RESTRICTIONS ON ALLOWABILITY OF EXPENDITURE [SECTION 14A]
Section 14A
As per section 14A, expenditure incurred in relation to any exempt income is not allowed as a deduction while computing income under any of the five heads of income [Sub-section (1)].
The Assessing Officer is empowered to determine the amount of expenditure incurred in relation to such income which does not form part of total income in accordance with such method as may be prescribed [Sub-section (2)].
The method for determining expenditure in relation to exempt income is to be prescribed by the CBDT for the purpose of disallowance of such expenditure under section 14A.
Method should be adopted by the Assessing Officer in the following cases –
(i)if he is not satisfied with the correctness of the claim of the assessee, having regard to the accounts of the assessee. [Sub-section (2)]; or
(ii) where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of total income [Sub-section (3)].
Rule 8D lays down the method for determining the amount of expenditure in relation to income not includible in total income.
If the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with –
(a) the correctness of the claim of expenditure by the assessee; or
(b) the claim made by the assessee that no expenditure has been incurred
in relation to exempt income for such previous year,
he shall determine the amount of expenditure in relation to such income in the manner provided hereunder –
The expenditure in relation to income not forming part of total income shall be the aggregate of the following:
(i) the amount of expenditure directly relating to income which does not form part of total income;
(ii) an amount equal to 1% of the annual average of the monthly averages of the opening and closing balances of the value of investment, income from which does not form part of total income.
However, the amount referred to in clause (i) and clause (ii) shall not exceed the total expenditure claimed by the assessee.
Clarification regarding disallowance of expenses under section 14A in cases where corresponding exempt income has not been earned during the financial year [Circular No. 5/2014, dated 11.2.2014] :
- Section 14A provides that no deduction shall be allowed in respect of expenditure incurred relating to income which does not form part of total income.
- A controversy has arisen as to whether disallowance can be made by invoking section 14A even in those cases where no income has been earned by an assessee, which has been claimed as exempt during the financial year.
- The CBDT has, through this Circular, clarified that the legislative intent is to allow only that expenditure which is relatable to earning of income.
- Therefore, it follows that the expenses which are relatable to earning of exempt income have to be considered for disallowance, irrespective of the fact whether such income has been earned during the financial year or not.
- The above position is clarified by the usage of the term “includible” in the heading to section 14A [Expenditure incurred in relation to income not includible in total income] and Rule 8D [Method for determining amount of expenditure in relation to income not includible in total income], which indicates that it is not necessary that exempt income should necessarily be included in a particular year’s income, for triggering disallowance.
- Also, the terminology used in section 14A is “income under the Act” and not “income of the year”, which again indicates that it is not material that the assessee should have earned such income during the financial year under consideration.
- In effect, section 14A read along with Rule 8D provides for disallowance of expenditure even where the taxpayer has not earned any exempt income in a particular year.
RELEVANT SIGNIFICANT CASE LAW:
CIT v. Kribhco (2012) 349 ITR 0618 (Delhi)
Issue:
Is section 14A applicable in respect of deductions, which are permissible and allowed under Chapter VI-A?
Decision:
Deductions under Chapter VIA are different from the exclusions/exemptions provided under Chapter III. Section 14A is applicable only if an income is not included in the total income as per the provisions of Chapter III of the Income-tax Act, 1961. Therefore, no disallowance can be made u/s 14A in respect of income included in total income in respect of which deduction is allowable u/s 80C to 80U.
Illustration:
Mr. VK has provided the following information regarding his income for the previous year 2021-2022:
•Income from Business (Computed) - ₹ 5,00,000
•Agriculture Income - ₹ 1,25,000
•Commission charges to agriculture agent - ₹ 15,000
•Interest expenditure related to both taxable and non-taxable Income - ₹ 2,25,000
Other Information:
✓ Value of investments in Agriculture
On first day of PY - ₹ 5,00,000
On last day of PY - ₹ 3,00,000
✓ Value of total assets appearing in Balance sheet
On first day of PY - ₹ 50,00,000
On last day of PY - ₹ 70,00,000
Mr. VK claims that no expenditure was incurred by him for exempt income earned.
The AO is not satisfied with the correctness of the assessee in respect of the expenditure related to exempt income.
You are required to compute the amount of expenditure incurred in relation to exempt income and resultant total income, assuming that Mr. VK has no other incomes.
Answer:
As per section 14A, expenditure incurred in relation to any exempt income is not allowed as a deduction.
If the Assessing Officer is not satisfied with the correctness of the claim of expenditure by the assessee or that no expenditure has been incurred by him in relation to income which does not form part of total income for such PY, he shall determine the amount of expenditure in relation to such in the manner provided in Rule 8D.
In the given case, the AO is not satisfied with the correctness of the claim of Mr. VK, he shall determine the amount of expenditure in relation to such in the manner provided in Rule 8D.
The agriculture income of ₹1,25,000 is exempt under section 10(1). Therefore agriculture income represents exempt income of Mr. VK.
Computation of amount of expenditure in relation to exempt income:
(i) The amount of expenditure directly related to exempt income
Commission charges paid to agriculture agent - ₹ 15,000
(ii) Calculation of interest expenditure related to exempt income
Interest expense incurred × [ Avg. of investments in Agriculture Income ÷ Avg. of total assets of the assessee in Balance sheet]
2,25,000 × [ (5,00,000+3,00,000)/2 ÷ (50,00,000+70,00,000)/2]
= 15,000
(iii) One percent of the avg. value of investment income from which is exempt from tax. i.e 1% of avg. value of investment in agriculture
= 4,00,000 × 1% = 4,000
Therefore, total amount of expenditure in relation to exempt income [i + ii + iii]
= 15,000 + 15,000 + 4,000 =34,000
Computation of total income of Mr. VK for the AY 2022-23:
Income from Business (Computed) - ₹ 5,00,000
Add: Amount of expenditure in relation to exempt income (Note) - ₹ 34,000
Income from Business or total income - ₹ 5,34,000
Note: Since, it has been stated in the question that Mr. VK has claimes that
no expenditure was incurred by him in relation exempt income earned. It is logical to assume that the entire has been deducted to arrive at the Income from Business of ₹ 5,00,000. Therefore the expenditure in relation to exempt income has been added back to compute the resultant total income.
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