19 February 2014 | Volume 6 Issue 21
CBDT clarifies that disallowance under section 14A will be attracted even if no exempt income is earned during the financial year
Section 14A was introduced in the Indian Income Tax Act, 1961 (ITA) vide the Finance Act 2001 with retrospective effect from 1 April 1962 for the purpose of disallowing the expenditure incurred in relation to earning of exempt income.
The controversy with respect to whether disallowance under section 14A of the ITA  can be invoked even if no exempt income has been earned during the financial year has been a matter of considerable litigation right from the introduction of section 14A.

The Central Board of Direct Taxes (CBDT) recently issued Circular No. 5/2014 dated 11 February 2014, through which it has taken a view that disallowance of expenditure for earning exempt income under section 14A read with Rule 8D would be attracted even if the corresponding exempt income has not been earned during the financial year, thereby superseding a few decisions rendered in this regard.
Being CBDT's view, this  would be binding on the tax authorities but not on the taxpayers. 
CBDT's Analysis and View
  • The legislative intent of section 14A is to allow only that expenditure which is relatable to earning of taxable income. It therefore follows that the expenses relatable to earning of exempt income have to be considered for disallowance, irrespective of whether any such income has been earned during the financial year or not.
  • Also, the usage of the term "includible" in the heading of section 14A of the ITA as well as the heading of Rule 8D of the Income Tax Rules, 1962 indicates that it is not necessary that exempt income should have been "included" in a particular year's income for disallowance to be triggered.
  • Section 14A does not use the word 'income of the year' but uses 'income under the Act' indicating that to invoke disallowance of section 14A, it is not material that the assessee should have earned such exempt income during the financial year.
  • Even the wording of Rule 8D suggests that section 14A would be triggered in respect of future exempt income. 
  • In light of the above, the CBDT has clarified that Rule 8D read with section 14A of the ITA provides for disallowance of expenditure even when a taxpayer has not earned any exempt income in a particular year.
SKP's Comments
By issuing this Circular, the CBDT has clarified its view and has superseded several decisions in this regard where it had been held that to invoke the disallowance under section 14A, it is necessary to have exempt income during that financial year. Generally, the CBDT issues circulars for the benefit of taxpayers. However, this Circular adversely affects the taxpayers. We have repeatedly clarified in our earlier alerts that the CBDT circulars are binding only on the tax authorities while taxpayers and appellate authorities are not bound by the same.

On the other hand, we would like to draw attention to an old Supreme Court decision in the case of Commissioner of Income Tax vs Rajendra Prasad Moody[1] dated 4 October 1978, wherein the court addressed a situation as to whether it is necessary that income should in fact be earned to claim expenditure. The court held that the deduction of the expenditure cannot be held to be conditional upon the making or earning of the income. Relying on this decision, the Special Bench of Delhi Income Tax Appellate Tribunal in the case of Cheminvest Limited[2] concluded that even for invoking the provisions of section 14A, it is not necessary that income must have been earned during the financial year since section 14A does not envisage any such exception. The CBDT is perhaps drawing a parallel view from these decisions. Thus, it would be interesting to wait and watch what the Apex Court would decide with respect to disallowance under section 14A when no exempt income is earned during the year.
[1] (1978) 115 ITR 519 (SC)
[2] (2009) 121 ITD 318 (Delhi)(SB)


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