Section 14A of Income Tax Act, 1961 r.w. Rule 8D of Income Tax Rules: Supreme Court standpoint – No tax in the absence of any exempt income

The much debated and extensively litigated issue has been resolved by the Supreme Court in 2018 & 2019. The article below summarises issues encountered by the assessee’s prior to the SC’s standpount judgement and summarises SC interpretation of Section 14A.

Brief overview of Section 14A & Rule 8D:

Section 14A had been introduced by Finance Act 2001 with retrospective effect from April 1, 1962 in Chapter IV of the Income Tax Act 1961. The essence to introduce this section was to bring under the ambit of taxation any expense which had been incurred directly / indirectly to earn exempt income. Subsequently, Rule 8D had been introduced with prospective effect from March 24, 2008. Pursuant to the said Rule, if the Assessing Officer (A.O.) is satisfied that claim made by assessee is incorrect or assessee claims that no expense has been incurred to earn exempt income, then AO may disallow expenditure as determined by applying formula mentioned in Rule 8D.

Analysis of the section, issued encountered and CBDT circular reference:

In case of assessee which has earned exempt income, the application was much more discreet. But issues arose mainly in case of assessee’s wherein no exempt income had been earned / derived during the previous year under assessment. There have been numerous case laws on the said subject at ITAT & HC wherein the ruling has been delivered either in favour or against the department. To reiterate, on one hand some of the ITAT / HC held that section 14A cannot be invoked since no exempt income had been earned, whereas on other hand it had been ruled that section can be invoked irrespective of income being earned by the assessee. To sum up, ambiguity persisted on application of this section in case of assessee’s who have earned Nil exempt income in the previous year.

Thus, CBDT issued a circular in February 2014, stating that the legislative intent is to allow only that expenditure which is relatable to earning of income and it therefore follows that the expenses which are relatable to earning of exempt income have to be considered for disallowance, irrespective of the fact whether any such income has been earned during the financial year or not. Thus, pursuant to this it was held that the expenses which are relatable to earning of exempt income have to be considered for disallowance, irrespective of the fact whether any such income has been earned during the financial year or not and this was being effected by the AO. The taxpayers were aggrieved by this and thus, as stated above the matter had been under litigation.

Supreme Court Standpoint:

Supreme Court in April 2019 dismissed the Revenue’s Special Leave Petition (SLP) in case of Cheminvest Ltd. v. CIT [2015] 378 ITR 33 (Delhi HC), against the decision of the Delhi High Court holding that no question of law arose from the order of the Income-tax Appellate Tribunal (Tribunal), thereby deleting the disallowance under section 14A of the Income-tax Act, 1961 (Act), absent any exempt income during the year. In 2018, SC had previously dismissed SLP in case of CIT v. Chettinad Logistics (P.) Ltd filed by the Revenue and thus, deleting the disallowance of expense under section 14A of the Act in the absence of exempt income.

Conclusion:

Thus, both these can be considered as a useful reference by the taxpayers wherein it has been clearly held that by the SC section 14A cannot be invoked in the absence of exempt income and avoid tax litigations / assessments.

Relevant links:

1. Sec 14 A – https://www.incometaxindia.gov.in/pages/acts/income-tax-act.aspx

2. Rule 8D – https://www.incometaxindia.gov.in/pages/rules/income-tax-rules-1962.aspx

3. Circular 5/2014 – https://taxguru.in/custom-duty/customs-baggage-declaration-regulations-2013-implementation-thereofreg.html

4. Orders in which SC dismissed the SLP:

https://indiankanoon.org/doc/172510364/

https://indiankanoon.org/doc/125997301/

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