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Section 14A - Disallowance of Expenditure Incurred for Exempt Income

As per Section 14A of the Income Tax Act, no deduction shall be allowed in respect of expenditure incurred by the taxpayer about income which does not form part of the total income under this Act.

What are Incomes that do not form part of Total Income?

The following are types of income that do not form part of total income :

  1. Exempt Income: Incomes that are specifically exempt u/s 10. To know about all the Income Exempt U/s 10 please read here

  2. Receipts that are not Income: Certain receipts do not take a category or form of income like Gifts from Relatives or Gift During Marriage. Gifts are exempt u/s 56, to know about it read here.

What is the Gist of Section 14A and Rule 8D of Income Tax Act?

Section 14A simply says that if any income is exempt from tax then expenditure incurred to earn that income also cannot be claimed as expenditure/ deduction under any provisions of the Income Tax Act.

Further, it lays down two rules to determine how much is the expenditure not allowed as a deduction. Rules are specified under Rule 8D.

Total Disallowed Expenditure will be the sum of the following :

  • Directo Rule - Any expenditure incurred which is directly attributable to exempt income that is completely disallowed.

  • Indirect Rule - An amount of 1% of the annual average of the opening and closing balance of investment (investment includes only those income from which is exempt from tax).

However, it is specifically provided in Rule 8D that total disallowance shall not exceed the expenditure incurred by the asseseee.

Further, the above rule shall be invoked only in the circumstance that the Assessing Officer is not satisfied with exempt income with :

  • the correctness of the claim of expenditure made by the assessee; or

  • the claim made by the assessee that no expenditure has been incurred,

No Reassessment / Reduced Refund : no Assessing Officer can re-open or do reassessment on grounds of Section 14A and also cannot reduce any refund which is already granted on account of Section 14A.

Practical Scenarios Relating Section 14A?

Majorly section 14A was invoked by the assessing officer when dividend income / long-term capital gain were totally exempt from income tax . However, now as both the above income are to the exempt taxable , question of disallowance of expenditure and litigations for the same will be reduced.

However , still the section is in valid form applicable for all other forms of exempt income and any wrongfull claim of expense relating to exempt income will attract disallowance


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