Finance Bill, 2022 proposes to amend Section 14A of the Income-tax Act, 1961 (‘Act’) to make it a non-obstante clause. Further, it is amended to clarify that the disallowance of expenses under section 14A shall apply where exempt income has not accrued or arisen or has not been received during the previous year relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such exempt income.
Background of Section 14A
Section 14A of the 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 (exempt income).
In this context, CBDT issued 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.
Section 14A was inserted by the Finance Act, 2001 with retrospective effect from 1st April 1962 to provide that expenditure incurred in relation to exempt income shall not be allowed as a deduction while computing total income.
The Finance Act, 2006 further amended this section to provide that in the cases where the Assessing Officer is not satisfied with the correctness of the disallowance claim made by the assessee, the amount of disallowance shall be computed in accordance with the prescribed methodology. For this purpose, CBDT has prescribed Rule 8D in the Income-tax Rules, 1962 to prescribe the methodology for computing the disallowance under section 14A.
Proposed Amendment to Section 14A
It is proposed to insert an Explanation to section 14A of the Act to clarify that notwithstanding anything to the contrary contained in this Act, the provisions of this section shall apply and shall be deemed to have always applied in a case where exempt income has not accrued or arisen or has not been received during the previous year relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such exempt income.
It is also proposed to amend sub-section (1) of the said section, so as to include a non-obstante clause in respect of other provisions of the Income-tax Act and provide that no deduction shall be allowed in relation to exempt income, notwithstanding anything to the contrary contained in this Act.
For this purpose, Clause 9 of the Finance Bill, 2022 proposes to amend Section 14A in the following manner-
Amendment of section 14A.
9. In section 14A of the Income-tax Act,––
(a) in sub-section (1), for the words “For the purposes of”, the words “Notwithstanding anything to the contrary contained in this Act, for the purposes of” shall be substituted;
(b) after the proviso, the following Explanation shall be inserted, namely:––
“Explanation.––For the removal of doubts, it is hereby clarified that notwithstanding anything to the contrary contained in this Act, the provisions of this section shall apply and shall be deemed to have always applied in a case where the 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 relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such income not forming part of the total income.”.
Explaining the proposed amendments to section 14A
Clause 9 seeks to amend section 14A of the Act relating to expenditure incurred in relation to income not includible in total income.
The said section, inter-alia, provides that no deduction shall be allowed in relation to income which does not form part of the total income under the Act.
It is proposed to amend sub-section (1) of the said section to provide that notwithstanding anything to the contrary contained in this Act, for the purpose of computing the total income, no deduction shall be allowable in respect of expenditure incurred in relation to income which does not form part of the total income.
It is also proposed to insert an Explanation to the said section to clarify that notwithstanding anything to the contrary contained in this Act, the provisions of the said section shall apply and shall be deemed to have been always applied in a case where the income, not forming part of the total income, has not accrued or arisen or has not been received during the previous year relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such income not form part of the total income.
This amendment will take effect from 1st April, 2022 and will, accordingly, apply in relation to the assessment year 2022-2023 and subsequent assessment years.
Objectives for the amendment in section 14A
The Explanatory Memorandum states that over the years, disputes have arisen in respect of the issue whether disallowance under section 14A of the Act can be made in cases where no exempt income has accrued, arisen or received by the assessee during an assessment year.
The Memorandum further states that CBDT had issued Circular No. 5/2014, dated 11/02/2014, in which it was clarified 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.
However, still some courts have taken a view that if there is no exempt income during a year, no disallowance under section 14A of the Act can be made for that year. Such an interpretation is not in line with the intention of the legislature.
The Memorandum has provided an illustration to clarify the concept.
Illustration: If during a previous year, an assessee incurs an expense of ₹1 lakh to earn non-exempt income of ₹1.5 lakh and also incurs an expense of ₹20,000/- to earn exempt income which may or may not have accrued/received during the year. By holding that provisions of section 14A of the Act does not apply in this year as the exempt income was not accrued/received during the year, it amounts to holding that ₹20,000/- would be allowed as deduction against non-exempt income of ₹1.5 Lakh even though this expense was not incurred wholly and exclusively for the purpose of earning non-exempt income.
Such an interpretation defeats the legislative intent of both section 14A as well as section 37 of the Act.
The tabulated format of the above illustration is as follows-
In order to make the intention of the legislation clear and to make it free from any misinterpretation, it is proposed to insert an Explanation to section 14A of the Act to clarify that notwithstanding anything to the contrary contained in this Act, the provisions of this section shall apply and shall be deemed to have always applied in a case where exempt income has not accrued or arisen or has not been received during the previous year relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such exempt income.
Analysis of the proposed amendment to section 14A
The proposed amendment to section 14A seeks to overrule the decision of the Delhi High Court in the case of Cheminvest Ltd. vs. CIT (2015) 378 ITR 33 (Del)(HC).
The Hon'ble Delhi High Court in this case has categorically held that section 14A envisages that there should be actual receipt of income which was not includible in the total income during the relevant previous year for the purpose of disallowing any expenditure in relation to the said income. Wherever there is no exempt income includible in the total income of the assessee, the provisions of section 14A cannot be invoked.
Aggrieved by the High Court’s decision, Revenue filed the Special Leave Petition (SLP) before the Supreme Court, which was dismissed by the Supreme Court.
The dismissal of SLP by the Hon’ble Supreme Court has led to conclusions that when the assessee has not earned any exempt income during the year under assessment, no disallowance is permissible under section 14A of the Act. After the dismissal of SLP, it became a settled law that section 14A will not apply if no exempt income is received or receivable during the relevant previous year.
With regard to CBDT Circular 5/2014, Hon'ble Delhi High Court in PCIT vs. IL&FS Energy Development Company Ltd. (2017) 84 Taxman.com 186(Delhi) and the Hon'ble Madras High Court in CIT vs. Chettinad Logistics (P.) Limited (2017) 80 taxmann.com 221(Madras) have expressed a clear disagreement with CBDT Circular and held that where there is no exempt income in the relevant year there cannot be a disallowance of expenditure under section 14A of the Act.
Similar proposition has been laid down by the Hon'ble Gujarat High Court in the case of Corrtech Energy (P.) Ltd (2014) 45 taxmann.com. 116 (Guj) and PCIT vs. India Gelatine and Chemicals Ltd. (2016) 66 taxmann.com 356 (Guj).
It was thus a settled legal position that the CBDT circular cannot override express provisions of section 14A read with Rule 8D.
Further, in the case of Joint Investments Pvt. Ltd. vs. CIT reported in 372 ITR 692 (Delhi) the Hon’ble Delhi High Court has categorically ruled that disallowance under section 14A of the Act cannot exceed the amount of tax-exempt income.
In order to overcome these decisions, it is proposed to include a non-obstante clause in section 14A to give it overriding effect in respect of other provisions of the Act.
Further, an Explanation is introduced in the section to clarify that the provisions of this section shall apply whether or not exempt income has been accrued or arisen or received during the previous year. Hence any expenditure incurred to earn exempt income shall be disallowed even in the absence of such income.
Now, it is clarified that expenses for earning exempt income will be disallowed under section 14A. But it is still unclear whether the disallowance of expenses can exceed the exempt income so as to overrule the decision of Joint Investments case (supra).
If this interpretation sustains then one may argue that a person by earning a meagre Rs 100 exempt income can restrict its disallowance to Rs. 100. Further, it can be interpreted that if exempt income is Nil, the disallowance of expenses shall also be reduced to Rs. Nil as the disallowance cannot exceed actual exempt income. This interpretation may not have legal leg to stand since Nil exempt income is already clarified by the amendment. However, confusion still persists in the case of Rs. 100 ie., where some exempt income is there.
Amendment to Section 14A is Prospective or Retrospective
Clause 9 of the Finance Bill, 2022 which seeks to amend section 14A is made applicable from 1st April 2022 which means Assessment Year 2022-23 and onwards. Hence, it appears to be a prospective amendment.
The Explanatory Memorandum also states that this amendment will take effect from 1st April, 2022 and will accordingly apply in relation to the assessment year 2022-23 and subsequent assessment years.
However, the expression in the Explanation “the provisions of this section shall apply and shall be deemed to have always applied” creates some confusion in its applicability. Such wordings are held to be retrospective in effect. This ambiguity may invite unwanted litigation as the tax officers will try to justify the amendment to be retrospective.
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