Complete Guide To The Law Of Disallowance U/s 14A And Rule 8D

1. Introduction – Legislative history of section 14A

Section 14A of the Income-tax Act, 1961 (the “Act”) was Legislature’s response to a host of judicial decisions which did not differentiate between expenditure incurred for earning taxable income and for earning exempt income for the purpose of allowability of expenditure as deduction. To overcome the Supreme Court decision in the case of Rajasthan State Warehousing Corporation v. CIT [2000] 242 ITR 450 (SC) wherein it was held that in case of an indivisible business, some income wherefrom is taxable while some exempt, entire expenditure would be permissible deduction and the principle of apportionment would apply only for an indivisible business.

As a result of these decisions, section 14A was enacted vide Finance Act, 2001 w.r.e.f. 1-4-1962, so thatnet taxable income is actually taxed and no deduction is allowed against taxable income for expenditure incurred in earning exempt income. As per the Memorandum Explaining Provisions of Finance Bill, 2001, “expenses incurred can be allowed only to the extent they are relatable to the earning of taxable income.”- [2001] 248 ITR (St.) 162, 196.

Sub-sections (2) and (3) of this section were introduced later which along with Rule 8D of the Income-tax Rules, 1962 (the “Rules”), prescribe a method of determining expenditure incurred for earning exempt income.

The constitutional validity of the provisions and that of Rule 8D has been upheld by the Bombay High Court in the case of Godrej & Boyce Mfg. Co. Limited v. CIT [2010] 328 ITR 81 (Bom.) (HC) observing that Rule 8D is applicable w.e.f Assessment Year (AY) 2008-09 and subsequent years. A special leave petition against this judgment of the Bombay High Court is admitted and pending for final hearing before the Supreme Court in Appeal Civil No. 7019/2011.

2. Basic issues and controversies

In practice, it would not be uncommon to see a situation arise where no incremental expenditure has been incurred for earning exempt income or where the amount of expenditure that is actually incurred would not have been any lesser than is even inabsence of exempt income. In such a situation, the application of rigours of section 14A may seem harsh and unjustified.

While on one hand, the kind of controversies and problems arising out of section 14A seem to have become more complex, on the other, even the most basic issues keep coming up time and again. The following are some of such basic controversies:

2.1 Non-recording of satisfaction of the Assessing Officer – Mechanical application of Rule 8D

A plain reading of the provisions of section 14A(2)/ (3)suggests that the disallowance can be made only if the Assessing Officer is satisfied that the amount claimed by the assessees incurred for earning exempt income is not correct. Furthermore, such satisfaction is to be arrived at from the accounts of the assessee. This position is also clear from the Memorandum explaining provisions of Finance Bill, 2006 – [2006] 281 ITR (St.) 178, 190.

The following are some important decisions wherein the above proposition was laid down:

• Maxopp Investment Ltd. &Ors. v. CIT [2011] 347 ITR 272 (Del.) (HC) – The requirement of the AO embarking upon a determination of the amount of expenditure incurred in relation to exempt income would be triggered only if AO returns a finding that he is not satisfied with the correctness of the claim of the assessee in respect of such expenditure [AY 1998-99 to 2005-06];

A similar view was also taken in the following cases by the Income-tax Appellate Tribunal (the “Tribunal”/ ITAT):

• CIT v. Hero Management Service Ltd. [2014] 360 ITR 68 (Del.) (HC) [AY 2007-08];
• Kodak India Pvt. Ltd. v. ACIT[2013] 155 TTJ 697 (Mum.)(Trib.)[AY 2008-09];
• JK Investors (Bombay) Limited (Mum.) (Trib.) (www.itatonline.org) [AY 2008-09];
• Auchtel Products Limited v. ACIT[2012] 52 SOT 39 (Mum.) (Trib.) [AY 2003-04, 2007-08, 2008-09];
• Priya Exhibitors Pvt. Ltd. v. ACIT [2012] 54 SOT 356 (Del.) (Trib.) [AY 2008-09];
• DCIT v. REI Agro Ltd. (Kol.)(Trib.)(www.itatonline.org)[AY 2009-10]. This decision has been upheld by the Calcutta High Court in GA 3022 of 2013 dated 23/12/2013 (www.itatonline.org);
• ACITv. Iqbal M. Chagla (Mum.) (Trib.) (www.itatonline.org) [AY 2009-10].

2.2Assessing Officer to show how Assessee’s computation is incorrect

In many cases, assessees offer a suo motu sum as disallowance u/s 14A. The principles of natural justice require that the Assessing Officer to first show how such computation is incorrect before proceeding tore-compute the disallowance. Such a view has been taken in the following cases:

• Kalyani Steels Ltd. v. Addtl. CIT (Pune) (Trib.)(www.itatonline.org)[AY 2008-09];
• Priya Exhibitors Pvt. Ltd v. ACIT[2012] 54 SOT 356 (Del.) (Trib.) [AY 2008-09].

Therefore, it becomes imperative on the Assessing Officer to first show how the suo motu disallowance, if any, offered or the claim that no expenditure is incurred for earning exempt income is incorrect and to record satisfaction as regards incorrectness of the claim of the assessee. If the same is not done, assessees would be well advised to mention this in the Statement of Facts and take specific grounds in the Grounds of Appeal to be filed before the First Appellate Authority, if they prefer an appeal.

2.3Expenditure must be claimed as deduction

Section 14A is a “disallowance” provision and not an “addition” provision. This means before invoking it, the impugned expenditure must be claimed as deduction in the first place. This is based on the simple proposition that what has not been claimed as deduction cannot be disallowed. A similar view was taken in the following case:

• CIT v. Hero Cycles Ltd. [2010] 323 ITR 518 (P&H) (HC) – Where it is found that for earning exempted income no expenditure has been incurred, disallowance u/s 14A cannot stand [AY 2004-05];
• Modern Info Technology P. Ltd. v. ITO (Del.)(Trib.)(www.itatonline.org) [AY 2009-10];
• Relaxo Footwears Ltd. v. ACIT[2012] 50 SOT 102 (Del.)(Trib.) [AY 2008-09].

As a corollary to this proposition, the disallowance computed in accordance with Rule 8D cannot also exceed the total expenditure claimed as deduction, as was held in the case of:

• Iqbal M. Chagla (supra) – Disallowance of Rs. 16.35 lakhs as against expenditure of Rs. 13 lakhs claimed by the assessee in P&L account is not justified. 

2.4 Nexus of expenditure with exempt income

In the following decisions, it was held that there should be a proximate relationship between the expenditure and exempt income:

• CIT v. Hero Cycles Ltd. (supra) – In the absence of nexus ofexpenditure incurred and the income generated, disallowance cannot be made [AY 2004-05];
• Justice Sam P. Bharucha v. Addtl. CIT [2012] 53 SOT 192 (Mum.) (Trib.) (URO) [AY 2008-09];
• DCIT v. Allied Investments Housing P Ltd.(Chennai)(Trib.) (www.itatonline.org) [AY 2009-10]

3. Recent issues andcontroversies in section 14A

The law on section 14A has evolved over the last 14 years and complex issues have arisen out of its application. Following are some of the recent issues that have arisen in this provision:

3.1 Disallowance in absence of exempt income

The intention of section 14A is to disallow expenditure incurred in relation to income which does not form part of total income (i.e. exempt income). Therefore, it seems only logical that unless there is exempt income in a particular year, section 14A should not trigger for that year. However, the Delhi Special Bench of the Tribunal, in Cheminvest Ltd. v. ITO [2009] 121 ITD 318 (Del.) (Trib.) (SB), took a view that when the expenditure is incurred in relation to exempt income, it has to suffer disallowance irrespective of the fact whether any exempt income is earned by the assessee or not. This also prompted the Board to issue a Circular no. 5/2014 dated 11/02/2014 reiterating the view of the Special Bench.

However, subsequently, in the following cases, various High Courts have taken a view that unless there is exempt income in a year, no disallowance u/s 14A can be made for that year:

• CIT v. Lakhani Marketing, ITA No. 970/2008 (www.itatonline.org) (P&H)(HC);
• CIT v. Shivam Motors (P) Ltd., ITA No. 88/2014 (www.itatonline.org) (All.)(HC);
• CIT v. Cortech Energy Pvt. Ltd., TA No. 239 of 2014 (www.itatonline.org) (Guj.) (HC);
• CIT v. Delite Enterprises, ITA No. 110/2009(www.itatonline.org)(Bom.)(HC).

Following the above High Court decisions, the Chennai bench of the Tribunal in ACITv. M. Baskaran (Chennai) (Trib.) (www.itatonline.org) held that the Delhi Special Bench decision of Cheminvest Ltd. (supra) and Circular no. 5/2014 dated 11/02/2014 (supra) are no more good law.

Thus, the current legal position is that no disallowance u/s 14A should be made for a year in the absence of exempt income.

3.2 Applicability to income for which deductions available under Chapter VI-A/ profit-linked exemption provisions

Allowability of expenditure incurred for earning income for which deductions are available under Chapter VI-A by virtue of which no tax is payable (either in whole or in part) on them is discussed, among others, in the following cases:

• Punjab State Co-operative Milk Producer Federation Ltd. v. ITO [2007] 104 ITD 408 (Chd.) (Trib.) – Section 14A is applicable even in respect of the incomes which are excluded from total income by virtue of deductions under Chapter VI-A [AY 2002-03].

Contrary view

• Infosys Technologies Ltd. v. JCIT [2007] 109 TTJ 631 (Bang.) (Trib.) – Section 14A would not be applicable to a deduction u/s 80G as it is limited in its operation to Chapter IV only whereas deduction u/s 80G falls under Chapter VI-A and donation made does not constitute expenditure [AY 1998-99];
• ACITv. Tamil Nadu Silk Producers Federation Ltd. [2007] 105 ITD 623 (Chennai)(Trib.) [AY 1996-97, 1997-98 and 1999-2000].

In our opinion, the decision of Bangalore Tribunal and Chennai Tribunal is better view because albeit in both situations (i.e. exempt income and income deductible under Chapter VI-A), the assessee would not have to pay tax, one of the fundamental differences between exempt income and income for which deduction is available under Chapter VI-A is that while the former type of income does not even enter the computation, the latter income enters the computation but is deductible under special provisions and section 14A deals only with the former type of income. Such a view is supported by the following decisions:

• CIT v. King Exports [2009] 319 ITR 100 (P&H) (HC);
• CIT v. KRIBHCO [2012] 349 ITR 618 (Del.) (HC)

3.3Applicability to shares held as stock-in-trade

Shares in a company can be held either as capital assets (i.e. as investment) or as stock-in-trade. If the same are held as stock-in-trade, their sale is not exempt from tax. The only exempt income from such shares can be in the form of dividend.

In the latest case of D. H. Securities Pvt. Ltd. v. DCIT [2014] 146ITD1 (Mum.) (TM), the Third Member bench of the Tribunal held that section 14A r.w. Rule 8D disallowance can be made in respect of tax-free securities held as stock-in-trade. This view was taken following the decisions in ITO v. Daga Capital Management (P) Ltd. [2009] 117 ITD 169 (Mum.) (SB). The Bombay High Court has admitted an appeal against the Special Bench decision in case of Daga Capital Management (P) Ltd. (supra) vide order dated 1/7/2009 in Income Tax Appeal No. 989 of 2009 while the appeal against the decision in D. H. Securities Pvt. Ltd. (supra) is pending admission before the Bombay High Court in ITXA/1233/2014.

However, in the case of DCIT v. Damani Estates & Finance Pvt. Ltd [2014] 41 taxmann.com 462 (Mum.) (Trib.), since share trading was found to be the dominant objective of the assessee and shares were held as stock-in-trade, disallowance of interest was restricted to 20% of the amount computed u/R 8D(2)(ii).

3.3.1 Authors’ views

The Tribunal, in D. H. Securities Pvt. Ltd. (supra) followed the jurisdictional High Court in the case of Godrej & Boyce Mfg. Co. Limited (supra) while coming to the conclusion that section 14A is applicable to shares held as stock-in-trade as well. However, this was not the issue before the jurisdictional High Court. A judgement ought to be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before the Court [CIT v. Sun Engineering Works (P) Ltd. [1992] 198 ITR 297 (SC)]

In view of the decisions of non-jurisdictional High Courts {CCI Ltd. v. JCIT [2012] 206 Taxman 563 (Kar.) (HC) & CIT v. Smt. Leena Ramachandran [2011] 339 ITR 293 (Ker.) (HC)} on the issue, the same ought to have been followed as was done in the following cases {See: Nanubhai D. Desai v. ACIT [2014] 104 DTR 1 (Ahm.) (Trib.) (SB)}:

• DCIT v. M/s India Advantage Securities Ltd. (Mum.) (Trib.) (www.itatonline.org) [AY 2008-09];
• Vivek Mehrotra v. ACIT(Mum.) (Trib.) (www.itatonline.org) [AY 2008-09].

Considering that this issue is affecting a large number of assessees, it is desirable that the Bombay High Court decides the appeal in case of Daga Capital Management (P) Ltd. (supra) at the earliest to bring some certainty on the issue.

3.4Investment in shares of foreign companies

Dividend received on shares held in foreign companies is not exempt from tax in India as such companies are not required to pay dividend distribution tax in accordance with section 115-O. Also, the profit/ gain on their sale are also not exempt from tax u/s 10. Thus, such shares (whether held as investment or stock-in-trade) neither earn nor are capable of earning exempt income for the holder. Therefore, section 14A should not apply in such cases as was held in the following cases:

• CIT v. Suzlon Energy Ltd. [2013] 354 ITR 630(Guj.) (HC)
• Birla Group Holdings Ltd. v. DCIT [2007] 13 SOT 642 (Mum.) (Trib.)
• ITOv. Strides Acrolab Ltd. [2012] 138 ITD 323 (Mum.) (Trib.)

Similarly, dividend on preference shares is also taxable. Hence, interest incurred for making investment in preference shares is also allowable –ACITv. Tellicherry Co-op Hospital Society Ltd., ITA No. 404/Coch/2013, dated 4/4/2014 (Coch.) ITAT) [AY 2008-09].

3.5Investment in mutual funds or in short term investments

Sundaram Asset Management Co. Ltd. v. DCIT [2013] 145 ITD 17 (Chennai) (Trib.) – Held, some of the investments made by the assessee are short term. Since assessee was paying capital gains tax on short term investments, Rule 8D will not apply on them and the AO was directed to recompute disallowance u/s 14A read with Rule 8D after excluding short term investments [AY 2008-09].

As regards units in a mutual fund, they are normally held as investment and not stock-in-trade. Whether the provisions of section 14A can be applied in such cases would depend on the nature of mutual fund units. In case of investment in liquid fund or debt fund mutual funds, since both the gains from sale and dividend are taxable, section 14A should not be applicable.

3.6Considering only those investments which derive exempt income

Sarabhai Holdings Pvt. Ltd. v. ACIT, ITA No. 2328/Ahd/2012, dated 11/4/2014 (Ahd.)(Trib.)–Only average of value of investment from which exempt income has been earned is to be considered and not total investment at beginning of year and at end of year in disallowing administrative expenses [AY 2009-10].

3.7Investment due to commercial expediency – whether a relevant factor

EIH Associated Hotels Ltd. v. DCIT (Chennai)(Trib.) (www.itatonline.org) – Investments made by the assessee in the subsidiary company were not on account of investment for earning capital gains or dividend income. Such investments had been made by the assessee to promote subsidiary company into the hotel industry and were on account of business expediency and dividend therefrom is purely incidental. Therefore, the investment made by the assessee in its subsidiary is not to be reckoned for disallowance u/s 14A r.w.r. 8D [AY 2008-09].

Other decisions on the issue: CIT v. Oriental Structural Engineers Pvt. Ltd. (Del.) (HC) (www.itatonline.org), JM Financial Ltd. v. ACIT (Mum.) (Trib.)(www.itatonline.org) [AY 2009-10].

3.8Investment in subsidiary and for acquiring controlling interest/ strategic investment

Interglobe Enterprises Ltd. v. DCIT(Del.)(Trib.)(www.itatonline.org) [AY 2008-09 & 2009-10] – Assessee had utilized interest free funds for making fresh investments and that too into its subsidiaries which were not for the purpose of earning exempt income but for strategic purposes only. No disallowance of interest is required to be made under rule 8D (i) & 8D (ii) as no direct or indirect interest expenditure has incurred for making investments. Strategic investment has to be excluded for the purpose of arriving at disallowance under Rule 8D (iii).

Other favourable decisions on the issue: Garware Wall Ropes Ltd. v. ACIT(Mum.)(Trib.)(www.itatonline.org) [AY 2009-10].

3.9Applicability to profit share from partnership firm

Share in partnership firm is exempt from tax u/s 10(2A). Therefore, expenditure incurred for earning such exempt income may be disallowed as deduction.In the following decision,among others, this view was taken:

• Vishnu Anant Mahajan v. ACIT[2012] 137 ITD 189 (Ahd.) (SB) – Any expenditure incurred in earning the share income will have to be disallowed [AY 2006-07].

The contrary decisions on the issue viz., Shri Sudhir Kapadia v. ITO and Hitesh D. Gajaria v. ACIT are no more good law on this issue.

3.10Whether net interest can be considered for computing disallowance under

Rule 8D(2)(ii)

ITO v. Karnavati Petrochem Pvt. Ltd.(Ahm.)(Trib.) (www.itatonline.org) – As the interest income was more than interest expense and the assessee was having net positive interest income, the interest expenditure cannot be considered for disallowance u/s 14A and Rule 8D [AY 2008-09].

Sitsons India (P) Ltd. v. ACIT [2014] 63 SOT 37 (Mum.)(Trib.) (URO) – On facts, the interest income was held tobe received from bank deposit, while interest payment is made to directors and not against any bank loan. Hence, in the absence of any nexus, the contention of netting off interest was rejected [AY 2008-09].

4. Other complex issues

4.1 Section 14A and presumptive taxation

4.1.1 Tonnage tax scheme

Varun Shipping Company Ltd. v. ACIT[2012] 134 ITD 339 (Mum.) (Trib.) –When income of the assessee from the business of operating ships is computed as per the special provisions of Chapter XII-G, any expenditure other than the expenditure incurred for the purpose of the said business cannot be said to have been allowed and consequently no addition to income so computed can be made by way of disallowance u/s 14A on account of expenditure incurred by the assessee in relation to earning of exempt dividend income.If at all the assessee has claimed any such expenditure in computation of profits of business of shipping, the same are to be taken as disallowed when the income of the said business is finally computed in accordance with the provisions of Chapter XII-G and no separate disallowance on account of such expenditure u/s 14A can be made [AY 2008-09].

4.1.2 Insurance business

Oriental Insurance Co. Ltd. v. ACIT[2010] 130 TTJ 388 (Del.) (Trib.) – In case of an insurance company, it is not permissible to the AO to travel beyond section 44 and Schedule I and make disallowance by applying section 14A.

4.1.3 Authors’ views

In our view, this analogy can also be applied when an assessee offers income u/s 44AD, 44AE and 44AF.

4.2 Interest capitalised and not claimed as deduction

When interest cost is capitalised and not claimed as deduction, same cannot be considered for disallowance u/s 14A – ITO v. M/s Arihant Advertising Pvt. Ltd, ITA No. 2750/Del/2011, dated 21/9/2012 (Del.)(Trib.)[AY 2007-08].

4.3 Power of enhancement when the matter is set aside by the Tribunal to the file of the Assessing Officer

While the First Appellate Authority has the power of enhancement, the Tribunal does not have such powers {See Mcorp Global (P) Ltd. v. CIT [2009] 309 ITR 434 (SC)}. Therefore, once a matter has been set aside by the Tribunal to the Assessing Officer, the assessee cannot be put in a worse off situation than he was earlier – Kellogg India Pvt. Ltd. v. ACIT (Mum.) (Trib.) (www.itatonline.org).

Thus, once a matter is set aside by the tribunal to the file of the Assessing Officer for redeterminationof the amount of disallowance u/s 14A, the Assessing Officer has no power of enhancement.

4.4 Can a method other than the one prescribed under Rule 8D be adopted if the same results in better estimation of expenditure incurred for earning exempt income

The objective of section 14A and Rule 8D are that net income is actually taxed. In our view, this objective should always be kept in mind while computing the disallowance. A reasonable disallowance, if results in more accurate estimation of such expenditure should be adopted. Similarly, if computation in accordance with Rule 8D results in manifestly unreasonable disallowance, the same should, in our view, be eschewed. In the case of Ramkumar Venugopal Investments Pvt. Ltd. v. ACIT (Mum.)(Trib.)(www.itatonline.org) [AY 2009-10], the Tribunal restricted the disallowance as computed by the lower authorities under Rule 8D(2)(ii) and (iii) to 5% and 10% of the amounts respectively as the same resulted in a better and fair estimation of the expenditure to be disallowed u/s 14A. The decision in the case of Damani Estates & Finance Pvt. Ltd. (supra) also merits consideration in this regard.

However, in the case of Joint Investment Pvt. Ltd. v. ACIT, ITA No. 785/Del/2013dated 06/06/2014 (Del.) (Trib.) [AY 2009-10], the Tribunal held that the word “shall” in section 14A(2) makes it mandatory for the Assessing Officer to determine the amount of expenditure incurred in relation to exempt income as per the prescribed method i.e. Rule 8D.

5. Interplay between section 14A and other provisions

5.1 Revision of assessment u/s 263

CIT v. Hotz Industries Ltd. [2014] 49 taxmann.com 267 (Del.) (HC)

Once inquiries were conducted and a decision was reached by the AO, it cannot be said that it was a case of no inquiry and in exercise of power u/s 263, the CIT must reach a finding that, finding of AO was erroneous, not because no inquiries were conducted, but because final finding was wrong and untenable.

Decisions in favour of the assessee

CIT v. Galileo India (P) Ltd. [2014] 220 Taxman 115 (Mag.) (Del.) (HC) – The CIT passed order u/s 263 and recorded that the AO should have conducted further inquiries and correct disallowance should have been made u/s 14A read with Rule 8D. Held, an order is not erroneous, unless the CIT holds and records reasons why it is erroneous [AY 2006-07].

DLF Ltd. v. CIT [2009] 27 SOT 22 (Del.) (Trib.) – There being no specific finding by CIT to the effect that any particular expenditure was incurred for earning dividend income exempt under s. 10(33), he was not justified in his revisional jurisdiction under s. 263 in asking the AO to make enquiry and find out of common expenses, which could be disallowed under s. 14A on proportionate basis [AY 2002-03]. This decision is upheld in CIT v. DLF Ltd. [2013] 350 ITR 555 (Del.) (HC).

Similar view was taken in CIT v. L and T Infrastructure Development Projects Ltd [2013] 357 ITR 763 (Mad.) (HC).

Decisions in favour of the Revenue

CIT v. RKBK Fiscal Services P Ltd [2013] 358 ITR 228 (Cal.) (HC) – Revision of order u/s 263 on account of no disallowance being made by AO u/s 14A was valid.

CIT v. Goetze (India) Ltd. [2014] 361 ITR 505 (Del.) (HC) – Revision order u/s 263 was held justified as the AO made error in computing income u/s.115JA and also failed to apply s.14A [AY 2000-01 to 2001-02].

Jammu & Kashmir Bank Ltd. v. ACIT[2009] 118 ITD 146 (Amr.)(Trib.) – AO having allowed exemption under ss. 10(15), 10(23G) and 10(33) without even considering the applicability of s. 14A, his order was erroneous as also prejudicial to interests of Revenue, hence rightly set aside by CIT in exercise of revisional jurisdiction. The total investment for earning such income must be more than 300 crores. An enquiry and examination was required to be made by the AO at the time of completing the assessment as regards disallowance under s. 14A [AY 2002-03].

5.2 Reassessment u/s 148

CIT v. P.G. Foils Ltd. [2013] 356 ITR 594 (Guj.) (HC) – The AO reopened assessment by issuing notice u/s 148 recording three reasons. Two of such reasons pertained to extent of earnings exempt from Income-tax, which Revenue contended should have been disallowed u/s 14A. The CIT(A) as well as the Tribunal held that both issues were examined by AO in original assessment. Held, CIT (A) noted that AO had raised several queries with respect to those issues. Thus, Tribunal correctly held that any attempt on part of AO to re-examine such issues would only amount to change of opinion [AY 2008-09].

CIT v. Dhanalakhsmi Bank Ltd. [2013] 357ITR448 (Ker.) (HC) – By virtue of proviso to s. 14A, there is no justification to make reassessment u/s 147 for any AY prior to AY 2001-02.

Reckitt Benckiser Healthcare India Ltd. v. ACIT[2013] 216 Taxman 209 (Guj.)(HC) – Since the entire issue pertaining to disallowance of expenditure under s. 14A was scrutinized by Assessing Officer during original assessment proceedings, reopening of assessment to make disallowance of such expenditure on basis of formula provided in rule 8D would amount to change of opinion, and hence, bad in law [AY 2007-08].

Similar issue was decided in favour of the assessee in ACITv. Sterling Infotech Ltd. [2013] 59 SOT 19 (Chennai) (Trib.) (URO) [reopening beyond four years].

5.3 Computation of book profits u/s 115JB

CIT v. Goetze (India) Ltd. [2014] 361 ITR 505 (Del.) (HC), Time Technoplast Ltd. v. Addtl. CIT, ITA No. 8126, 7576/M/2011, dated 2/1/2014 (ITAT Mumbai), Godrej Consumer Products Limitedv. Addtl.CIT[2014] 159 TTJ 21 (Mum.)(Trib.), ITO v. RBK Share Broking (P) Ltd. [2013] 60 SOT 61 (Mum.)(Trib.)(URO), Dabur India Ltd. v. ACIT [2013] 145 ITD 175 (Mum.) (Trib.) etc. – Amount of expenditure disallowable u/s 14A was to be added back while computing book profit under clause (f) of explanation (1) to section 115JB. The Bombay High Court has admitted an appeal on the issue whether disallowance u/s 14A is to be added back for the purpose of computing book profits u/s 115JB – CIT v. Garware Wall Ropes Ltd., ITA No. 1327 of 2013dt. 26/11/2014.

5.4 Section 14A and section 10B

Sandoz P. Ltd. v. DCIT [2013] 145 ITD 551 (Mum.) (Trib.) – Provisions of section 14A are not attracted in the case of the unit suffering losses eligible for deduction u/s 10B and further the assessee is entitled to set off of loss of STP unit u/s 10B against other business income [AY 2008-09].

5.5 Penalty u/s 271(1)(c)

Sunash Investment Co. Ltd. v. ACIT[2007] 14 SOT 80 (Mum.) (Trib.) – When Assessee claimed deduction of interest on borrowed funds which were invested in the financing business as well as purchase of shares of group companies under bona fide belief that such interest was deductible in entirety in view of some judicial pronouncements, it cannot be said that the assessee is guilty of concealment or furnishing of inaccurate particulars of income. Held, penalty under s. 271(1)(c) was not leviable [AY 1998-99].

CITv. Liquid Investment and Trading Co. [ITA 240/2009 dated 5/10/2010 – Delhi HC] – Disallowance u/s 14A of the Act was a debatable issue. Also, High Court had admitted the appeal of the assessee on quantum. Hence, penalty was not leviable.

Skill Infrastructure Ltd. v.ACIT[2013] 157 TTJ 565 (Mum.)(Trib.) – Disallowance u/s 14A does not call for penalty.

6. Relevant factors to be pointed out by assessee against invocation of section 14A and Rule 8D

In the case of AFL Private Limited [2013] 60 SOT 63 (Mum.) (Trib.), it was held that onus to prove that expenditure has been incurred for the purpose of earning taxable income is on the assessee. A similar view was taken in the case of CIT v. Deepak Mittal [2014] 361 ITR 131 (P&H) (HC).

In any case, the onus to substantiate claims made in the return of income is always on the assessee.

The fact whether a particular expenditure is incurred in relation to exempt income or in relation to taxable income is essentially a question of fact. In the case of Addtl. CIT v. M/s Dhampur Sugar Mills Pvt. Ltd., ITA No. 220 of 2014 dt. 5/11/2014, the Allahabad High Court held that in light of Tribunal’s finding that interest expenditure was attributable to taxable business, the same cannot be considered for disallowance under Rule 8D(2)(ii). Therefore, the submission against disallowance under these provisions should be on facts. The following factors may be pointed out by the assessee before the Assessing Officer against the disallowance:

• Establishing nexus of loans with taxable income/ business can help minimise disallowance under clause (ii) of Rule 8D(2) – CIT v. Ms. Sushma Kapoor [2009] 319 ITR 299 (Del.) (HC), ITO v. Narain Prasad Dalamia[2014] 30 ITR (T) 619 (Kol.) (Trib.), ACIT v. Best & Crompton Engineering Ltd. [2013] 60 SOT 53 (Chennai) (Trib.) (URO) etc.
• In case of secured loans from banks, this can be done with the help of “purpose of loan clause”in loan agreements. Interglobe Enterprises Ltd. v. DCIT (supra) – One of the factors that found favour with the Tribunal was that most of the interest bearing loans were vehicle loans and not for making tax-free investment.
• In case of unsecured loans from non-institutional lenders, it is advisable that the assessee enters into a loan agreement and mentions the purpose of taking loan in the agreement and utilizes the loan for that purpose;
• Apart from the above, sufficiency of own funds for the purpose of making investments would be an important factor – CIT v. HDFC Bank Ltd. [2014] 366 ITR 505 (Bom.) (HC)
• Other decisions on sufficiency of own funds/ interest-free funds:

CIT v. Torrent Power Ltd. [2014] 363 ITR 474 (Guj.) (HC), DIT v. BNP Paribas SA [2013] 214Taxman 548 (Bom.) (HC), CIT v. UTI Bank Ltd. [2013] 215 Taxman 8 (Mag.) (Guj.) (HC),CITv. Reliance Utilities & Power Ltd. [2009] 313 ITR 340 (Mum.)(Trib.), Sharekhan Financial Services (P) Ltd. v. ACIT, ITA No. 5861/M/2011, dated 20/8/2014 [AY 2008-09]etc.

• If some portion of interest is already disallowed under some other provisions of the Act such as section 36(1)(iii) or section 40(a)(ia), the assessee may request for exclusion of the such interest from computation of disallowance under Rule 8D(2)(ii).
• Against the disallowance of administrative expenditure under Rule 8D(2)(iii), the assessee must give submissions in respect of each item of expenditure and establish how it was incurred for the purpose of taxable income/ business only.
• Reasonable bifurcation of expenditure such as electricity expenses, salary, etc. as incurred towards exempt income and taxable income (depending on facts of each case) can be given.
• An individual-assessee may establish nexus of expenditure incurred for earning exempt income with drawings to show that such expenditure has not been claimed as expenditure.
• Separation of accounts for taxable business and other business.

In the case of Iqbal M. Chagla (supra), it was held that since the assessee had not claimed any expenditure in its P&L account as incurred for earning exempt income,the onus was on the Assessing Officer to prove that the expenditure incurred undervarious heads were related to earning of exempt income. This decision of the Tribunal is contrary to that in the case of AFL Private Limited(supra). However, after discharging the initial onus in the manner stated above, the burden of proof may shift on to the Assessing Officer and the decision in the case of Iqbal M. Chagla (supra) should come to the aid of the assessee.

7. Authors’ views

In recent times, it is seen that injudicious invocation of these provisions has become a cause of serious harassment for tax payers resulting in increased litigation.

While the purpose of introducing the provisions of section 14A was to ensure that net income is actually taxed and no expenditure incurred for earning exempt income is claimed as deduction from business income,the blanket application of this section read with Rule 8D oftenresults in a situation wherein even expenditure incurred for earning taxable income is disallowed.It is not uncommon to see a notional/ estimated disallowance computed by the Assessing Officer exceeding the amount of exempt income by multifold times or the disallowance so computed exceeding the total expenditure of the assessee.

The purpose of introduction of sections 10(34), 10(35) and 10(38) was to promote investment into Indian companies (directly or via mutual funds) by exempting dividends and capital gains upon their sale in certain circumstances, However, considering the amount of disallowance u/s 14A that can follow the receipt of such exempt income, an assessee would only be constrained to observe that the Assessing Officer takes by one handwhat the Legislature has given by the other.

It is the need of the hour for the Legislature to step in and carry out necessary amendments to prevent misuse of the provisions of section 14A of the Act. While in cases where the Assessing Officer is able to demonstrate nexus ofexpenditure with non-taxable business of the assessee, the actual amount of such expenditure (irrespective of the amount) should be disallowed u/s 14A, in cases where Rule 8D is appliedby the Assessing Officer for want of satisfaction with the correctness of the claim of the assessee as regards such expenditure, the introduction of the following proviso inRule 8D may curtail litigation in this regard:

“Provided that wheresuch expenditure determined in accordance with sub-rule (2)exceeds the amount of income which does not form part of the total income under the Act, then, such excess shall be ignored.”

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