Section 14A Expenditure incurred in relation to income not includible in Total Income. CA. Pramod Jain. B. Com (H), FCA, FCS, FCMA, LL.B.

Transcription

1 Section 14A Expenditure incurred in relation to income not includible in Total Income CA. Pramod Jain B. Com (H), FCA, FCS, FCMA, LL.B. DISA, MIMA This document would help in better understanding of critical issues under Section 14A of the Income Tax Act, 1961 through various judicial pronouncements. 14 th August 2015 admin 0

2 CONTENTS S. No Content Page No. 1 Statutory Summary 2 2 Mechanical application of Section 14A / Rule 8D 3 3 Limit of addition to be made 5 4 Disallowance in absence of Exempt Income Investment in subsidiary for acquiring controlling interest/ strategic investment / commercial expediency Establishment of real nexus between investment and non interest bearing funds Disallowance of expenses directly relatable to Taxable Income Nexus of expenditure with exempt income 11 9 Income for which have been claimed as deduction have been claimed under chapter VI-A Investment in shares of foreign company Shares held for Trading 12 Income Tax Section 14A Page 1

3 STATUTORY SUMMARY The major applicable statutory provisions are:- 1. Section 14A of Income Tax Act, Rule 8D of Income Tax Rules, CBDT Circular No. 5/2014 dated 11 th February, 2014 Section 14A was inserted by the Finance Act 2001 with retrospective effect from 1 st April The object was to disallow expenditure that had been incurred in relation to income which do not form part of the total income under the Act (exempt incomes). Sub-section (2) and (3) to section 14A were later added by Finance Act 2006 The section has to be read with rule 8D which provides the method of disallowance under this section. 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 AY and subsequent years. The said rule is to be applied when the assessing officer is not satisfied with: a. The correctness of the claim of expenditure incurred for earning the exempt income made by the assessee or b. The claim made by the assessee that no expenditure has been incurred for earning exempt income. The method prescribed in the Rule states that the expenditure in relation to income which does not form part of the total income shall be the aggregate of the following amounts: a. The amount of expenditure directly relating to income which does not form part of total income. b. In the case of interest on borrowed funds which is not directly attributable to any particular income or receipt. Income Tax Section 14A Page 2

4 c. An amount equal to ½ % 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 and the last day of the relevant accounting year. CBDT has issued a circular No. 5/2014 dated 11 th February, 2014 stating 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. MECHANICAL APPLICATION OF SECTION 14A / 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. Certain judicial precedents on the issue are as under:- 1. Mumbai ITAT in ACIT vs. Iqbal M. Chagala [2014-ITRV-ITAT-MUM-166] has held that S. 14A & Rule 8D cannot be applied in a mechanical manner. Disallowance cannot exceed expenditure claimed as a deduction 2. Delhi High Court in Maxopp Investment Ltd. & Ors. v. CIT [2011] 347 ITR 272 (Del.) has held that 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. 3. Delhi High Court in case of Joint Investments Pvt. Ltd. vs. CIT (ITA 117/2015) [2015- ITRV-HC-DEL-119] has held that no disallowance can be made u/s 14A if AO does not record satisfaction with reference to accounts that assessee claim is not satisfactory. S. 14A & Rule 8D cannot be interpreted to mean that the entire tax exempt income can be disallowed Income Tax Section 14A Page 3

5 4. Delhi High Court in CIT vs. Taikisha Engineering India Ltd [2015-ITRV-HC-DEL-118] has held that no disallowance can be made u/s 14A if AO does not record satisfaction with reference to accounts that assessee's claim is improper. However, if Rule 8D applies, assessee's claim that interest is not disallowable on ground of "own funds" is not acceptable. 5. Calcutta High Court in case of CIT vs. R. E. I. Agro Ltd. (ITA No. 1811/Kol./2012) [2014-ITRV-HC-KOL-022] has held that provision of section 14A cannot be invoked if AO has not examined the accounts of assessee and there is no satisfaction recorded by AO about the correctness of the claim of the assessee. 6. Pune ITAT Bench in ACIT vs. Magarpatta Township Development & Construction Co. Ltd. ITA.No.822/PN/2011 held that where AO did not record any satisfaction as required by section 14A(2), disallowance u/s 14A invoking rule 8D was unjustified. 7. Pune ITAT Bench in case of Kalyani Steels Ltd. vs. ACIT ITA No.1733/PN/2012 [2014- ITRV-ITAT-PUNE-027] has held that if AO does not deal with assessee s argument it means that he has not reached objective satisfaction u/s 14A that assessee method is incorrect and cannot invoke Rule 8D. 8. Cochin ITAT in Geojit Investment Services Ltd vs. ACIT [2014-ITRV-ITAT-COCN-195] held that in applying Rule 8D(2)(ii) for purposes of s. 14A interest expenses directly attributable to tax exempt income as also directly attributable to taxable income, are required to be excluded from computation of common interest expenses to be allocated. 9. Hyderabad ITAT in Bellwether Microfinance Fund Pvt. Ltd vs. ITO [2014-ITRV-ITAT- HYD-168] has held that for s. 14A disallowance computation in Rule 8D(2)(i) only expenditure relating to investments resulting in tax-free income can be considered. For Income Tax Section 14A Page 4

6 Rule 8D(2)(iii) all investments, whether yielding tax-free income or not, have to be considered. LIMIT OF ADDITION TO BE MADE The provisions of section 14A make a provision of disallowance of expenses and hence therefore before making the disallowance assessee must also have claimed the same expenses as deduction. This is based on the simple proposition that what has not been claimed as deduction cannot be disallowed. Further how much the disallowance has to be restricted to is another issue. Judicial precedents on the same are as under:- 1. In CIT v. Hero Cycles Ltd. [2010] 323 ITR 518 (P&H) (HC) it was held that for earning exempted income no expenditure has been incurred, disallowance u/s 14A cannot stand and also the disallowance of greater expenses as against the claim amount cannot be made. 2. Mumbai ITAT in Daga Global Chemicals Pvt. Ltd vs. ACIT [2015-ITRV-ITAT-MUM- 123] has held that disallowance u/s 14A r.w. Rule 8D cannot exceed the exempt income. 3. Ahmedabad ITAT in ITO vs. Karnavati Petrochmem Pvt. Ltd. [2013-ITRV-ITAT-AHD- 105] has held that interest expenditure has to be netted against interest income and only the difference, if any, can be considered for disallowance u/s 14A read with Rule 8D DISALLOWANCE IN ABSENCE OF EXEMPT INCOME A CBDT circular dated 5/2014 dated 11 th February, 2014 had clarified 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. There are certain judicial pronouncements which have come on this issue after the date of such circular and in the said judicial pronouncements contrary view has been taken by the courts and tribunals Income Tax Section 14A Page 5

7 discussing the circular. Certain judicial precedents on the issue prior and post circular are as under:- 1. Delhi High Court in case of CIT vs. Holcim India Pvt. Ltd. ITA No. 486/2014 & ITA No. 299/2014 [2014-ITRV-HC-DEL-19] has held that section 14A & Rule 8D disallowance cannot be made if there is no exempt income or if there is a possibility of the gains on transfer of the shares being taxable. 2. Allahabad High Court in the case of CIT vs Shivam Motors Pvt Ltd ITA No. 88/2014 [2014-ITRV-HC-ALL-101] has held that As regards the second question, Section 14A of the Act provides that for the purposes of computing the total income under the Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act. Hence, what Section 14A provides is that if there is any income which does not form part of the income under the Act, the expenditure which is incurred for earning the income is not an allowable deduction. For the year in question, the finding of fact is that the assessee had not earned any tax free income. Hence, in the absence of any tax free income, the corresponding expenditure could not be worked out for disallowance. The view of the CIT (A), which has been affirmed by the Tribunal, hence does not give rise to any substantial question of law. 3. Bangalore ITAT Bench in Alliance Infrastructure Projects Pvt. Ltd. vs. DCIT ITA Nos.220 & 1043(BNG.)/2013 [2014-ITRV-ITAT-BANG-200] has held that provision of section 14A cannot be invoked, if there is no receipt of exempt income for the concerned assessment year. Cheminvest Ltd. vs. ITO 121 ITD 318 (Ahd) (SB) is not good law. 4. Gujarat High Court in case of CIT vs. Corrtech Energy Pvt. Ltd. ITA No. 239/2014 [2014-ITRV-HC-GUJ-105] has held that no disallowance u/s 14A & Rule 8D can be made if the assessee does not have tax-free income & no claim for exemption is sought. Income Tax Section 14A Page 6

8 5. Delhi ITAT in Minda Sai Limited vs. ITO [2015-ITRV-ITAT-DEL-09] has held that in the absence of exempt income, s. 14A disallowance cannot be added to s. 115JB book profits even if assessee has accepted s. 14A disallowance in the normal computation 6. Chennai ITAT in ACIT vs. M. Baskaran [2014-ITRV-ITAT-CHN-165] has held that no disallowance can be made u/s 14A read with Rule 8D if there is no exempt income. Cheminvest (SB) & CBDT Circular are not good law. 7. Punjab & Haryana High Court in CIT vs. Lakhani Marketing [2014-ITRV-HC-P&H-108] has held that S. 14A disallowance cannot be made if the assessee has no tax-free income in the year INVESTMENT IN SUBSIDIARY FOR ACQUIRING CONTROLLING INTEREST / STRATEGIC INVESTMENT / COMMERCIAL EXPEDIENCY The investments in the subsidiaries and associates are made not for the purpose of earning dividend income but to get strategic advantage and to gain benefits of synergies in the different markets and to gain competitive advantage. Some investments are mande for commercial expediency too. A issue that arise in such cases is the disallowance u/s 14A in respect of such investment to be made or not. Certain judicial precedents on the issue are as under:- 1. Delhi ITAT in Interglobe Enterprises Ltd. v. DCIT I.T.A. No.1362 & 1032/Del/2013 [2014-ITRV-ITAT-DEL-196] has held that 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). Income Tax Section 14A Page 7

9 2. Chennai ITAT bench in the case of EIH Associated Hotels Ltd. v. DCIT I.T.A. No. 1503/Mds/2012 [2014-ITRV-ITAT-CHN-162] has held that 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. rule 8D. 3. Delhi ITAT in ITO v. Pioneer Radio Training Services Pvt. Ltd. I.T.A. No. 4448/Del/2013 [2015-ITRV-ITAT-DEL-104] has held that (i) Expenditure (like audit fees) required to be incurred irrespective of income cannot be disallowed, (ii) investments in subsidiaries are not to earn dividend income and cannot be considered for disallowance. 4. Mumbai ITAT Bench in case of Garware Wall Ropes Ltd. vs. ACIT ITA No. 5408/Mum/2012 [2014-ITRV-ITAT-MUM-038] has held that there would be no disallowance if primary object of investment is to hold controlling stake in group concern and not to earn tax free income. 5. Gujarat High court in CIT v. Suzlon Energy Ltd ITA 223/2013 has held that where assessee had own interest free funds many times over the investment made in Indian subsidiaries and further, there was no direct nexus between interest bearing borrowed funds and such investment, no disallowance of interest expenditure could be made under section 14A. 6. In CCI Ltd. vs. JCIT(2012) 250 CTR 291 (Kar.) has held that when assessee has not retained shares with the intention of earning dividend income and dividend income is incidental to his business of sale of shares then the expenditure incurred in acquiring the shares has not to be apportioned to the extent of dividend income. Income Tax Section 14A Page 8

10 7. ITAT Mumbai in JM Financial Limited vs. ACIT [2014-ITRV-ITAT-MUM-085] has held that there would be no s. 14A/ Rule 8D disallowance for investment made in shares of subsidiaries & Joint Ventures. 8. Delhi High Court in CIT vs. Oriental Structural Engineers P. Ltd. [2013-ITRV-HC-DEL- 163] expenditure on acquiring shares out of commercial expediency & to earn taxable income cannot be disallowed u/s 14A / Rule 8 D ESTABLISHMENT OF REAL NEXUS BETWEEN THE INVESTMENT AND NON INTEREST BEARING FUND A plain reading of the provisions of section 14A (2) / (3) suggests that the disallowance can be made only of the expenditure incurred to earn exempt income, thus in respect of disallowance of interest expenses there is need to establish a real nexus between the funds borrowed by the assessee and the same have been invested in the making tax free income investments or tax free securities. Certain judicial precedents on the issue are as under: 1. Bombay High Court in case of CIT vs. HDFC Bank Ltd. ITA 330/2012 [2014-ITRV-HC- MUM-148] has held that there would be no disallowance of interest paid on borrowings if assessee own funds and non interest bearing funds exceeds investments in tax free securities. In principle, if there are funds available, both interest -free and over draft and/or loans taken, then a presumption would arise that investments would be out of the interest-free funds generated or available with the company if the interest-free funds were sufficient to meet the investment. 2. In CIT vs. Reliance Utilities and Power Ltd. (2009) 313 ITR 340 (Bom) it was held that where an assessee has his own funds as well as borrowed funds, a presumption can be made that the advances for non-business purposes have been made out of the own funds Income Tax Section 14A Page 9

11 and that the borrowed funds have not been used for this purpose. Accordingly, the disallowance of the interest on the borrowed funds is not justified. 3. Mumbai ITAT in ITO vs. Reliance Share and Stock Brokers(P)Ltd. 274/Mum/2013 [2014-ITRV-ITAT-MUM-215] has held the requirement of making disallowance under Rule 8D(2)(ii) would arise only if nexus between the borrowings and the investments could not be clearly established. There would be no S. 14A/ Rule 8D Disallowance if accounts are not examined. DISALLOWANCE OF EXPENSE DIRECTLY RELATABLE TO TAXABLE INCOME A plain reading of the provisions of section 14A (2) / (3) suggests that the disallowance can be made only of the expenditure incurred to earn exempt income, thus if the assessee has incurred any specific expense for the business purpose then whether disallowance of such shall not be made. Judicial precedents on the issue are as under: 1. Kolkata ITAT Bench in case of ITO vs. Narain Prasad Dalmia ITA. 1180/Kol/2011 [2014-ITRV-ITAT-KOL-017] has held that for disallowance under section 14A and Rule 8D(2)(ii), interest expenditure on loan taken for taxable business purposes has to be excluded. 2. Allahabad High Court in ACIT vs. Dhampur Sugar Mill Pvt. Ltd [2015-ITRV-HC-ALL- 010] has held that interest expenditure attributable to a taxable business cannot be disallowed u/s. 14A/ Rule 8D. 3. Chennai ITAT in ACIT vs. Best & Crompton Engineering Ltd. [2013-ITRV-ITAT-CHN- 100] has held that interest on loans for specific taxable purposes is to be excluded for purposes of section 14A / Rule 8 D. Income Tax Section 14A Page 10

12 4. Kolkata ITAT bench in JCIT (OSD) vs. Pilani Investment & Industries Corpn. Ltd. [2013-ITRV-ITAT-KOL-026] has held that expense specifically relatable to taxable income cannot be disallowed u/s 14A read with Rule 8D. 5. Kolkata ITAT bench in ACIT vs. Champion Commercial Co. Ltd. [2012-ITRV-ITAT- KOL-243] has held that interest incurred on taxable income has also to be excluded to avoid incongruity & in view of Department s stand before High Court for calculation under Rule 8D(2)(ii) read with section 14A. NEXUS OF EXPENDITURE WITH EXEMPT INCOME For the disallowance of the expenditure u/s 14A there should be a proximate relationship between the expenditure and exempt income, because law clearly states that expenditure incurred in relation to exempt income. Certain judicial precedents on the issue are as under which have held that establishment of nexus is mandatory before making disallowance: 1. Justice Sam P. Bharucha v. Addtl. CIT [2012] 53 SOT 192 (Mum.) (Trib.) 2. DCIT v. Allied Investments Housing P Ltd. ITA No. 305/Mds/2013 [2013-ITRV-ITAT- CHN-164] Mumbai ITAT in DCIT vs. Damani Estates & Finance Pvt. Ltd has [2013-ITRV-ITAT-MUM- 106] has held that depreciation is an economic and accounting concept which is statutorily recognized and provided, is only a charge on capital account, i.e., a capital expenditure. It has to be excluded in computing the s. 14A disallowance. INCOME FOR WHICH DEDUCTIONS HAVE BEEN AVAILED UNDER CHAPTER VI-A 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 Income Tax Section 14A Page 11

13 computation, the latter income enters the computation but is deductible under special provisions and section 14A deals only with the former type of income. Therefore whether the disallowance u/s 14A shall be made for the deduction claimed under chapter VI-A. Certain judicial precedents on the issue are as under: 1. Infosys Technologies Ltd. v. JCIT [2007] 109 TTJ 631 (Bang.) (Trib.) it was held that 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. 2. CIT v. King Exports [2009] 319 ITR 100 (P&H) (HC) 3. CIT v. KRIBHCO [2012] 349 ITR 618 (Del.) (HC) INVESTMENT 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 would not apply in such cases as was held in the following cases: 1. CIT v. Suzlon Energy Ltd. [2013] 354 ITR 630(Guj.) (HC) 2. Birla Group Holdings Ltd. v. DCIT [2007] 13 SOT 642 (Mum.) (Trib.) 3. ITOv. Strides Acrolab Ltd. [2012] 138 ITD 323 (Mum.) (Trib.) SHARES HELD FOR TRADING Several assesses hold shares for trading. Applicability of section 14A has been discussed in the following judgments: Income Tax Section 14A Page 12

14 1. Kolkata ITAT in DCIT vs. Baljit Securities Private Limited [2014-ITRV-ITAT-KOL-217] has held that Rule 8D(ii) & 8D(iii) do not apply to shares held as stock-in-trade. 2. Mumbai ITAT (Third Member) in D. H. Securities P. Ltd. vs. DCIT [2013-ITRV-ITAT- MUM-160] has held that S. 14A & Rule 8D disallowance applies to tax-free securities held as stock-in-trade. 3. Kolkata ITAT bench in DCIT vs. Gulshan Investment Co. Ltd. [2013-ITRV-ITAT-KOL- 032] has held that Rule 8D(2)(ii) & (iii) do not apply to shares held as stock-in-trade. 4. Ahmedabad ITAT bench in Ethio Plastic Pvt. Ltd. vs. DCIT [2012-ITRV-ITAT-AHD- 283] has held that S. 14A does not apply to shares held as stock-in-trade. 5. Mumbai ITAT bench in Esquire Pvt. Ltd. vs. DCIT [2012-ITRV-ITAT-MUM-204] has held that S. 14A does not apply to dividend on shares held for trading purposes. If the dividend income is incidental to trading activity, following the principles laid down in CCI Ltd vs. JCIT 206 Taxman 563 (Kar); [2012-ITRV-HC-KAR-075], expenditure incurred in acquiring shares cannot be apportioned to the dividend for making disallowance u/s 14A. 6. Mumbai ITAT bench in JCIT vs. American Express Bank Ltd. [2012-ITRV-ITAT-MUM- 174] has held that S. 14A applies even if the securities are held as stock-in-trade. 7. Mumbai ITAT in DCIT vs. Damani Estates & Finance Pvt. Ltd has [2013-ITRV-ITAT- MUM-106] Rule 8D(2)(ii) needs to be scaled down by bifurcating the expenditure so arrived at between the tax-free and the taxable incomes. Given that the dominant objective of the share holding is to earn share trading income, an ad hoc ratio of 20% toward tax-exempt dividend income will be reasonable. Accordingly, in arriving at the Income Tax Section 14A Page 13

15 disallowance u/r 8D, the amount as per Rule 8D(2)(ii) qua shares held as stock-in-trade would be restricted to 20% thereof I hope this document would be of use to you. I thank Harshit Arora in assisting me in compiling this document. Best Regards CA. Pramod Jain pramodjain@lunawat.com Income Tax Section 14A Page 14