Sec 14A r/w Rule 8D of Income Tax Act have No Application when there is No Exempted Income: Madras HC [Read Judgment]

Madras High Court

The division bench of the Madras High Court held that the AO cannot invoke section 14A of the Income Tax Act read with Rule 8d of the Income Tax Rules when the assessee does not derived exempted income during the relevant assessment year.

In the instant case, the AO disallowed the expenditure claimed by the assessee by invoking s. 14A of the Act and Rule 8D of the Income Tax Rules. The assessee challenged the order by stating that the provisions of s.14A and Rule 8D would not be attracted in a case where exempt income had not been earned.

When the matter was brought before the Dispute Resolution panel, the DRP confirmed the view of the AO. The assesse further failed to secure relief from the ITAT, who confirmed the order of the DRP by relying up on the decision in Cheminvest Limited vs Commissioner of Income Tax. 

The division bench comprising of Justice Nooty Rama Mohana Rao and Justice Anita Sumant noted the fact that no exempt income has been earned by the assessee during the assessment year under consideration.

The Revenue, relied upon the relied upon a Circular issued by the CBDT i.e Circular No. 5 of 2014 dated 11.2.2014 which states that s. 14A was intended to cover even those situations whether there is a possibility of exempt income being earned in future.Based on the circular, it was contended that the provisions of s.14A are made applicable, in terms of sub section (1) thereof to income ‘under the act’ and not ‘of the year’ and a disallowance under s.14A r.w.Rule 8D can thus be effected even in a situation where a tax payer has not earned any taxable income in a particular year. 

Rejecting the contention, the bench noted that the provisions of section 14A were inserted as a response to the judgments of the Supreme Court in Commissioner of Income Tax Vs. Maharashtra Sugar Mills Limited (1971) (82 ITR 452) and Rajasthan State Ware Housing Corporation Vs. Commissioner of Income Tax ((2002) 242 ITR 450) in terms of which, expenditure incurred by an assesee carrying on a composite business giving rise to both taxable as well as non-taxable income, was allowable in entirety without apportionment.It was thus that s. 14A was inserted providing that no deduction shall be allowable in respect of expenditure incurred in relation to the earning of income exempt from taxation.

Based on the Apex Court decision in Commissioner of Income Tax vs. Walfort Share and Stock Brokers (P) Ltd, the bench pointed out that s. 14A is clearly relatable to the earning of actual income and not notional or anticipated income.“The submission of the Department to the effect that s.14A would be attracted even to exempt income ‘includable’ in total income would entail the assessment of notional income, assumed to be exempt in the future, in the present assessment year. The computation of total income in terms of s.5 of the Act is on real income and there is no sanction in law for the assessment of admittedly notional income, particularly in the context of effecting a disallowance in connection therewith.”

“where the statute indented that income shall be recognized for taxation in respect of any previous other than that immediately preceding the relevant assessment year, the provision shall expressly state so. The provisions of s.10 in Chapter III of the Act dealing with ‘Incomes not included in total income’ commences with the phrase ‘In computing the total income of a previous year, any income falling within any of the following clauses shall not be included …..’

“The exemption extended to dividend income would relate only to the previous year when the income was earned and none other and consequently the expenditure incurred in connection therewith should also be dealt with in the same previous year. Thus, by application of the matching concept, in a year where there is no exempt income, there cannot be a disallowance of expenditure in relation to such assumed income. (Madras Industrial Investment Corporation Ltd vs. CIT (225 ITR 802)). The language of s. 14A (1) should be read in that context and such that it advances the scheme of the Act rather than distort it.” The bench said.

Read the full text of the Judgment below.