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In clause 17l of Form 3CD expenditure incurred for earning any exempt income is disallowed. In this regard i want to confirm:
1.Whether expenditure (either direct or computed byRule 8d) shall be disallowed even if no exempt income accrued in p/y -
CBDT Circular No.14 of 2001 and judicial pronouncements support that there cannot be any disallowance when income is not exempt from tax. (Case Laws : Cheminvest Ltd. vs. ITO (2009) 121 ITD 318 (Del)(SB) (A.Y. 2004-05))
The case of investment on which exempt income is capable of being earned – though not actually earned (eg. Nil dividend in a given year) stands on a different footing. Such investment has potential to give rise to exempt income. S.14A can be invoked in such cases.
However, there can be no disallowance when an investment does not at all have potential to give rise to exempt income (eg. interest free loan).
2. As per Rule 8d if expenditure has not directly attributed to income, then disallowed expenditure shall be
(Interest expense*Avg Investment / Avg Assets) + (0.5%*Avg Investment)
Is the above formula correct..??
You must not add both the above formulas, if not it is correct.
3. Interest expense in the above formula is total interest income on borrowed fund even if loan has not been taken for the purpose of investment. Is it correct
Loan even if not taken for the purpose of Investment, then too there is an exposure where the tax authorities would hold that the loan is used for investment purpose as the section uses the word “in relation to”. Thus indirect nexus is also covered, however, if the expenditure is directly related to some other identifiable source of income, it will not be considered to be indirectly relatable to the exempt source of income. (e.g. Expenses incurred in operating production facility is directly related to manufacturing operations and does not require reckoning under S.14A)
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