SECTION 14A: DISALLOWANCE UNDER I.T ACT

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SECTION 14A: DISALLOWANCE UNDER I.T ACT

The income tax department has exempted some incomes from the scope of being taxed, such as agricultural income, tax-free interest, etc. There is a possibility of assesses incurring expenses on such incomes, e.g., interest paid on loan taken to invest in tax-free bonds. Thus, for a long time, there has been a debate between the officers of IT department and the tax payers regarding the disallowance of such expenditure. While the tax payers have been insisting on the deduction of such expenditures, the IT department has staunchly held the disallowance of expenses, as the income is completely exempt of tax and by deducting expenditure incurred on such income, it will result in reduced tax liability on non-taxable income as well.

As per Section 14A, expenditure incurred by taxpayer in relation to income which does not form part of total income at all as per the provisions of the Act should not be allowed as deduction while computing total income of taxpayer.

PROVISIONS OF SECTION 14A

Sec 14A was introduced by the Finance Act 2011, having a retrospective effect from 1962. The provision disallows the expenses incurred towards earning of income exempt from tax.

The section applies to the occurrence of one if more of the following events

  • If the assessee has incurred expenses to earn income which does not form a part of the total taxable income
  • If assessee claims that expenditure has been incurred, but the ASSESSING OFFICER is not satisfied with the explanation of the assessee having regarded the accounts of the assessee
  • If the assessee claims that he has not incurred any expenditure

  1. Section 14A(1) of Income Tax

If the assessee has incurred expenditure for earning tax-free income, then subsection 1 of section 14A is applied

  1. Section 14A(2) of Income Tax

If the assessee claims that the amount of expenditure is incurred on exempt income then the Assessing Officer needs to verify the correctness of this claims having regards the books of accounts of the assessee. The Assessing Officer needs to clarify the expenses in the books of accounts. Post verification if the Assessing Officer is satisfied then he shall disallow the expenses u/s 14A. If the assessee claim does not convince the Assessing Officer, then he must record his dissatisfaction and start with the application of rule 8D for calculating the disallowance amount.

 

  • Section 14A(3) Of Income Tax

Subsection 3 of Section 14A applies if an assessee claims that he/se has not incurred any expenditure on the tax-free income then Assessing Officer can directly apply rule 8D to determine the expenditure to be disallowed under section 14A. In this event, the Assessing Officer is not required to report his dissatisfaction.

RULE 8D OF INCOME TAX ACT

As per the Income-tax law as it stands today (post amendment in June 2016), expenditure incurred in relation to earning exempt income is the aggregate of following:

  • Any amount of expenditure which is directly relating to exempt income; and
  • Amount equal to 1% of annual average of monthly average of opening and closing balances of value of investment whose income is or shall be exempt

However, any disallowance computed under this Rule cannot exceed total expenditure claimed by taxpayer.

LET’S TAKE AN EXAMPLE:

Ms Priyanka has taken a loan on 2nd of January 2018 for Rs 20 lakhs at 12% for the FY 2017-18. Therefore, interest expenditure on loan is Rs 2, 40,000. The loan was used to invest funds in tax-free infrastructure bonds approved by the government.

Monthly closing balances of the investment are Rs 12, 00,000 (January 2018), Rs 13, 50,000 (February 2018), Rs 15, 50,000 (March 2018)

SOLUTION:

PARTICULARS AMOUNT(in Rupees)
Any amount of expenditure directly relating to exempt income 2,40,000
Amount equal to 1% of the annual average of monthly average of opening and closing balances of the value of investment whose income is or shall be exempt – 1% of 11,08,333

 

Monthly average of investment

January 2018 – 0 + 12,00,000/2 = Rs 6,00,000

 

February 2018 – 12,00,000 + 13,50,000/2 = Rs 12,75,000

 

March 2018 – 13,50,000 + 15,50,000/2 = Rs 14,50,000

Annual Average of the above monthly averages = Rs 6,00,000+12,75,000+14,30,000/3 = 11,08,333

 

11,083
Total disallowance under section 14A read with rule 8D 2,51,083

 

 

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