Section
14A was introduced by the Finance Act, 2001, with retrospective
effect from 01.04.1962 to overcome judgments of the Supreme Court in case of
CIT v. Indian Bank Ltd. (1965) 56 ITR 77 (SC) in which interest on tax free
bond was exempted, CIT v. Maharashtra Sugar Mills Ltd. 1973 CTR (SC) 489 :
(1971) 82 ITR 452 (SC) (agricultural income in course of business of sugar mill
was fully exempted under Income Tax Act) and Rajasthan Warehousing Corpn. Vs. v.
CIT 242 ITR 450 (SC) [full exemption under
section 10(29) was allowed. In these cases exempted income were derived in
course of business of and there was no tax in any other manner direct or
indirect or on some other party who paid such income.
Memorandum explaining the introduction says:
“………exemptions
to certain categories of income are Lunawat & Co used to reduce the tax
payable on non‐exempt income by debiting expenses incurred to earn the exempt
income against taxable income. This is against the basic principle of taxation
whereby only net income is taxed….Expenses incurred can be allowed only to the
extent they are relatable to the earning of taxable income.”
Text of Section 14A
EXPENDITURE
INCURRED IN RELATION TO INCOME NOT INCLUDIBLE IN TOTAL INCOME.
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 prescribed63, if the Assessing
Officer, having regard to the accounts of the assessee, is not satisfied with
the correctness of the claim of the assessee 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.
Overruled judicial
pronouncements of the Hon’ble Supreme Court:
In case of an indivisible business, some income
wherefrom is taxable while some exempt, entire expenditure would be permissible
deduction even if some of the
activities may yield tax free income and the principle of apportionment would apply
only for an indivisible business
In this case, the assessee claimed deduction of expenditure
of Rs. 38.14 lakhs under section 37 of the Act in computing its income under
the head “Profits and gains of business or profession’. The ITO allowed only so
much of the expenditure as could be allocated to the taxable income and
disallowed the rest of it, which was referable to the non-taxable income,
exempt under section 10(29) of the Act. It was held that in view of the fact
that income from various ventures was earned in the course of one indivisible
business, the impugned order upholding the apportionment of the expenditure and
allowing deduction of only that proportion of it which was referable to the
taxable income, was unsustainable. The Apex Court has laid down certain
principles in this connection. The same are to be found on page 455 of the
Report and they are reproduced as follows:
(i)
if income of an assessee is derived from various heads of
income, he is entitled to claim deduction permissible under the respective head
whether or not computation under each head results in taxable income;
(ii)
if income of an assessee arises under any of the heads of
income but from different items, e.g., different house properties or different
securities, etc., and income from one or more items alone is taxable whereas
income from the other item is exempt under the Act, the entire permissible
expenditure in earning the income from that head is deductible; and
(iii)
in computing “profits and gains of business or profession”
when an assessee is carrying on business in various ventures and some among
them yield taxable income and the others do not, the question of allowability
of the expenditure under section 37 of the Act will depend on:
(a) fulfilment of
requirements of that provision noted above; and
(b) on the fact whether
all the ventures carried on by him constituted one indivisible business or not;
if they do, the entire expenditure will be a permissible deduction but if they
do not, the principle of apportionment of the expenditure will apply because
there will be no nexus between the expenditure attributable to the venture not
forming an integral part of the business and the expenditure sought to be
deducted as the business expenditure of the assessee.” – [Rajasthan State
Warehousing Corporation v. CIT (2000) 242 ITR 450 (SC)]
Agricultural income in course of business of sugar mill was
fully exempted under Income Tax Act - Entire commission paid to managing
agents was allowable as deduction
Section 37(1) of the Income-tax Act,
1961 [Corresponding to section 10(2)(xv) of the Indian Income-tax Act, 1922],
read with rule 23 of the Indian Income-tax Rules, 1922 - In this case, the
assessee company owned extensive lands on which it grew sugar-cane and used the
sugar-cane for manufacture of sugar in the factory. The ITAT found that the
cultivation of sugar-cane and manufacture of sugar by the assessee constituted
one single and indivisible business. The assessee company was managed by the
managing agents. The managing agents were paid remuneration in accordance with
the Agreement entered into between the assessee company and the managing
agents. The managing agents’ commission roughly worked out at 10% of the
profits of the company. In the assessment year in question, the managing agents
were entitled to a commission of Rs. 4,86,228/-. Out of that sum, the ITO
disallowed a sum of Rs.1,26,359/- on the ground that the same relates to the
commission of the managing agents for managing the sugar-cane cultivation part
of the business, income from which was exempt from tax as agricultural income.
It was held by the Apex Court that the entire managing agency commission was
laid out or expended for the purpose of the business carried on by the assessee
and was allowable under section 10(2)(xv) of the Income-tax Act, 1922. The fact
that the income from a part of the business was not exigible to income-tax
under the Act was not a relevant circumstance. It was further held that if the
allowance claimed is permissible under the Act then the same has to be deducted
from the gross profit. (Related Assessment year : 1957-58) – [CIT v. Maharashtra
Sugar Mills Ltd. (1971) 82 ITR 452 (SC)]
Interest on borrowings for acquiring
tax-free securities held to be allowable
In this case, the
assessee, in the course of its banking business, invested a large sum in
securities, including securities the interest on which was exempt from tax. The
bank claimed a deduction of Rs. 25.92 lakhs as interest paid to various
depositors. The ITO, the AAC and the ITAT disallowed interest amounting to Rs.
2.80 lakhs. This amount was arrived at by calculating the proportionate
interest which would be payable on the money borrowed for the purchase of
Mysore Government securities for Rs. 250 lakhs, the interest relating to the
income, which was exempt from tax. It was held by the Apex Court that the
interest paid by the assessee on moneys borrowed from its various depositors
had to be allowed in its entirety and there was no warrant for the disallowance
of a proportionate part of the interest referable to moneys borrowed for the
purchase of securities whose interest was tax-free. – [CIT v. Indian Bank Ltd.
(1965) 56 ITR 77 (SC)]
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