Landmark ruling on Sec 14A-Updated as on 11th Sep

S. 14A provides for the disallowance of expenses incurred in relation to the income, which does not form part of the total income of the assessee.

14A. [(1)] 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.]

[(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.

(3) The provisions of sub-Section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act :]

[Provided that nothing contained in this Section shall empower the Assessing Officer either   to reassess under Section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under Section 154, for any assessment year beginning on or before the 1st day of April, 2001.]

1. (2012) 6 TaxCorp (DT) 52226 (SC)

SC remits issue of S. 14A applicability back to Calcutta HC.

Involving disallowance under S. 14A of the Act. A division bench observed that there was no judgment of High Court on the interpretation of S. 14A and yet HC, in its order, had merely stated that no substantial question of law arose in the case.

The assessee had claimed deduction for expenses incurred to earn amounts which were exempted from tax, its was observed that S. 14A has been introduced in the IT Act to provide that expenses incurred to earn amounts, which are exempted from tax are not entitled to deduction and High Court did not considered the same in its ruling. Accordingly, setting aside the minutes of the HC order, and remitted the matter to the HC for de-novo (fresh) consideration.

2. (2012) 6 TaxCorp (DT) 52227 (Bombay)

The co-ordinate bench decision in (2010) 4 TaxCorp (DT) 46941 (BOMBAY)  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 S. 14A disallowance, following the ruling reported in in (2010) 4 TaxCorp (DT) 46941 (BOMBAY)

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3. (2012) 6 TaxCorp (A.T.) 28300 (Chennai)

The Bench upheld disallowance on a presumptive basis u/s 14A(3) and 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 S. 14A read with Rule 8D, and make disallowance.

“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.”

4. (2010) 4 TaxCorp (DT) 46941 (BOMBAY)

Constitutional validity of Rule 8D r.w.s 14A upheld. Rule 8D to be applied prospectively. Computation of disallowance of expenses incurred to earn exempt income, under Rule 8D r.w.s 14A not arbitrary; Rule to be applied prospectively w.e.f AY 2008-09.

5. (2009) 312 ITR (A.T.) 1 (MUMBAI)

S.14A has an overriding effect and applies to all expenditure in relation to exempt income even though such expenditure would have been allowable under other provisions such as 36(1)(iii) 

Sub-Sections (2) and (3) of s. 14A, though inserted by the F. A. 2006 w.e.f. 1.4.2007, read with Rule 8D, are procedural and clarificatory in nature and apply to pending matters.

The words “in relation to” in s. 14A encompass not only the direct expense but also the indirect expense which has any relation to the exempt income. The argument that the words contemplate a “direct and immediate connection” between the expenditure and the exempt income cannot be accepted. Accordingly, the argument that s. 14A cannot apply to shares held as stock-in-trade cannot be accepted. The fact that the dividend income is “incidental” to the purchase of shares is also irrelevant. The question as to whether the onus is on the assessee or the AO for bringing an item of expenditure within s. 14A is also irrelevant in view of Rule 8D; 

Note: Disapproved by the Jurisdictional  High Court reported in (2010) 4 TaxCorp (DT) 46941 (BOMBAY) in so far as the retrospective applicability of Rule 8D.

6. (2010) 4 TaxCorp (DT) 46628 (SC)

Dividend Stripping Transaction - Loss arising in the course of Dividend Stripping Transaction - Business Transaction - Setoff - AO disallowed the loss of Rs. 2,09,44,793 claimed by the assessee inter alia on the ground that a dividend stripping transaction was not a business transaction and since such a transaction was primarily for the purpose of tax avoidance, the loss so called was an artificial loss created by a pre-designed set of transaction - ITAT and HC allowed the loss to be deducted - Held that: - Section 14A deals with disallowance of expenditure per se and not with a disallowance of a loss which arises at a point of time subsequent to the purchase of units and the receipt of exempt income and occurring only when there is a sale of the purchased units. - Under Section 94(7) the dividend goes to reduce the loss. It applies to cases where the loss is more than the dividend - Section 14A comes in when there is claim for deduction of an expenditure whereas Section 94(7) comes in when there is claim for allowance for the business loss. We may reiterate that one must keep in mind the conceptual difference between loss, expenditure, cost of acquisition, etc. while interpreting the scheme of the Act. - Para 12 of Accounting Standard AS-13 has no application to the facts of the present cases where units are bought at the ruling NAV with a right to receive dividend as and when declared in future and did not carry any vested right to claim dividends which had already accrued prior to the purchase.

7. (2012) 6 TaxCorp (A.T.) 27613 (DELHI)

Onus on AO to show expenditure incurred to earn tax-free income.

8. (2012) 6 TaxCorp (A.T.) 28301 (Mumbai)

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. “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.”

9. (2011) 5 TaxCorp (DT) 49842 (DELHI)

No S. 14A or Rule 8D Disallowance without showing how assessee’s calculation is wrong. Only real expenditure can be disallowed

The High Court had to consider two issues: (a) whether interest paid on funds borrowed to acquire “trading shares” is hit by s. 14A given that the profits there from are assessable to tax as “business profits” and the dividend is incidental and (b) whether Rule 8D has retrospective operation. HELD by the Court: 

i. The argument that if the dominant and main objective of the expenditure was not the earning of ‘exempt’ income then, the expenditure cannot be disallowed u/s 14A is not acceptable. The expression “in relation to” cannot be given a narrow meaning and simply means “in connection with” or “pertaining to”. If the expenditure has a relation or connection with or pertains to exempt income, it cannot be allowed as a deduction even if it otherwise qualifies under the other provisions of the Act;  

ii. The expression “expenditure incurred” in s. 14A refers to actual expenditure and not to some imagined expenditure. If no expenditure is incurred in relation to the exempt income, no disallowance can be made u/s 14A (Hero Cycles Ltd 323 ITR 518 referred). 

iii. The AO cannot proceed to determine the amount of expenditure incurred in relation to exempt income without recording a finding that he is not satisfied with the correctness of the claim of the assessee. This is a condition precedent. While rejecting the claim of the assessee with regard to the expenditure or no expenditure in relation to exempt income, the AO will have to indicate cogent reasons for the same; 

iv. Rule 8D comes into play only when the AO records a finding that he is not satisfied with the assessee’s method. Though s. 14A(2) & (3) were inserted w.e.f. 1.4.1962, Rule 8D was inserted on 24.03.2008. Accordingly, Rule 8D would operate prospectively. (Godrej and Boyce Mfg. Co. Ltd 328 ITR 81 (Bom) followed); 

v. For periods prior to Rule 8D, the AO will have to adopt a reasonable method on the basis of objective criteria to determine the expenditure. However, here also, he will have to show why he is not satisfied with the correctness of the assessee’s claim (argument that Rule 8D exceeds the mandate of s. 14A left open).

10. (2012) 6 TaxCorp (A.T.) 28302 (Delhi)

The assessee earned exempt income for AY 2008-09. The Assessing Officer (AO) disallowed Rs. 2.37 Crores u/s S. 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.

Held, that the disallowance u/s 14A read with Rule 8D could not exceed the actual expenditure incurred and debited in relation to exempt income. ITAT restricted the disallowance to the extent of expenditure actually claimed by the assessee.

11. (2011) 200 TAXMAN 154 (KERALA)

Can’t revise pre 2001 assessment orders to make disallowance u/s 14A. Proviso to S. 14A prohibiting reassessment and rectification also applicable to revision proceeding u/s 263 for AY prior to 2001; CIT(A) not entitled to pass enhancement order u/s 251(1)(a) in such cases.

12. (2010) 130 TTJ 388 (DELHI)

A Delhi bench of ITAT held that S. 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 S. 14A. Since, as per S. 44 no head-wise bifurcation of income was required to be made in case of insurance companies, S. 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.”

13. (2012) 6 TaxCorp (A.T.) 28303 (Kolkata)

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.

Held, that S. 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.

14. (2012) 6 TaxCorp (A.T.) 28299 (MUMBAI)

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’.

15. (2012) 6 TaxCorp (A.T.) 26417 (MUMBAI)

A Mumbai bench of ITAT held that S. 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.

16. (2012) 6 TaxCorp (DT) 51548 (KARNATAKA)

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

17. (2012) 6 TaxCorp (A.T.) 27575 (DELHI)

Section 14A of the Income-tax Act, 1961 - Expenditure incurred in relation to income not chargeable to tax - Assessment year 1999-2000 - Assessee filed return of income claiming deduction of interest paid on borrowed funds - Assessing Officer processed return under Section 143(1) - Thereafter he issued notice under Section 143(2) in order to verify claims made in return - Assessing Officer applied Section 14A and disallowed interest relatable to exempt income - Assessee contended that in view of proviso to Section 14A which prevent reopening of certain past cases, Assessing Officer was not empowered to apply Section 14A in this case to disallow claim of interest - Whether bar of proviso to Section 14A is applicable to reassessment or rectification proceedings and not to original assessment proceedings - Held, yes - Whether, therefore, Assessing Officer was justified in disallowing claim of interest under Section 14A - Held, yes

18. (2012) 6 TaxCorp (A.T.) 28295 (MUMBAI)

Disallowance u/s 14A cannot be made in every case involving exempt income; AO bound to "determine" expenses attributable to exempt income before making disallowance; AO to consider all surrounding circumstances.

19. (2012) 6 TaxCorp (A.T.) 28296 (MUMBAI)

Following  decision in Oriental Insurance Co [130 TTJ 388 (Del.) (Trib.)],  held that S. 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) .

20. (2011) 129 ITD 237 (MUMBAI)

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.

21. (2012) 6 TaxCorp (DT) 51386 (DELHI)

Section 14A of the Income-tax Act, 1961 - Expenditure incurred in relation to exempt income - Assessment year 2001-02 - During previous year relevant to assessment year 2001-02, assessee-company besides other income had also earned tax free dividend and interest income on shares held by it - Assessing Officer having found (i) that during previous year assessee had borrowed funds from three banks and claimed deduction of interest paid on same, and (ii) that assessee had invested a large sum of borrowed funds for purchase of aforesaid shares, held that interest paid on borrowed funds had a direct nexus with dividend and interest income earned - He, therefore, allocated interest expenses on basis of funds invested in shares at a certain amount and disallowed same under Section 14A - Whether since it was clear from record that shares in question resulting in tax free income had been purchased by assessee in earlier years, whereas bank loan was availed of in current year, Assessing Officer had wrongly disallowed a part of interest expenses under Section 14A - Held, yes

22. (2012) 6 TaxCorp (A.T.) 28304 (Ahmedabad)

The investment was made out of partners’ capital and accordingly, proportionate interest on partners’ capital was disallowable u/s 14A and 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.

23. (2012) 6 TaxCorp (A.T.) 28297 (Delhi)

S. 14A was applicable to co-operative society claiming S. 80(P) deduction. excluded from total income in view of loss. ITAT noted that S. 14A speaks of positive exclusion and not theoretical exclusion from total income.

24. (2012) 6 TaxCorp (A.T.) 28298 (MUMBAI)

Disallowance u/s 14A is not applicable to SEZ income, which is eligible for deduction u/s 10AA and 80IAB. ITAT held that S. 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.”

25. (2011) 5 TaxCorp (DT) 48924 (KERALA)

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 S. 14A.

26. (2012) 6 TaxCorp (DT) 51884 (KERALA)

Section 14A, read with Section 263, of the Income-tax Act, 1961 - Expenditure incurred in relation to income not chargeable to tax - Whether where assessment for any assessment year beginning on or before first day of April, 2001 has been concluded, to make Commissioner cannot be permitted to revise same under Section 263 as it is prohibited under proviso to Section 14A - Held, yes [In favour of assessee] Circulars & Notifications : Circular No. 11 of 2001, dated 23-7-2001

27. (2012) 6 TaxCorp (DT) 50002 (KERALA)

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.

28. (2012) 6 TaxCorp (A.T.) 28305 (Kolkata)

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. Disallowance u/s 14A could come into play only out of expenses incurred and claimed for deduction.

29. (2011) 5 TaxCorp (DT) 49868 (DELHI)

S. 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.

30. (2012) 6 TaxCorp (A.T.) 26984 (DELHI)

Section 14A of the Income-tax Act, 1961, read with rule 8D of the Income-tax Rules, 1962 - Expenditure incurred in relation to income not includible in total income - Assessment year 2008-09 - Whether earning of an income in a particular year is not a sine qua non for allowing an expenditure; and, thus, income may be 'nil', yet expenditure incurred in pursuit of earning such income is deductible - Held, yes - Whether similar proposition will apply while interpreting provision contained in Section 14A(1) - Held, yes - Whether, therefore, in absence of an income which is not includible in total income, provision of Section 14A can still be invoked to disallow expenditure relatable to income not includible in total income - Held, yes - Whether, however, there cannot be an assumption of some kind of in-built expenditure; some facts must be there on record to show that expenditure was actually incurred in relation to earning of exempt income - Held, yes - Assessee had made certain investments, income wherefrom was exempt - Assessing Officer disallowed expenditure incurred for earning said income under Section 14A - Assessee claimed that no expenditure had been incurred for earning exempt income - Commissioner (Appeals), however, upheld order of Assessing Officer on assumption that whenever exempt income is earning, there will be some expenditure incurred in relation thereto - Whether such an assumption by Commissioner (Appeals) could not form basis for making disallowance under rule 8D - Held, yes - Whether both Assessing Officer and Commissioner (Appeals) had not examined assessee's claim at all and had not followed provisions of Section 14A(1) - Held, yes - Whether, therefore, disallowance under Section 14A could not be upheld - Held, yes

31. (2012) 6 TaxCorp (A.T.) 26987 (DELHI)

Section 14A of the Income-tax Act, 1961 - Expenditure incurred in relation to income not included in total income - Assessment year 2008-09 - Whether actual earning of income is not sine qua non for deciding deduction of expenditure laid out or expended wholly or exclusively for purpose of earning such income - Held, yes - Whether, therefore where investment had been made in shares, which did not yield any dividend in year under consideration, expenditure incurred for earning income was deductible notwithstanding fact that no such income had been earned - Held, yes

32. (2011) 46 SOT 112 (CHENNAI) URO

Relying on the Special Bench ruling in (2009) 27 DTR 82 (DELHI) 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.

33. (2012) 6 TaxCorp (A.T.) 27083 (DELHI)

Even if the investment in shares did not yield any dividend in the year under consideration, the disallowance u/s 14A on the expenditure incurred for earning income was disallowable, notwithstanding the fact that no such income was earned.

34. (2012) 6 TaxCorp (A.T.) 27090 (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.

35. (2010) 33 DTR 140 (KERALA)

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 S.  14A.

36. (2012) 6 TaxCorp (A.T.) 26979 (KOLKATA)

Section 43(5) of the Income-tax Act, 1961 - Speculative transactions - Assessment year 2005-06 - Whether derivative instruments if not used as an hedging instrument, gain or loss on derivative instrument is required to be recognized as profit or loss in current earnings - Hed, yes - Assessee-company had debited in profit and loss account certain sum as loss on derivative trade - However, in computation of total income, assessee claimed such loss as short-term capital loss - Assessing Officer treated said loss as speculative loss in view of provision of Section 43(5)(d) read with Section 2(ae) of S. urity Control (Regulation) Act, 1956 - On appeal, Commissioner (Appeals) held that since assessee had shown income under head 'short-term capital gain' from its investment activity, derivative transaction was also to be treated as part of investment activity and, hence, Section 43(5) was not applicable - Whether since assessee was involved in day-to-day operation of share trading activity so as to keep a track of price trend, it could not be said that derivative transactions were part of investment portfolio of assessee - Held, yes - Whether where therefore, Assessing Officer rightly treated derivative transaction loss as being covered under head 'profit and gains of business or profession' and Section 43(5) was rightly applied - Held, yes [In favour of revenue]II. Section 194H of the Income-tax Act, 1961 - Deduction of tax at source - Commission or brokerage etc. - Assessment year 2005-06 - Whether deriviatives' are S. urities and, therefore, clearly covered by exception provided in Explanation (1) to Section 194H - Held, yes - Whether, therefore, tax at source is not deductible on payment of brokerage paid to an agency for facilitating derivatives trade - Held, yes [In favour of assessee]III. Section 14A of the Income-tax Act, 1961 - Expenditure incurred in relation to income not includible in total income - Assessment year 2005-06 - Whether where since proceeds of Keyman insurance policy are fully taxable under Section 28(vi), expenditure relating to same cannot come within ambit of Section 14A - Held, yes - [In favour of assessee]IV. Section 14A of the Income-tax Act, 1961 - Expenditure incurred in relation to income not includible in total income - Assessment year 2005-06 - Whether where it was not disputed that fund management fees paid had no nexus with earning of dividend, disallowance under Section 14A was not justified - Held, yes [In favour of assessee]V. Section 70 of the Income-tax Act, 1961 - Losses - Set off of from one source against income from another source under same head of income - Assessment year 2005-06 - Whether Section 70 nowhere provides that short-term capital loss arising from STT paid transactions can only be set off against short-term capital gain arising from STT paid transaction; only statutory requirement of Section 70 is that short-term capital loss can be set off only against income from short-term capital gain or long-term capital gain - Held, yes - Whether since no particular mode or manner of set off is provided in Act, Assessing Officer should adopt that chronological order or manner which is most beneficial to assessee - Held, yes

37. (2012) 6 TaxCorp (A.T.) 27173 (MUMBAI)

Section 14A of the Income-tax Act, 1961, read with rule 8D of the Income-tax Rules, 1962 - Expenditure incurred in relation to income not includible in total income - Assessment year 2007-08 - Assessee made investments in shares and S. urities on which dividend income was earned - Assessing Officer having applied rule 8D for computation of expenses disallowable under Section 14A, disallowed certain amount - Commissioner (Appeals) even though took a view that rule 8D had no application to assessee's case, yet he applied same formula by adopting it as a reasonable and fair basis for computing expenses disallowable under Section 14A - Whether in view of settled legal position that rule 8D of 1962 Rules has no application for assessment prior to assessment year 2008-09, impugned order passed by Commissioner (Appeals) was to be set aside - Held, yes - Whether, as a consequence, disallowance of direct costs and indirect costs made by assessee on his own, which remained undisputed, was to be accepted - Held, yes

38. (2012) 6 TaxCorp (A.T.) 27499 (AHMEDABAD)SB

S.14A disallowance is applicable to partners’ share in the firm’s profit, which is exempt u/s 10(2A). The profit from firm is not included in the total income of the partner by virtue of exemption provisions of S. 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.

39. (2011) 5 TaxCorp (DT) 48875 (KERALA)

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 S. 14A was clarificatory only. The main clause of Section 14A was applicable for all periods, which authorized the disallowance of the expenditure incurred for earning tax free income, irrespective of whether the assessee maintained separate accounts or not. However, with regard to administrative expenses, HC held that there was no precise formula for proportionate disallowance. Therefore, no disallowance was called for, for proportionate administrative cost attributable to earning of tax free income until Rule 8D came into force.

40. (2010) 6 ITR (A.T.) 686 (DELHI)

S. 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 a 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.”

41. (2012) 6 TaxCorp (A.T.) 27499 (AHMEDABAD)SB

Depreciation on a motor car was an allowance and not expenditure and hence, it could not be disallowed by invoking provisions of S. 14A. and upheld ITAT ruling in Hoshang D. Nanavati in which it was held that S. .14A was applicable only to the expenditure and not to any statutory allowance such as depreciation. Further, ITAT also noted that S. 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.

42. (2012) 6 TaxCorp (DT) 51449 (SC)

SC upheld Delhi HC decision allowing reopening of assessment for AY prior to AY 2000-01, despite the bar provided in proviso to S. 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 S. 14A. HC observed that the proviso prohibits reassessment but not original assessment based  on the  retrospective amendment. Thus,  the AO  ought to have  applied  S. 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.

43. (2011) 200 TAXMAN 154 (KERALA)

The proviso to S. 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).

44. (2011) 51 DTR 104 (KARNATAKA)

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 S. 14A in 2002 and thus, the said proviso was not applicable.

45. (2012) 143 TTJ 658 (CHENNAI)

A Majority of the Three-Member bench of Chennai ITAT held that the bar stated in proviso to S. 14A against reassessment did not operate in a case of first assessment. ITAT observed that the proviso to S. 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.

46. (2011) 5 TaxCorp (DT) 49727 (CALCUTTA)

S. 14A amendment by Finance Act, 2002 has retrospective application for pending assessments; Amended S. 14A also applicable for pending appeal before ITAT and HC; S. 14A disallowance upheld.

47. (2009) 28 DTR 215 (BOMBAY)

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 S. . 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 S. . 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.

48. (2011) 5 TaxCorp (A.T.) 24251 (DELHI)

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.

49. (2011) 5 TaxCorp (DT) 48975 (PUNJAB & HARYANA)

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.

50. (2011) 5 TaxCorp (A.T.) 25948 (DELHI)

Application of Rule 8D by the AO, to make disallowance u/s 14A without recording satisfaction regarding incorrectness of the assessee’s calculation, was not justified. ITAT observed, “Such satisfaction of the AO is a pre-requisite 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.

51. (2011) 5 TaxCorp (DT) 48875 (KERALA)

The assumption of the Assessing Officer, that the entire investment made by the assessee banks in bonds, shares and S. urities 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.

52. (2010) 130 TTJ 31 (MUMBAI)

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.

53. (2011) 55 DTR 177 (MUMBAI)

The disallowance for the interest expense u/s 14A should be calculated on ‘net interest’ debited to the profit and loss account and not on gross interest. ITAT observed, “There can be no dispute that since the 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.”

54. (2011) 5 TaxCorp (DT) 48644 (CALCUTTA)

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.

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Rupesh Srivastava

E.mail:  ropsrivastava@gmail.com, rupesh@thetaxcorp.com

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