Disallowance u/s 14A irrespective of Exempt Income earned or not during the relevant FY

There was controversy that whether disallowance can be made invoking section14A of the Act even in those cases where no income has been earned by an assessee which has been claimed as exempt during the financial-year.

Now CBDT issued the clarification that the disallowance of expenses by invoking section 14A shall be made irrespective of the fact that exempt income has been earned or not during the relevant financial year.

Refer circular 


Circular no. 05/2014  dated 11-02-2014

Clarification regarding disallowance of expenses under section 14A of the Income-tax Act in cases where corresponding exempt income has not been earned during the FY -regarding.

 1. Section 14A of the Income-tax Act, 1961. (‘Act’)  provides for disallowance of expenditure in relation to income not “includible” in total income.

2. A controversy has arisen in certain cases as to whether disallowance can be made by invoking section 14A of the Act even in those cases where no income has been earned by an assessee which has been claimed as exempt during the financial-year.

3.    The matter has been examined in the Board. It is pertinent to mention that section 14A of the Act was introduced by the Finance Act, 2001 with retrospective effect from 01.04.1962.The Purpose of introduction of section 14A with retrospective effect since  inception of the Act was clarified vide circular No. 14 of 2001 as under:

 “Certain   incomes are not includible while computing the total income, as these are exempt under various provisions of the Act There have been cases where deductions have been claimed in respect of such exempt income. This in effect means that the tax incentives given by way of exemptions to certain categories of income is being used to reduce also the tax payable on the no-exempt income by debiting the expenses incurred to earn the exempt income against taxable income. This is against the basic principles of taxation whereby only the net income, i.e, gross income minus the expenditure, is taxed. On the same analogy, the exemption is also in respect of the net income. Expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income”.

 Thus, legislative intent is to allow only that expenditure which is relatable to  earning of income and it therefore  follows that the expenses which are relatable to earnings of exempt income have to be considered for disallowance, irrespective of the fact whether any such income has been earned during the financial year or not .

4.The above position is further clarified by the usage of term ‘includible’ in the Heading to Section 14A of the act and also the heading to the Rule 8D of I.T Rules, 1962 which indicates that it is not necessary that exempt income  should necessarily be included in a particular year’s income, for disallowance to be triggered . Also section 14A of the Act does not use the word “income of the year” but” income under the Act”.  This also indicates that for invoking disallowance under section 14A, it is not material that assessee should have earned such exempt income during the financial year under consideration.

5. The above position is further substantiated by the language used in Rule 8D (2)(ii) & 8D (2)(iii) Of I.T Rules which are extracted below:

“(ii) in a case where the assessee has incurrened expenditure by way of  interest during the previous year which is not directly attributable to any particular income or receipt an amount computed in accordance with  following formula, namely :

 A*B/C

Where

 B= the average of value of investment income from  which does not or shall not form part of total income, as appearing in the balance sheet of assessee, on the first day and the last day of previous year

………………..

(iii) ) an amount equal to one-half percent of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day or the last day of the previous year”.

(Emphasis added)

6.         Thus,  in the light of above, Central Board of Direct Taxes, in exercise of its power under section 119 of the Act hereby clarifies that Rule 8D read with section 14A of the Act provides disallowance of the expenditure even where taxpayer in a particular year has not earned any exempt income.

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