Section 14A of the Income-tax Act provides that no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income that does not form part of the total income as per the provisions of the Act. The Finance Bill, 2022 proposed to amend Section 14A, by inserting an explanation. The author, Mr. Arpith Jain (Tax Lead at Finastra) delves into the implications of the proposed amendment. The author explains that the proposed amendment entails the inclusion of a non-obstante clause in respect of other provisions of the Income-tax Act and an Explanation is introduced in the section to clarify that the expenditure incurred shall be disallowed even in absence of the income. The author highlights that the proposed amendment is prospective and shall be applicable from AY 2022-23, but the wordings of explanation, "shall be deemed to have always applied" leaves room for ambiguity. The author analyses the brief history of Section 14A and states that the ambiguity with respect to the amendment may subject it to different interpretation, thus creating a cause for litigation. The author opines that, "with vastly income surrounding shares are now taxable and hence the judgements on these transactions are not relevant anymore. As the scope of this section is narrowed, the amendment in this section was uncalled for."

Proposed Amendment to Sec.14A - Analysis of Ambiguities

The Finance Act of 2022 has brought out changes in the Section 14A of the income tax act. Section 14A of the Income-tax Act provides that no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income that does not form part of the total income as per the provisions of the Act.

Amendment and Background

The language of the section refers to income which does not form part of the total income under this Act and accordingly various courts in Cheminvest Limited [TS-5471-HC-2015(Delhi)-O] Redington (India) Ltd [TS-6392-HC-2016(MADRAS)-O] had held that there must factually be some exempt income before invoking the Section.

CBDT had also issued a circular No. 5/2014, dated 11/02/2014, clarifying that Rule 8D read with section 14A of the Act provides for disallowance of the expenditure even where taxpayer in a particular year has not earned any exempt income. Even this Circular was held to be contrary to the terms of the statute and it cannot override the principle that there can be disallowance in the absence of any exempt income in FS Energy Development Company Ltd [TS-5745-HC-2017(DELHI)-O]. 

In order to overcome these decisions, it is proposed to include a non-obstante clause in respect of other provisions of the Income-tax Act and an Explanation is introduced in the section to clarify that the provisions of this section shall apply whether or not income, not forming part of the total income under this Act, has not accrued or arisen or has not been received during the previous year. Hence the expenditure incurred shall be disallowed even in absence of the income.

Past cases where it was held that disallowance cannot exceed exempt income:

In case of Joint Investments Pvt Ltd [TS-92-HC-2015(DEL)-O] , State Bank of Patiala in [TS-5309-HC-2017(Punjab & Haryana)-O], Caraf Builders and Constructions (P) Ltd in [TS-9570-HC-2018(Delhi)-O], it has been held that disallowance under this section cannot exceed the exempt income.

With the introduction of the new explanation can it be said that if there can be disallowance in the absence of the income then, the interpretation can be extended to cases where income to be lesser than expense and the disallowance could exceed income, thus overruling the above decisions.

On the contrary, can someone interpret the new amendment subject to the above rulings that, as the disallowance cannot exceed income, one could earn one rupee in exempt income and restrict the disallowance to one rupee; or, as the disallowance cannot exceed income, can it be said that in a given case income earned is “zero” and hence disallowance cannot exceed “zero” and thus making the amendment redundant. 

It appears that these judgements are overruled by this amendment, but one cannot rule out the alternative interpretations.

Whether the amendment prospective or retrospective:

Even though the amendment carried out is prospective and is applicable from assessment year 2022-23, the wordings in explanation creates some ambiguity, which is “the provisions of this section shall apply and shall be deemed to have always applied”, the wording shall be deemed to have always applied could imply that it may be retrospective and hence could be a cause for litigation. Hence, even though it is clearly stated that the amendment is prospective, it is not free from litigation.

Relevance of this amendment:

Section 14A was initially introduced, via Finance Act of 2001 w.r.e.f 1-4-1962, to overturn supreme court judgement where it was held that entire expenditure of the business will be held deductible, where the all the activities of the business constituted one indivisible business, that earned both taxable and non-taxable income. ((2000) 242 ITR 450 (SC)] = [TS-7-SC-2000-O] Rajasthan State Warehousing Corporation). It could be noted that the judgement was relating to agriculture income and the cases which followed initially were around agricultural income. However, the future of the litigations came around dividend income which was exempt under section 10(34), which had the underlying asset as shares. Almost all of the judgements which were discussed above are relating to shares in a company.

However, from the year 2020 dividend has been made taxable also the long-term capital gains (LTCG) on listed securities are taxable from 2018. With this backdrop, after the amendment it is a worrisome state for a taxpayer, who could end up with an disallowance today even without an income, whereas there is no certainty that person can earn income at all from those sources, also whether those sources will remain exempt or not. This can be learnt from the example of shares, where a person could have suffered disallowance with no income earned but paid tax on sale of those shares post 2018 and tax on dividend post 2020, which could be a double whammy to the taxpayer and lead to double taxation. Hence, this amendment is unfair to the taxpayers, is it lawful to not allow expenditure, when it is uncertain that one may pay tax on it or not.

Can an assessee take a stand after suffering disallowances that all the disallowances which he suffered in the past shall be deductible if the exempt income ultimately becomes taxable in a future date. If this could be allowed, then this amendment could be fair.

Since dividend and LTCG on listed securities are now taxable, the scope of this section has narrowed down significantly and would confine more to the original cases around agricultural income. In those cases, it is very unlikely to have expense without income and perhaps this amendment was unwarranted. One example where this could still be relevant are income earned from interest on tax free bonds, where one could invest today earn interest at the end of the bond period.  

Conclusion:

Irrespective of amounts of clarification given, it is never clear and there is always still room for different interpretation. In this case this could be around retrospectivity, limiting deduction to the income. Also, with vastly income surrounding shares are now taxable and hence the judgements on these transactions are not relevant anymore. As the scope of this section is narrowed, the amendment in this section was uncalled for.