S. 14A: Exempt Income Vs. Expenses For Exempt Income

CA Jyoti Gupta has considered the controversial question as to whether a disallowance under section 14A and Rule 8D can be made in respect of securities which are held by an assessee as stock-in-trade. She has referred to the latest judgements on the issue and explained the issue in the proper perspective

As could be discerned from the heading itself, vide this article we would be discussing the provisions of Sec.14A of the Income-tax Act.

The heading of Sec.14A, reads ‘Expenditure incurred in relation to income not includible in total income’.

Now the question which arises for consideration is, whether the provisions of Sec.14A would apply in cases where exempt income is earned or in cases where there are some expenses incurred for earning the exempt income.

Although Sec.14A is a Pandora’s box involving numerous issues, example, where the investments are strategic investments for business purpose, where no satisfaction is recorded, where owned funds are more than borrowed funds, etc. etc.

Also, it is been settled to an extent, with the judicial precedents like Cheminvest Ltd. Vs. CIT (Delhi HC), CIT Vs. Holcim India P. Ltd., that where no dividend income is earned, no disallowance can be made u/s 14A. However, vide this article, I would like to throw light on the issue: what if, if exempt income is earned, however the same is a passive income, which is earned without making any efforts, in such case provisions of Sec.14A would be attracted?

The point for discussion, vide this article is, ‘Dividend Income Earned On Stock In Trade’. This situation, would be most prone in the cases of assessees who are stock brokers and their business and profession is dealing in sale and purchase of shares and securities.

First, technically going with the language of Rule 8D(2)(ii) & (iii) which advocates a method to compute the disallowance of indirect expenses. The Rule uses the word ‘investment’, so apparently, when dividend income is earned from stock in trade no disallowance should be made, as stock in trade is not investment.

Second and most importantly, the practical situation is sometimes, that the shares were purchased as a part of business transaction, and by the time they are sold, some incidental dividend income is earned. Incidental because, the same is earned while assessee was indulged into business transactions and there was no intention as well as efforts to earn that income.

Now in such cases, the issue which arises is, is the intendment of Law, is to make the disallowance automatically in the cases where dividend income is earned, assuming that expenses would have been incurred, OR, to make disallowance only in cases where there could be some expenses attributable to earn the exempt income.

That is, the emphasis is to be laid on the exempt income, OR, expenses incurred for earning the exempt income, to attract the provisions of Sec.14A.

Recently, this issue has came before ITAT Kolkata, in case of Kalyani Barter P. Ltd. Vs. ITO, wherein the tribunal relying on the case of Dhanuka & Sons v. CIT [2011] 339 ITR 319, held that, provisions of Sec.14A are attracted in cases, where dividend income is earned from stock in trade, holding that, dividend income earned, is enough to attract the provisions of Sec.14A.

However, there are different views of courts in this regard, reference can be made to Vidyut Investment Ltd. Vs ITO (Del. ITAT); CCI Ltd. Vs JCIT (Kar. HC), in this case the High Court took just and pragmatic view holding that the brokerage was paid for getting shares for assessee’s business venture. The investment was not made for earning dividends. Dividends were incidental incomes on the shares remaining unsold constituting the assessee’s stock-in-trade. There could be no case for disallowing a portion of the brokerage paid which was entirely in the context of business activities and not for acquiring shares for earning dividend income. Hence, provisions of Sec.14A are not attracted.

As I started with the word, Sec.14A is a Pandora’s box, in light of above varying judicial precedents, one would acknowledge the fact that, provisions of sec.14A read with Rule 8D, are made, to lay down a machinery provisions to disallow the expenses which would have been incurred for earning exempt income and not merely in the cases where dividend income is earned.