Tax Bulletin - Vol.1 Issue 5

New Method for computing the disallowance u/s 14A

The Central Board of Direct Taxes on 2nd June 2016 vide notification number  [Notification No. 43/2016] [F.No. 370142/7/2016-TPL]  has amended Rule 8D of the Income tax Rules, 1962 which lays down the method of computation of disallowance u/s 14A of the Income tax Act, 1961.

 

Existing  Provisions

Section 14A seeks to disallow any expenditure which has been incurred by a tax payer for earning exempt income. In the normal course, a tax payer is expected to suo-moto determine the amount of expenditure incurred by him in a particular financial year for earning exempt income and disallow the same in his computation of income. If the Assessing Officer is not satisfied with manner in which the disallowance is calculated by the tax payer, he is expected to calculate the amount of expenditure to  be disallowed as per the guidelines given in Rule 8D.

As per the existing Rule 8D the disallowance of the expenditure is to be computed as under:-

The expenditure in relation to  income which does not form part of the total income shall be the aggregate of  following amounts, namely:

(i)    the  amount of expenditure directly relating to income which does not form part of  total income;

 (ii)   in  a case where the assessee has incurred expenditure by way of interest during  the previous year which is not directly attributable to any particular income  or receipt, an amount computed in accordance with the following formula, namely  :

A x B
C

Where, 

A = amount of expenditure by way of interest  other than the amount of interest included in clause (i) incurred during the  previous year;

B = the average of value of investment, income from which does not or  shall not form part of the total income, as appearing in the balance sheet of  the assessee, on the first day and the last day of the previous year ;

C = the average of total assets as appearing in the balance sheet of  the assessee, on the first day and the last day of the previous year;

 (iii) an amount equal to one-half per cent of th e average of the value  of investment, income from which does not or shall not form part of the total  income, as appearing in the balance sheet of the assessee, on the first day and  the last day of the previous year.

The formula given in Rule 8D has created several problems for a large number of tax payers. In many cases, the disallowance based on this formula resulted in disallowance of amount that were in excess of the total expenses incurred by the assessee. Thus, the formula was perceived to be unfair and had resulted in absurd disallowances. This had, in turn, given rise to large scale litigation across India.

It is with a view to reduce the hardship caused to tax payers and reduce litigation that the government seems to have thought it fit to amend Rule 8D.

Post CBDT’s notification dated 2nd June 2016, the formula for calculating the disallowance as per Rule 8D stands as under:-

The expenditure in relation to  income which does not form part of the total income shall be the aggregate of  following amounts, namely:

     (i) the amount of expenditure directly relating to income which does not form part of total income;

     (ii) an amount equal to one per cent of the annual average of the monthly averages of the opening and closing balances of the value of investment, income from which does not or shall not form part of total income:

Provided that the amount referred to in clause (i) and clause  (ii) shall not exceed the total expenditure claimed by the assessee;”

Thus, the CBDT has now provided an upper cap on the amount that can be disallowed in the hands of the tax payer (viz. the amount of expenditure incurred by the tax payer). At the same time, the ad hoc disall owance in respect of other expenses will now be higher. Earlier it was @ 0.5% of the annual average of the monthly averages of the opening and closing balances of investments. Now, it would be @ 1%.

MCA’s Comments

Any move to simplify or reduce the rigours of Rule 8D would always be welcomed by tax payers and tax professionals. Rule 8D has given rise to unprecedented amount of litigation in the country. The amendments in Rule 8D are therefore definitely welcome. The new Rule will come into force upon being notified in the Official Gazette. Thereafter, there will be at least one surety in the minds of every tax payer as to upper limit of the disallowance and this, in turn, would reduce litigation to some extent. The fact however still remains that section 14A will continue to be harsh and unfair to those companies who invest in shares / units of mutual funds only by way of treasury operations and with a view to park idle funds of the companies into income earning assets. Such companies will continue to be hit badly by the section since, in reality, they do not actually incur any expense or any material expense to earn exempt income but yet they invite the disallowance which is calculated on an artificial basis.

Tax Bulletin - Vol.1 Issue 6
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