Introduction

As per Section 14A of Income Tax Act, 1961, some of the Incomes is not Taxable (i.e. Exempt from Income tax), Like agricultural Income, Dividend Received from a company, Income received by charitable institution, and tax-free interest received. In fact, Expenditure which relates to that Income which is not taxable is disallowed. For Example – Interest Paid on a loan that is taken for Investment in Tax-free bonds. However, Taxpayers always musing that all the expenses which he had incurred are an allowable expenditure. That is why he claims all the expenses should be deductible in his books of accounts.

Before the introduction of section 14A

Provision of Section 14A is introduced by the Finance Act 2001, with the retrospective effect w.e.f. Since April 1, 1962, before this Section was introduced, Assessee has not bifurcated the taxable Income and the exempt Income. So, Assessee gains the benefit of expenditure, which relates to exempt income as well. As a result, the taxable income of the Assessee is less as compared to the Income when Assessee isn’t allowed the Expenditure of Exempt Income. However, it doesn’t mean that assessing officer empower to assess or reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any Assessment year before the period starting from 1st April 2001.
Therefore, Section 14A was come into force in the year 2001 with retrospective effect from April 1962 to explain the meaning of the governing body concerning expenses relating to earning of exempt income.

Section 14A read with Rule 8D

As per Section 14A of the Income Tax Act: –
1. For the computation of total income, any expenditure transacted by the assessee concerning exempt income is not to be allowed as deduction.
2. Where the Assessee Claims that no expenditure has been incurred by him concerning exempt income, the Assessing Officer shall determine the amount of expenditure concerning exempt income by the method laid down under rule 8D of the Income-tax Rules, 1962 for disallowance.

Method for determining the amount of expenditure concerning income not includible in total income.

Rule 8D of the Income Tax Rules, 1962 comes into force where the Assessing officer not satisfied with the accuracy of the claim of expenditure made by the taxpayer or where an assessee claims that no expenditure has been incurred concerning income which does not form the part of total income in the previous year.
The expenditure concerning income which does not form part of the total income shall be the aggregate of following amounts, namely:—
 The amount of expenditure directly relating to income which does not form part of total income; and
 an amount equal to one percent of the annual average of the monthly average of the opening and closing balances of the value of an investment, income from which does not or shall not form part of total income :
Provided that the amount referred to in clause (i) and clause (ii) shall not exceed the total expenditure claimed by the assessee.

Key points to be noted

Que. Whether Section 14A is applicable in respect of deductions, which are permissible and allowed under chapter VI-A?

Answer. In the case of CIT v. Kribhco (2012) 349 ITR 0618 (Delhi), The Delhi High Court held that no disallowance can be made under section 14A in respect of income included in total income in respect of which deduction is allowable under section 80C to 80U.

Que. Whether disallowance can be made by invoking section 14A of the Act even in those cases where no income has been earned by an assessee which has been claimed as exempt Income?

Answer. As per Circular No. 5/2014, Dated – 11.02.2014, Central Board of Direct Taxes, in the exercise of its powers under section 119 of the Act hereby clarifies that Rule 8D read with section 14A of the Act provides for disallowance of the expenditure even where taxpayer in a particular year has not earned any exempt income.

Que. Can the disallowance u/s Sec 14A by operation of Rule 8D exceed the actual expenditure incurred?

Answer. As per Rule 8D of the income tax rules, 1962, The expenditure concerning income which does not form part of the Total Income shall not exceed the total Expenditure Claimed by the Assessee