Section 14A of income tax act is a disallowance provision. This section provides that no deductions are allowed for expenses incurred in connection with income tax-exempt income when calculating gross income.
What Is Disallowance under Section 14A?
No deduction is allowed for expenses incurred by the assessee in connection with income that is not part of TI under this Act. If the AO is dissatisfied with the accuracy of the assessee’s claim in respect of such income, taking account of the assessee’s account, the AO may, in the prescribed manner, reimburse the amount disbursed for such income that is not part of TI under this Act.
The provisions of sub-section (2) shall also apply if the assessor claims that no expenses have been incurred on income that is not part of the gross income under this Act.
Provided that nothing in this section shall be construed as requiring the AO to re-evaluate u/s 147, improve the evaluation, reduce refunds already made, or otherwise not authorize the issuance of an order that increases the liability of u/s 154 of the assessee for AY beginning prior to April 1, 2001.
Who Is Eligible for Section 14A?
This section applies if an individual meets the conditions set out below.
- Section 14A applies only if the assessee made the investment to generate income that is not part of the gross income.
- Section 14A applies if the assessee alleges costs were incurred and the assessor is not satisfied with the accuracy of the assessee’s claim regarding the assessee’s account.
- Section 14A applies if the assessee claims no costs were incurred.
What Is Rule 8D?
Where the AO, considering the accounts of the assessee of a P.Y., is not satisfied with
(a) accuracy of the claim of expenditure made by the assessee; or
(b) the Assessor’s assertion that no costs were incurred,
In relation to income that does not form part of the total income under the Act for such P. Y., he shall determine the amount of expenditure in relation to such income following the provisions of sub-rule (2).
What Is the Mechanism of Rule 8D?
The expenditure is an aggregate of the following amounts (i.e., 1+2+3) namely:
1. Expenditure directly relating to income but not part of total income
2. In a case where the assessee has incurred expenditure was incurred that is not directly attributable to specific income or income, This amount is calculated according to the following formula, namely:‐
A = amount of expenditure in form of interest other than the amount of interest
included in clause (1) incurred during P.Y.
B = The average value of investments that are not, or are intended to be, part of the total income shown on P.Y.’s first and last-day balance sheets.
C = Average total assets shown on the balance sheet for the first and last day of the previous year.
3. An amount equal to 1/2% of the average value of the investment, the income of which is not or part of the total income shown on the balance sheet of the assessee on the first and last days of the P.Y.
How Do You Calculate Section 14A Disallowance?
Example of calculation of section 14A u/r 8D.
Balance Sheet as of 31st March 2022
| Liabilities | 31/3/22 | 31/3/21 | Assets | 31/3/22 | 31/3/21 |
| Eq. Share capital | 125 | 100 | Fixed Assets | 150 | 100 |
| Loans for Investment in Shares & MF | 100 | 50 | Shares | 150 | 100 |
| Other loans | 400 | 350 | Trade Receivable | 60 | 50 |
| Trade payables | 200 | 150 | Mutual Funds | 190 | 150 |
| Inventories | 225 | 200 | |||
| Cash and Bank | 50 | 50 | |||
| Total | 825 | 650 | Total | 825 | 650 |
For the year ending 31/3/22, the assessee earned dividend income
Rs. 8 lakhs, & interest on MF-Rs.16Lakhs.
Interest paid on loans:
For Investment in shares & MF – Rs.10Lakhs
For other loans – Rs.30Lakhs
Solution:
- Exp. directly related to exempt income= int. paid on loan for investment in shares & MF= 10Lakhs
- Proportionate exp. of int. exp by way of interest not directly related to exempt income X average value of invt. / average value of total assets
A = 30
B = (150 + 100 + 190 + 150) / 2 = 295
C = (825 + 650) / 2 = 737.5
i.e ( AX B/C)= 30 X 295 / 737.5 = 12 Lakhs
- ½% of avg value of invt. = 295 X ½% = 1.475 Lakhs
- Total Disallowance = 1+2+3 i.e., 10 + 12 + 1.475 = 23.475
What Is Income How Gross Total Income Is Computed under Section 14?
Gross income is the total income earned over a period of time. Under section 14 of the Income Tax Act 1961, the income of an individual or assessee is classified under these five categories:
- Income from Salary
- Income from House Property
- Profits and Gains of Business and Profession
- Capital Gains
- Income from Other Sources
Gross income is calculated by summing the income from all these five incomes.
FAQ: 14A of Income Tax Act
1. Can 14A disallowance exceed exempt income?
The disallowance under Section 14A of the income tax act cannot exceed the exempt income
2. Is Section 14A applicable to dividend income?
Yes, section 14A applies to dividend income. Section 14A applies if your strategic investment in the stock yields tax-exempt dividend income.
3. Is depreciation covered u/s 14A?
Depreciation is indeed permitting and is therefore not subject to disallowance under Section 14A.
4. How much amount is disallowed if TDS is not deducted?
30% of the amount is disallowed if TDS is not deducted.
Wrapping Up
Budget 2022 introduced such an amendment to Section 14A of income tax act with the express intention of clarifying the Section 14A controversy. Disallowance under section 14A can only be made in respect of expenses claimed as deductions. Therefore, there is no disallowance of expenses under this section if the taxpayer does not claim a deduction for such expenses.