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Be aware of disallowance under section 14A of Income Tax Act 1961


Section 14A of the Income Tax Act, 1961 provides for disallowance of expenditure incurred in relation to exempt income. The Section empowers the Assessing Officer if, having regard to the accounts of the Company, he is not satisfied with correctness of amount disallowed by the Company under this Section. CBDT has prescribed rules to determine the amount of disallowance.


As per rules, following three amounts are to be considered for disallowance:


  • Expenditure directly relating to exempt income (eg – Investment manager’s salary / brokerage etc)
  • In case of borrowed funds, interest expenditure in proportion to investments of the Company
  •  0.5% of average value of investments (which is to be understood as towards general / administrative expenditures which cannot be segregated as being incurred towards taxable / exempt income)


For example, a Company maybe is investing in mutual funds, of which incomes (dividend) are exempt from tax. However, since neither specific expenditures were being incurred in relation to earning such income nor any activity / function was being dedicated to managing such investments, no amounts were considered for disallowance u/s 14A by the company.


However, while assessing the Company’s income during scrutiny assessments, the Assessing Officer may invoke the provision 14A and disallow an amount equal to 0.5% of average value of investments (as given in point (iii) above).


While there are judicial pronouncements favourable to the company[i], there are also judgements where disallowances like this have been upheld[ii]


[i]Eg – (a) Priya Exhibitors (P) Ltd Vs.CIT [2012] – ITAT Delhi, wherein it was held that ‘if no direct expense has been incurred for earning exempt income, no disallowance under section 14A is warranted(b) In the case of Relaxo Footwears Ltd Vs.CIT, the Delhi Tribunal held that ‘assumption that whenever exempt income is earned, there will be some expenditure incurred in relation thereto cannot be a basis for disallowance under rule 8D’


[ii]Eg – In the case of Kalpataru Construction Overseas Pvt Ltd, Mumbai Tribunal held that ‘all expenses connected with exempt income have to be disallowed under section 14A regardless of whether they are direct or indirect, fixed or variable and managerial or financial in accordance with law


So, the company may either opt to pay the differential tax and proceed with 0.5% disallowance hereafter every year, or may protest the demand and go for an appeal citing justification for no expenses being incurred against exempt income.


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