Disallowance under section 14A should not exceed tax on Exempt Income – ICAI
ICAI Suggestion on Disallowance of expenditure incurred in relation to income not includible in total income under section 14A of the Act:
As per the existing provisions of section 14A of the Act, no deduction shall be allowed in respect of expenditure incurred by a taxpayer in relation to income which does not form part of the total income under the Act. Further, Section 14A of the Act states that the provisions of this section shall also apply in cases where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act.
In this regard, a method has been prescribed under rule 8D of the Income-tax Rules, to calculate the amount of disallowance for the purpose of section 14A of the Act. As per the prescribed method in rule 8D, the disallowance for the purpose of section 14A is aggregate of the following:
a) Amount of expenditure directly relating to exempted income.
b) Amount of interest expenses not directly attributable to any particular income- in the proportion of average value of investments (whose income is exempt) to average of total assets.
c) Half percent of average value of investments (which generate exempt income)
Rule 8D has created genuine hardships for tax payers, as the calculation basis under rule 8D is arbitrary. In many cases, the
disallowance calculated as per rule 8D method exceeds the amount of total exempted income earned during the year.
This is because of the following reasons:
Firstly, the interest expense,which does not form part of exempted income, is disallowed.
Secondly, while working out half percent of the average investments, all the investments in shares/mutual funds are considered.
Thirdly, this method does not demarcate between investments that have generated or not generated income during the year.
Lastly, no distinction has been made for companies earning dividend income due to holding strategic investments in group companies and very little expenditure is attributable to earn such dividend income.
It is suggested that:
a) Only those expenses which are directly related to earning of exempt income shall be disallowed.
b) Further, the overall maximum limit of expense to be disallowed should not exceed the tax payable on
exempted income earned.
c) Overall maximum limit of expense to be disallowed in case of dividend income earned from holding strategic investment in group companies shall be capped.
Source- Pre-Budget Memorandum 2014 on Direct Taxes by ICAI