Exempt Income under Section 14A Rule 8D of Income Tax Act 1961

Section 14A read with Rule 8D of Income Tax Act 1961.

This section deals with expenses incurred by an individual to earn exempt income. Such expenses are not deductible from one’s gross total income and are disallowed. Therefore, if expenses to earn such exempt incomes are shown in an assessee’s income statement, then the tax authorities will disallow such expenses and add it to the assesses s income. However, this section applies only and only when expenses have been incurred to earn the exempt income and not otherwise. This has lead to a lot of confusion and litigation issues.

The provisions of Section 14A has been under scrutiny for a long time. Recently, there was a case that dealt with the provisions of Section 14A of the Act and is as follows:

Trade Apartment Ltd. – Kolkata Tribunal
The company set off the interest expenses against the interest income earned. After such adjustment no interest expenditure remained to be disallowed. The taxpayer agreed to disallow expenditure other than interest of Rs.  1,11,521 for purposes of Section 14A of the Act on estimated basis.

The Kolkata Tribunal held that there was interest expenses remained after it was adjusted against the interest income earned. Therefore, no part of interest paid can be disallowed for earning tax free dividend. Further, expenditure other than interest was offered for dis-allowance by the taxpayer under Section 14A of the Act. Therefore, no further dis-allowance shall be made.

The Finance Act, 2006 inserted two new clauses under Section 14A of the Act with effect from 1 April 2007. As per the clauses, the Assessing Officer can calculate the dis-allowance under Section 14A in accordance with the method as may be prescribed, if the AO is not satisfied with the claim of the taxpayer. However, as discussed at the start of this article, this provision is not applicable if the taxpayer claims that no expenditure has been incurred to earn the exempt income.

The method to calculate the dis-allowance u/s 14Ais specified under rule 8D of the Income tax rules. The formula is as follows:-

Interest expenses = (a)
Average value of investments made in shares and MF’s= (b)
Average value of assets= (c)
Therefore, dis-allowance amount = a*(b/c)
To this amount you also need to add ½% of the average value of shares and MF’s i.e. (b) above.
The formula can be explained via an example:
Interest expense incurred in the FY 2011-12 = 1,00,000/-
Shares and MF’s as on 31/3/2011 = 8,00,000/-
Shares and MF’s as on 31/3/2012= 12,00,000/-
Therefore Average value of shares and MF’s is (800000+1200000)/2 = 10,00,000/-
Total Assets as on 31/3/2011 = 48,00,000/-
Total Assets as on 31/3/2012 = 52,00,000/-
Therefore Average value of Assets is (4800000+5200000)/2 = 50,00,000/-
Therefore dis-allowance amount for the year 2011-12 = 100000*(1000000/5000000)=20,000/-
To this figure of 20000, we need to also add 1/2% of the average total assets = ½ % of 5000000 = 25,000/-
Therefore total dis-allowance under Section 14A = 20,000+25,000=Rs. 25,000/-.

The article is the Guest Post contributed by Mr. Aashish Ramchand.  Aashish is a Chartered Accountant by qualification and the Co- founder of makemyreturns.com, an online tax advisory and filing site. He is very passionate about Indian taxes and loves to write articles about the Indian tax system. He has worked with KPMG and JRC advisory both in international and domestic taxation respectively. He has also completed level 1 of CFA (USA) exam.  You can reach Aashish at aashish@makemyreturns.com. You can also follow him on twitter – @aashishjr.

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