SEMINAR ON

SECTION 14A DISALLOWANCE

AND

DEEMED DIVIDEND

Deemed Dividend-Legislative Intent

The insertion of section 14A in 2001 was mainly done to make the following Supreme Court judgments non functional:

i) CIT v. Maharashtra Sugar Mills Ltd. [1971] 82 ITR 452 and

ii) Rajasthan State Warehousing Corporation v. CIT [2000] 242 ITR 450

wherein it was held that where there is one indivisible business giving rise to taxable income as well as exempt income, the entire expenditure incurred in relation to that business would have to be allowed even if a part of the income earned from the business is exempt from tax. Thus, Sec. 14A empowers the AO to apportion the indivisible expenditure to the tax exempt activity which was otherwise not possible in the light of the Supreme Court decisions as mentioned above.

The section was inserted vide Finance Act, 2001 with retrospective effect from

1.4.1962 as follows :

“14A. For the purposes of computing the total income under this Chapter, no

deduction shall be allowed in respect of expenditure incurred by the assessee

in relation to income which does not form part of the total income under this

Act.”.

Subsequently, the proviso was added by Finance Act 2002 with retrospective effect

from 11.5.2001. It provides that this section shall not empower the Assessing

Officer (AO) either to reassess or pass an order enhancing the assessment or

reducing the refund already made or otherwise increasing the liability of the

assessee for any assessment year beginning on or before 1st day of April 2001.

Sub sections 2 & 3 were inserted by Finance Act 2006 w.e.f. 1.4.2007. Sub section

(2) empowers the AO to determine the amount of expenditure incurred in relation

to such income which does not form part of total income in accordance with the

method as may be prescribed.

Insertion of Rule 8D

By virtue of the powers conferred under sub section (2), Rule 8D was inserted

by gazette notification dated 24.3.2008 which prescribes the method for

computing the expenditure incurred in relation to the income not forming part

of total income.

Thus, Rule 8D was made applicable w.e.f A.Y. 2008-09 for estimating

expenses relatable to exempt and income and to be disallowed u/s 14A.

Estimation of Disallowance

Prior to Rule 8D

Prior to A.Y. 2008-09 should be

restricted to 1% of exempt income.

Commissioner Of Income Tax,

Kolkata-iv, Kolkata Versus M/S. Rr.

Sen & Brothers (P) Ltd. GA No.

3019 of 2012 I.T.A.T. No. 243 of

2012 (Cal)

After insertion of

Rule 8D

In accordance with Rule 8D

Analysis “14A. [(1)] For the purposes of computing the total income under this Chapter, no deduction

shall be allowed in respect of expenditure incurred by the assessee in relation to income

which does not form part of the total income under this Act.]

[(2) The Assessing Officer shall determine the amount of expenditure incurred in

relation to such income which does not form part of the total income under this Act in

accordance with such method as may be prescribed, if the Assessing Officer, having regard

to the accounts of the assessee, is not satisfied with the correctness of the claim of the

assesee in respect of such expenditure in relation to income which does not form part of the

total income under this Act.

(3) The provisions of sub-section (2) shall also apply in relation to a case 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]

[Provided that nothing contained in this section shall empower the Assessing Officer either

to reassess under section 147 or pass an order enhancing the assessment or reducing a

refund already made or otherwise increasing the liability of the assessee under section

154, for any assessment year beginning on or before the 1st day of April, 2001.]

Sub-Section (2) provides that if an Assessing Officer is not satisfied with

the correctness of the claim of the assesee in respect of such expenditure

in relation to income then he shall proceed to compute the disallowance.

Thus, the pre-requisite is recording of satisfaction by the assessing

officer.

Godrej and Boyce Mfg. Co. Ltd vs. Deputy Commissioner of Income

Tax [2010] 328 ITR 0081

Maxopp Investment Ltd vs. CIT (Delhi High Court)

DCIT vs. Jindal Photo Ltd (Delhi High Court)

Rei Agro Ltd., Kolkata vs Department Of Income Tax I.T.A No.

1811/Kol/2012

Sub-section (1) of section 14A clearly postulates that while computing total

income under Chapter VI (Computation of Total Income) no deduction shall be

allowed in respect of expenditure ‘incurred’ by an assessee ‘in relation to’

income not forming part of the total income under the Income Tax Act, 1961.

Thus, the scope of Section 14A lies embedded in these two expressions

“incurred” and “in relation to”.

This, implies that:

(i) the expenditure should be actually ‘incurred’ i.e. no notional disallowance

can be made and

(ii) The expenditure should be related to the exempt income.

No notional/imagined expenditure can

be disallowed

• Maxopp Investment Ltd vs. CIT (Delhi High Court) ITA67/2009

Relatable expenditure

Nexus between expenditure sought to be disallowed and exempt income

has to be established in order to make disallowance in accordance with

Rule 8D.

• CIT V/s Wallfort Share and Stock Brokers pvt. Ltd [326 ITR 1] (SC)

• Godrej and Boyce Mfg co. l td V/s Dy CIT [328 ITR 81] (Bom)

• CIT vs. Hero Cycles [323 ITR 518] (P& H)

• Maruti Udyog vs. DCIT 92 ITD 119 (Del)

• Yatish Trading Co. (P) Ltd. Vs. ACIT (2011) 50 DTR (Mum)(Trib) 158: (2011) 129

ITD 237

Rule 8D

Inserted for prescribing a uniform method for computing the disallowance.

Rule 8D(1) emphasizes on the requirement of recording of satisfaction and

is in line with the provisions of Section 14A(2).

Rule 8D(2)

(2) The expenditure in relation to income which does not form part of the

total income shall be the aggregate of following amounts, namely:-

(i) the amount of expenditure directly relating to income which does

not form part of total income;

Rule 8D(2) (ii) in a case where the assessee has incurred expenditure by way of interest

during the previous year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely:-

A x B C

Where A = amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year;

B = the average of value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year;

C = the average of total assets as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year;

(iii) an amount equal to one-half per cent of the

average of the value of investment, income from

which does not or shall not form part of the total

income, as appearing in the balance sheet of the

assessee, on the first day and the last day of the

previous year."

Rule 8D(2)

Analysis of Rule 8D(2)

(i) provides for disallowance of direct expenses

such as demat charges etc.

(ii) provides for disallowance of proportionate

general interest expenditure.

(iii) provides for disallowance of indirect

expenses(0.5% of total assests)

Proportionate Interest disallowance

Nexus between borrowed funds and investments

has to be proved. No presumption can be made.

Hero Cycles 323 ITR 518 (P&H)

Winsome Textile Industries 319 ITR 204 (P&H)

If own funds are more than borrowed and mixed pool of funds is

maintained the presumption is that interest-free funds were used to make

investments.

Woolcombers of India Ltd. v. Commissioner of Income-tax (Cal) 134 ITR

219

Reckitt & Colman of India Ltd v. Commissioner of Income-tax (Cal) 135 ITR

698

Indian Explosives Ltd v. Commissioner of Income-tax (Cal) 147 ITR 392

British Paints (India) Ltd. v. Commissioner of Income-tax (Cal) 190 ITR 196

Alkali & Chemical Corporation of India Ltd. v. Commissioner of Income-tax

(Cal) 161 ITR 820

Proportionate Interest disallowance

Net Interest is to be taken for computing

Net Interest is positive- no interest disallowance

Trade Apartment Ltd- ITAT Kolkata

Morgan Stanley India Securities Private Limited- ITAT MUM

Karnavati Petrochem Pvt.Ltd.- ITAT AHM

Proportionate Interest disallowance

Indirect Expenses- 0.5% of Investments

For computing disallowance of indirect expenses- thumb rule of 0.5% of

investments is followed. However, even for this disallowance the

requirement of recording specific satisfaction is to be satisfied.

Godrej and Boyce Mfg co. l td V/s Dy CIT [328 ITR 81] (Bom)

J. K. Investors (Bombay) Ltd. Vs. ACIT- ITA No.7858/Mum/2011

Rei Agro Ltd., Kolkata vs Department Of Income Tax I.T.A No.

1811/Kol/2012

Meaning of Average Investment for Rule 8D

ITAT Kolkata has laid to rest the controversy whether Total Average

Investments have to be taken or only Dividend Yielding Investments have to

be taken.

REI Agro Ltd vs. DCIT (ITAT Kolkata) I.T.A. No. 1331/Kol/2011

No exempt income – no disallowance

CIT vs. M/s.Delite Enterprises (Bombay High Court)

N.B. Contrary views exist -Cheminvest Ltd vs. ITO (ITAT Delhi Special Bench)

Circular No.5 dated 11/02/2014

The CBDT has issued Circular No. 5 of 2014 dated 11.02.2014 in which it has

clarified that disallowance under section 14A and Rule 8D can be made in cases

where the corresponding exempt income has not been earned during the financial

year.

However, a circular is only binding on the Income Tax Authorities. When Supreme Court

or a High Court has declared the law on the question arising for consideration, it is not

be open to a Court to direct that a circular should be given effect to and not the view

expressed in the decision of the Supreme Court or the High Court.

Deemed Dividend

“(22) "dividend" includes-

(e) any payment by a company, not being a company in which the public are

substantially interested, of any sum (whether as representing a part of the assets of the

company or otherwise) made after the 31st day of May, 1987, by way of advance or

loan to a shareholder, being a person who is the beneficial owner of shares (not being

shares entitled to a fixed rate of dividend whether with or without a right to participate in

profits) holding not less than ten per cent. of the voting power, or to any concern in which

such shareholder is a member or a partner and in which he has a substantial interest

(hereafter in this clause referred to as the said concern) or any payment by any such

company on behalf, or for the individual benefit, of any such shareholder, to the extent to

which the company in either case possesses accumulated profits ;

Analysis

Three such situations are contemplated, being

(a) any payment by way of advance or loan to a shareholder was

considered as dividend paid to share- holder or

(b) any payment by any such company on behalf or for the individual benefit

of a shareholder was considered as dividend and

(c) any payment by way of advance or loan to a concern in which such

shareholder is a member or a partner and in which he has a substantial interest.

Further the three situations laid out above have to be seen disjoint and not as

interconnected.

It is firstly seen that the section records the term “shareholder”.

The words "shareholder” alone existed in the definition of dividend in the 1922 Act.

This expression "shareholder" has been interpreted under the 1922 Act to mean a

registered shareholder.

Thus the expression "shareholder" found in the 1961 Act also has to be, therefore,

construed as applying only to registered shareholder.

The word "shareholder" is followed by the following words "being a person who is the

beneficial owner of shares.

Thus, the shareholder has to be registered holder as well as beneficial owner of the

shares.

Further condition that the registered shareholder has also to be the

beneficial owner of shares (not being shares entitled to a fixed rate of

dividend whether with or without a right to participate in profits) holding

not less than ten per cent of the voting power.

Only accumulated profits not the entire Reserves and Surplus

and computed upto the date of payment.

Rajesh P. Ved Vs ACII (ITAT, Mum) 1 ITR (Trib) 275

Smt. Meena Talukdar v. ITO, 15 TTJ 379 (Cal.)

Accumulated Profit

Taking up the three situations

The first to situations are straight and cover payments to shareholder or

on his behalf.

The third situation requires discussion:

“ payment to any concern in which such shareholder is a member or a

partner and in which he has a substantial interest (hereafter in this clause

referred to as the said concern.”

(a) There must be a payment to a concern by a company.

(b) A person must be a shareholder of the company being a registered holder and

beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether

with or without a right to participate in profits) holding not less than ten per cent. of the

voting power.

(c) The very same person referred to in (b) above must also be a member or a

partner in the concern holding substantial interest in the concern and where the concern is a

company he must be the owner of shares, not being shares entitled to a fixed rate of

dividend whether with or without a right to participate in profits, carrying not less than

twenty per cent. of the voting power.

Conditions for attraction of the third limb

of the Section

If the conditions are satisfied then the payment by the company to the

concern will be dividend.

The question that arises is that in whose hands will it be taxed?

The said section does not not spell out in specific terms as to whose

hands such deemed dividend are to be taxed, whether in the hands of

the " concern" or the " share-holder" . The provisions are ambiguous.

Deeming fiction cannot be extended to

non-shareholder

Assistant Commissioner of Income-tax v. Bhaumik Colour P.

Ltd. (313 ITR(AT) 147) Mum SB

Commissioner Of Income Tax vs Ankitech Pvt Ltd. (Delhi H.C.)

242 CTR 129 dated 11/05/2011

Commissioner of Income-tax v. Universal Medicare Private

Limited (324 ITR 263) Bom

Only Gratuitous Advances

Pradip Kumar Malhotra v. Commissioner of Income-

tax [338 ITR 538] (Cal)

IFB Agro Industries Ltd vs. JCIT (ITAT Kolkata)

I.T.A No. 1721/Kol/2012

Bombay Oil Industries 28 SOT 383 (Bom)

Special situations - Inter-Corporate

Deposits

Special situations - Trade Advances

Trade advances which are in the nature of money transacted to give effect to a commercial transaction would not fall within the ambit of the provision of section 2(22)(e) of the Act.

CIT vs. Raj Kumar, 318 ITR 462 (Delhi)

CIT vs. Nagindas M. Kapadia, 177 ITR 393 (Bom)

CIT vs. Ambassador Travels P. Ltd., 318 ITR 376 (Delhi), and many more

Mere book entries do not constitute payment by the

company

CIT vs. Smt. Savithiri Sam (1998) 144 CTR (Mad)

17 : (1999) 236 ITR 1003 (Mad)

Special situations -Mere book entries