Disallowance Under Section 14A Not to be Added to Book Profits While Computing MAT Under Section 115JB: A Comprehensive Analysis by ITAT
Introduction
The interaction between Sec. 14A and Sec. 115JB of the Income Tax Act, 1961 has remained a matter of hot litigation and debate in Indian tax jurisprudence. The question of the day, causing concern to taxpayers as well as the Revenue authorities alike, was whether the dis allowances computed u/s. 14A, read with Rule 8D of the Income Tax Rules, 1962, are required to be added back to compute the Book Profits u/s. 115JB of the Act. This dispute, resulting in a split decision across the various benches of the Income Tax Appellate Tribunal, was laid to rest by the historical decision of the Special Bench in the matter of Assist. Commissioner of IT vs. Vireet Investment Pvt. Ltd. In the said judgment, the Special Bench held categorically that the computation u/ clause (f) of Explanation 1 to Sec. 115JB(2) should not involve any computation u/s. 14A and Rules 8D, ending the debate on a contentious issue.
It is imperative to understand the different purposes and calculation systems of these two sections for corporations to comply with tax laws. Section 14A applies within the framework of computation of total income to deny expenditure incurred in respect of exempt income, so as to disqualify the deduction of expenditure in respect of income that is not forming part of the total income. Contrary to this, Section 115JB is an alternative minimum tax system aimed at ensuring that companies that make large amounts of book profits while declaring little tax pay a fair amount of tax. The combination of these two different sections had caused a great deal of confusion, resulting in a great deal of disputes and inconsistent interpretations in different tax jurisdictions.
Recognizing Section 14A: The Disallowance Rule
Section 14A of the Income Tax Act, 1961 was introduced by Finance Act, 2001 with retrospective operating by April 1, 1962, in order to make it clearer what the intent of Section 14A with regard to exempt income expenses was all along. Section 14A itself reads: “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.”[1] It-handler of a very ancient principle, which states that if income is exempt, then expenses related to such income cannot be set off against income which is subject to tax.
The scope of Section 14A clarified further with the issuance of Rule 8D of the Income Tax Rules, 1962, from the Assessment Year 2008-09 onwards. Rule 8D contains a mathematical formula for the computation of the disallowance, in case the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the claim made by the assessee in regard to the expenditure incurred in relation to exempt income, as stated in the claim made by the assessee. The rule takes into account three aspects of the disallowance, namely the direct expenditure in respect of exempt income, one percent of the average of the monthly opening and closing balance of the investments yielding exempt income, and the proportionate share of the other expenses in the ratio of exempt income investments to the total assets of the assessee.
However, certain limitations have now been imposed on the application of Section 14A through the judiciary. It is now settled through various court judgments that the amount of disallowance under Section 14A cannot be more than the exempt income for the relevant assessment year. Furthermore, the Supreme Court, in the case of Maxopp Investment Ltd. v. CIT, has asserted through the judgment that the dominant intention/motive for the investment is irrelevant, and the disallowance under Section 14A is to be allowed even in the case of strategic investments or shares held in the nature of stock-in-trade, where the income is exempt. The section was further clarified through the Finance Act, 2022, whereby the Explanation under Section 14A was inserted, and the expenditure incurred in respect of the exempt income, which has neither accrued nor arisen within the current year, is liable for disallowance.
Section 115JB: The Minimum Alternate Tax Regime
Section 115JB was introduced to the Income Tax Act in 1987 to enact the Minimum Alternate Tax provision as it applies to companies. The provision was enacted to address an issue that became apparent as many profitable companies were able to legally take advantage of different exemptions available within the Income Tax Act to end up paying minimal to zero tax on financial statements despite showing substantial profit as per statements filed as per the Companies Act. The section states that if the income tax payable on total income as is required under normal provisions is less than eighteen and one-half percent of the book profit as is required under Section 115 JB(2) after being modified by the Finance Act 2019 to fifteen percent, then the book profit will be assumed to be the total income and tax will be payable @ fifteen percent of the book profit.
The calculation of the book profit in terms of section 115JB is regulated by means of Explanation 1 to subsection (2), which describes an elaborate procedure. Book profit is basically the net profit as disclosed in the profit and loss account prepared in terms of Schedule III to the Companies Act, 2013, as worked out after addition of certain amounts specified and reduced by certain amounts. Clause (f) of the first Explanation to subsection (2), which is of primary concern in this context, provides for addition of the amount(s) of expenditure as relatable to income liable to section 10 (except in terms of section 38 thereof) and sections 11 and 12 of the Income-tax Act, as and if any amount thereof is debited to the statement of profit and loss. The relevant expressions in this context are “relatable to,” along with “if any amount thereof is debited to the statement of profit and loss.” These show that matured and actually debited amounts are to be brought in and not amounts calculated.
The legislative perspective of Section 115JB clearly establishes that this provision is a self-contained code with a set of its own adjustments and modifications to determine the book profit. The Supreme Court, in _Apollo Tyres Ltd._ v. _CIT_, held that Section 115JB is a complete code, and the Assessing Officer is not free to play with the book profits calculated u/s of the Companies Act unless clearly provided by the clauses specified in the Explanation to Section 115JB of the Act. The above-mentioned doctrine of non-interference in the matter of book profits, except in accordance with the provision specified in the Act, assumes utmost significance in appreciating that Section 14A disallowances are not applicable for determining Section 115JB income.
The Landmark Case: Vireet Investment Judgment
The Special Bench of the Income Tax Appellate Tribunal, Delhi, in the case of Assistant Commissioner of Income Tax vs. Vireet Investment Pvt. Ltd., has given its judgment on the 16th of June 2017, resolving the contentious issue, the conflicting decisions on which were given by different benches.[3] The Special Bench, formed with the Chief Justice S.V. Mehrotra (Vice President), Justice I.C. Sudhir (Judicial Member), and Justice Amit Shukla (Judicial Member), was formed to meet two key issues. The first issue was whether the expenditure incurred on earning exempt income, as computed under Section 14A, should be added for the computation of the book profit under Section 115JB. The second issue was whether the investments not yielding exempt income should be taken into account for the computation of the average value of the investment under Rule 8D.
The Special Bench has carefully scrutinized legal provisions, legislative intent, and judicial precedents in arriving at its decision. The Bench held that Section 14A applies under Chapter IV of the Income Tax Act concerning the calculation of total income, whereas Section 115JB envisages Chapter XII-B containing an alternative method under law regarding taxation calculation. These are separate schemes having separate functions and corresponding mathematical computations. Section 14A seeks to avoid double benefits in cases involving deductions in respect of expenses incurred in relation to exempt income. Section 115JB ensures that all minimal taxes are paid by a company in respect of its book profits in line with accounting standards, irrespective of deductions and exemptions allowed under the Act.
The Special Bench explained that the clause (f) of Explanation 1 to Section 115JB refers specifically to “the amount or amounts of expenditure relatable to any income” debited to the profit & loss account. The expression ‘debited to the statement of profit & loss’ clearly means that only such amounts of expenditure actually debited to the profit & loss account can be added back, but no notional amounts of disallowed expenditurescribed by the formula specified inRule 8D. The amounts liable to be added back do not exceed the actual amounts of expenditure debitied to the profit & loss account. For example, the one percent of the average investment for the relevant two preceding assessment years specified inRule 8D(2)(ii) is a notion-al deduction, which need not be actually incurred or accounted for. A business cannot be required to actually have incurred the expenditure specified.
After much deliberation, the Special Bench held: “The computation under clause (f) of Explanation 1 to section 115JB(2) is to be made without recourse to the computation as Contemplated under section 14A read with Rule 8D of the Income Tax Rules, 1962.” The Bench went on to decide that in calculating the disallowance under clause (f) of Explanation 1 to Section 115JB, only those investments are to be taken into account that actually yielded exempt income within the year, and only the expenses directly and proximately attributable to such exempted income are liable to be added back.
Judicial Precedents Supporting the Vireet Investment Principle
The precedent set in the case of Vireit Investment has held good and has been upheld later by the judicial pronouncements in the cases cited above and below. The Bombay High Court, in the case of CIT vs. Bengal Finance & Investments Pvt. Ltd., upheld the judgment of the Tribunal that the amount which was not allowed in terms of Section 14A cannot be added to the book profit, as required by Section 115JB.[4] The judgment held that unless an amount is actually reduced against the profit and loss account with regard to the earning of the exempt income, it is not possible to import it into the computation of the book profit, in accordance with clause (f) of Explanation 1 to Section 115JB.
The Delhi High Court, in the case of Principal CIT vs. Bhushan Steel Ltd., has made a pertinent contribution to establishing the above principle when it upheld the decision that the amount of disallowance under section 14A read with rule 8D cannot be added to the book profits while computing under section 115JB. This decision relies on the aspect that Section 115JB’s explanation does not mention section 14A and that notional to be disallowed amounts to which the formula has to be applied cannot be engrafted on the computation of book profits. The review petition filed with the Delhi High Court has also resulted in thedismissal of the case.
In the latest instance of Bennett Coleman & Co. Ltd., the Mumbai Bench of the ITAT followed the decision in Vireet Investment and held the deletion of the addition made under Section 14A while calculating the book profit under Section 115JB. [6] Again, in the instance of Rajesh Estates and Nirman Pvt. Ltd., the ITAT Mumbai held that the disallowance under Rule 8D cannot be introduced into Clause (f) of the Explanation 1 to Section 115JB, thus dismissing the Revenue’s appeal. [7] Thus, the decision clearly indicate that the view has attained universal acceptability and is now widely applied to offer relief to the taxpayers.
The uniformity of judicial decisions can be attributed to the soundness of the reasoning followed in the Special Bench case. It has been held that Section 115JB embodies a complete and self-contained code in regard to the computation of book profit, and hence, any provision within the Act aimed at modifying Section 115JB would upset the nicely balanced provision of law. The accounting principle of matching necessitates that if any exemption of income is reduced in book profit under clause (ii) of Explanation 1 to Section 115JB, only actual expenses allowed in the profit and loss statement should be allowed back in firm under clause (f), and not any notional expenditure calculated on a different statutory basis.
The Regulatory Framework and Legislation
The norms for calculating book profits under Section 115JB have changed through a series of amendments, keeping in mind the adjustments in the accounting standards and the law regulating companies. Before the Companies Act, 2013, the law was that financial statements must be presented in accordance with Schedule VI, the Companies Act, 1956. However, since the legislation of the Companies Act, 2013, the law is now that financial statements must be presented in accordance with Schedule III, the regulations for financial statements presented under the guidelines for the Indian Accounting Standards.
“Section 115JB(2) states that for the purposes of calculation of the book profit, the statement of profit and loss of a company shall be prepared in accordance with the provisions of Schedule III to the Companies Act, 2013, or in accordance with the provisions of the Act applicable to the above-mentioned companies (in the case of those companies who have certain specific provisions like banks, insurance companies, electricity companies). It is evident from the Act that the calculation of the book profit has to be on the basis of the accounting profit in accordance with the generally accepted principles of accounting, and not on the basis of the tax calculations which involve several other aspects like disallowances.”
The Explanation to Section 115JB lays down the list of special adjustments that are to be made to the net profit as shown in the profit and loss account to determine the book profit. These adjustments are systematically laid down under clauses (a) to (k) of the provisions for additions and clauses (i) to (viii) for deductions. The principle of interpretation of statutes is that when a statue draws up a list of special matters, matters that are not included within that list must necessarily fall outside that list (expressio unius est exclusio alterius). As Section 14A is not specifically mentioned within the Explanation to Section 115JB as an exception to make an adjustment, Section 14A cannot be implied.
Furthermore, from the legislative history, it can be seen that if and when Parliament has meant that certain disallowances are to be introduced into this book profit calculation system, then these have been clearly introduced in the form of amendments. For example, certain conditions have been introduced in Explanation 1 regarding different kinds of income/expenditure over the years in various clauses. The fact that no reference has been specifically made in these amendments regarding Section 14A disallowances clearly indicates that these are not meant to be taken into account in this calculation system of book profits. Large changes were introduced in Section 14A by Finance Act 2022 but no change was introduced in Section 115JB to relate these two systems in any way whatsover.
Applications in Corporate Tax Systems
The implications arising from the judgments on the non-addability of Section 14A disallowances to book profits under Section 115JB for the corporate sector are quite pronounced. Companies, which were previously liable for addition on account of Section 14A disallowances under Section 115JB, now find relief under the judgment on the law on the issue. Companies, which are structured on the lines of the Minimum Alternate Tax regime because of the exemption and deduction availed by them under the Act, now get relief on account of the certainty on the issue as above.
For the purpose of compliance, it is to be ensured that the documents reflect the distinction between the actual expenditure demonstrated in the profit & loss account, which is directly traceable to the earnings of exempt income, and the notional disallowances, as required under Rule 8D. While the returns of income are to be filed, the computation of book profit, as required by Section 115JB, is to be made only on the basis of actual expenditure, mandated under clause (f) of Explanation 1, and shall not include the disallowed amounts in the computation of total income, mandated by Rule 8D. While chartered accountants sign the computation of book profits, they have to be meticulous about the above aspect.
For pending assessment notices and appeals, taxpayers are entitled to use this agreed-upon practice and contest any additions made by Assessing Officers on the basis of import of Section 14A disallowances in the computation of book profit. Given the uniform approval of this legal position in this matter, existing across multiple jurisdictions, this makes bona fide objections by taxpayers for such additions legitimate and likely to succeed. However, it is worth noting at this stage that this legal position is applicable and relevant only to the notional/formula-driven disallowances as per Rule 8D. If actual and direct expenses in earning exempt income are debited to the profit and loss account, these are, in fact, valid for inclusion in the universe of clause (f) of the Explanation 1 to Section 115JB and are to be taken for book profit purposes.
The difference between Section 14A disallowances while computing income and Section 115JB adjustments also has its implications on tax planning. Companies with exempt income investments must be cautious in this regard and plan their finance and expense arrangements carefully. Even if they cannot escape Section 14A disallowances, they must take heart in the knowledge that these disallowances will not affect their book profit under MAT, so long as they take care to ensure their actual expenses accounted for in their books of account have supporting documentation and records.
Conclusion
The issue regarding whether Section 14A disallowances are required to be added back in the computation of book profit under Section 115JB was conclusively decided in the favor of the taxpayer in the decision of the Special Bench in the case of Vireet Investment and following decisions. The legal position is clear that it is not necessary or permissible to add the amounts of disallowance under Section 14A read with Rule 8D while computing the book profit under Section 115JB. There is sound reasoning and justice in the above legal position, and it is based on the consideration that Section 115JB is a complete code in itself and not based, as is the general section, on the computation of total income.
The segregation between these two statutory provisions will ensure that objects of both are attained without any overlapping or conflicting obligations thereunder. Section 14A will thus continue to function within its intended domain of preventing double benefits in respect of income computation, while Section 115JB will secure them against the least tax for their accounting profits without being loaded with notional disallowances for other aspects of the Act. The companies are thus able to calculate their tax responsibility under both regimes with clarity that any adjustment under Section 14A will not have cascading effects for their MAT obligations.
This explanation is extremely pertinent to the development of Indian tax laws, which have consequently evolved to ensure equity and rationality with regards to taxation. This uniform application of the rule within various judicial forums attests to the maturity and capability of Indian tax laws to deal with intricate issues of interpretation through meticulous logic. For taxpayers and tax advisors, there has emerged a definitive rule concerning tax treatment with investments that generate tax-exempt income
References
[1] Income Tax Act, 1961, Section 14A.
[2] CIT v. Nirved Traders Pvt. Ltd., Income Tax Appeal No. 149 of 2017, Bombay High Court (2019). Available at: https://taxguru.in/income-tax/section-14a-disallowance-investment-yielded-exempt-income.html
[6] Income Tax Appellate Tribunal, Mumbai Bench, Bennett Coleman & Co. Ltd. case (2025).
[8] ClearTax. “Section 14A and Rule 8D of Income Tax Act.” Available at: https://cleartax.in/s/section-14a-rule-8d
[9] Taxmann. “Analysis of Section 14A of the Income-tax Act.” Available at: https://www.taxmann.com/post/blog/opinion-analysis-of-section-14a-of-the-income-tax-act/
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