1.  By : CA Sanjay Agarwal Mb: 9811080342 Email id: agarwal.s.ca@gmail.com Important aspects of Section 14A of the Income Tax Act, 1961 1

2.  Inserted by Finance Act, 2001, w.r.e.f 1-4-1962  Expenditure incurred in Relation to Income Not includible in Total Income. 2

3. “………exemptions to certain categories of income are used to reduce also the tax payable on non-exempt income by debiting expenses incurred to earn the exempt income against taxable income. This is against the basic principle of taxation whereby only net income is taxed.” The intention of the legislature is not to allow the expenses which are incurred to earn the income exempt from tax. 3

4. For computing the total income under this 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 this Act. AO shall determine the amount of Expenditure incurred in relation to exempt income in accordance with such method as may be prescribed under Rule 8D in following cases…… Sub-Sec. 1 Sub-Sec. 2Sub-Sec. 3 If AO, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure. where an assessee claims that no expenditure has been incurred by him in relation to income not forming the part of the total income under this Act. 4

5.  Nothing contained in this section shall empower the AO either to reassess u/s 147 or pass an order enhancing the assessment or reducing a refund made or otherwise increasing the liability of the assessee u/s 154, for any A.Y. beginning on or before the 1st day of April, 2001. Circular No. 11/2001, dated 23-7-2001, was inserted so as to direct that the assessments where the proceedings have become final before the first day of April, 2001 should not be re-opened under section 147 of the Act to disallow expenditure incurred to earn exempt income by applying the provisions of newly inserted section 14A of the Act. The same view has been expressed in CIT vs PNB Finance & Industries Ltd [2010] TIOL - 801-HC –DEL –IT. 5

6.  The proviso to sec14A bars reassessment but not original assessment on the basis of retrospective amendment. [Honda Siel Power Products Ltd. Vs. Dy. CIT (2011) 197 Taxman415 (Delhi) & Mohair Investment & Trading (P) Ltd. v. Dy. CIT [2012] 21 Taxmann.com 480(ITAT-Delhi)]  Bar under Circular No.11 on reopening of concluded assessment would not operate where assessment was pending finalization after remand by first appellate authority in appeal filed by assessee. [Catholic Syrian Bank Ltd. V. CIT (2010) 187 Taxman 185(Ker.)  Where order of CIT u/s 263 was passed earlier i.e. on 29/12/1999, the protection under the proviso is to available. [Mahesh G. Shetty & Ors. V. CIT (2011) 51 DTR 104 (Kar.)]  Whether issue to invoke section 14A be raised before the ITAT for the first time? Held No. [ACIT v. Delite Enterprises (P.) Ltd. (2011)50DTR193 (MUM.) (Trib.)] 6

7. Method for determining amount of expenditure in relation to Exempt Income (Inserted vide notification No. S.O. 547(E) on 24-3-2008) Rule 8D of Income Tax Rules, 1962 …. 7

8.  Where the AO, having regard to the accounts of the assessee of a P.Y., is not satisfied with— (a) the correctness of the claim of expenditure made by the assessee; or (b) the claim made by the assessee that no expenditure has been incurred,  in relation to income which does not form part of the total income under the Act for such P.Y., he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub- rule (2). 8

9.  The expenditure shall be the aggregate of following amounts namely: i. Expenditure directly relating to income (which does not form part of total income) ii. In a case where the assessee has incurred expenditure by way of interest during the P.Y., which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely:- iii. an amount equal to 0.5% of the average of the value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the P.Y. A*(B/C) 9

10. = amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the P.Y. = average of value of investment, income from which does not or shall not form part of the total income, as appearing In the balance sheet, on the first day and the last day of the P. y. = average of total assets as appearing in the balance sheet, on the first day and the last day of the previous year A B C 10

11.  Total assets shall means total assets as appearing in the balance sheet [excluding the increase on account of revaluation of assets but including the decrease on account of revaluation of assets.] 11

12. Balance sheet as on…. Liab.31-03-201031-03-2011Assets31-03-201031-03-2011 Eq. sh capital100 Fixed assets140100 Loans Investments for inv in bonds & Mutual funds 8060shares(L.T)150120 General Loans160140shares (S.T)6045 for trading activities220200 Mutual funds (s. 10(23D)) 160 s. creditors210165 Bonds (other than tax free) 40 stock in trade220200 Total770665 770665 During the year ending on 31-03-2011, assessee earned dividend income of Rs. 12 lacs, & int. on mutual funds of Rs. 15 Lacs. Interest paid on loans: For inv. In bonds & M.F (50 Lacs inv in M.F)Rs. 6 Lacs For General loans Rs. 8 Lacs For trading activities Rs. 20 Lacs 12

13. i.Exp. directly related to exempt income= int. paid on loan for inv in M.F= 6* 50/60= Rs. 5 Lacs ii.Proportionate exp. of int.= exp by way of int. not directly related to exempt inc. * (avg value of inv./ avg value of total assets) i.e ( A*B/C)= 8 * (150+60+160+120+45+160)/2= 347.5 =Rs. 3.8745Lacs (770+665)/2 = 717.5 iii.½% of avg value of investment = 347.5 * ½%= Rs. 1.7375 Lacs Total disallowance= 5 Lacs + 3.8745 Lacs + 1.7375 Lacs = Rs. 10.612 Lacs 13 Contd…

14. 14

15. Godrej & Boyce Mfg. Co. Ltd. v. DCIT [2010] 194 TAXMAN 203/ 328 ITR 81 (BOM.) SLP pending with Supreme Court,[No. 36516 of 2010] Held:  Provisions of sub-sections (2) and (3) of section 14A and Rule 8D are constitutionally valid having a retrospective effect.  The power of the AO to apply Rule 8D is not automatic and the AO is bound to give an opportunity to the taxpayer to prove the correctness of his claim. It is only where the AO is not satisfied with the claim of the taxpayer he can apply Rule 8D after recording reasons. The Hon’ble Bom HC has overruled the decision of the Mum. ITAT(SB) in case of ITO v. Daga Capital Management (P.) Ltd. [2009] 117 ITD 169. 15

16.  Even prior to the assessment year 2008-09, when rule 8D was not applicable, the Assessing Officer has to enforce the provisions of sub-section (1) of Section 14A by adopting a reasonable basis or method consistent with all relevant facts and circumstances. [Also see Maxopp Investment Ltd. Vs. CIT [2011] 15 taxmann.com 390 (Delhi), Continental Carriers (P.) Ltd. Vs. ACIT [2012] 18 taxmann.com 298 (Delhi), ACIT Vs. M/s Hexa Securities & Finance Co. Ltd. I.T.A. No. 977/Del/2012 (Delhi-ITAT), Sterling Re-rolling Mills (P.) Ltd. v. Asstt. CIT [2012] 23 taxmann.com 394 (ITAT-Mum.) 16

17. 17

18.  Nexus between the expenditure incurred and exempt income- whether direct and indirect. [i.e. the expenditure should be incurred in relation to exempt income]  Satisfaction of the AO- important aspect. Expenditures disallowed in view of s.14A are disclosed in clause 17(L) of Form 3CD (Tax audit report) 18

19.  Held: Yes. [CIT v. Hero Cycles Ltd. [2010] 323 ITR 518 (P & H)]  CIT vs. Walfort Share and Stock Private Limited [2010] 326 ITR 1(SC): held, For attracting section 14A, there has to be a proximate cause for disallowance, which is its relationship with tax exempt income and since pay-back or return of investment is not such proximate cause, section 14A is not applicable in such cases.  Space Financial Services v.Asst. CIT [2008] 115 TTJ 165(Del) addition was deleted holding as under: “lower authorities were not correct in disallowing proportionate expenditure against the dividend income without establishing the nexus thereto.” 19

20.  Onus is on the revenue to establish the nexus. [DCIT vs. Jindal Photo Ltd., [2011- TIOL-25-ITAT-DEL] I.T.A. No. 4539/Del./2010, K.J. Arora v. Dy. CIT 180 Taxman 131 (2009) (Delhi) (Mag.) and CIT Vs Kasturbhai Mayabhai Pvt. Ltd. (Gujarat)] “In the absence of any specific finding that any particular expenditure was incurred by the assessee in relation to exempted dividend income, no artificial disallowance can be made invoking section 14A of the Act” CIT v. Hindustan Co-op. Society Services Co. Ltd.” [2008] 170 TAXMAN 458 (DELHI), ACIT v. Sun Investments P. Ltd Ltd [2011]008 ITR(Trib)0033 ITAT(del)  There need be some evidence to establish the nexus. [Minda Investments Ltd. vs. DCIT, ITA No. 4046/Del-2009 (ITAT- Delhi)  Also see Asstt. CIT v. SIL Investment Ltd. [2012] 26 taxmann.com 78 (ITAT-Delhi) 20 Contd…

21. DCIT Vs. M/s Allied Investments Housing P. Ltd., ITA No. 305/Mad/2013, Date of Order: 07.11.2013, ITAT-Chennai S. 14A & Rule 8D: Onus is on AO to show how assessee’s claim is incorrect. AO has to show direct nexus between expenditure & exempt income. Disallowance cannot be made on presumptions i.No disallowance can be made on the basis of presumptions. ii.The mere fact that some interest expenses were incurred cannot be the reason for disallowance unless the nexus between the expense and the exempt income is established. iii.The assessee did not make any fresh investment during the year which could generate exempt income in forthcoming years. iv.The exempt income earned during the year comprised of dividend received from an investment made in an earlier year. v.The interest expenditure of the year is not directly related to the earning of exempt income. vi.The AO has not pointed out any direct nexus between the interest expenditure incurred and the exempt income earnd during the year. Contd…

22. REI Agro Ltd. Vs. DCIT 144 ITD 141 (ITAT - Kolkata) It is an admitted position in law that expenditure can be disallowed U/s.14A of the Act if and only if it is incurred in relation to income which does not form part of total income. The assessee has explained that the share capital and reserves, that is its own funds, were utilised for the purpose of investment in shares for earning dividend income and this has not been negated by lower authorities i.e. neither CIT(A) nor AO. The assessee has also explained each and every investment with sources of funds and its utilization as well as opening application of funds and closing application of funds. Thus, it is clear that the investment in shares was made out of own capital employed and not from borrowed funds and there is no link with expenditure for earning of dividend income incurred by the assessee and once the facts are clear, no disallowance can be made by invoking rule 8D. Further, neither the AO nor CIT(A) has recorded any finding that having regard to the account of assessee, they are not satisfied with the correctness of the claim of expenditure made by assessee or the claim made by assessee that no expenditure has been incurred in relation to income which do not form part of the total income under the Act for the relevant A.Y. In the absence of any such finding, no disallowance on account of interest expenditure can be made by invoking rule 8D of the Rules. Accordingly, in the given facts and circumstances, we delete the addition and allow this issue of assessee’s appeal. Contd…

23. Justice Sam P. Bharucha v. Add. CIT [ 2012] 25 taxmann.com 381 (ITAT- Mum.) Section 14A has within it implicit notion of apportionment in the cases where the expenditure is incurred for the composite/indivisible activities in respect of which taxable and non-taxable income is received. But when it is possible to determine the actual expenditure in relation to the exempt income or when no expenditure has been incurred in relation to the exempt income, then principle of apportionment embedded in section 14A has no application. In order to disallow the expenditure under section 14A, there must be a live nexus between the expenditure incurred and the income not forming part of total income. A notional expenditure cannot be apportioned for the purpose of earning exempt income unless there is an actual expenditure in relation to earning the income not forming part of total income. If the expenditure is incurred with an aim to earn taxable income and there is apparent dominant and immediate connection between the expenditure incurred and taxable income, then no disallowance can be made under section 14A merely because some tax exempt income is received by the assessee. 23 Contd…

24.  The term ‘expenditure’ occurring in section 14A would take in its sweep not only direct expenditure but also all forms of expenditure regardless of whether it is fixed, variable, direct, indirect, administrative, managerial or financial. [Kalpataru Construction Overseas (P.) Ltd. v. Dy. CIT [2007] 13 SOT 194 (Mum. - Trib.)]  Direct & indirect expenses have to be considered as per the rules framed in this regard. [Parry Agro Industries v. Asst. CIT 314 ITR (AT) 181(2009) (Cochin)] 24

25. Priya Exhibitors (P.) Ltd. v. Asstt. CIT [2012] 27 taxmann.com 88 (ITAT-Delhi) Disallowance u/s 14A requires a clear finding of incurring of expenditure and, hence, in absence of same, no disallowance could be made in instant case 25

26. The words ‘in relation to income which is exempt under the Act’, no doubt, appear to be broad at first impression, but on deeper examination, and read in conjunction with the word ‘incurred’, it seems that these are respective words, restricting the power of the AO to estimate a part of the expenditure incurred by the assessee as relatable to the exempted income. It seems that implicit in the expression ‘in relation to’ is the concept that the AO should be in a position to pinpoint, with an acceptable degree of accuracy, the expenditure which was incurred by the assessee to produce non-taxable income. ACIT v. Eicher Ltd. [2006] 101 TTJ (Delhi - Trib.) 369 CIT v. Wimco Seedlings Ltd. [2012] 17 taxmann.com 83 (Del) 26

27. As per provisions of section 14A, only expenditure which has been proved to be incurred in relation to earning of tax free income can be disallowed and section cannot be extended to disallow even expenditure which is assumed to have been incurred for earning tax free income. Common expenditure incurred cannot be broken artificially to apportion a part thereof to earning of tax-free income on assumption that such part of common expenditure was incurred in relation to tax-free income. DLF Ltd. v. CIT [2009] 27 SOT 22 (Delhi) 27

28. Satisfaction of AO as to the incorrect claim made by the assessee is sine qua non for invoking the applicability of Rule 8D. Without rendering any opinion on correctness of assessee's claim of not spending any amount for earning exempt income, AO cannot propose to make disallowance by applying rule 8D of 1962 Rules. Auchtel Products Ltd. Vs. ACIT [2012] 22 taxmann.com 99 (Mum.-ITAT) and DCIT Vs. Orient Craft Ltd. ITA No. 3864/Del/2009 (Del-ITAT)] 28

29. In the absence of error in computation of disallowance for the purpose of section 14A by the assessee, the AO is debarred from re-computing the amount for the purpose of disallowance. The onus is on the AO to show that the computation of the assessee is incorrect for assuming jurisdiction and re-computing the amount liable for disallowance. AIA Engineering Ltd. v. Addl. CIT [2012] 18 taxmann.com 307 (Ahd.-ITAT)] 29

30. Section 14A deals only with expenditure and not with any admissible statutory allowance  Section 14A permits a disallowance of “expenditure incurred by the assessee” and not of “allowance admissible” to him.  The expression “expenditure” does not include allowances such as depreciation allowance. Accordingly, depreciation cannot be the subject matter of disallowance under section 14A. Vishnu Anant Mahajan Vs. ACIT [2012] 22 taxmann.com 88 (Ahd.- ITAT) (SB) Hoshang D. Nanavati vs. ACIT [ITA No. 3567/Mum/07] (ITAT- Mumbai) (Trib) 30

31. Asstt. CIT v. Torrent Pharmaceuticals Ltd. [2012] 23 taxmann.com 55 (Ahd.) The Kerala High Court in Catholic Syrian Bank Ltd., [2012] 207 Taxman 2 (Ker.) (Mag.) had held that so far as disallowance of administrative expense was concerned, there was no precious formula or proportionate disallowance, no disallowance called for, for proportionate administrative cost, attributable to earning of tax free income until rule 8D came into force. It was further held that the proportionate disallowance u/s 14A should be limited to only interest liability and not overhead or administrative expenditure, which should be considered for disallowance under rule 8D from 2007-08.  Administrative expenditure is disallowable u/s 14A in accordance with rule 8D where the assessee has earned income from dividend and debentures which is exempt under section 10(23G) and Section 10(33). ITO v. Sanatan Textrade Ltd. (2010) 35 DTR (Mum.) 31

32. Held: Yes Proportionate interest pertaining to investment for earning of dividend was disallowable even though exempt income was not earned during the year. Cheminvest Ltd. V. ITO 121ITD 318 (2009) ITAT(Delhi)(SB) and Siva Industries & Holdings Ltd. v. ACIT [2012] 26 taxmann.com 96 (ITAT-Chennai) 32

33. CIT vs. Shivam Motors (P) Ltd (Allahabad High Court) In AY 2008-09, the assessee claimed that no s. 14A & Rule 8D disallowance could be made on the ground that (i) the assessee had not earned any tax-free income during the year and (ii) the assessee had sufficient surplus fund and borrowed funds were not utilized for making the tax-free investments. The AO rejected the claim and made a disallowance though the CIT(A) and Tribunal (included in file) deleted it on the basis that no s. 14A disallowance could be made in the absence of tax-free income. The Tribunal noted the judgement in Cheminvest 121 ITD 318 (Delhi) (SB) (which holds that s. 14A disallowance has to be made even if there is no tax-free income) but followed Siva Industries (Che). On appeal by the department to the High Court HELD dismissing the appeal: S. 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 s. 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) & Tribunal does not give rise to any substantial question of law. See also CIT vs. M/s.Delite Enterprises (Bombay High Court) where the same view was taken Issue - No s. 14A & Rule 8D disallowance if there is no tax-free income

34. 34 The CBDT has recently clarified the situation

35. The legislative intent is to allow only that expenditure which is relatable to earning of income and it therefore follows that the expenses which are relatable to earning of exempt income have to be considered for disallowance, irrespective’of the fact whether any such income has been earned during the financial-year or not. The above position is further clarified by the usage of term ‘includible’ in the Heading to section 14A of the Act and also the Heading to Rule 8D of I.T.Rules, 1962 which indicates that it is not necessary that exempt income should necessarily be included in a particular year’s income, for disallowance to be triggered. Also, section 14A of the Act does not use the word “income of the year” but “income under the Act”. This also indicates that for invoking disallowance u/s 14A, it is not material that assessee should have earned such exempt income during the financial year under consideration. 35 Taj Sats Air Catering Ltd. v. Dy. CIT 2012] 20 taxmann.com 80 (Mum.) & Visual Graphics Computing Services (India) (P.) Ltd. v Asst. CIT [2012] 21 taxmann.com 145 (ITAT-Chennai)

36.  Where the interest on borrowings made for investment in shares is capitalised, since in such a case interest paid is not in relation to exempt income, but as part of cost of share, such interest could not be disallowed u/s 14A. [S. Balan V. Dy. CIT 120 ITD 469 (2009) ITAT(Pune)]  However as per Mohananlal M. Shah V. DCIT [2007] 105 ITD 669 (ITAT-Mum.), Harish Krishnakant Bhatt v. ITO [2004] 91 ITD 311 (ITAT-Ahm.) the interest paid on borrowed funds utilized for the purpose of investment in shares was not to be allowed as either an expenditure or as part of cost of acquisition of the shares, in view of the provisions of section 14A. 36

37. The disallowance cannot exceed the expenditure actually claimed by the assessee.  Gillette Group India (P.) Ltd. Vs. ACIT [2012] 22 taxmann.com 61 (Delhi) State bank of Mauritius ltd. Dy. DIT (International Taxation) [2012] 19 ITR(Trb.) 675 (Mum.) 37

38. Kalyani Steels Ltd. vs. Addl. CIT, ITA No.1733/PN/2012 (ITAT- Pune), Dated: 30-01-2014 the Assessing Officer has not recorded any objective satisfaction in regard to the correctness of the claim of the assessee, which is mandatorily required in terms of section 14A(2) of the Act and therefore his action of invoking rule 8D of the Rules to compute the impugned disallowance is untenable. Disallowance as per section 14A(2) is required to be made, even if assessee claims that it did not incur any expenditure in earning dividend income Issue-Recording of satisfaction is pre-requisite for invoking rule 8D

39. CIT vs. M/S. R.E.I. AGRO LTD. GA 3022 OF 2013, ITAT 161 OF 2013 (High Court of Calcutta) Disallowance of expenditure u/s 14A without first recording the dissatisfaction that AO was not satisfied with the correctness of the claim as regards the claim that “no expenditure” was made by the assessee, is plainly contrary to the provisions of the statute. Issue-Recording of satisfaction is pre-requisite for invoking rule 8D

40. JCIT v. American Express Bank Ltd. [2012] 24 taxmann.com 50 (ITAT-Mum.) Whether relevant criterion for making disallowance of expenditure under section 14A is exempt income and not whether such exempt income arises intentionally or just incidentally - Held, yes - Whether, therefore, it cannot be concluded that where dividend income is only incidental to shares held as stock-in-trade, operation of section 14A shall cease - Held, yes [In favour of revenue] Whether section 14A does not provide that if income is liable to tax at a lower rate then also proportionate expenditure should not be allowed as deduction against other business income - Held, yes - Whether, therefore, expenses incurred by assessee in respect of income liable to tax at special rate under section 115A can be allowed as deduction against income chargeable to tax at normal rate - Held, yes [In favour of assessee] 40

41. 41

42. Yatish Trading Co. (P.) Ltd. v. ACIT, 9 taxmann.com 164 (2011) (MUM. – ITAT)  Sec. 14A can be invoked even if income is received incidentally, If the expenditure is incurred with a view to earn taxable income and there is apparent dominant and immediate connection between the expenditure incurred and taxable income then as such no disallowance can be made under section 14A merely because some tax exempt income is received incidentally. 42

43. The provisions of section 14A will apply to all income which is exempt whether the income is assessed under the head “Other sources’ or under the head “Business”  There is nothing in Section 14A which restricts the operation of section to income of a particular nature only. Insaallah Investments Ltd. V. ITO (2008) 23 SOT130 (DEL-Trib) 43

44. CIT vs D.C.M Ltd. 320 ITR 307[Del] SLP dismissed on 27-11- 2009. That the Tribunal had found that the assessee in order to ensure that the employees in accordance with the approval granted by the Regional Provident Fund Commissioner, would be paid a rate of interest equivalent to that paid by the Central Government had incurred expenditure. This was an expense incurred by the assessee towards its employees. The loss on sale of securities was only a trigger based on which these expenses had to be incurred by the assessee. Therefore, the provisions of section 14A had no application. G. Venkataswami Naidu and Co. v. CIT [1959] 35 ITR 594 (SC) followed. 44 Contd….

45.  The fact must be established that borrowed funds are invested to earn the exempt income and only the expenses to that extent will be disallowed under section 14A. CIT vs. Ms. Sushma Kapoor[2009] 319 ITR 299(Del)  When there is no evidence that the borrowed amount is utilised for investment in tax free security, and the major investment was made before the date of borrowings.- section 14A cannot be applied. CIT V. Gujarat Power Corporation Ltd. [2011-TIOL-219- HC-Ahm-IT] 45

46. M/s Dhanuka & Sons v. CIT (2011) 12 taxmann.com 227 (Cal.) It is for the assessee to show the source of acquisition of tax free securities those shares by production of materials that those were acquired from the funds available in the hands of the assessee at the relevant point of time without taking benefit of any loan. In the absence of any such materials placed by the assessee, in, the authorities below rightly held that proportionate amount should be disallowed having regard to the total income and the income from the exempt source. 46 Contd….

47. Assessing officer held that the diversion of borrowed funds by assessee to other firms was not for business purpose and so much so, the interest paid on borrowed capital advanced to other firms was not an allowable deduction under section 36(1)(iii). It was held that the share income from the partnership firm which is the only consideration for advancing loan to the firm did not constitute income of the assessee u/s 10(2A). Since the share income from the firm did not constitute part of the taxable income of assessee, section 14A applied which prohibited deduction of any expenditure incurred in relation to income not includible in total income. CIT v. Popular Vehicles & Services Ltd. [2010] 189 Taxman 14 (Ker). 47 Contd….

48. ACIT vs Novel Enterprises [2012] 22 taxmann.com 116 (ITAT-Mum.) Facts:  Assessee had raised interest bearing loan and for making loan/capital contribution to firm in which it was a partner. Assessee received interest income and profits from firm. AO with the an opinion that interest expenditure incurred by assessee had resulted into taxable as well as tax free income and, hence, that portion of interest expenditure which related to share of profit liable to disallowed u/s 14A. Held_ that where sharing of profit of a firm was not dependent on contribution of funds by partners, interest paid by a partner on capital borrowed to be utilized for making loan/ capital contribution to firm, could not be disallowed u/s 14A. 48

49. 49 However, contrary view has been taken by The ITAT- Chandigarh in the case of Asstt. CIT v. Vinay Singal [2012] 27 taxmann.com 136, Where assessee had received share of profit not taxable in his hands from partnership firm by investing borrowed funds, then the interest paid is to be disallowed u/s 14A. And Hoshang D. Nanavati vs. ACIT (2012) 16 ITR(Trib.) 614 (ITAT-Mum.) The assessee has earned income from profit share as also from remuneration from same firm, expenses incurred by assessee in ratio which profit share in firm bore to total receipts from firm, i.e., on account of profit share as also remuneration, were to be disallowed u/s 14A

50. 50 Avshesh Mercantile (P.) Ltd. v. Dy. CIT [2012] 26 taxmann.com 43 (ITAT-Mum.) Profits derived from a partnership firm is exempt from tax u/s 10(2A), the interest expense related to such tax-free profits is to be disallowed u/s 14A of the Income Tax Act. However, when there was no share of profit from the Firm which otherwise would be exempt for the relevant year, the question of disallowance would not arise.

51. 51

52. Object or purpose of investment does not affect operation of section 14A inasmuch as any expenditure incurred for earning tax free income is not an allowable deduction by virtue of operation of section 14A. Even though purchase of tax free bonds was for meeting SLR requirements, interest and other expenditure incurred on borrowing for investment in tax free bonds was to be disallowed. CIT vs. State Bank of Travancore [2011] 16 taxmann.com 289 (Ker.) 52

53.  Chapter VI-A does not postulate or state that the incomes which qualify for the said deduction will be excluded and not form part of the total income. They form part of the total income but are allowed as a deduction and reduced.  Provisions of Section 14A are not applicable.  CIT Vs. Kribhco [2012] 23 taxmann.com 312 (Delhi)  Hoshang D. Nanavati vs. ACIT (2012) 16 ITR(Trib.) 614 (ITAT-Mum.)  ACIT v. Bank of Madura [2011] 007 ITR (Trib) 0139 ITAT [Chen.  CIT v. Kings exports 318 ITR 100 (2009) (Punj. & Har.)  ACIT v. Tamil Nadu Silk Producers Federation Ltd. [2006] 103 TTJ (Chennai) 716] 53

54. Section 115 JB provides for increasing the book profit by the amount of expenditure relatable to any income to which section 10 [other than section 10(38)] applies and reducing the book profit by the amount of income to which section 10 [other than section 10(38)] applies. 54

55. Hon’ble Delhi High Court in the case of CIT v. Goetze (India) Ltd. [2014] 44 taxmann.com 138 (Delhi) Held that disallowance U/s. 14A is to be made for computing book profits u/s. 115JB Clause (i) of proviso of Explanation to section 115JA operates when an amount is withdrawn from reserve created but as per proviso adjustment could be made only when at time of creation of reserve or provision, such amount was duly accounted for by increasing book profits by said reserve or provision 55 Contd … Reverse the Goetze (India) Ltd. vs CIT (2009) 32 SOT 101 (ITAT-Del) and the same is relied in Quippo Telecom Infrastructure Ltd. vs. ACIT, I.T. A. No.4931/Del/2010 and Essar Teleholdings Ltd. vs. DCIT ITA Nos. 3850 /Mum/2010.

56. In Goetze (India) Ltd. vs CIT (2009) 32 SOT 101, ITAT held that Clause (f) of the Explanation to section 115JA requires the expenditure relatable to any income to which any of the provisions of Chapter III (Incomes which do not form part of total income) apply, has to be added to the book profit. Clause (f) uses the words ‘expenditure relatable to any income’, while section 14A uses the words ‘expenditure incurred by the assessee in relation to income’. These words have the same meaning. Further, section 14A contains two more sub-sections, sub-section (2) and (3), which do not find a place in clause (f). Insofar as computation of adjusted book profit is concerned, provisions of sub-section (2) and (3) of section 14A cannot be imported into clause (f) of the Explanation to section 115JA. Therefore, no addition to the book profit can be made on account of alleged expenditure incurred to earn exempt income while computing income u/s 115JB. 56 Contd … Prior to the decision of the Hon’ble High Court………

57. Meditap Specialities (P.) Ltd. v. Add. CIT [2012] 25 taxmann.com 399 (ITAT- Mum.) Section 14A disallowance only in respect of exempt income and not income eligible for deduction. Section 14A contemplates disallowance in respect of exempt income and not in respect of income which is eligible for deduction under any relevant provision 57 Contd …

58. By applying the prescribed method under rule 8D, addition by way of disallowance of expenditure under section 14A is made, we have to ascertain whether or not the assessee has furnished inaccurate particulars in the course of assessment proceedings. If the assessee offers an explanation which is not found by the AO to be false there is no need to invoke this penal provision. 58

59.  Where the disallowance is made for proportionate expenses claimed in respect of exempted income, no penalty can be levied u/s 271(1)(c) as prior to insertion of Rule 8D by the Finance Act 2008, the question of disallowance and its quantification was contentious. ACIT vs M/s Jindal Equipment Leasing & Consultancy Services Ltd. (2011) 11 taxmann.com 309(ITAT-Delhi)  No Penalty if no disallowance is made in tax audit report and Rule 8D was enacted latter that, segregation of expenditure relatable to tax-free income would be disputable and lead to bona fide difference in opinion. So, penalty u/s 271(1)(c) cannot be levied. Nalwa Investments Ltd.: ITA No. 3805(Del)/2010. 59

60. In case of an investment company, where the business of the company is to invest its funds in the share of sister concerns and other companies and also deposit the money with group concerns on which interest is received, the infrastructure of the company is utilized for the purpose of carrying out its objects, i.e., investment in other concerns and also earning income on such investments. In such a case, assessee is required to furnish details of expenditure incurred on salary of staff utilized for the object of assessee-company, which would be disallowed otherwise it would be disallowed under section 14A on estimate basis. Dy.CIT vs Tata Investment Corporation Ltd. (2008) 113 TTJ 512 (ITAT-Mum.) 60

61. Section 14A authorizes AO to make disallowance of expenditure incurred for earning tax free income, irrespective of whether assessee maintained separate accounts or not with regard to expenditure incurred for earning non-taxable income. CIT v. The catholic Syrian Bank Ltd. [2011] 9 taxmann.com148(KER.)  Non maintenance of separate accounts by assessee with regard to expenditure incurred for earning non-taxable income was not justification to claim immunity from operation of section14A. CIT v. Dhanalakshmy Bank Ltd, [2011] 10 taxmann.com 213(Ker.) 61

62. Facts: Assessee claimed that as no shares were allotted and money invested was lying as share application money, there should not be any disallowance u/s 14A on interest paid on borrowed capital used to make such investment. AO, however, held that since this investment was made for allotment of shares to earn dividend, disallowance u/s 14A was to be made. The intention of assessee for earning dividend income could not be attributed to amounts invested in share application money unless and until there was a commitment on part of company 'N' for allotment of shares - Held, yes Aban Investments (P.) Ltd. v. Dy. CIT [2012] 22 taxmann.com 44 (ITAT-Chennai) 62

63. Business income vs. capital gains Assessee maintains separate D-mat account for investment and for trading and the shares are duly recorded in the books of account under the head investments and stock in trade. It had maintained the investment portfolio separately, income for which was liable to be taxed as capital gains. As the intention in respect of this was to hold the investment as investment only,the income will be treated as capital gain Asstt. CIT v. M/s Bull & Bears Portfolios Ltd., 2011-TIOL- 109-ITAT-DEL 63

64. Asian PPG Industries Ltd. v. Deputy CIT [2010] 004 ITR(Tri) 017- Mum Held_ that the Assessing Officer had disallowed 10 per cent. of the dividend as expenses incurred for earning the dividend under the provisions of section 14A of the Act. While estimating the expenses he had also noticed that the assessee was having loan fund and investment was made for Rs. 150.83 million to earn dividend income. Since disallowance under ground relating to section 14A was not pressed, the addition to that extent was confirmed. No separate disallowance was required under section 36(1)(iii) ) on the same reason that the assessee had invested borrowed funds in investment of Rs. 150.83 million. The addition of Rs. 20,60,000 was to be deleted. 64

65. Investments out of Mix funds Assessee made investment for earning tax free income from mix funds and it is not possible to ascertain as to whether the investment in tax free was out of assessee’s own funds and the Assessing having not established the nexus between the borrowed funds and investment in tax free funds disallowance on pro rata basis was not proper. Dy. CIT vs. Maharashtra Seamless Ltd. (2011) 52 DTR 5 (Delhi)(Trib.) 65

66. If, in a particular year, there is an investment which might yield exempt income in future, there can be no disallowance under section 14A as there is no exempt income forming part of the total income. The view expressed in Jt. CIT v. Holland Equipment Co. B.V. [2005] 3 SOT 810 (Mum.),if there is no such exempted income during the year, no disallowance can be made under section 14A. In Asstt. CIT v. Lafarge India Holding (P.) Ltd. [2008] 19 SOT 121 (Mum.), the assessee had made investment in shares of various companies out of interest bearing borrowed capital which had yielded no dividend income. It was held that provisions of section 14A could not be applied as there was no exempted income. 66

67. The assessee is maintaining separate books of account for the purpose of business. The tax-free investments are in his personal capacity. As the Assessing Officer has not disallowed any expenditure of personal nature out of the business income, the expenditure claimed in the business of share dealings cannot be correlated to the incomes earned in personal capacity that too on dividend, PPF interest and tax free interest on RBI bonds Accordingly, the estimation of expenditure out of business expenditure as being incurred for earning tax free income is not acceptable. Pawan Kumar Parmeshwarlal vs. ACIT, ITA No. 530/Mum/2009, dt. 11- 1-2011, ITAT Mumbai ‘C’ 67

68. Holcim (India) Pvt. Ltd. vs DCIT 139 ITD 542 (ITAT – Delhi) Facts: That mere incorporation and receipt of share application money cannot be said to be commencement of the business. Neither any interest income has been earned from against advances nor any goods or services been obtained. Moreover, the assessee has also not disclosed any dividend income from its investment. Therefore, he disallowed the expenses amounting to Rs. 8,75,35,452/- claimed in the P&L A/c. Held that disallowances made u/s 14A were unwarranted as assessee has not invested in shares for earning of dividend but acquired the controlling interest in the respective companies for doing the business. Ld. CIT(A) himself has admitted that assessee is doing the business and the business of the assessee company has been set up, therefore, there is no question that assessee has invested the funds for earning of dividend. Issue - Mere incorporation & receipt of share application money cannot be said to be commencement of the business for claiming expenses in view of S. 14A.

69. Where assessee is able to show near proximity of availability of own funds, may be exactly not on date of investment or advancement of loan but in a very near future date or within a reasonable short period of time, even then presumption will be that investment was made by assessee from his own funds or in anticipation of availability of its own funds within a short period of time Binayak Tex Processors Ltd. vs. Asstt. CIT [2014] 44 taxmann.com 179 (Mumbai - Trib.) Where assessee had also used loan funds for making investments that earned tax free dividend, part of interest expenditure was to be disallowed in terms of rule 8D(2)(ii) read with section 14A Sitsons India (P.) Ltd. vs. Asstt. CIT [2014] 44 taxmann.com 340 (Mumbai - Trib.) Issues-

70. Rule 8D is prospective in nature and would apply from assessment year 2008-09 Birla Corporation Ltd. vs. CIT [2014] 43 taxmann.com 267 (Calcutta) Where it was apparent from records that assessee had sufficient funds for making investments in shares and interest free bonds and it had not used borrowed funds for such purpose, Assessing Officer was not justified in invoking provisions of section 14A in order to disallow one per cent of interest expenses incurred for earning exempt income. CIT vs. Torrent Power Ltd. [2014] 44 taxmann.com 441 (Gujarat) Issues-

71. Where assessee claimed that no expenditure was incurred towards exempt income but it was found that major part of available funds was invested in shares of various companies, proportionate disallowance was called for. J.H. Fin-vest (P.) Ltd. vs. Dy. CIT [2014] 43 taxmann.com 210 (Delhi - Trib.) Once Assessing Officer records satisfaction that he is not satisfied with claim of assessee of incurring of no expenditure or amount of expenditure specified by assessee, he is required to determine expenditure incurred by assessee in relation to exempt income as per rule 8D,Disallowance under section 14A on or before year 2007-08 could not be computed as per rule 8D. Asstt. CIT vs. ACB (India) Ltd. [2014] 43 taxmann.com 109 (Delhi - Trib.) Issues-

72. For purposes of disallowance under section 14A, what is to be seen is whether there is any investment which has potential to yield exempt income and once it is so, provisions of section 14A would apply, irrespective of fact as to whether investment is made by assessee in normal course of business or in compliance to directions of RBI. Sahara India Financial Corpn. Ltd. Vs. Dy. CIT [2014] 41 taxmann.com 251 (Delhi - Trib.) Where assessee-company received dividend on UTI and shares and investment in same was made in earlier years and interest free funds available with assessee were much larger as compared to investment, disallowance of assessee's claim for interest expenditure by applying section 14A was wrong CIT vs. Gujarat Narmada Valley Fertilizers Co. Ltd. [2014] 42 taxmann.com 270 (Gujarat) Issues-

73. Disallowance under section 14A can be made even in cases where dividend income has been earned on shares held as stock-in-trade. D.H. Securities (P.) Ltd. vs. Dy. CIT [2014] 41 taxmann.com 352 (Mumbai - Trib.) Disallowance as per section 14A(2) is required to be made, even if assessee claims that it did not incur any expenditure in earning dividend income Asstt. CIT vs. Kerala State Industrial Development Corporation Ltd. [2014] 41 taxmann.com 267 (Cochin - Trib.) Issues-

74.  Expenses related to Keyman insurance policy Dy. CIT v. Noble Enclave & Towers (P.) Ltd. [2012] 18 taxmann.com 288 (Kol.) The proceeds of Keyman insurance policy are fully taxable u/s 28(vi), expenditure relating to same cannot come within ambit of section 14A Disallowance u/s 14A in case of Amalgamation Greaves Leasing Finance Ltd. v. ITO [2012] 54 SOT 22 (URO) (ITAT-Mum.) No disallowance where assessee acquired shares of two companies on their amalgamation and earn dividend as assessee has not incurred any expenses to earn such dividend income. Further assessee disallowed certain % of dividend income itself. 74

75. By : CA Sanjay Agarwal Mb: 9811080342 Email id: agarwal.s.ca@gmail.com 75