Budget 2018 Income Tax Expectations: Modi government should redefine disallowance under Section 14A
The Financial Express, New Delhi | Updated: January 26, 2018
The crucial Union Budget will be presented on February 1. The Budget 2018 will be the last full budget before the 2019 Lok Sabha polls. Under Income Tax Act, different set of rules and rates of taxes have been prescribed for computation of income. Similarly, various set of rules and principals have been prescribed in Accounting Standards. These rules play a vital rule in calculating the income which is chargeable to tax during the year. One of such important rules is ‘Matching Concept’. It is an accounting principle whereby an entity is required to recognize the revenue and its related expenses in the same accounting period.
The matching concept is also relevant under Income-tax Act for the purpose of calculation of taxable income under different heads of income, i.e., Capital Gains, Residuary Income, Business profits, etc. An expense is matched with the source of income so that expense in relation to an exempt income is not deducted from a taxable income. Section 14A of the Income-tax Act specifically provides that specific and general expenses shall be disallowed if these expenses have been incurred to earn exempt income. However, lots of controversies and disputes have arisen from the date of its applicability. Here are a few recommendations to bring clarity on provisions of Section 14A in Budget 2018.
1. No disallowance if there is no exempt income
Due to Section 14A, various litigations arise between Taxpayers and Dept. on the matter of disallowance of an expense even if no tax-free income is generated during the year. The CBDT 1 has taken a pro-revenue stand by clarifying that all expenses pertaining to an exempt income will be disallowed, irrespective of the fact that no such income has been earned during the financial year. However, in various court decisions it has been held that Section 14A disallowance couldn’t be kicked in when no exempt income was earned by the taxpayer. The Delhi High Court 2 and the Madras High Court 3 had expressed a clear disagreement with the CBDT’s circular. The courts have held that there cannot be a disallowance of expenditure under section 14A if there is no exempt income earned by taxpayer in the relevant year. Therefore, there should be an amendment to Section 14A to provide that disallowance under Section 14A shall be made only to the extent of exempt income earned by the taxpayer during the financial year. Modi government should look into this in Budget 2018.
2. No Disallowance from Dividend Income
Under Income Tax Act, there is a provision to levy Dividend Distribution Tax (DDT) on dividend paid by domestic company to the shareholders. However, the dividend is categorized as tax free income in the hands of shareholders. In other words, even if dividend income has been subjected to dividend distribution tax, yet it is categorized as an exempt income for disallowance under Section 14A. Dividend income is already taxed at the rate of 20.357% then it is not legitimate to disallow expenses incurred in respect of investments which are earning dividend income for the taxpayers. It is therefore recommended that disallowance under Section 14A should not be invoked for the dividend income for the taxpayers in the Union Budget.
3. No disallowance if tax is payable as per MAT provisions
There is levy of Minimum Alternative Tax (MAT) under Income-tax Act on the book profit, which is computed after making prescribed adjustments in the net profits as reported in the financial statements. It is the minimum income-tax which is required to be paid by every company irrespective of actual profits during the financial year. A Company can make only those adjustments which are listed in the provision and the provision does not provide for adding back the disallowance made under Section 14A. However, tax officers often add back the disallowance under section 14A while computing the book profits for calculation of MAT. The Special Bench of Delhi Tribunal in the case of ACIT v. Vireet Investment (P.) Ltd. [2017] 82 taxmann.com 415 (Delhi – Trib.) (SB) held that while computing book profit under Section 115JB, provisions of Section 14A can’t be imported. Any amount of expenditure computed by applying Rule 8D is an artificial or notional expenditure, not debited in the profit and loss account. Therefore, it cannot be added back to compute the book profit. Thus, it is suggested that an amendment should be made to specifically provide that expenditure disallowed under Section 14A shall not be added back while computing the book profit in the Budget 2018 India.
4. Disallowance for depreciation of assets
Section 14A disallows the specific and general expenses incurred by the taxpayers to earn the exempt income. It is immaterial whether it is depreciation of the fixed assets, inter-alia, computers, office appliances, etc. If these assets are used in the process of earning the exempt income, this expense is disallowed under section 14A. In the decision of Honourable Mumbai Tribunal in case of Hoshang D. Nanavati v. ACIT [2012] 25 taxmann.com 141 (Mum.-Trib.), it was held that the disallowance under Section14A cannot indeed cover depreciation. Thus, depreciation cannot be the subject matter of disallowance of an expense under Section 14A. Therefore it is expected that an amendment may be proposed to Section 14A to take care of this decision in Budget 2018.
Naveen Wadhwa, DGM, Taxmann.com
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