Whether disallowance under section 14A of the income tax act, 1961 is related with earning of actual income or notional/anticipated income?
Most of taxpayers under Income tax act, 1961 afraid to file appeal against additions made by assessing officers due to fear of departmental procedures/penalty/bar/attachment in the thought process of normal taxpayers. however, most of cases seen where department made disallowance of expenditure under section 14A of the income tax act, 1961 without considering the fact that “the Company has adequate own funds at its disposal , hence invokation of 14A is quite harsh and burdensome and without appreciating the factual and legal backdrop”
If there is sufficient own funds, the invokation of 14A is not tenable”
Following example shows detailed plethora of case where department is disallowing expenditure.
Brief facts of the case :-
During the course of 153A assessment proceeding, a SCN has been issued to assesse (XYZ Ltd.) on 01-09-2019 and it was asked as to why disallowance of the interest expenditure of Rs. 1,09,00,000/- under provision of Rule 8D r.w.s. 14A is not disallowed.
The assesse (XYZ Ltd.) is engaged in the business of developing, operation and maintenance of infrastructure projects of roads and bridges, toll collection contracts etc
Matter of Litigation :-
1. Whether disallowance under section 14A exceed amount of exempt income???
2. Whether all investments become the subject matter of consideration when computing disallowance u/s. 14A read with rule 8D or the disallowance u/s. 14A is to be in relation to the income which does not form part of the total income ???
Submission of XYZ Ltd:-
1. Ld. AO has wrongly disallowed interest expenditure by incorrectly applying 14A r/w. Rule8D. Ld. AO overlooked or failed to consider that investment is equity shares of SPV Companies are for business expediency and under the compulsion to form a subsidiary under the NHAI model of one project one Company and is therefore cannot be considered as investment with underlying intention to earn exempt income of dividend.
Case Laws on above submission :-
1. Hon Madras High Court in the case of CIT Vs. Chettinad Logistics Pvt Ltd  80 Taxmann.com / 248 Taxmann 55 . has laid down a proposition that 14A cannot be invoked where no exempt income was earned by the Assessee in relevant assessment year.
2. Delhi High Court in the case of CIT Vs. Oil Industry Development Board [ 2019] 103 Taxmann.com 325 (Delhi) has held that in the absence of any exempt income , disallowance under section 14A of any amount was not permissible. The departmental SLP filed against such judgment has been rejected on 8th Feb, 2019 by Hon. Apex Court as reported as Principle CIT Vs. Oil Industry Development Board  103 Taxmann.com 326 (SC)/  262 Taxmann.com 102 (SC).
3. Delhi High Court in the case of CIT Vs. GVK Projects & Technical Services Ltd  106 Taxmann.com 180 ( Delhi) has noted that Assessing officer proceeded to calculate disallowance under section 14A on the basis of investment made by Assessee. Hon. ITAT opined that in the absence of any exempt income reported by the Assessee, disalllowance could not be made by the Assessing Officer. High Court on appeal upheld the ITAT order. The departmental SLP filed against the said order has been rejected by Hon. Apex Court on 3rd May, 2019 as reported in PCIT Vs. GVK Projects & Technical Services Ltd  106 Taxmann.com 180 ( Delhi)/ 264 Taxmann 76 (SC).
Authors’ comment on above matter :-
“Thus, not all investments become the subject matter of consideration when computing disallowance u/s. 14A read with rule 8D. The disallowance u/s. 14A read with rule 8D is to be in relation to the income which does not form part of the total income and this can be done only by taking into consideration the investment which has given rise to this income which does not form part of the total income. “
2. Coming to the second argument of the assessee, the assessee argued that it had earned meager dividend income of Rs.25,000 as against which, the AO disallowed a sum of Rs.1,09,00,000/- which is more than the exempt income. The assessee further argued that disallowance u/s 14A cannot exceed amount of exempt income. The assessee relied upon case laws in support of its arguments.
We find that the Hon’ble Delhi High Court in the case of Joint Investments P Ltd vs CIT (2015) 372 ITR 694 (Delhi) held that the window for disallowance is indicated in section 14A and is only to the extent of disallowing expenditure incurred by the assessee in relation to tax exempt income. This proportion or portion of the tax exempt income surely cannot swallow the entire amount as has happened in this case. We further notice that the Hon’ble Delhi High Court in the case of CIT vs Holcim India Pvt Ltd (2014) 272 CTR 282 (Del) has held that there can be no disallowance u/s 14A in the absence of exempt income. The rationale behind these judgments is that the amount of disallowance cannot exceed exempt income. In this case, on perusal of the facts, we find that the assessee has earned exempt income of Rs.25,000, whereas the AO disallowed an amount of Rs Rs.1,09,00,000. Therefore, considering the facts and circumstances of the case and also following the ratios of the case laws discussed above, we are of the view that disallowance u/s 14A cannot exceed the exempt income.
Authors’ comment on above case:-
Reference may be made to the decision of Hon’ble Gujarat High Court in case of CIT vs. Corrtech Energy (P) Ltd. (supra) and also to the decision of Hon’ble Punjab & Haryana High Court in the case of CIT V/s. Winsome Textile Industries Ltd. (supra). In the above decisions, it has been held that where assessee did not make any claim for exemption of income, provision of section 14A could have no application. It is an undisputed fact that the appellant has neither claimed any exempt income nor has claimed deduction for any expenditure in relation to exempt income. The issue is also covered by the decision of Hon’ble Delhi High Court in the case of CIT V/s. Holcim India Pvt. Ltd. (supra) wherein it was held that there could be no disallowance of expenditure for earning of exempt income in case exempt income was not earned during the year. Reliance is also placed on the decision of the Hon’ble Allahabad High Court in the case of CIT V/s. Shivam Motors Pvt. Ltd. (supra) and Cheminvest Ltd. Vs. CIT (supra) supporting the same ratio laid down by the Hon’ble Gujarat High Court. In a decision rendered by the Hon’ble Madras High Court in the case of Redington India Ltd. V/s. Addl.CIT (supra), it was held that Circular No.5/2014 Dtd. 11.02.2014 does not lay down the correct law. The provisions of Section 14A is clearly relatable to the earning of actual income and not notional or anticipated income. The computation of total income in terms of Sec.5 of the Act is on real income and there is no sanction in law for the assessment or admittedly notional income, particularly in the context of effecting a disallowance in connection therewith. Thus, accepting the submission of the Revenue that s.14A would be attracted even to exempt income ‘includable’ in total income would result in imposition of an artificial method of computation on notional and assumed income and this would be carrying the artifice too far. In a recent decision rendered by the Hon’ble Delhi High Court in the case of PCIT V/s. IL & FS Energy Development Co. Ltd. (supra), the Court was not persuaded with the interpretation placed by the Circular No.5/2014 Dtd. 11.02.2014 and it was held that what is taxable u/s.5 is the “total income” which is neither notional nor speculative. It has to be ‘real income’. The expenditure incurred as claimed by the Assessee has to be in relation to the income earned in ‘such previous year’ and if there is no exempt income earned in the particular assessment year, the question of disallowance of expenditure incurred to earn exempt income in terms of Section 14A and Rule 8D would not arise. In view of the above discussion, I agree with the argument of the Ld. AR that on this logic that ‘no disallowance can be made u/s 14A of the Act ‘when’ no exempted income claimed’. On this count, disallowance u/s 14A of the Act made in by the AO needs to be deleted being unsustainable on facts and in law.