Disallowance under section 14A would not arise unless there is income chargeable to tax.

Issue:

ABC (P) Ltd has paid up share capital and reserves and surplus of Rs.500 lakhs. During the year 2009-10 it had borrowed Rs.1000 lakhs from various financial institutions and invested Rs.1200 lakhs in shares of companies. For the financial year 2010-11 it has not received any dividend from the companies but proposes to claim interest on monies borrowed from financial institutions as a deduction. Decide whether the provisions of section 14A would be applicable for disallowing the interest claim of the assessee.

Opinion

Section 14A has the title “Expenditure incurred in relation to income not includible in total income”. It says for computing total income under Chapter IV (consisting of five heads of income) 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.

The Assessing Officer has to determine the amount of expenditure incurred in relation to such income which does not form part of the total income, in accordance with rule 8D of the Income-tax Rules if he is not satisfied with the correctness of the claim made by the assessee.

Section 14A(3) says that such amount of expenditure to be disallowed shall be determined by the Assessing Officer even where the assessee claims that no expenditure was incurred by him in relation to such income, which does not form part of the total income under the Act.

From the above, the conditions for applying section 14A are (i) no expenditure will be allowed as a deduction where the income does not form part of total income; (ii) the Assessing Officer will determine the amount of expenditure incurred in relation to such income when he is not satisfied with the correctness of the claim of the assessee; and (iii) such disallowance of expenditure will apply even where the assessee claims no expenditure was incurred in respect of such income i.e. exempt income.

In M/s. Siva Industries & Holdings Ltd v. Asstt. CIT (ITA No.2148/Mds/2010 decided on 20.05.2011) the aspect of disallowance of expenditure under section 14A, when could be made, was discussed in detail. The assessee filed its original return disallowing the interest expenditure to the extent of Rs.42 crores. Later, a revised return was filed wherein the disallowance to the extent of Rs.30.90 crores was withdrawn. The Assessing Officer accepted the claim of interest payment to the extent of Rs.8.14 crores and the balance of Rs.33.86 crores was disallowed by him. The assessee explained in detail the various transactions of borrowings and investments and fairly agreed that out of borrowings only Rs.8.68 crores was connected to investment in shares. Some of the borrowings made and for which interest was charged to revenue account did not show any nexus to the investment in shares. The assessee explained that it had not claimed any dividend income as exempt from tax and therefore the provisions of section 14A could not be invoked. It was also contended that only when there was an income which did not form part of total income under the Act during any relevant assessment year, no deduction in respect of expenditure incurred for earning such income which does not form part of total income, was allowable. During the relevant assessment year the assessee did not have any income which did not form part of total income and therefore no disallowance under section 14A could be made.

In CIT v. Winsome Textile Industries Ltd (2009) 319 ITR 204 (P&H) the assessee engaged in manufacture and sale of cotton yarn made investment in shares. The Assessing Officer disallowed interest on the amount of investments on the ground that the dividend income was exempt from tax and the provisions of section 14A are applicable. The court held that since the assessee did not make any claim for exemption, the provisions of section 14A would not be applicable.

The tribunal while deciding M/s.Siva Industries (Supra) also referred to the apex court decision in the case of CIT v. Walfort Share & Stock Brokers (P) Ltd (2010) 326 ITR 1 (SC) and enunciated the following principles which emerged from the decision.

a) the mandate of section 14A is to prevent claims for deduction of expenditure in relation to income which does not form part of the total income of the assessee;

b) section 14A is enacted to ensure that only expenses incurred in respect of earning taxable income are allowed;

c) the principle of apportionment of expenses is widened by section 14A to include even the apportionment of expenditure between taxable and non-taxable income of an indivisible business;

d) the basic principle of taxation is to tax net income. This principle applies even for the purposes of section 14A and expenses towards non-taxable income must be excluded;

e) once a proximate cause for disallowance is established – which is the relationship of the expenditure with income which does not form part of the total income – a disallowance has to be effected.

The tribunal held that for application of section 14A there must be (i) income which is taxable under the Act for the relevant assessment year; and (ii) there should also be an income which does not form part of the total income under the Act during the relevant assessment year. If either one is absent, section 14A(1) has no applicability.

If we assume that section 14A would apply even when the assessee does not have any income which does not form part of total income, then it would lead to conclusion that the expenditure in relation to investment would stand for disallowance. If this would continue and go on accumulating, when the assessee liquidates the investment and derives gain that will also be taxed. These are not contemplated under section 14A.

Thus once there is no claim of income which does not form part of the total income, there cannot be any disallowance in relation to an investment which may or may not give rise to any income which does not form part of total income. Since the investments made have not generated any dividend income, the disallowance of interest expenditure would not arise in this case.

Position under DTC: Section 18(1)(a) of the DTC says that any expenditure attributable to income which is not included in total income shall not be allowed deduction. Incomes which are not to be included in the total income are listed in the Sixth Schedule. It contains any dividend declared, distributed or paid to a company or a non-resident in respect of which dividend distribution tax has been paid under section 109 of the DTC.

Source: The Tax Referencer, Volume 120 dt.01.08.2011
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