There are various controversies surrounding the interpretation of section 14A of the Income tax Act, 1961 (‘the Act’), which has been the subject matter of extensive litigation. Recently, there have been various judicial decisions rendered by High Court(s) whereby much needed clarity has evolved regarding such controversies. Few of such decisions have been discussed hereunder:

ISSUE 1:

Recording of satisfaction by the assessing officer mandatory

The provisions of sub-section (2) and (3) to section 14A, which empowers the assessing officer to compute disallowance as per provisions of Rule 8D of the Income tax Rules, 1962 (‘the Rules’), w.e.f. assessment year 2008-09, provides that disallowance under Rule 8D can be computed, only if the assessing officer, having regard to the accounts of assessee is not satisfied with the claim of assessee that no expenditure in relation to exempt income has been incurred by assessee. In other words, even from assessment year 2008-09 and onwards, the assessing officer can compute disallowance under section 14A as per the provisions of Rule 8D, only if assessing officer, having regard to accounts of assessee, reaches a finding, that assessee has incurred expenses, having proximate nexus with earning of exempt dividend income.

Recently, the Delhi High Court in the case of CIT vs I P Support Services India Pvt Ltd [TS-5499-HC-2015(DELHI)-O]  has held that disallowance under section 14A read with Rule 8D (2) of the Rules cannot be made by the assessing officer without recording his satisfaction as to why “the voluntary disallowance made by the assessee was unreasonable and unsatisfactory”.

ISSUE 2:

Disallowance under section 14A of the Act should not be made when there is no exempt income earned by the assessee during the relevant previous year

Assessee used to contend that in terms of the plain language of section 14A of the Act, if no income, which does not form part of the total income, is earned during the previous year, disallowance of expenses under said section was not warranted.

The Revenue, on the other hand, was of the view that the provisions of section 14A would apply even in a situation where exempt income is neither received nor is receivable during the relevant year. The said view of the Revenue was supported by the decision of the Special Bench of the Tribunal in the case of Cheminvest Ltd [TS-54-ITAT-2009(Delhi)-O]. Further, CBDT vide Circular No. 5 of 2014 clarified that disallowance under section14A of the Act read with Rule 8D of the Rules needs to be made even in a case where the assesseedid not earn exempt income during a particular year.

Recently, the Delhi High Court has, however, in the case of Cheminvest Limited vs CIT [TS-5469-HC-2015(DELHI)-O reversing the decision of the Special Bench of the Tribunal heldthat where no exempt income has been received by the assessee in the previous year, disallowance under section 14A of the Act is not warranted. The High Court has further held that reliance placed by the Special Bench on the decision of the Supreme Court in the case of Rajendra Prasad Moody [TS-8-SC-1978-O]  was misplaced inasmuch as the Supreme Court in the said case dealt with the interpretation of section 57(3) of the Act, which is an allowance provision and the same would, therefore, not apply with respect to interpretation of section 14A of the Act, which is for computing disallowance of expenditure incurred in relation to earning of exempt income.

ISSUE 3:

Disallowance under section 14A of the Act shall not exceed the exempt income

There have been cases where the disallowance made under section 14A of the Act by applying formula prescribed under Rule-8D of the Ruleshas exceeded the exempt income earned by the assessee during the relevant year. In the following decision, the Tribunal has, however, held that disallowance under section 14A of the Act could not exceed the actual exempt income earned by the assessee:

• CIT vs. Punjab State Co-op. & Marketing Federation Ltd: ITA No. 548/Chd./2011
• Sahara India Financial Corpn. Ltd. v. DCIT: ITA No. 3199/Del/2013

Recently, the Delhi High Court in the case of Joint Investments vs ACIT [TS-92-HC-2015(DEL)-O]  held that disallowance under section 14A of the Act must not be made to the extent that it is almost equal to or more than the actual dividend income received by the assessee.

Similar view has also been taken recently by the Punjab & Haryana High Court in the case of Pr. CIT v. Empire Package Pvt. Ltd.: ITA No. 415 of 2015.

ISSUE- 4:

Only dividend yielding investments shall be considered while computing disallowance under section 14A read with Rule 8D

There are cases where an assessee earns exempt income during the relevant year only on some investments. In such cases, while computing ‘average value of investment’ under Rule-8D of the Rules, there has been a lot of debate as to whether those investments which have not yielded any exempt income should also be considered or not.

Recently, the Delhi High Court in the case of ACB India Ltd vs ACIT [TS-176-HC-2015(DEL)-O] has held that for the purpose of Rule-8D, only those investments shall be considered which have actually yielded exempt income during the relevant previous year.Thus, it is not the total investment at the beginning of theyear and at the end of the year, which is to be considered but it is the average of the value ofinvestments which has given rise to the income which does not form part of the total incomewhich is to be considered.

Prior to the above decision of the Delhi High Court, similar view was also taken by the Kolkata Bench of the Tribunal in the case of REI Agro Ltd vs DCIT [TS-6731-ITAT-2013(KOLKATA)-O].

ISSUE- 5:

Strategic/Business investments to be excluded while computing disallowance under section 14A

Numerous corporate assessees made investments in the shares of subsidiaries/associates companies with a view to acquire and retain controlling interest therein and not for the purpose of earning dividend and /or capital appreciation.  Such investments are made in larger business interest, on account of commercial expediency and not with the intent of earning dividend therefrom. The exempt income, if any, earned from such investments is always incidental to such shareholding.

The Delhi High Court in the case of CIT v. Oriental Structural Engineers Pvt Ltd [TS-5537-HC-2013(DELHI)-O] upholding the order of the lower authorities held that no disallowance can be made under section 14A of the Act qua strategic business investment made by an assessee with a view to retain controlling interest.

ISSUE- 6:

No disallowanceof interest expenditure incurred for earning taxable income

Any interest expenditure incurred on the borrowings made specifically for the purposes of making investments are disallowed under clause (i) of Rule-8D(2), whereas in case of mixed pool of funds and common interest expenditure, the same is apportioned in terms of clause (ii) of Rule-8D(2) of the Rules.

Recently, the Delhi High Court in the case of Pr CIT vs Bharti Overseas Pvt Ltd [TS-5584-HC-2015(DELHI)-O] has held that while apportioning interest expenditure under  clause (ii) of Rule-8D(2) of the Rules, interest expenditure incurred for earning taxable income should be excluded from consideration.

Prior to the above decision, the Allahabad High Court in the case of ACIT vs Dhampur Sugar Mills Pvt Ltd [TS-5944-HC-2014(ALLAHABAD)-O]  has also held likewise.

CONCLUSION

All the above decisions of the High Court(s) definitely provides a sigh of relief to the taxpayers, but the same still needs to be tested before the Supreme Court.

Disclaimer:

The above analysis is based on the personal views of the author and does not necessarily convey the views of the firm concerned.