it as an allowance.
(A) Capital must have been borrowed: The borrowing must be of money, if interest is paid, not on capital borrowed but for part consideration remaining unpaid on acquisition of a business, section36(iii) will have no application but the same may fall under section37(1).
Further for a loan there has to be a positive act of lending money coupled with acceptance of it by the other side.[CEPT v Bhartia Electric Steel Co. Ltd.(1954) 25 ITR 192(Cal)]
An element of refund or repayment is inherent in the concept of borrowing. [CIT v Bazpur Co. operative Sugar Factory Ltd.(1989) 177 ITR 469(SC)]
(B) Borrowing must be for the purpose of business: The expression “for the purpose of business” occurring in section 36(1)(iii) is wider in scope than the expression “for the purpose of making or earning income”. [Madhav Prasad Jatia v CIT(1979) 118 ITR 200(SC)]
The purpose may be to acquire a capital asset or stock-in-trade, as also to pay off a trading debt or loss. Capital borrowed to pay off such a debt is capital borrowed for the purpose of the business [Banarasi Das Gupta v CIT(1977) 106 ITR 559 (A11)]
Where the borrowed moneys are not used for the purpose of the business but are utilized for meeting personal obligations of the assessee himself or for paying tax liability, the claim for interest is not allowable.[Madhav Prasad Jatia v CIT(1979) 118 ITR 200(SC)]
Where the business has ceased to be carried on, no deduction can be claimed in respect of interest on borrowings. [Assam Biscuit Mfg. Co. Ltd. V CIT(1990)185 ITR 535(Gau)]
Other judicial decisions
(i) If the interest free funds available to the assessee are sufficient to meet its investment, it could be presumed that the investments are made from the interest free funds available with the assessee and not from borrowed funds.[CIT vs Reliance Industries Ltd CA No 37/2019 pronounced on 02.01.2019]
(ii) The Hon’ble jurisdictional High Court has held in the case of CIT vs Max India Ltd. ITA No.210/Chd/2013 dated 08.03.2017 that if an assesse establishes that its interest free funds were equal to or more than the interest bearing funds it would be open to it to contend that presumption arises that investments have been made out of the same. Similar position was held in :
Bright Enterprises P. Ltd. vs. CIT, (2016) 381 ITR 107 (P&H)
CIT vs. Kapsons Associates, (2015) 381 ITR 204 (P&H)
Gurdas Garg vs. CIT, ITA No.413/2014 dated 16.7.2015 (P&H)
Pr. CIT vs. M/s. Malhotra Book Depot, ITA No.31 of 2017 dated 23.02.2017 (P&H)
Pr.CIT vs. M/s. Holy Fai th Internat ional Pvt . Ltd. , ITA No.87 of 2017 dated 24.07.2017 (P&H)
Trident Infotech Corporat ion Ltd. vs. CIT & Anr, (2016) 385 ITR 335 (P&H)
ACIT vs. Janak Global Resources Pvt. Ltd [ITAT Chandigarh- 470/Chd /2018]
(iii) Interest is allowable irrespective of the fact whether the amount has been borrowed for working capital or for acquiring a capital asset.[India Cements Ltd v CIT(1966)60 ITR 52(SC)]
(iv) Expenditure incurred for obtaining loan amount for acquiring a capital asset, is not part of cost of acquiring an asset: Expenditure incurred by the assessee for obtaining loan amount which was to be utilized for acquiring a capital asset, could not be treated as capital expenditure as its direct nexus was with acquiring loan and not with acquiring of an asset.
[Patel Filters Ltd. V CIT(2003)264 ITR 21 (Guj)following decision of the Supreme Court in India Cements Ltd v CIT(1966)60 ITR52; Madras Industrial Investment Corporation Ltd. v CIT(1997)225 ITR 802]
(v) Interest on money borrowed, for the period prior to commencement of business, is not allowed under this Section, but it can be treated as a part of the cost of the asset acquired. [Challapalli Sugar Limited v CIT(1975) 98 ITR 167(SC)]
(vi) Interest on money utilized not for business but for meeting personal obligations of the assessee or its partners or its directors is not allowed. [Mahadev Prasad Jatia v CIT(1979)118 ITR 200(SC)]
(vii)Interest paid on money borrowed for meeting income tax liability, interest for late payment or non-payment of advance tax or for late filing of returns is not allowed.[Jindal Industries Limited v CIT(1998)230 ITR733 (SC)]
(viii) Interest paid on purchase of debentures will not be allowable under this clause but may be allowed u/s 37(1). [Eastern Investments Ltd. v CIT(1951)20 ITR 1 (SC)]
(ix) Where the assessee was having sufficient non-interest bearing fund by way of share capital and reserves and there was no nexus between the borrowings of the assessee and advances made by it, no disallowance under section 36(1)(iii) of the act was called for. [CIT v Bharti Televenture Ltd.(2011) 51 DTR 98(Del)]
(x) Interest free advance given to sister concern need not inhibit the deduction if such loan or advance has been given for business purposes.[CIT v Neel Kanth Synthetics & Chemicals Pvt. Ltd.(2011)330 ITR 463 (Bom). Also see CIT v Dalmia Cement Bharat Ltd.(2011)330 ITR 595(Del)]
(xi) Amount advanced to sister concern without interest-Finding that assesse had some funds for making advance- Interest deductible [CIT vs Gujrat Reclaim and Rubber Products Ltd .383 ITR 236 (Bom HC)]:CIT vs Harrisons Malayalam Ltd [2019 414 ITR 344 Ker HC]
(xii) Assessee failed to make out a case of commercial expediency in advancing interest free advance to its sister concern which we made from its CC account with a bank, proportionate interst paid by assessee on borrowing was rightly disallowed.[Punjab Stainless Steel Inds. V CIT (2010)41 DTR 88(Del)]
(xiii) Where the assessee purchased shares through a stock broker but due to shortage of funds could not make the payment in due time and had to pay interest on delay payment, the interest is an allowable deduction as business expenditure.[CIT v Raghav Behl (2006)150 Taxman 3(Del)]
(xiv) Once it is borne out from the record that the assesse has borrowed certain funds on which liability to pay tax is being incurred and on the other hand certain amounts have been advanced to sister concerns or others without carrying any interest and without any business purpose, the interest to the extent the advance has been made without carrying any interest is to be disallowed under section 36(1)(iii). [CIT v Abhishek Industries Ltd.(2006) 286 ITR 1(P&H)]
But where assesse-firm had given loan to its sister concern and Assessing Officer held that assesse was charging lesser rate of interest on loans advanced to sister concern whereas it was paying higher rate of interest on moneys borrowed by it from banks and treated difference of interest as income of assesse, as it was found that assesse had sufficient capital of its own to advance loan to sister concern, disallowance of interest was not justified.[CIT vs Anr & Glaxo Smithkline Asia (P) Ltd (2010) 47 DTR 0065 , CIT v Harbhajan Sarabjeet & Associates(2006)151 Taxman 27(All). Also see CIT v Prem Heavy Engg. Works Pvt. Ltd.(2006)285 ITR 554(All)]
However, in an another case where the assesse argued that:
(a) The advance had been made to sister company out of bank account, wherein both its own and borrowed funds were mixed up, so that there was no direct nexus between borrowing and advance; and
(b) The loan to a sister company which in this case was a subsidiary company is one which should be treated as prompted by commercial expediency,
The Supreme Court upheld the argument of the assesse and the interest was not disallowed. [S.A Bulders Ltd. v CIT(Appeal)2007) 288 ITR 1 (SC)]
Interest under section 36(1)(iii) vs Interest under residuary provisions of section 37(1):
Sections 36(1)(iii) and section 37(1), so far as the allowance of interest is concerned, run parallel to each other. But later, they do differ and it can then be discerned whether a given case falls within the phraseology of section 36(1)(iii) or section 37(1). Comparing the two, we may see that they do differ:
|Section 36(1)(iii)||Section 37(1)|
|1. It must be interest on capital(moneys) borrowed.
2. The borrowing must be for the purpose of the business.
|1. It may be interest even
on any debt incurred.2. The debt incurred must be wholly and exclusively for the purposes of the business.
However, there can be no double deduction- once under section 36(1)(iii) and again under section 37(1)- for one and the same amount of interest.
Sec 36 (1) (va)-Sums received from employees towards certain welfare schemes if credited to their accounts before the due date.
36 (1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28—
(va) any sum received by the assessee from any of his employees to which the provisions of sub-clause (x) of clause (24) of section 2 apply, if such sum is credited by the assessee to the employee’s account in the relevant fund or funds on or before the due date.
Explanation.—For the purposes of this clause, “due date” means the date by which the assessee is required as an employer to credit an employee’s contribution to the employee’s account in the relevant fund under any Act, rule, order or notification issued thereunder or under any standing order, award, contract of service or otherwise;
This section deals with the due date for crediting the contribution of employees to the respective funds.
According to the section the employee’s contribution credited to the employees account in the relevant fund after the due date specified under section 36(1)(va) are disallowed to the employer.
Further, due to recent amendment inserted by Finance Act , 2016 in subclause (iii) to (vi) in sec 143 (1)(a) of the IT Act many assesses have received notices from CPC, Bengaluru u/s 143 1(a) of the IT Act.
Relevant extract being produced below:
143. (1) Where a return has been made undersection 139,or in response to a notice under sub-section (1) of section 142, such return shall be processed in the following manner, namely:—
(a) the total income or loss shall be computed after making the following adjustments, namely:—
(i) any arithmetical error in the return; [***]
(ii) an incorrect claim, if such incorrect claim is apparent from any information in the return;
Following subclauses (iii) to( vi) inserted by Finance Act 2016,Amendment w.e.f 1.4.17
[(iii) disallowance of loss claimed, if return of the previous year for which set off of loss is claimed was furnished beyond the due date specified under sub-section (1) of section 139;
(iv) disallowance of expenditure indicated in the audit report but not taken into account in computing the total income in the return;
(v) disallowance of deduction claimed undersections 10AA, 80-IA, 80-IAB, 80-IB, 80-IC, 80-ID or section 80-IE, if the return is furnished beyond the due date specified under sub-section (1) of section 139; or
(vi) addition of income appearing in Form 26AS or Form 16A or Form 16 which has not been included in computing the total income in the return:
Provided that no such adjustments shall be made unless an intimation is given to the assessee of such adjustments either in writing or in electronic mode:
Provided further that the response received from the assessee, if any, shall be considered before making any adjustment, and in a case where no response is received within thirty days of the issue of such intimation, such adjustments shall be made:]
Notices communicating proposed addition u/s 143 (1) (a) of the IT Act have been received by the assesse s wherein adjustments are proposed on the delayed payments of employees contribution to any provident fund or superannuation fund or any other fund set up under ESI Act or any other fund for the welfare of employees to the extent not credited to the employees account on or before the due date as specified under the respective Act.[36 (1) (va)].
The replies given in respose to these notices have not been accepted by the CPC and vide intimation order u/s 143 (1) of the IT Act , the delayed payments (supra) have been added to the income of the assesse.
It may be noted that the statutory laws under the respective contribution schemes have provisions to levy interest, penalty etc. for the delayed payment. Hence, disallowing a genuine business expenditure merely on the ground that it has been paid after relevant due date is not justified.
Further, the Employer’s contribution made after the due date specified under the relevant social security legislation but deposited within the due date of filing return of income are allowed under the Act by virtue of Section 43B.
On the subject there have various conflicting judgments. Where Hon’ble Uttarakhand High Court and Hon’ble Delhi High Court have considered the due date under section 36(1)(va) to be read in sync with the due date mentioned in section 43B, Hon’ble Gujarat High Court has given a different view.
To remove the hardship caused to the assessee and to reduce avoidable litigations, it is suggested that deduction be allowed on the employee’s contribution made before the due date of filing the return of income.
In CIT vs AIMIL Ltd & ORS cited in 229 CTR 0418 (DEL HC) it was held that
“As soon as employees’ contribution towards PF or ESI is received by the assessee by way of deduction or otherwise from the salary/wages of the employees, it will be treated as ‘income’ at the hands of the assessee. It clearly follows therefrom that if the assessee does not deposit this contribution with PF/ESI authorities, it will be taxed as income at the hands of the assessee. However, on making deposit with the concerned authorities, the assessee becomes entitled to deduction under the provisions of s. 36(1)(va). Sec. 43B(b), however, stipulates that such deduction would be permissible only on actual payment. This is the scheme of the Act for making an assessee entitled to get deduction from income insofar as employees’ contribution is concerned. Deletion of the second proviso has been treated as retrospective in nature and would not apply at all. The case is to be governed with the application of the first proviso. If the employees’ contribution is not deposited by the due date prescribed under the relevant Acts and is deposited late, the employer not only pays interest on delayed payment but can incur penalties also, for which specific provisions are made in the Provident Fund Act as well as the ESI Act. Therefore, the Acts permit the employer to make the deposit with some delays, subject to the aforesaid consequences. Insofar as the IT Act is concerned, the assessee can get the benefit if the actual payment is made before the return is filed.
CIT vs. Vinay Cement Ltd. (2007) 213 CTR (SC) 268, CIT vs. Dharmendra Sharma (2007) 213 CTR (Del) 609 : (2008) 297 ITR 320 (Del) and CIT vs. P.M. Electronics Ltd. (2008) 220 CTR (Del) 635 : (2008) 15 DTR (Del) 258 followed.”
Other Important Cases in favour of assessee:
1. CIT vs. Alom Extrusions Ltd. (2009) 319 ITR 306 (SC)
2. CIT vs NUCHEM LTD. 371 ITR 164 (P and H)
3. CIT Vs LAKHANI INDIA LTD.188 TAXMAN 132 (P and H)
4. CIT vs HEMLA EMBROIDERY MILLS (P) LTD 366 ITR 167 (P AND H)
5. CIT vs. MARK AUTO INDUSTRIES LTD.358 ITR 43 (P and H)
6. CIT vs. LAKHANI RUBBER WORKS 326 ITR 415 (P and H)
7. JURISDICTIONAL ITAT,CHANDIGARH B BENCH in the case of DCIT vs Malwa Cotton Spinning mills ltd. ITA No. 431 to 433/CHD/2017
8. CIT v UT Star Com. Inc. (2014) 98 DTR 107 (P&H)
9. CIT v Kamal Family Trust (2013) 219 taxman 81 (Mag.) ( P& H )
10. CIT v Kichha Sugar Company Ltd. (2013) 356 ITR 351 (Uttarakhand)
11. CIT v NIPSO Poly Fabrics Ltd. (2013) 350 ITR 327 (HP),
12. CIT v Udaipur Dugdh Utpadak Sahkari Sangh Ltd. (2013) 35 taxguru.in 616 (Raj),
13. CIT v Spectrum Consultants India (P.) Ltd.(2014) 100 DTR 129 (Karn.),
14. CIT v Vijay Shree Ltd. (2014) 43 taxguru.in 396 (Cal.),
15. CIT v Jaipur Vidyut Vitran Nigam Ltd. (Raj.)
Disclaimer: The contents of this document are solely for informational purpose. It does not constitute professional advice or a formal recommendation. While due care has been taken in preparing this document, the existence of mistakes and omissions herein is not ruled out.
(Author B R Kaushal is Secretary General of Punjab Tax Bar Association and State coordinator of National Action Committee of GST Professionals.)