COMPILATION OF PRONOUNCEMENTS U/S 14A OF THE INCOME-TAX ACT,1961. Legislative history and purpose of Sec. 14A Section 14A has been inserted in Chapter IV of the Income-tax Act by the Finance Act 2001, with retrospective effect from April 1, 1962. This Section provided for disallowance of expenditure incurred in relation to income which is not included in the total income of the assessee. The retrospective amendment follows the position in law as laid down by the Supreme Court in CIT vs Indian Bank Ltd. ((56 ITR 77)), CIT vs Maharashtra Sugar Mills Ltd. [TS-3SC-1971] and Rajasthan State Warehousing Corporation vs CIT [TS-7SC-2000]. It aims to prevent misuse of these rulings by certain assesses to reduce the tax payable on taxable income by adjusting the expenditure incurred in relation to income which does not form part of the total income under the Act. Purpose of Sec. 14A In practice, in certain cases, it was noticed that there was misuse of the above mentioned principle in adjusting expenses relating to exempt income against the taxable income to reduce the tax liability. The introduction of Sec 14A was meant to curb the said practice. Accordingly, Sec 14A was inserted by Finance Act, 2001 so as to clarify the intention of the Legislature since the inception of 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. Further, the amendment will apply retrospectively from AY 1962-63 onwards. The basic principle of taxation is to tax the net income, i.e. gross income minus the expenditure. On the same analogy, the exemption too, is in respect of the net income. Expenses allowed can only be in respect of earning of taxable income. This is the purport of Sec. 14A. 1. In this section, the first phrase is 'for the purposes of computing the total income under this chapter' which makes it clear that various heads of income, as prescribed under Chapter IV, would fall within Sec. 14A. 2. The next phrase is 'in relation to income which does not form part of total income under the Act'. It means that if certain income does not form part of the total income, then the related expenditure is outside the ambit of the applicability of Sec. 14A. Analysis of Sec 14A(1) The two expressions in this sub-section which have been a matter of judicial debate are 'incurred by the assessee' and 'in relation to' income which does not form part of the total income. Meaning of terms used in Sec. 14A Delhi High court in the case of Maxopp Investment Ltd. vs CIT [TS668-HC-2011(Del)] observed, “While we agree that the expression ‘expenditure incurred’ refers to actual expenditure and not to some imagined expenditure, we would like to make it clear that the 'actual' expenditure that is in contemplation u/s 14A(1) of the act is the actual expenditure in relation to or in connection with or pertaining to exempt income. The corollary to this is that if no expenditure is incurred in relation to the exempt income, no disallowance can be made u/s 14A of the said Act.” A reference also was made to a similar finding by Punjab & Haryana High Court in the case of CIT-II vs Hero Cycles Ltd. (323 ITR 518). A similar view was taken in Metalman Auto P Ltd. (336 ITR 434) (P&H HC). However, the Delhi HC held that the phrase 'in relation to' is of wide import and found 'the context (in Sec14A) does not suggest that a narrow meaning ought to be given to the said expression'. Accordingly, the expression 'in relation to' does not imply any dominant and immediate purpose in the earning of exempt income and it will be understood in the normal, natural sense without any restriction. Also, the expression 'in relation to' does not have any embedded object. It simply means 'in connection with' or 'pertaining to'. Accordingly, if the expenditure in question has a relation or connection with or pertains to exempt income, it cannot be allowed as deduction even if it otherwise qualifies under other provisions of the Act. What constitutes exempt income? Yet another issue is what constitutes exempt income. If a particular income like dividend has already been taxed u/s 115-0 of the Act, can it be called exempt income or income not forming part of the total income? Courts and Tribunals have given very wide meaning to the scope of disallowance u/s 14A. Accordingly, income covered in Sections 10, 10A, 10AA, 10B, 10BA, 10C as well as Chapter VIA, where 100% exemption is allowable, will get covered u/s 14A for disallowance of expenditure relating to such income. Reassessment disallowance:- / revision / rectification & Sec. 14A The proviso to Sec.14A inserted by Finance Act, 2002 makes it clear that nothing in Sec.14A empowered the assessing officer to either reassess u/s 147, or pass an order enhancing the assessment or reducing the refund already made or otherwise increasing the liability of the assessee u/s 154, for any assessment year before 1st April 2001. Scope of Sub-Sections (2) and (3) of Section 14A and Rule 8D Analysis of Sec. 14(2) and 14A(3) Sub Section (2) provides the manner in which the Assessing Officer is to determine the amount of expenditure incurred in relation to income not forming part of the total income. However, the Assessing officer would be called upon to do so only in the event of his dissatisfaction with the correctness of the assessee’s claim in respect of the expenditure. Sub-Section (3) is nothing but an offshoot of sub-section (2). It applies to cases where the assessee claims that no expenditure has been incurred in relation to the income which does not form part of the total income. Under both sub-sections (2) and (3), the Assessing Officer gets jurisdiction to determine the amount of expenditure incurred in relation to such income not forming part of the total income, only when he is not satisfied with the correctness of the claims of the assessee. Effective date for applicability Rule 8D was introduced on March 24, 2008 by CBDT vide Notification No. 45/2008, dated March 24, 2008 to take effect from AY 2008-09. It would be seen from the legislative history and developments as described above that sub-sections (2) and (3) of Sec 14A remained empty shells and inoperative till A.Y.2008-09. Though they were introduced with effect from April 1, 2007, in the absence of Rule 8D, subsections (2) and (3) lacked the 'prescribed method' for operationalization. The operation of Rule 8D has been held to be prospective both by Bombay HC in the case of Godrej & Boyce Mfg. Co. Ltd. and Delhi HC in the case of Maxopp Investment Ltd. Bombay HC observed in this regard, 'unless expressly or by necessary implication, or contrary provision is made, no retrospective effect is to be given to any rule so as to prejudicially affect the interests of the assessee. The Rules were notified to come into force on March 24, 2008. From the above it is clear that, in effect, the provisions of sub sections (2) and (3) of Section 14A would be workable only with effect from the date of introduction of Rule 8D. This is so because prior to that date, there was no prescribed method and subsections (2) and (3) of Sec.14A remained unworkable. The only requirement was that such rejection must be for cogent reasons and the AO was free to adopt any reasonable and acceptable method. In addition, the Assessing Officer will not have suo moto rights to resort to Rule 8D. It is imperative on part of the Assessing Officer to invoke Rule 8D, only if he is dissatisfied with the correctness of the quantum of disallowance admitted by the assessee, or where the assessee claims that no expenditure has been incurred with respect to exempt income. Rule 8D, as already stated, would apply assessment from year assessment 2008-09, when year Rule 2008-09. 8D was 'Even not prior to the applicable, the assessing officer had to enforce the provisions of sub section (1) of sec.14A. Computation of disallowance Rule 8D has three components. 1. The first component is the amount of expenditure directly relating to income not forming part of total income (Direct expenditure). 2. The second component is computed on the basis of the formula given therein. In the case of interest expenditure which is not directly attributable to any particular income or receipt, the formula essentially apportions the amount of expenditure by way of interest (other than the amount of interest included in direct expenses as above), incurred during the previous year in the ratio of the average value of investment, income from which does not or shall not form part of the total income, to the average of the total assets of the assessee. 3. The third component is an artificial figure namely, a half percent of the average value of the investment, income from which does not or shall not form part of the total income, as appearing in the balance sheets of the assessee, on the first day and the last day of the previous year. It is the aggregate of the three components which would constitute the expenditure in relation to exempt income and it is the amount of expenditure which would be disallowed under section 14A of the Act. There is a view that the method prescribed by Rule 8D seeks only to determine the notional cost for holding/maintaining investments which may or may not yield an exempt income. It is a moot point whether such a notional cost has any truck with the actual expenditure incurred and claimed by the assessee. Also, one half percent of component the average supra, is value a rule of of investment, the referred thumb figure as and third its artificiality may tweak the expenditure to be disallowed disproportionately, out of sync with the earning of the exempt income. This disallowance may not have any relation, either to the exempt income or to the expenditure claimed by the assessee. To that extent, it will be inequitable, and will render the Rule 8D as being in excess of Sec.14A. Compilation of rulings on Sec.14A:This compilation lists rulings delivered in the last 3 years on various issues in the context of Sec. 14A. Sr.No:-1 Issue Case laws Applicability of Sec 14A to different classes of assessees Oriental Insurance Co. Ltd [130 TTJ 388 (Del.) (Trib.)] A Delhi bench of ITAT held that Sec 14A was not applicable to insurance companies. ITAT observed that the income of the insurance companies had to be computed u/s 44 read with Rule 5 of the First Schedule to Income Tax Act, which is a specific provision overriding Sec 14A. Since, as per Sec 44 no head-wise bifurcation of income was required to be made in case of insurance companies, Sec 14A disallowance could not be made. ITAT observed, “…it is not permissible to the Assessing Officer to travel beyond s. 44 and First Schedule of the Income-tax Act.” Birla Sunlife Insurance Co. Ltd [TS-23-ITAT-2010(Mum)] Following Delhi ITAT decision in Oriental Insurance Co [130 TTJ 388 (Del.) (Trib.)], a Mumbai bench of ITAT held that Sec 14A disallowance was not attracted in case of a life insurance company due to the special provisions relating to their taxation (Section 44 read with Rule 5 of the First Schedule to the Act) . Varun Shipping Company Ltd [144 TTJ 286 2011(Mum)] A Mumbai bench of ITAT held that Sec. 14A was not applicable to a shipping company subject to tonnage tax. ITAT observed that as the income of the shipping business was computed as per the tonnage tax scheme, only those expenses, which pertained to the shipping business, were deemed to have been allowed. Thus, it could not be said that the expenses in relation to earning dividend income were included in such expenses. Accordingly, ITAT held that the separate disallowance u/s 14A was not applicable and no addition on that account could be made to the income from the shipping business computed under the tonnage tax scheme. Sr.No:-2 Relevance of purpose of investment for applicability of Sec.14A Dividend earned on shares held as stock in trade CCI Ltd [TS-226-HC-2012 (Kar)] Karnataka HC held that the disallowance u/s 14A was not applicable on shares held as stock in trade. HC held that the dividend income was incidental to the business of share trading and the expenditure was not incurred with an intention to earn dividend. Since dividend was earned on unsold portion of shares, no expenditure could be disallowed u/ 14A. Yatish Trading Co. P Ltd [(2011)129 ITD 237 (Mum)] Interest incurred for share trading activity could not be disallowed u/s 14A, as the earning of dividend was only incidental to the share trading activity. Simply because shares purchased for trading incidentally resulted in some dividend, it would not change the nature, character and purpose of the interest expenditure. In order to disallow expenditure u/s 14A, there must be live nexus between the expenditure and earning of income. Disallowance of administrative expenses on the basis of ratio of dividend income to taxable income was set aside. In case of transactions of purchase and sale of shares, a reasonable basis of apportionment of expenditure could be the volume and the nature of transactions. There could not be parity or equal basis for the apportionment of administrative expenses between delivery based and non-delivery based transactions, and trading and investment activity. Yogesh J Shah [(2010)(46 SOT 183)(Mum)(URO] Mumbai ITAT held that it was not necessary that dividend should be earned out of intended activity so as to apply disallowance u/s 14A. When the assessee had incurred expenditure for an activity which had resulted into an exempt income, the disallowance u/s 14A was applicable. Rule 8D was not applicable for the relevant AY and the issue of determination of exact disallowance u/s 14A remitted back to the AO. Sr.No:-3 Strategic investments where earning of dividend income is not the motive Investments for banking business. Maxopp Investment Ltd [203 taxman 185 (Del)] was Sec. 14A disallowance applicable to the interest paid on the borrowings used for strategic investments, even though earning of dividend income is only incidental. Smt. Leena Ramachandran [(2011) 339 ITR 296 (Ker)] The assessee was engaged in trading in goods. She acquired controlling interest of a company engaged in leasing of articles by way of purchasing its shares. The shares were acquired with borrowed capital. She contended that the company leased articles similar to the ones she was trading in and hence, the acquisition was for business purpose. The AO disallowed the interest paid on borrowed capital, which was more than the dividend earned during the year on the said investment. HC held that entire interest was disallowable u/s 14A, as the entire funds were utilized for acquisition of shares. HC held that the only benefit derived from investment was dividend, which was exempt from tax and accordingly, the AO was right in invoking provisions of Sec. 14A. State Bank of Travancore [124 ITD 332 2011(KER)] The assessee made investments in tax free bonds for meeting SLR requirements. The assessee had borrowed funds for making investments. HC held that even though the investment was made for meeting SLR requirements which was essential for the assessee’s banking business, the interest and other expenditure incurred on borrowings for investment was disallowable u/s 14A. Applicability of Sec. 14A when no relevant year Cheminvest Ltd [121 ITD 318 2009(DEL)] exempt income earned during Delhi Special Bench held that Sec. 14A disallowance had to be made in respect of interest on loans, which were utilized for investment in shares, even though no dividend income was earned on those shares during the relevant year. Siva Industries & Holding Ltd [TS-438-ITAT-2011(CHNY) and TS-317ITAT-2012(CHNY)] Relying on the Special Bench ruling in Cheminvest Ltd, Chennai ITAT held that the disallowance u/s 14A was applicable, even though the assessee did not earn any exempt income in AY 2007-08. ITAT noted that while disposing the appeal for the earlier year, the ruling of the Special Bench in Cheminvest was not considered by ITAT and hence, that ruling was incorrect. In the earlier year, ITAT had held that the disallowance for interest paid on loans borrowed for making investment in shares was not applicable, as the assessee did not earn any dividend from such investment. Technopack Advisors P Ltd [(2012) 50 SOT 31 (Delhi)(URO)] Even if the investment in shares did not yield any dividend in the year under expenditure consideration, incurred for the disallowance earning income u/s14A was on the disallowable, notwithstanding the fact that no such income was earned. Relaxo Footwear Ltd [(2012) 50 SOT 102 (Delhi)] Even if the assessee had not earned any income which was not includible in the total income, the provisions of section 14A could still be invoked to disallow the expenditure relatable to the income not includible in the total income. Since the AO did not consider the claim of the assessee that no expenditure was incurred for earning exempt income before invoking provisions of Rule 8D, the matter was restored to AO for fresh consideration in view of the Bombay HC ruling in Godrej & Boyce. Applicability of Sec.14A disallowance to share of profit from partnership firm Popular Vehicles & Services Ltd [(2010)325 ITR 523 (Ker)] The assessee borrowed funds from banks, which were diverted to partnership firms, in which it was a partner. HC noted that the assessee did not receive any interest from those firms. The only benefit derived was share of profit, which was exempt u/s 10(2A). HC sustained the disallowance of interest by invoking provisions of Sec.14A. Vishnu Anant Mahajan [TS-396-ITAT-2012(Ahd)] An Ahmedabad Special Bench of ITAT held that Sec. 14A disallowance is applicable to partners’ share in the firm’s profit, which is exempt u/s 10(2A). ITAT SB held that profit from firm is not included in the total income of the partner by virtue of exemption provisions of Sec. 10(2A). ITAT held that a partnership firm is not a pass through vehicle and the firm and partners are separately assessable to tax, despite the position of law under the Partnership Act that the firm is a compendium or collective name of the partners. Non-maintenance immunity from of separate applicability books of of Sec accounts 14A does not disallowance provide prior to introduction of Rule 8D Catholic Syrian Bank Ltd. & Ors. (2011) 237 CTR 164 (Ker) The assessee bank did not maintain separate accounts for the expenditure incurred towards interest paid on funds borrowed for investments in securities, bonds and shares which yielded tax free income. In the absence of separate accounts, the Assessing Officer made proportionate disallowance of interest attributable to the funds invested to earn tax free income, based on the average cost of deposit in the year under consideration. A division bench of Kerala HC held that the amendment introducing sub-sections (2) and (3) in Sec 14A was clarificatory only. The main clause of Section 14A was applicable disallowance of the for all expenditure periods, incurred which for authorized earning tax the free income, irrespective of whether the assessee maintained separate accounts or not. However, with regard to administrative expenses, HC held that disallowance. there was Therefore, no no precise formula disallowance was for proportionate called for, for proportionate administrative cost attributable to earning of tax free income until Rule 8D came into force. Applicability of Sec 14A to deductions and allowances Deductions National Agricultural Cooperative Marketing Federation of India Ltd [TS-280-ITAT-2012(DEL)] A Delhi bench of ITAT held that Sec 14A was applicable to cooperative society claiming Sec 80(P) deduction. However, ITAT deleted the disallowance since the co-operative society reported loss. ITAT observed that dividend income received by the assessee from other co-operative societies was not excluded from total income in view of loss. ITAT noted that Sec 14A speaks of positive exclusion and not theoretical exclusion from total income. Kribhco  6 ITR (Trib) 686 (Delhi) A Delhi bench of ITAT held that Sec 14A was not applicable where the co-operative society was claiming deduction u/s 80P, for dividend and interest income on deposits with other co-operative banks. ITAT had observed, “The terms „exempt income‟ and „deduction from income‟ are two different propositions and Depreciation Allowance deduction from income will not amount to an exemption from income. Since both the above receipts of the assessee were not exempt and includible in income, merely because deduction under section 80P is provided, it cannot be assumed to be hit by section 14A.” Meditap Specialities Private Ltd [TS-393-ITAT-2012(Mum)] Mumbai ITAT held that disallowance u/s 14A is not applicable to SEZ income, which is eligible for deduction u/s 10AA and 80IAB. ITAT held that Sec 10AA is a ‘deduction’ provision and not an ‘exemption’ provision, even though it falls under Chapter III of the Act. Disallowance u/s 14A is not applicable to deductions. Thus, ITAT ruled that “It is impermissible to mix both the deduction and exemption provisions and then take them in one stride for computing disallowance u/s 14A.” Hoshang D. Nanavati v. ACIT [TS-404-ITAT-2012(Mum)] A Mumbai bench of ITAT held that disallowance u/s 14A is not applicable to 'depreciation'. ITAT held that depreciation is ‘an allowance’ and not ‘expenditure’ and relied on the Supreme Court decision in the case of Nectar Beverages P Ltd (314 ITR 314). ITAT also held that disallowance u/s 14A could not be made in respect of deduction u/s 80D for ‘mediclaim payments’. Vishnu Anant Mahajan [TS-396-ITAT-2012(Ahd)] ITAT SB held that depreciation on a motor car was an allowance and not expenditure and hence, it could not be disallowed by invoking provisions of Sec. 14A. ITAT SB upheld ITAT ruling in Hoshang D. Nanavati (supra) in which it was held that Sec.14A was applicable only to the expenditure and not to any statutory allowance such as depreciation. Further, ITAT also noted that Sec. 14A used the words ‘expenditure incurred by the assessee in relation to income’. Hence, ITAT held that depreciation could not be considered for disallowance u/s 14A. Prohibition on Reassessment and Revision Honda Siel Power Products Ltd. v. Dy. CIT (2012) 340 ITR 64 (SC) SC upheld Delhi HC decision allowing reopening of assessment for AY prior to AY 2000-01, despite the bar provided in proviso to Sec 14A. In this case, though the return was filed in 2000, the assessment u/s 143(3) was completed in 2003 i.e. after insertion of Sec. 14A. HC observed that the proviso prohibits reassessment but not original assessment based on the retrospective amendment. Thus, the AO ought to have applied Sec 14A and his failure has resulted in escapement of income. HC observed that the assessee had failed to point out the expenses related to earning exempt income during the assessment proceedings. Hence, reopening beyond 4 years was held to be justified. Shri Paul John, Delicious Cashew Co [TS-199-HC-2010(KER)] Kerala HC held that the proviso to Sec 14A, prohibiting reassessment u/s 147 and rectification u/s 154 for enhancing the assessee’s liability for the completed assessments, was also applicable to revision proceedings u/s 263 and to the order of enhancement issued by the CIT(A) u/s 251(1)(a). Mahesh G. Shetty  238 CTR 440 (Kar.) Karnataka HC held that revision u/s 263, enhancing the assessment by making disallowance u/s 14A, was valid. HC observed that the revision order was passed in Dec 1999 i.e. before the insertion of the proviso to Sec 14A in 2002 and thus, the said proviso was not applicable. Tube Investments of India Ltd. (2011) 133 ITD 79 (Chennai)(TM)(Trib.) A Majority of the Three-Member bench of Chennai ITAT held that the bar stated in proviso to Sec 14A against reassessment did not operate in a case of first assessment. ITAT observed that the proviso to Sec 14A was not applicable, when the initial proceedings were completed u/s 143(1) and thereafter notice u/s 148 was issued to make an assessment at the first instance, to disallow the relevant expenditure u/s 14A. Appeals and Sec 14A Wallfort Financial Services Ltd. [TS-718-HC-2011(BOM)] Bombay HC held that the co-ordinate bench decision in Godrej & Boyce Manufacturing Company Ltd. (TS-125-HC-2010), holding Rule 8D to be prospective and not retrospective, was binding on ITAT, despite IT Department's SLP in SC. Revenue had filed an appeal before HC claiming that ITAT was not justified in remanding the matter back to the AO to reconsider Sec 14A disallowance, following the ruling in Godrej & Boyce. ISG Traders Ltd Vs CIT [ TS-567-HC-2011(CAL) ] Calcutta HC held that Sec 14A amendment by Finance Act, 2002 had retrospective application for pending assessments. HC also held that the amended Sec 14A was applicable to all pending appeals before ITAT and HC. Topstar Mercantile (P.) Ltd.  225 CTR 351(BOM.) During assessment proceedings, the AO made an inquiry about disallowance u/s 14A, but did not give any adverse finding in his order on applicability of Sec. 14A. The AO disallowed interest expenditure holding that it was not incurred wholly and exclusively for earning business income. ITAT remanded the case back to the AO to consider the applicability of Sec. 14A in view of the Special Bench ruling in Daga Capital. Bombay HC held that ITAT was not justified in remitting 14A issue to AO, in the absence of a specific finding with respect to the disallowance u/s 14A. Is Rule 8D automatic and mandatory? Continental Carriers P Ltd [(2011) 138 TTJ 249 (Delhi)] Delhi ITAT held that where Rule 8D was not applicable for AY prior to March 24, 2008; the disallowance u/s 14A was to be computed in accordance with the decision of Bombay HC in the case of Godrej & Boyce Mfg. Co Ltd. Lakshmi Ring Travelers [TS-210-ITAT-2012(CHNY)] A Chennai bench of ITAT, ruling in favour of the Revenue, upheld disallowance on a presumptive basis u/s 14A(3). ITAT observed that that even in a case where an assessee claims that no expenditure was incurred, the assessing authority has to presume the incurring of such expenditure as provided under sub-section (2) of Sec 14A read with Rule 8D, and make disallowance. ITAT observed, “Therefore, it becomes clear that even in a case where the assessee claims that no expenditure was so incurred, the statute has provided for a presumptive expenditure which has to be disallowed by force of the statute In a distant manner, literally speaking, it may even be considered for the purpose of convenience as a deeming provision. When such deeming provision is made on the basis of statutory presumption, the requirement of factual evidence is replaced by statutory presumption and the Assessing Officer has to follow the consequences stated in the statute.” Metalman Auto(P)Ltd [(2011)336 ITR 434 (P&H)] P&H HC held that disallowance u/s 14A cannot be made in the absence of actual expenditure. In other words, disallowance u/s 14A cannot be made on presumptive expenditure basis. Auchtel Products Ltd [TS-401-ITAT-2012(Mum)] Mumbai ITAT held that it was incorrect on the part of the Assessing Officer (AO) to proceed on the premise, as if the disallowance as per Rule 8D is automatic, irrespective of the genuineness of the assessee’s claim in respect of expenses incurred in relation to exempt income. ITAT observed, “Satisfaction of the AO as to the incorrect claim made by the assessee in this regard is sine qua non for invoking the applicability of Rule 8D. Such satisfaction can be reached and recorded only when the claim of the assessee is verified. If the assessee proves before the AO that it incurred a particular expenditure in respect of earning the exempt income and the AO gets satisfied, then there is no requirement to still proceed with the computation of amount disallowable as per Rule 8D.” Jindal Photo Limited [TS-405-ITAT-2012(Del)] A Delhi bench of ITAT held that application of Rule 8D by the AO, to make regarding disallowance incorrectness u/s 14A of without the recording assessee’s satisfaction calculation, was not justified. ITAT observed, “Such satisfaction of the AO is a prerequisite to invoke the provisions of Rule 8D of the Rules.” ITAT held that the disallowance required a clear finding of incurring of expenditure and no disallowance on presumptive basis was possible. Sec 14A disallowance not to exceed actual expenditure Gillette Group India Pvt Limited [TS-403-ITAT-2012(Del)] The assessee earned exempt income for AY 2008-09. The Assessing Officer (AO) disallowed Rs. 2.37 Crores u/s Sec 14A read with Rule 8D, whereas the actual expenditure incurred and debited to P&L account was Rs 49 lakhs. The assessee challenged disallowance on the ground that it could not exceed the actual expenditure. A Delhi bench of ITAT, ruling in favour of the assessee, held that the disallowance u/s 14A read with Rule 8D could not exceed the actual income. expenditure ITAT incurred restricted and the debited in disallowance relation to to extent the exempt of expenditure actually claimed by the assessee. Candlewood Holdings Pvt. Ltd [TS-402-ITAT-2012(Kol)] The assessee derived dividend income of Rs.1 lakh on which exemption u/s 10(38) of IT Act was claimed. The assessee disallowed an amount of Rs.11,000 u/s 14A against dividend income. However, the AO computed the disallowance at 0.5% of the average value of the investments which comes to Rs.4 lakhs. A Kolkata bench of ITAT held that Sec 14A disallowance could not be made on an estimated basis i.e. .5% on investments, when the assessee had disallowed actual expenditure in relation to exempt income and there was no contrary finding by Revenue. Owned fund vs borrowed fund Catholic Syrian Bank Ltd. & Ors. (2011) 237 CTR 164 (Ker) Kerala HC held that the assumption of the Assessing Officer, that the entire investment made by the assessee banks in bonds, shares and securities was out of borrowed funds (deposits), was not justified. HC noted that the assessee-banks had a specific case that they had funds available with them which were neither borrowals nor interest bearing deposits and such funds also had been utilized in making investments for earning tax free income. Hence, HC remitted the issue back to the AO to determine the disallowance u/s 14A on rational basis. Ultramarine & Pigments Ltd [TS-786-ITAT-2011(Mum)] ITAT noted that no fresh investment was made during the relevant year and the assessee had sufficient capital and free reserves for making investment in equity shares. In the absence of any material or basis to hold that interest was directly or indirectly attributable to earning of dividend, no disallowance of interest could be made u/s 14A. Shankar Chemical Works v DCIT [ TS-260-ITAT-2011(Ahd) ] ITAT held that investment was made out of partners’ capital and accordingly, proportionate interest on partners’ capital was disallowable u/s 14A. ITAT also observed that the partners would not be entitled to corresponding relief, even if the deduction for interest was not allowable in the hands of the firm. Dhanuka & Sons [TS-173-HC-2011(Cal)] The assessee carried on indivisible business giving rise to taxable as well as exempt income. Since the assessee failed to prove that shares were acquired out of borrowed funds, the disallowance u/s 14A for interest expenditure was upheld. Whether disallowance U/S 14A to be of based on Gross interest expense or Net interest expense? Morgan Stanley India Securities Private Limited [TS-148-ITAT- 2011(Mum)] A Mumbai bench of ITAT held that the disallowance for the interest expense u/s 14A should be calculated on ‘net interest’ debited to the profit observed, and “There loss can account be no and not dispute on gross interest. that since the ITAT amount of interest debited to the Profit and Loss Account is on net basis, the disallowance of interest should also be made only with reference to the net interest, as was done by the assessee.” Trade Apartment Ltd [TS-214-ITAT-2012(Kol)] A Kolkata bench of ITAT held that when the interest income credited to P&L account exceeded the interest expenditure incurred by the assessee, no interest expenditure was left which could be disallowed u/s 14A. CIT v/s K. Raheja Corporation pvt. Ltd. (BOM) No disallowance u/s 14A of interest on borrowed funds if AO does not show nexus between borrowed funds & tax free investments. CIT v/s Gujarat Power Corporation Ltd. (Guj) Sec. 14A disallowance of interest on borrowings on ground that assessee ought not to have used own funds for tax-free investments invalid. Finally basis of disallowance u/s 14A in nut shell:1. The onus is on the AO to establish nexus of the expenditure incurred with the earning of exempt income.. 2. The disallowance cannot be made on adhoc basis. 3. The AO has to reject the disallowance offered by the assessee with precise recording of the reasons. 4. AO cannot suggest disallowance on the basis of assumptions of direct or indirect expenses incurred by the assessee to earn exempt income. Disallowance u/s 14A could come into play only out of expenses incurred and claimed for deduction.