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 the 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.
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.
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.
Ans: Dividend on shares is exempt income, whereas any gains on sale of shares are subject to taxation. Supreme Court, in its judgement, clarified that this Section would be applicable in case of shares as stock in trade only when one is earning exempt dividend income. In the case of profit from the sale of shares, one can claim expenses incurred on them as deductions.
Ans: A high court verdict settled this question. With regard to various provisions, the disallowance under the relevant Section cannot exceed exempt income. Therefore, authorities must restrict the disallowance amount till the limit of tax-exempt income.
Ans: There are several categories of disallowed expenses under the Income Tax Act. These include – expenses in case of TDS default, expenses in case of equalisation levy default and some cash expenditures.
Ans: This Section allows taxpayers to reduce their tax liability by making tax-saving investments or incurring certain expenses. The maximum limit of deductions u/s 80C in each financial year is Rs. 1.5 lakh. Investments eligible for deduction under Section 80C are PPF, SCSS, ELSS, EPF, tax-saving FDs, infrastructure bonds, etc.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
|Section 112A||Section 50||Section 245|
|Section 80QQB||Section 32AD||Section 250|
|Section 35D||Section 143 (1a)||Section 115BAB|
|Section 143||Section 79||Section 140A|
|Section 17(2)||Section 3||Section 94A|
|Section 147||Section 80||Section 40A|
|Section 48||Section 115AD||Section 14A|
|Section 45||Section 285BA||Section 6|
|Section 36||Section 87A||Section 80GGA|
|Section 244A||Section 234E||Section 28|
|Section 197||Sectio 548||Section 194J(1)(ba)|
|Section 145A||Section 80P||Section 92CD|
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