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 [2010] 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 [2011] 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. [2009] 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.