Know Section 14A of the Income Tax Act with Case Laws

Last Updated at: December 24, 2019
906
Know section 14A of the Income Tax Act with case laws

In India, the Income Tax Act 14A has some provisions where certain income is not taxable like dividends earned from equities, revenue from agricultural activities. This section is about expenses pertaining to earning of exempt income. Let’s see in detail.

Section 14A:

As per Section 14A of the Indian Income Tax Act, any expenditure incurred on earning an income that is already exempt and excludes the total revenue while computing the total income of the taxpayer should not be considered as a deduction.

Section 14A of the Income Tax Act was introduced in the Finance Act, 2001 with retrospective effect from 01 April 1962 to disallow deduction with respect to the expenditure incurred by the taxpayer concerning income which does not form part of the total income under this Act.

View of Different Parties and Conflict

However, there has always been a conflict between the taxpayers and the income tax authorities on whether to allow the expenditure earned on exempted income or not for tax computation. There has also been a different take on this section by the Honourable Supreme court as well, where the Court had held that where there was one unified business that gave rise to the expenditure and income, payment will be considered for tax computation. Judgment in two cases, i.e., CIT v. Indian Bank Ltd., (56 ITR 77) in 1964 and CIT v. Maharashtra Sugar Mills Ltd., (82 ITR 452) were passed by the Supreme Court.

Get free legal advice now

Can the Expenditure be allowed for Deductions?

They added this provision in Sec 14A, stating that the Assessing Officer (AO) is not empowered to take action under Section 147 to reassess or pass the rectification order under section 154 for the assessment year 2001-02 or any earlier year to disallow any expenditure by applying this section.

Allocating Expenditure

The introduction of this Act has also introduced the method of allocating expenditure to exempt income. This was included in Rule 8D of the income tax rules, 1962. However, this rule 8D was amended on 02 June 2016 to provide for a revised method to allocate the expenditure to exempt income.

What is Rule 8D of Section 14A?

As mentioned above, Rule 8D was introduced to pen down the method of determining the expenditure incurred concerning earning exempt income. There are two parts:

Rule 8D (1) 

Rule 8D (1) Lists down the rules for the assessment officer, where he is not satisfied with the following with regards to the accounts of the assesse of the previous year.

Where the claim of expenditure made by the assessee is not correct or where the assessee claims that no cost has been incurred. The assessment officer shall consider the amount of expenditure with the income, which is not part of the total income under the Act for such previous year in line with the provisions of sub-rule (2).

Rule 8D (2) lists down the nature of amounts put together that are determined to compute the expenditure incurred in earning the income, which does not form part of the total revenue. These are as follows:

  • Any amount of cost that directly relates to income which does not form part of the total income
  • Any income arising by calculating one per cent of the annual average of the monthly average of the opening and closing balances of the value of the investment does not or shall not form a part of the total income.

Note: Both the above amounts to be considered should not exceed the total expenditure claimed by the assessee.                                

Interpretation 

It has also been observed that over the years, the interpretation of Section 14A has changed with the times and has been controversial to the extent that these controversies constitute a substantial portion of tax litigation in today’s time. Some of the noticeable recent decisions of the Honourable Supreme Court in matters of the tax computation as per Section 14A are mentioned below:

Maxopp Investment Ltd vs. CIT – In this case, the Supreme Court took cognizance under the circumstance of applicability of section 14A in situations where shares are conducted to gain a controlling interest in group companies as stock-in-trade. Here the intention while making such investment or the dominant purpose is not relevant while determining the disallowance. It also held that the expenses incurred in earning dividends have to be apportioned appropriately and disallowed as Section 10(34) of the Act exempts dividend income made when shares are held in stock as stock-in-trade.

CIT v/s. Essar Teleholdings Ltd. – Here the prospective or retrospective operation of Rule 8D was in question, and the honourable Supreme Court held that Rule 8D was intended to operate prospectively and cannot be applied for Assessment Years before AY 2008-09.

Godrej & Boyce Manufacturing Company Ltd. v/s. DCIT – herein, the applicability of disallowance under section 14A was questioned for dividend income, which is taxable under section 115-O, the Court held that it is the liability of the dividend-paying company to pay the tax under section 115-O. Section 14A would apply on a dividend of such income, and the shareholder/assessee has no connection with the same.

These are a few cases, and the significant issues arising around Section 14A litigation are:
  • Its application to investments capable of yielding taxable income.
  • Application to the investment made to purchase shares held as stock-in-trade.
  • Application of Section 14A in disallowance for a sum lower than the one calculated basis Rule 8D.
  • Implementation of the section in disallowance of interest in case of Owned funds v/s borrowed funds.

 

2+

Know Section 14A of the Income Tax Act with Case Laws

906

In India, the Income Tax Act 14A has some provisions where certain income is not taxable like dividends earned from equities, revenue from agricultural activities. This section is about expenses pertaining to earning of exempt income. Let’s see in detail.

Section 14A:

As per Section 14A of the Indian Income Tax Act, any expenditure incurred on earning an income that is already exempt and excludes the total revenue while computing the total income of the taxpayer should not be considered as a deduction.

Section 14A of the Income Tax Act was introduced in the Finance Act, 2001 with retrospective effect from 01 April 1962 to disallow deduction with respect to the expenditure incurred by the taxpayer concerning income which does not form part of the total income under this Act.

View of Different Parties and Conflict

However, there has always been a conflict between the taxpayers and the income tax authorities on whether to allow the expenditure earned on exempted income or not for tax computation. There has also been a different take on this section by the Honourable Supreme court as well, where the Court had held that where there was one unified business that gave rise to the expenditure and income, payment will be considered for tax computation. Judgment in two cases, i.e., CIT v. Indian Bank Ltd., (56 ITR 77) in 1964 and CIT v. Maharashtra Sugar Mills Ltd., (82 ITR 452) were passed by the Supreme Court.

Get free legal advice now

Can the Expenditure be allowed for Deductions?

They added this provision in Sec 14A, stating that the Assessing Officer (AO) is not empowered to take action under Section 147 to reassess or pass the rectification order under section 154 for the assessment year 2001-02 or any earlier year to disallow any expenditure by applying this section.

Allocating Expenditure

The introduction of this Act has also introduced the method of allocating expenditure to exempt income. This was included in Rule 8D of the income tax rules, 1962. However, this rule 8D was amended on 02 June 2016 to provide for a revised method to allocate the expenditure to exempt income.

What is Rule 8D of Section 14A?

As mentioned above, Rule 8D was introduced to pen down the method of determining the expenditure incurred concerning earning exempt income. There are two parts:

Rule 8D (1) 

Rule 8D (1) Lists down the rules for the assessment officer, where he is not satisfied with the following with regards to the accounts of the assesse of the previous year.

Where the claim of expenditure made by the assessee is not correct or where the assessee claims that no cost has been incurred. The assessment officer shall consider the amount of expenditure with the income, which is not part of the total income under the Act for such previous year in line with the provisions of sub-rule (2).

Rule 8D (2) lists down the nature of amounts put together that are determined to compute the expenditure incurred in earning the income, which does not form part of the total revenue. These are as follows:

  • Any amount of cost that directly relates to income which does not form part of the total income
  • Any income arising by calculating one per cent of the annual average of the monthly average of the opening and closing balances of the value of the investment does not or shall not form a part of the total income.

Note: Both the above amounts to be considered should not exceed the total expenditure claimed by the assessee.                                

Interpretation 

It has also been observed that over the years, the interpretation of Section 14A has changed with the times and has been controversial to the extent that these controversies constitute a substantial portion of tax litigation in today’s time. Some of the noticeable recent decisions of the Honourable Supreme Court in matters of the tax computation as per Section 14A are mentioned below:

Maxopp Investment Ltd vs. CIT – In this case, the Supreme Court took cognizance under the circumstance of applicability of section 14A in situations where shares are conducted to gain a controlling interest in group companies as stock-in-trade. Here the intention while making such investment or the dominant purpose is not relevant while determining the disallowance. It also held that the expenses incurred in earning dividends have to be apportioned appropriately and disallowed as Section 10(34) of the Act exempts dividend income made when shares are held in stock as stock-in-trade.

CIT v/s. Essar Teleholdings Ltd. – Here the prospective or retrospective operation of Rule 8D was in question, and the honourable Supreme Court held that Rule 8D was intended to operate prospectively and cannot be applied for Assessment Years before AY 2008-09.

Godrej & Boyce Manufacturing Company Ltd. v/s. DCIT – herein, the applicability of disallowance under section 14A was questioned for dividend income, which is taxable under section 115-O, the Court held that it is the liability of the dividend-paying company to pay the tax under section 115-O. Section 14A would apply on a dividend of such income, and the shareholder/assessee has no connection with the same.

These are a few cases, and the significant issues arising around Section 14A litigation are:
  • Its application to investments capable of yielding taxable income.
  • Application to the investment made to purchase shares held as stock-in-trade.
  • Application of Section 14A in disallowance for a sum lower than the one calculated basis Rule 8D.
  • Implementation of the section in disallowance of interest in case of Owned funds v/s borrowed funds.

 

2+

FAQs

No FAQs found

Add a Question


No Record Found
SHARE
Senior Executive - Content in Vakilsearch | Former TEDxSKCET Licensee | Content Marketing | Psychology | Engineering (IT) | Google Developers Group (GDG) co-organizer | WTM Ambassador