The officer relies on CBDT Circular 5/2014 to disallow under s.14A although I earned no exempt income at all in the year. Does the Circular carry it?
For years before the Finance Act 2022 Explanation, no. The Delhi High Court held that Circular No. 5/2014 cannot override the express provisions of s.14A read with Rule 8D, because Rule 8D(1) speaks of income not forming part of total income 'for such previous year' — so if no exempt income was earned in the year, no disallowance arises. That position has since been altered prospectively by statute, and the entry must be read with that.
Decided by the High Court (S. Muralidhar J and Prathiba M. Singh J (order by Dr. S. Muralidhar J)) on 2017-08-16, reported as ITA No. 520/2017 (High Court of Delhi). It bears on section 14A, section Rule 8D, section 115JB, section 57(iii), section 5, section 260A of the Income Tax Act 1961, in Deductions & Disallowances, Capital Gains Exemptions, How Tax Law Is Read and Assessment & Scrutiny matters.
This is the decision that meets the Circular head on, which Cheminvest did not, and it is the answer where the officer's only reasoning is the Circular. It also disposes of the department's favourite analogy: Rajendra Prasad Moody, decided on s.57(iii), turns on the purpose of the expenditure, whereas s.14A uses the different expression 'in relation to income which does not form part of the total income', and the analogy cannot be run in reverse. But the shelf life of the ratio is defined. Parliament inserted the Explanation to s.14A by the Finance Act 2022 precisely to reverse this rule, providing that the section applies whether or not the exempt income accrued, arose or was received in the year; the Explanation says it is deemed always to have applied, while the Memorandum and the High Courts that have ruled put it at AY 2022-23 onwards. Para 12 is separately useful: it is a judgment, dated after the amendment, recording that Rule 8D was further amended with effect from 2 June 2016 to a two-limb rule capped at the total expenditure claimed.
Binding within that High Court's jurisdiction. Persuasive elsewhere.
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The assessee, a consultancy company, filed its return for AY 2011-12 on 26 September 2011 at a loss of Rs 2,42,63,176. Asked to explain why a disallowance should not be made under s.14A read with Rule 8D for normal computation and for book profit under s.115JB, it responded that it had invested in mutual funds and that no interest bearing funds had been invested to earn tax free income. The Assessing Officer rejected the plea, relying on the Special Bench decision in Cheminvest Ltd. v. ITO [2009] 121 ITD 318 (Del)(SB), and by order dated 20 February 2014 made an addition of Rs 15,44,43,369, noting investments in shares of Rs 5,29,38,26,780 and that the auditors had themselves computed a s.14A disallowance of Rs 5,89,22,873. The Commissioner (Appeals), relying on the Special Bench and on CBDT Circular No. 5/2014, held that some borrowed funds must have gone into investments and reduced the disallowance to Rs 4,00,78,074. The Tribunal on 7 November 2016 allowed the assessee's appeal, noting that Rs 35,70,40,000 of the investment was in fully convertible debentures which could yield no tax free income, that investments in subsidiaries and joint ventures were made for business purposes, and that interest free funds exceeded the investments.
No substantial question of law arose and the Revenue's appeal was dismissed (para 25). The CBDT Circular dated 2014 cannot override the express provisions of s.14A read with Rule 8D (para 24), and if no exempt income is earned in the assessment year in question, the question of disallowance of expenditure incurred to earn exempt income under s.14A read with Rule 8D does not arise (para 17).
The Court read the words 'in relation to income which does not form part of the total income under the Act for such previous year' in Rule 8D(1) as establishing a correlation between the exempt income earned in the year and the expenditure incurred to earn it (para 17). It held that the Circular's reasoning was a truncated reading, resting on the word 'includible' in the headings to s.14A and Rule 8D while never referring to Rule 8D(1) at all, and failing to account for the concept of real income, s.5 not admitting the taxation of notional income (paras 18 and 19). It read the object of s.14A as explained in Walfort Share and Stock Brokers, and declined to hold that Cheminvest required reconsideration in the light of the Circular. It followed the Madras High Court in Redington (India) Ltd., which had refused to apply the Circular on the ground that s.14A is clearly relatable to the earning of actual income and not notional or anticipated income, and noted the concurring decisions of the Punjab and Haryana and Allahabad High Courts (paras 20 and 21). The Revenue's reliance on Rajendra Prasad Moody was answered by reproducing the passage from Cheminvest distinguishing s.57(iii), where the expression is 'for the purpose of making or earning such income', from s.14A, where it is 'in relation to income which does not form part of the total income' (para 22). Tribunal decisions to the contrary were held not to merit acceptance, and the auditors' own suggestion of a disallowance was held not determinative (para 23).
This implies that if there is no exempt income earned in the AY in question, the question of disallowance of the expenditure incurred to earn exempt income in terms of Section 14A read with Rule 8D would not arise.
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Handle my notice → Ask a CA on WhatsAppFor years before the Finance Act 2022 Explanation, no. The Delhi High Court held that Circular No. 5/2014 cannot override the express provisions of s.14A read with Rule 8D, because Rule 8D(1) speaks of income not forming part of total income 'for such previous year' — so if no exempt income was earned in the year, no disallowance arises. That position has since been altered prospectively by statute, and the entry must be read with that. This was decided by the High Court (S. Muralidhar J and Prathiba M. Singh J (order by Dr. S. Muralidhar J)) and bears on section 14A, section Rule 8D, section 115JB, section 57(iii), section 5, section 260A of the Income Tax Act 1961. It is reported as ITA No. 520/2017 (High Court of Delhi). This is the decision that meets the Circular head on, which Cheminvest did not, and it is the answer where the officer's only reasoning is the Circular. It also disposes of the department's favourite analogy: Rajendra Prasad Moody, decided on s.57(iii), turns on the purpose of the expenditure, whereas s.14A uses the different expression 'in relation to income which does not form part of the total income', and the analogy cannot be run in reverse. But the shelf life of the ratio is defined. Parliament inserted the Explanation to s.14A by the Finance Act 2022 precisely to reverse this rule, providing that the section applies whether or not the exempt income accrued, arose or was received in the year; the Explanation says it is deemed always to have applied, while the Memorandum and the High Courts that have ruled put it at AY 2022-23 onwards. Para 12 is separately useful: it is a judgment, dated after the amendment, recording that Rule 8D was further amended with effect from 2 June 2016 to a two-limb rule capped at the total expenditure claimed. If it applies to you, the first step is this: Check the assessment year first. For AY 2021-22 and earlier this decision answers a Circular-based disallowance; for AY 2022-23 onwards do not lead with it.
The assessee, a consultancy company, filed its return for AY 2011-12 on 26 September 2011 at a loss of Rs 2,42,63,176. Asked to explain why a disallowance should not be made under s.14A read with Rule 8D for normal computation and for book profit under s.115JB, it responded that it had invested in mutual funds and that no interest bearing funds had been invested to earn tax free income. The Assessing Officer rejected the plea, relying on the Special Bench decision in Cheminvest Ltd. v. ITO [2009] 121 ITD 318 (Del)(SB), and by order dated 20 February 2014 made an addition of Rs 15,44,43,369, noting investments in shares of Rs 5,29,38,26,780 and that the auditors had themselves computed a s.14A disallowance of Rs 5,89,22,873. The Commissioner (Appeals), relying on the Special Bench and on CBDT Circular No. 5/2014, held that some borrowed funds must have gone into investments and reduced the disallowance to Rs 4,00,78,074. The Tribunal on 7 November 2016 allowed the assessee's appeal, noting that Rs 35,70,40,000 of the investment was in fully convertible debentures which could yield no tax free income, that investments in subsidiaries and joint ventures were made for business purposes, and that interest free funds exceeded the investments. The matter was decided on 2017-08-16 by the High Court (S. Muralidhar J and Prathiba M. Singh J (order by Dr. S. Muralidhar J)). On those facts the High Court held as follows. No substantial question of law arose and the Revenue's appeal was dismissed (para 25). The CBDT Circular dated 2014 cannot override the express provisions of s.14A read with Rule 8D (para 24), and if no exempt income is earned in the assessment year in question, the question of disallowance of expenditure incurred to earn exempt income under s.14A read with Rule 8D does not arise (para 17).
The Court read the words 'in relation to income which does not form part of the total income under the Act for such previous year' in Rule 8D(1) as establishing a correlation between the exempt income earned in the year and the expenditure incurred to earn it (para 17). It held that the Circular's reasoning was a truncated reading, resting on the word 'includible' in the headings to s.14A and Rule 8D while never referring to Rule 8D(1) at all, and failing to account for the concept of real income, s.5 not admitting the taxation of notional income (paras 18 and 19). It read the object of s.14A as explained in Walfort Share and Stock Brokers, and declined to hold that Cheminvest required reconsideration in the light of the Circular. It followed the Madras High Court in Redington (India) Ltd., which had refused to apply the Circular on the ground that s.14A is clearly relatable to the earning of actual income and not notional or anticipated income, and noted the concurring decisions of the Punjab and Haryana and Allahabad High Courts (paras 20 and 21). The Revenue's reliance on Rajendra Prasad Moody was answered by reproducing the passage from Cheminvest distinguishing s.57(iii), where the expression is 'for the purpose of making or earning such income', from s.14A, where it is 'in relation to income which does not form part of the total income' (para 22). Tribunal decisions to the contrary were held not to merit acceptance, and the auditors' own suggestion of a disallowance was held not determinative (para 23). In the words reproduced by the source cited on this page: "This implies that if there is no exempt income earned in the AY in question, the question of disallowance of the expenditure incurred to earn exempt income in terms of Section 14A read with Rule 8D would not arise." The decision followed or applied Cheminvest Ltd. v. Commissioner of Income Tax (2015) 378 ITR 33 (Del) — followed and held not to require reconsideration; M/s. Redington (India) Ltd. v. Additional Commissioner of Income Tax (Madras High Court, TCA No. 520 of 2016, 23 December 2016) — followed; CIT v. Corrtech Energy Pvt. Ltd. [2015] 372 ITR 97 (Guj) — noted with approval; Commissioner of Income Tax v. Rajendra Prasad Moody [1978] 115 ITR 519 (SC) — distinguished.
It was decided by the High Court on 2017-08-16 and is reported as ITA No. 520/2017 (High Court of Delhi). Binding within that High Court's jurisdiction. Persuasive elsewhere. A High Court decision binds the assessing officer, the Commissioner (Appeals) and the Income Tax Appellate Tribunal within that state, and is persuasive elsewhere. If your assessment is in a different jurisdiction, check whether your own High Court has taken the same view before relying on it. On section 14A, section Rule 8D, section 115JB, section 57(iii), section 5, section 260A, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. No substantial question of law arose and the Revenue's appeal was dismissed (para 25). The CBDT Circular dated 2014 cannot override the express provisions of s.14A read with Rule 8D (para 24), and if no exempt income is earned in the assessment year in question, the question of disallowance of expenditure incurred to earn exempt income under s.14A read with Rule 8D does not arise (para 17). It arises in Deductions & Disallowances, Capital Gains Exemptions, How Tax Law Is Read and Assessment & Scrutiny matters, on section 14A, section Rule 8D, section 115JB, section 57(iii), section 5, section 260A of the Income Tax Act 1961, and was decided by S. Muralidhar J and Prathiba M. Singh J (order by Dr. S. Muralidhar J). Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. If the assessment order simply reproduces Circular 5/2014, quote paras 18 and 19: the Circular relies on the word 'includible' in the headings and never addresses the words 'such previous year' in Rule 8D(1). Where the Revenue cites Rajendra Prasad Moody, answer with para 22 and the passage from Cheminvest reproduced there. Do not let a disallowance stand merely because the tax audit report suggested one — para 23 holds that the auditor's suggestion is not determinative of the legal position. Segregate investments that cannot yield exempt income at all, such as fully convertible debentures, from the computation, as the Tribunal did here.
Superseded by amendment. Superseded prospectively, and only on the 'no exempt income, no disallowance' proposition. The Finance Act 2022 inserted an Explanation in s.14A providing that the section applies, and shall be deemed always to have applied, where the income not forming part of total income has not accrued or arisen or has not been received in the previous year but the expenditure has been incurred in relation to it; the current text was read on the department's own page at incometaxindia.gov.in/w/section-14a. The Delhi High Court in PCIT v. Era Infrastructure (India) Ltd and again in PCIT v. Alchemist Ltd / PCIT v. Uno Minda Ltd (7 August 2024), the Madhya Pradesh High Court in PCIT v. Keti Construction Ltd and the Gauhati High Court in the Williamson Financial Services group have all held the Explanation prospective from AY 2022-23; the department reads it as retrospective and no High Court decision to that effect was located, nor was any Supreme Court ruling on the point traced. So for AY 2021-22 and earlier this judgment is the answer; for AY 2022-23 onwards it is not, and the treatment of the Circular for those later years has not been decided by anything read in this pass. The reasoning on Rajendra Prasad Moody and on the Circular's failure to address Rule 8D(1) is untouched by the amendment. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The first attempt at this document returned HTTP 403; a later ?type=print pass returned the full judgment in the original wording, and para 17 was re-confirmed verbatim through /docfragment/. There is a date conflict inside the report itself: paras 7(ii) and 18 give the CBDT Circular as dated 11 February 2014, while paras 19 and 24 give it as 11 May 2014. Circular No. 5 of 2014 is the one under discussion throughout; the February date is the one that appears where the Circular is first identified. The judgment is styled an ORDER and the disposal is that no substantial question of law arises. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
No substantial question of law arose and the Revenue's appeal was dismissed (para 25). The CBDT Circular dated 2014 cannot override the express provisions of s.14A read with Rule 8D (para 24), and if no exempt income is earned in the assessment year in question, the question of disallowance of expenditure incurred to earn exempt income under s.14A read with Rule 8D does not arise (para 17).
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