In India, several categories of income are completely tax-free. It includes agricultural income, the income of charitable institutions, etc. Taxpayers cannot claim expenses incurred while earning these exempt incomes as deductions. There was an ambiguity about it, and finally, Supreme Court gave its order, stating that individuals can claim expenses as deductions in specific cases. To negate or bypass that verdict, GOI inserted Section 14A in the Income Tax Act, which disallows expenses incurred for earning exempt income to be claimed as deductions.
This post gives you a detailed overview of what is Section 14A, its applicability and requirements and rule 8D. Keep reading!
There was a recurring battle between taxpayers and tax authorities on whether one can claim expenses incurred on all exempt income as deductions. This would have reduced tax liability for individuals. However, the Income Tax Department was of the view that those specific incomes were already tax-free.
Supreme Court in 2001 delivered its judgement partially in favour of taxpayers. GOI inserted Section 14A in Income Tax Act with retrospective effect from April 1962.
The Section states that taxpayers cannot claim expenses related to exempt income as deductions. This amendment to the tax law provides clarity and removes all ambiguity.
Section 14A applies in the following conditions:
The following are the subsections of Section 14a:
This subsection comes into force when an assessee claims any expense as a deduction. In such a case, the Assessing Officer will verify the fairness of claims after taking into consideration the books of accounts of the individual. The AO, if satisfied, will disallow the expenses under Section 14A.
On the other hand, if the AO is not satisfied with claims mentioned by the assessee, then an individual must report disapproval and go ahead and apply Rule 8D for computing the disallowance amount.
Under Section 14A(3), when a taxpayer claims that he/she has not incurred expenses while earning tax-free income, the AO will directly apply Rule 8D to determine disallowable expenses. The AO doesn’t need to express or report his/her disapproval.
Also Read: Deductions Under Section 80C of The Income Tax
Expenditure incurred while earning any exempt income is calculated by Income Tax Department officials through Rule 8D. In other words, IT Department officials read rule 8D with Section 14a of the Income Tax Act to compute disallowed expenses. However, it is only applicable in the following situations:
This enables one to compute disallowed expenses under deductions. The expenditure is an aggregate of the following:
Disallowance under this Section cannot exceed the total expenses claimed by assesses.
There was a controversy regarding the implementation of the aforementioned Section. It was not clear whether this disallowance provision would take effect even when no tax-free income was earned during a financial year.
The circular clarified that the intent of the Section was to discourage taxpayers’ motive to reduce tax liability by claiming expenses as deductions incurred while earning tax-free income. It also ended the controversy by mentioning that Rule 8D, when read with section 14a, disallows expenses in a year even when no tax-free income is earned.
Also Read: Tax Relief Under Section 87A Of Income Tax Act: How To Claim Tax Rebate Under Section 87A
Section 14A of the Income Tax Act clarifies legislative intent with regard to claiming expenses as deductions. Taxpayers must avoid claiming these deductions, or else authorities will trigger Rule 8D to negate these claims.
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