Issue at hand:

Whether any expenditure can be disallowed under Section 14A in a year in which the assesse has not earned or received any exempt income?

Important for Whom

This controversy has arisen in the past, especially in case of interest on borrowed funds, which have been used

• for investment as well as in business where dividend income on investment is exempt, whereas business income will be chargeable to tax.
• Investment in partnership firms, on which interest received is taxable and profits are exempt.

History of Section 14A:

Before the introduction of the Section 14A, the Supreme Court had come up with various decisions^[1] that where the assesse has indivisible businesses which result in taxable and non-taxable income, the Assessing Officer will not be able to apportion such expenditure incurred in relation to such taxable and non-taxable income. He shall have to allow the entire sum of expenditure as deduction from the income.

In order to reverse the decisions of the Supreme Court, a change in law was brought in by the Finance Act, 2001 wherein Section 14A was introduced with retrospective effect from 1^st April, 1962 for disallowance of expenditure incurred by an assessee to earn exempt income. Hence the idea behind insertion of this Section was not to allow set off of expenses related to exempt income against other taxable income.

Understanding the issue:

There have been ample controversies in Section 14A ever since its insertion.  One of the controversies in relation to Section 14A has been  as to whether any expenditure can be disallowed under Section 14A in a year in which the assesse has not earned or received any exempt income.

This controversy which was considered dead has suddenly been kicked alive due to various decisions by the Gujarat, Allahabad, Bombay, Punjab and Haryana High Courts which take a stand which is contrary to the stand taken by the Delhi Tribunal in case of Cheminvest Ltd. vs. ITO 317 ITR(AT) 86 and the Circular 5/ 2014 dated 11^th February, 2014 issued by CBDT (Central Board of Direct Taxes).

This controversy has arisen due to the different interpretations of Section 14A by the Revenue and the Assessee.

Revenue’s Interpretation of Section 14A:

The Revenue has interpreted Section 14A to mean that any expenditure which is incurred to earn the exempt income, will be disallowed, irrespective of the fact that whether the exempt income was earned or not. Expenses incurred can be allowed only to the extent they are relatable to earning taxable income. Such an interpretation is not in consonance with the plain reading of the provisions of Section 14A(1) of the Act as it stands.

Assessee’s Interpretation of Section 14A:

On plain reading of the Section, it can be understood that Section 14A will be applicable if:

• Assessee has earned some income which does not form part of the total income, I.e. it is exempt income, and,
• He has incurred some expenditure in relation to such exempt income.

If the Assessee has not fulfilled the first condition, i.e. exempt income has not been earned during the previous year, then Section 14A will not be applicable and hence the expenditure incurred shall not be disallowed.

Tribunal Judgements on the issue:

There was conflict of opinion between the coordinate Benches of the Tribunal on this issue.

The Mumbai Bench of the Tribunal in the case of ACIT v. Lafarge India Holding (P.) Ltd.: [2008] 19 SOT 121 (Mum.), held that no disallowance under the provisions of Section 14A of the Act can be made in the year when exempt income is not received/earned by the assessee.

A contrary view was, however, taken by the Delhi Bench of the Tribunal in the case of Inshaallah Investments Ltd v. ITO : [2008] 23 SOT 130 (Delhi).

In order to resolve the above conflict of judicial opinion, Special Bench of the Tribunal was constituted in the case of Cheminvest Ltd. vs. ITO 317 ITR(AT) 86. The Special Bench, in that case, relying upon the decision of the Supreme Court in the case of Rajendra Prasad Moody: 115 ITR 519, accepted the contention of the Revenue and held that if an expenditure is incurred in relation to earning of exempt income, then, disallowance under Section 14A of the Act may be made, irrespective whether any such exempt income is actually earned by the assessee or not.

Introduction of Circular 5/ 2014 dated 11th February, 2014:

The CBDT issued a Circular in February 2014, which reiterated the stance of the Special Bench of Tribunal. The Circular has confirmed that the expenditure in relation to exempt income shall be diallowed, irrespective of the fact, whether the assessee has earned such exempt income in that year or not, on the basis of the following ground:

• The legislative intent is to allow only that expenditure which is relatable to earning of taxable income,
• The term ‘includible’ and not ‘included’ is used in the heading of Section 14A and Rule 8D,
• Section 14A does not use the word ‘income of the year’ but uses ‘income under the Act’, and,
• In Rule 8(D)(2)(iii), which explaining the calculation of expenditure to be disallowed, the words used are ‘income which does not or shall not form part of the total income’.

High Court Decisions:

In the recent times, after the introduction of Circular 5/ 2014 by CBDT, various High Courts^[2] have pronounced judgements in favour of the assessee stating that expenditure shall not be disallowed under Section 14A, where the assessee has not earned any exempt income in the year.

The Delhi High Court in the case of CIT v. Holcim India (P) Ltd. (decided on 5^th September, 2014), held as under:

“On the issue whether the respondent -assessee could have earned dividend income and even if dividend income was not earned, yet Section 14A can be invoked and disallowance of expenditure can be made, there are three decisions of the different High Courts directly on the issue and against the appellant -Revenue. No contrary decision of a High Court has been shown to us. The Punjab and Haryana High Court in Commissioner of Income Tax, Faridabad Vs. M/s. Lakhani Marketing Incl., ITA No. 970/2008, decided on 02.04.2014, made reference to two earlier decisions of the same Court in CIT Vs. Hero Cycles Limited, : [2010] 323 ITR 518 and CIT Vs. Winsome Textile Industries Limited, : [2009] 319 ITR 204 to hold that Section 14A cannot be invoked when exempt income was not earned. The second decision is of the Gujarat High Court in Commissioner of Income Tax -I Vs. Corrtech Energy (P.) Ltd. : [2014] 223 Taxmann 130 (Guj.). The third decision is of the Allahabad High Court in Income Tax Appeal No. 88 of 2014, Commissioner of Income Tax Vs. M/s. Shivam Motors (P) Ltd. decided on 05.05.2014. In the said decision it has been held:

“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. Hence, the deletion of the disallowance of Rs.2,03,752/ – made by the Assessing Officer was in order.

Income exempt under Section 10 in a particular assessment year, may not have been exempt earlier and can become taxable in future years. Further, whether income earned in a subsequent year would or would not be taxable, may depend upon the nature of transaction entered into in the subsequent assessment year. For example, long term capital gain on sale of shares is presently not taxable where security transaction tax has been paid, but a private sale of shares in an off market transaction attracts capital gains tax.”

Conclusion:

It is clear from all the above quoted decisions that uniform view has been expressed by the High Courts of Gujarat, Allahabad, Delhi, Bombay, Punjab & Haryana that Section 14A cannot be invoked unless there is an exempt income claimed by the assesse.

It may also be noted that none of the above High Court decisions have considered Circular 5/2014 issued by the CBDT. However, it is a common knowledge that Circulars issued by the CBDT are binding on the tax officers and not the Courts or the assessee.

The disallowance cannot be made on the assumption that the investment may yield exempt income in future and may not be included in ‘total income’ of that year. This is not what Section 14A(1) of the Act provides.

Hence on the basis of above arguments, I am of the view that unless the Ministry comes up with a change in law to tumble the above judgements of the High Courts, the expenditure should not be disallowed under Section 14A in the year in which the assessee has not earned any exempt income.

^[1] Supreme Court Decisions: CIT Vs. Indian Bank Ltd, : 56 ITR 77, CIT vs. Maharashtra Sugar Mills Ltd.: 82 ITR 452, Rajasthan State Warehousing Corporation vs. CIT: 242 ITR 450

^[2] High court of Gujarat – CIT vs. Corrtech Energy Pvt. Ltd ITA 239 of 2014 – decided on 24^th March, 2014, High Court of Allahabad – CIT vs. Shivam Motors Pvt. Ltd. ITA 88 of 2014 – decided on 5^th May, 2014, High Court of Delhi – CIT Vs. Holcim India (P) Ltd. ILRDLH-2014-24-2488– decided on 5^th September, 2014, High Court of Mumbai – CIT vs. Delite Enterprises – decided on 26^th February, 2009, High Court of Punjab & Haryana – CIT vs. Lakhani Marketing 226 taxmann 45– decided on 2nd April, 2014 & CIT vs. Winsome Textile Industries 319 ITR 204 – decided on 25th August, 2009