(I) No disallowance under section 14A of the Act if there is no exempt income
Recently, the Hon’ble Delhi High Court in the case of CIT v. Holcim India (P) Limited, decided on 5th September 2014 that there can be no disallowance under section 14A of the Act where no exempt income has been earned. This decision would, primarily, put an end to a number of litigations on the issue whether any disallowance could be made under section 14A of the Act where no exempt income has been earned during the year of disallowance. Even the Hon’ble Punjab & Haryana High Court in CIT vs. M/s. Lakhani Marketing Inc, Gujarat High Court in CIT vs. Corrtech Energy (P.) Ltd., Allahabad High Court in CIT vs. Shivam Motors (P.) Ltd and Bangalore ITAT in Alliance Infrastructure Projects v. DCIT, have held that no disallowance under section 14A could be made if there is no exempt income.
Section 14A of the Act was introduced by the Finance Act, 2001 primarily to ensure that taxpayers do not reduce their tax liability by claiming expenditure on certain categories of income which are completely tax exempt. However, the broadly drafted wording of the provision has led to an indiscriminate use of the said provision by the tax department to disallow any expenditure in earning of any income, which may be characterized as exempt in the hands of the taxpayer. Therefore, this provision is increasingly being used by the revenue authorities to disallow expenditure incurred in respect of investment in shares/ mutual funds on the ground that dividends are exempt in the hands of the shareholder, foregoing the fact that dividends are subject to tax at the company level. Section 14A of the Act is extremely significant in debt transactions, for example, since the use of borrowed funds may result in large interest disallowances, which is a major commercial consideration for market players. In this context, the present decision of the Hon’ble Delhi High Court may provide respite to the taxpayer to the extent that interest/ other expenditure may not be disallowed for the years in which dividend has not been declared and paid to the shareholder.
Further, it is an accepted canon of tax law that each transaction should only be taxed once, so as to avoid 'economic double taxation'. Therefore, it may be noted that dividends are made exempt in the hands of the shareholder purely because they are made taxable at the company level. In such a situation, it is hard to understand how expenditure incurred in relation to investment in shares may be termed as expenditure incurred to earn 'exempt income' since dividend income is bound to be taxed at one level.
However, Section 14A seems to be achieving an object which is beyond the scope for which the provision was introduced. One can only hope that in light of the object and purpose of the provision and the various recent decisions in this regard, clarifications are introduced with regard to the appropriate applicability of Section 14A of the Act.
Despite several judgments holding that a disallowance under Section 14A of the Act can be made only upon receipt of tax exempt income, a recent CBDT circular (circular no. 5/2014 dated 11th February 2014) has stated that disallowance under Section 14A of the Act can be made even where the taxpayer has not earned any exempt income during a particular year. Nonetheless, as mentioned above, judicial authorities across the country have unanimously decided in favour of the taxpayers in this regard.